LOB - NYSE

Good morning ladies and gentlemen and welcome to the Q4 2024 Live Oak Bancshares Earnings Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Thursday, January 23, 2025. I would now like to turn the conference over to Claire Parker, Head of Investor Relations. Please go ahead.

Thank you and good morning, everyone. Welcome to Live Oak's fourth quarter 2024 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 go to the Events and Presentations tab for supporting materials. Our fourth 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 and in the presentation materials. I will now turn the call over to Chip Mahan, our Chairman and CEO.

Good morning, all. As always, we'll have BJ lead off. On deck will be our CFO, Walt and then I'll have a comment or two before we head to Q&A. BJ?

Thanks, Chip. Good morning, everybody. Happy New Year, if I haven't talked to you or seen you since then. Let's get started on Slide 4 and Slide 5. Live Oak enters 2025 with some really excellent business momentum. We're seeing small business sentiment and activity on the rise. Our loan pipelines are still near all-time highs and our key growth initiatives such as Live Oak Express which is our small dollar SBA 7(a) loan offering and acquiring checking relationships are continuing to ramp. Our ability to grow the company was on full display in 2024. We delivered strong PPNR growth on both a reported and adjusted basis, excellent loan and deposit growth, record loan production, a great start to our quest for full relationships with checking account growth and well-controlled expenses even while continuing to invest in people and technology. The loan disappointment in 2024 was elevated provision in the second half of the year. More on that in a moment. Stepping back and looking at our performance over the last 3 years, we see some significant improvement in our ability to control what we can control and deliver top line growth well in excess of expense growth. Starting with loan production and pipelines on Slide 6, you see the power of the Live Oak lending engine. Not only did we have record loan production in 2024 but as you can see, pipelines have steadily increased as well, meaning, as we have closed business, we've more than replenished the pipeline with new activity which continues to support our optimistic outlook for balance sheet and revenue growth in 2025. As you see on Slide 7, this has driven strong PPNR and top line revenue growth, particularly over the last year despite a headwind from NIM compression as rates have decreased and deposit rates have temporarily lagged asset repricing. Turning to credit trends on Slide 8 and 9, while we had been monitoring rising industry default trends, we had not seen meaningful increases in our default activity until the middle to latter part of the fourth quarter. When we did experience this, we took action to appropriately move those through to either impairment or charge-off. While not ultimately surprising, given the rapid rise in rates in 2022 and 2023, we had experienced relative stability in our overall portfolio through most of the year. So to see this kind of increase was disappointing. While our default rates remain well below industry trends, we always strive to be much better and we will continue to do so. A bright spot this quarter was a meaningful reduction in past dues to just $15 million or 20 basis points with 0 past dues in our entire commercial banking portfolio. One quarter does not a trend make but we are redoubling our efforts to identify emerging issues early and keep that front door closed as much as possible. Context is always important and there are two distinct advantages that Live Oak has. While we tend to focus on our unguaranteed loan portfolio, over 1/3 or 34% of our loan portfolio is government guaranteed which is very unique and provides significant credit quality and capital advantages. And second, while this quarter reminds us that we are obviously not fully immune to credit cycles for small business borrowers, you can see on Slide 9 that both our current and historical performance relative to the SBA lender universe is unmatched due to our deep knowledge and expertise in small business lending. We will continue to lean on and enhance our extensive servicing and watch list processes to assist borrowers where we can and work through problem credits efficiently. The overall portfolio across both small business and commercial banking remains well managed and I remain confident in our people and our credit approval and monitoring processes. To wrap up on Slide 10, we know who we are and who we want to be: America's small business bank and how we will get there. As a growth company, I'm very excited about where we're headed. Small business sentiment is on the rise. There's a lot of gas remaining in the loan pipeline tank. We are extending our leadership in SBA. Our new small dollar SBA lending effort is ramping up quickly and will be a meaningful contributor to our results over time. We went from virtually none to $125 million of small dollar loans closed in 2024 and expect to do much more. Checking balances which were immaterial a year ago, ended the year at about $215 million and continue to build as do full relationships with our customers. About 18 months ago, the percentage of customers with both a loan and deposit relationship with Live Oak was only around 5%. Today, it is almost triple that percentage at 14%, with 35% of our new loan relationships last year also having a checking account with us. We continue to add new avenues of revenue growth with our commercial banking efforts being the most visible. Our brand and reputation continues to attract and retain the highest quality talent and customers and we continue to heavily invest in the future, both in our people and our technology. And as our CIO, Renato Derraik says, the AI wave is here, we can either learn how to surf or drown. And we are confident we will successfully ride the wave. With a big thank you to all of our Live Oakers and our customers, Walt, how about running through some of the financial highlights.

