BofI Holding 10-K 2008
Documents found in this filing:
U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the year ended June 30, 2008
Commission file number: 000-51201
BofI HOLDING, INC.
(Exact name of registrant as specified in its charter)
Registrants Telephone Number, Including Area Code: (858) 350-6200
Securities registered under Section 12(b) of the Exchange Act:
Securities registered under Section 12(g) of the Exchange Act: None
Indicated by a check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨ Yes x No
Indicated by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨ Yes x No
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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. x Yes ¨ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filed, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
The aggregate market value of the voting and non-voting stock held by non-affiliates of the Registrant, based upon the closing sales price of the common stock on the NASDAQ National Market of $7.15 on December 31, 2007 was $44,797,774.
The number of shares of the Registrants common stock outstanding as of August 31, 2008 was 8,299,563.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrants definitive Proxy Statement for the period ended June 30, 2008 are incorporated by reference into Part III.
TABLE OF CONTENTS
Forward Looking Statements
This report may contain various forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include projections, statements of the plans and objectives of management for future operations, statements of future economic performance, assumptions underlying these statements, and other statements that are not statements of historical facts. Forward-looking statements are subject to significant business, economic and competitive risks, uncertainties and contingencies, many of which are beyond the control of BofI Holding, Inc. (BofI). Should one or more of these risks, uncertainties or contingencies materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated. Among the key risk factors that may have a direct bearing on BofIs results of operations and financial condition are:
In addition, actual results may differ materially from the results discussed in any forward-looking statements for the reasons, among others, discussed under the heading Factors that May Affect Our Performance in the Managements Discussion and Analysis of Financial Condition and Results of Operations, herein under Item 7.
References in this report to the Company, us, we, our, BofI Holding, or BofI are all to BofI Holding, Inc. on a consolidated basis. References in this report to Bank of Internet, Bank of Internet USA, the Bank, or our bank are to Bank of Internet USA, our consolidated subsidiary.
Item 1. Business
BofI Holding, Inc. is the holding company for Bank of Internet USA, a consumer-focused, nationwide savings bank operating primarily through the Internet. We provide a variety of consumer banking services, focusing primarily on gathering retail deposits over the Internet and originating and purchasing multifamily, single-family and home equity mortgage loans, vehicle loans and mortgage-backed securities. We attract and service our customers primarily through the Internet which affords us low operating expenses and allows us to pass these savings along to our customers in the form of attractive interest rates and low fees on our products.
We operate our Internet-based bank from a single location in San Diego, California, currently serving approximately 29,000 retail deposit and loan customers across all 50 states. At June 30, 2008, we had total assets of $1,194.2 million, loans of $631.4 million, mortgage-backed and other investment securities of $510.0 million, total deposits of $570.7 million and borrowings of $534.2 million. Our deposits consist primarily of interest-bearing checking and savings accounts and time deposits. Our loans are primarily first mortgages secured by multifamily (five or more units) and single family real property. Our mortgage-backed securities consist of mortgage pass-through securities issued by government-sponsored entities and AAA-rated non-agency collateralized mortgage obligations.
Our mission statement is to become a premier provider of consumer banking products and to increase shareholder value through growth in our assets and earnings.
Over the last two years, we have limited the impact of the current credit problems in the mortgage markets by redirecting our asset gathering from retail online originations to wholesale purchases of whole loans and mortgage-backed securities with higher credit quality. Our online delivery channels and online advertising can be opened, closed or expanded rapidly allowing us to change product offerings faster and with less cost than many traditional banks. We believe our speed and flexibility will be a competitive advantage as we look to re-enter retail mortgage originations in the next several years as the housing market and mortgage markets become more favorable.
Our business strategy is to lower the cost of delivering banking products and services by leveraging technology, while continuing to grow our assets and deposits to achieve increased economies of scale. We have designed our automated Internet-based banking platform and workflow process to handle traditional banking functions with reduced paperwork and human intervention. Our thrift charter allows us to operate in all 50 states and our online presence allows us increased flexibility to target a large number of loan and deposit customers based on demographics, geography and price. We plan to continue to increase our deposits by attracting new customers with competitive pricing, targeted marketing and new products and services. Within the next 18 months, we plan to increase our originations of single family loans by attracting new customers through our websites. We also plan to continue to purchase pools of high quality single family and multifamily mortgage loans and mortgage-backed securities.
Our present goals are to:
Copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports are available, free of charge, through the Securities and Exchange Commissions website at www.sec.gov and our website at www.bofiholding.com as soon as reasonably practicable after their filing with the Securities and Exchange Commission. The information contained therein or connected thereto is not incorporated into this Annual Report on Form 10-K.
Lending and Investment Activities
General. We divide our loan acquisition activities into two primary channels - retail and wholesale. Our retail channel originates loans nationwide either directly to consumer or through dealer or broker arrangements. Our wholesale channel purchases closed loans in flow or bulk from a variety of business partners. Our originations, purchases and sales of mortgage loans include both fixed and adjustable interest rate loans. Originations are sourced, underwritten, processed, controlled and tracked primarily through our customized websites and software. We believe that, due to our automated systems, our lending business is scalable, allowing us to handle increasing volumes of loans and enter into new geographic lending markets with only a small increase in personnel, in accordance with our strategy of leveraging technology to lower our operating expenses.
We purchase mortgage-backed securities when their risk-adjusted returns exceed those of our loan origination or loan purchase opportunities
Loan Products. Our loans primarily consist of first mortgage loans secured by single family and multifamily properties and, to a lesser extent, commercial properties. We also provide home equity second mortgages, primarily closed end loans and, to a lesser extent, lines of credit. Further details regarding our loan programs are discussed below:
Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio in amounts and percentages by type of loan at the end of each fiscal year-end since June 30, 2004:
The following table sets forth the amount of loans maturing in our total loans held for investment at June 30, 2008 based on the contractual terms to maturity:
The following table sets forth the amount of our loans at June 30, 2008 that are due after June 30, 2009 and indicates whether they have fixed or floating or adjustable interest rate loans:
Our mortgage loans are secured by properties primarily located in the western United States. The following table shows the largest states and regions ranked by location of these properties at June 30, 2008:
Percent of Loan Principal Secured by Real Estate Located in State
The ratio of the loan amount to the value of the property securing the loan is called the loan-to-value ratio or LTV. The following table shows the LTVs of our loan portfolio on weighted average and median bases at June 30, 2008. The LTVs were calculated by dividing (a) the loan principal balance less principal repayments by (b) the appraisal value of the property securing the loan at the time of the funding or, for certain purchased seasoned loans, an adjusted appraised value based upon an independent review at the time of the purchase.
Lending Activities. The following table summarizes the volumes of real estate loans originated, purchased and sold for each fiscal year since 2004:
The following table summarizes the amount funded, the number and the size of real estate loans and RV loans originated and purchased for each fiscal year since 2004:
Loan Marketing. We market our lending products directly to customers through a variety of channels depending on the product. When we market single family mortgage and home equity loans, we target Internet comparison shoppers generally in all 50 states through our purchase of advertising on search engines, such as Google and Yahoo, and popular product comparison sites, such as Bankrate.com. For home equity loans, we also buy customer leads and loan applications from major lead aggregators and from our marketing affiliates and partners with affinity agreements. Previously, we marketed multifamily loans primarily in five states through Internet search engines and through traditional origination techniques, such as direct mail marketing, personal sales efforts and limited media advertising. More recently, we have decreased our multifamily marketing, however, we expect to use these marketing techniques in the future when the residential mortgage markets stabilize. We currently market our RV loans on a direct basis and on an indirect basis through RV dealers.
