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Here are some other thoughts on your query.
With regards to deposits, I have never been a fan of the supposed “deposit premium” as a concept. I believe in valuing banks based on their actual performance
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<p>Here are some other thoughts on your query.</p>
<p class="MsoNormal">With regards to deposits, I have never been a fan of the supposed “deposit premium” as a concept. I believe in valuing banks based on their actual performance rather than, I guess, what someone else might be able to do with their deposits. This is why I look to look at return on assets and (especially, since I am an equity holder) return on equity as a metric for valuation.</p>
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<p class="MsoNormal">Focusing on these metrics (ROE and ROI) also help to address your second paragraph. If the peer banks have so much noninterest income that it more than offsets their cost disadvantage, then they must have correspondingly high returns on equity and assets. In fact, the two that come closest to BOFI’s REO and ROI are SFBS are EGBN which trade at 3.54x book and 2.72x book and 22.2PE and 20.6PE respectively; on average well above the numbers to calculate my price target for BOFI.</p>
<p class="MsoNormal">We know that in current economic conditions BOFI has outperformed the peer group. If conditions remain unchanged, it is not unreasonable to assume that it will continue to do so. So what happens if conditions change?</p>
<p class="MsoNormal">If economic conditions get better and rates rise you postulate this BOFI will be hurt because it must raise rates more on its deposit base that the “sticker” branch deposits at other banks. (As an aside, it think this is a fallacy and that the branch deposits are much less sticky than many assume. After all billions have already un-stuck and moved to BOFI). However, BOFI will also benefit disproportionately from its loan book repricing upwards due to the higher rates. In fact, the loans reprice automatically based on the loan contract while deposit rates are completely under the bank’s control. And since BOFI has few fixed rate loans on its books, unlike many of the peer banks its NIM will not decline in a rising rate environment. Quite the opposite, NIM is mostly likely to increase as rates go up as I think they will. However, for my projections have kept NIM flat. Note also, that in this scenario credit defaults are likely to continue to decrease since we are assuming a good economy.</p>
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<p class="MsoNormal">The other possibility is that we slide into recession. We know that during the Great Recession BOFI’s annualized net charge off’s peeked in 2011 at just over 70 Bps. This is interesting for two reasons that go directly to the points you bring up about BOFI’s borrowers. First the charge off rate is very low and second it peeks about 3 years after the peak of the crisis. So why is that? The borrowers are of Prime credit quality and while they may indeed have lumpy income streams they are also like to have significant reserves in the form of saving and investments. Also, they have very substantial equity in their homes which they are unwilling to lose. So while their currently incomes may be negatively affected in a crises, they will do what they can to keep paying their mortgage in order to protect the equity they have in their home. After about 3 years of bad economic times, these saving started to run out for some borrowers, resulting in peek charge offs. However, by then even the Financial Crisis was coming to an end economic activity was again picking up as we see by the steep decline in charge offs the following year. Far from being risky, I believe that BOFI’s borrowers are the very best kind; wealthy individuals with substantial assets who are highly motivated to pay their mortgages due to the low loan to value. </p>
<p class="MsoNormal">My final point on stickiness of deposits which I forget to mention earlier has to do with how most people pay bills today. Most people have their bills set up on the internet banking site of their deposit institution. They either pay bills by writing a check on line or by having their bill ADH'ed out of their account. Since BOFI is already one of the highest yielding deposit accounts, it is unlikely someone will be paid enough to switch to another bank. Also, since BOFI is already an interent only bank, it customers have chosen to move away from bricks and mortar banking. It is unlikely that they will move back.</p>
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