S-1/A 1 a01836a3sv1za.htm BOFI HOLDING, INC.- AMENDMENT NO.3 - 333-121329 sv1za
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As filed with the Securities and Exchange Commission on March 11, 2005
Registration No. 333-121329


SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


AMENDMENT NO. 3

TO

Form S-1

REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

BofI Holding, Inc.

(Exact name of registrant as specified in its charter)
         
Delaware   6035   33-0867444
(State or other jurisdiction of
incorporation or organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification No.)

BofI Holding, Inc.

12220 El Camino Real, Suite 220
San Diego, CA 92130
(858) 350-6200
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

Gary Lewis Evans

President and Chief Executive Officer
BofI Holding, Inc.
12220 El Camino Real, Suite 220
San Diego, CA 92130
(858) 350-6200
(Name, address, including zip code, and telephone number,
including area code, of agent for service)


Copies to:

     
Allen Z. Sussman, Esq.
  Ellen R. Marshall, Esq.
Charles C. Kim, Esq.   Ivan A. Gaviria, Esq.
Morrison & Foerster LLP   Manatt, Phelps & Phillips, LLP
555 West Fifth Street   695 Town Center Drive, 14th Floor
Los Angeles, CA 90013-1024   Costa Mesa, CA 92626
(213) 892-5200   (714) 371-2500


    Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

    If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.    o

    If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    o

    If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    o

    If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    o

    If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box.    o


CALCULATION OF REGISTRATION FEE

                 


Proposed Maximum Proposed Maximum
Title of Each Class of Amount to be Offering Aggregate Amount of
Securities to be Registered Registered(1) Price Per Share Offering Price(2) Registration Fee(3)

Common stock, par value $0.01 per share
  2,587,500   $13.00   $33,637,500   $3,959.13


(1)  Includes shares of common stock that the underwriters have the option to purchase to cover over-allotments, if any.
 
(2)  Estimated solely for the purpose of determining the registration fee in accordance with Rule 457(o) under the Securities Act of 1933.
 
(3)  Previously paid.


    The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the SEC, acting pursuant to Section 8(a), may determine.




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The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

SUBJECT TO COMPLETION, DATED MARCH 11, 2005

             
    B of I Holding, Inc.,
the holding company for:

(BANK OF INTERNET USA LOGO)
     
2,250,000 Shares
of Common Stock


We are BofI Holding, Inc., the holding company for Bank of Internet USA.  

This is BofI Holding’s initial public offering and no public market currently exists for its shares. We expect that the public offering price will be between $9.00 and $13.00 per share.

                 
THE OFFERING PER SHARE TOTAL

Public Offering Price
  $       $    
Underwriting Discount
  $       $    
Proceeds to BofI Holding, Inc.
  $       $    

BofI Holding has granted the underwriters the right to purchase up to 337,500 additional shares from it within 30 days after the date of this prospectus to cover any over-allotments. The underwriters expect to deliver shares of common stock to purchasers on                , 2005.  
 
Nasdaq National Market Symbol: BOFI  
 
OpenIPO®:     The method of distribution being used by the underwriters in the offering differs somewhat from that traditionally employed in firm commitment underwritten public offerings. In particular, the public offering price and allocation of shares will be determined primarily by an auction process conducted by the underwriters and other securities dealers participating in the offering. The minimum size for any bid in the auction is 100 shares. A more detailed description of this process, known as an OpenIPO, is included in “Plan of Distribution” beginning on page 100.


Investing in the common stock of BofI Holding involves a high degree of risk.

See “Risk Factors” beginning on page 7 to read about risks you should consider carefully before buying shares of BofI Holding’s common stock.


Neither the Securities and Exchange Commission nor any state securities commission or other regulatory body has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

These securities are not savings or deposit accounts or obligations of any bank and are not insured by the Federal Deposit Insurance Corporation, Bank Insurance Fund, Savings Association Insurance Fund or any other governmental agency.

WRHAMBRECHT+CO                              THE SEIDLER COMPANIES LOGO       

The date of this prospectus is                     , 2005.


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(IMAGE)

[MAP OF THE UNITED STATES SHADED TO INDICATE IN WHICH STATES OUR BANK HAS DEPOSITS ONLY AND IN WHICH STATES OUR BANK HAS DEPOSITS AND LOANS ORIGINATED OR PURCHASED SINCE INCEPTION THAT INCLUDES THE FOLLOWING TEXT: “INTERNET BANKING CUSTOMERS IN ALL 50 STATES” AND “BANK OF INTERNET CURRENTLY ORIGINATES CUSTOMER DEPOSITS AND SINGLE FAMILY MORTGAGE LOANS ON A NATIONWIDE BASIS AND MULTIFAMILY LOANS PRIMARILY IN CALIFORNIA, ARIZONA, TEXAS AND WASHINGTON. BANK OF INTERNET OPERATES OUT OF A SINGLE LOCATION IN SAN DIEGO, CALIFORNIA.”] [PHOTOGRAPHS OF THE MAIN AND MULTIFAMILY LOAN WEBSITES FOR OUR BANK THAT INCLUDES THE FOLLOWING TEXT: “OUR WEBSITES PROVIDE A USER-FRIENDLY INTERFACE WHERE OUR CUSTOMERS OPEN ACCOUNTS, REVIEW INTEREST RATES AND TERMS, ENTER LOAN APPLICATIONS, LOCK IN INTEREST RATES AND MONITOR LOAN PROCESSING. OUR DEPOSIT CUSTOMERS PAY BILLS ONLINE, VIEW CANCELLED CHECKS AND USE OUR FREE ATM AND VISA CHECK CARDS”]


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 EXHIBIT 1.1
 EXHIBIT 5.1
 EXHIBIT 23.2


      You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should assume that the information contained in this prospectus is accurate only as of the date on the front cover of this prospectus. Our business, financial condition, results of operations and prospects may have changed since that date.

      This prospectus contains product names, trademarks and trade names of our company and other organizations.


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PROSPECTUS SUMMARY

      This summary provides an overview of information contained elsewhere in this prospectus and does not contain all of the information you should consider. You should read the following summary together with the more detailed information set out in this prospectus, including the “Risk Factors” section beginning on page 7 and our consolidated financial statements and notes to those consolidated financial statements that appear elsewhere in this prospectus.

      Unless otherwise stated, all information in this prospectus assumes that the underwriters will not exercise their over-allotment option to purchase any of the 337,500 shares of our common stock subject to that option.

BofI Holding, Inc.

General

      We are BofI Holding, Inc., the holding company for Bank of Internet USA, a consumer-focused, nationwide savings bank operating primarily through the Internet from a single location in San Diego, California. We provide a variety of consumer banking services, focusing primarily on gathering retail deposits over the Internet and originating and purchasing multifamily and single family loans for investment. Since the inception of our bank in 2000, we have designed and implemented an automated Internet-based banking platform and electronic workflow process that we believe 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. Our bank was designed from the ground-up to use this platform, providing us with an advantage in leveraging technology to handle routine banking transactions with lean staffing.

      We believe that our business model is highly scalable, and we expect to be able to grow with the addition of new capital. Through our Internet marketing efforts and our ability to adjust interest rates quickly in response to market conditions, we have been able to expand into new regions and products and rapidly increase deposits and, to a lesser extent, loans, without significant delays and with limited additional fixed assets and personnel. We are able to operate in all 50 states and can be selective in entering new geographic markets and targeting demographic groups such as seniors or students. We currently originate deposits and single family mortgage loans on a nationwide basis, and multifamily loans primarily in California, Arizona, Texas and Washington.

      At December 31, 2004, we had total assets of $513.1 million, net loans held for investment of $417.9 million and total deposits of $320.0 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 (one to four units) real property.

      During the past three fiscal years, we have achieved strong growth. From the fiscal year ended June 30, 2002 to the fiscal year ended June 30, 2004, we have:

  •  increased our net income from $1.0 million to $2.2 million and diluted earnings per share from $0.21 to $0.39;
 
  •  increased our total assets at year end from $217.6 million to $405.0 million, while only increasing our employment base from 20 to 24 full time employees;
 
  •  increased net loans held for investment at year end from $167.3 million to $355.3 million, increased originations of multifamily loans held for investment from $30.0 million to $57.3 million and increased originations of single family loans held for sale from $7.0 million to $76.6 million;
 
  •  increased total deposits at year end from $167.6 million to $269.8 million and the number of online deposit accounts from 6,400 to 13,700;
 
  •  increased advances from the Federal Home Loan Bank, or the FHLB, from $29.9 million to $101.4 million;
 
  •  improved our efficiency ratio, or noninterest expense as a percentage of net interest income plus noninterest income, which decreased from 79.3% to 49.5%;
 
  •  improved our return on average common stockholders’ equity from 6.3% to 8.4%; and

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  •  further leveraged our capital base as our bank’s Tier 1 leverage (core) capital to adjusted tangible assets ratio decreased from 8.7% to 7.8%.

Business Strategy

      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. Our strategy includes a number of key elements:

  •  Leverage Technology. We have designed our automated Internet-based banking platform and workflow process to handle traditional banking functions with reduced paperwork and human intervention. We plan to continue to incrementally improve our proprietary software and systems on an ongoing basis. We currently expect the annual rate of capital expenditures for technology-related improvements will remain consistent with our past growth experience.
 
  •  Exploit Advantages of Nationwide Presence. Our thrift charter allows us to operate in all 50 states. Our nationwide, online presence allows us increased flexibility to target a large number of loan and deposit customers based on demographics, geographic location and price. It also provides us with a low cost of customer acquisition and the ability to be selective in approving prospective loan customers. We can rapidly shift and target our marketing based on the demographics and location of the target audience nationwide and establish a presence in new geographic and demographic markets with relatively low entry costs. Our marketing costs are fairly uniform on a nationwide basis because we advertise mainly over the Internet.
 
  •  Continue to Grow Online Deposits and Expand Services. We offer a broad selection of retail deposit instruments and plan to continue to develop new products and services to serve specific demographics. We intend to expand the volume and breadth of our deposit marketing over the Internet. We expect that the annual rate of our marketing costs compared to growth in new customers will remain consistent with our past growth experience.
 
  •  Increase Loan Originations and Purchases. We intend to continually increase single family and multifamily loan originations through our websites, including our “ApartmentBank” and “Broker Advantage” websites. We also plan to continue to purchase high-quality multifamily and, to a lesser extent, single family loans. We expect that our loan marketing and origination costs will rise incrementally as our originations grow at a rate in line with our past experience.

Corporate Information

      BofI Holding, Inc. was incorporated in the State of Delaware on July 6, 1999 for the purpose of organizing and opening an Internet-based bank. Bank of Internet USA, our wholly-owned subsidiary, is a federal savings bank that opened for business over the Internet on July 4, 2000. Our only other subsidiary is BofI Trust I, a Delaware statutory trust formed in connection with the issuance of our trust preferred securities in December 2004. Our executive offices are located at 12220 El Camino Real, Suite 220, San Diego, California 92130, and our telephone number is (858) 350-6200.

      We maintain the following active websites:

  •  www.bankofinternet.com and www.bofi.com, the main websites for our bank where we provide, among other things, traditional banking products and services;
 
  •  homeloans.bankofinternet.com, our website for originating single family loans;
 
  •  www.apartmentbank.com, our website for originating multifamily loans;
 
  •  broker.bofi.com, our website dedicated to the loan brokers with whom we have relationships;
 
  •  www.bancodeinternet.com, a redesigned version of our main website to focus on Spanish speaking customers; and
 
  •  www.seniorbofi.com, our website to market to seniors.

Information contained on our websites is not a part of this prospectus.

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The Offering

 
Common Stock offered 2,250,000 shares(1)
 
Common Stock outstanding as of December 31, 2004 4,563,399 shares
 
Common Stock outstanding as of December 31, 2004, assuming the exercise and conversion of all outstanding exercisable and convertible securities 6,672,216 shares
 
Common Stock outstanding after the offering 7,497,649 shares(2)
 
Net proceeds The net proceeds from the offering will be approximately $21.8 million, assuming an offering price of $11.00 per share (the midpoint of the range) and that the underwriters’ over-allotment option is not exercised.
 
Use of proceeds We intend to contribute approximately $16.0 million of the net proceeds from this offering to Bank of Internet USA to provide additional capital to support its growth. We also intend to use a portion of the net proceeds to prepay in full a note payable that had an outstanding principal balance of $5.0 million at December 31, 2004. The note payable bears interest at prime plus one percent per annum. We intend to use the remaining net proceeds for general corporate purposes. Pending these uses, we will invest the net proceeds initially in short term, investment grade securities and other qualified investments. See “Use of Proceeds” for more information.
 
Dividends on Common Stock We have never paid cash dividends on our common stock, electing to retain earnings for funding our growth and business. We currently anticipate continuing our policy of retaining earnings to fund growth. See “Dividend Policy” for more information.
 
Nasdaq National Market symbol Our common stock has been approved for quotation on the Nasdaq National Market under the symbol “BOFI.”


(1)  The number of shares of our common stock offered assumes that the underwriters’ over-allotment option is not exercised. If the over-allotment option is exercised in full, we will issue and sell an additional 337,500 shares.
 
(2)  The number of shares of our common stock outstanding after the offering is based on the number of shares outstanding at December 31, 2004, and assumes that the underwriters’ over-allotment option is not exercised. The number includes 684,250 shares of common stock issuable upon exercise of warrants with an exercise price of $4.19 per share, which warrants we expect to be exercised on a cash basis prior to the offering because they terminate if not exercised prior to that time.

      The number excludes:

  •  722,017 shares of common stock issuable upon exercise of outstanding stock options with a weighted average exercise price of $6.11 per share;
 
  •  59,950 shares of common stock issuable upon the exercise of warrants with an exercise price of $14.00 per share;

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  •  642,600 shares of common stock currently issuable upon conversion of our Series A — 6% Cumulative Nonparticipating Perpetual Preferred Stock, or our Series A preferred stock. Our Series A preferred stock is convertible at prices which increase periodically through January 2009, after which time our Series A preferred stock is no longer convertible into our common stock. The current conversion price of $10.50 per share is in effect through January 1, 2006;
 
  •  shares of common stock reserved for future issuance under our 2004 stock incentive plan, which provides that aggregate equity awards under our 2004 stock incentive plan and options outstanding under our 1999 stock option plan may not exceed 14.8% of our outstanding common stock at any time. Based on the number of shares of common stock outstanding at December 31, 2004, and assuming 2,250,000 shares of common stock are sold in the offering and warrants to purchase 684,250 shares of common stock are exercised on a cash basis prior to the offering, the maximum number of shares of common stock issuable upon exercise of options granted under our 2004 stock incentive plan would be 1,109,652; and
 
  •  up to 500,000 shares of common stock reserved for future issuance under our 2004 employee stock purchase plan.

Risk Factors

      See “Risk Factors” beginning on page 7 for a discussion of material risks related to an investment in our common stock.

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Summary Consolidated Financial Information

      You should read the summary consolidated financial information set forth below together with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. Our consolidated income statement information for the six months ended December 31, 2004 and 2003 and the consolidated balance sheet information as of December 31, 2004 are derived from our unaudited consolidated financial statements, which are included in this prospectus and, in the opinion of management, include all adjustments necessary for fair presentation of the results of such periods. The consolidated balance sheet information as of December 31, 2003 is derived from our unaudited consolidated financial information. The consolidated income statement information for the fiscal years ended June 30, 2004, 2003 and 2002 and the consolidated balance sheet information as of June 30, 2004 and 2003 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated income statement information for the fiscal year ended June 30, 2001 and the period from July 6, 1999 (inception) to June 30, 2000 and the consolidated balance sheet information at June 30, 2002, 2001 and 2000 have been derived from our audited consolidated financial statements that are not included in this prospectus. Historical results are not necessarily indicative of future results.

                                                         
At or for
At or for the Period
the Six Months July 6, 1999
Ended December 31, At or for the Fiscal Years Ended June 30, (inception) to


June 30,
2004 2003 2004 2003 2002 2001 2000







(Dollars in thousands, except per share data)
Selected Balance Sheet Data:
                                                       
Total assets
  $ 513,108     $ 316,804     $ 405,039     $ 273,464     $ 217,614     $ 156,628     $ 13,295  
Loans held for investment, net of allowance for loan losses
    417,915       283,764       355,261       245,933       167,251       139,679        
Loans held for sale, at cost
    845             435       3,602       128       22        
Allowance for loan losses
    1,220       825       1,045       790       505       310        
Investment securities
    53,041       311       3,665       441       726       1,522        
Total deposits
    320,019       220,235       269,841       193,992       167,618       127,204        
Advances from the FHLB
    148,504       66,389       101,446       55,900       29,900       15,900        
Note payable
    5,000       3,060       1,300                   870        
Junior subordinated debentures
    5,155                                      
Total stockholders’ equity
    32,844       26,623       31,759       22,885       19,501       11,903       12,936  
Selected Income Statement Data:
                                                       
Interest and dividend income
  $ 10,192     $ 7,218     $ 15,772     $ 13,514     $ 11,641     $ 4,697     $ 24  
Interest expense
    5,905       4,342       9,242       8,426       8,144       3,535        
     
     
     
     
     
     
     
 
Net interest income
    4,287       2,876       6,530       5,088       3,497       1,162       24  
Provision for loan losses
    175       35       255       285       195       310        
     
     
     
     
     
     
     
 
Net interest income after provision for loan losses
    4,112       2,841       6,275       4,803       3,302       852       24  
Noninterest income
    385       474       1,190       1,349       297       52        
Noninterest expense
    2,546       1,985       3,819       3,158       3,008       1,985       1,012  
     
     
     
     
     
     
     
 
Income (loss) before income tax expense (benefit)
    1,951       1,330       3,646       2,994       591       (1,081 )     (988 )
Income tax expense (benefit)
    776       580       1,471       1,264       (429 )     1        
     
     
     
     
     
     
     
 
Net income (loss)
  $ 1,175     $ 750     $ 2,175     $ 1,730     $ 1,020     $ (1,082 )   $ (988 )
     
     
     
     
     
     
     
 
Net income (loss) attributable to common stock
  $ 972     $ 731     $ 2,035     $ 1,730     $ 1,020     $ (1,082 )   $ (988 )

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At or for
At or for the Period
the Six Months July 6, 1999
Ended December 31, At or for the Fiscal Years Ended June 30, (inception) to


June 30,
2004 2003 2004 2003 2002 2001 2000







(Dollars in thousands, except per share data)
Per Share Data:
                                                       
Net income (loss):
                                                       
 
Basic
  $ 0.21     $ 0.16     $ 0.45     $ 0.39     $ 0.25     $ (0.29 )   $ (0.33 )
 
Diluted
  $ 0.19     $ 0.14     $ 0.39     $ 0.34     $ 0.21     $ (0.29 )   $ (0.33 )
Book value per common share
  $ 5.74     $ 5.27     $ 5.57     $ 5.11     $ 4.50     $ 3.21     $ 3.50  
Tangible book value per common share
  $ 5.74     $ 5.27     $ 5.57     $ 5.11     $ 4.50     $ 3.21     $ 3.50  
Weighted average number of common shares outstanding:
                                                       
 
Basic
    4,527,519       4,498,045       4,502,284       4,468,296       4,128,051       3,706,050       2,950,999  
 
Diluted
    5,172,864       5,156,898       5,160,482       5,134,940       4,795,401       3,706,050       2,950,999  
Common shares outstanding at end of period
    4,563,399       4,506,524       4,506,524       4,474,351       4,334,401       3,707,156       3,694,031  
Performance Ratios and Other Data:
                                                       
Loan originations for investment
  $ 27,682     $ 37,198     $ 64,478     $ 58,609     $ 34,659     $ 16,003       NM  
Loan originations for sale
    9,795       43,643       76,550       124,739       6,994       3,317       NM  
Loan purchases
    70,859       52,468       129,193       81,778       132,298       139,565       NM  
Return (loss) on average assets
    0.53%       0.52%       0.67%       0.71%       0.53%       (1.56 )%     NM  
Return (loss) on average common stockholders’ equity
    7.52%       6.16%       8.42%       7.87%       6.32%       (8.68 )%     NM  
Interest rate spread(1)
    1.78%       1.76%       1.81%       1.76%       1.45%       0.67 %     NM  
Net interest margin(2)
    1.98%       2.02%       2.04%       2.11%       1.83%       1.73 %     NM  
Efficiency ratio(3)
    54.49%       59.25%       49.47%       49.06%       79.28%       163.51 %     NM  
Capital Ratios:
                                                       
Equity to assets at end of period
    6.40%       8.40%       7.84%       8.37%       8.96%       7.60 %     NM  
Tier 1 leverage (core) capital to adjusted tangible assets(4)
    7.45%       8.94%       7.84%       8.09%       8.65%       8.16 %     NM  
Tier 1 risk-based capital ratio(4)
    11.44%       12.09%       11.11%       11.40%       13.76%       15.00 %     NM  
Total risk-based capital ratio(4)
    11.80%       12.44%       11.48%       11.81%       14.13%       15.37 %     NM  
Tangible capital to tangible assets(4)
    7.45%       8.94%       7.84%       8.09%       8.65%       8.16 %     NM  
Asset Quality Ratios:
                                                       
Net charge-offs to average loans outstanding(5)
                                         
Nonperforming loans to total loans(5)
                                         
Allowance for loan losses to total loans held for investment at end of period
    0.29%       0.29%       0.29%       0.32%       0.30%       0.22 %     NM  
Allowance for loan losses to nonperforming loans(5)
                                         


(1)  Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate paid on interest-bearing liabilities.
 