Loan Originations. We originate loans through four different origination channels: online retail, online wholesale and direct and indirect.
Wholesale Loan Purchases. We purchase selected single family, multifamily and commercial real estate loans from other lenders to supplement and diversify our loan portfolio geographically. We currently purchase loans from major banks and mortgage companies. At June 30, 2008, approximately $309.2 million, or 48.8%, of our loan portfolio was acquired from other lenders who are servicing the loans on our behalf, of which 51.5% were multifamily loans and 48.5% were single family loans.
Loan Servicing. We typically retain servicing rights for all home equity, multifamily and RV loans that we originate. We typically do not acquire servicing rights on purchased single family and multifamily loans, and we typically release-servicing rights to the purchaser when we sell single family loans that we originate.
Loan Underwriting Process and Criteria. We individually underwrite the loans that we originate and all loans that we purchase. Our loan underwriting policies and procedures are written and adopted by our board of directors and our loan committee. Each loan, regardless of how it is originated, must meet underwriting criteria set forth in our lending policies and the requirements of applicable lending regulations of the Office of Thrift Supervision (OTS).
We have designed our loan application and review process so that much of the information that is required to underwrite and evaluate a loan is created electronically during the loan application process. Therefore we can automate many of the mechanical procedures involved in preparing underwriting reports and reduce the need for human interaction, other than in the actual credit decision process. We believe that our systems will allow us to handle increasing volumes of loans with only a small increase in personnel, in accordance with our strategy of leveraging technology to lower our operating expenses.
We perform underwriting directly on all multifamily and commercial loans that we originate and purchase. We rely primarily on the cash flow from the underlying property as the expected source of repayment, but we also endeavor to obtain personal guarantees from all borrowers or substantial principals of the borrower. In evaluating multifamily and commercial loans, we review the value and condition of the underlying property, as well as the financial condition, credit history and qualifications of the borrower. In evaluating the borrowers qualifications, we consider primarily the borrowers other financial resources, experience in owning or managing similar properties and payment history with us or other financial institutions. In evaluating the underlying property, we consider primarily the net operating income of the property before debt service and depreciation, the ratio of net operating income to debt service and the ratio of the loan amount to the appraised value.
We perform underwriting directly on all home equity and RV loans that we originate. In the underwriting process we consider the borrowers credit score, credit history, documented income, existing and new debt obligations, the value of the collateral, and other internal and external factors.
Lending Limits. As a savings association, we generally are subject to the same lending limit rules applicable to national banks. With limited exceptions, the maximum amount that we may lend to any borrower, including related entities of the borrower, at one time may not exceed 15% of our unimpaired capital and surplus, plus an additional 10% of unimpaired capital and surplus for loans fully secured by readily marketable collateral. We are additionally authorized to make loans to one borrower, by order of the Director of the OTS, in an amount not to exceed the lesser of $30.0 million or 30% of our unimpaired capital and surplus for the purpose of developing residential housing, if certain specified conditions are met. See Regulation Regulation of Bank of Internet USA.
At June 30, 2008, Bank of Internets loans-to-one-borrower limit was $12 .7 million, based upon the 15% of unimpaired capital and surplus measurement. At June 30, 2008, no single loan was larger than $4.1 million and our largest single lending relationship had an outstanding balance of $4.7 million.
Loan Quality and Credit Risk. Since inception through June 30, 2007, the end of our last fiscal year, we had no mortgage foreclosures and no loan charge-offs. During the fiscal year ended June 30, 2008, we experienced our first mortgage loan foreclosure and consumer loan charge-off during a period of major deterioration in housing values and consumer credit. We believe that our level of nonperforming loans has been and remains today relatively low. Given the significant down turn in the mortgage and consumer credit markets, we expect in the future to have additional loans that default or become nonperforming. Nonperforming assets are defined as nonperforming loans and real estate acquired by foreclosure or deed-in-lieu thereof. Generally, nonperforming loans are defined as nonaccrual loans and loans 90 days or more overdue. Troubled debt restructurings are defined as loans that we have agreed to modify by accepting below market terms either by granting interest rate concessions or by deferring principal or interest payments. Our policy with respect to nonperforming assets is to place such assets on nonaccrual status when, in the judgment of management, the probability of collection of interest is deemed to be insufficient to warrant further accrual. When a loan is placed on nonaccrual status, previously accrued but unpaid interest will be deducted from interest income. Our general policy is to not accrue interest on loans past due 90 days or more, unless the individual borrower circumstances dictate otherwise.
See Management Discussion and Analysis Asset Quality and Allowance for Loan Loss for a history of nonperforming assets and allowance for loan loss.
Investment Portfolio. In addition to loans, we invest available funds in high grade mortgage-backed securities, investment grade fixed income securities and preferred securities of government sponsored entities. We also invest available funds in term deposits of other FDIC-insured financial institutions. Our investment policy, as established by our board of directors, is designed to maintain liquidity and generate a favorable return on investment without incurring undue interest rate risk, credit risk or portfolio asset concentration risk. Under our investment policy, we are currently authorized to invest in agency mortgage-backed obligations issued or fully guaranteed by the United States government, AAA rated non-agency mortgage-backed obligations, specific federal agency obligations, specific time deposits, negotiable certificates of deposit issued by commercial banks and other insured financial institutions, investment grade corporate debt securities and other specified investments. We also buy and sell mortgage-backed securities to facilitate liquidity and to help manage our interest rate risk.
In the last two fiscal years, we have increased our purchases of mortgage-backed securities because we believed the mortgage-backed securities provided better risk adjusted yields than certain single-family whole loan originations or whole loan pools.
The following table sets forth, at June 30, 2008, the dollar amount of our investment portfolio by type, based on the contractual terms to maturity and the weighted average yield for each range of maturities:
The following table sets forth changes in our investment portfolio for each fiscal year since 2004:
Deposit Products and Services
Deposit Products. We offer a full line of deposit products over the Internet to customers in all 50 states. Our deposit products consist of demand deposits (interest bearing and non-interest bearing), savings accounts and time deposits. Our customers access their funds through ATMs, debit cards, Automated Clearing House funds (electronic transfers) and checks. We also offer the following additional services in connection with our deposit accounts:
Deposit Marketing. We currently market to deposit customers through targeted, online marketing in all 50 states by purchasing key word advertising on Internet search engines, such as Google, and placement on product comparison sites, such as Bankrate.com. We target deposit customers based on demographics, such as age, income, geographic location and other criteria. We also pay for customer leads and applications from our marketing affiliates and partners with affinity agreements
As part of our deposit marketing strategies, we actively manage deposit interest rates offered on our websites and displayed in our advertisements. Senior management is directly involved in executing overall growth and interest rate guidance established by our asset/liability committee, or ALCO. Within these parameters, management and staff survey our competitors interest rates and evaluate consumer demand for various products and our existing deposit mix. They then establish our marketing campaigns accordingly and monitor and adjust our marketing campaigns on an ongoing basis. Within minutes, our management and staff can react to changes in deposit inflows and external events by altering interest rates reflected on our websites and in our advertising. Our external advertising cost per new account was approximately $0.80, $7.51 and $20.34 for the fiscal years 2008, 2007 and 2006, respectively.
The number of deposit accounts at June 30, 2008 and at each of June 30, 2007, 2006, 2005 and 2004 is set forth below.
Deposit Composition. The following table sets forth the dollar amount of deposits by type and weighted average interest rates at June 30, 2008 and at each of June 30, 2007, 2006, 2005 and 2004:
The following tables set forth the average balance of each type of deposit and the average rate paid on each type of deposit for the periods indicated:
The following table shows the maturity dates of our certificates of deposit at June 30, 2008, 2007 and 2006:
The following table shows maturities of our time deposits having principal amounts of $100,000 or more at June 30, 2008, 2007 and 2006:
In addition to deposits, we have historically funded our asset growth through advances from the Federal Home Loan Bank (FHLB). Our bank can borrow up to 40.0% of its total assets from the FHLB, and borrowings are collateralized by mortgage loans and mortgage-backed securities pledged to the FHLB. Based on loans and securities pledged at June 30, 2008, we had a total borrowing capacity of approximately $443.9 million, of which $399.0 million was outstanding and $44.9 million was available. At June 30, 2008, we also had a $10.0 million unsecured fed funds purchase line with a major bank under which no borrowings were outstanding.
The Company has sold securities under various agreements to repurchase for total proceeds of $130.0 million. The repurchase agreements have fixed interest rates between 3.24% and 4.65% and scheduled maturities (after 5 years) between January 2012 and December 2017. Under these agreements, the Company may be required to repay the $130.0 million 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 6.4 years and the weighted average remaining period before such repurchase agreements could be called is 1.2 years.
On December 16, 2004, we completed a transaction in which we formed a trust and issued $5.0 million of trust-preferred securities. The net proceeds from the offering were used to purchase approximately $5.2 million of junior subordinated debentures of our company with a stated maturity date of February 23, 2035. The debentures are the sole assets of the trust. The trust preferred securities are mandatorily redeemable upon maturity, or upon earlier redemption as provided in the indenture. We have the right to redeem the debentures in whole (but not in part) on or after specific dates, at a redemption price specified in the indenture plus any accrued but unpaid interest through the redemption date. Interest accrues at the rate of three-month LIBOR plus 2.4%, which was 5.04% at June 30, 2008, with interest to be paid quarterly starting in February 2005.
The table below sets forth the amount of our borrowings, the maximum amount of borrowings in each category during any month-end during each reported period, the approximate average amounts outstanding during each reported period and the approximate weighted average interest rate thereon at or for the fiscal years ended June 30, 2008, 2007, 2006, 2005 and 2004:
We have purchased, customized and developed software systems to provide products and services to our customers. Most of our key customer interfaces were designed by us specifically to address the needs of an Internet-only bank and its customers. Our website and CRM software drive our customer self-service model, reducing the need for human interaction while increasing our overall operating efficiencies. Our CRM software enables us to collect customer data over our websites, which is automatically uploaded into our customer databases. The databases drive our workflow processes by automatically linking to third-party processors and storing all customer contract and correspondence data, including emails, hard copy images and telephone notes. We intend to continue to improve our systems and implement new systems, with the goal of providing for increased transaction capacity without materially increasing personnel costs.
The following summarizes our current technology resources:
Core Banking Systems. We outsource substantially all of our core banking systems. The outsourcer is responsible for all of our basic core processing applications, including general ledger, loans, deposits, bill pay, ATM networks, electronic fund transfers, item processing and imaging. These outsourced services for our core banking systems are located in California, Texas and Kansas, with a backup location in Branson, Missouri. We use a variety of vendors to provide automated information for our customers, including credit, identity authentication, tax status and property appraisal.
Internet and CRM Systems. We developed software for our website interface with loan and deposit customers, including collection and initial processing of new customer information. We also developed software to manage workflow and fraud control and provide automated interfaces to our outsourced service providers. We host our primary web servers in San Diego, California, and fully control and manage these servers with a staff of technology personnel. Web servers used by our customers to access real time account data are located in Kansas, with a backup location in Texas.
Systems Architecture. Our internally developed software is based on a Microsoft development language and Intel-based hardware. Our outsourced core processing system uses IBM hardware and software. We use a variety of specialized companies to provide hardware and software for firewalls, network routers, intrusion detection, load balancing, data storage and data backup. To aid in disaster recovery, customer access to our websites is supported by a fully redundant network and our servers are mirrored so that most hardware failures or software bugs should cause no more than a few minutes of service outage. Mirroring means that our server is backed up continuously so that all data is stored in two physical locations.
Because we operate almost exclusively through electronic means, we believe that we must be vigilant in detecting and preventing fraudulent transactions. We have implemented stringent computer security and internal control procedures to reduce our susceptibility to identity theft, hackers, theft and other types of fraud. We have implemented an automated approach to detecting identity theft that we believe is highly effective, and we have integrated our fraud detection processes into our CRM technology. For example, when opening new deposit accounts, our CRM programs automatically collect customers personal and computer identification from our websites, send the data to internal and third-party programs which analyze the data for potential fraud, and quickly provide operating personnel with a summary report for final assessment and decision making during the account-opening process.
We continually evaluate the systems, services and software used in our operations to ensure that they meet high standards of security. The following are among the security measures that are currently in place:
Intellectual Property and Proprietary Rights
We register our various Internet URL addresses with service companies, and work actively with bank regulators to identify potential naming conflicts with competing financial institutions. Policing unauthorized use of proprietary information is difficult and litigation may be necessary to enforce our intellectual property rights.
We own the Internet domain names bankofinternet.com, bofi.com, apartmentbank.com, seniorbofi.com, myrvbank.com, insurancesales.com, investmentsales.com, bancodeinternet.com and many other similar names. Domain names in the United States and in foreign countries are regulated, and the laws and regulations governing the Internet are continually evolving. Additionally, the relationship between regulations governing domain names and laws protecting intellectual property rights is not entirely clear. As a result, we may in the future be unable to prevent third parties from acquiring domain names that infringe or otherwise decrease the value of our trademark and other intellectual property rights.
At June 30, 2008, we had 44 full time employees. None of our employees are represented by a labor union or subject to a collective bargaining agreement. We have not experienced any work stoppage and consider our relations with our employees to be good.
The market for banking and financial services is intensely competitive, and we expect competition to continue to intensify in the future. We believe that competition in our market is based predominantly on price, customer service and brand recognition. Our competitors include:
In real estate lending, we compete against traditional real estate lenders, including large and small savings banks, commercial banks, mortgage bankers and mortgage brokers. Many of our current and potential competitors have greater brand recognition, longer operating histories, larger customer bases and significantly greater financial, marketing and other resources and are capable of providing strong price and customer service competition. In order to compete profitably, we may need to reduce the rates we offer on loans and investments and increase the rates we offer on deposits, which actions may adversely affect our overall financial condition and earnings. We may not be able to compete successfully against current and future competitors.
Savings and loan holding companies and savings associations are extensively regulated under both federal and state law. This regulation is intended primarily for the protection of depositors and not for the benefit of our stockholders. The following information describes aspects of the material laws and regulations applicable to us and our subsidiary, and does not purport to be complete. The discussion is qualified in its entirety by reference to all particular applicable laws and regulations.
Legislation is introduced from time to time in the U.S. Congress that may affect the operations of our company and Bank of Internet USA. In addition, the regulations governing us and Bank of Internet USA may be amended from time to time by the OTS. Any such legislation or regulatory changes in our future could adversely affect Bank of Internet USA. No assurance can be given as to whether or in what form any such changes may occur.
Regulation of BofI Holding, Inc.
General. We are a savings and loan holding company subject to regulatory oversight by the OTS. As such, we are required to register and file reports with the OTS and are subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over us and our subsidiary, which also permits the OTS to restrict or prohibit activities that are determined to be a serious risk to Bank of Internet USA.
Activities Restrictions. Our activities, other than through Bank of Internet USA or any other SAIF-insured savings association we may hold in the future, are subject to restrictions applicable to bank holding companies. Bank holding companies are prohibited, subject to certain exceptions, from engaging in any business or activity other than a business or activity that the Federal Reserve Board has determined to be closely related to banking. The Federal Reserve Board has by regulation determined that specified activities satisfy this closely-related-to-banking standard. We currently do not engage in any activities that fall under this standard.
