Investors Are Betting Big Against BofI Holdings. Are They Right?
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As far as battleground stocks go, BofI Holdings (NASDAQ: BOFI) -- commonly referred to as the Bank of the Internet -- is at the head of the class. Starting with fraud allegations surfacing in May of 2015, the company has been dogged by short-sellers and lawyers with an axe to grind. As it stands today, 36% of BofI's float is sold short.
But between August and December, shares have exploded, nearly doubling. Does that mean that the short-sellers have given up, and that the good times are set to roll at BofI once again?
Perhaps, but the answers aren't anywhere near as clear as shareholders might have hoped. Here's why.
The original complaint
This entire incident began when Matt Erhart, a former employer working in the company's internal audit department, filed a suit against BofI for wrongful termination.
The details he provided in his filings were the stuff that soap operas are made of: allegations of the CEO Greg Garrabrants laundering money through the bank, a toxic culture where cover ups and lying to the authorities were encouraged, and dangerous business practices where risks were much higher than what was being reported.
In the month immediately following this filing, the company's shares tanked 45%. The company held an immediate press conference to deny many of the allegations, but at the time, it had little effect.
The aftermath
Since Erhart's complaint was filed almost 20 months ago, the company has been squarely in the cross hairs of short-sellers. Numerous hit pieces have shown up on popular blogging sites. But perhaps the most damning came not from short-sellers, but from lawyers representing the Houston Municipal Employees Pension System.
The group contends that it has checked in with up to nine former employees, and they confirm -- to varying levels -- the accusations that Erhart threw at the company. One stated, "internal controls were whatever Greg [Garrabrants] wanted them to be," with another accusing, "it started to become very rare that we would deny a loan." The stock once again dipped significantly following this filing, dropping 25% over the next two days.
Is there another shoe that's about to drop?
BofI's performance, however, has defied all of the detractors. While the company hasn't enjoyed quite the same growth rates that it has in years past, that is to be expected from any growing company. What's important is that BofI's deposits and loan portfolios have continued to grow at enviable clips, 33% and 25%, respectively, during the most recent quarter.
Meanwhile, Garrabrants has continued to deny any and all accusations flung at the company. The court case with Erhart has yet to get meaningfully under way, as well as the case with the Houston group. That leaves very little to surface in the form of a "smoking gun."
Investors are left in a very precarious situation as a result. If nothing turns up in the allegations, and BofI's loans are indeed every bit as safe as they say they are, we are looking at a very cheap stock relative to its long-term potential.
There are two things that could happen this year that would cause the stock to plummet. The first would be any major finding by regulators or courts that demonstrate orchestrated fraud taking place. The second would be bad loans coming home to roost, probably spurred by external circumstances like a decline in the California real estate market where many of BofI's loans are.
How I'm approaching the situation
So far, I've been against buying shares of BofI. For a long time, that was a wise stance to take. But over the past few months, the market has acted as if the chance of fraud is less. If that's the case, betting against the company would unequivocally be a bad decision. That's why I have no shares sold short of the company.
At the same time, I have absolutely no interest in owning shares. There are too many factors adding up to a probably toxic culture. For starters, reviews by former employees on Glassdoor.com -- both before and after the short-sellers began hammering the company -- paint a very unhealthy situation.
As to whether or not the short-sellers will be proven right, only time will tell. As I'm not a banking expert myself, I am making my decision based on the cultural evidence available. How you choose to make a decision will be highly personal. The important thing is to enter the investment with eyes wide open.
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Brian Stoffel has no position in any stocks mentioned. The Motley Fool owns shares of and recommends BofI Holding. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.