(2)  Net interest margin represents net interest income as a percentage of average interest-earning assets.
 
(3)  Efficiency ratio represents noninterest expense as a percentage of the aggregate of net interest income and noninterest income.
 
(4)  Reflects regulatory capital ratios of Bank of Internet USA only.
 
(5)  For every quarter from inception to June 30, 2004, we had no loan defaults, no foreclosures, no nonperforming loans and no specific loan loss allowances. Since that time, one loan with a principal balance of approximately $152,000 at June 30, 2004 defaulted, but the loan was repaid in full in September 2004. At September 30, 2004 and December 31, 2004, we had no loan defaults, no foreclosures, no nonperforming loans and no specific loan loss allowances.

“NM” means not meaningful.

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RISK FACTORS

      An investment in our common stock involves risk, and you should not invest in our common stock unless you can afford to lose some or all of your investment. You should carefully read the risks described below, together with all of the other information included in this prospectus, before you decide to buy any of our common stock. Our business, prospects, financial condition and results of operations could be harmed by any of the following risks or other risks which have not been identified which we believe are immaterial or unlikely.

Risks Relating to Our Business

 
      Our limited operating history makes our future prospects and financial performance unpredictable, which may impair our ability to manage our business and your ability to assess our prospects.

      We commenced banking operations in July 2000. We remain subject to the risks inherently associated with new business enterprises in general and, more specifically, the risks of a new financial institution and, in particular, a new Internet-based financial institution. Our prospects are subject to the risks and uncertainties frequently encountered by companies in their early stages of development, including the risk that we will not be able to implement our business strategy. In addition, we have a limited history upon which we can rely in planning and making the critical decisions that will affect our future operating results. Similarly, because of the relatively immature state of our business, it will be difficult to evaluate our prospects. Accordingly, our financial performance to date may not be indicative of whether our business strategy will be successful.

 
      We may not be able to implement our plans for growth successfully, which could adversely affect our future operations.

      We have grown substantially, from $217.6 million in total assets and $167.6 million in total deposits at June 30, 2002 to $513.1 million in total assets and $320.0 million in total deposits at December 31, 2004. We expect to continue to grow our assets, our deposits, the number of our customers and the scale of our operations generally and will seek to grow at an accelerated rate following completion of the offering. Our future success will depend in part on our continued ability to manage our growth. We may not be able to achieve our growth plans, or sustain our historical growth rates or grow at all. Various factors, such as economic conditions, regulatory and legislative considerations and competition, may also impede our ability to expand our market presence. If we are unable to grow as planned, our business and prospects could be adversely affected.

      Our business strategy involves, among other things, continuing to grow our assets and loan portfolio and our customer base. We intend to use the net proceeds from the offering to help us achieve this objective. Our ability to achieve profitable growth depends in part upon our ability to identify favorable loan and investment opportunities and successfully attract deposits. Our management may not be able to use the net proceeds from the offering to implement our business strategy effectively, and we may encounter unanticipated obstacles in implementing our strategy. If we are unable to expand our business as we anticipate, we may be unable to benefit from the investments we have made to support our future growth. If this occurs, we may not be able to maintain profitability.

 
      Our inability to manage our growth could harm our business.

      We anticipate that our asset size and deposit base will continue to grow over time, perhaps significantly. To manage the expected growth of our operations and personnel, we will be required to, among other things:

  •  improve existing and implement new transaction processing, operational and financial systems, procedures and controls;
 
  •  maintain effective credit scoring and underwriting guidelines; and
 
  •  expand our employee base and train and manage this growing employee base.

      If we are unable to manage growth effectively, our business, prospects, financial condition and results of operations could be adversely affected.

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      In a rising interest rate environment, an institution with a negative interest rate sensitivity gap generally would be expected, absent the effects of other factors, to experience a greater increase in its cost of liabilities relative to its yield on assets, and thus a decrease in its net interest income.

      Our profitability depends substantially on our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between the income we earn on interest-earning assets, such as mortgage loans and investment securities, and the interest we pay on interest-bearing liabilities, such as deposits and other borrowings. Because of the differences in both maturities and repricing characteristics of our interest-earning assets and interest-bearing liabilities, changes in interest rates do not produce equivalent changes in interest income earned on interest-earning assets and interest paid on interest-bearing liabilities. Accordingly, fluctuations in interest rates could adversely affect our net interest income and therefore profitability. We may not be able to manage our interest rate risk.

      Interest rates are highly sensitive to many factors which are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve Board, or the FRB. Changes in monetary policy, including changes in interest rates, will influence not only the interest we receive on our loans and investment securities and the amount of interest we pay on deposits, it will also affect our ability to originate loans and obtain deposits and our costs in doing so. When interest rates rise, the cost of borrowing also increases. Our business model is predicated on our operating on levels of net interest income that other banks might find unacceptable or unsustainable, as we typically pay interest rates on deposits in the higher end of the spectrum and often charge lower interest rates and fees than those charged by competitors. Accordingly, changes in levels of market interest rates could materially and adversely affect our net interest income, asset quality, loan origination volume, business and prospects.

      We expect more of our interest-bearing liabilities will mature or reprice within one year than will our interest-earning assets, resulting in a one year negative interest rate sensitivity gap (the difference between our interest rate sensitive assets maturing or repricing within one year and our interest rate sensitive liabilities maturing or repricing within one year, expressed as a percentage of interest-earning assets). During the six months ended December 31, 2004, interest income earned on loans and interest expense paid on deposits were influenced by a general decline in the historical spread between short term and long term rates earned on U.S. Treasury securities. If short term rates continue to rise faster than long term rates, our net interest income may be negatively impacted. For a further discussion of our interest rate risks and the assumptions underlying our interest rate risk calculations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Quantitative and Qualitative Disclosures About Market Risk.”

 
      We may need to raise additional capital that may not be available, which could harm our business.

      Due to applicable capital adequacy regulations and sound banking practices, our growth will require that we generate additional capital either through retained earnings or the issuance of additional shares of common stock or other capital instruments. We believe that the net proceeds from the offering, cash generated from operations and borrowings available under existing lines of credit and credit agreements and from the FHLB will be sufficient to finance our operations and capital expenditures for at least the next 12 months. However, we may wish to raise additional capital, which may not be available on terms acceptable to us, if at all. Any equity financings could result in dilution to our stockholders or reduction in the earnings available to our common stockholders. If adequate capital is not available or the terms of such capital are not attractive, we may have to curtail our growth and our business, and our business, prospects, financial condition and results of operations could be adversely affected.

 
      We may not be able to offer Internet-based banking services that have sufficient advantages over the Internet-based banking services and other characteristics of conventional “brick and mortar” banks to enable us to compete successfully.

      We are an independent Internet-based bank, as distinguished from the Internet banking services of an established “brick and mortar” bank. Independent Internet-based banks often have found it difficult to

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achieve profitability and revenue growth. Several factors contribute to the unique challenges that Internet-based banks face. These include concerns for the security of personal information, the absence of personal relationships between bankers and customers, the absence of loyalty to a conventional hometown bank, customers’ difficulty in understanding and assessing the substance and financial strength of an Internet-based bank, a lack of confidence in the likelihood of success and permanence of Internet-based banks and many individuals’ unwillingness to trust their personal assets to a relatively new technological medium such as the Internet. As a result, some potential customers may be unwilling to establish a relationship with us.

      Conventional “brick and mortar” banks, in growing numbers, are offering the option of Internet-based banking services to their existing and prospective customers. The public may perceive conventional banks as being safer, more responsive, more comfortable to deal with and more accountable as providers of their banking services, including their Internet-based banking services.

      Moreover, both the Internet and the financial services industry are undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to improving the ability to serve customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. We may not be able to effectively implement new technology-driven products and services or be successful in marketing theses products and services to our customers. If we are unable, for technical, legal, financial or other reasons, to adapt in a timely manner to changing market conditions, customer requirements or emerging industry standards, our business, prospects, financial condition and results of operations could be adversely affected.

      Many of our competitors have substantially greater resources to invest in technological improvements. To remain competitive, we must continue to enhance and improve the responsiveness, functionality and features of our Internet-based services. Most of our software and computer systems are comprised of “off-the-shelf” applications, and we have limited proprietary computer software, information databases and applications. Others may develop and offer superior banking products and services that may gain greater acceptance among potential customers. Our success will depend in part on our ability both to license and develop leading technologies to enhance our existing services, develop new services and technologies that address the increasingly sophisticated and varied needs of our customers and respond to technological advances and emerging industry standards and practices on a cost effective and timely basis.

 
      We face strong competition for customers and may not succeed in implementing our business strategy.

      Our business strategy depends on our ability to remain competitive. There is strong competition for customers from existing banks and other types of financial institutions, including those that use the Internet as a medium for banking transactions or as an advertising platform. Our competitors include:

  •  large, publicly-traded, Internet-based banks, as well as smaller Internet-based banks;
 
  •  “brick and mortar” banks, including those that have implemented websites to facilitate online banking; and
 
  •  traditional banking institutions such as thrifts, finance companies, credit unions and mortgage banks.

      Some of these competitors have been in business for a long time and have name recognition and an established customer base. Most of our competitors are larger and have greater financial and personnel resources. 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 business, prospects, financial condition and results of operations.

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      To remain competitive, we believe we must successfully implement our business strategy. Our success depends on, among other things:

  •  having a large and increasing number of customers who use our bank for their banking needs;
 
  •  our ability to attract, hire and retain key personnel as our business grows;
 
  •  our ability to secure additional capital as needed;
 
  •  the relevance of our products and services to customer needs and demands and the rate at which we and our competitors introduce or modify new products and services;
 
  •  our ability to offer products and services with fewer employees than competitors;
 
  •  the satisfaction of our customers with our customer service;
 
  •  ease of use of our websites; and
 
  •  our ability to provide a secure and stable technology platform for financial services that provides us with reliable and effective operational, financial and information systems.

      If we are unable to implement our business strategy, our business, prospects, financial condition and results of operations could be adversely affected.

 
      A natural disaster or recurring energy shortage, especially in California, could harm our business.

      We are based in San Diego, California, and approximately 58.2% of our total loan portfolio was secured by real estate located in California at December 31, 2004. In addition, the computer systems that operate our Internet websites and some of their back-up systems are located in San Diego, California. Historically, California has been vulnerable to natural disasters. Therefore, we are susceptible to the risks of natural disasters, such as earthquakes, wildfires, floods and mudslides. Natural disasters could harm our operations directly through interference with communications, including the interruption or loss of our websites which would prevent us from gathering deposits, originating loans and processing and controlling our flow of business, as well as through the destruction of facilities and our operational, financial and management information systems. A natural disaster or recurring power outages may also impair the value of our largest class of assets, our loan portfolio, which is comprised substantially of real estate loans. Uninsured or underinsured disasters may reduce borrowers’ ability to repay mortgage loans. Disasters may also reduce the value of the real estate securing our loans, impairing our ability to recover on defaulted loans through foreclosure and making it more likely that we would suffer losses on defaulted loans. California has also experienced energy shortages which, if they recur, could impair the value of the real estate in those areas affected. Although we have implemented several back-up systems and protections (and maintain business interruption insurance), these measures may not protect us fully from the effects of a natural disaster. The occurrence of natural disasters or energy shortages in California could have a material adverse effect on our business, prospects, financial condition and results of operations.

 
      Our multifamily residential and commercial real estate loans held for investment are generally unseasoned, and defaults on such loans would harm our business.

      At December 31, 2004, our multifamily residential loans held for investment were $366.7 million, or 88.2% of our total loans held for investment, and the average loan size of our multifamily residential loans was $705,000. At December 31, 2004, our commercial real estate loans held for investment were $13.0 million, or 3.1% of our total loans held for investment, and the average loan size of our commercial real estate loans was $721,000. The payment on such loans is typically dependent on the cash flows generated by the projects, which are affected by the supply and demand for multifamily residential units and commercial property within the relative market. If the market for multifamily residential units and commercial property experiences a decline in demand, multifamily and commercial borrowers may suffer losses on their projects and be unable to repay their loans.

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      Our emphasis on multifamily loans increases the possibility of loan losses.

      We may incur significant losses because approximately 88.2% of our loans at December 31, 2004 were secured by multifamily properties. Loans secured by multifamily properties may have a greater risk of loss than loans secured by single family properties because they typically involve larger loan balances to single borrowers or groups of related borrowers. Significant losses on loans secured by multifamily properties are possible because the cash flows from multifamily properties securing the loans may become inadequate to service the loan payments. The payment experience on these loans typically depends upon the successful operation of the related real estate project and is subject to risks such as excessive vacancy rates or inadequate rental income levels. Many of our borrowers have more than one commercial real estate or multifamily loan outstanding with us.

      Multifamily underwriting typically requires inspection of each property and familiarity with the location of the property and the local real estate market. While we have a policy to conduct a site visit of the property underlying every multifamily loan and focus our multifamily originations in only four states with which we believe we have greater familiarity, we intend to expand our multifamily loan originations beyond those four states. We may not be able to develop the requisite experience with other markets to be able to underwrite successfully multifamily loans in additional communities and states. We also may not be able to assess correctly relevant criteria such as the level of vacancies with respect to a particular property or the community in which it is located or that we will be able to continue to physically inspect each multifamily property. Our inability to successfully underwrite multifamily loans could lead to delinquencies and charge-offs and could adversely affect our business, prospects, financial condition and results of operations.

 
      If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings, capital adequacy and overall financial condition may suffer materially.

      Our loans are generally secured by multifamily and, to a lesser extent, commercial and single family real estate properties, each initially having a fair market value generally greater than the amount of the loan secured. However, even though our loans are typically secured, the risk of default, generally due to a borrower’s inability to make scheduled payments on his or her loan, is an inherent risk of the banking business. In determining the amount of the allowance for loan losses, we make various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate serving as collateral for the repayment of our loans. Defaults by borrowers could result in losses that exceed our loan loss reserves. We have originated or purchased many of our loans recently, so we do not have sufficient repayment experience to be certain whether the allowance for loan losses we have established is adequate. We may have to establish a larger allowance for loan losses in the future if, in our judgment, it is necessary. Any increase in our allowance for loan losses will increase our expenses and consequently may adversely affect our profitability, capital adequacy and overall financial condition.

 
      Declining real estate values, particularly in California, could reduce the value of our loan portfolio and impair our profitability and financial condition.

      Substantially all of the loans in our portfolio are secured by real estate. At December 31, 2004, approximately 58.2% of our total loan portfolio was secured by real estate located in California. If there is a significant decline in real estate values, especially in California, the collateral for our loans will become less valuable. If such an event were to occur, we may experience charge-offs at a greater level than we would otherwise experience, as the proceeds resulting from foreclosure may be significantly lower than the amounts outstanding on such loans. Declining real estate values frequently accompany periods of economic downturn or recession and increasing unemployment, all of which can lead to lower demand for mortgage loans of the types we originate. These changes would likely have a material adverse effect on our business, prospects, financial condition and results of operations.

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      We frequently purchase loans in bulk or “pools.” We may experience lower yields or losses on loan “pools” because the assumptions we use when purchasing loans in bulk may not always prove correct.

      From time to time, we purchase loans in bulk or “pools.” For the six months ended December 31, 2004 and for the fiscal years ended June 30, 2004 and 2003, we purchased $70.9 million, $129.2 million and $81.8 million, respectively, in single family and multifamily mortgage loans. When we determine the purchase price we are willing to pay to purchase loans in bulk, management makes certain assumptions about, among other things, how fast borrowers will prepay their loans, the real estate market and our ability to collect loans successfully and, if necessary, to dispose of any real estate that may be acquired through foreclosure. When we purchase loans in bulk, we perform certain due diligence procedures and we purchase the loans subject to customary limited indemnities. To the extent that our underlying assumptions prove to be inaccurate or the basis for those assumptions change (such as an unanticipated decline in the real estate market), the purchase price paid for “pools” of loans may prove to have been excessive, resulting in a lower yield or a loss of some or all of the loan principal. For example, in the past, we have purchased “pools” of loans at a premium and some of the loans were prepaid before we expected. Accordingly, we earned less interest income on the purchase than expected. To date, none of the loan “pools” that we purchased at a premium have resulted in a net investment loss. Our success in growing through purchases of loan “pools” depends on our ability to price loan “pools” properly and on general economic conditions in the geographic areas where the underlying properties of our loans are located.

      Acquiring loans through bulk purchases may involve acquiring loans of a type or in geographic areas where management may not have substantial prior experience. We may be exposed to a greater risk of loss to the extent that bulk purchases contain such loans.

 
      We face limits on our ability to lend.

      The amount that we can lend to a single borrower is limited to 15.0% of the unimpaired capital and surplus of our subsidiary bank. Based upon the 15.0% of unimpaired capital and surplus measurement, at December 31, 2004, our loans-to-one-borrower limit was $5.7 million. At December 31, 2004, no single loan was larger than $3.0 million and our bank’s largest single lending relationship had an outstanding balance of $4.7 million. We expect that our lending limit will increase to approximately $8.1 million immediately following the offering, assuming $21.8 million in net proceeds is raised in the offering and that $16.0 million of the net proceeds are contributed to our bank, based on the assumptions set forth below the table in “Capitalization.” Because our lending limits may be significantly lower than those of our competitors, we may be at a competitive disadvantage in pursuing relationships with larger borrowers in our market areas. Notwithstanding our loan limits, we may elect not to make loans up to our maximum loan limit for any reason. If we do elect to make larger loans, we may seek to reduce our exposure by making the loan with one or more other financial institutions which become solely liable for their portion of the loan. We may not be successful in securing other institutions to make loans with us or in successfully administering those loans, if we elect to make larger loans.

 
      Our success depends in large part on the continuing efforts of a few individuals. If we are unable to retain these personnel or attract, hire and retain others to oversee and manage our company, our business could suffer.

      Our success depends substantially on the skill and abilities of our senior management team, including our President and Chief Executive Officer Gary Lewis Evans, our Chief Financial Officer Andrew J. Micheletti and our bank’s Chief Credit Officer Patrick A. Dunn, each of whom performs multiple functions that might otherwise be performed by separate individuals at larger banks, as well as our Chairman Jerry F. Englert and our Vice Chairman Theodore C. Allrich. These individuals may not be able to fulfill their responsibilities adequately, and they may not remain with us. The loss of the services of any of these individuals or other key employees, whether through termination of employment, disability or otherwise, could have a material adverse effect on our business. In addition, our ability to grow and manage our growth depends on our ability to continue to identify, attract, hire, train, retain and motivate highly skilled executive, technical, managerial, sales and marketing, customer service and professional personnel. The implementation of our business plan

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and our future success will depend on such qualified personnel. Competition for such employees is intense, and there is a risk that we will not be able to successfully attract, assimilate or retain sufficiently qualified personnel. If we fail to attract and retain the necessary technical, managerial, sales and marketing and customer service personnel, as well as experienced professionals, our business, prospects, financial condition and results of operations could be adversely affected. We maintain a “key man” life insurance policy on Gary Lewis Evans and bank-owned life insurance on other executive officers.
 
      We depend on third-party service providers for our core banking technology, and interruptions in or terminations of their services could materially impair the quality of our services.

      We rely substantially upon third-party service providers for our core banking technology and to protect us from bank system failures or disruptions. For example, Jack Henry & Associates, Inc. is responsible for all our basic core processing applications, including general ledger, loans, deposits, ATM networks, electronic fund transfers, item processing and imaging, and our bill pay system is outsourced to Metavante Corporation. For the six months ended December 31, 2004 and for the fiscal years ended June 30, 2004 and 2003, we paid approximately $181,000, $328,000 and $278,000, respectively, to third-party service providers for our core banking technology, which expenses are reflected in our consolidated financial statements as data processing and internet expenses. This reliance may mean that we will not be able to resolve operational problems internally or on a timely basis, which could lead to customer dissatisfaction or long-term disruption of our operations. Our operations also depend upon our ability to replace a third-party service provider if it experiences difficulties that interrupt operations or if an essential third-party service terminates. If these service arrangements are terminated for any reason without an immediately available substitute arrangement, our operations may be severely interrupted or delayed. If such interruption or delay were to continue for a substantial period of time, our business, prospects, financial condition and results of operations could be adversely affected.

 
      A national or regional economic downturn could reduce our customer base, our level of deposits and demand for our financial products such as loans.

      A deterioration in economic conditions, whether caused by national events or local events, in particular an economic slowdown in California, where approximately 58.2% of our total loan portfolio was located at December 31, 2004, could result in the following consequences, any of which could hurt our business materially:

  •  loan delinquencies may increase;
 
  •  problem assets and foreclosures may increase;
 
  •  demand for our products and services may decline; and
 
  •  the value of collateral supporting our loans, especially real estate, may decline, in turn reducing customers’ borrowing power and reducing potential proceeds from foreclosures and from sales of loans.

      The State of California continues to face its own fiscal challenges, the long term effect of which on the State’s economy cannot be predicted.

 
      We rely substantially on third parties to service our loans and to provide us with appraisals, credit reports, title searches, environmental inspections and reports and other underwriting services without errors or fraud and in a timely manner.

