Live Oak Bancshares Inc (LOB) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Live Oak Bancshares third-quarter earnings conference call. At this time all participants in a listen-only mode. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to hand the conference over to Greg Seward.

Thank you, and good morning, everyone. Thank you for joining our call today, where we will discuss third-quarter results and answer your questions. This call is being recorded.

Before we get started, I would like to remind you that our third-quarter earnings release is available on our website at investor.liveoakbank.com. I would also like to caution you that we may make forward-looking statements during today's call that are subject to risks and uncertainties.

Factors that may cause actual results to differ materially from our expectations are detailed in our SEC filings, including the Form 8-K filed prior to this call containing our earnings release. We do not undertake to update the forward-looking statements to reflect the impact of circumstances or events that may arise after the date of today's call. Information about any non-GAAP financial measures referenced, including reconciliation of those measures to GAAP measures, can also be found in our SEC filings.

I will now turn the call over to Chip Mahan, our Chairman and Chief Executive Officer.

Good morning and thank you for joining the call today. I'm accompanied by our President, Neil Underwood; and our Chief Financial Officer, Brett Caines. Hopefully, you have had a chance to read through our third-quarter earnings release issued after the market closed yesterday, which demonstrates that our growth momentum has continued on many fronts.

Brett will take you through our financial results following my comments. We met many of you on the roadshow in July. This being our first earnings call, I would like to offer a brief background on our Company for those listeners who don't know us all that well.

Live Oak has fundamentally changed small business lending through the use of our proprietary technology, which greatly streamlines the borrower experience. We believe there is a tremendous value in the digital experience and the efficiencies it creates. In conjunction with our deep industry expertise, we are able to create a borrowing experience that is unmatched in our space.

We originate, sell, and service loans partially guaranteed by the US Small Business Administration to small businesses and professionals with low risk characteristics. We believe our focus on specific industries, which we call verticals, has allowed Live Oak to prudently and effectively meet the financing needs of the small business sector across the US.

We have the lowest default rate and the fifth lowest charge-off rate compared to lenders that have originated in excess of 300 loans under the SBA 7(a) program for the 14-year period ending September 30, 2014. At September 30, 2015, we ranked as the nation's second-largest small-business lender by dollar volume, utilizing the SBA Section 7(a) program. Since our inception in 2007, we have grown our origination levels at a compounded annual rate of 54% through the end of 2014.

We differ from traditional banks in many fundamental ways, not least of which is our unique business model. Unburdened by brick-and-mortar infrastructure and cumbersome branch network, we can invest more freely in multiple growth initiatives designed to sustain and enhance our success.

Technology and speed-to-market represent another major point of distinction. Our digital base franchise affords us tremendous access to growth markets on a national scale. What further sets us apart is our superior financial performance compared to our peers as it relates to return on assets and return on equity.

Another difference we have with traditional banks lies in the inherent variability of our revenue streams. In various verticals, we assist business owners by advancing funds for expansion or buildout of their facilities, which takes time to complete and fully fund. Only at this point are we allowed to sell the guaranteed portion into the secondary market.

This, in turn, causes cyclicality in gain-on-sale revenue recognition. So this is really a timing issue, while the real driver lies with growth in the origination activity. So, as we emphasized on our roadshow, quarterly comparisons of financial performance for us are not that meaningful compared to, say, annual ones.

We ended the third quarter of 2015 with a year-to-date origination volume of $828 million, and we are on track to originate $1.1 billion this year. The year-to-date origination volume represents a 40% growth over the same three quarters in 2014. This has been a result of growth in our legacy verticals as well as new verticals added in 2015.

The opportunities to empower small businesses for success are great, with approximately 1,000 industries eligible for the SBA 7(a) program. We are focused not only on building out existing verticals, but incrementally adding new verticals to our lending portfolio. With this approach, we believe we can continue to grow our loan origination volume in excess of 15% per year.

We are proud of the work of our emerging markets team to identify four new verticals for 2015. We have closed loans in wine and craft beverages and self-storage. Our newest verticals, hotels and insurance agents, all have loans progressing through the pipeline toward closing. We are very excited about the new opportunities that exist for Live Oak Bank.

We are putting the capital raise to work. We are successfully growing the number of verticals present in our loan portfolio, and we have launched our new small loan platform we call eLending. Additionally, we continue to invest in an end-to-end solution for American small businesses on the deposit side. Using the same eLending platform, we intend to offer unique merchant services, remote deposit capture, bill pay, and financial forecasting alternatives to our customers mid-next year.

It is our belief that in addition to our SBA business, there are substantial opportunities serving those businesses that need to borrow under $1 million. In our opinion, there are literally hundreds of FinTech lenders who have identified the problem of distributing capital to these small businesses. Unfortunately, their cost of funds are substantially higher than a federally regulated bank.

In addition to offering both loans and deposits online, we believe it is incredibly important to develop a digital and video relationship with our customer -- from the day they log on to our portal through the approval and loan-closing process. After successful completion, we are well positioned to begin a transactional relationship on a fully-integrated, next-generation deposit platform.

Neil will discuss the eLending launch as well as some other new initiatives momentarily. At this point, I would like to turn it over to Brett to review our financials in greater detail. Brett?

Thank you, Chip. Good morning, everyone. Our after-tax earnings for the third quarter totaled $2.9 million. This equates to basic earnings per share of $0.09 on 32.8 million weighted average shares outstanding for the quarter.

As Chip mentioned, loan origination activity continues to be robust, with year-to-date growth of approximately 40%. In the third quarter, loan production rose nicely to $303 million versus $277 million in the second quarter.

In terms of the balance sheet, total loans outstanding grew by over $100 million from the second quarter or by a healthy 18% to $703 million. The vast majority of this increase, 80% of it, was concentrated in the held-for-sale portfolio. Some of this was naturally due to the steady rise in origination volumes. But another contributing factor is these multi-advanced expansion loans Chip alluded to that take longer to fully fund.

This is especially the case within our chicken industry vertical. This will likely be amplified by our newer verticals, such as hotels and self storage, which also carry a disbursement period. At the end of the third quarter, the guaranteed portion of such loans yet to be fully funded have grown to about $488 million from $253 million a year ago, and we expect the held-for-sale component of our loan portfolio to continue to grow. Ultimately, we expect the pent-up gain-on-sale and servicing revenue due to these loans will be realized.

In the third quarter, the volume of loan sales of guaranteed loans in the secondary market totaled $147 million, well above the $115 million of a year ago, but only slightly higher than second-quarter levels. Net gains on these loans was $15.4 million in the third quarter. We have remained around the $15 million mark for the past three quarters, even with rising loan production levels, further illustrating the added time involved in monetizing the guaranteed portion of our loans.

To echo Chip's comments, we are not preoccupied with the quarterly variability of revenues inherent to our business model, but instead focused on growing our business volumes, as their intrinsic profitability is creating long-term value. One valuable trade-off with having various loans stay on books longer is the resultant growth in net interest income from the spread we earn on these loans.

Our net interest income grew $1.2 million or 22% to $6.6 million from the second quarter of 2015. Compared to the third quarter of 2014, net interest income grew $2.7 million or 70%.

Servicing revenue in the third quarter rose by 9% from the second quarter to $4.2 million on our $1.6 billion servicing portfolio at a weighted average fee of 1.08%. The combined net interest income and servicing revenue, which we consider our recurring revenue streams, totaled $10.8 million for the third quarter of 2015, an increase of $1.5 million or 16% versus the second quarter of 2015.

Compared to the same period of 2014, recurring revenue grew $3.6 million or 51%. At September 30, 2015, our servicing asset was valued at $40.6 million for the $1.6 billion in loans outstanding in the secondary market. As you know, the servicing asset represents the present value of the anticipated revenue from the ongoing servicing of the sold loans. In the third quarter, the carrying value of this asset was reduced by $2.6 million, due equally to the amortization of the portfolio and to changing market conditions for guaranteed loans.

Credit quality improved as the unguaranteed exposure of nonperforming assets declined from $3.1 million at June 30, 2015 to $2.6 million at September 30, 2015. Net loan charge-offs were $243,000 in the third quarter of 2015 compared to $101,000 in the second quarter of 2015. Year-to-date annualized net charge-offs equaled 21 basis points on the nine-month average unguaranteed loan balances versus 29 basis points in the same period of

2014.

The provision for loan losses totaled $1.2 million in the quarter ended September 30, 2015. The provision increased in conjunction with growth of our loan portfolio. On a linked-quarter basis, non-interest expense grew $1.2 million or 7.4%, reflective of the strategic investing underway to grow the franchise and capitalize on near-term opportunities. The increase was largely related to personnel and operational costs to build out new verticals and new lines of business.

For example, teams are in place and ramping up efforts to build loan pipelines in self-storage, hotel, and the independent insurance agent verticals. In this way, we are continuing to build out future sources of profitability. Additionally, we incurred expenses with the launch of eLending, development of our deposit platform, our customer portal, and our trust division. Neil will touch on the progress of each of these. Neil?

Thanks, Brett. To further expound upon Chip's comments, in August we successfully launched our eLending initiative, built specifically to serve small businesses nationally. In our pilot phase, we are focusing on businesses within our current verticals which wish to borrow anywhere from $25,000 to $350,000. Given a 10-year term and a maximum rate of prime plus 4%, we believe we can attract the right small businesses and take advantage of a $180 billion market opportunity.

In addition, we are beginning to recognize that efficiencies gained in this market segment will also have a positive impact on our larger loans. Completing the digital bank vision, we are extending the eLending platform to include deep deposits functionality. We believe free omnichannel online banking, remote deposit capture, and discounted merchant will appeal to our small business loan customer base.

Construction phase will ensue for the remainder of this year, followed by the pilot launch in the first half of 2016 and general availability in the second half of that year. Finally, with the launch of our preneed trust division, we are putting incremental low-yielding deposits on the books as well.

Thanks, Neil. We have provided a high level overview of the quarter for you. We would now like to open the call for any questions.

(Operator Instructions) Aaron Deer, Sandler O'Neill.

Brett, you touched a little bit on the increased time between the origination and the sale as the holding periods increased. Can you talk about the percentage change or maybe just the overall percentage of production that you had this past quarter that was in construction, since it sounds like that's the loan type that is causing the delays? And then -- I shouldn't -- delays probably isn't the right word, but causing a longer holding period. And then talk about how that holding period between origination and sale has changed between where it is now versus, say, where was a year ago.

Yes, I will start out with a year ago. Roughly 50% of our loan originations were full funders, and the remainder of those were loans that had some period of future disbursement. And ending Q3, based on Q3 loan originations, the percent of the portfolio for construction was right at 57%.

And as Chip alluded to, and I as well in previous comments, we do see that likely rolling as time goes on -- specifically related to hotels, self-storage, the growth in chickens, the growth in our healthcare vertical as well. So we see that percentage and construction on a quarterly basis on the trend up.

Yes, let me just add to that real quick, Aaron. We have Jody Murphey here with us today who runs our chicken business. So healthcare and chickens in 2015 have been our hottest verticals, almost all of which is construction. I would say that the average in the healthcare construction portfolio is 15-ish months.

15 to 18.

15 to 18 months. We thought that the chicken houses we built in roughly 9 months -- and Jody is going to comment on that in just a second -- but depending on one's perspective it is going to get worse or better, right? So self-storage is probably going to be 18 months-ish.

The hotel vertical is coming out of the ground quite quickly. You're looking at probably 18 to 24, maybe more, in these 80- to 100-key hotels. But Jody, why don't you comment a little bit on what you have seen relative to the weather in Arkansas, and actually what we have done to the industry in general and the capacity to build these houses.

Sure. So there are very few qualified contractors throughout the country that are qualified to actually build -- and certified to build -- chicken houses for the Company that are out there doing it. And what you've got right now is pretty much unprecedented. You've got two brand-new complexes that were being built at the same time. You had Sanderson Farms building a plant, brand-new plant in Palestine, Texas; and Peco Foods building a new complex in Pocahontas, Arkansas.

So what that caused -- we had quite a bit of weather delays in Texas and Arkansas, where probably 50% of our construction business was in the chicken vertical this past year. So you have got weather delays; but on top of that, once the weather broke you got massive contractor delays, because there are so few out there that are qualified to do it and certified with the integrators to do that construction. And those guys are just backed up.

We anticipate them being backed up probably for another, I would say, 4 to 6 months, depending on winter weather. Obviously if we get some bad weather again in those areas, it could be a little bit longer than that. But those houses are starting to come online now. But it has been more like a 12- to 15-month process rather than the normal 9- to 12-month process.

Thanks, Jody.

So I guess given that, how do you think about the sales volumes over the next few quarters as all of this kind of works through the pipeline? And then at what point does -- do we start seeing, I guess, a big ramp as more of this gets fully funded and you are able to disperse it into the secondary market?

You know, that's a really good question, Aaron. Put one in, take one out.

I would say Jody has done right close to $0.5 billion since January of 2014 to date. And cruise altitude may be another 9 to 12 months out, and probably level off there. Probably the same thing in healthcare, but then you are going to that with self-storage and hotels that will continue the same delayed ramp.

So, again, that is a bit of a blessing and a curse, Aaron. But -- so it is really capital markets analysis. So if it is going to take 24 months to monetize a hotel loan, and almost all of those will be full funders -- I mean, max $5 million deals, then it is an Excel spreadsheet waiting to happen, so to speak.

Okay, and then lastly, the gain-on-sale premium or margin came in just a touch this quarter. It sounds like that is mostly just due to kind of what is going on in the secondary market. Any additional color you can give on that? Or what your expectations are for those sale premiums going forward?

Yes, you are correct. Q3 our net gain on sales was down compared to prior quarters. It is largely a function of supply and demand -- some excess supply out in the secondary market reducing investors' desire to buy. Since the end of September, there has been a stabilization in the market. And the prices have started trending back up from what we were seeing at the end of September. The length of time it can take for those to stabilize after some upward momentum is unknown. However, it does feel like a bottom was reached.

Yes, just to add to that, Brett, I talked to the capital markets team this morning -- and this is going to be a bit confusing relative to page 6 of the earnings release. But typically we look at this, the gain-on-sale, in the 100,000s per 1 million. Historically over the past 18 months or so, on a 1.75% over prime deal, 25 years, we would get about [114,000] per million. And I understand as of today that is back to [112,000] so we are almost back to where we were, to your point.

Okay, that's great. I will step back into the queue.

Doug Mewhirter, SunTrust.

A quick question about the SBA -- the federal funding limits. I know that there was sort of a brief hiccup in the market when they had to reauthorize the ceiling. If you can give your general comments on the -- for next year what you think the atmosphere is to keep raising that ceiling? And also, in this quarter was any disruption where you had to make some bridge loans until they had to sort of close the gap, so to speak?

Great question, Doug. We have with us on the call Steve Smits, who actually used to run the Office of Capital Access before becoming our Chief Credit Officer; and Patrick Kelley just left the SBA 90 days ago as, fundamentally, their number three person. I am going to let them comment on the politics of the matter. But David and Steve, I don't think we had to bridge any deals this summer in anticipation of the slide, so to speak. We did not, right?

We did not.

Steve, do you want to -- Patrick, do you want to comment on Doug's question?

I think the important thing about the vote in July and August is that it raised the program authority to $23.5 billion and the really important thing for the year ahead in thinking about budget process is that if there is a CR for the full-year, that $23.5 billion is in place. So we think we have, industrywide, enough space. That number was reached in close coordination with the Office of Management and Budget as well as SBA. So the next 12 months looks like the program will have decent room to grow. And regardless of how -- whether we have a permanent budget or a CR, that is in place.

But both sides of the aisle, shockingly, came together in weeks to get this done, did they not, because of the funding mechanism? You might want to comment on that.

Yes, I mean SBA continues to be a place where both Republicans and Democrats alike support. And one of the reasons that they support that is because the program is zero subsidy.

So, again, with respect to the deficit hawks, this is a program that does not impact that. So it should continue to be in good favor, regardless of which party controls the chambers -- and for that matter, which party controls the executive branch.

Steve, you have anything to add?

My point was it continues to be at a zero subsidy, which is an important component.

Got it.

Great. And I just had a follow-up question on the cost line. Neil, you sound pretty excited about the eLending initiative in the -- and you are making some pretty significant investments in there. How sort of full is the pot in terms of costs, in terms of hiring or infrastructure costs? Is there more to go? Do you think you're halfway there, three-quarters of the way there in terms of building out the platform?

Yes, great question. I think that 50% of the engineers that were on eLending have been redeployed to the deposits platform. But we kind of see all this as one; and that is the most important thing to recognize, this digital bank concept. Again, this term has been overused.

Typically it is ascribed to online banking, and then they will throw in some fancy term, like omnichannel. Really, what we are attempting to do is marry up true electronic lending, so that's end-to-end -- from when a lead hits the website, to the adjudication of the credit, to the funding, much like the non-bank lenders are doing a great job of marrying that up with a low cost of funding strategy on the deposit side and offering few end-to-end bank functionality.

And again, given our branchless situation, we feel the borrower experience is naturally important; but that, given an iPad or the latest in video-over-IP technology, we can still maintain that one-to-one experience. So to answer your question directly, that team has now gone off from eLending -- 50% of it -- and onto deposits product. The things that we innovate on on the deposit side will be also used in eLending.

Okay. But it sounds like you're not going to significantly expand the team, or do a lot more incremental hiring, or have to pay a lot more infrastructure-related costs.

Yes, I think we see this opportunity as massive. So we will probably -- again, that team -- as you take a look at noninterest expense, which is where I think you are going with this, that team is a small set of that. Remember all the new verticals that we are getting as well. So relative to the technology investment, we will probably grow that team by 20% to 30% to take advantage of what we feel is a very unique market opportunity.

As you guys have so well pointed out on the road, in a rising interest rate environment deposits become massively strategic. So we feel we can go after -- with this platform we can go after our end vertical customers and offer this service and receive, ultimately, very low cost to deposit. So those trends we hope we see in our blended deposits will start moving in the right direction.

Okay, thanks. That's all my questions.

Jefferson Harralson, KBW.

I wanted to drill down into that gain-on-sale number, that 114,000 per million that you said have moved back up to 112,000. What was the average for the quarter? And what was your feel for what that trough would've been? Does that just make you possibly lose some confidence about the pricing and what you guys are going to sell going forward?

So Q3, our average net gain on sale was 104.6, so roughly 105,000 for every million sold. That bottomed out. Depending on what type of loan you are selling, 25-year term, 10-year term, if it is quarterly adjusting versus a five-year adjusting, that varies. As far as the bottom out and the term return or the trend back up, that has been slight over the past couple of weeks.

I guess we would take comfort in the fact that it feels like the bottom was reached. I don't know how quickly prices will rebound or where they're going. However, it does feel like the 100,000 per million or the 105,000 per million was a bottom that, barring any economic event, may not be reached again in Q4.

Okay. And this quarter you sold 49% of what you originated if you take the 147 and divide it by 302. But it sounds like you are adding in more longer-term construction, I guess, contract delays. Should that number stay around 50% for a few quarters here? Or do you think that's -- that what it sounded like you were saying, but I wanted to (multiple speakers)

No, the percentage of loans sold as a function of origination -- we see that percentage declining in coming quarters. The percentage of new originations that are construction we see increasing over the coming quarters. In Q3 that number was 57% -- so 57% of all new originations had a disbursement period and could not be sold. And we see that number trending up, given our growth in healthcare, chickens, and upcoming self-storage and hotels.

Okay, got it. And one more on the assets -- the servicing revaluation, that minus $3 million -- within there, you talk about changing market conditions. I wasn't sure what you were -- I guess, does that change in market conditions -- does it change the value that seemed to be increasing the expense on that valuation of that rate.

Yes, the comment about market conditions was related specifically to the market's reaction or the market's hesitation on purchasing ahead of the Fed decision and somewhat of a further slowdown immediately following the Fed decision. So market conditions primarily refers to that period around mid-to-late September related to the Fed's announcement.

Okay, so these are loans you've already sold; yet the change in potential sale price for those loans -- I guess the resale price of those loans -- hurts the valuation of the rate?

Yes, the servicing asset, the current market conditions of what those like loans are being sold for that comprise the servicing asset, that value -- a component of that value or a component of that valuation is what the current secondary market is. And then as they (technical difficulty) prepayment speeds; and then the other component, of course, is amortization.

Okay. And last one: did you guys sell any nonguaranteed loans this quarter? Or is that strategy just not one you're going to use now that you have a lot more capital?

We sold a few unguaranteed loans this quarter. We are still looking at unguaranteed loan sales as a function of concentration risk mitigation. And potentially some other outlets there, or not --

They're just minor, right?

Yes, the sales are minor.

Right.

Okay, all right. Okay. Thank you, guys.

Christopher Marinac, FIG Partners.

Chip, as you mentioned the evolution of the deposit side and how that plays out in the near-term, I was just curious if you have sort of short-term or intermediate-term targets in terms of how the deposit mix will look for Live Oak as 2016 and 2017 come into focus?

Well, I am going to start this, and then Neil can clean up. It was -- and you remember this, Chris. It was 21 years ago tomorrow that my brother-in-law and I launched Security First Network Bank in an effort to prove that the consumer did not need to go into a bank branch.

Neil has been writing code on the force.com platform for six years. And if you go to his eLending module, you will see that for the first time it is possible to develop a digital/video relationship over an iPhone, or an iPad, or your computer.

The platform is built. 85% of small businesses in this country under $35 million in revenues still write checks. Drives me crazy, shockingly.

But if we can deliver -- let's just say -- and it is not lost on me that we have 3,600 loan customers. If we can deliver to those folks free merchant services -- so most banks take 100 bps there. So if you have a $2 million vet practice, would you want to put another $20,000 in your pocket?

Elegantly, fully integrated into remote deposit capture, into financial forecasting with QuickBooks, into bill pay. Might we convince them to bank with us? We do business, again, with a vet example, with about 900 veterinarians. It is not lost on us that there are 79,000 other veterinarians that do not bank with us, and we have a reputation in that vertical.

So it is really too early to do any deposit predictions. We raised, what, Brett, $400 million or $500 million here locally in Wilmington?

Over the long-term, yes.

Over the long-term at, obviously, a slightly higher money market price. And then we utilize the Internet and broker to fund the business today. But we are pretty excited, now that we have a wicked fast pipe that I, frankly, have been waiting on for 21 years, as I said earlier, to deliver those products and services a small business person needs to operate their business without going into a bank branch, and have the consistent level of service that all of our customers know to expect from Live Oak Bank. So, Neil, I probably botched that for you, but (multiple speakers)

The only thing I would add to this is that -- mentioned earlier -- is that we are not just focusing on what I call this omnichannel business checking product. We would like to innovate on the deposit side as we have on the asset generation side of the balance sheet.

And another example of that is trust. Early days still, and at some point maybe we will share some numbers with you. But it's important to recognize that we are now licensed in 27 states. And this is the preneed opportunity, where death care -- the same folks who are doing loans with us would like to use a preneed trust. 10% of that AUM goes into the deposits. Very sticky, very low-yielding deposits category.

We are engaged with another firm to look at other boutique deposit products while we are also launching this business checking, which we ultimately think will be the bigger initiative that yields results, because we have got such presence in each of these verticals. So, again, to Chip's point, very difficult to actually forecast what that will be, the trust stuff. We've already gotten deposits as a result of trust on the books now.

And there are some very aggressive goals. And the team that we brought on board with another organization and grew that access (inaudible) up to about $4 billion -- and again, just for simple metrics, about 10% needs to stay on balance sheet and [liquid away] in deposit accounts.

So I think as a function of each of these verticals within deposits, we have high hopes probably by the end of 2016 that those will be yielding what I would call material results. But there is a lot of work between now and then.

Great, thanks for the color on this. And I guess Neil and Chip, suffice to say you're looking for non-CD deposits. And that is really what you are kind of chasing as this place out.

No CD deposits. All business checking, yielding, DDA, yes.

Super, thanks again.

Thank you, and that concludes our question-and-answer session. I would like to turn the conference back over to management for any closing comments.

No, I think we are good if there are no further questions.

All right, thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone have a good day.