Live Oak Bancshares Inc (LOB) 2018 Q1 法說會逐字稿

Thanks for calling, ladies and gentlemen, and welcome to the Q1 2018 Live Oak Bancshares, Inc. Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I'd now like to introduce your host for today's conference, Mr. Greg Seward, General Counsel of Live Oak Bancshares. Sir, you may begin.

Thank you, and good morning, everyone. Welcome to Live Oak's First Quarter 2018 Earnings Conference Call. We are webcasting live over the Internet, and this call is being recorded.

To access the call over the Internet and to review the presentation materials and commentary that we will reference on the call, please visit our website at investor.liveoakbank.com and go to today's call on our Event calendar for supporting materials. Our first 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 the actual results to differ materially from our expectations are detailed in the materials accompanying this call and 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, and good morning, all. I'm going to talk about, for a few minutes of the future of our platform, a few industry observations. I'm then going to turn it over to Neil Underwood to discuss next-generation technologies, and Scott Custer will take us home and talk about our wonderfully profitable bank.

First of all, let me unpack the first slide, scalable business model that we show every time. And before we do that, a comment on where we are in the cycle. I think this is la la land. We see banks throwing money at small businesses. Everybody's in the SBA lending business. I was speaking with the head of our trade association yesterday, and when we started this business, the annual conference had about 400 attendees. This year's conference may have 1,200 attendees. So everybody is out there. So specifically, we saw a few weeks ago a money center bank, veterinary loan, 100% financing, 20-year loan in the mid-4s; regional bank dental deal, 100% financing, 25-year and 15-year balloon in the low-5s. Ladies and gentlemen, we are not in that business. We will never be in that business.

Okay, so what is the plan for success? More verticals? Yes. If you look in this slide in 3.0, you see in the last 15 or 16 months, we've added 6 new verticals under Jason Lumpkin's leadership. Last time, we talked about an R&D project. So is it possible to address the 4,800 SBA lenders, affectionately called by our industry BDOs, business development officers, which I personally can't stand. So can we hire folks that are incredibly experienced, that understand both safety and soundness and the rules of the SBA 7a program and become a big part of our culture, not commission sales folks, but understand, taking care of the customer like they're the only customer of the bank and making sure we lend money to folks that have the eye of the tiger. [Kay's] brought on 5 of those folks in the recent past and has 12 in the pipeline. So can we grow this business? The answer is, yes.

Now if you look at production, which we typically do on this slide, I would focus on where we are as of tonight. So last year, in 2017, that number of $583 million goes to $587 million. And so far, year-to-date, that $554 million goes to $563 million. So is a couple of billion dollars in originations in our future? Sure. Is that pretty good for a $3.5 billion bank originated to -- originating $2 billion a year? Absolutely. That said, we're much more of a recurring-revenue bank that we have been in the past, and you'll see more of that in the future, which Caines talks about in his comments last night.

Now to do all this, we need a deeper bench. We're incredibly excited. I'm looking across the table at Susan Janson, many years experience, both in the banking business and with the Federal Deposit Insurance Corporation; as well as Huntley Garriott joining us in the fall.

And moving on to the next slide, the only thing that I want to point out here is, again, the operating leverage. So if you look at the vertical 1.0 section, started off with the vets, all the way to chickens in 2014. Each of those verticals has somewhere between, on the low end, 5 or 6 folks in family entertainment, maybe up to 20 folks in the health care division. Obviously, if you add up all the revenues from interest income on unguaranteed paper, the servicing revenue to gain on sale dollar's nowhere near the operating expense involved in those groups.

So just a word or 2 about what's going on out there. And in our humble opinion, I could not help moving on to the next slide but in the middle section of this slide.

Goldman Sachs' stock fell Tuesday after it reported earnings when management explained that it would suspend share buybacks for the quarter. So you, the bank stock investor, provide us precious capital, certainly as you did in the fall of last year. I can assure you one thing: We will not give you your money back. We will deploy that capital in a thoughtful fashion.

It gets better. Let's turn the page to the next slide, the current obsession with deposit betas. The last line: Morgan, Wells get fat profits by skimping on savers as rates rise. Move up a section. The metric to watch is the deposit beta, essentially the percentage of each Fed rate hike that gets passed along to customers. The higher the number, the better it is for savers; the lower the number, the better it is for bank profits.

