How we bank in the future will be very different from how we bank today. But that doesn't mean we should throw out all the old rules, many of which are in place for a reason.
It's this dichotomy that should come to mind when investors think about BofI Holding (NYSE:AX), the parent company of BofI Federal Bank, a.k.a. Bank of Internet.
There's no denying BofI's appeal. By dispensing with the traditional bricks-and-mortar branch model, BofI has constructed a comparatively efficient operation that allows it to pay a higher interest rate on deposits and thereby grow its funding source at a pace it deems fit.
"Because we do not incur the significantly higher fixed operating costs inherent in a branch-based distribution system, we are able to provide a better value to our customers," said its president and chief executive officer, Gregory Garrabrants. "This means our interest rates on deposit products are generally among the highest available and our loan products feature low rates and fees."
At the same time, however, investors would be foolish (small "F") to ignore the downside to this approach. That is, by relying effectively on brokered deposits (I'm aware they aren't formally brokered, but they share the same active ingredient, if you will, of being a flight risk if interest rates become more attractive elsewhere), BofI's funding source is both expensive and highly vulnerable.
In the most recent quarter, its cost of interest-bearing liabilities was 1.26%. To put that in context, the same figure at Wells Fargo (NYSE:WFC) was 0.32%, at M&T Bank (NYSE:MTB) it was 0.58%, and at US Bancorp (NYSE:USB) it was 0.71%.
The net result is twofold. First, this causes BofI to reach for yield (and thus risk) on its asset portfolio. In the third quarter, its yield on earning assets came in at 4.99%. Meanwhile Wells Fargo, M&T Bank, and US Bancorp all had earning asset yields of less than 4%.
And second, because depositors use BofI much as they would a bond or money market fund, albeit a federally insured one, when the risk-free rate of return becomes more attractive elsewhere, it's reasonable to conclude that a portion of them could flee elsewhere, triggering a liquidity run.
At the end of the day, in turn, the one thing investors need to be aware of when it comes to BofI Holding is that while it may sport an interesting and appealing business model from a theoretical perspective, one should not lose sight of the increased amount of risk that comes along with it.