Thanks, BJ. Let's get started on Slide 13 with an overview of our Q4 performance. Earnings per share of $0.2 was a result of a healthy PPNR, offset by an elevated provision. Our core PPNR remained flat to the third quarter and up 15% compared to the fourth quarter of 2023, driven by our strong loan production and revenue growth. A few key highlights within our Q4 PPNR figure include loan balance growth from strong production activity offset expected margin compression following the Fed's late September rate cut, enabling our net interest income to stay flat to Q3 of 2024. More on this point in a few slides. Our secondary market sales increased in Q4, aided by our small loan production efforts and our core operating expenses were slightly up quarter-over-quarter, driven primarily by growth-driven variable costs such as FDIC insurance expense and loan-related expenses. The momentum that BJ just spoke to continue in Q4 with strong loan originations of $1.4 billion; our second largest quarter of loan production in bank's history. This resulted in a linked quarter loan growth of 4% net of loan sales, consistently outstanding growth that sets us apart from industry trends. Our customer deposit engine continues to grow even through a typically weaker quarter of the annual cycle. We are also excited to see our checking balances increase 46% linked quarter as we continue to penetrate our existing borrower base while also adding checking accounts from new customers. The major themes influencing our provision expense in the fourth quarter are consistent with the comments BJ just made. We are a growing bank and as such, our good provision will increase naturally with our growth. And it's not unexpected that variable rate borrowers from years preceding the rate hike cycle would feel the impact of 500 basis points of rate increases and prolonged elevated levels of inflation. Improving inflation levels, 100 basis points of recent rate cuts, will certainly help but these benefits need time to take effect. In fact, these borrowers have only seen 50 basis points of rate relief in the fourth quarter. The remaining 50 basis points from the November and December Fed cuts took effect on January 1. Now let's unpack the quarter performance a bit more on the following slides. Slide 14 highlights our loan originations by vertical and business unit. As shown on the right-hand side of the page, our Q4 2024 loan origination totaled approximately $1.4 billion, a 45% increase in loan originations compared to Q4 of 2023. 54% of Q4's loan production came via our small business banking team, primarily in the form of SBA 7(a) loans, a 35% increase year-over-year. And 46% of Q4's loan production came via our commercial lending team, a 58% increase compared to the prior year. As BJ mentioned, we had a record year of loan origination in 2024 that totaled $5.2 billion, a 33% increase compared to 2023. And yet, over the same time comparison, our loan pipeline has increased 24% to $3.6 billion. You can see the year-over-year momentum across our verticals on the left-hand side of the page, with approximately 70% of our verticals originating more production in 2024 than they did in 2023. Overall, 2024 was an outstanding effort by our lending, funding and operational teams and we are excited to see their success continue into 2025. Slide 15 illustrates the quarter-over-quarter loan and deposit balance growth, highlighting strong consistent growth trends throughout 2024 on both fronts. Loan balances were up 4% linked quarter and 17% compared to the prior year, tremendous growth over a year that saw muted loan growth across the industry. Our customer deposit balances grew 1% linked quarter, impressive, considering the strong competition we are seeing across the deposit market and the fact that Q4 is typically a difficult time of the year to grow deposits. We highlighted Slide 16 in our last quarterly call and are extremely excited about the continued momentum that we are seeing in building fuller relationships with both our loan and business deposit customers. We now have approximately 3,000 business checking accounts on our platform and our business checking balances increased 46% linked quarter to $212 million. That is approximately 5x or $173 million above where our business checking balances were just 1 year ago. The percentage of customers with both a loan and deposit account increased for the fourth consecutive quarter to approximately 14%, more than 2x what it was at the end of 2023. And more than 1/3 of our new loan customers also have opened a checking account in Q4, a trend that has increased throughout 2024. Lastly, the savings and CD balances related to businesses with a checking account at Live Oak have also increased 44% to $334 million. The result of all this expanding our business relationships with our customers is stickier deposits with an average blended cost of funds in Q4 2024 of 2.47%, approximately 160 basis points or 40% less than our total bank blended cost of funds. Net interest income and margin trends are highlighted on Slide 17. As I mentioned on our last call, we expected our margin to compress in this quarter after the Fed cut of 50 basis points late in September and our expectation that deposit market would be initially slow to react, given the competitive arena. That being said, despite the near-term margin compression, we expect to maintain our net interest