Business model of Internet Banks

In January 2010, we wrote an introductory article introducing our long thesis on It has been nearly two years since that article, and it's time to provide an update on what continues to be one of our favorite long ideas.

By and large our thesis remains intact, and the high-level arguments that we highlighted in our original post continue to be the main points supporting our long thesis today.

Nevertheless, given that two years have passed, it makes sense to provide an update.

The Big Picture

Before we get to the numbers, it's important to explain some of the distinguishing aspects of BOFI's business model. Bank of Internet is an internet bank, and the only publicly traded internet bank in the United States as far as we know. As such, it has no direct comparables and the nuances of its unique approach to banking have received scant equity research coverage.

Internet banks are banks of extremes, as in some of their metrics are industry-leading while others are potentially industry-lagging.

On the positive side, internet banks feature:

• Industry-leading efficiency ratios, because they don't operate physical branch locations. BOFI has one branch and its loan officers, sales team, and management are primarily based out of its San Diego headquarters
• Industry-leading deposit growth, because they aren't reliant on branch locations to gain customers, but rather benefit from consumers' increasing shift to the internet to fulfill their banking needs
• A more rational underwriting policy, because credit officers are located in a single, central location and are not pressured to make loans to local customers at the branch level

On the negative side, internet banks feature:

• The potential for industry-lagging net interest margins, because internet banks gain customers by offering high savings interest rates
• Industry-lagging non-interest income, because internet banks have historically had limited business customers and have found it difficult to offer ancillary banking services like trust services, investment management fees, etc.

As we can see, when compared to traditional brick-and-mortar banks, internet banks have some positive traits and some negative ones. Yet when all the pros and cons of the internet bank operating model are combined, the end result is actually a sound business that can achieve attractive returns on equity and earnings growth as long as it's run by a management team that diligently monitors credit quality.

Strong Operating Momentum

As far as banks go, Bank of Internet's financial statements are among the most straightforward that you'll come across, partly because the company maintained robust credit quality during the credit crunch.