Don't Fear BofI Holding's Interest Rate Gap

| About: BofI Holding, (BOFI)
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Summary

A short-term negative interest rate gap is normal for banks.

Bank of Internet's long-term interest rate gap is positive.

Bank of Internet will profit if rates stay low in the short term and then slowly rise gradually.

The big news for BofI Holding (Bank of Internet) (NASDAQ:BOFI) of course is the acquisition of H&R Block's banking business which occurred shortly after I wrote most of this article. This should have big impacts on the short theses recently presented on Seeking Alpha. Clearly this will provide immediate access to a larger deposit base and a lot of loans which will help with the growth the market expects.

The recent short theses here and here both highlight Bank of Internet's large negative one-year interest rate gap. Like all banks, Bank of Internet loans long-term and borrows (deposits) short-term. The danger is that if interest rates rise, the interest paid on the deposits rises faster than interest received from loans, and profits vanish. The interest rate gap measures assets whose rates adjust in a given time frame minus liabilities adjusting in that same time frame (divided by assets to get a percentage). According to BOFI's 10-Q for 2013 Q4, the one year or less interest rate gap is -137%. So if interest rates rise in 2014, approximately two-thirds of BOFI's liabilities will pay higher rates, while only a quarter of its assets will pay more.

That sounds bad, but note that 1) all banks face a similar issue on portfolio mortgages and more importantly 2) Bank of Internet holds a large portion of adjustable rate loans. The interest rate gap for one to five years out is positive 66.4% or cumulatively negative 3.7%. Out past five years BOFI's cumulative interest rate gap is positive 11%.

Since all banks borrow short and loan long, we should ask if Bank of Internet is extreme compared to its peers in the degree of interest rate sensitivity. Given the highlighting in the short articles, I was surprised to discover that interest rate gap is not reported in the 10-Ks of EverBank (NYSE:EVER) or First Internet Bancorp (NASDAQ:INBK). Unfortunately, it's not even clear the portion of adjustable versus loans at EverBank. One article references a March report from Sterne Agee claiming to show gap numbers - but that report is not evident at the web site, so I am unable to read their assumptions.

For EverBank I made the following assumptions: all conventional mortgages are fixed-rate, all jumbo mortgages adjust in one to five years, all other assets adjust in less than one year, due to refinances and new mortgages, one-seventh of the fixed and jumbo mortgages will adjust in the next year (same as the ratio given for BOFI). For deposits I assumed time deposits will adjust after one year, and demand deposits in less than one year. First Internet gives a breakdown of all loans into fixed or adjustable. They also break down all time deposits by maturity, so I was able to use that for deposits. I assumed that securities available for sale (which is 22% of First Internet's total assets) adjust within one year since mostly they are marketable government securities held at fair value - note that the interest rate risk is in the value, not the payment, so this muddies the gap analysis.

One year or Less

One to Five Years

Assets

Liab

Gap

Assets

Liab

Gap

Cum. Gap

EverBank

4893

9000

(83.9)

7143

3000

58.0

0.3

First Internet

307

485

(57.9)

198

168

15.2

(29.2)

Bank Of Internet

946

2257

(137.2)

1814

609

66.4

11.3

Given this analysis, in the long term, one should be worried about First Internet, not Bank of Internet. Over time it's clear that Bank of Internet's loans will adjust, so that if rates increase slowly (after 2014), Bank of Internet's profitability goes up, and by a slightly larger percentage than EverBank's profitability.

Another common approach is to look at sensitivity of equity to "an immediate parallel and sustained shift in interest rates." This allows the bank to account for hedging strategies. Unfortunately, First Internet does not report this figure in its latest 10-K, so I include only EverBank and Bank Of Internet.

EverBank Interest Rate Sensitivity:

Bank Of Internet Sensitivity:

This clearly shows the impact of EverBank's hedging - EverBank asset values increase from a sudden jump in rates, while Bank of Interest drops.

The strategies relating to interest rates should be clear now. 1) All banks borrow short and lend long - that's what a bank does, 2) EverBank is hedged against near term upwards shocks to interest rates and roughly neutral to interest rate moves longer term; Bank Of Internet is hurt by near term upwards movements, but should profit from longer term upwards rate movements; First Internet's position is less clear, but they seem less set for higher rates in the long term.

So the question becomes where do you think rates will go in the short and long term? If you believe Chair Yellen, then rates should stay approximately where they are until sometime in 2015 and then gradually rise over the following 1-2 years. That would be good for Bank of Internet, not bad. If you think that something will jerk rates up faster than that (tapering effects on long-term rates or inflation), then Bank of Internet will fare relatively poorly.

Disclosure: I am long BOFI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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