income, given our strong growth outlook. As you can see in the top graph, both expectations held true. Our net interest income remained flat to Q3 2024 and 9% above the prior year despite the 18 basis points of NIM compression in the fourth quarter. A few other key highlights from this page. As I mentioned, our loan growth momentum and pipeline remains robust which will continue to drive our net interest income going forward. Our margin has been influenced by timing of rate cuts over the past few quarters with another 50 basis points of reduction to our variable loan -- our variable rate loans taking effect January 1. Yet our margin continues to be supported by the great pricing discipline of our lending teams. Our loan production yields of approximately 8.5% noted in the second bullet on the top right are 100 basis points above our current portfolio yield of approximately 7.5%, as shown in the top of the table in the middle of the page. There are two primary factors driving our savings rates. First, our growth. We just had three of the largest quarters of loan origination and balance sheet growth in bank history and the pipeline is not slowing down. We continue to position our products in the market to remain competitive to support our strong loan origination. Secondly, the funding market remains highly competitive. We are seeing downward repricing amongst competitors but at a cautious pace, especially in the consumer and business savings markets. Our 20% beta on consumer savings and 30% beta on business savings thus far has been intentionally conservative and less in the market as we support our growth. Fortunately, the CD market repricing has been quick to react to Fed changes. Even with the market competitive position, we expect to continue to see near-term tailwinds from our CDs renewing into rates approximately 100 basis points below the maturing rates as highlighted in the middle of the page. And lastly, the individual drivers of net interest income and net interest margin movement are detailed on the bottom right of the page. One item to note here was the impact that the quarter's elevated nonaccruals had on both net interest income and margin. Q4 nonaccrual levels caused a drag on net interest income of approximately $3 million and compressed our margin by 11 basis points. Said another way, absent the nonaccrual impact, our net interest income would have increased 3% quarter-over-quarter and our margin compression would have been limited to 7 basis points. Moving on to a view of our guaranteed loan sale trends on Slide 18. The demand for government-guaranteed SBA loans in the secondary market remains strong, providing consistent gain-on-sale revenue and recycling liquidity back into the bank. Our loan sales typically scale upwards each quarter throughout the year and 2024 trajectory has been no different with $278 million sold in Q4 2024 for an average premium of 7%. Expense trends are detailed on Slide 19. Our Q4 2024 expenses of $81 million included $1.1 million of a residual investment tax credit impairment from an investment we made in Q4 of 2023 which also provided a tax benefit both in 2023 and in Q1 of 2024. The remaining quarter-over-quarter growth in non-personnel costs were largely variable base costs driven by our balance sheet growth. Our teams have shown great expense discipline over the last year, even while adding 62 [ph] FTEs, primarily within growth-oriented sectors focused on revenue generation and funding growth as well as investing in our risk and technology groups within the bank. We will continue to invest in our people and technology to support our growth aspirations, yet remain focused on maintaining positive operating leverage as we have shown in 2024. Slide 20 illustrates the 5 quarter trend of our provision expense, net charge-offs and our reserve coverage relative to our unguaranteed loan portfolio. It is important to remember that approximately $3.5 billion or about 34% of our total loan portfolio is excluded from this view as it is fully government-guaranteed. While our reserves to our unguaranteed loan portfolio ratio have remained relatively steady over the past 5 quarters, we have seen an increase in our second half provision expense, partly due to the approximately $1 billion of loan balance growth in the last 2 quarters as well as the increase in classified assets and nonaccrual trends that BJ just spoke of. We strive to be proactive, identifying impairments and reserving for them ahead of charge-offs. In the fourth quarter, we took action to quickly move small business defaults through either impairment or charge-off. This, coupled with charge-offs associated with previous large Q3 impairments, resulted in a high level of Q4 charge-offs. We have been and will continue to be proactive with provisioning for growth, changes in portfolio performance and impairments or charge-offs of specific loans when warranted. Our reserve levels remain very healthy. Lastly, Slide 21 highlights our capital profile. We remain well above regulatory capital minimums and we'll continue to ensure that capital levels remain appropriate for our robust growth trajectory. To wrap up, we are happy with our strong PPNR performance and growth trends. We will continue to enhance our credit quality and processes and we are excited about our momentum as we head into 2025. I will now turn it over to Chip for his final comments.

Thanks, Walt. Before we move to Q&A, just a word on credit quality. When we started this business 17 years ago, we sought to put capital in the hands of American small business folks using a government program that has been around since the Eisenhower administration. The nuances of that program are complex on one hand and create somewhat of a barrier to entry on the other. BJ's slide shows how we perform compared to all other banks relative to defaults. We stand on that record. That said, we can do better. Over the last 36 months, we have originated over $13 billion in loans. We pride ourselves in treating every customer like the only customer and collecting financial statements every 90 days to determine if there is any stress out there. Helping a small business with challenges is more of an art than a science. Beside us is a borrower-friendly agency. And yes, we could have been more creative in helping these folks that have the eye of the tiger and we will. Claire, let's go to Q&A.

[Operator Instructions] Your first question comes from Crispin Love with Piper Sandler.

My first question is just on the provision. Walt, I heard some of your comments relate to growth in rates. And Chip, really appreciate that credit quality commentary at the end. But are you able to share how much of the elevated provision is related to growth versus specific relationships that are worth calling out? And then, do you have a new normal for the provision run rate to support the growth that you've been putting out? I'm just curious if there's any thoughts that you can put around that and any guardrails?

Yes. So this is Michael Cairns, Chief Credit Officer. So I will say that the majority of the provision expense is related to loans within our SBA portfolio. Our commercial portfolio has held up really well outside of those three credits we talked about last quarter. And so the SBA industry is showing some signs of weakness and we have seen a little bit of that in our portfolio as well but we're focused on servicing and we'll continue to work with all of our customers, as Chip and BJ both alluded to. And I'll remind everyone, too, that we do have very seasoned lenders and credit officers at this bank that have been through challenges in the past. And we are adding experience and expertise to both our special assets team and our servicing team so that we can be creative and working through challenges with our customers, as Chip alluded to.

Great. I appreciate that. So you would say that the provision driven more broadly rather than specific relationships. Is that fair?

Yes. And we talked about this a little bit on the last call and we have today as well. Our SBA borrowers, small businesses across the country have had to navigate pretty significant challenges over the last few years, especially related to rate and labor and other economic challenges and inflation. So we expect to continue to work with all of our customers on that end.

Great. And then last question for me, just on the net interest margin. You had the headwind in the fourth quarter which you detailed from the 50 basis point cut in September which hurt you timing-wise. But Walt, can you discuss the forward outlook a little bit, views on the margin in the first quarter relative to the fourth from your seat? And then just confidence in hitting or getting close to that 3.50% margin target that you've talked about in the past in 2025 or towards the end of 2025?

Yes. Thanks, Crispin. I think from a Q1 standpoint, we'll have another 50 bps of cuts on our variable loan portfolio that took effect on January 1. I think you'll see a similar margin here in the near term, really just giving our time -- our funding portfolio time to reprice. Fortunately, we have a pretty large CD maturity event in Q1 every year. And the gap between maturing and renewing rate is pretty large. So that's going to help out. And we're still seeing the market, both on business and consumer savings reprice over time which will obviously address our funding needs and our market position and move accordingly. I think as you kind of get through further in the year, I mean, there's a lot to be essentially determined at this point from what the Fed decides to do. Right now, we're largely in line with the forward curve with our expectations. I think that 3.50% target or that objective for margin that we talked to in the last call being more towards the end of 2025 is still in play. Could it go into early 2026? Potentially. I think it just really depends on what the Fed does and then how the deposit market reacts.

Your next question comes from Tim Switzer with KBW.

It might be a little early for this but with the change in administration occurring yesterday, there's a lot of different puts and takes on kind of the macro outlook and the impact of tariffs and where rates will go, all of which I know impacts small businesses quite a bit. Are you seeing that result in any caution from some of your borrowers at all or maybe even in the other direction from certain industries where they're a little bit more bullish as it's -- and has that impacted your loan pipeline in any way?

Tim, it's BJ. First, I would say it's way too early to actually know what is going to happen relative to the new administration. What I would tell you, though, is two things. One is we do a quarterly pulse survey with small businesses, not just our customers but across the country. We did one of those in mid-October and the sentiment was significantly higher. So that was pre-election. And then you've seen some of the government small business sentiment results come out and they have been through the roof as well. And we're seeing that in our pipelines and our activity. As I talked about at the beginning, those pipelines are still at all-time or near all-time highs. So we are seeing sentiment getting better. Theories around that include less regulation, inflation coming down, more growth opportunity, more capital investment, et cetera but it remains to be seen. So we're optimistic that there's going to be a favorable environment for small businesses and that's what we're seeing from our customers and our pipelines right now.

I would also say that the Trump administration has put someone that we're quite familiar with in the Office of Capital Access that is a real pro and knows the industry and the SBA quite well.

Okay. That's helpful. And as far as the rate outlook goes, rates have moved up a little bit since the end of the quarter. Has that impacted or do you think it will impact SBA margins or secondary market demand at all? Has that created any issues from some of your typical purchasers?

Tim, this is Walt. No, it hasn't. I think most of the time, secondary market will price in and assume [ph]. They largely kind of aligned with the forward curve. We have not seen any change in our demand. In fact, I think our demand has been stronger here in the last second half of the year with premiums ticking up to that 107% range. Pricing on small loans which obviously we've been focused on recently, still continues to be strong, too. Premiums on that are typically north of 110% and that's maintained regardless of any of the recent changes that you've seen.

And Walt, haven't you seen more activity, more pool assemblers?

We have seen more pool assemblers. There's another few kind of in the pipeline that are working through. So that's always going to create more demand because basically more mouths to feed. Yes. So the secondary market feels like it's in a really good spot right now.

[Operator Instructions] Your next question comes from David Feaster with Raymond James.

Chip, I just wanted to follow up on your -- in your closing commentary, you talked about being more creative to help your borrowers. I'm curious if you could expound on that a bit. And is there any new initiatives you're expecting to put into underwriting or the way that you approach work out? I was just curious what opportunities do you see?

Yes. I rather expected that from you, David. Thank you. I'll give you an example, right? I think that we have a lot of young people. As you know, we have 70 to 22-year [ph] olds that examine financial statements every quarter on most of our borrowers where we can collect them. So we had a self-storage -- self-service storage customer that was having some challenges. And then we kind of looked into that later after the fact and said, well, you haven't had a price increase in 10 years. So a guy named Terry Campbell helped us start that business 10 or 12 years ago, left to do something on his own. So we asked Terry to go visit with that customer to walk them through how to do a price increase after 10 years. And lo and behold, they're back in the game. So it's just things like that. It's like just common sense. And Michael Cairns alluded to that as well. We're going to put some more experienced people with little wood behind the arrow in that area. That's all I meant by that comment.

Okay. And to that point, I mean, I guess, how do you look at hiring? I mean you're seeing the pipeline at near all-time highs like you talked about, production is set to improve. Where do you think you need -- I mean, do you need people or teams to support this level of growth and sustain that pace of growth? And where are you looking to potentially add talent?

David, it's BJ. We are always looking to add revenue-generating talent. So we're continuing to hire lenders, both in our general lending group and in verticals where we see opportunities. So that's kind of one. Number two is we are beefing up our treasury management groups and our deposit groups as we are growing checking accounts which is particularly exciting to us. But I think what we're really focused on in terms of scalability from this activity and things we're really excited about is what I alluded to at the end of my comments, the effective AI on what we're going to see throughout not just our industry but across the country. Neil Underwood, one of our founders, has been around a long time in technology and he would say this is kind of the third major wave that he's seen beyond Internet, cloud computing and now AI. And we are working with some really interesting companies and software that are doing really amazing things to allow us to take a lot of manual processes and data entry and document collection and tax return collection and bank statement collection, all those types of things, out of the grind of what currently happens between a potential borrower and our lenders and underwriters and closers and people in loan operations to streamline those things very efficiently so that we can actually do what Chip just talked about which is be thinking about how to help customers succeed as opposed to doing a lot of data entry. So we are very, very bullish on what we can do with AI. As you well know, we are never afraid to experiment with technology and look at new and innovative things that will help us grow. And so we've got a lot of people across our company looking at different types of ways to be able to do that.

Okay, that's great color. Pretty exciting to see what's on the horizon. Touching on the business checking balances, we've seen kind of an acceleration in growth. We're still in the early innings there. First, I guess, how has reception been? And then you talked about 35% of new relationships now have a deposit relationship too. Is that a realistic target for that book over time? Or do you think you can actually do better than that?

Well, I'll start with the latter, David. I think we can do far better than that. There's -- your typical bank would do at least twice that, if not more, with a mature checking account offering. When we launched it really in full at the beginning of this year, we had a very strong offering but not a completely full offering. I'd say we're at about 95% -- 90%, 95% of the feature functionality now that we wanted to have. And so we had to make -- it's a new muscle for a lending organization to then ask for deposits. And so we started slow. We started with education of our people. We then would educate our customers and we've started to see that ramp. If you look at Walt's 5-quarter trend, started at about 20% of customers, now it's up to 35%. And we continue to see that growing every month and every quarter. It's hard to move a checking account. That's why we're most focused, not completely but most focused on new customers because at that moment of transition, at that moment when we are putting capital in their hands to grow business is the best time for us to be able to ask for the opportunity for a full relationship with them. And we're starting to see really, really good success. So we've talked about before that there's no reason over the next several years, we shouldn't have 10% to 15% of our deposit mix -- of customer deposit mix in checking accounts. That's our goal. It takes a while to ramp that up but going from virtually nothing to $215 million in balances is a pretty good start. So we're excited about where we can take it.

And BJ, I think we have a secret weapon, too. Wilmington, North Carolina. Southeastern North Carolina has 350,000 folks. And last week, we hired 3 experienced bankers to attack small business, Wilmington and others. I have been told, I'm not sure if it's true or not, that the big guys like BofA and Wells do not have any small business lending officers in our market area and we're going to go like hell to see if we can promote ourselves as the only hometown bank where we live.

That's great. If I could squeeze one more in, I wanted to touch on the small dollar SBA. Obviously, we're still in the early innings here. Curious, what you're seeing, how it's performed relative to expectations? Any tweaks you need to put in into the process and the model? And just -- I think you did $125 million this year. What do you think we can do in 2025?

So David, I'll start. We did $125 million of small dollar loans after doing virtually none last year and quite candidly, with not a lot of technology. Our team -- our technology teams were ramping up as quickly as they could and to help assist in our processes and they put some things in place. But most of that $125 million was sheer grit and grind from our people getting out there, talking to customers, getting web leads, following up on those leads and trying to create as quick and efficient and safe a process as we possibly could to stand up this business. Now we've got fantastic technology from origination all the way through servicing in our Live Oak Express platform that is going to significantly accelerate our capabilities and enable our people that have been doing a lot of everything from the beginning of the process to the end to actually spend a lot more time on prospecting and underwriting to get more through the pipeline. So all of that to say, if we did $125 million this year, I would be disappointed if we didn't do more than double that in 2025 and we'll continue to ramp.

There are no further questions at this time. I will now turn the call over to Chip Mahan for closing remarks.

Well, we thank everyone for dialing in today and we look forward to seeing you in April. Good day.