      We rely on other companies to administer and service some of our loans by collecting payments, disbursing proceeds of collection and, if necessary, conducting foreclosures. We also rely on other companies to support our loan underwriting process by providing us with, among other things, appraisals, credit reports, environmental inspections and reports and title searches. We typically pay a fee of 25 basis points (0.25%) for servicing of fixed interest rate loans and 37.5 basis points (0.375%) for servicing of adjustable interest rate loans. The fee is calculated based on the principal amount of a loan. We record interest income on loans serviced by others net of applicable service fees. At December 31, 2004 and at June 30, 2004 and 2003, we had

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$218.1 million, $168.0 million and $119.9 million, respectively, in loan principal serviced by others. The value to our customers of the services we offer and the success of our business ultimately depend in large part on third parties providing these ancillary services without errors, interruptions, delays and fraud. If third parties commit fraud or perform their services negligently, such as by intentionally or negligently reporting false or misleading information, we could suffer losses by relying on that information in conducting our business. Errors, interruptions or delays by third parties providing these ancillary services could also cause losses, as well as delays, in the processing and closing of loans for our customers. If we cannot manage these third parties so that they deliver these ancillary services as we expect, we likely will experience customer dissatisfaction, and our business, prospects, financial condition and results of operations could be adversely affected.
 
Our operations are subject to numerous laws and government regulation, which may change.

      We are subject to a large body of laws governing our business, such as laws governing our charter, state laws determining our remedies as lenders, laws governing labor relations, taxation, contracts, consumer issues and many other aspects of our business. We are regulated primarily by the Office of Thrift Supervision, Department of the Treasury, or the OTS, the Federal Deposit Insurance Corporation, or the FDIC, and, to a lesser extent, the FRB. Because we are an Internet-based bank, we are subject to various electronic funds transfer rules adopted by the FRB. We are also subject to various general commercial and consumer laws and regulations, such as the Truth-in-Lending Act, the Truth-in-Savings Act, the Real Estate Settlement Procedures Act of 1974 and the Uniform Commercial Code, among many others. Any significant change in applicable laws, rules and regulations, as well as new laws, rules and regulations could significantly increase our cost of compliance and adversely affect our business, prospects, financial condition and results of operations.

      Laws and regulations directly applicable to the Internet and electronic commerce may become more prevalent in the future. In the event Congress or state legislatures or regulators such as the OTS, the FDIC, the FRB, the Federal Trade Commission or other governmental authorities enact or modify laws or adopt regulations relating to the Internet, our business, prospects, financial condition and results of operations could be adversely affected. Such legislation and regulation could reduce the rate of growth in Internet usage generally and decrease the acceptance of the Internet as a commercial medium. The laws and regulations governing the Internet remain largely unsettled, even in areas where there has been some legislative or regulatory action. It may take years to determine whether, and how, existing laws and regulations such as those governing intellectual property, privacy and taxation apply to the Internet. The growth and development of the market for electronic commerce may prompt calls for more stringent consumer protection laws and regulations, both in the United States and abroad, that may impose additional burdens on companies conducting business over the Internet.

 
      We will incur increased costs as a result of being a public company.

      As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with our public company reporting requirements. We also anticipate that we will incur costs associated with recently adopted corporate governance requirements, including requirements under the Sarbanes-Oxley Act of 2002, as well as new accounting pronouncements and new rules implemented by the Securities and Exchange Commission, or the SEC, and the Nasdaq National Market. Any expenses required to comply with evolving standards may result in increased general and administrative expenses and a diversion of management time and attention from our business. In addition, these new laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially greater costs to obtain the same or similar coverage. The effect of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on our board committees or as executive officers. We are presently evaluating and monitoring developments with respect to these laws and regulations and cannot predict or estimate the amount or timing of additional costs we may incur to respond to their requirements.

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      Ownership of our common stock is highly concentrated, which may prevent you or other stockholders from influencing significant corporate decisions and may result in conflicts of interest that could cause our stock price to decline.

      Our executive officers, directors and their affiliates beneficially owned or controlled approximately 33.0% of our outstanding common stock at December 31, 2004, and will beneficially own or control approximately 23.4%, or approximately 22.4% assuming full exercise of the underwriters’ over-allotment option, of our outstanding common stock following the offering, in each case assuming the exercise of all outstanding warrants held by them and the conversion of all shares of Series A preferred stock held by them into common stock (based on current conversion terms). Accordingly, these executive officers, directors and their affiliates, acting as a group, will have substantial influence over the outcome of corporate actions requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate transactions. This concentration of ownership may also delay or prevent a change of control of our company, even if such a change of control would benefit our other stockholders, and might affect our stock price.

 
Anti-takeover provisions of our certificate of incorporation and bylaws and federal and Delaware law may prevent or frustrate a change in control, even if an acquisition would be beneficial to our stockholders, which could affect our stock price adversely and prevent attempts by our stockholders to replace or remove our current management.

      Provisions of our certificate of incorporation and bylaws may delay or prevent a change in control, discourage bids at a premium over the market price of our common stock and adversely affect the market price of our common stock and the voting or other rights of the holders of our common stock. These provisions, among other things:

  •  authorize our board of directors to issue preferred stock with voting and other rights to be determined by them;
 
  •  limit the persons who can call special meetings of stockholders;
 
  •  prohibit stockholder action by written consent;
 
  •  create a classified board of directors pursuant to which our directors are elected for staggered three-year terms; and
 
  •  provide that a supermajority vote of our stockholders is required to amend certain provisions of our certificate of incorporation and bylaws.

      We are subject to the provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for five years unless the holder’s acquisition of our stock was approved in advance by our board of directors or other conditions are met.

      Acquisition of control of a federal savings bank such as Bank of Internet USA requires advance approval by the OTS. Under federal law, acquisition of more than 10% of our common stock would result in a rebuttable presumption of control of Bank of Internet USA and the ownership of more than 25% of the voting stock would result in conclusive control of Bank of Internet USA. Depending on the circumstances, the foregoing requirements may prevent or frustrate a change in control of us, discourage bids at a premium over the market price of our common stock and adversely affect the market price of our common stock and the voting or other rights of the holders of our common stock.

 
We are exposed to risk of environmental liability with respect to properties to which we take title.

      In the course of our business, we may foreclose and take title to real estate and could be subject to environmental liabilities with respect to those properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination or may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities

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could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we become subject to significant environmental liabilities, our business, prospects, financial condition and results of operations could be adversely affected.
 
The U.S. government’s monetary policies or changes in those policies could have a major effect on our operating results, and we cannot predict what those policies will be or any changes in such policies or the effect of such policies on us.

      Our earnings will be affected by domestic economic conditions and the monetary and fiscal policies of the U.S. government and its agencies. The monetary policies of the FRB have had, and will continue to have, an important effect on the operating results of commercial banks and other financial institutions through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession.

      The monetary policies of the FRB, effected principally through open market operations and regulation of the discount rate and reserve requirements, have had major effects upon the levels of bank loans, investments and deposits. For example, in 2001, several drops in the discount rate by the Federal Open Market Committee placed tremendous pressure on the profitability of all financial institutions because of the resulting contraction of net interest margins. Any increase in prevailing interest rates due to changes in monetary policies may adversely affect banks such as us, whose liabilities tend to reprice quicker than their assets. It is not possible to predict the nature or effect of future changes in monetary and fiscal policies.

 
We have risks of systems failure and security risks, including “hacking” and “identity theft.”

      The computer systems and network infrastructure utilized by us and others could be vulnerable to unforeseen problems. This is true of both our internally developed systems and the systems of our third-party service providers. Our operations are dependent upon our ability to protect computer equipment against damage from fire, power loss, telecommunication failure or similar catastrophic events. Any damage or failure that causes an interruption in our operations could adversely affect our business, prospects, financial condition and results of operations.

      Our operations depend upon encryption and authentication technology to provide secure transmission of confidential information and upon our ability to generally protect the computer systems and network infrastructure utilized by us against damage from security breaches and other disruptive problems associated with Internet-related technological problems or malicious behavior of other users. Advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the processes and systems used to protect customer data. Notwithstanding such possible advances and developments, “hackers” and other disruptions could jeopardize the security of information stored in, and transmitted through, such computer systems and network infrastructure, which may result in significant liability to us and deter potential customers. With the rise in business conducted over the Internet, incidents of “identity theft” have become more frequent. Although management has implemented security technology and established operational procedures to prevent these and other threats to security, these security measures may not continue to be successful. A failure of such security measures, or the failure of our third-party service providers to design, implement and monitor their own security systems, could adversely affect our business, prospects, financial condition and results of operations.

      Any disruption in our operations due to systems failure or security breach could deter potential customers or cause existing customers to leave, could cause losses for which we would be liable and could adversely affect our reputation. Any such system failure or security breach could adversely affect our business, prospects, financial condition and results of operations.

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Risks Relating to the Offering

 
You will experience substantial dilution in the value of your shares immediately following the offering.

      Investors purchasing shares of our common stock in the offering will pay more for their shares than the amount paid by existing stockholders who acquired shares prior to the offering. Accordingly, if you purchase common stock in the offering, you will incur immediate dilution in pro forma net tangible book value of approximately $3.95 per share. In the past, we issued options and warrants to acquire common stock at exercise prices significantly below the initial public offering price and Series A preferred stock that is currently convertible at a conversion price of $10.50 per share. If the holders of outstanding options and warrants exercise those securities or, depending on the per share initial public offering price, holders of Series A preferred stock convert their securities into common stock, you will incur further dilution. See “Dilution.”

 
A public trading market for our common stock may not develop or be maintained.

      Our common stock has been approved for quotation on the Nasdaq National Market under the symbol “BOFI.” However, we cannot assure you that an established and liquid trading market for our common stock will develop, that it will continue if it does develop or that after the completion of the offering the common stock will trade at or above the initial public offering price. The representatives of the underwriters have advised us that they intend to make a market in our common stock. However, neither the representatives of the underwriters nor any other market maker is obligated to make a market in our shares, and any market making in our common stock may be discontinued at any time in the sole discretion of the party making such market.

 
We have never paid cash dividends on our common stock, and we do not expect to pay cash dividends on our common stock following the offering.

      We have never paid cash dividends on our common stock and do not expect to pay cash dividends on our common stock following the offering. Rather, we intend to retain earnings and increase capital in furtherance of our overall business objectives. We will periodically review our dividend policy in view of our operating performance and may declare dividends in the future if such payments are deemed appropriate and in compliance with applicable law and regulations. Cash and stock dividends are subject to determination and declaration by our board of directors, which will take into account our consolidated earnings, financial condition, liquidity and capital requirements, applicable governmental regulations and policies and other factors deemed relevant by our board of directors. Our ability to pay dividends, should we elect to do so, depends largely upon the ability of our bank to declare and pay dividends to us, which are subject to, among other things, the regulations of the OTS and the FDIC. The principal source of our revenues is dividends paid to us by our bank.

 
After an initial period of restriction, there will be a significant number of shares of our common stock available for future sale, which may depress our stock price.

      The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market after the offering, or even the perception that such sales could occur. We have agreed, and our directors, executive officers and certain holders of our outstanding common stock have also agreed, not to sell, offer, agree to sell, contract to sell, hypothecate, pledge, grant any option to purchase, make any short sale or otherwise dispose of or hedge, directly or indirectly, any of our common stock or securities that are substantially similar to our common stock, including but not limited to any securities that are convertible into or exchangeable for, or that represent the right to receive, our common stock or any substantially similar securities, or publicly announce an intention to do any of the foregoing for a period of 180 days in the case of our company and our directors, executive officers and certain holders of our common stock, and 90 days in the case of certain other holders of our common stock, after the date of this prospectus without the prior written consent of WR Hambrecht + Co, LLC.

      Based on the number of shares of common stock outstanding at December 31, 2004 and on the assumptions set forth below the table in “Capitalization,” there will be 7,497,649 shares of common stock

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outstanding immediately following the offering, or 7,835,149 shares if the underwriters exercise their over-allotment option in full. Of these shares, assuming no exercise of the underwriters’ over-allotment option, the following will be available for sale in the public market as follows, subject in some cases to volume and other limitations:

  •  2,628,100 shares will be eligible for sale upon completion of the offering, including all of the shares sold in the offering;
 
  •  2,505,457 shares will be eligible for sale 90 days from the date of this prospectus upon the expiration of the lock-up agreements described above; and
 
  •  1,622,967 shares will be eligible for sale 180 days from the date of this prospectus upon expiration of the lock-up agreements described above.

Risks Relating to the Auction Process

 
Potential investors should not expect to sell our shares for a profit shortly after our common stock begins trading.

      Prior to the offering, there has been no public market for our common stock. We will determine the initial public offering price for the shares sold in the offering through an auction conducted by us and our underwriters. We believe the auction process will reveal a clearing price for the shares of our common stock offered in the offering. The clearing price is the highest price at which all of the shares offered (including the shares subject to the underwriters’ over-allotment option) may be sold to potential investors. Although we and our underwriters may elect to set the initial public offering price below the auction clearing price, the public offering price may be at or near the clearing price. If there is little to no demand for our shares at or above the initial public offering price once trading begins, the price of our shares would decline following the offering. You may not be able to resell your shares at or above the initial public offering price. If your objective is to make a short term profit by selling the shares you purchase in the offering shortly after trading begins, you should not submit a bid in the auction.

 
Some bids made at or above the initial public offering price may not receive an allocation of shares.

      Our underwriters may require that bidders confirm their bids before the auction for the offering closes. If a bidder is requested to confirm a bid and fails to do so within a required time frame, that bid will be rejected and will not receive an allocation of shares even if the bid is at or above the initial public offering price. In addition, we, in consultation with our underwriters, may determine, in our sole discretion, that some bids that are at or above the initial public offering price are manipulative and disruptive to the bidding process or are not creditworthy, in which case such bids may be reduced or rejected. For example, in previous transactions for other issuers in which the auction process was used, the underwriters have rejected or reduced bids when the underwriters, in their sole discretion, deemed the bids not creditworthy or had reason to question the bidder’s intent or means to fund its bid. In the absence of other information, an underwriter or participating dealer may assess a bidder’s creditworthiness based solely on the bidder’s history with the underwriter or participating dealer. The underwriters have also reduced or rejected bids that they deemed, in their sole discretion, to be potentially manipulative or disruptive or because the bidder had a history of alleged securities law violations. Eligibility standards and suitability requirements of participating dealers may vary. As a result of these varying requirements, a bidder may have its bid rejected by a participating dealer while another bidder’s identical bid is accepted.

 
Potential investors may receive a full allocation of the shares they bid for if their bids are successful and should not bid for more shares than they are prepared to purchase.

      If the initial public offering price is at or near the clearing price for the shares offered in the offering, the number of shares represented by successful bids will equal or nearly equal the number of shares offered by this prospectus. Successful bidders may therefore be allocated all or nearly all of the shares that they bid for in the auction. Therefore, we caution investors against submitting a bid that does not accurately represent the number of shares of our common stock that they are willing and prepared to purchase.

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

      A number of the presentations and disclosures in this prospectus, including any statements preceded by, followed by or which include the words “may,” “could,” “should,” “will,” “would,” “hope,” “might,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “assume” or similar expressions, constitute forward-looking statements. These forward-looking statements, implicitly and explicitly, include the assumptions underlying the statements and other information with respect to our beliefs, plans, objectives, goals, expectations, anticipations, estimates, intentions, financial condition, results of operations, future performance and business, including our expectations and estimates with respect to our revenues, expenses, earnings, return on equity, return on assets, efficiency ratio, asset quality and other financial data and capital and performance ratios.

      Although we believe that the expectations reflected in our forward-looking statements are reasonable, these statements involve risks and uncertainties that are subject to change based on various important factors (some of which are beyond our control). The following factors, among others, could cause our financial performance to differ materially from our beliefs, plans, objectives, goals, expectations, anticipations, estimates, intentions and other forward-looking statements:

  •  inflation and interest rate, market and monetary fluctuations;
 
  •  higher defaults on our loan portfolio than we expect;
 
  •  the strength of the United States economy in general and the strength of the regional and local economies within California and other regions in which we have loan collateral and high concentrations of loans;
 
  •  the continued acceptance of Internet-based banking by consumers and businesses;
 
  •  the willingness of users to substitute competitors’ products and services for our products and services;
 
  •  our timely development of new products and services in a changing environment, including the features, pricing and quality of our products and services compared to the products and services of our competitors;
 
  •  technological changes;
 
  •  changes in consumer spending and savings habits;
 
  •  the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;
 
  •  the effect of changes in financial services policies, laws and regulations, including laws, regulations and policies concerning taxes, banking, securities and insurance, and their application by regulatory bodies; and
 
  •  the other risks discussed under “Risk Factors.”

      If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, our forward-looking information and statements. We caution you not to place undue reliance on our forward-looking information and statements.

      We do not intend to update our forward-looking information and statements, whether written or oral, to reflect events or circumstances after the date of this prospectus. All forward-looking statements attributable to us are expressly qualified by our cautionary statements.

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USE OF PROCEEDS

      As shown in the table below, our net proceeds from the sale of our shares of common stock in the offering are expected to be approximately $21.8 million (or approximately $25.3 million if the underwriters’ over-allotment option is exercised in full), assuming an initial public offering price of $11.00 per share and after deducting estimated underwriting discounts and commissions and estimated offering expenses.

                 
No Exercise of Full Exercise of
Over-Allotment Option Over-Allotment Option


Gross proceeds
  $ 24.75 million     $ 28.46 million  
Underwriting discounts and commissions
    1.49 million       1.71 million  
Estimated offering expenses
    1.42 million       1.42 million  
     
     
 
Net proceeds
  $ 21.84 million     $ 25.33 million  
     
     
 

      We intend to contribute approximately $16.0 million of the net proceeds of the offering to Bank of Internet USA to provide additional capital to support its growth, including the addition of loans secured by single family (one to four units) and multifamily (five or more units) residential properties and commercial real estate and U.S. government agency mortgage-backed and other securities, as well as to increase deposits and advances from the FHLB.

      We also intend to use a portion of the net proceeds of the offering to prepay in full a note payable. At December 31, 2004, the note payable had an outstanding principal balance of $5.0 million. The note payable bears interest at prime plus one percent per annum, which at December 31, 2004 was 6.25% per annum, and interest is payable quarterly. Principal on the note payable is due quarterly in 36 equal installments beginning on January 24, 2005 and ending on October 24, 2013. We contributed all $5.0 million of the proceeds received in connection with the note payable to Bank of Internet USA to provide additional capital to support its growth. As a result of repaying the note payable, our bank’s common stock that is collateral for the note payable will be released. We intend to use the remaining net proceeds for general corporate purposes. Pending these uses, we will invest the net proceeds initially in short term, investment grade securities and other qualified investments, such as federal funds sold.

DIVIDEND POLICY

      We have never paid cash dividends on our common stock, electing to retain earnings for funding our growth and business. We currently anticipate continuing our policy of retaining earnings to fund growth. Our ability to pay dividends, should we ever elect to do so, depends largely upon the ability of our bank to declare and pay dividends to us as the principal source of our revenues 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, which limit the amount that may be paid as dividends without prior approval. See “Regulation — Regulation of Bank of Internet USA — Capital Distribution Limitations.”

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CAPITALIZATION

      The following table sets forth our capitalization at December 31, 2004. Our capitalization is presented:

  •  on an actual basis; and
 
  •  on an as adjusted basis to reflect our receipt of the net proceeds from the sale of 2,250,000 shares of common stock in the offering at an assumed initial public offering price of $11.00 per share, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us in the offering (and assuming no exercise of the underwriters’ over-allotment option), as if the sale of our common stock had been consummated on December 31, 2004.

      The following information should be read together with our consolidated financial statements and the related notes thereto.

                       
At December 31, 2004

Actual As Adjusted


(Dollars in thousands)
Borrowings:
               
 
Advances from the FHLB
  $ 148,504     $ 148,504  
 
Note payable(1)
    5,000        
 
Junior subordinated debentures
    5,155       5,155  
     
     
 
   
Total borrowings(2)
  $ 158,659     $ 153,659  
     
     
 
Stockholders’ equity:
               
 
Convertible preferred stock, $10,000 stated value; 1,000,000 shares authorized; 1,200 shares designated Series A preferred stock, 675 shares issued and outstanding
  $ 6,637     $ 6,637  
 
Common stock, $.01 par value; 10,000,000 shares authorized; 4,563,399 shares issued and outstanding actual and 7,497,649 shares issued and outstanding as adjusted(3)
    46       75  
 
Additional paid-in capital
    22,601       47,281  
 
Accumulated other comprehensive loss, net of tax
    (126 )     (126 )
 
Retained earnings
    3,686       3,686  
     
     
 
   
Total stockholders’ equity
  $ 32,844     $ 57,553  
     
     
 
     
Total capitalization
  $ 191,503     $ 211,212  
     
     
 
Capital ratios:
               
 
Equity to assets at end of period
    6.40 %     10.70 %
 
Tier 1 leverage (core) to adjusted tangible assets(4)
    7.45 %     10.25 %
 
Tier 1 risk-based capital ratio(4)
    11.44 %     16.08 %
 
Total risk-based capital ratio(4)
    11.80 %     16.45 %
 
Tangible capital to tangible assets(4)
    7.45 %     10.25 %


(1)  We intend to prepay in full without penalty the note payable with a portion of the net proceeds from the offering.
 
(2)  In addition to the indebtedness reflected above, we had total deposits of $320.0 million at December 31, 2004.
 