Regulation of Bank of Internet USA
General. As a federally chartered, FDIC-insured savings association, Bank of Internet USA is subject to extensive regulation by the OTS and the FDIC. Lending activities and other investments of Bank of Internet USA must comply with various statutory and regulatory requirements. Bank of Internet USA is also subject to reserve requirements promulgated by the Federal Reserve Board. The OTS, together with the FDIC, regularly examines Bank of Internet USA and prepares reports for Bank of Internet USAs board of directors on any deficiencies found in the operations of Bank of Internet USA. The relationship between Bank of Internet USA and depositors and borrowers is also regulated by federal and state laws, especially in such matters as the ownership of savings accounts and the form and content of mortgage documents utilized by Bank of Internet USA.
Bank of Internet USA must file reports with the OTS and the FDIC concerning its activities and financial condition, in addition to obtaining regulatory approvals prior to entering into specified transactions such as mergers with or acquisitions of other financial institutions, raising capital or issuing trust preferred securities. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the SAIF and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulations, whether by the OTS, the FDIC or the Congress, could have a material adverse effect on us, Bank of Internet USA and our operations.
Insurance of Deposit Accounts. In February 2006, the Budget Reconciliation Bill (S. 1932) was enacted by the U.S. Congress. The legislation provides for legislative reforms to modernize the federal deposit insurance system. Among other things, provisions in the legislation and subsequent implementing regulations merged the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) into the new Deposit Insurance Fund (DIF) effective March 31, 2006; indexed the $100,000 deposit insurance limit to inflation beginning in 2010 and every succeeding five years while giving the FDIC and the National Credit Union Administration (NCUA) boards authority to determine whether raising the standard maximum deposit insurance is warranted; increased the deposit insurance limit for certain retirement accounts to $250,000 and indexed that limit to inflation; established a general range of 1.15 percent to 1.50 percent within which the FDIC Board of Directors may set the DIF reserve ratio; required certain actions by the FDIC if the reserve ratio varies within this range; and allowed the FDIC Board to set assessments for deposit insurance according to risk for all insured institutions. The legislation granted a one-time initial assessment credit to recognize institutions past contributions to the insurance fund.
The FDIC charges an annual assessment for the insurance of deposits based on the risk a particular institution poses to its deposit insurance fund. This risk classification is based on an institutions capital group and supervisory subgroup assignment. The FDIC may terminate insurance of deposits upon a finding that Bank of Internet USA has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS.
Regulatory Capital Requirements and Prompt Corrective Action. The prompt corrective action regulation of the OTS requires mandatory actions and authorizes other discretionary actions to be taken by the OTS against a savings association that falls within undercapitalized capital categories specified in the regulation.
Under the regulation, an institution is well capitalized if it has a total risk-based capital ratio of at least 10.0%, a Tier 1 risk-based capital ratio of at least 6.0% and a leverage ratio of at least 5.0%, with no written agreement, order, capital directive, prompt corrective action directive or other individual requirement by the OTS to maintain a specific capital measure. An institution is adequately capitalized if it has a total risk-based capital ratio of at least 8.0%, a Tier 1 risk-based capital ratio of at least 4.0% and a leverage ratio of at least 4.0% (or 3.0% if it has a composite rating of 1 and is not experiencing or anticipating significant growth). The regulation also establishes three categories for institutions with lower ratios: undercapitalized, significantly undercapitalized and critically undercapitalized. At June 30, 2008, Bank of Internet USA met the capital requirements of a well capitalized institution under applicable OTS regulations.
In general, the prompt corrective action regulation prohibits an insured depository institution from declaring any dividends, making any other capital distribution, or paying a management fee to a controlling person if, following the distribution or payment, the institution would be within any of the three undercapitalized categories. In addition, adequately capitalized institutions may accept brokered deposits only with a waiver from the FDIC, but are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew or roll-over brokered deposits.
If the OTS determines that an institution is in an unsafe or unsound condition, or if the institution is deemed to be engaging in an unsafe and unsound practice, the OTS may, if the institution is well capitalized, reclassify it as adequately capitalized; if the institution is adequately capitalized but not well capitalized, require it to comply with restrictions applicable to undercapitalized institutions; and, if the institution is undercapitalized, require it to comply with restrictions applicable to significantly undercapitalized institutions. Finally, pursuant to an interagency agreement, the FDIC can examine any institution that has a substandard regulatory examination score or is considered undercapitalized without the express permission of the institutions primary regulator.
OTS capital regulations also require savings associations to meet three additional capital standards:
These capital requirements are viewed as minimum standards by the OTS, and most institutions are expected to maintain capital levels well above the minimum. In addition, the OTS regulations provide that minimum capital levels greater than those provided in the regulations may be established by the OTS for individual savings associations upon a determination that the savings associations capital is or may become inadequate in view of its circumstances. Bank of Internet USA is not subject to any such individual minimum regulatory capital requirement and our regulatory capital exceeded all minimum regulatory capital requirements as of June 30, 2008. See Managements Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources.
Loans-to-One-Borrower Limitations. Savings associations generally are subject to the lending limits applicable to national banks. With limited exceptions, the maximum amount that a savings association or a national bank may lend to any borrower, including related entities of the borrower, at one time may not exceed 15% of the unimpaired capital and surplus of the institution, plus an additional 10% of unimpaired capital and surplus for loans fully secured by readily marketable collateral. Savings associations are additionally authorized to make loans to one borrower by order of the Director of the OTS, in an amount not to exceed the lesser of $30.0 million or 30% of unimpaired capital and surplus for the purpose of developing residential housing, if the following specified conditions are met:
Qualified Thrift Lender Test. Savings associations must meet a qualified thrift lender, or QTL, test. This test may be met either by maintaining a specified level of portfolio assets in qualified thrift investments as specified by the HOLA, or by meeting the definition of a domestic building and loan association under the Internal Revenue Code of 1986, as amended, or the Code. Qualified thrift investments are primarily residential mortgage loans and related investments, including mortgage related securities. Portfolio assets generally mean total assets less specified liquid assets, goodwill and other intangible assets and the value of property used in the conduct of Bank of Internet USAs business. The required percentage of qualified thrift investments under the HOLA is 65% of portfolio. An association must be in compliance with the QTL test or the definition of domestic building and loan association on a monthly basis in nine out of every 12 months. Associations that fail to meet the QTL test will generally be prohibited from engaging in any activity not permitted for both a national bank and a savings association. At June 30, 2008, Bank of Internet USA was in compliance with its QTL requirement and met the definition of a domestic building and loan association.
Liquidity Standard. Savings associations are required to maintain sufficient liquidity to ensure safe and sound operations.
Affiliate Transactions. Transactions between a savings association and its affiliates are quantitatively and qualitatively restricted pursuant to OTS regulations. Affiliates of a savings association include, among other entities, the savings associations holding company and companies that are under common control with the savings association. In general, a savings association or its subsidiaries are limited in their ability to engage in covered transactions with affiliates. In addition, a savings association and its subsidiaries may engage in certain covered transactions and other specified transactions with affiliates only on terms and under circumstances that are substantially the same, or at least as favorable to the savings association or its subsidiary, as those prevailing at the time for comparable transactions with nonaffiliated companies.
The OTS regulations generally exclude all non-bank and non-savings association subsidiaries of savings associations from treatment as affiliates, except to the extent that the OTS or the Federal Reserve Board decides to treat these subsidiaries as affiliates. The regulations also require savings associations to make and retain records that reflect affiliate transactions in reasonable detail and provide that specified classes of savings associations may be required to give the OTS prior notice of affiliate transactions.
Capital Distribution Limitations. OTS regulations impose limitations upon all capital distributions by savings associations, like cash dividends, payments to repurchase or otherwise acquire its shares, payments to stockholders of another institution in a cash-out merger and other distributions charged against capital. Under these regulations, a savings association may, in circumstances described in those regulations:
Community Reinvestment Act and the Fair Lending Laws. Savings associations have a responsibility under the Community Reinvestment Act and related regulations of the OTS to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An institutions failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities and the denial of applications. In addition, an institutions failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in the OTS, other federal regulatory agencies or the Department of Justice taking enforcement actions against the institution.
Federal Home Loan Bank System. Bank of Internet USA is a member of the FHLB system. Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB makes available loans or advances to its members in compliance with the policies and procedures established by the board of directors of the individual FHLB. As an FHLB member, Bank of Internet USA is required to own capital stock in an FHLB in specified amounts based on either its aggregate outstanding principal amount of its residential mortgage loans, home purchase contracts and similar obligations at the beginning of each calendar year or its outstanding advances from the FHLB.
Federal Reserve System. The Federal Reserve Board requires all depository institutions to maintain noninterest-bearing reserves at specified levels against their transaction accounts (primarily checking, NOW, and Super NOW checking accounts) and nonpersonal time deposits. At June 30, 2008, Bank of Internet USA was in compliance with these requirements.
Activities of Subsidiaries. A savings association seeking to establish a new subsidiary, acquire control of an existing company or conduct a new activity through a subsidiary must provide 30 days prior notice to the FDIC and the OTS and conduct any activities of the subsidiary in compliance with regulations and orders of the OTS. The OTS has the power to require a savings association to divest any subsidiary or terminate any activity conducted by a subsidiary that the OTS determines to pose a serious threat to the financial safety, soundness or stability of the savings association or to be otherwise inconsistent with sound banking practices.
Item 1A. Risk Factors
See Management Discussion and Analysis of Financial Condition and Results of Operations - Factors that May Affect Our Performance.
Item 2. Properties
Our principal executive offices, which also serve as our banks main office and branch, are located at 12777 High Bluff Drive, Suite 100, San Diego, California 92130, and our telephone number is (858) 350-6200. This facility occupies a total of approximately 12,300 square feet under a lease that expires in October 31, 2012.
Item 3. Legal Proceedings
We may from time to time become a party to legal proceedings arising in the ordinary course of our business. We are not currently a party to any material legal proceedings, lawsuit or claim.
Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock began trading on the NASDAQ National Market on March 15, 2005 under the symbol BOFI. There were 8,299,563 shares of common stock outstanding held by approximately 115 registered owners as of August 31, 2008. The following table sets forth, for the calendar quarters indicated, the range of high and low sales prices for the common stock of BofI Holding, Inc. for each quarter during the last two fiscal years. Sales prices represent actual sales of which our management has knowledge. The transfer agent and registrar of our common stock is Computershare.
Our board of directors has never declared or paid any cash dividends on our common stock and does not expect to do so for the foreseeable future.
The holders of record of our Series A preferred stock, which was issued in 2003 and 2004, are entitled to receive dividends at the rate of six percent (6%) of the stated value per share of $10,000 per share per year. The holders of record of our Series B preferred stock, which were issued in June, July and August of 2008, are entitled to receive dividends at the rate of eight percent (8%) of the stated value per share of $1,000 per share per year. Dividends on the Series A and Series B preferred stock accrue and are payable quarterly. Dividends on the preferred stock must be paid prior and in preference to any declaration or payment of any distribution on any outstanding shares of junior stock, including our common stock.
Other than dividends to be paid on our preferred stock, we currently intend to retain any earnings to finance the growth and development of our business. Our ability to pay dividends, should our board of directors elect to do so, depends largely upon the ability of our bank to declare and pay dividends to us as our principal source of revenue is dividends paid to us by our bank. Future dividends will depend primarily upon our earnings, financial condition and need for funds, as well as government policies and regulations applicable to us and our bank that limit the amount that may be paid as dividends without prior approval.
Issuer Purchases of Equity Securities
On June 30, 2005, our board of directors approved a common stock buyback program to purchase up to 5% of BofI outstanding common shares when and if the opportunity arises. The buyback program became effective on August 23, 2005 with no termination date. The program authorizes BofI to buy back common stock at its discretion, subject to market conditions. During the fiscal year starting July 1, 2007 through June 30, 2008, the Company did not buy back any of its common shares under this program. Prior to July 1, 2007, a total of 319,500 shares of BofI were purchased under the June 2005 buyback program.
Net Settlement of Restricted Stock Awards
Effective November 2007, the stockholders of the Company approved an amendment to the 2004 Stock Incentive Plan, which among other changes, permitted net settlement of restricted stock awards for purposes of payment of a grantees income tax obligation. During the fiscal year ended June 30, 2008, there were 8,777 restricted stock award shares which were retained by the Company and converted to cash at the rate of $7.39 per share to fund the grantees income tax obligations.
Sale of Unregistered Securities
In June 2008 the Company commenced a private offering of a newly created series of its preferred stock designated Series B 8% Cumulative Convertible Nonparticipating Perpetual Preferred Stock ( the Series B preferred stock). The Series B preferred stock has a liquidation preference of $1,000 per share over shares of common stock. In the event of liquidation, the Series B preferred stock ranks pari passu with the Series A. The Series B preferred stock is entitled to cumulative dividends at a rate of 8.0% per annum when and as declared by the Companys board of directors quarterly in arrears on January 15, April 15, July 15 and October 15 of each year. Each share of Series B preferred stock is immediately convertible at the option of the holder into 111 shares of the Companys common stock, par value $0.01 per share common stock, which is equivalent to a conversion price of $9.00 per share of common stock. Under certain circumstances specified in the certificate of designation governing the Series B preferred stock, the Company may require holders of Series B preferred stock to convert their shares into common stock. Generally, the Series B preferred stock has no voting rights and may be redeemed by the Company at a 5% premium starting in June of 2011, a 3% premium starting in June 2012 or a 2% premium anytime after June 2013.
During the year ended June 30, 2008, the Company issued $3,750,000 of Series B preferred stock representing 3,750 shares at a $1,000 face value. The Company declared dividends to holders of its Series B preferred stock totaling $3, for the year ended June 30, 2008. Subsequent to June 30, 2008, the Company issued another $1,040,000 of Series B preferred stock representing 1,040 shares. The net proceeds of the offering will be used for general corporate purposes, including additional capital funding to support asset growth at the Bank.
Equity Compensation Plan Information
The following table provides information regarding the aggregate number of securities to be issued under all of our stock options and equity-based plans upon exercise of outstanding options, warrants and other rights and their weighted-average exercise prices as of June 30, 2008. There were no securities issued under equity compensation plans not approved by security holders.
Item 6. Selected Financial Data
The following selected consolidated financial information should be read in conjunction with Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations and the audited consolidated financial statements and footnotes included elsewhere in this Form 10-K.
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis contains forward-looking statements that are based upon current expectations. Forward-looking statements involve risks and uncertainties. Our actual results and the timing of events could differ materially from those anticipated in our forward-looking statements due to various important factors, including those set forth under Factors the May Affect Our Performance and elsewhere in this Form 10-K. The following discussion and analysis should be read together with the Selected Financial Data and our consolidated financial statements, including the related notes, included elsewhere in this Form 10-K.
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 generate retail deposits in all 50 states and originate loans for our customers directly through our websites, including www.bankofinternet.com, www.bofi.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 OTS.
Net income for the fiscal year ended June 30, 2008 was $4.2 million, or $0.46 per diluted share, as compared to $3.3 million, or $0.36 per diluted share, in fiscal 2007 and $3.3 million, or $0.34 per diluted share, in 2006. Growth in our interest earning assets, particularly our loans and investment securities, has been the primary driver of the increase in net income. Higher interest earning assets caused net interest income (interest income from loans and investments minus interest expense from deposits and borrowings) to grow to $18.0 million for the fiscal year ended June 30, 2008 compared to $10.8 million for fiscal 2007 and $10.0 million for 2006.
During the year ended June 30, 2008, our net interest margin (net interest income divided by average interest earning assets) increased 36 basis points to 1.72% compared to 1.36% for the year ended June 30, 2007. The improvement in our net interest margin was due primarily to increases in the yields of our loans and securities. During fiscal 2008 we purchased higher yielding loans and mortgage-backed securities. We also sold lower yielding agency mortgage-backed securities and replaced them with higher yielding non-agency securities.
Total assets at June 30, 2008 were $1,194.2 million as compared to $947.2 million at June 30, 2007 and $737.8 million at June 30, 2006. Assets grew $247.0 million or 26.1% during the last fiscal year primarily due to the purchase of mortgage-backed securities and mortgage loan pools, and the origination of RV and home equity loans. These investments were funded with growth in deposits, advances from the FHLB, and borrowings from securities sold under agreements to repurchase. Total assets grew $209.4 million or 28.4% in fiscal 2007 due to the purchase of mortgage-backed securities and the origination and purchase of mortgage loans, and total assets grew $128.3 million or 21.1% in fiscal 2006 from the previous year as a result of the purchase of mortgage-backed securities
On September 7, 2008, the U.S. Treasury, the Federal Reserve and the Federal Housing Finance Agency (FHFA) announced that the FHFA was putting Fannie Mae and Freddie Mac under conservatorship and giving management control to their regulator, the FHFA. The U.S. Treasury also announced that dividends on Fannie Mae and Freddie Mac common and preferred stock were eliminated. Based upon the government announcement, we sold our investment in Fannie Mae Preferred stock on September 8, 2008 at a significant loss. The book value of our Fannie Mae preferred stock investment was $9.1 million at June 30, 2008 and the loss realized after the sale in the first quarter of fiscal 2009 was $7.9 million pretax or approximately $4.7 million after tax.
Our future performance will also depend on many factors, including changes in interest rates, competition for deposits and quality loans, the credit performance of our assets, regulatory actions and our ability to improve operating efficiencies. (See Factors that May Affect our Performance).
Critical Accounting Policies
The following discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements and the notes thereto, which 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.
Investment SecuritiesCurrently, we classify investment securities as either available-for-sale or held to maturity. Securities available for sale are reported at estimated fair value, with unrealized gains and losses, net of the related tax effects, excluded from operations and reported as a separate component of accumulated other comprehensive income or loss. The fair value of securities traded in active markets are obtained from market quotes. If quoted prices in active markets are not available, we determine the fair value from our internal pricing models. Securities that management has the positive intent and ability to hold to maturity are classified as held to maturity and recorded at amortized cost. Amortization of purchase premiums and accretion of discounts on securities are recorded as yield adjustments on such securities using the effective interest method. The specific identification method is used for purposes of determining cost in computing realized gains and losses on investment securities sold.
At each reporting date, we monitor our available-for-sale and held to maturity securities for other-than-temporary impairment. Other-than-temporary impairment losses are recognized in noninterest income with a corresponding reduction in the carrying value of the investment.
Allowance for Loan LossesThe 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 generally 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 loans 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 are calculated by grouping each loan by collateral type and by grouping the loan-to-value ratios of each loan within the collateral type. 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. 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.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following tables set forth, for the periods indicated, 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.
Results of Operations
Our results of operations depend on our net interest income, which is the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities. Our net interest income has grown primarily as a result of the growth in our assets. We also earn non-interest income primarily from prepayment fee income from multifamily borrowers who repay their loans before maturity and from gains on sales of investment securities. The largest component of non-interest expense is salary and benefits, which is a function of the number of personnel, which increased from 25 full time employees at June 30, 2006 to 44 full time equivalent employees at June 30, 2008. We are subject to federal and state income taxes, and our effective tax rates were 40.15%, 40.8%, and 40.0% for the fiscal years ended June 30, 2008, 2007, and 2006, respectively. Other factors that affect our results of operations include expenses relating to occupancy, data processing and other miscellaneous expenses.
Comparison of the Year Ended June 30, 2008 and 2007
Net Interest Income. Net interest income totaled $18.0 million for the fiscal year ended June 30, 2008 compared to $10.8 million for the fiscal year ended June 30, 2007. The following table sets forth the effects of changing rates and volumes on our net interest income. Information is provided with respect to (i) effects on interest income and interest expense attributable to changes in volume (changes in volume multiplied by prior rate); (ii) effects on interest income and interest expense attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) changes in rate/volume (change in rate multiplied by change in volume) for the fiscal year ended June 30, 2008 compared to the fiscal year ended June 30, 2007.
Interest Income. Interest income for the year ended June 30, 2008 totaled $63.3 million, an increase of $18.7 million, or 41.9%, compared to $44.6 million in interest income for the year ended June 30, 2007 primarily due to interest-earning asset growth. Average interest-earning assets for the year ended June 30, 2008 increased by $247.4 million compared to the year ended June 30, 2007 due to the purchase of mortgage-backed and investment securities which increased $202.7 million during the year ended June 30, 2008 compared to 2007. Also increasing by $37.7 million was the average balance of the loan portfolio, primarily the result of our purchase of pools of multifamily and single family loans and the originations of RV and home equity loans. Average interest earning balances associated with our stock of the FHLB increased by $2.1 million in the year ended June 30, 2008 compared to the year ended June 30, 2007 because our required minimum investment increased, in line with our increased advances from the FHLB. For the year ended June 30, 2008, the growth in average balances contributed additional interest income of $13.2 million, and the average rate increase resulted in a net $3.9 million increase in interest income. The average yield earned on our interest-earning assets increased to 6.04%
for the year ended June 30, 2008, up from 5.57% for the same period in 2007 due primarily to the higher yields on our loan portfolio and our mortgage-backed securities portfolio.
Interest Expense. Interest expense totaled $45.3 million for the year ended June 30, 2008; an increase of $11.6 million, compared to $33.7 million in interest expense during the year ended June 30, 2007. Average interest-bearing balances for the year ended June 30, 2008 increased $241.1 million compared to the same period in 2007, due to higher deposit totals from increased customer accounts and additional borrowings from the FHLB. The average interest-bearing balances of advances from the FHLB increased $30.3 million as primarily short term advances were added to replace time deposits. Our addition of short-term fixed rate borrowings is a part of our strategy to manage our interest rate risk. For the year ended June 30, 2008, the growth in the average balance of interest bearing liabilities resulted in additional interest expense of $11.0 million, and increases in interest rates resulted in a net increase of $0.5 million in interest expense. The average rate paid on all of our interest-bearing liabilities increased to 4.64% for the year ended June 30, 2008 from 4.59% for the year ended June 30, 2007. The maturity of lower-rate term deposits and the addition of new term deposits in the first half of the year at higher rates caused the average term deposit rates to increase to 5.06% in fiscal 2008 from 4.89% in fiscal 2007. New lower rate FHLB advances added during the last half of fiscal 2008 caused the average FHLB advance rate to decrease to 4.23% in fiscal 2008 from 4.34% in fiscal 2007. These rate changes in fiscal 2008 were accompanied by an increase in the weighted average rate paid on interest-bearing demand and savings accounts, which increased to 3.59% from 3.37%, and the average rate paid on other borrowings that decreased to 7.16% in fiscal 2008 from 8.01% in fiscal 2007. The increase in the rate paid on checking and savings was due to competitive increases in our rates for money market savings accounts and interest-bearing checking accounts. Our average rate on term deposits increased 17 basis points between fiscal 2008 and 2007.
Provision for Loan Losses. Provision for loan losses was $2.2 million for the year ended June 30, 2008 and a benefit of $25,000 for fiscal 2007. The provisions were made to maintain our allowance for loan losses at levels which management believed to be adequate. 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, loss history and changes in the volume and mix of loans and collateral values.
See Asset Quality and Allowance for Loan Loss for discussion of our allowance for loan loss and the related loss provisions.
Noninterest Income. The following table sets forth information regarding our noninterest income for the periods shown.
Noninterest income totaled $1.4 million for the year ended June 30, 2008 compared to $1.2 million for the same period in 2007. The increase of $199,000 in fiscal 2008 was primarily due to an increase in gain on sale of securities of $308,000, offset by the lower prepayment penalty income of $112,000 and lower mortgage banking income of $91,000. Lower prepayment penalty income in fiscal 2008 was generally the result of fewer new multifamily loans and the expiration of penalties on seasoned multifamily loans. Mortgage banking income decreased due to a reduction in the number of single family and multifamily loans originated for sale.
The increase in gains on sales of securities for fiscal 2008 was partially offset by an other-than-temporary impairment charge on an investment in Fannie Mae preferred stock. The net gain on sale of mortgage-backed securities for fiscal 2008 increased to $1.7 million compared to $0.4 million realized in fiscal 2007. The increased net gain was the result of our strategy to sell lower
yielding government agency mortgage-backed securities and reinvest the proceeds in higher yielding whole loan pool purchases and non-agency AAA mortgage-backed securities. An other-than- temporary-impairment charge of $1.0 million partially offset the realized gains and was recorded as of June 30, 2008 as a result of the decline in the market value of our $10.1 million investment in Fannie Mae (FNMA) 8 1/4% Series S FNMA Preferred stock. Subsequent to June 30, 2008, the U.S. Treasury, the Federal Reserve and the Federal Housing Finance Agency (FHFA) announced that the FHFA was putting Fannie Mae and Freddie Mac under conservatorship and giving management control to their regulator, the FHFA. The U.S. Treasury also announced that dividends on the FNMA Preferred stock were eliminated. Based upon the government announcement of the conservatorship and the elimination of dividends on FNMA Preferred, the Bank sold on September 8, 2008 its entire position in FNMA Preferred at a realized loss of an additional $7.9 million or approximately $4.7 million after income tax.
Noninterest Expense. The following table sets forth information regarding our noninterest expense for the periods shown:
Noninterest expense totaled $10.2 million for the year ended June 30, 2008, an increase of $3.7 million compared to fiscal 2007. Salaries, employee benefits and stock-based compensation increased $2.4 million during fiscal 2008 due primarily to the addition of staffing for RV and home equity loan products and the addition of our new CEO. Included in the $2.4 million increases was $675,000 of one-time expense related to the new CEO and a contract amendment of the former CEO. Professional services increased $117,000 in fiscal 2008 compared to 2007 generally due to an increase in professional, legal services and consulting fees associated with Bank pool purchases and product development. Data processing and Internet expenses increased $70,000 in fiscal 2008 compared to fiscal 2007 due to increases in service bureau charges associated with new deposit and loan customers and additional software for investment securities. Advertising and promotion expense increased $166,000, primarily due to increased activity for our new home equity loan products. FDIC and OTS regulatory fees increased $506,000 due to higher standard assessment rates and due to the deposit and asset growth of the Bank. Other general and administrative costs increased in fiscal 2008 mainly due increases in loan expenses of $173,000 compared to fiscal 2007.
Income Tax Expense. Income tax expense was $2.8 million for the year ended June 30, 2008 compared to $2.3 million for fiscal 2007. Our effective tax rates were 40.15% and 40.8% for the year ended June 30, 2008 and 2007, respectively. The decrease in the effective tax rate is primarily due to higher level of non-taxable dividend income.
Comparison of the Years Ended June 30, 2007 and 2006
Net Interest Income. Net interest income totaled $10.8 million for the fiscal year ended June 30, 2007 compared to $10.0 million for the fiscal year ended June 30, 2006. The following table sets forth the effects of changing rates and volumes on our net interest income. Information is provided with respect to (i) effects on interest income and interest expense attributable to changes in volume (changes in volume multiplied by prior rate); (ii) effects on interest income and interest expense attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) changes in rate/volume (change in rate multiplied by change in volume) for the fiscal year ended June 30, 2007 compared to the fiscal year ended June 30, 2006.
Interest Income. Interest income for the year ended June 30, 2007 totaled $44.6 million, an increase of $11.9 million, or 36.4%, compared to $32.7 million in interest income for the year ended June 30, 2006. Earning asset growth and higher average rates contributed to the increase in interest income. Average interest-earning assets for the year ended June 30, 2007 increased by $140.3 million compared to the year ended June 30, 2006 due to the purchase of mortgage-backed and investment securities which increased $154.8 million during the year ended June 30, 2007 compared to 2006. Partially offsetting the increase was a $20.9 million decrease in the average balance of the loan portfolio, primarily the result of our multifamily and single family loan payoff in excess of originations and purchases. The mortgage-backed securities we purchase provide a guarantee from a government sponsored entity like FNMA, while single-family whole loan originations and purchases do not have a credit guarantee and the mortgage-backed securities offer increased liquidity compared to whole loans. Average interest earning balances associated with our stock of the FHLB increased by $2.4 million in the year ended June 30, 2007 compared to the year ended June 30, 2006 because our required minimum investment increased, in line with our increased advances from the FHLB. For the year ended June 30, 2007, the growth in average balances contributed additional interest income of $5.2 million, and the average rate increase resulted in a net $6.7 million increase in interest income. The average yield earned on our interest-earning assets increased to 5.57% for the year ended June 30, 2007, up from 4.96% for the same period in 2006 due primarily to the higher yields on our loan portfolio and our mortgage-backed securities portfolio. Loan rate increases from adjustable rate loans contributed to the increase in the loan portfolio yield. In the second half of fiscal 2007, we originated higher yielding home equity and RV loans which also contributed to the increase in loan yield. Higher market rates on new loan pools and mortgage-backed securities purchases also caused the increase in the yield on earning assets.
Interest Expense. Interest expense totaled $33.7 million for the year ended June 30, 2007, an increase of $10.9 million, compared to $22.8 million in interest expense during the year ended June 30, 2006. Average interest-bearing balances for the year ended June 30, 2007 increased $142.5 million compared to the same period in 2006, due to higher deposit totals from increased customer accounts and additional borrowings from the FHLB. The average interest-bearing balances of advances from the FHLB increased $46.1 million as primarily new 5- and 10-year fixed-rate advances were added. Our addition of long-term fixed rate borrowings is a part of our strategy to manage our interest rate risk. For the year ended June 30, 2007, the growth in the average balance of interest bearing liabilities resulted in additional interest expense of $4.6 million, and increases in interest rates resulted in a net increase of $6.4 million in interest expense. The average rate paid on all of our interest-bearing liabilities increased to 4.59% for the year ended June 30, 2007 from 3.84% for the year ended June 30, 2006. The maturity of lower-rate term deposits and the addition of new term deposits at higher rates caused the average term deposit rates to increase to 4.89% in fiscal 2007 from 4.01% in fiscal 2006. Similarly, new higher rate FHLB advances added during fiscal 2007 caused the average FHLB advance rate to increase to 4.34% in fiscal 2007 from 3.86% in fiscal 2006. These rate changes in fiscal 2007 were accompanied by an increase in the weighted average rate paid on interest-bearing demand and savings accounts, which increased to 3.37% from 2.82%, and the average rate paid
on other borrowings that increased to 8.01% in fiscal 2007 from 7.02% in fiscal 2006. The increase in the rate paid on checking and savings was due to competitive increases in our rates for money market savings accounts and interest-bearing checking accounts. Our average rate on term deposits increased 88 basis points between fiscal 2007 and 2006. Long-term U.S. Treasury rates, which generally influence our mortgage market rates, did not move proportionally higher and the yield curve inverted during fiscal 2007. As a result, the rate on our loan portfolio increased only 55 basis points. Deposit market rates increased faster than loan rates in fiscal 2007 causing our net interest margin to decline to 1.36% from 1.51% in fiscal 2006.
Provision for Loan Losses. Provision for loan losses was a benefit of $25,000 for the year ended June 30, 2007 and an expense of $60,000 for fiscal 2006.
See Asset Quality and Allowance for Loan Loss for discussion of our allowance for loan loss and the related loss provisions.
Noninterest Income. The following table sets forth information regarding our noninterest income for the periods shown:
Noninterest income totaled $1.2 million for the year ended June 30, 2007 compared to $1.3 million for the same period in 2006. The decrease of $0.1 million in fiscal 2007 was primarily due to the lower prepayment penalty income of $322,000, lower mortgage banking income of $196,000, partially offset by an increase in gain on sale of securities. Lower prepayment penalty income was generally the result of fewer new multifamily loans and the seasoning and expiration of penalties on seasoned loans. Mortgage banking income decreased due to a reduction in the number of single family and multifamily loan originated for sale. The increase in gains on sales of securities resulted from mortgage backed securities that were sold primarily to provide proceeds to invest in higher yielding investment securities and whole loans.
Noninterest Expense. The following table sets forth information regarding our noninterest expense for the periods shown.
Noninterest expense totaled $6.5 million for the year ended June 30, 2007, an increase of $0.7 million compared to fiscal 2006. Salary expense increased $116,000 due primarily to the addition of staff to accommodate the addition of RV and home equity loan products. Stock-based compensation increased for the year ended June 30, 2007 by $82,000 due to additional stock option and
restricted stock grants in July 2006. Professional services increased $94,000 in fiscal 2007 compared to 2006 generally due to an increase in professional filing services and consulting fees. Data processing and Internet expenses increased $95,000 in fiscal 2007 compared to fiscal 2006 due to increased development costs for new websites and increases in service bureau charges associated with new deposit and loan customers. Advertising and promotion expense increased $246,000, primarily due to increased activity for our new home equity loan products.
Income Tax Expense. Income tax expense was $2.3 million for the year ended June 30, 2007 compared to $2.2 million for fiscal 2006. Our effective tax rates were 40.8% and 40.0% for the year ended June 30, 2007 and 2006, respectively. The increase in the effective tax rate is primarily due to adjustments for the tax treatment for incentive stock options.
Comparison of Financial Condition at June 30, 2008 and June 30, 2007
Total assets increased by $247.0 million, or 26.1%, to $1,194.2 million at June 30, 2008 from $947.2 million at June 30, 2007. The increase in total assets resulted primarily from purchases of non-agency AAA mortgage-backed securities net of sales of U.S. agency securities and repays, resulting in increases in mortgage-backed securities of $152.0 million. Also, we increased loans by $123.5 million through pool purchases and originations. Total liabilities increased by $236.8 million, or 27.1%, to $1,111.2 million at June 30, 2008 from $874.4 million at June 30, 2007. The increase in total liabilities resulted primarily from growth in short-term advances from FHLB of $171.7 million.
Stockholders equity increased by $10.2 million, or 14.0%, to $83.0 million at June 30, 2008 from $72.8 million at June 30, 2007. The increase was the result of $4.2 million in net income and the issuance of Series B preferred stock of $3.8 million, the increase in comprehensive income of $1.9 million, and additional paid in capital of $0.9 million resulting from the exercise of stock options and stock-based compensation expense.
Our net deposit growth of $22.8 million during the fiscal year ended June 30, 2008 resulted from a $50.9 million net increase in checking and savings account balances offset by a $28.1 million decrease in time deposits. The increase in checking and savings and the decrease in time deposits are the result of lower rates being offered on time deposits. The additional proceeds from our liability and equity growth were invested in originations and purchases of loans held for investment, which totaled $270.0 million for the year ending June 30, 2008. Also, to supplement our loan activity, we purchased $493.2 million in mortgage-backed and investment securities. We increased our purchases of mortgage-backed securities during the year ended June 30, 2008 because we believed they provided better risk adjusted yields than certain single family whole loan originations or whole loan pools. We expect to continue to purchase mortgage-backed securities to supplement our loan portfolio in the next fiscal year.
Asset Quality and Allowance for Loan Loss
Nonperforming loans and foreclosed assets or nonperforming assets consisted of the following:
The increase in nonperforming loans at June 30, 2008 compared to 2007 was due primarily to one commercial mortgage loan for $2.4 million which was in the foreclosure process at June 30, 2008. No reserve for impairment was allocated to the $2.4 million loan based upon a current appraisal of the collateral. The 1.8 million in single family nonperforming loans represents six loans in four states ranging in amounts from $399,000 to $97,000. The increase in nonperforming single family loans reflects the nationwide downturn in residential housing values. If residential housing values continue to decline, we are likely to experience growth in the level of nonperforming and foreclosed loans in future periods.
The Bank had one single family mortgage loan with an outstanding principal balance of $421,000 which was considered a troubled debt restructuring at June 30, 2008. A troubled debt restructuring is a performing loan with temporary modifications of principal and interest payments or an extension of maturity dates. Under these arrangements, loan terms are typically reduced to no less than a required monthly interest payment. If the borrower is unable to return to scheduled principal and interest payments at the end of the modification period, foreclosure procedures will be initiated. There were no troubled debt restructurings at the end of fiscal 2007 or at any prior fiscal year end.
Allowance for Loan Losses
We maintain an allowance for loan losses in an amount that we believe is sufficient to provide adequate protection against probable incurred losses in our loan portfolio. We evaluate quarterly the adequacy of the allowance based upon reviews of individual loans, recent loss experience, current economic conditions, risk characteristics of the various categories of loans and other pertinent factors. The evaluation is inherently subjective, as it 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. The allowance is decreased by the amount of charge-offs of loans deemed uncollectible and increased by recoveries of loans previously charged off.
Under our allowance for loan loss policy, impairment calculations are determined based on general portfolio data for general reserves and loan level data. Specific loans are evaluated for impairment and are generally classified as nonperforming or in foreclosure if they are 90 days or more delinquent. A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors that we consider 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 loans effective interest rate or the fair value of the collateral if repayment of the loan is expected from the sale of collateral.
General loan loss reserves are calculated by grouping each loan by collateral type and by grouping the loan-to-value ratios of each loan within the collateral type. An estimated impairment 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. We use an allowance rate that provides a larger loss allowance for loans with greater loan-to-value ratios, measured at the time the loan was funded. The internal asset review committee of our board of directors reviews and approves the banks calculation methodology. Specific reserves are to be 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.
The following table sets forth the changes in our allowance for loan losses, by loan type, from July 1, 2003 through June 30, 2008: