April 2014 Kerrisdale Capital Management, LLC 1212 Avenue of the Americas, 3rd Floor New York, NY 10036 Tel: 212.792.7999 Fax: 212.531.6153 Email: info@kerrisdalecap.com C ONFIDENTIAL I NVESTOR P RESENTATION
Once one of our largest long positions… Today, we discuss a short idea on a company that was once one of our favorite long positions − What originally attracted us to the opportunity years ago Small business with negligible market share with good management We acquired the business at a low P/EPS, P/TBV, PEG, etc. No sellside coverage (compared to 7 coverage analysts today) − We were investors in the business for several years, and are now short Company’s shares have appreciated by 1200% in the past 5 years! Numerous competitors are copying the company’s low-cost model and entering the market with the same products We believe the company’s margins are significantly inflated due to several factors that will reverse in the coming years By all valuation metrics, company now trades at a significant premium to its competitors, and to our estimate of reasonable profit potential Page 1 / Confidential
BofI Holding Inc. (Nasdaq: BOFI) BOFI is a branchless online bank that operates a variety of online bank brands, including Bank of Internet, NetBank, Bank X and others Loans are made via branded websites such as apartmentbank.com, via relationships with affinity groups, call centers, as well as through wholesale and correspondent channels $3.6bn total assets, $312m TBV, $47m LTM Net Income Page 2 / Confidential
Capitalization We hold a short position in BofI Holding Inc. (“BOFI” or the “Company”), one of the most expensive banks in the US BOFI has earned investors nearly 1200% in the past 5 years, and now trades at ~3.5x TBV and 20x EPS, far higher than its banking sector peers − Investors expect rapid earnings growth; we believe future earnings are likely to materially disappoint as interest rates rise We believe BOFI’s investors are extrapolating results that will be difficult to achieve going forward as interest rates rise Page 3 / Confidential
Strategy in a nutshell BOFI has no branches and attracts depositors by offering high interest rates − BOFI can afford high cost of funding due to its low operating costs: no branches and low employees / assets ratio (only 312 full time employees at 6/30/13) Source: BOFI March 2014 investor presentation Page 4 / Confidential
Online banks typically have a higher liability cost Internet banks, like BOFI, attain their deposits at a higher cost than their brick-and-mortar peers − Forward curve indicates that funding costs for banks will rise significantly in coming few years Internet banks also tend to attract a more price-sensitive, and less “sticky” depositor base − Depositors choose the bank based on price, not service or convenience Source: FDIC statistics on depository institutions , Bloomberg Online banks have a higher funding cost than conventional banks, and this funding cost is expected to go up Page 5 / Confidential
Online banks typically earn weaker asset yields Typically, internet banks tend to earn asset yields that are at or slightly below their banking industry peers − No brick-and-mortar branches − Few customer relationships − Little-to-no cross-selling opportunity or services revenue − Forced to acquire wholesale assets (competition tends to be more fierce) BOFI asset yields now exceed banking industry peers for non-recurring factors that will be outlined in this presentation Source: FDIC statistics on depository institutions , Bloomberg Online banks are at a disadvantage in sourcing or originating loans; as asset base grows, allocating capital becomes far more difficult Page 6 / Confidential
Online banks typically have lower NIMs Online banks tend to have significantly lower NIMs than their banking industry peers, yet BOFI’s recent NIMs are above? How? − Typical online banks have higher funding costs, and lower asset yields, than their conventional brick-and-mortar peers − While BOFI’s funding costs are higher than peers, their asset yields are significantly higher, creating NIMs that match the banking industry BOFI NIMs now exceed banking industry peers; as the bank’s asset base grows, their NIMs will likely fall back below the banking industry, typical for an online bank Source: FDIC statistics on depository institutions , Bloomberg BOFI NIMs are an anomaly in the industry; this is not due to a sustainable advantage, but rather, temporary factors that will reverse Page 7 / Confidential
We think BOFI is over-earning BOFI’s Net Interest Margin (“NIM”) is unlikely to be sustainable − Liabilities: BOFI has one of the largest negative interest gaps amongst public banks; when rates rise, its deposit costs will rise significantly New competition : numerous players are replicating BOFI’s online business model, which will either slow deposit growth or increase funding costs − Assets: BOFI is temporarily earning far higher returns on its assets than its peers because it made a large, timely bet in high-yield distressed MBS; these assets are rolling off and will be difficult to replicate Valuation: BOFI is one of the most expensive publicly traded banks in the US − ~3.5x TBV and 20x PE − Investors have mistakenly assumed current profitability and growth is sustainable despite the forward yield curve indicating otherwise This presentation will illustrate why we believe BOFI’s current earnings are unsustainable given the forward rate curve Page 8 / Confidential
BOFI’s asset yields are likely not sustainable BOFI management made some astute investment decisions during the financial crisis, allowing the company to sustain very attractive interest income despite a falling rate environment BOFI lacks a competitive advantage on the asset side of its balance sheet; management will find it difficult to sustain yields with a growing balance sheet Page 9 / Confidential
Why is asset yield high? Nonrecurring bets on MBS! BOFI’s asset yields are far higher than peers due to opportunistic bets on distressed MBS during the financial crisis BOFI’s loan yield and other asset yields are largely in line − As the securities portfolio matures and rolls over, BOFI’s asset yield should decline to a level on par with its peers During the financial crisis, management made some astute once-in-a-lifetime investments in distressed MBS, which greatly enhanced asset yields Page 10 / Confidential
BOFI’s asset yield compared to peers As outlined earlier, BOFI and other internet banks are at a disadvantage from a capital deployment perspective As its balance sheet grows, and as its high-return securities portfolio rolls over, BOFI’s profits may fall significantly − Asset yield in line with peers (as defined by BOFI proxy) would imply ~20% downside to LTM EPS BOFI WFC USB FITB Peer Avg. Average Securities Yield 4.74% 3.65% 2.29% 3.32% 2.19% Incremental BOFI yield 1.09% 2.45% 1.42% 2.55% Average Securities Balance ($mm) 478 Excess BOFI Net Income ($mm) 3.1 7.0 4.0 7.3 Excess BOFI EPS $0.22 $0.49 $0.28 $0.51 % Downside to LTM EPS (7%) (17%) (9%) (18%) Source: company filings, FDIC Statistics on Depository Institutions, Kerrisdale analysis As BOFI’s balance sheet grows, and its opportunistic securities portfolio rolls over, BOFI’s asset yields will fall closer to peer average Page 11 / Confidential
Comparison of BOFI to Everbank Confirms View Everbank is a similar online-only bank Comparing the two firms, BOFI’s NIMs are significantly enhanced by the yield on its securities portfolio BOFI EVER Diff. Loans 5.25% 4.75% 0.50% Securities & other assets 4.07% 2.74% 1.34% <--- BOFI's main advantage is securities Total earnings assets 5.03% 4.35% 0.68% 0.04% <--- Both firms pay similar funding cost Cost of funding 1.02% 0.98% NIM 4.01% 3.37% 0.64% Average balances Loans $2,664 $12,735 Other earning assets $613 $3,154 Total earnings assets $3,276 $15,889 Excess earnings appear to be driven by a maturing securities portfolio and longer duration, riskier, loan book Page 12 / Confidential
BOFI’s loan portfolio is going to roll into lower yield BOFI’s historical loan yields are supported by focus on jumbo loans, which today have far lower excess yield BOFI Loan Pipeline Source: BOFI investor presentation March 2014 Source: Financial Times Jumbo loans, which form the largest segment of BOFI’s loan pipeline, are facing increased competition and declining yields Page 13 / Confidential
Multifamily mortgages getting more competitive 31% of BOFI’s loan portfolio is “multifamily real estate secured” (apartment buildings) This sector has recently become intensely competitive: − January: “There’s no question that the marketplace is highly competitive” (New York Community Bancorp) − February: “We know the year is going to be challenging…We are prepared for elevated competition” (Freddie Mac) − February: “With all the supply of capital, 2014 will be a challenging year for lenders. There is robust competition for origination talent, as well as access to clients.” (Walker & Dunlop, February) − “The multifamily market has always been competitive, but it has become much more competitive in the last two years as more lenders enter the business” (Dime Savings Bank, March) BOFI’s lending niches have become crowded, which will depress yields Page 14 / Confidential
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