Let's move to the next slide. Really? Could it be that our model is broken? Could it be that the distribution system of tellers and CSRs and branches is under scrutiny? Let's think about for a minute self service and full service, right? So I'd ask you this question: When's the last time you called the call center at Apple, at Uber, at Amazon? So if you look at the Amazon Web Services slide, you see that the richest man in the world created an overnight wonder beginning in 2006. And it looks like in 2018, that business will generate an excess of $20 billion in revenues by letting others use their cloud-based services platform. Is he investing in the future, $10 billion worth of CapEx in 2017? No, that's not just Amazon Web Services. That's the entire company. He does not split that out. So I have never seen the glee in the eyes of our software developers as I have at Apiture, Finxact, Payrailz and others that Neil and I talk to. And it is true that in our Payrailz team, 4-0 price decreases from Amazon Web Services in the last 18 months.

Moving on to my last slide before I hand this over to Neil. Things are going swimmingly at our joint venture with First Data. That company has been renamed Apiture. That business services about 550 banks in a data center in Austin, Texas. So you should think of guys and gals walking in with badges and blinking or lights and servers. It is our estimate that, that data center costs us $6.5 million today.

Neil and his team are in the process of taking that 20-year-old technology, lifting it out of that data center, putting it on the services of Amazon Web Services, and the cost goes $750,000. Not so fast. When Neil finishes writing the new code, the cost goes to $100,000. That's right. $6.5 million to $100,000. So can we, as an industry, elegantly serve our customers in a fully digital fashion? Neil's going to tell you about that.

So point of clarification. I'm actually not writing the code myself. We have a fantastic team that's doing it. But thanks, Chip.

Turning on the next slide. You're going to hear a term out there by the name of cloud native or serverless or born in the cloud. And it's a new, highly scalable way to deploy code. I think we're at another inflection point when it comes to cloud computing. And when you look at total cost of ownership of a financial institution, and certainly ours, who have to operate digitally, this must be considered.

The old way of designing a data center meant you had to consider peak loads and have tons of excess capacity. You then had to double everything in consideration for business continuity and fault tolerance. This architecture just allows us to pay for what we use, kind of like cell phone minutes, and allows us to scale at massive levels. And you guessed it, Amazon is right at the center.

Moving on to the next slide. This slide demonstrates Live Oak Bank's digital deployment plan, all cloud native. You can see these companies by the way, many of which were inspired and incubated by Live Oak Bank and/or Live Oak Ventures, to solve the problem. It's a busy year at Live Oak Bank relative to these platforms, while nCino and Apiture have been deployed for some time and are driving massive efficiencies. We're really busy deploying Finxact, which is a next-gen Core-as-a-Service on top of AWS; and Payrailz, which is a payments platform, also on top of AWS. We intend to have these projects live by year-end and should be seeing some of these efficiencies in 2019.

I love this next slide because it demonstrates the power of the platform and how our deposit engine is humming. Last year, our total deposit originations were $839 million. As you can see, we originated $515 million in Q1 alone. Since Q1 of last year, the total combined is $1.35 billion, but I think the interesting point is we only had to hire 6 people to support that $1.35 billion. We were laser focused on efficiency and transfer account openings per FTE are very positive.

In addition, I'm proud to say that as of yesterday, we won Bankrate's best online savings account for ease of use award. And I'll share an excerpt from that award with you. "While other online banks may offer higher rate APYs, Live Oak Bank's online and mobile tools have great functionality. All functions are available on both the app and online portal and get very high ratings from users, both iOS and Android versions. Among other great features, like mobile check deposits, you could view balances on external, non-Live Oak accounts on the bank's app, a highly unusual feature."

And maybe my favorite excerpt: "Typically, the mega banks are seen as the organizations with the kinds of resources and organizational heft needed to build great technology. Live Oak Bank has partnered with fintech giant, First Data Corporation, in a joint venture named Apiture, to develop technology solutions for financial institutions and its customers." The point in all this being, we don't always have to pay a higher rate, and client experiences matter in our mission of treating every customer like they're the only customer in the bank. Scott, over to you.

Thanks, Neil. Before you move on past that slide, Slide 11, the power of the platform, just one final comment on it. For a traditional banker like me, those are really almost staggering numbers in terms of deposit growth, new deposit, new deposit account acquisition in a quarter. And maybe the number there that doesn't get as much air time is in the middle of the page, and that's the 78% renewal rate in our CD book. And you say, okay, well, we're an online digital bank. We're just growing that with price, and we're just out there, top of the market. But we're also keeping and retaining almost 80% of our CD book, which is an amazingly good percentage if you were in a traditional branch bank and customers were walking in and talking to somebody across the desk. So I think we are cracking the code on not only efficiently growing deposits, but delivering a level of customer service through that channel that really has not been seen before. And to me, that's, as the slide says, that's the power of the platform.

Now moving on to the bank and how it performed in the quarter. And maybe in one simple sentence -- I've got 3 slides to cover, but in one simple sentence is the power of the business model, the momentum in the company continues. The trajectory of our earnings and the earnings power of the company is reflected here on the Slide 12. I would call your attention to 3 key metrics that I believe are important. First, top middle, 45% growth in net interest income. I'll touch on that in a moment, but that is the ability of the company to retain more on balance sheet to create a more stable source of revenue. And you're seeing that growth year-over-year at almost 50%, exceptional.

We're doing that well, not really losing momentum on our noninterest income and our ability to grow our guaranteed loans that are sold. And that number is up 18%, almost 20%. So we're not really sacrificing that. So we had $247 million of growth there, so -- or excuse me $247 million of revenue created on our loans that were guaranteed loans that were sold. So both of those factors working together give us a robust revenue picture. And if you really look at Q1 revenue '17 to Q1 revenue '18, total revenue of the business is up about 35%. I know most companies would gladly trade for those percentage increases.

Bottom right, I think you continue to see the business becoming more diversified. We're now below 70% of our loans on the books that are SBA loans to total originations as we begin to find new and different ways to grow our business. And I think you'll continue to see that diversification continue as we move along.

The next slide is one we've begun to show each quarter because it does begin to show that indeed, Live Oak is not a one-trick pony. We're not just an SBA 7a lender, living on the gain on sale that we get quarter-to-quarter. But indeed, we've now created a stable source of revenue. We're a bank that's $3-plus billion in assets. We've grown the balance sheet nicely. In a moment, we'll talk about how we're growing it prudently and safely. But this slide, this is under the heading that a picture is worth a thousand words. If you can grow recurring revenue 45% year-over-year, you can grow your balance sheet 43%, that speaks to an absolute sustainable business model and a -- and importantly, for me, a consistent earnings trajectory that you can really forecast into the future.

So you say, with that kind of growth, what's happening to the credit quality of the company? Are we still paying attention to safety and soundness? And as Chip always says, this really is job one, so it's probably appropriate that it's the last thing we speak to. And it is a story that continues to be one of exceptional credit quality. We have a risk management framework and infrastructure here that every single Life Oak employee takes seriously, and the results are right there. I don't need to say much more other than you get 15 basis points in charge-offs. If your nonperforming loans are the leading indicator of future losses, we've got a whopping $7.5 million in nonperforming loans against our unguaranteed book, only 22 basis points. Again, I would say just about every bank in the country would swap those numbers for their own. So credit quality continues to hold very nicely, and we're pleased with the results of the quarter.

Chip, that's it on your bank.

Thanks, Cus. And certainly, open to any questions on the line.

(Operator Instructions) Our first question comes from Aaron Deer with Sandler O'Neill.

Chip, loan origination numbers were down in the quarter. But it -- based on the slide deck here, looks like the first few weeks of this quarter anyway had been very strong. As you're looking at the pipeline and out through the year, you -- it sounded like maybe you intimated that you expect to do about $2 billion in originations for the year. Is that -- does that sound right?

Yes. I mean, I think it's plus or minus 5% or 10% on that. Cus, you might have a comment on that. You're a bit closer than I.

Yes, I -- Aaron, I'd say your point's well taken. We obviously know where production was for the quarter. It wasn't exactly where we wanted it. I can draw you 6 pictures on the scorecard as to why. But the important thing is that we're making all the -- sort of the mid-round adjustments here that we need to make. The SBA SOP changes have affected the business. There's no doubt. Chip referenced some of the crazy competition. That's making a difference, no doubt. But when you take a look at the new verticals that we launched, we just brought in new bankers that are bringing pipelines of business. When you look at the current pipelines, I feel very good about this quarter, about the rest of the year. And look, $3-plus billion bank, as Chip said, doing $2 billion worth of originations in a year, that is exceptional. And we're going to hold to our standards, both with respect to pricing, with respect to discipline around the type business we go after, and more importantly, the discipline around credit quality.

Okay. That's helpful. And then, based on the kind of that production outlook and what's funding up in the book as well, and then how you want to retain versus sell, is it your thinking at this point that you'll probably sell something similar to the levels that you did in the first quarter as you look out through the year? So $250 million a quarter, is that kind of a reasonable run rate on those sales?

Brett, help us out.

Yes, I would say, I guess, just thinking about your modeling, we'll continue to target, as we've said, we'll continue to target holding roughly 25% of what becomes available. That will ebb and flow on a snapshot basis of a quarter, just based on timing of closing and timing of loan sales. But going forward, the volume we sold in Q1, I would say, probably won't see much growth over that volume throughout the year. I'd say it would bounce around that amount, rather than forecast any substantial increase in that full volume.

Okay. And then maybe one for Neil. With Finxact set to come online at year-end and some of the cost saves that you -- that if there's a correlation between any sort of cost saves that you've eliminated with the First Data data center, what kind of cost saves might we expect as you shift over the core system to Finxact's as we go into 2019?

I think it's a great question. There are a couple of points. One, as you know, the Apiture dev team, we're still supporting. So when you think about that cost -- going away from 2019, there's one bucket. The truth is, I don't know the answer to the Finxact question, but my sense is it will probably follow the experience that Chip mentioned and possibly be 10 to 20% of what we're paying (inaudible) today. That said, we are replacing a core system, so I want to temper -- I added 90 days of contingency, and we're trying to get friends and family (inaudible) Q3. But it is a new core, and there are new things. So I don't know how much I'd model cost takeout relative to the core in 2019. I would draw your attention, though, as you calculate cost of funds and efficiencies to the power -- even the current platform that's in place, the fact that we were able to put on $1.3 billion with 6 FTE, and I think we'll continue to see that trend more favorably over time.

Okay. And then, I guess related to that, where are the incremental deposit costs coming on at this point? And how are you guys thinking about the funding that you've built up? How is that going to be? I mean, can you kind of throttle back on what you've done in terms of the deposit pricing? Will you look to deploy liquidity such that we should see some pretty strong margin expansion here over the next couple of quarters?

Well, my -- I'll defer to -- I'll make a comment, and then defer to Brett. I think NIM compression happened as a result of our increased liquidity. We don't see that continuing to go up. And as was identified in the award that we received, we don't have to pay top of market, given the way the solution is being received. So my sense is that NIM compression that you saw was a -- was more like a Q1-type situation, and I'll turn it over to Brett to add color.

Yes, maybe what I will add to that is, as you're thinking about deposit rates, it's -- I think that the environment we're in, it's a bit hard to forecast what those rates are going to do. It's a very competitive environment currently for deposits. You can see online where our rates are relative to other folks, and that's something that you can track in real time throughout the quarter or even see where we've been over the past quarter. Related to net interest margin, I would echo what Neil said. The compression we saw from the end of Q4 through the end of Q1 was largely driven by the increase in liquidity. We felt like it was a smart and prudent time to strengthen our liquidity profile. We do plan to maintain a strong liquidity profile going forward, but we don't have -- I guess we're more in maintain mode than strengthening mode. Now it's just maintain that strength.

And our next question comes from Jennifer Demba with SunTrust.

It's actually Steve on for Jenny. First question here, kind of just piggybacking on that last question here. Can you go through what made you guys so successful on generating deposits? Was it just the online bank? I know there were some other initiatives you guys have been talking about to generate some of these deposits from your loan customers. What's the status on those?

Yes. Just -- I would say, specifically, the online bank, those numbers, the $515 million were specifically tied to online CD originations and online savings originations. So right now, we're looking to continue to build out the platform and have alternative sources, like noninterest-bearing checking. But given the move to Finxact and Payrailz, I don't feel it's prudent to do that, given the conversions required if we were to in put all these core platforms. So we're going to continue to diversify the product set on top of the new cloud native platforms that I was referring to earlier.

So this is a guess and only a guess. But that thing that you mentioned that came out last night at Bankrate.com, that we're really the best of the best, I would assume that there are chat boards out there of these people, that they're shopping rates on online banks, probably know that and talk to each other. And that's probably helpful as well.

Yes. I mean, the banks that are on Bankrate and certainly looked at in this kind of thing are Goldman Sachs Marcus. You've got Synchrony, all the usual suspects that there are and...

Allied Bank.

Allied Bank. Pretty proud that our team was able to put something together to make that much of a difference. I don't think it's going to be something where -- we don't have to be top, but we are going to still pay up as compared to a noninterest-bearing account. So that's why we're aggressively seeking completion of the cloud-based platform, so we can offer noninterest-bearing checking accounts, both to our customers, but also as I mentioned in the last earnings call, to other e-commerce partners out there driving deposits at scale.

Okay. So we should expect, I guess, that noninterest checking account sometime next year, right?

Yes. I think that's right. Because we don't want to put it on -- the alternative would be insert core here, putting it on their payment platform, like a check for your (inaudible) or their antiquated core, and then we have a conversion right thereafter. And so we're going to keep riding this engine, keep investing in this engine until those other back-office systems are there, upon which point we'll launch additional products.

Okay. I guess the other question, also following up on what we just heard, is so with just this online kind of deposit gathering and you guys winning these Bankrate awards, it seems like you're pretty desirable as a place to go. How do you stop people and, I guess, keep the liquidity kind of in line with loan growth?

Yes. Do you want to take that one, Scott?

Well, I think you just -- it's like anything else. I mean, if you have -- It's a bit of a high-class problem, and you can manage it with rate. You can manage it with how you market the product. And so if we believe we're getting too much in, we can just -- as Brett said, it becomes more of a maintain strategy than a grow, and we can do that. At this point, though, we're still a loan origination machine. And being able to fund ourselves with very reliable sources of fund is a good thing, and I think we're proving we can do that.

Yes, the other thing I'd add to that, Scott, is as rates go up, which they will, we don't have to be that sensitive. But at some point, there are going to be those that care just about the rate that'll -- so we could very manageable -- my head of deposits would tell you, it's a very manageable situation. And we're going to pay out now, but at some point -- so we can just throttle back by not modifying the rates.

Okay. I guess, this is more for Chip. Can we talk a bit about Live Oak Ventures. Are you guys kind of looking to actively expand that portfolio, kind of any other fintech either partnerships or acquisitions you'd be looking at?

Yes, but I can't go into further detail.

The only thing -- I am not going to say anything. Don't worry. But the only thing that I would add is that we've been consistent in talking on earnings calls about Live Oak Ventures being very small investment in technology companies so as not to use our beautiful Tier 1 capital that will fuel organic growth. And so I'd sort of remind you that these are minor investments up to this point.

Okay. So should we think more partnerships and than kind of full-out acquisitions? Or...

Not acquisitions, but we'll continue to do what we've done in the past: make small bets. We always talk about the unbelievable nature of Amazon Web Services and the cost, and how the software developers loved to develop on that platform and the feature functionality. And we'll make small bets with folks that have done it before.

Okay. And then just kind of the final one, looking at kind of some of the verticals you guys are in now, where do you think -- kind of what innings are we in? I mean, is it kind of Live Oak 1.0, kind of just static now? We're kind of there at just maintaining that kind of growing 2, 3, 4?

Well, I'll start and Cus can clean up here. But yes, right. So there are 1,100 industries that the SBA allows you to lend to. And we're in 20-ish, right? There are 4,800 SBA lenders and [Kay's] hired 3 with 12 in the pipe. I think it's like 1.1, maybe. I mean, maybe second pitch, first inning. I mean, if I were you, I'd say, like why are you only in 20? I mean, it's the United States of America, 50 states, 3 time zones. Why can't you get to 200? Scott?

I think there are 4 time zones. I couldn't add anything to that. You're right. It's a -- we're very -- even though Live Oak's been at it 10 days, in many ways, we're -- this is a very early days in terms of what this business can be. And I'm encouraged by the comment I made and the fact that it's not just about verticals that lend themselves to SBA. That's always going to be a core strategy. But less than 70% of our origination now is SBA 7a. We're getting 32% of our business from non-SBA-type business, and I think you'll continue to see that grow.

Thank you, and I see no further questions in the queue at this time. I'd like to turn the call back over to Chip Mahan, CEO, for any closing remarks.

No closing remarks. See you next quarter, folks. Thanks for dialing in.

Ladies and gentlemen, thank you for dialing in. This does conclude your program. You may all disconnect. Everyone, have a great day.