As hard as it may be to believe, big bank stocks have performed fairly well this year. The Select Sector SPDR-Financial (NYSE: XLF), the largest ETF tracking major bank stocks, is up 10.3% year-to-date. Despite all the recent controversy pertaining to a $2 billion loss tied to complex credit securities trading (the loss is expected to be much larger), Dow component JPMorgan Chase (NYSE: JPM) is clinging to an 8.2% year-to-date gain. Those are good numbers, but not nearly as good as our microcap stock pick which is up 18% YTD.

Even Citigroup (NYSE: C) is higher on the year and Bank of America (NYSE: BAC) can at least say it was the Dow’s best-performing stock in the first quarter. Those superlatives aside, the major U.S. money center banks are still a group fraught with more peril than potential for investors.

Combine the headline risk tied to U.S. banks’ exposure to European sovereign debt with the fact that trading revenues are declining and mergers and acquisitions activity has all but ground to a halt, and it’s easy to see why big bank stocks are still big risks.

Enter…Bank of Internet

The good news for investors seeking exposure to the financial services sector is that there are legitimate opportunities for significant capital appreciation. One of those opportunities comes courtesy of a micro-cap name many investors aren’t yet familiar with, BofI Holding, Inc. (Nasdaq: BOFI), the parent company of BofI Federal Bank…aka…the Bank of [the] Internet.

San Diego-based BofI has a market cap of just $219 million, putting the company firmly in micro-cap territory and that might be one reason the stock isn’t a household name. To that point, this isn’t a new stock, either. BofI has been trading for more than seven years and in that time has returned almost 61%.

BOFI up 61%…XLF down 48%

Over the same time, XLF has plunged more than 48%, indicating we really don’t need to engage in side-by-side comparisons of BofI against major bank stocks because it’s pretty safe to assume BofI will be the winner in almost all instances.

A large part of the allure with BofI is the bank’s ability to keep costs low, which partially stems from the fact they have just one branch in San Diego. Despite having just one physical location, BofI is able to offer services in all 50 states. After all, it is the “Bank of the Internet.”

Branchless banking is a big key

The one branch factoid may not seem like much, but consider this: Branches cost major banks money; a lot of money…either through leases or owning the property outright. Then there is the cost of paying all those folks to work in the branches, paying for utilities, cleaning services and related fare.

None of that stuff is free and it explains why when you walk into a Bank of America or Wells Fargo branch, they tell you about the ATM machine as if you’ve never heard of it before. The banks want customers to use ATM machines so they can move toward closing more branches to save money.

Unfortunately for the big banks, it will be decades longer before they completely wean their customers off branch usage (even though branch traffic has dropped significantly in the last 10-15 years) and that’s decades of money flowing out the door to support branches. Thing is, that’s the shareholders money that’s going out the door.

There is no such concern with BofI, which is one of a small number of pure-play, Internet-based consumer banks that has a stock trading on a major stock exchange. That’s not the only good news about the BofI story. Consider the following:

“If you would also rather own a bank stock that has few of the loan loss issues plaguing its competition, that trades at a discount despite posting better operating performance relative to its peer group, that has delivered solid performance in good times and bad, then you need to check out BOFI,” according to Stone Street Capital Advisors.

INVESTMENT OVERVIEW: BofI will continue to be the beneficiary of structural and cyclical changes in the banking industry; higher regulatory costs for large, global institutions; reduced nuisance fees; no toxic/legacy assets tying up capital; ability to provide similar products and superior customer service at a lower cost. Add to that an experienced management team and multiple new business initiatives and you have a recipe for success.

It’s understandable that many investors may feel like this isn’t the time to own bank stocks and who could generally argue with that assessment? However, BofI doesn’t fit into that generalization.

Bottom Line Recommendation for BOFI

BOFI is making new highs…almost weekly. And with consumer service preferences continuing to shift toward the Internet (62% in 2011 vs 23% in 2007…ABA) there is a lot of upside to this name. BOFI is one microcap stock you had better not just keep on your radar…it belongs in your portfolio.

Mike Casson
Executive Editor
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