Bank of Internet USA has never hidden its contrarian streak.
Near the height of the mortgage boom in 2005, the San Diego thrift quit originating mortgages, rather than compete with lenders offering interest-only, option adjustable-rate, and low-documentation loans, and it started investing more heavily in mortgage-backed securities.
Now many others are curtailing their mortgage lending and trying to unload loans they cannot securitize, but the $1.2 billion-asset, Internet-based unit of B of I Holding Inc. is selling its securities and using the proceeds to buy mortgages from other institutions, mostly outside California. Over the last year it has been originating second mortgages to prime customers, and this month it plans to start originating primary mortgages in markets it serves.
"I think the time is right" to ramp up mortgage lending, said Gregory Garrabrants, Bank of Internet's chief executive. Borrowers "are being more reasonable — they are willing to put more money down, and a lot of lenders have left the market."
Bank of Internet's earnings and net interest margins suffered when it stopped originating mortgages, but its management team was determined to preserve its credit quality and avoid the oversized risks it saw the industry taking, Mr. Garrabrants said. (His predecessor, Gary Lewis Evans, made the decision to stop originations. Mr. Evans remains the thrift's president and chief operating officer.)
But since it started shifting away from agency mortgage-backed securities and investing in loans, its margins and profits have improved.
Its net interest margin rose 103 basis points from a year earlier, to 2.42% at June 30, and its earnings for its fiscal fourth quarter, which ended June 30, almost doubled, to $1.8 million.
Ron Shevlin, a senior analyst at Aite Group LLC, agreed that Bank of Internet's renewed focus on lending — given its strong capital levels, its clean balance sheet, and the reduced competition in the market — was well timed.
"It is probably a very good strategy for them, because they are starting off with a stronger balance sheet and a good understanding of what is performing," he said.
Some industry watchers said there is still a danger that housing prices will continue falling, and that the thrift could have trouble recouping its losses if borrowers default.
The decision to start lending again "could be too soon," said Dan Arnold, an associate director at Sandler O'Neill & Partners LP. "This is obviously increasing the risk in their portfolio."
Mr. Garrabrants said he is aware of the risk, though he pointed out that real estate values have already fallen 40% in some markets.
In any event, he said, Bank of Internet is "cherry picking" the best loans and the best borrowers. The average Fair Isaac Corp. score of its second mortgage borrowers is 770, and as of June 30 it had not reported any delinquencies or losses on the loans.
Richard Levenson, the president of the San Diego investment banking firm Western Financial Corp., said the interest rate risk of funding today's 30-year mortgages with tomorrow's deposits could put a crimp on Bank of Internet's earnings down the road.
"You can bet the interest rate is going to go up over the next few years," Mr. Levenson said. "That is the down side, and one of the reasons banks like to originate loans, get the fee, and retain the servicing, but they sell to Fannie Mae or Freddie Mac, so they eliminate the interest rate risk."
Mr. Garrabrants said that Bank of Internet is managing this risk carefully, and that the Office of Thrift Supervision classifies its interest rate risk as minimal. He said it funds loans with certificates of deposit that have durations of 60 months, as well as with Federal Home Loan bank borrowings.
The thrift still expects some writedowns this quarter on its investment in Fannie preferred stock, for which it took a $1 million pretax writedown for the fiscal fourth quarter.
Still, Mr. Garrabrants said Bank of Internet has the capital to cover expected losses, since its holding company raised $5 million in a private placement of preferred stock in recent months. Its Tier 1 risk-based capital ratio was 13.95% at the end of June, and its total risk-based capital ratio was 14.4%.
Brian Chappelle, a former Department of Housing and Urban Development official and now a mortgage industry consultant and partner at Potomac Partners, said Bank of Internet should be commended for its decision to stop mortgage lending when it did, especially since mortgages were once the thrift's staple product.
"In 2005, 2006, and early 2007 is when there was this total infatuation with these alternative mortgage products," he said. "They definitely did the right thing at the right time. That's for sure. They haven't had the credit or capital reserve loss issues."
