SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
For the Quarterly Period ended December 31, 2007
OR
For the Transition Period from to
Commission file number 000-51201
BofI HOLDING, INC.
(Exact name of registrant as specified in its charter)
12777 High Bluff Drive, Suite 100, San Diego, CA 92130
(Address of principal executive offices and zip code)
(858) 350-6200
(Registrant’s telephone number and area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter Period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares outstanding of the registrant’s common stock on the last practicable date: 8,287,590 shares of common stock as of February 11, 2008.
TABLE OF CONTENTS
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets (unaudited) at December 31, 2007 and June 30, 2007
Condensed Consolidated Statements of Income (unaudited) for the three months and six months ended December 31, 2007 and 2006
Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income (unaudited) for the six months ended December 31, 2007
Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended December 31, 2007 and 2006
Notes to Condensed Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Selected Consolidated Financial Information
Results of Operations
Financial Condition
Liquidity
Contractual Obligations and Commitments
Capital Resources and Requirements
Quantitative and Qualitative Disclosures about Market Risk
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Item 4. Controls and Procedures
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Securities Holders
Item 5. Other Information
Item 6. Exhibits
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BofI HOLDING, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
(Unaudited)
ASSETS
Cash and due from banks
Federal funds sold
Total cash and cash equivalents
Time deposits in financial institutions
Investment securities available for sale
Investment securities held to maturity
Stock of the Federal Home Loan Bank, at cost
Loans — net of allowance for loan losses of $1,502 in December 2007, $1,450 in June 2007
Accrued interest receivable
Furniture, equipment and software — net
Deferred income tax
Bank-owned life insurance — cash surrender value
Other assets
TOTAL
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
Non-interest bearing
Interest bearing
Total deposits
Securities sold under agreements to repurchase
Advances from the Federal Home Loan Bank
Junior subordinated debentures
Accrued interest payable
Accounts payable and accrued liabilities
Total liabilities
STOCKHOLDERS’ EQUITY:
Convertible preferred stock — $10,000 stated value; 1,000,000 shares authorized; 515 shares issued and outstanding (December 2007) and 515 shares outstanding (June 2007)
Common stock — $.01 par value; 25,000,000 shares authorized; 8,607,090 shares issued and 8,287,590 shares outstanding (December 2007) and 8,587,090 shares issued and 8,267,590 shares outstanding (June 2007)
Additional paid-in capital
Accumulated other comprehensive income (loss), net of tax
Retained earnings
Treasury stock
Total stockholders’ equity
See condensed notes to consolidated financial statements.
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CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except earnings per share)
INTEREST AND DIVIDEND INCOME:
Loans, including fees
Investments
Total interest and dividend income
INTEREST EXPENSE:
Deposits
Other borrowings
Total interest expense
Net interest income
Provision (benefit) for loan losses
Net interest income, after provision for loan losses
NON-INTEREST INCOME:
Prepayment penalty fee income
Mortgage banking income
Gain on sale of securities
Banking service fees and other income
Total non-interest income
NON-INTEREST EXPENSE:
Salaries, employee benefits and stock-based compensation
Professional services
Occupancy and equipment
Data processing and internet
Advertising and promotional
Depreciation and amortization
Other general and administrative
Total non-interest expense
INCOME BEFORE INCOME TAXES
INCOME TAXES
NET INCOME
NET INCOME ATTRIBUTABLE TO COMMON STOCK
COMPREHENSIVE INCOME
Basic earnings per share
Diluted earnings per share
4
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
(Dollars in thousands)
BALANCE — July 1, 2007
Comprehensive income:
Net income
Net unrealized gain from available for sale securities — net of income tax benefit and reclassifications
Total comprehensive income
Cash dividends on convertible preferred stock
Stock-based compensation expense
Stock options exercises
Tax effect of stock options exercised
Tax effect of stock options cancelled
BALANCE — December 31, 2007
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Amortization of premiums on securities
Amortization of premiums and deferred loan fees
Amortization of borrowing costs
Deferred income taxes
Origination of loans held for sale
Net gain on sale of loans held for sale
Proceeds from sale of loans held for sale
Stock dividends from Federal Home Loan Bank
Net changes in assets and liabilities which provide (use) cash:
Net cash provided by operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investment securities available for sale
Purchases of investment securities held to maturity and time deposits
Proceeds from sale of available for sale securities
Proceeds from repayments of available for sale securities
Proceeds from repayments of securities held to maturity and time deposits
Purchase of stock of Federal Home Loan Bank
Proceeds from redemption of stock of Federal Home Loan Bank
Origination of loans
Purchase of loans
Principal repayments and participation sales on loans
Purchases of furniture, equipment and software
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits
Proceeds from Federal Home Loan Bank advances
Repayment of the Federal Home Loan Bank advance
Proceeds from securities sold under agreements to repurchase
Purchase of treasury stock
Proceeds from exercise of common stock options
Tax benefit from exercise of common stock options
Cash dividends paid on convertible preferred stock
Net cash provided by financing activities
NET CHANGE IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS — Beginning of year
CASH AND CASH EQUIVALENTS — End of period
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid on deposits and borrowed funds
Income taxes paid
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED DECEMBER 31, 2007 AND 2006
(Dollars in thousands, except per share data)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements include the accounts of BofI Holding, Inc. and its wholly owned subsidiary, Bank of Internet USA (the “Bank” and collectively with BofI Holding, the “Company”). All significant intercompany balances have been eliminated in consolidation.
The accompanying interim condensed consolidated financials statements, presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”), are unaudited and reflect all adjustments which, in the opinion of management, are necessary for a fair statement of financial condition and results of operations for the interim periods. All adjustments are of a normal and recurring nature. Results for the three and the six months ended December 31, 2007 are not necessarily indicative of results that may be expected for any other interim period or for the year as a whole. Certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted. The unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes for the year ended June 30, 2007 included in our Annual Report on Form 10-K.
Certain reclassifications have been made to the prior-period financial statements to conform to the current period presentation.
All dollar amounts presented in these notes are in thousands unless otherwise indicated.
2. SIGNIFICANT ACCOUNTING POLICIES
Allowance for Loan Losses — The allowance for loan losses is maintained at a level estimated to provide for probable losses in the loan portfolio. Management determines the adequacy of the allowance based on reviews of individual loans and pools of loans, recent loss experience, current economic conditions, the risk characteristics of the various categories of loans and other pertinent factors. This evaluation is inherently subjective and requires estimates that are susceptible to significant revision as more information becomes available. The allowance is increased by the provision for loan losses, which is charged against current period operating results and recoveries of loans previously charged-off. The allowance is decreased by the amount of charge-offs of loans deemed uncollectible.
Under the allowance for loan loss policy, impairment calculations are determined based on general portfolio data for general reserves and loan level data for specific reserves. Specific loans are evaluated for impairment and are classified as nonperforming or in foreclosure when they are 90 days or more delinquent. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if repayment of the loan is expected primarily from the sale of collateral.
General loan loss reserves for real estate loans are calculated by grouping each loan by collateral type and by grouping the loan-to-value ratios of each loan within the collateral type. Loan-to-value ratios are calculated using the loan principal balance at period end and the loan valuation at the time of origination or purchase of loan. An estimated allowance rate for each loan-to-value group within each type of loan is multiplied by the total principal amount in the group to calculate the required general reserve attributable to that group. Management uses an allowance rate that provides a larger loss allowance for loans with greater loan-to-value ratios. General loan loss reserves for consumer loans are calculated by grouping each loan by credit score (e.g. FICO) at origination and applying an estimated allowance rate to each group. Specific reserves are calculated when an internal asset review of a loan identifies a significant adverse change in the financial position of the borrower or the value of the collateral. The specific reserve is based on discounted cash flows, observable market prices or the estimated value of underlying collateral.
Stock-Based Compensation — The Company determines stock-based compensation expense using the fair value method required by Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-based Payment. Refer to Note 4, Stock-based Compensation below, for additional disclosures.
New Accounting Pronouncements — In September 2006, the FASB issued Statement No. 157,Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The standard is effective for fiscal years beginning after November 15, 2007. The Company has not completed its evaluation of the impact of the adoption of this standard.
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In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, (“SFAS No. 159”). This statement allows entities to voluntarily choose, at specified election dates, to measure many financial assets and financial liabilities (as well as certain non-financial instruments that are similar to financial instruments) at fair value. The election is made on an instrument-by-instrument basis and is irrevocable. The statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Earlier adoption of the Statement is permitted as of the beginning of an entity’s fiscal year, provided the choice to early adopt is made within 120 days of the beginning of the fiscal year of adoption and the entity has not yet issued financial statements for any interim period of that fiscal year. We expect to adopt SFAS No. 159 on July 1, 2008.
In July 2006, the FASB issued Interpretation No. 48 (“FIN 48”) “Accounting for Uncertainty in Income Taxes: an interpretation of FASB Statement No. 109.” This interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for a tax position taken or expected to be taken in a tax return. Under FIN 48, an income tax position will be recognized if it is more likely than not that it will be sustained upon IRS examination, based upon its technical merits. Once that status is met, the amount recorded will be the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective as of the beginning of fiscal years that begin after December 15, 2006.
The Company adopted FIN 48 effective July 1, 2007. There was no cumulative effect of applying the provisions of FIN 48 and there was no material effect on our provision for income taxes for the three months ended September 30, 2007. The adoption of FIN 48 had no effect on our financial condition or results of operations. The Company is subject to federal income tax and income tax of the state of California as well as various other states. Our federal income tax returns for the years ended June 30, 2004, 2005, 2006, and 2007 and our California state tax returns for the years ended June 30, 2003, 2004, 2005, 2006 and 2007 are open to audit under the statutes of limitations by the Internal Revenue Service and Franchise Tax Board. We record interest and penalties related to uncertain tax positions as part of income tax expense. There was no penalty or interest expense recorded for the quarter or the six months ended December 31, 2007 or 2006. We do not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months.
In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements (EITF 06-4). This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. Management does not expect the adoption of this EITF to have a material impact on the Company’s consolidated financial position or results of operations.
3. INVESTMENT SECURITIES
The following table sets forth the amortized cost and the estimated fair values of investment securities available for sale as of December 31, 2007:
Available for sale
Mortgage-backed securities
(GNMA, FNMA, FHLMC)
Preferred Stock - FNMA
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The following table sets forth the amortized cost and the estimated fair values of investment securities held to maturity as of December 31, 2007:
Held to maturity
Mortgage-backed securities(GNMA, FNMA, FHLMC)
Collateralized debt obligations
U.S. Government agency debt
The Company believes that the estimated fair value of the securities disclosed above is dependent upon market interest rates. Although the fair value will fluctuate as market interest rates move, the majority of the investment portfolio consists of mortgage-backed securities from GNMA, FNMA and FHLMC. If held to maturity, the contractual principal and interest payments of the securities are expected to be received in full. No loss in principal is expected over the lives of the securities. Although not all of the securities are classified as held to maturity, the Company has the ability and intent to hold these securities until they mature or for a period of time sufficient to allow for a recovery in the fair value. Thus, unrealized losses are not other-than-temporary. The determination of whether a decline in market value is other-than-temporary is necessarily a matter of subjective judgment.
4. STOCK-BASED COMPENSATION
The Company has two stock incentive plans, the 2004 Stock Incentive Plan (2004 Plan) and the 1999 Stock Option Plan (1999 Plan), which provide for the granting of non-qualified and incentive stock options, restricted stock and restricted stock units, stock appreciation rights and other awards to employees, directors and consultants.
2004 Stock Incentive Plan—In October 2004, the Company’s Board of Directors and the stockholders approved the 2004 Plan. In November 2007, the 2004 Plan was amended and approved by the Company’s shareholders. The maximum number of shares of common stock available for issuance under the 2004 Plan is 14.8% of the Company’s outstanding common stock measured from time to time. In addition, the number of shares of the Company’s common stock reserved for issuance will also automatically increase by an additional 1.5% on the first day of each of four fiscal years starting July 1, 2007. At December 31, 2007, there were a maximum of 1,350,877 shares available for issuance under the limits of the 2004 Plan.
1999 Stock Option Plan— In November 2007, the shareholders of the Company approved the termination of the 1999 Plan. No new option awards will be made under the 1999 Plan and the outstanding awards under the 1999 Plan will continue to be subject to the terms and conditions of the 1999 Plan. The options issued under the 1999 Plan generally vest over periods between three and five years.
Stock Options— Prior to July 1, 2005, the Company accounted for the Plans under the recognition and measurement provisions of APB Opinion No. 25 and related Interpretations, as permitted by SFAS No. 123. No stock option compensation cost was recognized in the income statements as all options granted had an exercise price equal to the market value of the underlying common stock on the grant date.
Effective July 1, 2005, the Company adopted the fair value recognition provisions of SFAS No. 123(R), Share-Based Payment, using the modified-prospective-transition method. Under this method, compensation cost recognized for the period includes compensation cost for all options granted prior to, but not yet vested as of July 1, 2005, and all options granted subsequent to January 1, 2005, based on the grant date fair value estimated in accordance with the provisions of Statements No. 123 and 123(R), respectively. Under this transition method, the Company was not required to restate its operating results for periods ending prior to July 1, 2005 for additional compensation cost associated with the change to fair value recognition.
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The Company’s income before income taxes for the quarters ended December 31, 2007 and 2006 included stock option compensation expense of $97 and $122, respectively. For the six months ended December 31, 2007 and 2006 stock option compensation expense was $194 and $221, respectively. At December 31, 2007, unrecognized compensation expense related to non-vested stock option grants aggregated $609 and is expected to be recognized in future periods as follows:
Remainder of fiscal:
Total
The fair value of each option awarded under the Plans is estimated on the date of grant based on the Black Scholes option pricing model. The weighted average grant-date fair value and the assumptions used in the valuations for each period are summarized as follows. There were no options granted during the quarter or the six months ended December 31, 2007.
Weighted-average grant-date fair value per share
Assumptions used:
Risk-free interest rates
Dividends
Volatility
Weighted-average expected life
Grant-date market and exercise price
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Prior to March 15, 2005, the Company was a nonpublic entity and used the minimum value method, which excludes a volatility factor in estimating the value of stock options in accordance with SFAS 123. The Company was a public entity at the time SFAS 123(R) became effective. After the Company became publicly traded on March 15, 2005, expected volatilities have been based on the historical volatility of the Company’s common stock and the common stock volatility of similar banks with a longer history of public trading. The weighted-average expected life of options granted is based upon an estimate of the life, as prescribed in SAB 107. A forfeiture rate of 1.5% was estimated in determining expense for the six months ended December 31, 2007 and 2006, based upon past experience.
A summary of stock option activity under the Plans during the period July 1, 2006 to December 31, 2007 is presented below:
Outstanding – July 1, 2006
Granted
Exercised
Cancelled
Outstanding – June 30, 2007
Outstanding – December 31, 2007
Options exercisable – June 30, 2007
Options exercisable – December 31, 2007
The following table summarizes information as of December 31, 2007 concerning currently outstanding and exercisable options:
Options Outstanding
Exercise
Prices
$ 4.19
$ 6.76
$ 7.35
$ 8.50
$ 9.20
$ 9.50
$ 10.00
$ 11.00
$ 7.11
The aggregate intrinsic value of options outstanding and options exercisable under the Plans at December 31, 2007 were $1,075 and $1,070 respectively.
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Restricted Stock and Restricted Stock Units— Under the Company’s 2004 Plan, employees and directors are eligible to receive grants of restricted stock and restricted stock units. In accordance with SFAS 123R, the fair value of restricted stock and restricted stock units is equal to the closing sale price of the Company’s common stock on the date of issuance. On November 20, 2007, the Company’s Board of Directors awarded 115,200 restricted stock units to the chief executive officer and directors. The directors’ restricted stock units vest over three years, one-third on each anniversary date. The chief executive’s restricted stock units vest ratably on each of the four fiscal year ends of the initial term in his employment contract.
The Company’s income before income taxes for the quarters ended December 31, 2007 and 2006 included restricted stock compensation expense of $48 and $24, respectively. For the six months ended December 31, 2007 and 2006, the Company’s income before income taxes included restricted stock compensation expense of $72 and $45, respectively. The Company recognizes compensation expense based upon the grant-date fair value divided by the vesting and the service period between each vesting date. At December 31, 2007, unrecognized compensation expense related to non-vested grants aggregated $850 and is expected to be recognized in future periods as follows:
The following table presents the status and changes in non-vested restricted stock and restricted stock units grants from July 1, 2006 through December 31, 2007:
Non-vested balance at July 1, 2006
Vested
Non-vested balance at June 30, 2007
Non-vested balance at December 31, 2007
2004 Employee Stock Purchase Plan—In October 2004, the Company’s Board of Directors and stockholders approved the 2004 Employee Stock Purchase Plan, which is intended to qualify as an “Employee Stock Purchase Plan” under Section 423 of the Internal Revenue Code. An aggregate of 500,000 shares of the Company’s common stock has been reserved for issuance and will be available for purchase under the 2004 Employee Stock Purchase Plan. At December 31, 2007, there have been no shares issued under the 2004 Employee Stock Purchase Plan.
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5. EARNINGS PER SHARE
Information used to calculate earnings per share was as follows:
Dividends on preferred stock
Net income attributable to common shares
Weighted-average shares:
Basic weighted-average number of common shares outstanding and average common shares earned on restricted stock awards
Dilutive effect of stock options
Dilutive weighted-average number of common shares outstanding
Net income per common share:
Basic
Diluted
Options and stock grants of 684,679 and 588,614 shares for the three months ended December 31, 2007 and 2006, respectively, were not included in determining diluted earnings per share, as they were antidilutive.
6. COMMITMENTS AND CONTINGENCIES
Credit-Related Financial Instruments — The Company is a party to credit-related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. At December 31, 2007, the Company had $71.8 million in commitments to originate or purchase loans.
7. EMPLOYMENT AGREEMENTS
On October 22, 2007, the Company executed an employment agreement (the “Employment Agreement”) with Gregory Garrabrants pursuant to which he was appointed to serve as the Company’s Chief Executive Officer (“CEO”) effective immediately. The term of the Employment Agreement is from October 22, 2007 through October 22, 2011. Under the Employment Agreement, Mr. Garrabrants receives an annual base salary of $285,000, an annual short-term cash bonus, an initial restricted stock grant, an annual restricted stock grant and medical and other benefits. Mr. Garrabrants will earn an annual short-term bonus of a minimum of $137,000 and $86,000 for fiscal 2008 and 2009, respectively, which will be paid in quarterly installments during the year. Mr. Garrabrants has the opportunity to earn as much as $171,000 (or 60% of his base pay at the time) as an annual short-term bonus based upon annual objectives set by the Board of Directors. Also under the terms of the Employment Agreement, Mr. Garrabrants is entitled to i) an initial restricted stock unit award of 83,000 shares, which vests ratably over four years and ii) an annual restricted stock unit award, starting at the end of fiscal 2008 and consisting of a minimum of 44,000 shares and 32,000 shares at the end of fiscal 2008 and 2009, respectively. The annual restricted stock unit award increases based upon the return on equity of the Company each year. Annual awards vest over three years from the grant date of each award after each fiscal year. The maximum annual restricted stock unit shares Mr. Garrabrants may be awarded in any year is 272,000 and the maximum aggregate number of shares for all restricted share awards under the Employment Agreement is 500,000 shares. Mr. Garrabrants will receive a relocation allowance not to exceed $95,000, net of income tax, and shall be entitled to the same paid vacation and fringe benefits including health and welfare benefits that all senior executives receive under the current Company policies. Upon termination of the Employment Agreement by the Company “without cause” or by Mr. Garrabrants for “good reason” (as such terms are defined in the Employment Agreement), Mr. Garrabrants will be entitled to (a) an amount in cash equal to two times his base salary, (b) a pro-rated portion of his annual short-term bonus, (c) accelerated vesting of his outstanding restricted stock unit awards, (d) at the Company’s election, either a pro-rated portion of his annual restricted stock unit award based upon the Company’s return on equity, or an equivalent amount in cash, and (e) continuation of health benefits for up to twelve months.
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On October 22, 2007, the Company and Mr. Evans executed an amendment to the July 1, 2003 Employment Agreement by and between Gary Lewis Evans and Bank of Internet USA (the “Amendment”). The Amendment i) provides for the resignation of Mr. Evans duties from the office of CEO and appoints him Chief Operating Officer (“COO”) of Bank of Internet USA (the “Bank”) and ii) and provides that Mr. Evans will not be entitled to any severance payments unless or until the Bank terminates Mr. Evans’ employment or Mr. Evan’s terminates his employment, without cause.
The following discussion provides information about the results of operations, financial condition, liquidity, off balance sheet items, contractual obligations and capital resources of BofI Holding, Inc. and subsidiary. This information is intended to facilitate the understanding and assessment of significant changes and trends related to our financial condition and the results of our operations. This discussion and analysis should be read in conjunction with our financial information in our Annual Report on Form 10-K and the accompanying interim unaudited condensed consolidated financial statements and notes thereto.
Certain matters discussed in this report may constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and as such, may involve risks and uncertainties. These forward-looking statements can be identified by the use of terminology such as “estimate,” “project,” “anticipate,” “expect,” “intends,” “believe,” “will,” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. These forward-looking statements relate to, among other things, expectations of the environment in which the Company operates and projections of future performance. Forward-looking statements are inherently unreliable and actual results may vary. Factors that could cause actual results to differ from these forward-looking statements include economic conditions, changes in the interest rate environment, changes in the competitive marketplace, risks associated with credit quality and other risk factors discussed under the heading “Risk Factors” in our Prospectus dated March 14, 2005, and under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Factors That May Affect Our Performance” in our Annual Report on Form 10-K for the year ended June 30, 2007, both of which have been filed with the Securities and Exchange Commission. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. All written and oral forward-looking statements made in connection with this report, which are attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing information.
General
Our company, BofI Holding, Inc., is the holding company for Bank of Internet USA, a consumer-focused, nationwide savings bank operating primarily over the Internet. We offer loans and deposits in all 50 states to our customers directly through our websites, including www.BankofInternet.com, www.BofI.com, www.RVbank.com and www.Apartmentbank.com. We are a unitary savings and loan holding company and, along with Bank of Internet USA, are subject to primary federal regulation by the Office of Thrift Supervision.
Using online applications on our websites, our customers apply for deposit products, including time deposits, interest-bearing demand accounts (including interest-bearing checking accounts) and savings accounts (including money market savings accounts). We originate small- to medium-size multifamily and single-family mortgage loans and secured consumer loans, primarily home equity and vehicle loans. More recently, we increased our efforts to purchase single family and multifamily loans. We also purchase mortgage-backed securities. We manage our cash and cash equivalents based upon our need for liquidity, and we seek to minimize the assets we hold as cash and cash equivalents by investing our excess liquidity in higher yielding assets such as mortgage loans or mortgage-backed securities.
Critical Accounting Policies
Our consolidated financial statements and the notes thereto, have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various factors and circumstances. We believe that our estimates and assumptions are reasonable under the circumstances. However, actual results may differ significantly from these estimates and assumptions that could have a material effect on the carrying value of assets and liabilities at the balance sheet dates and our results of operations for the reporting periods.
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Our significant accounting policies and practices are described in greater detail in Note 1 to our June 30, 2007 audited consolidated financial statements and under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission.
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Selected Financial Data
The following tables set forth certain selected financial data concerning the periods indicated:
SELECTED CONSOLIDATED FINANCIAL INFORMATION
Selected Balance Sheet Data:
Total assets
Loans – net of allowance for loan losses
Allowance for loan losses
Advances from the FHLB
Selected Income Statement Data:
Interest and dividend income
Interest expense
Provision for loan losses
Net interest income after provision for loan losses
Non-interest income
Non-interest expense
Income before income tax expense
Income tax expense
Net income attributable to common stock
Per Share Data:
Net income:
Book value per common share
Tangible book value per common share
Weighted average number of common shares outstanding:
Common shares outstanding at end of period
Common shares issued at end of period
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Performance Ratios and Other Data:
Loan originations
Loan originations for sale
Loan purchases
Return on average assets
Return on average common stockholders’ equity
Interest rate spread1
Net interest margin2
Efficiency ratio3
Capital ratios:
Equity to assets at end of period
Tier 1 leverage (core) capital to adjusted tangible assets4
Tier 1 risk-based capital ratio4
Total risk-based capital ratio4
Tangible capital to tangible assets4
Asset Quality Ratios:
Net charge-offs to average loans outstanding
Nonperforming loans to total loans
Allowance for loan losses to total loans held for investment
Allowance for loan losses to nonperforming loans
1
Interest rate spread represents the difference between the annualized weighted average yield on interest-earning assets and the weighted average rate paid on interest-bearing liabilities.
Net interest margin represents annualized net interest income as a percentage of average interest-earning assets.
Efficiency ratio represents non-interest expense as a percentage of the aggregate of net interest income and non-interest income.
Reflects regulatory capital ratios of Bank of Internet USA only.
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RESULTS OF OPERATIONS – Comparison of Three Months and the Six Months Ended December 31, 2007 and 2006
During the quarter ended December 31, 2007, we earned $651,000 or $0.07 per diluted share compared to $807,000, or $0.09 per diluted share for the three months ended December 31, 2006. Key comparisons between our operating results for the quarters ended December 31, 2007 and 2006 are:
net interest income increased $927,000 in 2007 due to our 31.9% increase in average earning assets from increased investment in mortgage-backed securities and due to a 5 basis point increase in our net interest margin;
loan loss provisions were $264,000 this quarter due to loan portfolio growth and increased loss reserve allocation for recreational vehicle loans;
non-interest expense for the 2007 quarter increased $797,000 primarily due to increases in salaries and benefits, $169,000 for moving allowance and one-time fees associated with hiring the new chief executive officer, advertising and promotional, and other general and administrative expenses.
For the six months ended December 31, 2007, we earned $1.4 million or $0.15 per diluted share compared to $1.6 million, or $0.17 per diluted share for the six months ended December 31, 2006.
Net Interest Income
Net interest income for the quarter ended December 31, 2007 totaled $3.4 million, a 36.0% increase compared to net interest income of $2.5 million for the quarter ended December 31, 2006. Net interest income for the six months ended December 31, 2007 increased 30.6% to $6.4 million up from the $4.9 million for the six months ended December 31, 2006.
Total interest and dividend income during the quarter ended December 31, 2007 increased 40.2% to $15.0 million, compared with $10.7 million during the quarter ended December 31, 2006. For the six months ended December 31, 2007, total interest and dividend income increased 38.2% to $28.6 million, compared to $20.7 million for the six months ended in 2006. The increase in interest and dividend income for the quarter and the six months is attributable to growth in average earning assets, primarily investment securities and higher rates earned on loans. The average balance of investment securities (primarily mortgage-backed securities) increased 108.1% and 119.1% when compared for the three-month and the six-month periods ended December 31, 2007 and 2006, respectively. The increase in interest income was also the result of our higher rates earned on new loans including recreational vehicles and home equity loans. The loan portfolio yield increased 46 and 39 basis points when compared with the three-month and six-month periods. The net growth in average earning assets for the three-month and the six-month periods was funded largely by increases in time deposits and securities sold under agreements to repurchase, which account for the majority of the increases in interest expense. Total interest expense increased 40.2% to $11.5 million for the quarter ended December 31, 2007 compared with $8.2 million for the quarter ended December 31, 2006. For the six months ended December 31, 2007, total interest expense increased 40.5% to $22.2 million, compared to $15.8 million for the six months ended in 2006. The average balances for time deposits and securities sold under agreements to repurchase increased 62.6% and 60.7 % when compared for the three-month and the six-month periods ended December 31, 2007 and 2006, respectively. Also contributing to the increase in total interest expense were higher funding rates for time deposits and FHLB advances. The average time deposit rate increased 22 and 33 basis points when compared with the three-month and the six-month periods ended December 31, 2007 and 2006, respectively. Similarly, higher rates paid on FHLB advances used to replace maturing advances caused an increase of 18 and 19 basis points when compared with the three-month and the six-month periods ended December 31, 2007 and 2006, respectively.
Net interest margin, defined as net interest income divided by average earning assets, increased by 5 basis points to 1.34% for the quarter ended December 31, 2007, compared with 1.29% for the quarter ended December 31, 2006. The net interest margin increase was the result of growth in the yield of our investment securities and the yield on our new originations of recreational vehicles and home equity loans.
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Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table presents information regarding (i) average balances; (ii) the total amount of interest income from interest-earning assets and the weighted average yields on such assets; (iii) the total amount of interest expense on interest-bearing liabilities and the weighted average rates paid on such liabilities; (iv) net interest income; (v) interest rate spread; and (vi) net interest margin for the three months ended December 31, 2007 and 2006:
Assets
Loans 2 3
Interest-bearing deposits in other financial institutions
Investment securities 3 4
Stock of FHLB, at cost
Total interest-earning assets
Non-interest earning assets
Liabilities and Stockholders’ Equity
Interest-bearing demand and savings
Time deposits
Advances from FHLB
Total interest-bearing liabilities
Noninterest-bearing demand deposits
Other interest-free liabilities
Stockholders’ equity
Total liabilities and stockholders’ equity
Net interest spread 5
Net interest margin 6
Annualized
Loans include loans held for sale, loan premiums and unearned fees.
Interest income includes reductions for amortization of loan and investment securities premiums and earnings from accretion of discounts and loan fees. Loan fee income is not significant. The rate earned on loans does not include loan prepayment penalty income, which is classified as non-interest income.
All investments are taxable.
Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate paid on interest-bearing liabilities.
Net interest margin represents net interest income annualized as a percentage of average interest-earning assets.
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The following table presents information regarding (i) average balances; (ii) the total amount of interest income from interest-earning assets and the weighted average yields on such assets; (iii) the total amount of interest expense on interest-bearing liabilities and the weighted average rates paid on such liabilities; (iv) net interest income; (v) interest rate spread; and (vi) net interest margin for the six months ended December 31, 2007 and 2006:
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Analysis of Changes in Net Interest Income
Changes in net interest income are a function of changes in rates and volumes of both interest-earning assets and interest-bearing liabilities. The following table presents information regarding changes in interest income and interest expense for the periods indicated. The total change for each category of interest-earning asset and interest-bearing liability is segmented into the change attributable to changes in volume (changes in volume multiplied by prior rate), the change attributable to variations in interest rates (changes in rates multiplied by old volume) and the change attributable to changes in rate/volume (change in rate multiplied by the change in volume):
Increase / (decrease) in interest income:
Loans
Mortgage-backed security
Stock of Federal Home Loan Bank
Increase / (decrease) in interest expense:
Federal Home Loan Bank advances
Provision for Loan Losses
The loan loss provision was $264,000 for the quarter ended December 31, 2007, compared to a benefit of $80,000 for the quarter ended December 31, 2006. For the six months ended December 31, 2007, loan loss provisions totaled $269,000, compared to a benefit of $105,000 for the six months ended December 31, 2006. The increased provision for the quarter ended December 31, 2007 was the result of loan growth, continued changes in portfolio mix and higher estimated losses from our recreational vehicle portfolio. The benefit provisions in 2006 resulted from shifting our asset mix out of mortgage loans and into government-sponsored mortgage-backed securities, which do not require loan loss reserves. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management based on the factors discussed under the “Allowance for Loan Losses” section of this report.
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Non-interest Income
The following table sets forth information regarding our non-interest income for the periods shown:
Mortgage banking fee income
Non-interest income for the quarter ended December 31, 2007 decreased $45,000, or 11.9% to $333,000 compared to $378,000 for the quarter ended December 31, 2006. For the six months ended December 31, 2007 non-interest income increased 4.8%. Decreased loan originations from mortgage banking reduced fee income in 2007 compared to 2006. Prepayment penalty fee income increased in 2007 compared to 2006 as more customers elected to prepay their multifamily and commercial mortgage loans.
Non-interest Expense
The following table sets forth information regarding our non-interest expense for the periods shown:
Salaries, benefits and stock-based compensation
Efficiency ratio1
Non-interest expense as annualized % of average assets
Non-interest expense, which is comprised primarily of compensation, data processing and internet expenses, occupancy, advertising and other operating expenses, was $2.4 million for the three months ended December 31, 2007 up from $1.6 million for the three months ended December 31, 2006. Non-interest expense increased to $4.6 million for the six months ended December 31, 2007 compared to $3.2 million for the six months ended December 31, 2006.
Total salaries, benefits and stock-based compensation increased $608,000 to $1,358,000 for the quarter ended December 31, 2007, compared to $750,000 for the same quarter last year. The increase this quarter includes $169,000 for relocation and other one-time fees for our new chief executive officer who assumed his position in October 2007. The balance of the increase is primarily the result
Represents non-interest expense divided by the aggregate of net interest income before provision for loan losses and non-interest income.
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of growth in our consumer loan business, as our bank staff increased from 28 full time equivalents to 47 full-time equivalents between December 31, 2006 and 2007. For the six months ended December 31, 2007, compensation increased $910,000 of which $294,000 is one-time fees associated with our new chief executive officer. The remainder of the increase in salaries, benefits and stock-based compensation is primarily related to staff increases in the consumer lending business.
Professional services, which include accounting and legal fees, decreased $27,000 for the quarter and $88,000 for the six-month comparison. The decrease in professional services was primarily due to the completion of a loan consulting contract in 2006 that was no longer in place in 2007 and a reduction in investor relations expenses.
Advertising and promotion expense increased $65,000 and $215,000 for the comparison of the three-month and six-month periods ending December 31, 2007 and 2006. These increases were primarily due to increased activity for internet advertising and lead acquisitions for our home equity loan program. For the quarter ended December 31, 2007, the origination volume of home equity loans was $9.4 million; an increase of $7.4 million over the $2.0 million originated in the quarter ended December 31, 2006.
Other general and administrative expense increased $140,000 and $290,000 when comparing the three-month and six-month periods ending December 31, 2007 and 2006. The cost of our FDIC and OTS standard regulatory charges increased $81,000 during the quarter and increased $136,000 for the six-month period ended December 31, 2007 compared to the same periods in 2006. Loan processing expense increased $25,000 and $102,000 due to increased home equity loan originations for the three-month and six-month periods ending December 31, 2007 and 2006.
Provision for Income Taxes
Our effective income tax rates (income tax provision divided by net income before income tax) for the three months ended December 31, 2007 and 2006 were 40.22% and 40.13%, respectively. Our effective income tax rates for the six months ended December 31, 2007 and 2006 were 40.36% and 40.22%, respectively.
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FINANCIAL CONDITION
Balance Sheet Analysis
Our total assets increased $93.0 million, or 9.8%, to $1,040.2 million, as of December 31, 2007, up from $947.2 million at June 30, 2007. The increase in total assets was primarily due to the purchase of mortgage-backed securities, which caused a net increase in mortgage-backed securities available for sale of $87.7 million. The asset growth was funded by a net increase in deposits totaling $52.2 million and $35.0 million in securities sold under repurchase agreements.
Net loans held for investment increased to $517.3 million at from $507.9 million at June 30, 2007. The decrease in multi-family loan portfolio was attributable to principal repayments and payoffs. The home equity portfolio and the RV portfolio increased by $23.5 and $17.8 million, respectively, due to increased origination activity. The growth in the single-family portfolio resulted from $29.7 million in loan pool purchases during the quarter ended December 31, 2007.
The following table sets forth the composition of the loan portfolio as of the dates indicated:
Residential real estate loans:
Single family (one to four units)
Home equity
Multifamily (five units or more)
Commercial real estate and land
Consumer - Recreational vehicle
Other
Total loans
Unamortized premiums, net of deferred loan fees
Net loans
The Bank originates and purchases mortgage loans with terms that may include repayments that are less than the repayments for fully amortizing loans, including interest only loans, option adjustable-rate mortgages, and other loan types that permit payments that may be smaller than interest accruals. Through December 31, 2007, the net amount of deferred interest on these loan types was not material to the financial position or operating results of the Company.
Nonperforming Assets
Nonperforming assets are comprised of nonaccrual loans, loans past due 90 days or more and on nonaccrual, restructured loans and other real estate owned, net. At December 31, 2007, our nonperforming loans totaled $249,000, or 0.05% of total loans.
Allowance for Loan Losses
We are committed to maintaining the allowance for loan losses at a level that is considered to be commensurate with estimated and known risks in the portfolio. Although the adequacy of the allowance is reviewed quarterly, our management performs an ongoing assessment of the risks inherent in the portfolio. While we believe that the allowance for loan losses is adequate at December 31, 2007, future additions to the allowance will be subject to continuing evaluation of estimated and known, as well as inherent, risks in the loan portfolio.
The assessment of the adequacy of our allowance for loan losses is based upon a number of quantitative and qualitative factors, including levels and trends of past due and nonaccrual loans, change in volume and mix of loans, collateral values and charge-off history. In March 2007, we commenced RV lending which has more credit risk than prime mortgage lending. Prior to the year ended June 30, 2007, we did not have any charge offs. For the six-months ended December 31, 2007, we had net charge offs of $217,000 associated with our RV portfolio. We have never had a charge-off associated with our mortgage loan portfolios. We provide general
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loan loss reserves for our RV loans based upon the borrower credit score at the time of origination and based upon the type of RV. During the quarter ended December 31, 2007, based upon our loss experience to date, we increased our allowance for our RV loan portfolio resulting in an increased allocation of approximately $110,000 for the quarter. General reserves will vary based upon the amount of loans and the loan type mix. Generally, the larger the increase in our loan portfolio the higher loan loss provisions will be. Increased consumer loan originations, compared to mortgage loan originations and purchases, will require additional provisions to increase our allowance for loan loss as a % of loans in the future.
The following table summarizes activity in the allowance for loan losses for the six months ended December 31, 2007:
Balance at July 1, 2007
Provision for loan loss
Write-offs
Recoveries
Balance at December 31, 2007
The following table reflects management’s allocation of the allowance for loan losses by loan category and the ratio of each loan category to total loans as of the dates indicated:
Single family
Multifamily
Consumer - Recreational vehicles
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Investment Securities
Total mortgage-backed securities available for sale were $383.7 million as of December 31, 2007, compared with $296.1 million at June 30, 2007. During the months ended, we purchased $199.9 million in mortgage-backed securities available for sale, $10.1 million in preferred stock, and received principal repayments of approximately $51.0 million. During that same period, we sold $75.6 million in available for sale mortgaged-backed securities to provide proceeds to purchase higher yielding mortgage-backed securities and to reduce our interest rate risk. We also purchased $17.8 million of mortgage-backed securities held to maturity and had $18.8 million in callable bonds called. We currently classify agency mortgage-backed and debt securities as held to maturity at the time of purchase based upon small issue size and based on issue features, such as callable terms. Until we increase our level of origination of consumer and mortgage loans, we are likely to continue to increase our investments in mortgage-backed securities.
The following table sets forth the amortized cost and the estimated fair values of investment securities available for sale as of :
Mortgage-backed securities (GNMA, FNMA, FHLMC)
The following table sets forth the amortized cost and the estimated fair values of investment securities held to maturity as of :
We believe that the estimated fair value of the securities disclosed above is dependent upon market interest rates. Although the fair value will fluctuate as market interest rates move, the majority of our investment portfolio consists of mortgage-backed securities from GNMA, FNMA and FHLMC. If held to maturity, the contractual principal and interest payments of the securities are expected to be received in full. No loss in principal is expected over the lives of the securities. Although not all of the securities are classified as held to maturity, we have the ability and intent to hold these securities until they mature or for a period of time sufficient to allow for a recovery in the fair value. Thus, unrealized losses are not other-than-temporary. The determination of whether a decline in market value is other-than-temporary is necessarily a matter of subjective judgment.
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Deposits increased a net $52.3 million, or 9.5%, to $600.2 million at December 31, 2007 from $547.9 million at June 30, 2007. Our deposit growth was comprised of increases in time deposit accounts of $56.3 million offset by a decline in checking, savings, and money market accounts of $3.1 million. Our growth in deposits was the result of increased promotion and competitive pricing on time deposits. Our money market savings decreased as a result of less competitive rate pricing resulting in customer transfers to our higher rate time deposits or withdrawals.
The following table sets forth the composition of the deposit portfolio as of the dates indicated:
Interest bearing:
Demand
Savings
Time deposits:
Under $100,000
$100,000 or more
Total time deposits
Total interest bearing
The following table sets forth the number of deposit accounts by type at the date indicated:
Checking and savings accounts
Total number of deposit accounts
Securities Sold Under Agreements to Repurchase
Since November 2006, the Company has sold securities under various agreements to repurchase for total proceeds of $125,000. The repurchase agreements have interest rates between 2.50% and 4.65% and scheduled maturities between January 2012 and October 2017. Under these agreements, the Company may be required to repay the $125,000 and repurchase its securities before the scheduled maturity if the issuer requests repayment on scheduled quarterly call dates. The weighted-average remaining contractual maturity period is 6.9 years and the weighted average remaining period before such repurchase agreements could be called is 1.4 years.
FHLB Advances
We regularly use FHLB advances to manage our interest rate risk and, to a lesser extent, manage our liquidity position. Generally, FHLB advances with terms between three and ten years have been used to fund the purchase of single family and multifamily mortgages and to provide us with interest rate risk protection should rates rise. At December 31, 2007, a total of $57.0 million of FHLB advances include agreements that allow the FHLB, at its option, to put the advances back to us after specified dates. The weighted-average remaining contractual maturity period of the $57.0 million in advances is 3.7 years and the weighted average remaining period before such advances could be put to us is 1.1 years.
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Stockholders’ Equity
Stockholders’ equity increased $4.1 million to $76.9 million at December 31, 2007 compared to $72.8 million at June 30, 2007. The increase was the result of our net income for six months of $1.4 million, a $2.5 million unrealized gain from our available for sale securities, and $0.4 million for paid in capital from stock-based compensation activity, partially offset by a $0.2 million for dividends paid to holders of our convertible preferred stock.
LIQUIDITY
During the six months ended we had net cash inflows from operating activities of $2.7 million compared to $2.7 million for the six months ended 2006. Net cash inflows for the periods ended in and 2006 were primarily due to net income earned during the period, plus the add-back of non-cash adjustments of amortization of loan and security premiums and the decrease in accrued interest receivable, and partially offset by an increase in other assets, and a decrease in accrued interest payable.
Net cash outflows from investing activities totaled $84.8 million and $76.2 million for the six months ended December 31, 2007 and 2006, respectively. Net cash outflows from investing activities increased $8.6 million for the six months ended December 31, 2007 primarily due to a $44.2 million increase in loan originations, offset by a decrease from investment securities available for sale and held to maturity by $21.4 million, and an increase of $13.4 million in proceeds from loan principle repayments.
Our net cash provided by financing activities totaled $87.2 million and $62.0 million for the six months ended and 2006, respectively. Net cash provided from financing activities increased $25.2 million for the months ended compared to December 31, 2006, primarily due to in flows from deposits of a net $10.0 million and in flow from reverse repurchases of $20.0 million, less net maturities of FHLB advances of $5.9 million. During the quarter, Bank of Internet USA could borrow up to 40.0% of its total assets from the FHLB. Borrowings are collateralized by the pledge of certain mortgage loans and investment securities to the FHLB. We increased our borrowing capacity at the FHLB to 40.0% of total assets in October 2007. Based on the loans and securities pledged at December 31, 2007 we had total borrowing capacity of $409.8 million, of which $227.5 million was outstanding and $182.3 million was available. At December 31, 2007 we also had a $10.0 million unsecured federal funds purchase line with a bank under which no borrowings were outstanding. In the past, we have used long-term borrowings to fund our loans and to minimize our interest rate risk.
We believe our liquidity sources to be stable and adequate for our anticipated needs and contingencies. We can increase our level of deposits and borrowings to address our future liquidity needs.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
At December 31, 2007 we had commitments to fund loans of $71.8 million. Time deposits due within one year of December 31, 2007 totaled $270.9 million. We believe the large percentage of time deposits that mature within one year reflects customers’ hesitancy to invest their funds long term. If these maturing deposits do not remain with us, we may be required to seek other sources of funds, including other time deposits and borrowings. Depending on market conditions, we may be required to pay higher rates on deposits and borrowings than we currently pay on time deposits maturing within one year. We believe, however, based on past experience, a significant portion of our time deposits will remain with us. We believe we have the ability to attract and retain deposits by adjusting interest rates offered.
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The following table presents certain of our contractual obligations as of December 31, 2007:
Long-term debt obligations 2
Operating lease obligations 3
Our contractual obligations include long-term debt, time deposits and operating leases as shown. We had no capitalized leases or material commitments for capital expenditures at December 31, 2007.
Amounts include principal and interest due to recipient.
Payments are for a lease of real property.
CAPITAL RESOURCES AND REQUIREMENTS
Bank of Internet USA is subject to various regulatory capital requirements set by the federal banking agencies. Failure by our bank to meet minimum capital requirements could result in certain mandatory and discretionary actions by regulators that could have a material adverse effect on our consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, our bank must meet specific capital guidelines that involve quantitative measures of our bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Our bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation require our bank to maintain certain minimum capital amounts and ratios. The Office of Thrift Supervision requires our bank to maintain minimum ratios of tangible capital to tangible assets of 1.5%, core capital to tangible assets of 4.0% and total risk-based capital to risk-weighted assets of 8.0%. At December 31, 2007 our bank met all the capital adequacy requirements to which it was subject. At December 31, 2007 our bank was “well capitalized” under the regulatory framework for prompt corrective action. To be “well capitalized,” our bank must maintain minimum leverage, tier 1 risk-based and total risk-based capital ratios of at least 5.0%, 6.0% and 10.0%, respectively. No conditions or events have occurred since that date that management believes would materially adversely change the bank’s capital levels. From time to time, we may need to raise additional capital to support our bank’s further growth and to maintain its “well capitalized” status.
