I've been pondering Bank of Internet a lot because it looks like a low cost producer in a commodity field. I use the term "looks like" because there is nothing stopping other companies from replicating the same model and undercutting them, albeit having to absorb some starting costs as they hit critical mass. What is interesting about Bank of Internet is that they are quite complex in their simplicity, as they have not followed down the money losing path of other internet banks and heck, its been a better performers than most banks in general. The funny thing though is that everyone who has operating a similar business model, NetBank and ING Direct, have been real duds as far as business operations and investments go. While just 3 examples don't make for a ground breaking study, NetBank, ING Direct and BofI, make for an interesting example of the benefits of meaningful inside ownership, the herd mentality, and the idea that mindlessly growing the business with no regard for the return generated for shareholders is a really (x10) dumb idea.
The benefit of high inside ownership with some exceptions is generally just seen as an alignment of incentives between management and shareholders. It trickles down to the basic psychology of the managers. If their stake is sizable enough they are going to act in the interest of making that stake worth more. They're going to focus on shareholder value as opposed to more easily manipulated measures of performance, since they are very well rewarded for this. Bank of Internet has inside ownership that is about 17% of the shares. While they are likely competent as well, this is the reason their loans are written at ~55% of the value and they had a limited number of write downs and an unsuccessful foray into RV loans that never crippled the company. They really powered through the worst of the financial panic and have been growing rapidly. The bank is run as if management owns the company instead of just collecting a paycheck on easily manipulated metrics. Oh, wait...they do.
Contrast this to NetBank and ING Direct. According to the most recent proxy before they stopped filing, insiders at NetBank owned about 4% excluding options. This might explain why the company dived head first into rolling up various companies that expanded the product offerings such as auto financing, selling insurance, and free standing ATMs. While these are nice extensions for a brick and mortar bank, these all require addition capital and labor to execute on. This erodes the key competitive advantage of an internet bank, as their low cost servicing allows them to offer super competitive interest rates. Worse still, these acquisitions were made using debt, even though the company wasn't exactly a stellar profit maker. From 1997-2005 its best year resulted in a a 1.85% ROA and a 12.25% ROE, which is mediocre. Its second best year was very similar, but its third best year produced a 0.28% ROA and 2.45% ROE. That is not good at all. It's best year, measured in ROA and ROE, was 1998 when they generated a modest $6.6m in net interest income and $4.4m in net income. All its expansion did nothing. This is what I think would be referring to as value destruction.
This poor performance was a result of the herd mentality and a desire to grow the business for the sake of growing it that so often grip managers. The idea that a bank had to offer all those services was, and still is, prevalent. Everyone else is doing it. While I could be confusing causation and correlation between a strategy of diversification and poor management, the two combined resulted in NetBanks deposits being sold to ING Direct in 2007.
ING Direct is a different beast than BofI is or NetBank was due to the sheer size. BofI's management has remarked in conference calls that they don't consider themselves to be competing with ING Direct. Their homepage does compare their rates to ING Direct though, but I think management is right to a degree. BofI's value proposition is that it has super competitive interest rates on its products. They aren't interested in being you insurance broker, or help you plan for retirement. Judging from interest rates offered , ING Direct is far from a low cost provider and is run along the same lines as NetBank although since it had the backing of ING, it did not need to acquire a suite of companies to broaden its product offering.
There are is another thing that indicate that ING Direct is poorly run and not a real low cost producer despite lacking a brick and mortar presence. From 2007-2009, $3 billion worth of Alt-A loans were written down in the ING Direct subsidiary of ING. ING also had its own problems, but this indicates the a) management was poor and b) the net interest margin is earned was artificially inflated by poor asset quality and excessive risk taking. Additionally, as part of its Dutch bailout, ING is in the process of divesting ING Direct. This will likely not have the effect of installing a well aligned management since the companies being discussed as potential acquirers are as large as ING.
Judging from the divergent business models and the mishaps encountered by NetBank and ING Direct, it seems like BofI is cut from a different cloth. BofI benefits from the culmination of several factors such as high inside ownership, a divergence from the herd mentality, and its simple focus. It's focus on providing plain vanilla banking products appears to have ensured its survival through the financial crisis unscathed. If my conclusion is correct that these are the key factors behind the differences, then the self restraint that BofI has exhibited is essentially a competitive advantage. A disciplined management team is going to guide the company to success and intelligently allocate capital. If BofI continues to be run in such a manner, it should see continued success. Essentially, everyone else is not properly executing on the internet only model, which seems to only work when it focuses on being low cost as opposed to full service. This could change though and I just don't have the skills to get comfortable with a bank. Of course, there could be something I'm missing. Food for thought.
Talk to Andrew about Bank of Internet
ING Direct is a different beast than BofI is or NetBank was due to the sheer size. BofI's management has remarked in conference calls that they don't consider themselves to be competing with ING Direct. Their homepage does compare their rates to ING Direct though, but I think management is right to a degree. BofI's value proposition is that it has super competitive interest rates on its products. They aren't interested in being you insurance broker, or help you plan for retirement. Judging from interest rates offered , ING Direct is far from a low cost provider and is run along the same lines as NetBank although since it had the backing of ING, it did not need to acquire a suite of companies to broaden its product offering.
There are is another thing that indicate that ING Direct is poorly run and not a real low cost producer despite lacking a brick and mortar presence. From 2007-2009, $3 billion worth of Alt-A loans were written down in the ING Direct subsidiary of ING. ING also had its own problems, but this indicates the a) management was poor and b) the net interest margin is earned was artificially inflated by poor asset quality and excessive risk taking. Additionally, as part of its Dutch bailout, ING is in the process of divesting ING Direct. This will likely not have the effect of installing a well aligned management since the companies being discussed as potential acquirers are as large as ING.
Judging from the divergent business models and the mishaps encountered by NetBank and ING Direct, it seems like BofI is cut from a different cloth. BofI benefits from the culmination of several factors such as high inside ownership, a divergence from the herd mentality, and its simple focus. It's focus on providing plain vanilla banking products appears to have ensured its survival through the financial crisis unscathed. If my conclusion is correct that these are the key factors behind the differences, then the self restraint that BofI has exhibited is essentially a competitive advantage. A disciplined management team is going to guide the company to success and intelligently allocate capital. If BofI continues to be run in such a manner, it should see continued success. Essentially, everyone else is not properly executing on the internet only model, which seems to only work when it focuses on being low cost as opposed to full service. This could change though and I just don't have the skills to get comfortable with a bank. Of course, there could be something I'm missing. Food for thought.
Talk to Andrew about Bank of Internet
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