(3)  Common stock actual, but not common stock as adjusted, excludes 684,250 shares of common stock issuable upon exercise of warrants with an exercise price of $4.19 per share, which warrants we expect to be exercised on a cash basis prior to the offering because they terminate if not exercised prior to that time. Common stock actual and common stock as adjusted exclude:

  •  722,017 shares of common stock issuable upon exercise of outstanding stock options, with a weighted average exercise price of $6.11 per share;

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  •  59,950 shares of common stock issuable upon the exercise of warrants with an exercise price of $14.00 per share;
 
  •  642,600 shares of common stock currently issuable upon conversion of our Series A preferred stock. Our Series A preferred stock is convertible at prices which increase periodically through January 2009, after which time our Series A preferred stock is no longer convertible into our common stock. The current conversion price of $10.50 per share is in effect through January 1, 2006;
 
  •  shares of common stock reserved for future issuance under our 2004 stock incentive plan, which provides that aggregate equity awards under our 2004 stock incentive plan and options outstanding under our 1999 stock option plan may not exceed 14.8% of our outstanding common stock at any time. Based on the number of shares of common stock outstanding at December 31, 2004, and assuming 2,250,000 shares of common stock are sold in the offering and warrants to purchase 684,250 shares of common stock are exercised on a cash basis prior to the offering, the maximum number of shares of common stock issuable upon exercise of options granted under our 2004 stock incentive plan would be 1,109,652; and
 
  •  up to 500,000 shares of common stock reserved for future issuance under our 2004 employee stock purchase plan.

(4)  Reflects regulatory capital ratios of Bank of Internet USA only. The as adjusted ratio assumes the deployment of the net proceeds of the offering in assets with a 20% risk weighting under applicable regulations.

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DILUTION

      If you invest in our common stock, your interest will be diluted to the extent of the difference between the public offering price per share of our common stock and the pro forma net tangible book value per share of our common stock after the offering. Net tangible book value per share is equal to the amount of our common stockholders’ equity less intangible assets, divided by the number of shares outstanding. The net tangible book value of our common stock at December 31, 2004 was $26.2 million, or $5.74 per share, based on 4,563,399 shares of common stock outstanding at December 31, 2004.

      After (1) giving effect to the sale of the 2,250,000 shares of common stock in the offering, at an assumed initial public offering price of $11.00 per share (the midpoint of the $9.00 to $13.00 range), assuming that the underwriters’ over-allotment option is not exercised, and (2) deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma net tangible book value at December 31, 2004 would be approximately $48.0 million, or $7.05 per share. The offering will result in an immediate increase in net tangible book value of $1.31 per share to existing stockholders and an immediate dilution of $3.95 per share to new investors, or approximately 35.9% of the assumed initial public offering price of $11.00 per share. Dilution is determined by subtracting pro forma net tangible book value per share after the offering from the assumed initial public offering price of $11.00 per share. The following table illustrates this per share dilution:

                   
Assumed initial public offering price per share
          $ 11.00  
 
Net tangible book value per share at December 31, 2004
  $ 5.74          
 
Increase in net tangible book value per share attributable to new investors
    1.31          
     
         
Pro forma net tangible book value per share at December 31, 2004
            7.05  
             
 
Dilution per share to new investors
            3.95  
             
 

      We expect warrants for 684,250 shares of common stock with an exercise price of $4.19 per share to be exercised on a cash basis prior to the offering because they terminate if not exercised prior to that time. If these warrants are exercised, then the dilution per share to new investors would be $4.21.

      The following table summarizes the tangible book value of the outstanding shares and the total consideration paid to us and the average price paid per share by existing stockholders and new investors purchasing common stock in the offering. This information is presented on a pro forma basis at December 31, 2004, after giving effect to the sale of the 2,250,000 shares of common stock in the offering at an assumed initial public offering price of $11.00 per share.

                                           
Shares Purchased Total Consideration Average


Price
Number Percent Amount Percent Per Share





(Dollars in thousands)
Existing stockholders
    5,247,649 (1)     70 %   $ 25,407       51 %   $ 4.84  
New investors
    2,250,000       30 %     24,750 (2)     49 %     11.00  
     
     
     
     
         
 
Total
    7,497,649       100 %   $ 50,157       100 %        
     
     
     
     
         


(1)  Assumes the exercise on a cash basis of warrants to purchase 684,250 shares of common stock with an exercise price of $4.19 per share, which warrants we expect to be exercised prior to the offering because they terminate if not exercised prior to that time. We have assumed no exercise of outstanding stock options and other warrants or conversion of our Series A preferred stock. In addition to the warrants for 684,250 shares of common stock, at December 31, 2004, there were outstanding:

  •  722,017 shares of common stock issuable upon exercise of outstanding stock options with a weighted average exercise price of $6.11 per share;
 
  •  59,950 shares of common stock issuable upon the exercise of warrants with an exercise price of $14.00 per share; and

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  •  642,600 shares of common stock currently issuable upon conversion of our Series A preferred stock (based on the current conversion price of $10.50 per share).

(2)  Before deducting estimated underwriting discounts and commissions of approximately $1.5 million and estimated offering expenses of approximately $1.4 million payable by us.

      To the extent that any outstanding options or warrants are exercised or, depending on the per share initial public offering price, Series A preferred stock is converted into common stock, there will be further dilution to new investors. In addition, we may choose to raise additional capital even if we believe we have sufficient funds for our current or future operating plans. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities could result in further dilution to our stockholders.

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SELECTED CONSOLIDATED FINANCIAL INFORMATION

      You should read the selected consolidated financial information set forth below together with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. Our consolidated income statement information for the six months ended December 31, 2004 and 2003 and the consolidated balance sheet information as of December 31, 2004 are derived from our unaudited consolidated financial statements, which are included in this prospectus and, in the opinion of management, include all adjustments necessary for fair presentation of the results of such periods. The consolidated balance sheet information as of December 31, 2003 is derived from our unaudited consolidated financial information. The consolidated income statement information for the fiscal years ended June 30, 2004, 2003 and 2002 and the consolidated balance sheet information at June 30, 2004 and 2003 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated income statement information for the fiscal year ended June 30, 2001 and the period from July 6, 1999 (inception) to June 30, 2000 and the consolidated balance sheet information at June 30, 2002, 2001 and 2000 have been derived from our audited consolidated financial statements that are not included in this prospectus. Historical results are not necessarily indicative of future results.

                                                         
At or for
At or for the Period
the Six Months July 6, 1999
Ended December 31, At or for the Fiscal Years Ended June 30, (inception) to


June 30,
2004 2003 2004 2003 2002 2001 2000







(Dollars in thousands, except per share data)
Selected Balance Sheet Data:
                                                       
Total assets
  $ 513,108     $ 316,804     $ 405,039     $ 273,464     $ 217,614     $ 156,628     $ 13,295  
Loans held for investment, net of allowance for loan losses
    417,915       283,764       355,261       245,933       167,251       139,679        
Loans held for sale, at cost
    845             435       3,602       128       22        
Allowance for loan losses
    1,220       825       1,045       790       505       310        
Investment securities
    53,041       311       3,665       441       726       1,522        
Total deposits
    320,019       220,235       269,841       193,992       167,618       127,204        
Advances from the FHLB
    148,504       66,389       101,446       55,900       29,900       15,900        
Note payable
    5,000       3,060       1,300                   870        
Junior subordinated debentures
    5,155                                      
Total stockholders’ equity
    32,844       26,623       31,759       22,885       19,501       11,903       12,936  
Selected Income Statement Data:
                                                       
Interest and dividend income
  $ 10,192     $ 7,218     $ 15,772     $ 13,514     $ 11,641     $ 4,697     $ 24  
Interest expense
    5,905       4,342       9,242       8,426       8,144       3,535        
     
     
     
     
     
     
     
 
Net interest income
    4,287       2,876       6,530       5,088       3,497       1,162       24  
Provision for loan losses
    175       35       255       285       195       310        
     
     
     
     
     
     
     
 
Net interest income after provision for loan losses
    4,112       2,841       6,275       4,803       3,302       852       24  
Noninterest income
    385       474       1,190       1,349       297       52        
Noninterest expense
    2,546       1,985       3,819       3,158       3,008       1,985       1,012  
     
     
     
     
     
     
     
 
Income (loss) before income tax expense (benefit)
    1,951       1,330       3,646       2,994       591       (1,081 )     (988 )
Income tax expense (benefit)
    776       580       1,471       1,264       (429 )     1        
     
     
     
     
     
     
     
 
Net income (loss)
  $ 1,175     $ 750     $ 2,175     $ 1,730     $ 1,020     $ (1,082 )   $ (988 )
     
     
     
     
     
     
     
 
Net income (loss) attributable to common stock
  $ 972     $ 731     $ 2,035     $ 1,730     $ 1,020     $ (1,082 )   $ (988 )

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At or for
At or for the Period
the Six Months July 6, 1999
Ended December 31, At or for the Fiscal Years Ended June 30, (inception) to


June 30,
2004 2003 2004 2003 2002 2001 2000







(Dollars in thousands, except per share data)
Per Share Data:
                                                       
Net income (loss):
                                                       
 
Basic
  $ 0.21     $ 0.16     $ 0.45     $ 0.39     $ 0.25     $ (0.29 )   $ (0.33 )
 
Diluted
  $ 0.19     $ 0.14     $ 0.39     $ 0.34     $ 0.21     $ (0.29 )   $ (0.33 )
Book value per common share
  $ 5.74     $ 5.27     $ 5.57     $ 5.11     $ 4.50     $ 3.21     $ 3.50  
Tangible book value per common share
  $ 5.74     $ 5.27     $ 5.57     $ 5.11     $ 4.50     $ 3.21     $ 3.50  
Weighted average number of common shares outstanding:
                                                       
 
Basic
    4,527,519       4,498,045       4,502,284       4,468,296       4,128,051       3,706,050       2,950,999  
 
Diluted
    5,172,864       5,156,898       5,160,482       5,134,940       4,795,401       3,706,050       2,950,999  
Common shares outstanding at end of period
    4,563,399       4,506,524       4,506,524       4,474,351       4,334,401       3,707,156       3,694,031  
Performance Ratios and Other Data:
                                                       
Loan originations for investment
  $ 27,682     $ 37,198     $ 64,478     $ 58,609     $ 34,659     $ 16,003       NM  
Loan originations for sale
    9,795       43,643       76,550       124,739       6,994       3,317       NM  
Loan purchases
    70,859       52,468       129,193       81,778       132,298       139,565       NM  
Return (loss) on average assets
    0.53%       0.52%       0.67%       0.71%       0.53%       (1.56)%       NM  
Return (loss) on average common stockholders’ equity
    7.52%       6.16%       8.42%       7.87%       6.32%       (8.68)%       NM  
Interest rate spread(1)
    1.78%       1.76%       1.81%       1.76%       1.45%       0.67%       NM  
Net interest margin(2)
    1.98%       2.02%       2.04%       2.11%       1.83%       1.73%       NM  
Efficiency ratio(3)
    54.49%       59.25%       49.47%       49.06%       79.28%       163.51%       NM  
Capital Ratios:
                                                       
Equity to assets at end of period
    6.40%       8.40%       7.84%       8.37%       8.96%       7.60%       NM  
Tier 1 leverage (core) capital to adjusted tangible assets(4)
    7.45%       8.94%       7.84%       8.09%       8.65%       8.16%       NM  
Tier 1 risk-based capital ratio(4)
    11.44%       12.09%       11.11%       11.40%       13.76%       15.00%       NM  
Total risk-based capital ratio(4)
    11.80%       12.44%       11.48%       11.81%       14.13%       15.37%       NM  
Tangible capital to tangible assets(4)
    7.45%       8.94%       7.84%       8.09%       8.65%       8.16%       NM  
Asset Quality Ratios:
                                                       
Net charge-offs to average loans outstanding(5)
                                         
Nonperforming loans to total loans(5)
                                         
Allowance for loan losses to total loans held for investment at end of period
    0.29%       0.29%       0.29%       0.32%       0.30%       0.22%       NM  
Allowance for loan losses to nonperforming loans(5)
                                         


(1)  Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate paid on interest-bearing liabilities.
 
(2)  Net interest margin represents net interest income as a percentage of average interest-earning assets.
 
(3)  Efficiency ratio represents noninterest expense as a percentage of the aggregate of net interest income and noninterest income.
 
(4)  Reflects regulatory capital ratios of Bank of Internet USA only.
 
(5)  For every quarter from inception to June 30, 2004, we had no loan defaults, no foreclosures, no nonperforming loans and no specific loan loss allowances. Since that time, one loan with a principal balance of approximately $152,000 at June 30, 2004 defaulted, but the loan was repaid in full in September 2004. At September 30, 2004 and December 31, 2004, we had no loan defaults, no foreclosures, no nonperforming loans and no specific loan loss allowances.

“NM” means not meaningful.

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MANAGEMENT’S 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 “Risk Factors” and elsewhere in this prospectus. The following discussion and analysis should be read together with the “Selected Consolidated Financial Information” and our consolidated financial statements, including the related notes, included elsewhere in this prospectus.

General

      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.

      Our deposit customers are acquired and serviced exclusively over the Internet. Using online applications on our websites, our customers apply for deposit products, including time deposits, interest-bearing demand accounts (including interest-bearing checking accounts) and savings accounts (including money market savings accounts). We specialize in originating and purchasing small- to medium-size multifamily mortgage loans. We manage our cash and cash equivalents based upon our need for liquidity, and we seek to minimize the assets we hold as cash and cash equivalents by investing our excess liquidity in higher yielding assets such as loans or securities.

      Our ability to increase our assets is limited primarily by the capital we are required to maintain by regulation. Our bank must maintain certain minimum ratios of capital to assets. Thus, to enable us to increase the rate at which our bank grows its assets, we have raised additional capital in three separate private placements totaling $14.5 million between September 2001 and June 2004. Following each of these private placements, we increased our total assets. Other than the constraints of these capital requirements, we believe that our business model is highly scalable, allowing us to expand into new regions and products and rapidly increase deposits and, to a lesser extent, loans, without significant delays and with a significantly slower growth rate of noninterest expenses and fixed assets.

      At June 30, 2001, the end of our first fiscal year of operations, our total deposits were $127.2 million and total assets were $156.6 million. We have since grown our deposits and assets to $320.0 million and $513.1 million, respectively, at December 31, 2004. During the last three fiscal years, we have operated with net interest margins (the difference between the rate on average interest-earning assets and the rate on average interest-bearing liabilities) ranging from 1.83% to 2.11%. During the same three-year period, our efficiency ratio (noninterest expense divided by the sum of net interest income and noninterest income) improved from 79.3% to 49.5%.

      During our first two years of operation, we focused primarily on building our online franchise and deposit growth. We became profitable during the fiscal year ended June 30, 2002, as we grew sufficiently to generate enough net interest income to exceed our operating expenses. In our deposit gathering business, we initially sought time deposits because of their large average size and their relatively simple application and processing. This initial focus gave us time to develop our customer relationship management, or CRM software and manage workflow, as well as develop our online advertising strategy. The proceeds from our deposits were invested primarily in single family mortgage loans, which we purchased in pools with servicing retained by the sellers. The initial pool purchases and third-party servicing provided us the time to hire and train loan origination and servicing staff. In the last half of the fiscal year ended June 30, 2002, we began to shift our focus from purchasing single family mortgage loans to originating and purchasing multifamily mortgage loans. At June 30, 2002, we had 20 full time employees and $217.6 million in assets. For the fiscal year ended

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June 30, 2002, our net interest income, the primary component of our net income, was $3.5 million, which resulted in a net interest margin of 1.83% on average interest earning assets.

      During the fiscal years ended June 30, 2003 and 2004, we developed and strengthened our online loan origination capabilities. We launched our single family loan origination website in March 2002. We originated single family mortgage loans for sale of $7.0 million for the fiscal year ended June 30, 2002, $124.7 million for the fiscal year ended June 30, 2003 and $76.6 million for the fiscal year ended June 30, 2004. We launched our multifamily loan origination website in December 2002. We originated multifamily mortgage loans of $30.0 million for the fiscal year ended June 30, 2002, $49.9 million for the fiscal year ended June 30, 2003 and $57.3 million for the fiscal year ended June 30, 2004.

      At June 30, 2004, we had $405.0 million in assets, or $16.9 million in assets per full time equivalent employee. For the fiscal year ended June 30, 2004, our net interest income was $6.5 million which resulted in a net interest margin of 2.0% on average interest-earning assets. Our asset growth, the shift in our loan portfolio toward multifamily loans and the relative increase in demand and savings accounts, combined with the relatively slower growth in our operating expense as result of our Internet platform, are principally responsible for our increase in earnings from $1.0 million for the fiscal year ended June 30, 2002 to $1.7 million for the fiscal year ended June 30, 2003 and $2.2 million for the fiscal year ended June 30, 2004.

      At December 31, 2004, we had $513.1 million in assets, or $20.5 million in assets per full time equivalent employee. For the six months ended December 31, 2004, our net income was $1.2 million and increased 56.7% compared to the same period ended December 31, 2003. The earnings increase was a result of asset growth after incurring a contract termination expense for the six months ended December 31, 2003.

      Our future performance will depend on many factors, including changes in interest rates, competition for deposits and quality loans, regulatory burden and our ability to improve operating efficiencies. We believe we are well positioned for asset growth and processing efficiencies that will increase profitability.

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.

      Our significant accounting policies and practices are described in Note 1 to our June 30, 2004 audited consolidated financial statements, which are included in this prospectus. Following is a summary of the accounting policies and practices that require management’s judgment and estimates:

      Investment Securities. Investment securities generally must be classified as held-to-maturity, available-for-sale or trading. The appropriate classification is based partially on our ability to hold the securities to maturity and largely on management’s intentions with respect to either holding or selling the securities. The classification of investment securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Unrealized gains and losses on trading securities flow directly through earnings during the periods in which they arise, whereas for available-for-sale securities, they are recorded as a separate component of stockholders’ equity (accumulated comprehensive other income or loss) and do not affect earnings until realized. The fair values of our investment securities are generally determined by reference to quoted market prices and reliable independent sources. We are obligated to assess, at each reporting date, whether there is an “other-than-temporary” impairment to our investment securities. Any impairment must be recognized in current earnings rather than in other comprehensive income. We have not had any impaired investment securities.

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      Allowance for Loan Losses. We maintain an allowance for loan losses at an amount that we believe is sufficient to provide adequate protection against probable losses in our loan portfolio. Quarterly, we evaluate 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 for specific reserves. Specific loans are evaluated for impairment and are 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 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 loan’s 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. We use 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.

      For every quarter from inception to June 30, 2004, we had no loan defaults, no foreclosures, no nonperforming loans and no specific loan loss allowances. Since that time, one loan with a principal balance of approximately $152,000 at June 30, 2004 defaulted, but the loan was repaid in full in September 2004. At September 30, 2004 and December 31, 2004, we had no loan defaults, no foreclosures, no nonperforming loans and no specific loan loss allowances. Our history is limited, and we expect to have over time additional loans default or become nonperforming. We have provided general loan loss allowances as an estimate of the impairment inherent in our portfolio. See “Risk Factors” for more information regarding the risks associated with our loan portfolio.

Comparison of Financial Condition at December 31, 2004 and June 30, 2004

      Total assets increased by $108.1 million to $513.1 million at December 31, 2004 from $405.0 million at June 30, 2004. The increase in total assets resulted primarily from purchases of mortgage-backed securities and mortgage loans held for investment during the six months ended December 31, 2004, resulting in increases in investment securities available for sale and loans held for investment of $44.8 million and $62.7 million, respectively. Total liabilities increased by $107.0 million to $480.3 million at December 31, 2004 from $373.3 million at June 30, 2004. The increase in total liabilities resulted from growth in deposits of $50.2 million, advances from the FHLB of $47.1 million, increase in notes payable of $3.7 million and our issuance of $5.2 million in junior subordinated debentures.

      Stockholders’ equity increased by $1.1 million during the six months ended December 31, 2004. The increase was the result of $1.2 million in net income, $239,000 from the exercise of common stock warrants less $203,000 in cash dividends paid to holders of our Series A preferred stock.

      Our deposit growth of $50.2 million between June 30, 2004 and December 31, 2004 was primarily the result of a $60.7 million net increase in time deposits due to increased offering rates and increased advertising.

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Our originations and purchases of loans held for investment, primarily multifamily loans, were $27.7 million and $70.9 million, respectively, for the six months ended December 31, 2004. Deposit funding in excess of our loan originations, advances from the FHLB and proceeds from our issuance of junior subordinated debentures were invested in hybrid mortgage-backed securities to build our investment portfolio, increase its yield and add liquidity. In addition to our loan originations, we intend to continue purchasing multifamily and single family loans and mortgage-backed securities from time to time.

Comparison of Financial Condition at June 30, 2004 and 2003

      Total assets increased by $131.5 million, or 48.1%, to $405.0 million at June 30, 2004 from $273.5 million at June 30, 2003. The increase in total assets resulted primarily from a $109.3 million increase in net loans due to loan purchases and originations totaling $193.7 million, which were offset by loan principal repayments of $83.6 million. The $109.3 million increase in net loans was primarily the result of the expansion of our multifamily loan origination and purchase capabilities, including the development and launch of our multifamily loan origination websites. Investment securities increased by $3.2 million to $3.7 million due to the purchase of a government agency debt security. Total liabilities increased by $122.7 million, or 49.0%, to $373.3 million at June 30, 2004 from $250.6 million at June 30, 2003. The increase in total liabilities resulted primarily from growth in deposits of $75.8 million and increases in advances from the FHLB of $45.5 million. We designed and marketed new savings account programs, which increased our savings accounts by $75.3 million between June 30, 2003 and 2004. We used advances from the FHLB to extend the average maturities of our liabilities to match better the expected timing of changes in the interest rates on our loans.

      Stockholders’ equity increased by $8.9 million, or 38.9%, during the fiscal year ended June 30, 2004. The increase is primarily due to $6.6 million in net cash received from our issuance of Series A preferred stock and an increase of $2.2 million in retained earnings from net income, less a total of $140,000 in cash dividends paid to holders of our Series A preferred stock.

