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An Internet Mortgage Provider Reaps the Rewards of Lending Boldly

Gregory Garrabrants has been the chief executive of BofI Holding, Bank of Internet’s parent company, since 2007.Credit...Dustin Michelson for The New York Times

You have substantial assets, but your income is erratic and your finances are what in polite company would be called “complex.” Your credit history may contain a smudge or two. Yet you would like to buy one more luxury apartment.

Major banks like Wells Fargo and JPMorgan Chase are not eager to give you the $3 million mortgage you need, nor are any traditional banks that specialize in making big-dollar home loans to higher-income clients.

If that’s your profile, Gregory Garrabrants may be your man.

As the leader of Bank of Internet USA, based in San Diego, Mr. Garrabrants has been issuing big mortgages to high earners whom other lenders might not necessarily welcome with open arms. But because its financial performance has, in many ways, been spectacular, Bank of Internet has been turning heads — and setting off alarm bells as well. The bank has made loans to people who were later found to have run afoul of the law, and Mr. Garrabrants has had to reassure investors that the bank has good relations with regulators.

Bank of Internet’s loans have increased fivefold, to nearly $5 billion, over the last five years — an almost unheard-of rate of growth for these tepid times in banking. Its losses from bad loans are practically nonexistent, and profits are surging, in part because it charges a much higher interest rate than the bigger banks operating in the same market.

“I am passionate about what we do here, and I believe in it,” Mr. Garrabrants said in one of several telephone interviews in recent weeks. “We are proud of what we are doing here. We try to really run a good, ethical shop, and I want people to know that.”

The bank’s stock has risen a staggering 1,600 percent since Mr. Garrabrants came on board in 2007 as chief executive of BofI Holding, the parent of Bank of Internet, with fortunate timing: He left IndyMac, a large lender that collapsed under the weight of its mortgage losses less than a year later.

Now that much of the mortgage industry involves little more than churning out government-backed cookie-cutter loans, Bank of Internet is an intriguing reminder of the money that can be made when a bank dares to take a chance on borrowers and then keeps those loans on its books. And in an environment of prim conformity after the housing bust, it may be viewed as a fascinating test case: Can bankers venture beyond the guardrails to make riskier loans without getting into serious trouble?

Some investors are already betting that Bank of Internet’s amazing run will fizzle. Short-sellers, who try to profit from a decline in a company’s shares, have increased their wagers against Bank of Internet in the last 12 months.

They contend that the bank is attracting people who simply can’t get cheaper loans — borrowers who may be more risky. Bank of Internet also makes large mortgages to wealthy foreigners, a practice that requires meticulous controls to comply with federal regulations aimed at stopping money laundering. The bank’s critics wonder whether its compliance department is up to the task, though Mr. Garrabrants vigorously defended its practices. They also take issue with the bank’s funding, contending that the lender is too dependent on customer deposits that could evaporate if turbulence returns to the banking world.

“The reality is you are getting a 2005-style jumbo mortgage lender (with other odd high-risk loans) funded primarily by high-cost brokered deposits,” John Hempton, the manager of Bronte Capital, wrote on his blog in April.

To naysayers like Mr. Hempton, then, Bank of Internet is not that different from some of the go-go lenders — like Countrywide Financial, Washington Mutual and IndyMac — that made mortgages to wealthy people with complicated finances before the financial crisis of 2008.

Mr. Garrabrants, who has also worked at Goldman Sachs and McKinsey & Company, says the critics are spreading disinformation — and losing money — as they bet against his firm’s soaring stock.

“Here’s the problem for them: They are going into an earnings juggernaut that has none of the things that they’re talking about,” Mr. Garrabrants said. And he says the bank is as judicious as any other lender in picking its borrowers. “It’s about being thoughtful about what risks you take and watching them and being careful,” he said, adding that Bank of Internet’s deposits are a reliable source of funding.

Bank of Internet USA has always been something of a curiosity. It was formed 16 years ago during the first dot-com boom, and, as its name suggests, it has no bricks-and-mortar branches, eliminating many costs. Its website isn’t flashy. And the bank attracts money by offering relatively high deposit rates. In turn, much of that money is used for mortgage loans. The bank relies heavily on independent mortgage brokers to bring it borrowers, but the last housing boom showed that it can be hard to control the quality of loans that come in from mortgage brokers.

Even so, its broker network is helping Bank of Internet grow like a weed. It holds $2.72 billion of “single-family” mortgages, for example, up 215 percent from $864 million in mid-2012. Mr. Garrabrants says the average interest rate on its mortgages is just below 5 percent, far higher than the rates charged by banks that also focus on wealthy borrowers. For instance, the average rate on mortgages at First Republic Bank, which also caters to a wealthy clientele, was 3.01 percent in the second quarter, according to the bank’s financial filing.

Bank of Internet’s profits are surging, and Mr. Garrabrants disputes the argument that he is scooping up less dependable borrowers that are willing to pay more because they can’t get cheaper loans elsewhere. Many borrowers, he said, are willing to pay higher rates because his bank can provide carefully thought-out loans that fit its customers’ needs more quickly than other lenders. In addition, other banks’ screening processes sometimes exclude well-heeled borrowers who are safe bets, he said.

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Mr. Garrabrants at the new Bank of Internet offices in California. Profits are surging, in part because the bank dares to take a chance on some borrowers, and charges much higher interest than bigger banks in the same market. His bank’s critics, he says, are spreading disinformation — and losing money — as they bet against the firm’s soaring stock.Credit...Dustin Michelson for The New York Times

Steve McRory, a Florida mortgage broker who works with Bank of Internet, said, “They are doing what they can to cobble and stitch together income to make sure the borrowers have the ability to repay the loans, versus just saying no.”

Still, Bank of Internet has lent money to some unsavory characters. For example, in 2012 it issued a $5 million mortgage to Purna Chandra Aramalla on a house in Sands Point, an affluent section of Long Island, according to local property records. In 2013, federal law enforcement authorities in New York charged Mr. Aramalla with Medicare and Medicaid fraud. In March, he was sentenced to three years in prison.

In mid-2014, Bank of Internet lent $1.05 million to Frederic Elm for a house in Fort Lauderdale, Fla., property records show. In January, the Securities and Exchange Commission accused Mr. Elm of running a “Ponzi-like” scheme that had raised $17 million since November 2013. Mr. Elm partly settled with the agency in June.

And in 2012, Bank of Internet issued a $1.26 million mortgage to Deepal Wannakuwatte, a Sacramento businessman who received a 20-year prison sentence last year for operating, for more than 10 years, what the F.B.I. called a Ponzi scheme.

Mr. Garrabrants defended his practices in an email. “It is unfair to characterize our borrowers’ profiles as different than other banks that serve high-net-worth customers,” he said. “You would easily be able to find lawsuits and an occasional legal issue if you scanned First Republic or another bank with high-net-worth borrowers as well.”

Bank of Internet has lent to people who have failed to pay loans made by other banks. For instance, last year it made a $4.8 million mortgage on a home in Coral Gables, Fla., that belongs to John H. Ruiz, a prominent Miami lawyer. SunTrust, a large regional bank, is currently suing Mr. Ruiz and his wife, asserting that they failed to make payments on a nearly $3 million promissory note.

Mr. Ruiz said that Bank of Internet was aware of the SunTrust dispute when it made the mortgage. In a text message, Mr. Ruiz said he was happy with his loan from Bank of Internet, and added, “Because of the economic downturn, everyone can benefit from a lender like BofI that understands the challenges in the marketplace.”

In certain cases, and after careful scrutiny, Mr. Garrabrants said, Bank of Internet may decide to lend to people who have defaulted on past loans. He declined to comment specifically on its loan to Mr. Ruiz.

If Bank of Internet’s borrowers do have problems later, the bank, in theory, has an important fallback. Just over half of its single-family mortgages do not exceed 60 percent of the value of a property, and an additional third do not exceed 70 percent, according to the bank’s filings. That means that if it repossessed and sold such properties, their value would have to fall 30 to 40 percent for the bank to take losses. “I don’t think they’ve ever had a single dollar charged off on any single-family residential mortgage that they’ve originated,” said Bob Ramsey, a bank analyst at FBR Capital Markets.

But with certain customers, Bank of Internet could end up with less protection. That could happen when it lends more than once to the same borrower, a practice that shows up in public real estate records. In such cases, Mr. Garrabrants said, Bank of Internet might require that borrowers pledge types of collateral other than just real estate.

Still, in rocky economic times, steep declines in home prices might whittle away much of the cushion that Bank of Internet builds into its loans. And it is not clear that the bank has enough financial protection against loan defaults. Its reserve for bad loans, for instance, is equivalent to 0.54 percent of its loans, according to an analysis of data in the bank’s filings. That number is slightly below the percentage for First Republic, which, in general, appears to have safer borrowers.

Then there are questions about Bank of Internet’s marketing of itself as a lender to “foreign nationals.” It does not disclose exactly what proportion of its loans are made to foreigners. When asked, Mr. Garrabrants said it was “nowhere near the majority.” Banks that do this sort of lending can expect extra scrutiny from federal regulatory agencies, which have punished banks for not properly applying bank secrecy and anti-money-laundering laws when vetting their international customers.

In recent months there has been unrest in the division of Bank of Internet that deals with regulatory compliance. Earlier this year, a senior internal auditor, Jonathan Ball, and another employee in the division, Matt Erhart, left the bank. Mr. Ball did not respond to requests for comment. Mr. Erhart’s lawyer, Carol L. Gillam, said that she had communicated with regulators, including the Office of the Comptroller of the Currency, the bank’s primary regulator. She declined to provide details.

Regulators have not publicly warned or penalized the bank for its lending to foreign nationals, and Mr. Garrabrants often sounds exasperated when defending that business. In his view, short-sellers had sought to stir up concerns about those loans to try to persuade regulators to stop Bank of Internet from acquiring parts of H&R Block’s banking unit. The deal was concluded this month.

And, according to Mr. Garrabrants, regulators have inspected Bank of Internet’s processes for vetting loans to foreigners — and given the bank positive feedback. “We’ve had full regulatory review of that process and specific compliments on it,” he said, noting that the review took place after the two internal auditors left. “It is beyond a nonissue.” The Office of the Comptroller of the Currency declined to comment on Bank of Internet or any interactions with the bank.

Bank of Internet recently closed another fiscal year, reporting net profit of $83 million, nearly 50 percent higher than in the previous one. Those earnings were equivalent to 18 percent of the bank’s shareholder capital, an astonishing return in these humdrum times in banking.

“It’s a great business,” Mr. Garrabrants said, “and the sole thing that keeps us from growing it more is that we’re just trying to make sure that we don’t make mistakes.”

A version of this article appears in print on  , Section BU, Page 1 of the New York edition with the headline: The Rewards of Lending Boldly. Order Reprints | Today’s Paper | Subscribe

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