Bank of Internet capital amounts, ratios and requirements at December 31, 2007 were as follows:
Tier 1 leverage (core) capital to adjusted tangible assets
Tier 1 capital (to risk weighted assets)
Total capital (to risk-weighted assets)
Tangible capital (to tangible assets)
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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We measure interest rate sensitivity as the difference between amounts of interest-earning assets and interest-bearing liabilities that mature or contractually reprice within a given period of time. The difference, or the interest rate sensitivity gap, provides an indication of the extent to which an institution’s interest rate spread will be affected by changes in interest rates. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities and negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. In a rising interest rate environment, an institution with a positive gap would be in a better position than an institution with a negative gap to invest in higher yielding assets or to have its asset yields adjusted upward, which would result in the yield on its assets to increase at a faster pace than the cost of its interest-bearing liabilities. During a period of falling interest rates, however, an institution with a positive gap would tend to have its assets mature at a faster rate than one with a negative gap, which would tend to reduce the growth in its net interest income. The following table sets forth the interest rate sensitivity of our assets and liabilities at December 31, 2007:
Interest-earning assets:
Cash and cash equivalents
Investment securities 1
Stock of the FHLB, at cost
Loans - net of allowance for loan loss 2
Loans held for sale
Interest-bearing liabilities:
Interest-bearing deposits 3
Securities sold under agreements to repurchase 4
Advances from the FHLB 4
Other borrowed funds
Other noninterest-bearing liablilities
Total liabilities and equity
Net interest rate sensitivity gap
Cumulative gap
Net interest rate sensitivity gap - as a % of interest earning assets
Cumulative gap - as % of cumulative interest earning assets
Comprised of U.S. government securities and mortgage-backed securities, which are classified as held to maturity and available for sale. The table reflects contractual repricing dates and does not estimate prepayments or calls.
The table reflects either contractual repricing dates or maturities.
The table assumes that the principal balances for demand deposit and savings accounts will reprice in the first year.
The table reflects either contractual repricing dates or maturities and does not estimate prepayments or puts.
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Although “gap” analysis is a useful measurement device available to management in determining the existence of interest rate exposure, its static focus as of a particular date makes it necessary to utilize other techniques in measuring exposure to changes in interest rates. For example, gap analysis is limited in its ability to predict trends in future earnings and makes no assumptions about changes in prepayment tendencies, deposit or loan maturity preferences or repricing time lags that may occur in response to a change in the interest rate environment.
We attempt to measure the effect market interest rate changes will have on the net present value of assets and liabilities, which is defined as market value of equity. We use the measurement model developed and maintained by our Bank regulators, the Office of Thrift Supervision. At September 30, 2007 (the most recent period for which data is available), we analyzed the market value of equity sensitivity to an immediate parallel and sustained shift in interest rates derived from the current treasury and LIBOR yield curves. For rising interest rate scenarios, the base market interest rate forecast was increased by 100, 200 and 300 basis points. For the falling interest rate scenarios, we used 100 and 200 basis point decreases due to limitations inherent in the current rate environment. The following table indicates the sensitivity of market value of equity to the interest rate movement described above at September 30, 2007:
Assumed Interest Rate Change
Up 300 basis points
Up 200 basis points
Up 100 basis points
Base
Down 100 basis points
Down 200 basis points
The board of directors of our bank establishes limits on the amount of interest rate risk we may assume, as estimated by the net present value model for each 100 basis point movement. As of December 31, 2007, the board’s established minimum was 5.50%, meaning that the net present value after a theoretical 300 basis point instantaneous increase in interest rates must be greater than 5.50%. The bank‘s net present value after a theoretical 300 basis point increase was 5.66%, 16 basis points above the board of directors minimum requirement at December 31, 2007.
The computation of the prospective effects of hypothetical interest rate changes is based on numerous assumptions, including relative levels of interest rates, asset prepayments, runoffs in deposits and changes in repricing levels of deposits to general market rates, and should not be relied upon as indicative of actual results. Furthermore, these computations do not take into account any actions that we may undertake in response to future changes in interest rates.
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For quantitative and qualitative disclosures regarding market risks in our portfolio, see, “Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations—Quantitative and Qualitative Disclosures About Market Risk.”
The Company’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, pursuant to Exchange Act Rule 13a-15(e). Based upon that evaluation, our Chief Executive Officer along with our Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms.
There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation referred to above that occurred during the quarter that have materially affected, or are reasonably likely to materially affect, the registrant’s internal control over financial reporting.
The Company’s size dictates that it conduct business with a minimal number of financial and administrative employees, which inherently results in a lack of documented controls and segregation of duties within the Company. Management will continue to evaluate the employees involved and the controls procedures in place, the risks associated with such lack of segregation and whether the potential benefits of adding employees to clearly segregate duties justifies the expense associated with such added personnel. In addition, management is aware that many of the internal controls that are in place at the Company are undocumented controls. The Company is working to document these controls and take other steps required to be in compliance with Section 404 of the Sarbanes –Oxley Act of 2002 as of June 30, 2008, the Company’s deadline under current implementing rules and regulations.
The Company believes that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control are met and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
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PART II—OTHER INFORMATION
We are not involved in any material legal proceedings. From time to time we are a party to claims or litigation that arises in the ordinary course of business, such as claims to enforce liens, claims involving the origination and servicing of loans, and other issues related to the business of the Bank. In the opinion of our management, the resolution of any such issues would not have a material adverse impact on our financial position, results of operations, or liquidity.
We face a variety of risks that are inherent in our business and our industry. The following are some of the more significant factors that could affect our business and our results of operations:
Our limited operating history makes our future prospects and financial performance unpredictable, which may impair our ability to manage our business and your ability to assess our prospects. Our inability to manage our growth could harm our business, particularly growth in our new products such as home equity loans and other types of consumer loans that are not secured by real estate.
In a rising interest rate environment, an institution with a negative interest rate sensitivity gap generally would be expected, absent the effects of other factors, to experience a greater increase in its cost of liabilities relative to its yield on assets, and thus a decrease in its net interest income.
We face strong competition for customers and may not succeed in implementing our business strategy.
A natural disaster or recurring energy shortage, especially in California, could harm our business. The Bank did not experience any serious long-term interruption in its business as a result of the wildfires experienced in Southern California in October 2007.
Our home equity loans and RV loans, as well as some of our multifamily residential and commercial real
estate loans, are unseasoned, and significant defaults on such loans would harm our business.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings, capital adequacy and overall financial condition may suffer materially.
Declining real estate values, particularly in California, could reduce the value of our loan portfolio and impair our profitability and financial condition.
We purchase and originate loans in bulk or “pools.” We may experience lower yields or losses on loans because the
assumptions we use may not always prove correct.
We invest in mortgage-backed securities and other securities issued by entities, which may be downgraded by large credit rating agencies decreasing the value of our securities.
Our success depends in large part on the continuing efforts of a few individuals. If we are unable to retain these personnel
or attract, hire and retain others to oversee and manage our company, our business could suffer.
We depend on third-party service providers for our core banking technology, and interruptions in or terminations of their
services could materially impair the quality of our services.
We are exposed to risk of environmental liability with respect to properties to which we take title.
We have risks of systems failure and security risks, including “hacking” and “identity theft.”
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These risks are described in more detail under “Risk Factors” in Item 1A of our Form 10-K for the year ended June 30, 2007. We encourage you to read these risk factors in their entirety. Other factors may also exist that we cannot anticipate or that we currently do not consider being significant based on information that is currently available.
None.
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Exhibit No.
Document
31.1
31.2
32.1
32.2
SIGNATURE
In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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