      During the fiscal year ended June 30, 2004, we originated and purchased $57.3 million and $120.3 million, respectively, in multifamily loans, increasing our multifamily loan portfolio by 67.7% from $191.4 million to $321.0 million. We expect to continue to emphasize multifamily lending through the addition of direct loan originators and through increased online contact from our customers and potential customers searching for loans. Our originations of single family loans held for sale declined from $124.7 million for the fiscal year ended June 30, 2003 to $76.6 million for the fiscal year ended June 30, 2004. This decline was primarily due to rising interest rates and the resulting decline in refinance activity.

Comparison of Financial Condition at June 30, 2003 and 2002

      Total assets increased by $55.9 million, or 25.7%, to $273.5 million at June 30, 2003 from $217.6 million at June 30, 2002. The increase in total assets resulted primarily from loan purchases and originations of $140.4 million, 70% of which were multifamily mortgage loans. The increase was offset by principal repayments during the fiscal year ended June 30, 2003, which totaled $60.9 million, consisting primarily of single family mortgage prepayments by borrowers who refinanced during a period of low interest rates. Loans held for sale increased $3.5 million to $3.6 million at June 30, 2003 from $128,000 at June 30, 2002, due to increased originations of single family mortgage loans which were held for sale.

      Total liabilities increased by $52.5 million, or 26.5%, to $250.6 million at June 30, 2003 from $198.1 million at June 30, 2002. The increase in total liabilities resulted from growth in deposits of $26.4 million and $26.0 million in advances from the FHLB.

      Stockholders’ equity increased by $3.4 million, or 17.4%, during the fiscal year ended June 30, 2003. The increase is primarily due to $1.7 million in new common stock issued in a private placement, which closed on July 31, 2002, and $1.7 million in net income which increased retained earnings.

      During the fiscal year ended June 30, 2003, we originated $124.7 million in single family loans held for sale. The development and launch of our single family loan origination website and low mortgage interest rates favoring refinancing caused our originations to rise from the $7.0 million originated in the fiscal year ended June 30, 2002.

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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.

                                                 
For the Six Months Ended December 31,

2004 2003


Interest Rates Interest Rates
Average Income/ Earned/ Average Income/ Earned/
Balance(1) Expense Paid(2) Balance(1) Expense Paid(2)






(Dollars in thousands)
Assets:
Loans(3)(4)
  $ 366,070     $ 9,169       5.01 %   $ 250,237     $ 6,929       5.54 %
Federal funds sold
    14,082       113       1.60 %     19,713       91       0.92 %
Interest-earning deposits in other financial institutions
    9,745       126       2.59 %     11,073       133       2.40 %
Investment securities(4)(5)
    38,081       676       3.55 %     385       5       2.60 %
Stock of the FHLB, at cost
    5,412       108       3.99 %     2,996       60       4.01 %
     
     
             
     
         
Total interest-earning assets
    433,390       10,192       4.70 %     284,404       7,218       5.08 %
Noninterest-earning assets
    8,309                       4,081                  
     
                     
                 
Total assets
  $ 441,699                     $ 288,485                  
     
                     
                 
 
Liabilities and Stockholders’ Equity:
Interest-bearing demand and savings
  $ 118,872     $ 1,077       1.81 %   $ 72,261     $ 620       1.72 %
Time deposits
    174,763       2,867       3.28 %     129,726       2,512       3.87 %
Advances from the FHLB
    107,551       1,857       3.45 %     59,072       1,198       4.06 %
Other borrowings
    3,490       104       5.96 %     447       12       5.37 %
     
     
             
     
         
Total interest-bearing liabilities
    404,676       5,905       2.92 %     261,506       4,342       3.32 %
Noninterest-bearing demand deposits
    3,355                       2,172                  
Other noninterest-bearing liabilities
    1,176                       748                  
Stockholders’ equity
    32,492                       24,059                  
     
                     
                 
Total liabilities and stockholders’ equity
  $ 441,699                     $ 288,485                  
     
                     
                 
Net interest income
          $ 4,287                     $ 2,876          
             
                     
         
Interest rate spread(6)
                    1.78 %                     1.76 %
Net interest margin(7)
                    1.98 %                     2.02 %

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For the Fiscal Years Ended June 30,

2004 2003 2002



Average Average Average
Yields Yields Yields
Interest Earned/ Interest Earned/ Interest Earned/
Average Income/ Rates Average Income/ Rates Average Income/ Rates
Balance(1) Expense Paid Balance Expense Paid Balance(1) Expense Paid









(Dollars in thousands)
Assets:
Loans(3)(4)
  $ 284,617     $ 15,177       5.33 %   $ 202,955     $ 12,723       6.27 %   $ 158,105     $ 10,765       6.81 %
Federal funds sold
    20,944       192       0.92 %     16,446       235       1.43 %     21,953       459       2.09 %
Interest-earning deposits in other financial institutions
    10,919       261       2.39 %     19,327       445       2.30 %     8,793       305       3.47 %
Investment securities held to maturity, at cost(4)(5)
    336       7       2.08 %     586       17       2.92 %     1,082       46       4.25 %
Stock of the FHLB, at cost
    3,467       135       3.89 %     1,866       94       5.05 %     1,182       66       5.58 %
     
     
             
     
             
     
         
Total interest-earning assets
    320,283       15,772       4.92 %     241,180       13,514       5.60 %     191,115       11,641       6.09 %
Noninterest-earning assets
    5,790                       3,040                       1,927                  
     
                     
                     
                 
Total assets
  $ 326,073                     $ 244,220                     $ 193,042                  
     
                     
                     
                 
 
Liabilities and Stockholders’ Equity:
Interest-bearing demand and savings
  $ 93,797     $ 1,668       1.78 %   $ 41,373     $ 854       2.07 %   $ 28,391     $ 759       2.67 %
Time deposits
    132,166       4,866       3.68 %     142,903       5,854       4.10 %     123,812       6,196       5.00 %
Advances from the FHLB
    69,932       2,648       3.79 %     35,343       1,718       4.86 %     22,764       1,143       5.02 %
Other borrowings
    1,119       60       5.36 %                       487       46       9.45 %
     
     
             
     
             
     
         
Total interest-bearing liabilities
    297,014       9,242       3.11 %     219,619       8,426       3.84 %     175,454       8,144       4.64 %
             
                     
                     
         
Noninterest-bearing demand deposits
    2,003                       1,756                       825                  
Other noninterest-bearing liabilities
    796                       850                       620                  
Stockholders’ equity
    26,260                       21,995                       16,143                  
     
                     
                     
                 
Total liabilities and stockholders’ equity
  $ 326,073                     $ 244,220                     $ 193,042                  
     
                     
                     
                 
Net interest income
          $ 6,530                     $ 5,088                     $ 3,497          
             
                     
                     
         
Interest rate spread(6)
                    1.81 %                     1.76 %                     1.45 %
Net interest margin(7)
                    2.04 %                     2.11 %                     1.83 %


(1)  Average balances are obtained from daily data.
 
(2)  Annualized.
 
(3)  Loans include loans held for sale, allowance for loan losses, loan premiums and unearned fees.
 
(4)  Interest income includes reductions for amortization of loan and investment securities premiums and earnings from accretion of discounts and loan fees. Loan fee income is not significant.
 
(5)  All investments are taxable.
 
(6)  Interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate paid on interest-bearing liabilities.
 
(7)  Net interest margin represents net interest income as a percentage of average interest-earning assets.

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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 and, to a lesser extent, from the shift in our loan portfolio and the relative increases in demand and savings accounts, as compared to time deposits. We also earn noninterest income from gains on sales of single family mortgage loans and prepayment fee income from multifamily borrowers who repay their loans before maturity. During the fiscal year ended June 30, 2003, lower interest rates resulted in higher mortgage refinancing activity. Interest rates increased during the fiscal year ended June 30, 2004 and, as a result, mortgage loan refinancing activity declined. In the near term, we believe that prepayment penalty fee income and gain on sale income will be reduced as a result of rising interest rates. The largest component of noninterest expense is salary and benefits, which is a function of the number of personnel, which increased from 20 full time employees at June 30, 2001 to 25 full time equivalent employees at December 31, 2004. We are subject to federal and state income taxes, and our effective tax rate has changed from a benefit of 72.6% for the fiscal year ended June 30, 2002 to an expense of 42.2% and 40.4% for the fiscal years ended June 30, 2003 and 2004, respectively. We recognized the benefit of prior tax operating losses for the fiscal years ended June 30, 2002 and 2003. No such benefit was recognized for the fiscal year ended June 30, 2004. Other factors that affect our results of operations include expenses relating to occupancy, data processing and other miscellaneous expenses.

      Net income for the six months ended December 31, 2004 totaled $1.2 million compared to $750,000 for the six months ended December 31, 2003. The $425,000 increase resulted from a $1.4 million increase in net interest income, reduced by an increase in noninterest expense of $561,000, an increase in our loan loss provision of $140,000 and a decrease in noninterest income of $89,000. The principal reason for the $561,000 increase in noninterest expense for the six months ended December 31, 2004 compared to the six months ended December 31, 2003 was an increase in salary and benefits of $432,000, which was primarily the result of accruing $280,000 in special one-time bonuses for our executives. Net income totaled $2.2 million for the fiscal year ended June 30, 2004, compared to $1.7 million for the fiscal year ended June 30, 2003. The $445,000 increase resulted from a $1.4 million increase in net interest income, reduced by a $661,000 increase in noninterest expense, a $207,000 increase in income tax expense and a $159,000 decrease in noninterest income. The increase in noninterest expense for the fiscal year ended June 30, 2004 was due to increased salaries and benefits and the termination of a services contract. Net income increased $710,000 to $1.7 million for the fiscal year ended June 30, 2003 compared to $1.0 million for the fiscal year ended June 30, 2002. The increase in net income resulted from a $1.6 million increase in net interest income and a $1.1 million increase in noninterest income, a $90,000 increase in loan loss provisions, a $150,000 increase in noninterest expense and a $1.7 million increase in income tax expense.

 
Comparison of the Six Months Ended December 31, 2004 and 2003

      Net Interest Income. Net interest income is determined by our interest rate spread (i.e., the difference between the yields earned on our interest-earning assets and the rates paid on our interest-bearing liabilities) and the relative amounts (volume) of our interest-earning assets and interest-bearing liabilities. Net interest income totaled $4.3 million for the six months ended December 31, 2004 compared to $2.9 million for the six months ended December 31, 2003. 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

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(iii) changes in rate/volume (change in rate multiplied by change in volume) for the six months ended December 31, 2004 compared to the six months ended December 31, 2003.
                                 
Six Months Ended December 31, 2004 vs.
Six Months Ended December 31, 2003

Increase (Decrease) Due to

Total
Increase
Volume Rate Rate/Volume (Decrease)




(Dollars in thousands)
Increase/(decrease) in interest income:
                               
Loans
  $ 3,209     $ (663 )   $ (306 )   $ 2,240  
Federal funds sold
    (26 )     67       (19 )     22  
Interest-earning deposits in other financial institutions
    (16 )     11       (2 )     (7 )
Investment securities
    490       2       179       671  
Stock of the FHLB, at cost
    48                   48  
     
     
     
     
 
    $ 3,705     $ (583 )   $ (148 )   $ 2,974  
     
     
     
     
 
Increase/(decrease) in interest expense:
                               
Interest-bearing demand and savings
  $ 401     $ 33     $ 23     $ 457  
Time deposits
    871       (383 )     (133 )     355  
Advances from the FHLB
    985       (180 )     (146 )     659  
Other borrowings
    82       1       9       92  
     
     
     
     
 
    $ 2,339     $ (529 )   $ (247 )   $ 1,563  
     
     
     
     
 

      Our net interest margin for the six months ended December 31, 2004 declined to 1.98% compared to 2.02% for the six months ended December 31, 2003. During the six months ended December 31, 2004, interest income earned on loans and interest expense paid on deposits were influenced by a general decline in the historical spread between short term and long term rates earned on U.S. Treasury securities. If short term rates continue to rise faster than long term rates, our net interest income may be negatively impacted. See “— Quantitative and Qualitative Disclosures About Market Risk.”

      Interest Income. Interest income for the six months ended December 31, 2004 totaled $10.2 million, an increase of $3.0 million, or 41.7%, compared to $7.2 million in interest income for the six months ended December 31, 2003. Average interest-earning assets for the six months ended December 31, 2004 increased by $149.0 million compared to the six months ended December 31, 2003 due primarily to an $115.8 million increase in the average balance of the loan portfolio as a result of our emphasis on building our multifamily loan portfolio. Also, our average balance of investment securities increased to $38.0 million during the six months ended December 31, 2004 compared to the $385,000 average balance for the same period in 2003 as a result of the purchase of $53.0 million of mortgaged-backed securities. Average interest earning balances associated with our stock of the FHLB increased by $2.4 million for the six months ended December 31, 2004 compared to the six months ended December 31, 2003 because our required minimum investment increased, in line with increased advances from the FHLB. The average yield earned on our interest-earning assets declined to 4.7% for the six months ended December 31, 2004 from 5.1% for the same period in 2003 due primarily to the lower yield on our loan portfolio as market interest rates declined. The widespread increase in prepayments or refinancing of mortgage loans during 2003 and 2004 reduced the higher-yielding older loans which were replaced with lower yielding new loans, causing the average yield on the loan portfolio to decline to 5.0% for the six months ended December 31, 2004 from 5.5% for the same period in 2003. Thus, the loan portfolio volume increase in the six months ended December 31, 2004 would have increased interest income $3.2 million, but the average rate decline and the higher volume of loans originated at the lower average rates reduced the interest income by $1.0 million, resulting in a net increase in interest income of $2.2 million.

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      Interest Expense. Interest expense totaled $5.9 million for the six months ended December 31, 2004, an increase of $1.6 million, compared to $4.3 million in interest expense during the six months ended December 31, 2003. Average interest-bearing balances for the six months ended December 31, 2004 increased $143.2 million compared to the same period in 2003, 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 $48.5 million as new 2-, 3-, 4-, 5- and 7-year fixed-rate advances were added. In addition, $15.9 million of advances scheduled to mature during the fiscal year ended June 30, 2004 were modified and extended for periods of three to six years. Our increased borrowing of long-term fixed rate amounts during fiscal 2003 and 2004 was part of our strategy to manage our interest rate risk. The average rate paid on our interest-bearing liabilities declined to 2.9% for the six months ended December 31, 2004 from 3.3% for the same period in 2003, due principally to the maturity of higher-rate term deposits and the adding of new advances from the FHLB at market rates that were significantly lower in 2004 than in 2003. Our weighted average rates paid on interest-bearing demand and savings accounts, time deposits and advances from the FHLB and other borrowings for the six months ended December 31, 2004 was 40 basis points lower than for the six months ended December 31, 2003. Thus, the decline in average rates paid on interest-bearing liabilities would have reduced interest expense in the six months ended December 31, 2004 by $776,000, but the growth of average balances in demand and savings accounts and advances from the FHLB caused an increase in interest expense of $2.3 million, resulting in a net increase in interest expense of $1.6 million. We believe our trend of declining average rates paid on time deposits for the six months ended December 31, 2004 compared to the six months ended December 31, 2003 is likely to change in the next six months to a rising average rate because market rates paid for deposits have risen, $106.8 million of our time deposits are scheduled to mature during the twelve months ended December 31, 2005 and renewing customers will likely earn higher interest rates on time deposits.

      Provision for Loan Losses. Provision for loan losses was $175,000 for the six months ended December 31, 2004 and $35,000 for the same period in 2003. 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, change in volume and mix of loans and collateral values. We did not have any nonperforming loans at December 31, 2004 or 2003. We believe that our history is limited and it is unlikely that every loan in our investment portfolio will continue to perform without exception so we provide general allowances based upon the overall volume of loans, the loan types and the estimated collateral values. Between December 31, 2004 and June 30, 2004, our gross loans held for investment grew $61.2 million and included $49.7 million of multifamily loans purchased on December 14, 2004. A provision of $175,000, or approximately 29 basis points on the net loan growth, was recorded for general loan loss allowances during the six months ended December 31, 2004. The primary reason for the $140,000 increase in the loan loss provision for the six months ended December 31, 2004 compared to the six months ended December 31, 2003 was our $49.7 million purchase of multifamily loans, which accounted for approximately 81%, or $142,000, of the loan loss provision during the six months ended December 31, 2004.

      Noninterest Income. The following table sets forth information regarding our noninterest income for the periods shown.

                   
For the Six Months
Ended
December 31,

2004 2003


(Dollars in thousands)
 
Prepayment penalty fee income
  $ 200     $ 203  
 
Gain on sale of loans originated for sale
    44       204  
 
Banking service fees and other income
    141       67  
     
     
 
Total noninterest income
  $ 385     $ 474  
     
     
 

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      Noninterest income totaled $385,000 for the six months ended December 31, 2004 compared to $474,000 for the same period in 2003. The decrease in 2004 was primarily due to lower gains on sale of loans offset by an increase in banking service fees and other income. Our gain on sale income decreased $160,000 as result of the general decline in mortgage loan refinance volumes in the six months ended December 31, 2004 compared to refinance volumes in the same period in 2003. Banking fees and other income increased by $74,000 as a result of value increases in bank-owned life insurance policies for our executives.

      Noninterest Expense. The following table sets forth information regarding our noninterest expense for the periods shown.

                   
For the Six Months
Ended
December 31,

2004 2003


(Dollars in thousands)
 
Salaries and employee benefits
  $ 1,373     $ 941  
 
Professional services
    149       64  
 
Occupancy and equipment
    128       120  
 
Data processing and internet
    181       152  
 
Advertising and promotional
    131       97  
 
Depreciation and amortization
    56       47  
 
Service contract termination
    59       197  
 
Other general and administrative
    469       367  
     
     
 
Total noninterest expenses
  $ 2,546     $ 1,985  
     
     
 

      Noninterest expense totaled $2.5 million for the six months ended December 31, 2004, an increase of $561,000 compared to the same period in 2003. This increase was due primarily to a $432,000 increase in salaries and employee benefits, including $280,000 in special one-time bonuses for our executives, $76,000 in accruals for executive performance bonuses and additional operations staff. The increase in noninterest expense was also due to a $85,000 increase in professional services due to an increase in audit, legal and professional fees related to corporate planning and increased audit fees. This was offset by a $138,000 reduction in expenses associated with the termination of two contracts for advice and placement of a capital funding.

      Income Tax Expense. Income tax expense was $776,000 for the six months ended December 31, 2004 compared to $580,000 for the same period in 2003. Our effective tax rates were 39.8% and 43.6% for the six months ended December 31, 2004 and 2003, respectively. Our effective tax rate decreased for the six months ended December 31, 2004 primarily due to six months of tax-free income earned on $3.8 million in bank-owned life insurance purchased in November and December 2003.

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Table of Contents

 
Comparison of Fiscal Years Ended June 30, 2004 and 2003

      Net Interest Income. Net interest income totaled $6.5 million for the fiscal year ended June 30, 2004, compared to $5.1 million for the fiscal year ended June 30, 2003. 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 (changes in rate multiplied by change in volume) for the fiscal year ended June 30, 2004 compared to the fiscal year ended June 30, 2003.

                                 
Fiscal Year Ended June 30, 2004 vs.
Fiscal Year Ended June 30, 2003

Increase (Decrease) Due to

Total
Increase
Volume Rate Rate/Volume (Decrease)




(Dollars in thousands)
Increase (decrease) in interest income:
                               
Loans
  $ 5,119     $ (1,908 )   $ (757 )   $ 2,454  
Federal funds sold
    64       (84 )     (23 )     (43 )
Interest-earning deposits in other financial institutions
    (193 )     17       (8 )     (184 )
Investment securities
    (7 )     (5 )     2       (10 )
Stock of the FHLB, at cost
    81       (21 )     (19 )     41  
     
     
     
     
 
    $ 5,064     $ (2,001 )   $ (805 )   $ 2,258  
     
     
     
     
 
Increase (decrease) in interest expense:
                               
Interest-bearing demand and savings
  $ 1,083     $ (120 )   $ (149 )   $ 814  
Time deposits
    (440 )     (586 )     38       (988 )
Advances from the FHLB
    1,681       (378 )     (373 )     930  
Other borrowings
                60       60  
     
     
     
     
 
    $ 2,324     $ (1,084 )   $ (424 )   $ 816  
     
     
     
     
 

      Interest Income. Interest income for the fiscal year ended June 30, 2004 totaled $15.8 million, an increase of $2.3 million, or 17.0%, compared to $13.5 million in interest income for the fiscal year ended June 30, 2003. Average interest-earning assets for the fiscal year ended June 30, 2004 increased by $79.1 million compared to the fiscal year ended June 30, 2003 due primarily to an $81.7 million increase in the average balance of the loan portfolio as a result of our emphasis on building our multifamily loan portfolio. We reduced our average balances in interest-earning deposits in other financial institutions and investment securities by $8.4 million during the fiscal year ended June 30, 2004 compared to the fiscal year ended June 30, 2003, as we redirected maturing time deposits into higher yielding mortgage loans. Average interest-earning balances associated with our stock of the FHLB increased by $1.6 million during the fiscal year ended June 30, 2004 compared to the fiscal year ended June 30, 2003 because our required minimum investment increased, as a result of increased advances from the FHLB. The average yield earned on our interest-earning assets declined to 4.9% for the fiscal year ended June 30, 2004 from 5.6% for the fiscal year ended June 30, 2003 due primarily to the lower yield on our loan portfolio as market interest rates declined. The widespread increase in prepayments and refinancing of mortgage loans during the fiscal years ended June 30, 2003 and 2004 reduced the amount of higher yielding older loans, which were replaced with lower yielding loans, causing the average yield on the loan portfolio to decline to 5.3% for the fiscal year ended June 30, 2004 from 6.3% for the fiscal year ended June 30, 2003. Thus, the average rate declined, reducing interest income from what it otherwise would have been by $2.7 million, resulting in a net increase in interest income of $2.5 million. The average rate on all other interest-earning assets declined in the fiscal year ended June 30, 2004 due to the general decline in market interest rates in the fiscal years ended June 30, 2003 and 2004.

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      Interest Expense. Interest expense totaled $9.2 million for the fiscal year ended June 30, 2004, an increase of $816,000 from $8.4 million in interest expense during the fiscal year ended June 30, 2003. Average interest-bearing liabilities in the fiscal year ended June 30, 2004 increased $77.4 million compared to the fiscal year ended June 30, 2003, due to higher deposits from increased customer accounts and increased advances from the FHLB. In the fiscal year ended June 30, 2004, we emphasized increasing our savings and checking accounts, particularly our money market savings accounts. As a result, average balances in interest-bearing demand and savings accounts increased by $52.4 million in the fiscal year ended June 30, 2004 compared to the fiscal year ended June 30, 2003, while average time deposits declined $10.7 million in the fiscal year ended June 30, 2004 as we replaced maturing time deposits with money market savings accounts. The average interest-bearing balances of advances from the FHLB increased $34.6 million as new 2-, 3-, 4-, 5- and 7-year fixed rate advances were added during the fiscal years ended June 30, 2003 and 2004. In addition, $15.9 million of advances scheduled to mature during the fiscal year ended June 30, 2004 were modified and extended for three to six years. Our increase in long-term fixed rate borrowings during the fiscal years ended June 30, 2003 and 2004 was part of our strategy to manage our interest rate risk. The average rate paid on our interest-bearing liabilities declined to 3.1% for the fiscal year ended June 30, 2004 from 3.8% for the fiscal year ended June 30, 2003, due principally to the addition of new money market savings accounts, the maturity of higher-rate term deposits and the adding of new advances from the FHLB at market rates that were significantly lower in the fiscal year ended June 30, 2004 compared to past periods. During the fiscal year ended June 30, 2004, our savings account balances (including money market savings) increased by $75.3 million and had an average interest rate of 2.0%. At June 30, 2003, time deposits scheduled to mature within one year from that time were $71.1 million, which bore a weighted average interest rate of 3.7%. The declines in average rates paid on our interest-bearing demand and savings accounts, time deposits and advances from the FHLB were 29 basis points, 42 basis points and 107 basis points, respectively, during the fiscal year ended June 30, 2004. Thus, the growth in average balances in demand and savings accounts and advances from the FHLB would have increased interest expense by $2.8 million. However, the volume decrease in time deposits and the decline in interest rates paid on all interest-bearing liabilities reduced interest expense by $1.9 million, resulting in a net increase in interest expense of $816,000.

      Provision for loan losses. Provision for loan losses was $255,000 and $285,000 for the fiscal years ended June 30, 2004 and 2003, respectively. We have not had any nonperforming loans through June 30, 2004. Our history is limited, and we expect over time to have some defaulted and nonperforming loans. As there were no nonperforming loans for the fiscal years ended June 30, 2004 and 2003, the provisions for loan losses represent increases in general allowances which are determined based upon the overall volume of loans, the loan types and the estimated collateral values. Our loans held for investment increased by net amounts of $109.3 million and $78.7 million during the fiscal years ended June 30, 2004 and 2003, respectively. The provisions for loan losses were approximately 23 basis points and 36 basis points on the net increase in our loans held for investment for the fiscal years ended June 30, 2004 and 2003, respectively. The provision for loan losses for the fiscal year ended June 30, 2004 declined by 13 basis points primarily due to the addition of more multifamily loans with lower loan-to-value ratios in the fiscal year ended June 30, 2004 compared to the fiscal year ended June 30, 2003. Management estimates that the lower average loan-to-value ratio should result in a smaller percentage of impairment.

      Noninterest income. The following table sets forth information regarding our noninterest income for the periods shown:

                   
For the Fiscal Years
Ended June 30,

2004 2003


(Dollars in thousands)
 
Prepayment penalty fee income
  $ 624     $ 446  
 
Gain on sale of loans originated for sale
    364       778  
 
Banking service fees and other income
    202       125  
     
     
 
Total noninterest income
  $ 1,190     $ 1,349  
     
     
 

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      Noninterest income totaled $1.2 million for the fiscal year ended June 30, 2004, compared to $1.3 million for the fiscal year ended June 30, 2003. The decrease is attributable to lower gains on sale, partially reduced by higher prepayment penalty fee income and income from banking services fees. Prepayment penalty fee income increased $178,000 in the fiscal year ended June 30, 2004 due to a higher volume of multifamily loans and market interest rates that continued to be low compared to historical rates, which encouraged more multifamily borrowers to refinance and incur a prepayment penalty. Most of our multifamily mortgage loans have prepayment penalties at the time of origination, while most of our single family mortgage loans do not have prepayment penalties. Our gain on sale income is derived from the origination and sale of single family loans, which we generally do not hold for investment. During the fiscal year ended June 30, 2003, the mortgage industry experienced record volumes of mortgage refinancings. Many of the single family loans that we originated in the fiscal year ended June 30, 2003 were mortgage refinancings with lower rates and longer fixed terms, which we sold. During the fiscal year ended June 30, 2004, the mortgage refinancing volumes declined, leading to a $414,000 decline in our gain on sales in the fiscal year ended June 30, 2004 compared to the fiscal year ended June 30, 2003. Mortgage loan refinancing activity has declined and will likely decline further if mortgage rates rise. In the near term, we believe that prepayment penalty fee income and gain on sale income likely will be reduced by rising interest rates.

      Noninterest Expense. The following table sets forth information regarding our noninterest expense for the fiscal years ended June 30, 2004 and 2003:

                   
For the Fiscal
Years Ended
June 30,

2004 2003


(Dollars in
thousands)
 
Salaries and employee benefits
  $ 1,880     $ 1,538  
 
Professional services
    166       152  
 
Occupancy and equipment
    245       205  
 
Data processing and Internet
    328       278  
 
Advertising and promotional
    220       189  
 
Depreciation and amortization
    97       144  
 
Service contract termination
    197        
 
Other general and administrative
    686       652  
     
     
 
Total noninterest expense
  $ 3,819     $ 3,158  
     
     
 

      Noninterest expense totaled $3.8 million for the fiscal year ended June 30, 2004, an increase of $661,000 compared to $3.2 million for the fiscal year ended June 30, 2003. This increase was due principally to a $342,000 increase in salaries and employee benefits for additional operations staff, increased existing staff wages and new management bonus plans, and a $197,000 charge for unrecoverable expenses associated with the termination of a contract for advice regarding a capital funding.

      Income Tax Expense. Income tax expense was $1.5 million for the fiscal year ended June 30, 2004, compared to $1.3 million for the fiscal year ended June 30, 2003. Our effective tax rates were 40.4% and 42.2% for the fiscal years ended June 30, 2004 and 2003, respectively. The lower effective tax rate for the fiscal year ended June 30, 2004 included the benefit primarily from nontaxable income from our investment in bank-owned life insurance.

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Comparison of Fiscal Years Ended June 30, 2003 and 2002

      Net Interest Income. Net interest income totaled $5.1 million for the fiscal year ended June 30, 2003 as compared to $3.5 million for the fiscal year ended June 30, 2002. 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, 2003 compared to the fiscal year ended June 30, 2002.

                                 
Fiscal Year Ended June 30, 2003 vs.
Fiscal Year Ended June 30, 2002

Increase (Decrease) Due to

Total
Increase
Volume Rate Rate/Volume (Decrease)




(Dollars in thousands)
Increase (decrease) in interest income:
                               
Loans
  $ 3,054     $ (854 )   $ (242 )   $ 1,958  
Federal funds sold
    (115 )     (145 )     36       (224 )
Interest-earning deposits in other financial institutions
    365       (103 )     (122 )     140  
Investment securities
    (21 )     (14 )     6       (29 )
Stock of the FHLB, at cost
    38       (6 )     (4 )     28  
     
     
     
     
 
    $ 3,321     $ (1,122 )   $ (326 )   $ 1,873  
     
     
     
     
 
Increase (decrease) in interest expense:
                               
Interest-bearing demand and savings
  $ 347     $ (173 )   $ (79 )   $ 95  
Time deposits
    955       (1,127 )     (170 )     (342 )
Advances from the FHLB
    632       (36 )     (21 )     575  
Other borrowings
    (46 )                 (46 )
     
     
     
     
 
    $ 1,888     $ (1,336 )   $ (270 )   $ 282  
     
     
     
     
 

      Interest Income. Interest income totaled $13.5 million for the fiscal year ended June 30, 2003, an increase of $1.9 million, or 16.4%, from $11.6 million during the fiscal year ended June 30, 2002. Average interest-earning assets in the fiscal year ended June 30, 2003 increased $50.1 million compared to the fiscal year ended June 30, 2002 due primarily to the $44.9 million increase in the average balance of our loan portfolio. Our average balances in interest-earning deposits in other financial institutions and investment securities increased by $10.0 million in the fiscal year ended June 30, 2003 compared to the fiscal year ended June 30, 2002. The average interest-earning balance associated with our stock of the FHLB increased $684,000 in the fiscal year ended June 30, 2003 compared to the fiscal year ended June 30, 2002 because our required minimum investment increased due to increased advances from the FHLB. The average yield earned on interest-earning assets declined to 5.6% for the fiscal year ended June 30, 2003 from 6.1% for the fiscal year ended June 30, 2002, due primarily to the decline in interest rates generally during this period. The widespread increase in prepayments and refinancings of mortgage loans during the fiscal years ended June 30, 2003 and 2002 reduced the higher yielding loans which were replaced with lower yielding loans, causing the average yield on the loan portfolio to decline to 6.3% for the fiscal year ended June 30, 2003 from 6.8% for the fiscal year ended June 30, 2002. Thus, the loan portfolio volume increase in the fiscal year ended June 30, 2003 was partially offset by the decline in average rate, thereby reducing the interest income by $1.1 million, resulting in a net increase in interest income of $1.9 million. The average rate on all other interest-earning assets declined in the fiscal year ended June 30, 2003 due to the general decline in market interest rates in the fiscal years ended June 30, 2002 and 2003.

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      Interest Expense. Interest expense for the fiscal year ended June 30, 2003 totaled $8.4 million, an increase of $282,000 from $8.1 million in interest expense during the fiscal year ended June 30, 2002. Average interest-bearing liabilities in the fiscal year ended June 30, 2003 increased $44.2 million compared to the fiscal year ended June 30, 2002 due to higher deposits in customer accounts and additional advances from the FHLB. The average balance of time deposits increased by $19.1 million in the fiscal year ended June 30, 2003 compared to the fiscal year ended June 30, 2002. The average balance of advances from the FHLB increased $12.6 million in the fiscal year ended June 30, 2003 compared to the fiscal year ended June 30, 2002, as new 3-and 5-year fixed rate advances were added. Our increased borrowing of long-term fixed rate amounts was part of our strategy to manage interest rate risk. The average rate paid on our interest-bearing liabilities declined to 3.8% for the fiscal year ended June 30, 2003 from 4.6% for the fiscal year ended June 30, 2002, due principally to the maturity of higher-rate term deposits and the addition of new lower rate deposits and advances. The declines in our average rates paid on interest-bearing demand and savings accounts, time deposits and advances from the FHLB were 60 basis points, 90 basis points and 16 basis points, respectively. The decline in average rates paid on interest-bearing liabilities was more than offset by the growth of average balances in demand and savings accounts, time deposits and advances from the FHLB, which, had rates not declined, would have resulted in an increase in interest expense of $1.9 million. The net increase in interest expense for the year was $282,000.

      Provision for loan losses. Provision for loan losses was $285,000 and $195,000 for the fiscal years ended June 30, 2003 and 2002, respectively. Since we did not have any nonperforming loans during these periods, our loan loss provisions were added to general loan loss reserves. Our loans held for investment increased by net amounts of $78.7 million and $27.6 million during the fiscal years ended June 30, 2003 and 2002, respectively. The provisions for loan losses were approximately 36 basis points and 71 basis points on the net increase in our loans held for investment for the fiscal years ended June 30, 2003 and 2002, respectively. The provision declined to 36 basis points in the fiscal year ended June 30, 2003 because the prior fiscal year included a large shift away from single family loans with lower estimated loss rates towards multifamily loans with higher estimated loss rates. During the fiscal year ended June 30, 2002, our mix of loans held for investment moved from 9.2% to 75.2% in multifamily loans, while during the fiscal year ended June 30, 2003 the mix moved a smaller amount, from 75.2% to 78.0% in multifamily loans.

      Noninterest income. Noninterest income totaled $1.3 million for the fiscal year ended June 30, 2003, compared to $297,000 for the fiscal year ended June 30, 2002. The increase in the fiscal year ended June 30, 2003 is attributable to greater prepayment penalty fee income and increased gains on sale of loans. Prepayment penalty income increased $332,000 due to our increased investment in multifamily loans and declining mortgage rates. Our gain on sale of loans increased $711,000 in the fiscal year ended June 30, 2003, the first full year of operation of our single family mortgage loan origination website. Also, in the fiscal year ended June 30, 2003, declining interest rates encouraged high levels of mortgage refinancing nationwide. Our single family mortgage loan originations in the fiscal year ended June 30, 2003 were primarily refinancings which were sold.

                   
For the Fiscal
Years Ended
June 30,

2003 2002


(Dollars in
thousands)
 
Prepayment penalty fee income
  $ 446     $ 114  
 
Gain on sale of loans originated for sale
    778       67  
 
Banking service fees and other income
    125       116  
     
     
 
Total noninterest income
  $ 1,349     $ 297  
     
     
 

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      Noninterest expense. The following table sets forth information regarding our noninterest expense for the fiscal years ended June 30, 2003 and 2002:

                   
For the
Fiscal Years
Ended June 30,

2003 2002


(Dollars in
thousands)
 
Salaries and employee benefits
  $ 1,538     $ 1,300  
 
Professional services
    152       172  
 
Occupancy and equipment
    205       161  
 
Data processing and Internet
    278       210  
 
Advertising and promotional
    189       141  
 
Depreciation and amortization
    144       118  
 
Other general and administrative
    652       906  
     
     
 
Total noninterest expense
  $ 3,158     $ 3,008  
     
     
 

      Noninterest expense was $3.2 million and $3.0 million for the fiscal years ended June 30, 2003 and 2002, respectively. The increase of $150,000 in noninterest expense was due principally to a $238,000 increase in salaries and employee benefits for additional operations staff and reduced by a $254,000 decrease in other general and administrative expenses. The decrease in other general and administrative expenses is due to a $318,000 non-cash expense incurred in the fiscal year ended June 30, 2002 for a two-year extension of previously issued warrants to acquire 736,750 shares of common stock.

      Income Tax Benefit. Income tax expense was $1.3 million for the fiscal year ended June 30, 2003, compared to an income tax benefit of $429,000 in the fiscal year ended June 30, 2002. During the fiscal year ended June 30, 2002, we began to operate profitably, making it likely that our deferred tax benefits accumulated from operating losses incurred since inception could be realized. The valuation allowance of $823,000 at June 30, 2001 associated with the tax benefit of operating loss carryforwards was reversed in the fiscal year ended June 30, 2002, reducing our effective tax rate. The reversal of the valuation allowance was large enough to create a net tax benefit for the fiscal year ended June 30, 2002.

Liquidity and Capital Resources

      Liquidity. Our sources of liquidity include deposits, borrowings, payments and maturities of outstanding loans, sales of loans, maturities or gains on sales of investment securities and other short term investments. While scheduled loan payments and maturing investment securities and short term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. We invest excess funds in overnight deposits and other short term interest-earning assets. We use cash generated through retail deposits, our largest funding source, to offset the cash utilized in lending and investing activities. Our short term interest-earning investment securities are also used to provide liquidity for lending and other operational requirements. As an additional source of funds, we have three credit agreements. Bank of Internet USA can borrow up to 35% of its total assets from the FHLB. Borrowings are collateralized by the pledge of certain mortgage loans and investment securities to the FHLB. Based on the loans and securities pledged at December 31, 2004 we had total borrowing capacity of approximately $158.7 million, of which $148.9 million was outstanding and $9.8 million was available. At December 31, 2004, we also had a $4.5 million unsecured fed funds purchase line with a major bank under which no borrowings were outstanding. In the past, we have used long-term borrowings to fund our loans and to minimize our interest rate risk. Our future borrowings will depend on the growth of our lending operations and our exposure to interest rate risk.

      We intend to contribute approximately $16.0 million of the net proceeds from the offering to Bank of Internet USA to provide additional regulatory capital to support its growth. We expect to continue to use deposits and advances from the FHLB as the primary sources of funding our future asset growth.

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      On October 24, 2003, we entered into a $5.0 million loan facility with a commercial bank consisting of a one-year revolving line of credit plus a fully amortizing term loan of up to nine years. Interest is payable quarterly under the credit line at prime plus 1% per annum. Principal is payable in 36 equal quarterly installments starting on January 24, 2005. We may prepay all or a portion of the principal at anytime without a prepayment penalty. At December 31, 2004, the note payable balance was $5.0 million and the interest rate was 6.25% per annum. We entered into this loan facility to provide additional regulatory capital to our bank to support its growth. We intend to use a portion of the net proceeds from the offering to prepay in full the entire amount outstanding under the note payable. See “Use of Proceeds.”

      The loan facility is secured by our bank’s common stock held by BofI Holding, Inc. Under the terms of the loan facility, we are bound by a number of significant covenants that restrict our ability, out of the ordinary course of business, to dispose of assets, to incur additional debt or guarantees, to invest in or acquire any interest in another enterprise and to suffer a change in ownership of 51% or more of our common stock. The loan facility also requires us to maintain a debt coverage ratio of 1.50 as calculated by the lender. At December 31, 2004, management believes we were in compliance with all such covenants and restrictions and does not anticipate that such covenants and restrictions will limit our operations.

      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 4.9% at December 31, 2004, with interest to be paid quarterly starting in February 2005. We entered into this transaction to provide additional regulatory capital to our bank to support its growth.

      During the six months ended December 31, 2004, interest income earned on loans and interest expense paid on deposits were influenced by a general decline in the historical spread between short term and long term rates earned on U.S. Treasury securities. If short term rates continue to rise faster than long term rates, our ability and replace maturing short term deposits may be negatively impacted. We believe the historical spread between short term and long term U.S. Treasury rates will increase over time. We cannot predict when this might occur or what effect any change in rates will have on our future liquidity needs. However, we believe we can adjust the interest rates we pay on our deposits to reduce deposit outflows should they occur. We can also increase our level of borrowings to address our future liquidity needs.

      Contractual Obligations. At December 31, 2004, we had $2.1 million in loan commitments outstanding. Time deposits due within one year of December 31, 2004 totaled $106.8 million. We believe the large percentage of time deposits that mature within one year reflects customers’ hesitancy to invest their funds long term when they expect interest rates to rise. If these maturing deposits do not remain with us, we may be required to seek other sources of funds, including other time deposits and borrowings. Depending on market conditions, we may be required to pay higher rates on deposits and borrowings than we currently pay on time deposits maturing with one year. We believe, however, based on past experience, that a significant portion of our time deposits will remain with us. We believe we have the ability to attract and retain deposits by adjusting interest rates offered.

      The following table presents certain of our contractual obligations as of June 30, 2004.

                                           
Payments Due by Period

Less than One to Three to More Than
Total One Year Three Years Five Years Five Years





(In thousands)
Long-term debt obligations
  $ 114,243     $ 6,451     $ 62,883     $ 35,866     $ 9,043  
Operating lease obligations(1)
    220       220                    
     
     
     
     
     
 
 
Total
  $ 114,463     $ 6,671     $ 62,883     $ 35,866     $ 9,043  
     
     
     
     
     
 


(1)  Payments are for the lease of real property.

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      Capital Requirements. Bank of Internet USA is subject to various regulatory capital requirements set by the federal banking agencies. Failure by our bank to meet minimum capital requirements could result in certain mandatory and discretionary actions by regulators that could have a material adverse effect on our consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, our bank must meet specific capital guidelines that involve quantitative measures of our bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Our bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

      Quantitative measures established by regulation require our bank to maintain certain minimum capital amounts and ratios. The OTS requires our bank to maintain minimum ratios of tangible capital to tangible assets of 1.5%, core capital to tangible assets of 4.0% and total risk-based capital to risk-weighted assets of 8.0%. At December 31, 2004, our bank met all the capital adequacy requirements to which it was subject.

      At December 31, 2004, our bank was “well capitalized” under the regulatory framework for prompt corrective action. To be “well capitalized,” our bank must maintain minimum leverage, tier 1 risk-based and total risk-based capital ratios of at least 5.0%, 6.0% and 10.0%, respectively. No conditions or events have occurred since that date that management believes would change the bank’s capital levels. To maintain its status as a “well capitalized” financial institution under applicable regulations and to support additional growth, we anticipate the need for additional capital, which includes raising funds in this offering. From time to time after the offering, we may need to raise additional capital to support our bank’s further growth and to maintain its “well capitalized” status.

      Bank of Internet capital amounts, ratios and requirements at December 31, 2004 were as follows:

                                                   
To Be “Well
Capitalized” Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations



Amount Ratio Amount Ratio Amount Ratio






(Dollars in thousands)
Tier 1 leverage (core) capital:
                                               
 
Amount and ratio to adjusted tangible assets
  $ 38,137       7.45 %   $ 20,479       4.00 %   $ 25,598       5.00 %
Tier 1 capital:
                                               
 
Amount and ratio to risk-weighted assets
  $ 38,137       11.44 %     N/A       N/A     $ 20,004       6.00 %
Total capital:
                                               
 
Amount and ratio to risk-weighted assets
  $ 39,357       11.80 %   $ 26,672       8.00 %   $ 33,340       10.00 %
Tangible capital:
                                               
 
Amount and ratio to tangible assets
  $ 38,137       7.45 %   $ 7,679       1.50 %     N/A       N/A  

Quantitative and Qualitative Disclosures About Market Risk

      Market risk is defined as the sensitivity of income and capital to changes in interest rates, foreign currency exchange rates, commodity prices and other relevant market rates or prices. The primary market risk to which we are exposed is interest rate risk. Changes in interest rates can have a variety of effects on our business. In particular, changes in interest rates affect out net interest income, net interest margin, net income, the value of our securities portfolio, the volume of loans originated, and the amount of gain or loss on the sale of our loans.

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      We are exposed to different types of interest rate risk. These risks include lag, repricing, basis, prepayment and lifetime cap risk, each of which is described in further detail below:

      Lag/ Repricing Risk. Lag risk results from the inherent timing difference between the repricing of our adjustable rate assets and our liabilities. Repricing risk is caused by the mismatch of repricing methods between interest-earning assets and interest-bearing liabilities. Lag/repricing risk can produce short term volatility in our net interest income during periods of interest rate movements even though the effect of this lag generally balances out over time. One example of lag risk is the repricing of assets indexed to the monthly treasury average, or the MTA. The MTA index is based on a moving average of rates outstanding during the previous 12 months. A sharp movement in interest rates in a month will not be fully reflected in the index for 12 months resulting in a lag in the repricing of our loans and securities based on this index. We expect more of our interest-bearing liabilities will mature or reprice within one year than will our interest-earning assets, resulting in a one year negative interest rate sensitivity gap (the difference between our interest rate sensitive assets maturing or repricing within one year and our interest rate sensitive liabilities maturing or repricing within one year, expressed as a percentage of total interest-earning assets). In a rising interest rate environment, an institution with a negative gap would generally be expected, absent the effects of other factors, to experience a greater increase in its cost of liabilities relative to its yield on assets, and thus a decrease in its net interest income.

      Basis Risk. Basis risk occurs when assets and liabilities have similar repricing timing but repricing is based on different market interest rate indices. Our adjustable rate loans that reprice are directly tied to indices based upon U.S. Treasury rates, LIBOR, Eleventh District Cost of Funds and the prime rate. Our deposit rates are not directly tied to these same indices. Therefore, if deposit interest rates rise faster than the adjustable rate loan indices and there are no other changes in our asset/liability mix, our net interest income will likely decline due to basis risk.

      Prepayment Risk. Prepayment risk results from the right of customers to pay their loans prior to maturity. Generally, loan prepayments increase in falling interest rate environments and decrease in rising interest rate environments. In addition, prepayment risk results from the right of customers to withdraw their time deposits before maturity. Generally, early withdrawals of time deposits increase during rising interest rate environments and decrease in falling interest rate environments. When estimating the future performance of our assets and liabilities, we make assumptions as to when and how much of our loans and deposits will be prepaid. If the assumptions prove to be incorrect, the asset or liability may perform differently than expected. In the last three fiscal years, the mortgage industry and our bank have experienced high rates of loan prepayments due to historically low interest rates. Market rates began rising in the fiscal year ended June 30, 2004 and, if they continue, mortgage loan prepayments are expected to decrease. In addition, if that occurs, we may experience increased rates of customer early withdrawals of their time deposits.

      Lifetime Cap Risk. Our adjustable rate loans have lifetime interest rate caps. In periods of rising interest rates, it is possible for the fully indexed interest rate (index rate plus the margin) to exceed the lifetime interest rate cap. This feature prevents the loan from repricing to a level that exceeds the cap’s specified interest rate, thus adversely affecting net interest income in periods of relatively high interest rates. On a weighted average basis, our adjustable rate loans at December 31, 2004 had lifetime rate caps that were 500 basis points or more greater than the effective rate at December 31, 2004. If market rates rise by more than the interest rate cap, we will not be able to increase these customers’ loan rates above the interest rate cap.

      The principal objective of our asset/liability management is to manage the sensitivity of net income to changing interest rates. Asset/liability management is governed by policies reviewed and approved annually by our board of directors. Our board of directors has delegated the responsibility to oversee the administration of these policies to the asset/liability committee, or ALCO. ALCO’s members are board members Theodore C. Allrich and Robert Eprile, our President and Chief Executive Officer Gary Lewis Evans and our Chief Financial Officer Andrew J. Micheletti. ALCO meets regularly to consider investment and financing alternatives with particular emphasis on duration and interest rate risk. The interest rate risk strategy currently deployed by ALCO is to use “natural” balance sheet hedging (as opposed to derivative hedging) or to avoid

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holding loans which ALCO views as higher risk. Specifically, we attempt to match the effective duration of our assets with our borrowings. To reduce the repricing risk associated with holding certain adjustable loans, which typically are fixed for the first three to five years, we have matched estimated maturities by obtaining long-term three to five year advances from the FHLB. Other examples of ALCO policies designed to reduce our interest rate risk include limiting the premiums paid to purchase mortgage loans or mortgage-backed securities to 3% or less of mortgage principal. This policy addresses mortgage prepayment risk by capping the yield loss from an unexpected high level of mortgage loan prepayments. Once a quarter, ALCO members report to our board of directors the status of our interest rate risk profile.

      We measure interest rate sensitivity as the difference between amounts of interest-earning assets and interest-bearing liabilities that mature within a given period of time. The difference, or the interest rate sensitivity gap, provides an indication of the extent to which an institution’s interest rate spread will be affected by changes in interest rates. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities and negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. In a rising interest rate environment, an institution with a positive gap would be in a better position than an institution with a negative gap to invest in higher yielding assets or to have its asset yields adjusted upward, which would result in the yield on its assets to increase at a faster pace than the cost of its interest-bearing liabilities. During a period of falling interest rates, however, an institution with a positive gap would tend to have its assets mature at a faster rate than one with a negative gap, which would tend to reduce the growth in its net interest income. The following table sets forth the interest rate sensitivity of our assets and liabilities at December 31, 2004:

                                 
Term to Repricing, Repayment, or Maturity at
December 31, 2004

Over Over
One Year One Year Five Years
or through and
Less Five Years Insensitive Total




(Dollars in thousands)
Interest-earning assets:
                               
Cash and cash equivalents
  $ 18,577     $     $     $ 18,577  
Interest-earning deposits in other financial institutions
    4,648       2,874             7,522  
Investment securities(1)
    9,592       43,449             53,041  
Stock of FHLB, at cost
    6,998                   6,998  
Loans held for investment, net of allowance for loan loss(2)
    110,089       247,329       60,497       417,915  
Loans held for sale, at cost
    845                   845  
     
     
     
     
 
Total interest-earning assets
    150,749       293,652       60,497       504,898  
Noninterest-earning assets
                8,210       8,210  
     
     
     
     
 
Total assets
  $ 150,749     $ 293,652     $ 68,707     $ 513,108  
     
     
     
     
 

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Table of Contents

                                 
Term to Repricing, Repayment, or Maturity at
December 31, 2004

Over Over
One Year One Year Five Years
or through and
Less Five Years Insensitive Total




(Dollars in thousands)
Interest-bearing liabilities:
                               
Interest-bearing deposits(3)
  $ 215,519     $ 100,650     $     $ 316,169  
Advances from the FHLB
    21,000       119,588       7,916       148,504  
Other borrowings
    10,155                   10,155  
     
     
     
     
 
Total interest-bearing liabilities
    246,674       220,238       7,916       474,828  
Other noninterest-bearing liabilities
                5,436       5,436  
Stockholders’ equity
                32,844       32,844  
     
     
     
     
 
Total liabilities and equity
  $ 246,674     $ 220,238     $ 46,196     $ 513,108  
     
     
     
     
 
Net interest rate sensitivity gap
  $ (95,925 )   $ 73,414     $ 52,581     $ 30,070  
Cumulative gap
  $ (95,925 )   $ (22,511 )   $ 30,070     $ 30,070  
Net interest rate sensitivity gap — as a % of interest-earning assets
    (63.63 )%     25.00 %     86.92 %     5.96 %
Cumulative gap — as a % of cumulative interest-earning assets
    (63.63 )%     (5.07 )%     5.96 %     5.96 %


(1)  Comprised of U.S. government securities and mortgage-backed securities which are classified as held to maturity and available for sale. The table reflects contractual repricing dates.
 
(2)  The table reflects either contractual repricing dates or maturities.
 
(3)  The table assumes that the principal balances for demand deposit and savings accounts will reprice in the first year.

      Although “gap” analysis is a useful measurement device available to management in determining the existence of interest rate exposure, its static focus as of a particular date makes it necessary to utilize other techniques in measuring exposure to changes in interest rates. For example, gap analysis is limited in its ability to predict trends in future earnings and makes no assumptions about changes in prepayment tendencies, deposit or loan maturity preferences or repricing time lags that may occur in response to a change in the interest rate environment.

      We supplement our gap analysis above to include certain assumptions. There are $215.5 million of interest-bearing deposits shown in the gap table as repricing in one year or less, which includes all $108.7 million of checking and savings account balances. There also are $247.3 million of interest-earning loans held for investment shown in the gap table as repricing or maturing in one through five years, with no prepayment assumptions included in the loan totals. Based on prior experience, we believe that checking and savings account customers do not act immediately to close or move their checking and savings accounts in response to rising interest rates and that some mortgage loans will be prepaid (for example, due to sale of property) before scheduled. If 70% of our checking and savings accounts close or reprice during the year (rather than 100% as shown in the table) and assuming that on average 10% of our loans are prepaid during the year (rather than no prepayments as shown in the table), our negative gap would be reduced from $95.9 million to approximately $32.5 million. We believe we can adjust the interest rates we pay on our deposits to reduce deposit outflows should they occur.

      Our net interest margin for the six months ended December 31, 2004 declined to 1.98% compared to 2.02% for the six months ended December 31, 2003. During the six months ended December 31, 2004, interest income earned on loans and interest expense paid on deposits were influenced by a general decline in the historical spread between short term and long term rates earned on U.S. Treasury securities. If short term rates continue to rise faster than long term rates, our net interest income may be negatively impacted. We believe the historical spread between short term and long term U.S. Treasury rates will increase over time.

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However, we cannot predict when this might occur or what effect any change in rates will have on our net interest income or results of operations.

      As of December 31, 2004, we had not entered into any derivative financial instruments such as futures, forwards, swaps and options. On February 15, 2005, we entered into an interest rate cap, with a notional amount of $5.0 million and a term of four years expiring in March 2009, to lower the interest payments on the junior subordinated debentures should the three-month LIBOR increase above 5.25%. We designated this derivative as a non-hedging instrument and intend to report changes in the fair value of this instrument in current-period earnings. We have no market risk-sensitive instruments held for trading purposes. Our exposure to market risk is reviewed on a regular basis by management.

      We attempt to measure the effect market interest rate changes will have on the net present value of assets and liabilities, which is defined as market value of equity. At September 30, 2004 (the most recent period for which data is available), we analyzed the market value of equity sensitivity to an immediate parallel and sustained shift in interest rates derived from the current treasury and LIBOR yield curves. For rising interest rate scenarios, the base market interest rate forecast was increased by 100 and 200 basis points. For the falling interest rate scenarios, we used a 100 basis point decrease due to limitations inherent in the current rate environment. The following table indicates the sensitivity of market value of equity to the interest rate movement described above at September 30, 2004:

                                 
Net Present
Percentage Value as Board
Change from Percentage Established
Sensitivity Base of Assets Minimum




(Dollars in thousands)
Up 200 basis points
  $ (6,267 )     (15.00 )%     8.07 %     8.00 %
Up 100 basis points
  $ (3,007 )     (7.00 )%     8.64 %     8.00 %
Base
                9.14 %     8.00 %
Down 100 basis points
  $ 2,389       6.00 %     9.50 %     8.00 %

      The board of directors of our bank establishes limits on the amount of interest rate risk we may assume, as estimated by the net present value model. At September 30, 2004, the board’s established limit was 8.0%, meaning that the net present value after a theoretical instantaneous increase or decrease in interest rates must be greater than 8.0%. At September 30, 2004, the net present value for a 200 basis point and 100 basis point increase in interest rates exceed the board requirement by 7 basis points and 64 basis points, respectively.

      The computation of the prospective effects of hypothetical interest rate changes is based on numerous assumptions, including relative levels of interest rates, asset prepayments, runoffs in deposits and changes in repricing levels of deposits to general market rates, and should not be relied upon as indicative of actual results. Furthermore, these computations do not take into account any actions that we may undertake in response to future changes in interest rates.

Recent Accounting Pronouncements

      In March 2004, SEC Staff Accounting Bulletin, or SAB, No. 105 was issued, which provides guidance regarding loan commitments that are accounted for as derivative instruments under Financial Accounting Standards Board, or the FASB, No. 133 (as amended), Accounting for Derivative Instruments and Hedging Activities. In this Bulletin, the SEC ruled that the amount of the expected servicing rights should not be included when determining the fair value of derivative interest rate lock commitments. This guidance must be applied to rate locks initiated after March 31, 2004. The adoption of SAB No. 105 did not have a material effect on our consolidated financial statements.

      In December 2003, the FASB issued Interpretation No. 46R, or FIN 46R, which revised the January 2003, FASB issued Interpretation No. 46, or FIN 46, Consolidation of Variable Interest Entities. FIN 46R is a revision to the original FIN 46 that addresses the consolidation of certain variable interest entities (e.g., nonqualified special purpose entities). The revision clarifies how variable interest entities should be

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identified and evaluated for consolidation purposes. We adopted FIN 46R as of June 30, 2004. The adoption of FIN 46R did not have a material effect on our consolidated financial statements.

      In December 2003, the Accounting Standards Executive Committee of the AICPA issued Statement of Position No. 03-3, or SOP 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer. SOP 03-3 addresses the accounting for differences between contractual cash flows and the cash flows expected to be collected from purchased loans or debt securities if those differences are attributable, in part, to credit quality. SOP 03-3 requires purchased loans and debt securities to be recorded initially at fair value based on the present value of the cash flows expected to be collected with no carryover of any valuation allowance previously recognized by the seller. Interest income should be recognized based on the effective yield from the cash flows expected to be collected. To the extent that the purchased loans or debt securities experience subsequent deterioration in credit quality, a valuation allowance would be established for any additional cash flows that are not expected to be received. However, if more cash flows subsequently are expected to be received than originally estimated, the effective yield would be adjusted on a prospective basis. SOP 03-3 will be effective for loans and debt securities acquired after December 31, 2004. Management does not expect the adoption of this statement to have a material effect on our consolidated financial statements.

      In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of these instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective for public companies at the beginning of the first interim period beginning after June 15, 2003. The adoption of this standard did not have a material effect on our consolidated financial statements.

      In December 2004, the FASB issued SFAS No. 123 (R), or SFAS 123(R), Share-Based Payment. SFAS No. 123 (R) replaces the existing requirements under SFAS No. 123 and APB 25. SFAS 123 (R) requires companies to measure and recognize compensation expense equal to the fair value of stock options or other share based payments. SFAS 123 (R) is effective for all interim and annual periods beginning after June 15, 2005 and, thus, will be effective for our company beginning with the first quarter of fiscal 2006. We are in the process of evaluating the impact of this standard on our consolidated financial statements.

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BUSINESS

General

      We are the holding company for Bank of Internet USA, a consumer-focused, nationwide savings bank operating primarily over the Internet. We provide a variety of consumer banking services, focusing primarily on gathering retail deposits over the Internet and originating and purchasing multifamily and single family loans for investment. Since the inception of our bank in 2000, we have designed and implemented an automated Internet-based banking platform and electronic workflow process that we believe 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 deposits and loans. This approach to banking is the foundation of our business model, allowing us to leverage technology and handle routine banking functions electronically.

      We operate our Internet-based bank from a single location in San Diego, California. At December 31, 2004, we had total assets of $513.1 million, net loans held for investment of $417.9 million and total deposits of $320.0 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 (one to four units) real property. To a lesser extent, we also make commercial real estate and consumer loans.

Business Strategy

      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. Our strategy includes a number of key elements:

  •  Leverage Technology. We believe that efficient management and processing of information is critical in online banking. We have designed and implemented an automated Internet-based banking platform and workflow process to handle traditional banking functions with reduced paperwork and human intervention. Our websites and CRM software support our customer self-service model by automating interactions with customers. Our banking platform also increases the efficiency of routine analysis work by our personnel and assists our account representatives in handling customer requests and applications. Our banking platform transfers much of the data entry tasks to the customer and allows for batch handling of applications by our employees. We plan to continue to incrementally improve our proprietary software and systems on an ongoing basis. We currently expect the annual rate of capital expenditures for technology-related improvements will remain consistent with our past growth experience.
 
  •  Exploit Advantages of Nationwide Presence. Our nationwide, online presence allows us increased flexibility to target a large number of loan and deposit customers based on demographics, geographic location and price and provides us with a low cost of customer acquisition and the ability to be selective in approving prospective loan customers. Our advertising is carried mostly over the Internet so we can rapidly shift and target our marketing based on the demographics and location of the target audience nationwide. We can also establish a presence in new geographic and demographic markets with relatively low entry costs, such as our recent efforts to target multifamily lending in the State of Texas. Our thrift charter allows us to operate in all 50 states without the need to seek regulatory approval to enter new markets. Our marketing costs are fairly uniform on a nationwide basis because we advertise mainly over the Internet.
 
  •  Continue to Grow Online Deposits and Expand Services. We offer a broad selection of retail deposit instruments, including interest-bearing demand accounts, savings accounts (including money market savings) and time deposits. We provide our customers with many options for accessing funds, including ATM machines, debit cards, automated clearing house funds and checking accounts. We plan to continually develop new products and services within the next two years in order to serve specific demographics. For example, we recently opened our “Senior Banking Center” website to market to seniors, who we believe tend to maintain relatively high balances but are also more interest rate sensitive. We are also developing “Banco de Internet,” a redesigned version of our existing website to

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  focus on Spanish speaking U.S. customers. During our fiscal year ended June 30, 2004, we opened 6,408 new deposit accounts, resulting in approximately $136.0 million in new deposits, and spent approximately $29,000 in external advertising targeted for deposit gathering. For the six months ended December 31, 2004, we opened 5,028 new deposit accounts, resulting in approximately $110.3 million in new deposits, and spent approximately $46,000 in external advertising for deposit gathering. We intend to expand the volume and breadth of our deposit marketing over the Internet through websites and search engines such as Google. We expect that the annual rate of our marketing costs compared to growth in new customers will remain consistent with our past growth experience.
 
  •  Increase Loan Originations and Purchases. As we increase our deposits, we intend to utilize the funds to originate multifamily and single family mortgage loans over the Internet. We offer single family mortgage loans in 50 states for sale, servicing released, to generate fee income. We also originate multifamily loans primarily in California, Arizona, Texas and Washington. We intend to continually increase single family and multifamily loan originations through our websites, including our “Broker Advantage” website, which we have developed to manage our relationships with loan brokers and our wholesale loan pipeline. We also plan to continue to purchase multifamily and single family loans. We expect that our loan marketing and origination costs will rise incrementally as our originations grow at a rate in line with our past experience.

Lending and Investment Activities

      General. We originate single family mortgage loans on a nationwide basis, and currently originate multifamily loans primarily in California, Arizona, Texas and Washington. We currently sell substantially all of the single family loans that we originate and retain all of our multifamily loan originations. In addition, we purchase single family and multifamily mortgage loans from other lenders to hold in our portfolio. Our originations, purchases and sales of mortgage loans include both fixed and adjustable interest rate loans. All originations and purchases 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 highly 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.

      Loan Products. Our loans consist of first mortgage loans secured by single family and multifamily properties and, to a lesser extent, commercial properties. We also provide a limited amount of home equity financing and unsecured consumer loans. Further details regarding our loan programs are discussed below:

  •  Single Family Loans. We offer fixed and adjustable rate, single family mortgage loans in all 50 states, and provide both conforming and jumbo loans. We currently sell substantially all of the single family loans that we originate on a nonrecourse basis to wholesale lending institutions, typically with servicing rights released to the purchaser. Before we fund each loan, we obtain prior approval by a purchaser, who delivers a specific delivery and pricing commitment, which reduces our risk in funding the loan. In addition, while each loan is underwritten to our standard guidelines, we may also follow specific underwriting guidelines put in place by the purchaser of the loan.
 
  •  Multifamily Loans. We currently originate adjustable rate multifamily mortgage loans primarily in California, Arizona, Texas and Washington, and we plan to expand in the future the states and geographic markets in which we originate new multifamily loans. In addition, we held multifamily loans secured by property in 17 states at December 31, 2004. We typically hold all of the multifamily loans that we originate and perform the loan servicing directly on these loans. Our multifamily loans as of December 31, 2004 ranged in amount from approximately $43,000 to $3.0 million and were secured by first liens on properties typically ranging from five to 70 units. We offer multifamily loans with interest rates that adjust based on a variety of industry standard indices, including U.S. Treasury security yields, LIBOR and Eleventh District Cost of Funds. Borrowers may obtain a fixed initial interest rate for a period of up to five years, which then floats based on a spread to the applicable index. Our loans typically have prepayment protection clauses, interest rate floors, ceilings and rate change caps.

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  •  Commercial Loans. We originate a small volume of adjustable rate commercial real estate loans, primarily in California. We currently hold all of the commercial loans that we originate and perform the loan servicing on these loans. Our commercial loans as of December 31, 2004 ranged in amount from approximately $113,000 to $2.2 million, and were secured by first liens on mixed-use, shopping and retail centers, office buildings and multi-tenant industrial properties. We offer commercial loans on similar terms and interest rates as our multifamily loans.

      Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio in amounts and percentages by type of loan at December 31, 2004 and at each fiscal year-end since inception of our operations:

                                                                                     
At June 30,

At December 31,
2004 2004 2003 2002 2001





(Dollars in thousands)
Residential real estate loans:
                                                                               
 
Single family (one to four units)
  $ 35,893       8.64 %   $ 21,753       6.14 %   $ 42,124       17.16 %   $ 32,763       19.67 %   $ 118,377       84.89 %
Multifamily (five units or more)
    366,658       88.22 %     320,971       90.55 %     191,426       77.99 %     125,303       75.22 %     12,878       9.23 %
 
Commercial real estate and land
    12,980       3.12 %     11,659       3.29 %     11,839       4.82 %     8,396       5.04 %     8,122       5.82 %
 
Consumer loans and other
    81       0.02 %     63       0.02 %     62       0.03 %     109       0.07 %     78       0.06 %
     
     
     
     
     
     
     
     
     
     
 
   
Total loans held for investment
  $ 415,612       100 %   $ 354,446       100 %   $ 245,451       100 %   $ 166,571       100 %   $ 139,455       100 %
             
             
             
             
             
 
Allowance for loan losses
    (1,220 )             (1,045 )             (790 )             (505 )             (310 )        
 
Unamortized premiums, net of deferred loan fees
    3,523               1,860               1,272               1,185               534          
     
             
             
             
             
         
 
Net loans held for investment
  $ 417,915             $ 355,261             $ 245,933             $ 167,251             $ 139,679          
     
             
             
             
             
         

      The following table sets forth the amount of loans maturing in our total loans held for investment at December 31, 2004 and June 30, 2004 based on the contractual terms to maturity:

                                         
Term to Contractual Repayment or Maturity

Over Three
Less Months Over One
Than Three through One Year through Over Five
Months Year Five Years Years Total





(Dollars in thousands)
December 31, 2004
  $ 81           $ 4,046     $ 411,485     $ 415,612  
June 30, 2004
  $ 454           $ 3,090     $ 350,902     $ 354,446  

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      The following table sets forth the amount of our loans at December 31, 2004 and June 30, 2004 that are due after December 31, 2005 and June 30, 2005, respectively, and indicates whether they have fixed or floating or adjustable interest rate loans:

                           
Floating or
Fixed Adjustable Total



(In thousands)
December 31, 2004
                       
Single family (one to four units)
  $ 251     $ 35,642     $ 35,893  
Multifamily (five units or more)
    26,911       339,747       366,658  
Commercial real estate and land
    272       12,708       12,980  
Consumer
                 
     
     
     
 
 
Total
  $ 27,434     $ 388,097     $ 415,531  
     
     
     
 
 
June 30, 2004
                       
Single family (one to four units)
  $ 1,230     $ 20,523     $ 21,753  
Multifamily (five units or more)
    26,872       293,700       320,572  
Commercial real estate and land
    187       11,472       11,659  
Consumer
          8       8  
     
     
     
 
 
Total
  $ 28,289     $ 325,703     $ 353,992  
     
     
     
 

      Our 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 December 31, 2004 and June 30, 2004:

Percent of Loan Principal Secured by Real Estate Located in State

                                 
Total Real
Estate Single
State Loans Family Multifamily Commercial and Land





December 31, 2004
                               
California-south(1)
    49.21 %     24.44 %     50.46 %     81.71 %
California-north(2)
    8.96 %     21.34 %     8.07 %      
Colorado
    6.23 %     0.35 %     7.03 %      
Washington
    9.88 %     3.18 %     10.89 %      
Arizona
    5.41 %     1.65 %     5.97 %      
Texas
    5.08 %     1.20 %     5.47 %     4.63 %
Oregon
    5.01 %     2.75 %     5.41 %      
All other states
    10.22 %     45.09 %     6.70 %     13.66 %
     
     
     
     
 
      100 %     100 %     100 %     100 %
     
     
     
     
 
June 30, 2004
                               
California-south(1)
    54.83 %     46.68 %     54.28 %     90.84 %
California-north(2)
    9.71 %     44.58 %     7.50 %      
Colorado
    8.27 %           9.13 %      
Washington
    7.61 %           8.40 %      
Arizona
    5.14 %     1.82 %     5.55 %      
Texas
    3.84 %           4.05 %     5.20 %
Oregon
    4.05 %           4.47 %      
All other states
    6.55 %     6.92 %     6.62 %     3.96 %
     
     
     
     
 
      100 %     100 %     100 %     100 %
     
     
     
     
 


(1)  Consists of loans secured by real property in California with zip code ranges from 90000 to 92999.
 
(2)  Consists of loans secured by real property in California with zip code ranges from 93000 to 96999.

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      Another measure of credit risk is the ratio of the loan amount to the value of the property securing the loan (called loan-to-value ratio or LTV). The following table shows the LTVs of our loan portfolio on weighted average and median bases at December 31, 2004 and June 30, 2004. 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 funding.

                                 
Total Real
Estate Single Commercial
Loans Family Multifamily and Land




December 31, 2004
                               
Weighted Average LTV
    52.66%       61.47%       52.05%       46.13%  
Median LTV
    50.99%       65.39%       49.78%       36.43%  
 
June 30, 2004
                               
Weighted Average LTV
    53.45%       61.61%       53.09%       48.45%  
Median LTV
    53.00%       61.44%       52.00%       39.68%  

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      Lending Activities. The following table summarizes the volumes of real estate loans originated, purchased and sold for the six months ended December 31, 2004 and for each fiscal year since inception of our operations:

                                             
For the Six
Months Ended For Years Ended June 30,
December 31,
2004 2004 2003 2002 2001





(Dollars in thousands)
Loans Held for Sale:
                                       
Single family (one to four units):
                                       
   
Beginning balance
  $ 435     $ 3,602     $ 128     $ 22     $  
   
Loan originations
    9,795       76,550       124,739       6,994       3,317  
   
Loans purchases
                             
   
Proceeds from sale of loans held for sale
    (9,429 )     (80,081 )     (122,042 )     (6,932 )     (3,317 )
   
Gains on sales of loans held for sale
    44       364       778       67       22  
   
Other
                (1 )     (23 )      
     
     
     
     
     
 
   
Ending balance
  $ 845     $ 435     $ 3,602     $ 128     $ 22  
     
     
     
     
     
 
Loans Held for Investment:
                                       
Single family (one to four units):
                                       
   
Beginning balance
  $ 21,753     $ 42,124     $ 32,763     $ 118,377     $  
   
Loan originations
    489       1,641       1,838       3,595       6,797  
   
Loans purchases
    19,208       7,855       32,919       7,792       127,340 (1)
   
Loans sold
                             
   
Principal repayments
    (5,557 )     (29,867 )     (25,396 )     (97,024 )     (14,807 )
   
Other
                      23       (953 )
     
     
     
     
     
 
   
Ending balance
  $ 35,893     $ 21,753     $ 42,124     $ 32,763     $ 118,377  
     
     
     
     
     
 
Multifamily (five units or more):
                                       
   
Beginning balance
  $ 320,971     $ 191,426     $ 125,303     $ 12,878     $  
   
Loan originations
    24,902       57,337       49,949       29,970       4,945  
   
Loans purchases
    49,733       120,264       48,267       123,349       7,965  
   
Loans sold
    (543 )                        
   
Principal repayments
    (28,405 )     (48,056 )     (32,093 )     (40,894 )     (32 )
   
Other
                             
     
     
     
     
     
 
   
Ending balance
  $ 366,658     $ 320,971     $ 191,426     $ 125,303     $ 12,878  
     
     
     
     
     
 
Commercial real estate and land:
                                       
   
Beginning balance
  $ 11,659     $ 11,839     $ 8,397     $ 8,122     $  
   
Loan originations
    2,265       5,467       6,784       1,073       4,261  
   
Loans purchases
                            4,273  
   
Loans sold
                             
   
Principal repayments
    (944 )     (5,647 )     (3,342 )     (798 )     (412 )
   
Other
                             
     
     
     
     
     
 
   
Ending balance
  $ 12,980     $ 11,659     $ 11,839     $ 8,397     $ 8,122  
     
     
     
     
     
 
Consumer loans and other:
                                       
   
Beginning balance
  $ 63     $ 62     $ 108     $ 78     $  
   
Loan originations
    26       33       38       21        
   
Loans purchases
                             
   
Loans sold
                             
   
Principal repayments
    (8 )     (33 )     (108 )     8       (272 )
   
Other
          1       24       1       350  
     
     
     
     
     
 
   
Ending balance
  $ 81     $ 63     $ 62     $ 108     $ 78  
     
     
     
     
     
 
TOTAL LOANS HELD FOR INVESTMENT
  $ 415,612     $ 354,446     $ 245,451     $ 166,571     $ 139,455  
   
Allowance for loan losses
    (1,220 )     (1,045 )     (790 )     (505 )     (310 )
   
Unamortized premiums, net of deferred loan fees
    3,523       1,860       1,272       1,185       534  
     
     
     
     
     
 
 
NET LOANS HELD FOR INVESTMENT
  $ 417,915     $ 355,261     $ 245,933     $ 167,251     $ 139,679  
     
     
     
     
     
 


(1)  Single family loan purchases in our first year of operations provided us the time to develop our internal loan origination capabilities.

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      The following table summarizes the amount funded, the number and the size of real estate loans originated and purchased for the six months ended December 31, 2004 and for each fiscal year since inception of our operations:

                                             
For the Six
Months
Ended For the Fiscal Years Ended June 30,
December 31,
2004 2004 2003 2002 2001





(Dollars in thousands)
Type of Loan
                                       
Single family (one to four units):
                                       
 
Loans originated
                                       
   
Amount funded
  $ 10,284     $ 78,191     $ 126,577     $ 10,589     $ 10,114  
   
Number of loans
    28       317       560       46       38  
   
Average loan size
  $ 367     $ 247     $ 226     $ 230     $ 266  
 
Loans purchased
                                       
   
Amount funded
  $ 19,208     $ 7,855     $ 32,919     $ 7,792     $ 127,340  
   
Number of loans
    85       11       68       130       296  
   
Average loan size
  $ 226     $ 714     $ 484     $ 60     $ 430  
Multifamily (five or more units):
                                       
 
Loans originated
                                       
   
Amount funded
  $ 24,902     $ 57,337     $ 49,949     $ 29,970     $ 4,945  
   
Number of loans
    33       84       80       50       9  
   
Average loan size
  $ 755     $ 683     $ 624     $ 599     $ 549  
 
Loans purchased
                                       
   
Amount funded
  $ 49,733     $ 120,264     $ 48,267     $ 123,349     $ 7,965  
   
Number of loans
    52       116       79       315       16  
   
Average loan size
  $ 956     $ 1,037     $ 611     $ 392     $ 498  
Commercial real estate and land:
                                       
 
Loans originated
                                       
   
Amount funded
  $ 2,265     $ 5,467     $ 6,784     $ 1,073     $ 4,261  
   
Number of loans
    3       5       6       3       5  
   
Average loan size
  $ 755     $ 1,093     $ 1,131     $ 358     $ 852  
 
Loans purchased
                                       
   
Amount funded
                          $ 4,273  
   
Number of loans
                            16  
   
Average loan size
                          $ 267  

      Loan Marketing. We market our lending products through a variety of channels depending on the product. We market single family mortgage loans in all 50 states to Internet comparison shoppers through our purchase of advertising on search engines, such as Google and Yahoo, and popular product comparison sites, such as Bankrate.com. We market multifamily loans primarily in four states through Internet search engines and through traditional origination techniques, such as direct mail marketing, personal sales efforts and limited media advertising.

      Loan Originations. We originate loans through three different origination channels: online retail; online wholesale; and direct.

  •  Online Retail Loan Origination. We originate single family and multifamily mortgage loans directly online through our websites, where our customers can review interest rates and loan terms, enter their loan applications and lock in interest rates directly over the Internet.

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  •  Single Family Loan Website. Our primary website for single family loans is located at homeloans.bankofinternet.com. We maintain and update the rate and other information on this website. Once a single family loan application is received, we outsource processing of the loan application to a third-party processor, which handles all of the tasks of underwriting and processing the loan. Customers seeking direct contact with a loan officer during the application process are directed to a loan officer at the third-party loan processor.
 
  •  Multifamily Loan Website. Our primary website for multifamily loans is located at www.ApartmentBank.com, where customers can obtain loan rates and terms, prequalify loan requests, submit loan applications, communicate with loan officers and monitor loan processing in a secure, online environment. Multifamily loan applications are underwritten and processed internally by our personnel. We designed our multifamily website and underlying software to expedite the origination, processing and management of multifamily loans. For example, customers can directly input or import loan application data electronically, or submit data by facsimile. Once a customer begins an online application, he or she can save the application and resume the process at a later date through a secure password. Our software determines which forms are needed, populates the forms and allows multiple parties, such as guarantors, to access the application.
 
  •  Online Wholesale Loan Origination. We have developed relationships with independent multifamily loan brokers in our four primary multifamily markets, and we manage these relationships and our wholesale loan pipeline through our “Broker Advantage” website located at broker.bofi.com. Through this password-protected website, our approved independent loan brokers can compare programs, terms and pricing on a real time basis and communicate with our staff. Additionally, through a secure loan pipeline management feature, brokers can submit prequalification requests, submit, edit and manage full loan applications, manage loans in process, track outstanding documents and obtain any necessary forms required for documentation. We do not allow brokers to perform any loan processing beyond acting as the originating broker of record. We handle all further loan processing, including verification of loan requests, underwriting, preparation of loan documents and obtaining third party reports and appraisals. We believe that the tools and services offered by Broker Advantage free loan brokers from much of the administrative tasks of loan processing and allow brokers to focus more of their time on local marketing and business development efforts.
 
  •  Direct Loan Origination. We employ a staff of three loan originators who directly originate multifamily and commercial loans and develop wholesale lending relationships with loan brokers on a regional basis. Our internal software, known as “Origination Manager,” allows each loan originator to have direct online access to our multifamily loan origination system and originate and manage their loan portfolios in a secure online environment from anywhere in the nation. Routine tasks are automated, such as researching loan program and pricing updates, prequalifying loans, submitting loan applications, viewing customer applications, credit histories and other application documents and monitoring the status of loans in process. We have three direct loan originators, located in Dallas/ Fort Worth, Phoenix and San Diego.

      Loan Purchases. We purchase selected single family and multifamily loans from other lenders, allowing us to utilize excess cash when direct originations are not available and diversify our loan portfolio geographically. We currently purchase loans primarily from three major banks or mortgage companies. We evaluate each purchased loan as an independent credit decision and apply the same lending policies as our originated loans. Each purchased loan is internally underwritten pursuant to our credit policies for the applicable loan type, and subject to the same loan credit quality scrutiny and approval levels as originated loans. As part of the underwriting and due diligence process for purchased multifamily loans, additional techniques are employed, including a full credit file review for each loan, on-site property inspection, acquisition of independent third party reports as needed, and compliance/documentation quality control audits. At December 31, 2004, approximately $218.1 million, or 52%, of our loan portfolio was acquired from other lenders who are servicing the loans on our behalf, of which 85.7% were multifamily loans and 14.3% were single family loans.

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      Loan Servicing. We typically retain servicing rights for all multifamily 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. At December 31, 2004, we serviced 300 mortgage loans with two full time employees.

      Loan Underwriting Process and Criteria. We individually underwrite all multifamily and commercial loans that we originate, and all loans that we purchase. We outsource to a third-party processor the underwriting of all single family loans that we originate, based on underwriting criteria that we establish and provide to the processor. Our loan underwriting policies and procedures are written and adopted by our board of directors and our loan committee, consisting of President and Chief Executive Officer Gary Lewis Evans and board members Thomas Pancheri and Robert Eprile. 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 OTS.

      Our staff of loan underwriters operates independently of commissioned loan officers. Utilizing our required format, policies and procedures, the underwriters analyze the credit request and prepare credit memoranda and financial analyses for submission to the Chief Credit Officer and loan committee. Loans under $1.0 million require the approval of both the Chief Credit Officer and one loan committee member, while loans over $1.0 million require the approval of the Chief Credit Officer and two loan committee members.

      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 apply different underwriting criteria depending on the type of loan. Each single family loan is underwritten by our third-party processor based on standard FNMA/ FHLMC guidelines, and we may from time to time implement additional underwriting guidelines determined by the expected purchaser of the loan. For example, a purchaser may specify single family loans that meet additional underwriting criteria, such as loan size and type of property.

      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 borrower’s qualifications, we consider primarily the borrower’s 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 typically require a debt service coverage ratio, after operating expense adjustments, of at least 1.25 times for multifamily and 1.50 times for commercial loans, based on the actual operating history of the property over the prior two calendar years and assuming an interest rate equal to the greater of the contractual start rate or the fully indexed margin. We also prepare a pro forma debt service coverage ratio, which must also meet or exceed a 1.25 or 1.50 multiple, based on assumptions including current macro, regional and local economic trends, recent financial statements and current rent rolls. In evaluating multifamily and commercial properties securing loans we originate, we obtain third-party reports, including title and environmental risk reports, third-party appraisals and review appraisals. One of our employee underwriters typically visits each multifamily or commercial property before loan approval and may also visit related properties owned by the borrower or its affiliates or comparable properties in the area, to further our comfort with the loan. We typically do not require updated appraisals or cash flow analysis on our loans held for investment.

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      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 December 31, 2004, Bank of Internet’s loans-to-one-borrower limit was $5.7 million, based upon the 15% of unimpaired capital and surplus measurement. At December 31, 2004, no single loan was larger than $3.0 million and our largest single lending relationship had an outstanding balance of $4.7 million. We expect that our lending limit will increase to approximately $8.1 million immediately following this offering, assuming that $21.8 million in net proceeds are raised in the offering and that $16.0 million of the net proceeds are contributed to our bank, based on the assumptions set forth below the table in “Capitalization.”

      Asset Quality and Credit Risk. For every quarter from inception to June 30, 2004, we had no nonperforming assets or troubled debt restructurings. Since that time, one loan with a principal balance of approximately $152,000 at June 30, 2004 defaulted, but the loan was repaid in full in September 2004. At September 30, 2004 and December 31, 2004, we had no loan defaults, no foreclosures, no nonperforming loans and no specific loan loss allowances. Since our history is limited, 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. Nonperforming loans are defined as nonaccrual loans and loans 90 days or more overdue but still accruing interest to the extent applicable. 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 in the event of 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 policy is to not accrue interest on loans past due 90 days or more.

      Investment Portfolio. In addition to loans, we invest available funds in investment grade fixed income securities, consisting mostly of federal agency securities. 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 primarily to maintain liquidity and generate a favorable return on investment without incurring undue interest rate risk, credit risk or portfolio asset concentration. Our investment policy is currently implemented by an investment committee of the board of directors, comprised of Messrs. Evans, Allrich and Eprile, within overall parameters set by our board of directors. Under our investment policy, we are currently authorized to invest in obligations issued or fully guaranteed by the United States government, 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.

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      The following table sets forth changes in our investment portfolio for the six months ended December 31, 2004 and for each fiscal year since 2002:

                                           
For the Six
Months Ended For the Fiscal Years Ended
December 31, June 30,


2004 2003 2004 2003 2002





(Dollars in thousands)
Securities at beginning of period
  $ 3,665     $ 441     $ 441     $ 726     $ 1,522  
 
Purchases
    52,808             3,409              
 
Sales
                                       
 
Repayments and prepayments
    (3,221 )     (64 )     (185 )     (285 )     (796 )
 
(Decrease) increase in unrealized gains/losses on available-for-sale securities(1)
    (211 )                        
     
     
     
     
     
 
Securities at end of period
  $ 53,041     $ 377     $ 3,665     $ 441     $ 726  
     
     
     
     
     
 


(1)  Through June 30, 2004, we did not have any securities designated as available-for-sale.

      The following table sets forth, at December 31, 2004, 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:

                                                                                 
Due within After One but After Five but
Total Amount One Year within Five Years within Ten Years After Ten Years





Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1) Amount Yield(1)










(Dollars in thousands)
Investment Securities Available-for-Sale:
                                                                               
GNMA MBS(2)
  $ 9,380       3.07 %   $ 205       3.02 %   $ 889       3.03 %   $ 1,286       3.03 %   $ 7,000       3.08 %
FNMA MBS(2)
    35,656       3.66 %     625       3.66 %     2,773       3.66 %     4,180       3.66 %     28,078       3.66 %
     
             
             
             
             
         
Total debt securities
  $ 45,036       3.54 %   $ 830       3.50 %   $ 3,662       3.51 %   $ 5,466       3.51 %   $ 35,078       3.54 %
     
             
             
             
             
         
Total fair value of debt securities
  $ 44,825       3.54 %   $ 830       3.50 %   $ 3,662       3.51 %   $ 5,466       3.51 %   $ 34,867       3.54 %
     
             
             
             
             
         
 
Investment Securities Held to Maturity: