Live Oak Bancshares Inc (LOB) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Live Oak Bancshares, Inc. third-quarter 2016 earnings conference call and webcast. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference call over to Greg Seward, General Counsel of Live Oak Bank. Sir, please go ahead.

Thank you and good morning, everyone. Welcome to Live Oak's third-quarter 2016 earnings conference call. We are webcasting live over the Internet and this call is being recorded. To access the call over the Internet and review the presentation materials that we will reference on the call, please visit our website at investor.liveoakbank.com and follow the links from there. Our third-quarter earnings release is also available on our website.

Before we get started, I would 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 the materials accompanying this call and in our SEC filings. 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.

Thanks, Greg. We are pleased with our Q3 results for several reasons. Number one, year to date, year-over-year total revenues increased from $76 million to $101 million, or a 32% increase. On slide 1, the originations are up 24% for nine months ending September 30, 2016 versus 2015, or $828 million to $1.022 billion.

On slide 2, our efforts to create a more predictable business model is working. Net interest income plus servicing revenue less loan servicing asset revaluation cost grew 67% year to date year-over-year, from $24.6 million last year to $40.9 million this year.

On slide 3, growth in non-interest expense less stock-based comp expense for restricted stock awards has slowed dramatically from Q1 to Q3 each of the last two years. The actual drop was from 22.9% growth in non-interest expense to 9.9% this year.

On the fourth slide, our thesis of combining entrepreneurial bankers with domain experts and allowing them to operate their own business provides leverage atypical in the banking business. Slide 4, again, shows that our six legacy verticals: veterinary, healthcare, independent pharmacies, death care, investment advisors, family entertainment and the chicken business, originated $806 million in loans for the first nine months of 2016, while the new group: wine and craft beverage, self storage, independent insurance agents, the hotel division, renewable energy and government contracting, generated $217 million in new loans.

The estimating operating cost is identified in slide 5, which is $21.9 million for the vintage group versus $30,200 per $1 million of loans originated for the newbies. Mature verticals generated $78.9 million in revenues net of operating costs, versus fundamentally a breakeven situation for the new verticals.

Now, let me take a minute and talk about two of our newest groups: renewable energy and government contracting. The recently launched renewable energy lending vertical conforms to Live Oak's history of targeting low default industries.

The vertical's focus is on utility scale solar facilities with capacities of 1 megawatt to 25 megawatts. Virtually all of Live Oak's solar facility customers sell power to investment-grade buyers under long-term power purchase agreements. The vertical utilizes a United States Department of Agriculture loan guarantee program to help finance energy-efficient upgrades and newly constructed renewable energy systems. Live Oak is pleased to be part of this solution to provide clean, renewable energy while producing economic development and job growth in disadvantaged communities across America.

Secondly, lending money to small business government contractors plays to our strengths. It allows us to leverage data, domain expertise, robust servicing and technology in a market segment where the government awards $90 billion annually to roughly 150,000 potential borrowers. We see the combination of business-acquisition financing with asset-based lending as a competitive advantage and an excellent way to capture core deposits.

As we put together our 2017 budget, we can see that the 2015 and 2016 group begin to move toward maturity. And now it's time to begin to search for new growth opportunities in other verticals.

Neil, over to you.

Thanks, Chip. First, let's talk funding. We have been very pleased with the changes to our funding model in 2016. With our online CD campaign, we have opened nearly 6,000 new accounts totaling $442 million in deposits, at an acquisition expense of $0.66 for every $1,000 in deposits. The portfolio rate remains roughly 1.1%. This is higher than the industry average, but our cost of funds is offset by our branchless environment, driving down operational expenses.

Additionally, our customer experience keeps driving market-leading retention rates, which is currently 74% as a rollover rate based upon a 13-month curve. As originally planned, we expect the launch of Acorn Business Checking in Q1 2017, which will leverage our expanding customer base and drive down our overall cost of funds.

On the eLending front, we've got exciting news to report. While still abiding by rigid, traditional credit standards, we are experiencing triple-digit, year-over-year growth in this market segment. Perhaps more importantly, we are experiencing a 5 X efficiency factor, meaning we can originate five small loans at the same cost structure as one big loan.

We are now proving that our bank can indeed be as efficient an originator as an alternative lender, but take advantage of a stable, proven cost of funds. While the growth is significant, I would like to remind you it is still small relative to overall Live Oak Bank production. We look forward to an exciting 2017 as we roll out new loan products and new deposit products.

Brett, over to you.

Thanks, Neil. Good morning, everyone. The third quarter was marked by record-setting loan originations of $381 million, an increase of a robust 26% over the third quarter of 2015. As Chip referenced, this has been driven by growth in both our legacy verticals as well as in the newer verticals that began production in 2015 and 2016.

Our combined recurring revenue streams of net interest income and servicing revenue benefited from this increase in origination, rising to $17 million for the quarter, a 61% increase over a year ago. The net interest income component increased by $5 million from one year ago to $11.6 million, a 75% increase.

We are already starting to see the benefits of our recent decision to diversify our revenue streams from the historical gain-on-sale revenue concentration by retaining more of our loans on the balance sheet. In future periods, we would expect greater consistency and growth in our more stable revenue streams with less reliance on market-sensitive sources.

Total loans on book at quarter end increased to $1.1 billion, a 58% increase over Q3 2015. Of the $1.1 billion in loans, approximately $735 million represents the unguaranteed portion of SBA loans and conventional loans. This is an increase of 11% in unguaranteed loans from the prior-quarter amount of $660 million.

Cash balances were high at quarter end, as we raised funds in anticipation of Q4's loan production and also settled a large volume of loan sales at quarter end. In total, we settled $211 million in guaranteed loan sales in the third quarter, which included $38 million in loans that were sold but did not settle in Q2 as we discussed during last quarter's call.

The corresponding net gain on sales in the second quarter was $21.8 million, or approximately $104,000 of revenue for each $1 million of loans sold, versus $15.4 million a year ago at approximately $105,000 per $1 million sold. The net gain on sale was well above last quarter's amount of $14.6 million, while the average premium declined from the [107] level, primarily as a function of the mix of loans.

Overall, pricing in the secondary market has remained fairly steady when comparing loans with similar characteristics, largely due to the continuation of low interest rates that have kept prepayments low on a historical basis.

Regarding the owned-book construction portfolio, the guaranteed portion of the note amount for loans in the construction stage increased to $692 million from $499 million one year ago, a 39% increase. Remember, these loans are eligible for sale only when fully funded and, therefore, represent pent-up earnings not reflected in our financial statements.

Expanding on Chip's discussion of our renewable energy vertical, we expect to begin selling USDA loans in Q4. We have not yet sold any USDA loans in the secondary market and are, therefore, unsure of the timing required to settle. While we anticipate these loans will receive lower premiums compared to our traditional SBA 7(a) loan sales and will likely lower our combined gain per million in Q4 as a result of this new mix of sold loans, they will serve to boost overall sale volumes and related revenues.

We are also increasing our forecasted amounts sold in 2016 to a range of $700 million to $725 million, which indicates a sold-loan volume of between $200 million and $225 million in the fourth quarter, with sale premiums averaging roughly in the low- to mid-90s for the above reasons, assuming otherwise stable market conditions.

The resulting total loan portfolio on balance sheet is best estimated to be approximately $1.3 billion by year and. The servicing revenue from our sold-loan portfolio increased to $5.9 million for the third quarter compared to $4.2 million for the third quarter of 2015, a 39% increase. This servicing revenue arose from a weighted-average servicing fee of 1.05% on $2.1 billion guaranteed outstanding in the secondary market.

The servicing-asset value at quarter end was $49.7 million after a revaluation loss of $3.4 million for the quarter, compared to a $1.6 million loss in the second quarter. Third-quarter net charge-offs equated to an annualized 51 basis points of average loans held for investment.

The majority of the $937,000 in charge-offs for the quarter was concentrated in a single relationship. This is an isolated occurrence in the context of our long history of stellar credit performance and is not indicative of any fundamental weakening of the loan portfolio.

At quarter end, the unguaranteed exposure of nonperforming loans and foreclosed assets was $3.6 million compared to $2.6 million at June 30, 2016. As a percent of total assets, nonperforming loans and foreclosures were 22 basis points, fairly consistent with the past four quarters.

The credit performance and growth in the portfolio resulted in a provision expense of $3.8 million in the third quarter. Non-interest expense totaled $27.2 million in the third quarter. The special RSU awards Chip mentioned contributed $3.4 million to this amount. As a reminder, there will be another, and the final, $3.4 million charge associated with these specific awards in the fourth quarter.

Excluding the special RSU expense in both the second and third quarters, non-GAAP adjusted NIE grew less than $1 million from the linked-quarter as we digested recent expansion and various initiatives in their conclusion.

Compared to the third quarter of 2015, non-GAAP adjusted NIE grew $5.8 million or 32%, as a result of increasing loan demand and multiple new initiatives of the Company over the past year. We do expect to see some additional growth in non-interest expense in the coming quarters, as we discussed during the Q2 earnings call.

This increase will be related to bringing portions of the legal process associated with our loan closings in-house, along with the preparation and investment involved in exploring new verticals to consider for 2017.

Overall, we are encouraged by the solid performance in Q3 and are looking forward to a strong closeout of 2016 in the fourth quarter. We would like to thank everyone that has dialed into the call today, and we will now entertain any questions you may have.

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

Good morning, everyone. Let me begin by saying the words, our thoughts certainly go out to the folks who are still working through the after effects of Hurricane Matthew. But related to that, I was curious to know what, if any, impacts the storm and its after effects had on some of your borrowers, particularly the chicken farmers in terms of their flocks or structures, and how that might be affecting their business cash flows and collateral and how you are dealing with that.

Aaron, this is Chip. I'm going to ask Steve to answer that question and at the tail end of the answer to that question, Steve, also comment if you would about -- our provision this quarter was a bit higher than we are used to. And why don't you get in front of that and chat about your view of the portfolio in general?

Absolutely, thank you. Good question. We were concerned most with our chicken borrowers. We actually reached out to every borrower. Happy to report that there was only one borrower that had minor damage to his roof of one of his barns. That didn't have a material impact in his operations, so that's very good news.

We also reached out to the integrators to anticipate whether there would be any delays in picking up the chickens or the timing of the flocks, but happy to report that we fared very well. Don't expect to have any disruption from our borrowers related to Matthew, so that's very good news.

We also have not heard from other businesses that have been materially impacted. We reach out to as many as we can, but the first calls were to our chicken borrowers for sure in the affected areas, so that's good news.

Chip, you are right, the provision expense at $3.8 million, it's continued loan growth, certainly is a major component to that. Also as Brett had mentioned, we experienced a charge-off this quarter of $928,000. And as Brett also pointed out, that is centered primarily around one relationship -- it's a healthcare relationship due to -- I don't like to comment on the specifics on an individual credit, but I can say that it was personal issues that translated into some challenges with this business that we've seen it.

They are working very closely with the Special Assets Group. They are very cooperative but, again, it's centered around that.

I will point out, as Brett had mentioned and we can see it by the numbers, that if you annualized the charge-offs that we've experienced this quarter, it would be 51 basis points compared to the average held for investment.

But I also would want to point out that we are coming off of a very good several quarters, with last quarter having an annualized net recovery. So the actual trailing 12-month charge-off to net loans is 19 basis points, which is slightly improved from a year ago where it was 21 basis points.

Okay, that's very helpful. Thank you. Then, Brett, if I heard you correctly the volume drifted out for a minute while you were giving some of your guidance numbers. But maybe can you repeat what you said your expectations are for the gain-on-sale premium in the fourth quarter? And it sounded like it was down and, if so, how much of that might be related to the sales of solar?

Yes. So in Q4, we expect our guaranteed loan sales actually between $200 million and $225 million. That is a little bit higher than the indication that we gave during last quarter's call. And the gain on sale, again, just to give the disclaimer that we always give, anything can change. And the secondary market is subject to interest rate moves, which will affect the premiums that we receive.

But right now, we are expecting a gain-on-sale premium somewhere in the low- to mid-90s as the average for Q4. Again, that will be down from Q3. Primarily, that is a function of the volume of loans that we are expecting to sell related to these renewable energy products, which are USDA loans. Those will command a lower premium in the secondary market compared to our traditional quarterly-adjusting 7(a) loans.

So we are looking for that decline. I don't necessarily want to comment on the volume of that $200 million to $225 million that's related to USDA, but in total that's what we are expecting, and then a depression of gain-on-sale revenue from there.

Okay. That's helpful. Then just one last question for me on the capital front. You guys have been growing like gangbusters for several years, and I guess since the capital that you took in from the IPO, you've been putting a lot of that to work.

As you watch the balance sheet grow relative to capital generation, what's your thoughts on the potential need for capital as you look out over the next year or two to continue supporting your growth?

Yes. Looking at capital, a lot of the models that we ran as we've talked about holding more of our production, both portions of the guaranteed loans that we would've historically sold, plus holding the majority, if not all, of our unguaranteed production. We ran those models in anticipation of not needing additional capital going forward.

That's one of the reasons we chose and made the strategic decision, as we indicated on last quarter's call, to be in the range of guaranteed loans held up to 25% of what would otherwise be available for sale.

Okay, great. Thanks for taking my questions.

Jefferson Harralson, KBW.

Hi, thanks. I wanted to ask about the eLending piece of it. What sorts of loans are you originating on the eLending platform now? Are they non-SBA loans and, if so, what percentage of your loan book is now not SBA?

So we have actually made the leap from SBA 7(a) to other types of loans. Probably not going to give the actual numbers there, but indeed we are launching products such as the SBA Express, which has a 50% guarantee. More importantly, it has a prime -- up to, depending upon the loan size -- a prime plus 4% yield.

And, in addition, what we are calling Fast Fund Conventional, which are a look into higher-yielding conventional products for loans under $350,000.

And I think the other thing I would add to that is these are all still loans in vertical. What we found is our marketing efforts are working wonderfully as we go down market, as well as what you've obviously seen in the big loan market. We understand the credits and it's -- from a customer acquisition cost perspective which we compare ourselves with the alt lenders, at least in this market segment -- it's allowed us to scale much more efficiently.

All right. So can you talk about -- is it consumer, is it commercial? It's all commercial I take it then, or what type of loans are these?

Yes, all small business loans from $75,000 is our minimum to $350,000 is the max. C&I, working capital, for the most part, equipment.

Okay. So you may not be ready to talk about this, I guess, but can you talk about yields or expected loss rates on this business?

I will turn it over to Steve on the expected loss rate, which we do expect to be higher. But in terms of yield, yes, I would rather wait because we, as you probably know, for the first year they are all 7(a) loans, which have implied maximums based upon the SBA limits. So we are just starting to experience some of the higher-yielding loans.

So I would rather wait a little bit of time to get to that. Plus, I don't have that at my fingertips. Steve, would you like to comment on the asset quality?

Yes. So far the asset quality is excellent. We don't have any delinquencies; very early on. We did model this to expect a higher loss rate, 2%. If we were expecting a typical portfolio to be 1%, we would expect this portfolio to be 2%.

Also, I know you guys hired and put a press release out that you hired a Bankers Healthcare Group person. Can you talk about, is there a new initiative around healthcare that you are possibly ready to talk about?

Yes -- well, we will talk about it in terms of really building out a sales culture around the online lending, the eLending space, and actually not just limiting it to healthcare; kind of applying that same kind of sales culture to other verticals as well.

So again, as I mentioned, it's triple-digit growth on $1.5 billion. It's still not material, but at some point in time given that growth rate, we expect it to be a more significant portion of originations.

All right. I will ask one more for Brett. On the servicing-asset revaluation, the $3.4 million; it's kind of large. Did the change come in shortening of expected time frames or durations of the asset or worsening credit; or what changed in the model for that big of an asset valuation change?

Yes, that change was driven entirely by the natural amortization rate of the portfolio, and during one of the months during Q3, we had a tick-up in prepayments. That was isolated in that one month, and we were very aware and saw that coming ahead of time.

But as related to the secondary market as a whole, performance of loans in the secondary market and what premiums we are currently seeing, that did not have an impact on that revaluation loss. The market has been fairly stable.

So, it was entirely related to the paydown of the portfolio and those servicing assets associated with those loans coming off.

Okay. Is there any way to forecast this number? Should it be a smaller negative number going forward; is that what we should think about?

As for now, I don't see any reason why you guys should change from what you had been using for the amortization of our portfolio, the amortization rate and the paydown rate. I think those still apply very well. As I said, August was somewhat of an isolated month with the tick-up. So I would say continue forecasting the way you've been forecasting.

Great. Thanks, guys.

Jennifer Demba, SunTrust.

Thank you. Good morning. Could you remind us what you are expecting in terms of non- interest expense growth for 2017, and how many verticals do you think you may be launching next year? Would it be two or could it be more?

Good question, Jennifer. We are going to crank that engine back up. We are in the process of doing that right now. We are going to approach it a bit differently than we've done in the past. In the past, we would hire a domain expert and then fully staff that group day one, in anticipation of future business. This time we are going to be a bit more circumspect and try to match revenues with expenses.

As to the number, I can't tell you the number. I would say certainly two, but really wouldn't want to go beyond that. Four would be nice, but we've just got to take what the market gives us.

Thank you.

(Operator Instructions) I'm showing no further questions at this time. I'd like to turn the call back to Chip Mahan for closing remarks.

Well, we just thank everyone for attending today, and I look forward to chatting after the first of the year.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.