This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk07: Ladies and gentlemen, thank you for standing by, and welcome to the Quarter 3 2020 Live Oak Bank Shares Incorporated Earnings Conference Call. At this time, all participant lines are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session, and to ask a question during this session, you will need to press star 1 on your telephone. Please be advised that the today's conference is being recorded. If you require any further assistance, please press star 01. I would now like to hand the conference over to your speaker today, Greg Seward, General Counsel. Thank you. Please go ahead.
spk02: Thank you, and good morning, everyone. Welcome to Live Oak's third quarter 2020 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 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 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 and in the presentation materials and commentary. I will now turn the call over to Chip Mayham, our Chairman and Chief Executive Officer.
spk00: Chip Mayham Thanks, Greg. Good morning, all. Slide three. We are extremely excited about talking about the best quarter in our company's history. We acknowledge, as Chris Donat from Sandler Piper noted in his report this morning, that Live Oak is a complicated story. And we're going to attempt to unpack that for you now. Headlines. We're hitting on all cylinders. Margins up. Originations all-time high. Loan sale prices at or near all-time highs. FinTech investments raising money at frothy valuations. even got a break on the servicing asset reval. And with all this production, Huntley was able to keep expenses in check. What could possibly go wrong? Everyone knows that small business in America, the 28 million small businesses in America, create 66% of the new jobs, and they're struggling. Many of you that hold bank stocks are worried about the small business portfolios. The object of this exercise today is we want to create the most transparent bank in the United States relative to showing you the quality of our loan portfolio and the capital that stands behind it. So let's get going. Next slide. You've seen this one before. Capital at the end of the quarter, $532 million. Fairmark and Loan Loss Reserve, allowance for credit losses it is these days of $62 million. gets you to about a 26% capital ratio adjusted compared to $2.3 billion of unguaranteed paper. I'm happy to report that our guaranteed loan portfolio grew from about $1.1 billion to about $1.7 billion, and with this frothy secondary market, that is worth about $155 million pre-tax to put another arrow in our quiver. I guess the third thing I'd like to show you on this slide is the past dues. like there are not any. This had to do with the SBA subsidy in the spring where the federal government said they were going to make P&I payments for six months to every SBA borrower. Then they also said that if you borrow money on or before September 25th, we're going to help you out for six months P&I as well, which is in some part the reason for our frothy increase in loan originations. Lastly, I would like to point out what we call the examiners ratio. In the last crisis, federal banking examiners looked very closely at classified assets to capital and reserves, and today that number for us is a little over 9%. They get a wee bit fussy around 30, so you see we have a very long runway there. So moving on to the next slide. As you know, we have 45 22- to 30-year-olds that collect financial statements, attempt to collect financial statements every quarter. That number as of today is 65% interim and 86% for annual financial statements. Most banks don't do that, but we do. And Steve Smith, who will probably help out later in this call, asked every one of our folks that are in touch with these customers literally every day to call every one of them. and put them in one of these categories, high, medium, and low in terms of stress. So what you see on the left is a 5.5 stress level on the whole portfolio. And then we created what we affectionately call the COVID-6. That would be the pie chart on the right. That would be our more stressful verticals, hotels, early education, family entertainment, wine and craft beverage, fitness centers, and quick service restaurants. Again, the port is here. We know our customer. Moving on to the next slide, loan portfolio characteristics. What we try to do here is break out for you in an open fashion, a transparent fashion, our top five or big five verticals. That would be mainly chickens, healthcare is mainly dentists, veterinary and self-storage, and our general lending group. More to come on them in a minute. Compare that to the COVID-6, and I would say, you know, effectively the COVID-5. Quick service restaurants are doing quite well these days. And really this is kind of, you know, case by case, right? So if you're running anything, whether it's a fitness center or a quick service restaurant in Los Angeles, trouble. New York, trouble. Michigan, trouble. It's almost state by state, governor by governor, mayor by mayor. So moving on to the next slide, we wanted to give you more transparency relative to our credit reserves and fair value mark on Big Five and COVID-6. And there's also data here on deferrals and those that receive the SBA subsidy. The point here is that this type of data will be published each quarter, and we just don't know what we don't know is the short of this. For small business America, will we get more federal funding? How fast will the federal government give us the ability to forgive the $45 million in earnings we have hung up in the Triple P product? Will the SBA come back and make P&I payments for our borrowers? Will the SBA do what they did in the last crisis and potentially increase the 7A product from $5 million to $10 million accompanied with a 90% guarantee. We just don't know. But we are going to manage this bank as if nothing happens. As always, we're going to take care of our customers. We understand if they have the eye of the tiger and they want to fight. And in some unfortunate situations, we're going to have to have tough conversations. There will be more losses. So, Continuing on with the credit analysis, let's look at our hotel portfolio. 39 properties, about $130 million of exposure a day, 59% occupancy. The average daily room rate in our portfolio is $116 with revenue per available room of about 74. In the minutiae on the right, you can see our top 10 exposures as of today, and more importantly, see the products, the SBA 504, is prominent here along with some USDA paper, and importantly, the loan-to-value ratios you see on the right. Now let me walk you through what we did in the quarter. We had about $190 million in exposure. We put $81 million of these loans up for sale. We actually sold $55 million face amount of the note at a $5.2 million loss. We kept five that we didn't want to sell at those prices, and we wrote them down to the prices that we received So the 5.2 and the 4.7 get you to what Brett told you in last night's write-up, a $9.8 million charge-off. And again, the theme here is we're going to give you as much data quarter-to-quarter on this portfolio and anything else that gets in trouble as we move forward through this crisis. Next slide. We've shown this in the past. We want to continue to highlight our geographic diversity and lack of concentration risk. Obviously, where the population is, is where we have the most exposure. You could probably take North Carolina out of there, California, Texas, Florida, New York, largest states in the United States, and 212 million in exposure in our home state of North Carolina. Moving on to originations and soon profits. As you can see, take the PPP out of it, we typically do about 500 million in originations per quarter. And this time we did almost a billion, and you see the granularity of that in the box up top. 7A was $639 million. And so the real question is, which we're not going to disclose, which is what is after this? And I will tell you that after the billion in originations, our pipeline is at an all-time high. Next slide. Again, geographic diversification and lack of concentration in the billion dollars we put on the books this quarter. A little bit smaller loans this time, 46 states, $790,000 worth of exposure of unguaranteed paper. Moving on to the next slide. This has been fun. How did all this happen? $966 million for the quarter. Clearly, the SBA subsidy had something to do with this. My guess is, Steve, 40% to 33% would probably be from the subsidy, and the rest would be from hard work. And really kicking in this time were our general lenders and sponsor finance people. And certainly, the PPP basket had a lot to do with this. We did almost 12,000 PPP loans totaling $1.8 billion, and that gave us you know, many more looks than we would have had. Moving on to the next slide, here's a little more discussion of our general lenders and our sponsor group, right? So we built this bank until about three years ago on the theory of verticality. Hire a domain expert, have that domain expert sit down with Steve and his credit guys, create a credit box, tell the sales guys go get that because we'd rather think that our customers care about two things. Am I approved and when are you going to give me the money? So Evidence and CINO and all that workflow that allows that to happen to treat every customer like the only customer in the bank. And then we stepped outside of that and said, well, you know, the former number one SBA lender in the country had a lot of folks that were unhappy. And as you can see from the map on the right, we have hired a total of 19 lenders. from Los Angeles to Austin, Texas, Miami, Florida, to Boston, and you see these folks all over the country making loans this quarter in 17 separate industries, totaling some $228 million. And if you go to the next slide, we are continually proud of maintaining our number one position as the top SBA lender in the country, and you can make a case that we're pulling away from the PAC this year And if, in fact, our general lenders and sponsor group, again, outside the theory of verticality, were on their own, they would be top ten in and of themselves. Worthy of note is the tiny little note at the bottom about 7A program gross loan approvals per quarter jumping to almost $8 billion. Maybe, just maybe, this will get the attention of the folks in Washington, and maybe, just maybe, we'll get a little more help as we get through this crisis from them. So, You know, my last slide is on profits that Huntley's going to really jump into before I turn it over to Neil to talk about our finance, fintech investments. But, you know, we're finally here. Take the second quarter out, a lot of noise there. We're bopping along at $17 million of pre-tax, pre-provision, and earnings, and now we're at $24 million. So finally, all those investments are kicking in. Those investments in and the general lenders that I just discussed, because it's just not those folks, the architect of the deal. Behind them, there are underwriters, closers, servicers. So all of the investments that we made, all the money that we spent to get to this point are finally beginning to translate to the profit line. So let your mind wander on post-COVID. What is the provision going to be with all the arrows we have in our quiver? What is the tax rate going to be when we manage that in the past with our leasing income to somewhere in the mid-teens? And I think you're going to see that we're going to get to some of the things that Huntley puts in every slide at the end of the day of what is the ultimate object of the exercise. So, Neil, why don't you jump in and talk about investments and let Huntley take us home.
spk01: Sounds good. We have a couple slides on some of the big tech investments, both in the context of Live Oak Ventures and Canopy. Jeff, you've mentioned right place, right time, right model. I'd probably add right tech to that. We are finally live with the deposits platform after five years in the shop, and this is really exciting because it's the new tech stack, Aperture is the next-gen onboarding system, Finzact is the next-gen core, all cloud-native, API first. Huntley's going to talk more about this, but a shout-out to Jennifer Demba because you've been more than patient on this particular topic. Relative to Live Oak Ventures, look, we've been really excited to get some write-ups based upon some of the recent valuations. This should be seen as precious, non-dilutive, Tier 1 capital to the bank. When Live Oak Bank decides to upstream it to the holding company and then downstream it to the bank, there are some significant advantages there. The most notable this quarter, obviously, is Greenlight, where we took a $13.7 million mark to the good. If you recall, we invested $3 million in 2018 in the Series A and $2 million in 2019 in the B. And Greenlight continues to perform at record levels. As you know, these are debit cards for kids, but it's a mission-based theme where it's really helping families with financial literacy. On to Canopy, as you guys know, Canopy is the successor of Live Oak Ventures, and it really allows us to invest at scale. I mean, given it's a $600 million fintech fund powered by banks as limited partners. We've been super busy in quarter three as well, and as you all know, it's a highly competitive market, and valuations are frothy. Even still, we won three deals against the best names in Silicon Valley. We led or co-led Alloy, Blend, and Greenlight. And we can go further into these at a later point or just go to our website to understand these technologies. But suffice to say, these are led by the industry's best, all bringing next-gen fintech capability to banks. And as important as the financial upside, Live Oak Bank can now use these assets and be first up with the latest in fintech technology. Moving on to the next slide. This shows six Libo Ventures companies, and as you can see, on the $18.6 million invested, the current carrying value on our books is $90 million. We feel this is conservative, given the accountants and their view of how this has to sit on our books. If you actually just did the math and looked at the valuations of these companies and the most recent valuations in our ownership, I believe closer to about $150 million in value. You know, we feel this is good progress, but given the growth rates of each of these companies, we do expect these numbers to grow over time. And again, just providing precious tier one non-dilutive capital to the bank while giving us access to the latest in fintech advancements. So, Huntley, over to you.
spk04: Great. Thanks, Neil. We'll turn to page 19. I mean, to say it's been a challenging year for everybody would be a massive understatement. and especially for small business owners. In the face of everything that was going on this year, Live Oaks, roughly 600 people, accomplished some pretty amazing things in the third quarter, just like we did in the second quarter when the PPP program was live. Our focus throughout the year has been constant, that of our customers, our employees, the communities that we're in, and then supporting small businesses with our personal service, our capital, and our technology. Well, we've all been affected by the events of this year. We're exceptionally proud of how the dedication of our people, the commitment to our industries, and our brand have resonated across small businesses. Hopefully, we've all gotten a chance to review our earnings release and Brett's CFO highlights, and as Chip said, it's a really strong quarter financially across the board. On pages 20 and 21, we'll try to unpack some of the headline numbers, and all of these are adjusted for PPP, both the loans and the excess liquidity to give a bit more view into into the core. We'll run through these relatively quickly and then get into some more details on subsequent slides. So as Chip said, our loan portfolio grew $600 million in the quarter, driven by our origination, as well as slower prepayment speeds across the portfolio. Total assets were relatively flat as we were able to redeploy a substantial amount of the excess liquidity we stockpiled earlier this year. We enjoyed a really strong capital build, driven by our core earnings plus the FinTech activities and as the PPP earnings flow into capital as well, with our capital ratios, as you can see there, increasing across the board. Page 21, on the earnings side, core earnings were driven by NII growth as we replaced that excess liquidity with loans and our deposit repricing went down. Loan yields remained strong at just under 5.5 percent across the portfolio. And our margin recovered nicely after the Q2 impact of the rate cuts. Gain on sale benefited from a stronger market. Secondary market allowing us to sell less loans and still generate higher gains. And we're back on track for our targeted 65% hold of the SBA loans that come available despite increased sale activity at the beginning of the year. And as Chip mentioned, it's a great story on the expense side as well. With travel curtail, we found creative ways to engage with our customers and partners and dramatically increase our productivity. All that led to a core pre-tax, pre-provision profitability of $24 million, and we'll go through that in a lot more detail here in a little bit. So let's spend a minute on the PPP, page 22. As folks know, a little over $1.7 billion of origination And you count that with the excess liquidity that we stockpiled, you know, had a balance sheet impact at the end of the second quarter of $2.6 billion. And that's come down a bit as we've deployed that excess liquidity, but still over $2 billion of impact on our balance sheet. From an income perspective, we recognized $13.6 million of income from both the deferred fees and the interest income. offset by a bit of a negative carry on the excess liquidity. So about $13 million of net impact in the income statement as well. As Chip mentioned, we booked a total of about $60 million of those deferred fees. There's still about $43 million remaining on the balance sheet as of September 30th that will come through with forgiveness. And as it relates to forgiveness, we're off to a solid start. We've got about 1,500 of those 11,000 loans that are in flight, that are in the process of being forgiven. And our friends at Encino have been helpful building out the portal. And we've actually used that as an opportunity to advance the ball on some other customer-facing technology initiatives. We expect we'll start to see some forgiveness come through in the fourth quarter, but the bulk of it will still probably be the first half of next year. And as Chip mentioned, there's still significant funding available in that program that was unused, over $130 billion. And so we think that we could see additional funds released in some form to the benefit of our customers, but predicting things in D.C. is pretty tricky right now, so we'll wait and see. Turning to page 23... A lot to unpack here. This is really all the adjustments that we've made to get to that core number of $24 million that we mentioned. So we'll just run through it. For starters, if you look at the top two rows, the stated pre-tax earnings up considerably with a headline number of $45 million. You add the provision to that, which is $10 million, which was largely driven by our origination growth. and the sale of the hotel loans that Chip mentioned, that gets you to about $56 million of pre-tax, pre-provision earnings. But there's still a lot of noise in there, so let's go through those. And most of them broke our way this quarter, right? So, beginning of the year, we faced some headwinds around valuations and mark-to-market. You can see those effectively reversed or got some of those back, so we take those out. We had $1 million of an expense for the pending sale of an aircraft. Neil touched on the $13-plus million of FinTech gains. And then you've got the $13 million of PPP activity that we mentioned as well. So all of that drops to about $23.7, $23.8 million of core pre-tax pre-provision earnings, which is up 40 percent from this time last year. And that's the result of a ton of hard work, the commitment we made a couple years ago to strengthen our balance sheet and driving that sustainable profitability. And when you couple that with the growth that we still believe we have, we think it's pretty unique. So turn the page to the franchise fundamentals. Chip covered a lot of this ground already, so I won't repeat it, but a couple things to note. And the first is operating leverage. If you look at those two lines on the top of the page, net interest income increasing by 25% in the quarter and non-interest expense decreasing by 11% in the quarter, obviously massive operating leverage. Even if you adjust for the PPP impact and for the Q2 special bonus related to PPP, there's still a roughly 17% increase in NII and flat expenses, so continuing to drive that operating leverage. The second thing to note is, as Chip mentioned, you know, the increase in our guaranteed loan portfolio to $1.7 billion from 1.1 last quarter and over doubled over the course of the year. That's a great driver of low risk earnings, but also a really nice source of contingent capital. And you add that to the unrealized gains in the FinTech portfolio that Neil talked about. And we like having those levers from a capital perspective in, you know, in an uncertain time. So originations, I think Chip hit this pretty well. So I'll just add one or two comments. You know, how did we How do we accomplish this level of origination in the course of a quarter? And I think importantly, we did that without sacrificing any of our credit standards, any of our closing processes, any of the ways we do business. We feel really good that we didn't cut any corners across the board. And in some cases, we tightened our credit standards. You look across our credit scores of our borrowers, the equity injections, debt service coverage ratios, they're consistent with or tracking above the balance of the portfolio, so we feel really good about the quality of the portfolio. You can see on the top of this page the originations skewing towards these newer verticals. A lot of this, as Chip said, our business is coming online that we've invested in, whether that's generalists, whether that's some of the bioenergy community facilities, things that are coming online here over the last couple years that are really hitting on all cylinders. And then the final comment is, you know, the at-risk verticals and the origination there. And as you can see in the entertainment centers and hotels, you know, we've all but stopped origination there, put a little bit of capital back into some of our customers to help support them. But in these other verticals, we're actually seeing some pretty interesting opportunities as a lot of competition has fallen away. We're seeing stronger customers, some really interesting opportunities. So we'll continue to be selective in those spaces as well. Chip mentioned the SBA subsidy, which clearly supported our customers and drove some of the activity in the third quarter, and that applied to all the fully funded 7A loans that closed prior to September 25th. It's worth noting that the SBA 7A program is really designed for times like these to support lending to small businesses during periods of uncertainty. And we've been working at it for over a decade to be the best SBA lender we can be, and I think it really paid off and then showed in this quarter. You know, we're also fortunate. We don't have some of the issues that other banks are dealing with, like, you know, income-producing series, retail or office spaces, and energy. So I think that helps support that lack of competition that we've seen there as well. We just kept singularly focused on small businesses and avoided distractions. So, and maybe flip to loan sales. We touched on this already as well. Slowing prepayment speeds, increased liquidity in the capital markets, drove spread significantly higher in the secondary market in both SBA and USDA products. We're seeing gains at or near all-time highs. And we really like the market dynamics, but we also really like the assets that we're originating. So, we elected to sell incrementally less this quarter. than we had earlier in the year, where we really were kind of stockpiling liquidity in the face of all the uncertainty at the beginning of the year. And so we were kind of back in line with our long-term targets in terms of hold. We've deployed a fair amount of that excess liquidity that we had, too. So we like where we are, and I think we'll continue on track from a target perspective in terms of our hold versus sell that we've indicated. Turning to expenses. Chip mentioned a really, really solid story there. That's pretty remarkable given all the franchise growth that we've seen. Last quarter, there was a $7 million bonus accrual and a bit of additional deferred origination expenses. When you net that out, core expenses are down a little bit quarter over quarter. Travel and entertainment expenses are obviously way down. We had a bump up in FDIC assessments that offset each other. You know, we recognize that the pace that we've been running this year is unsustainable. We've driven folks really, really hard. And, you know, in Q2, we tackled the once-in-a-lifetime opportunity to serve our customers with PPP loans. And then right after that expired, we were looking at a record pipeline and a bunch of loan activity in the third quarter as well. So we did all this with flat headcount. And our folks, you know, just delivered, right? And so we're going to add a little bit to the team to help load balance a bit as we see, you know, continued opportunity and continued pipelines. So, you know, and if travel starts to come back a little bit, we may see expenses creep back up a bit. But we're really excited about how efficiently we've been operating and we'll stay disciplined on that front as well. So turning to deposits, and this might be the unsung hero of our model right now, which is our direct deposit platform. So 60,000 customers, $4 billion in retail deposits, and the efficiency of this portfolio in a zero interest rate environment is pretty remarkable. We pay 60 basis points on new CD, 70 basis points on customer savings. and those numbers are down, you know, deposit costs down 25 basis points in the quarter, savings rate down 100 basis points this year, CD rate down 150 basis points this year, and all of that being operated with six basis points of allocated expenses. So, you know, from an earnings perspective, we've got the CD portfolio that's continued to run off, and that'll reprice, you know, we'll talk about it in a second, but, you know, close to $3 billion in the next 12 months. But a really, really impressive operation funding in this environment. I think it's hard to see even a branch-based checking account portfolio with a lower fully loaded cost than that. We still remain really committed to our checking cost strategy. We're really excited about all the things we're doing there. We'll drive deeper customer relationships. We'll capture transaction flows. We'll be able to better provide liquidity to our customers. But this funding model right now in this environment is incredibly efficient and incredibly attractive. Let's turn and stay on deposits for a minute. So almost $3 billion of retail CDs and broker CDs that will reprice in the next 12 months. That will, at today's rates of savings in CDs, drop another $30 million of non-interest expense. Net interest expense? To the bottom line, apologies. So $30 million of pre-tax earnings on an annualized basis, that's 40 to 50 basis points of NIM just on the runoff of that stuff. So again, really excited about the deposit portfolio we have and how we're managing that over the course of the next 12 months. That'll be a nice tailwind. So looking at NIM, Obviously, a big drop in the second quarter with interest rates dropping 100 basis points and our floating rate loan book. So we were down on a core basis close to 50 basis points, and then you had the PPP and the excess liquidity, but core margin down close to 50 basis points. We've gotten almost half of that back in one quarter, and with the deposit savings that we talked about, you should continue to see a solid tailwind on that. On the right-hand side, you can see liquidity, which obviously elevated in the course of the second quarter from an average basis. It's still up, but we've done a really good job of redeploying that liquidity. We took 10 percentage points down on a spot basis over the course of the quarter, and we'll continue to redeploy that as we go forward. So turning to capital and liquidity. In an uncertain time, it feels pretty good to have over half your balance sheet guaranteed by the US government and in cash. You add to that the 13% CDT1 ratio, excess liquidity, continued capital sources, and we feel really, really solid about where our balance sheet is, which also gives us confidence to continue to provide capital to small businesses, which is sort of our mission every day. I feel really good about where the balance sheet's positioned as we sit here right now. And, again, Chip mentioned this, but our portfolio is really diversified, not just across government and government programs and across all of these industries as well. It's granular, you know, a lot of small loans. We're working really hard to stay in touch with all of them and know where they all stand. But we like the diversification across that. And then finally on capital, tier one leverage, which obviously took a big step down in the second quarter with PPP and the excess liquidity. We got a lot of that PPP back as all those loans pledged to the PPPLF. And so that was a big jump back. We still are sitting on a bunch of excess liquidity, but over 50 basis points recovery on that tier one leverage. So we're close to that 850. We're right on top of that 850 number that we feel pretty good about. All right, let's go and look at the slide we show every quarter, these high-performing bank metrics and sort of what we see as these targets. And yes, as Chip mentioned, there is some one-time stuff in there, PPP and FinTech, et cetera. But on a core basis, we're a $6 billion asset bank and moving up. pretty quickly in that regard. You know, core NIM is over three and a quarter and making its way north. You know, fee income side feels really good. Efficiency expenses feel really good. And the capital is kind of right in line. So all these things with our continued growth, we feel really good that we're going to try to deliver all of this. Final note before we open up for questions on the new deposit platform, you know, Neil touched on this. You know, we went live at the end of September with business savings and CDs on the new stack, so new core in production. We got almost 200 customers and over $10 million in account balances already. That's with no marketing, basically. And, you know, that provides us the ability to seamlessly open a business account online, which is actually pretty rare, and it's got a great mobile app and all these features. But that's really just a start. With our partners at Aperture and Finzact and others, Our roadmap has new product design, enhanced customer experience, integrations with software companies, and that's what we're really playing for and what we believe will truly improve the lives of these small business owners that we serve. And then on the checking account front, we are currently live with our first debit cards. They're in production. They're working. And we'll be expanding that pilot group over the next few weeks. Given the strength of our existing deposits and our liquidity base, we can afford to take our time with the rollout to make sure we get it right. And I think you'll see a broad market launch to small businesses, as well as the conversion of our existing consumer deposits scheduled for early in the new year. And we just remain incredibly excited about everything that we can accomplish in addition to what we're currently delivering with the core business. So with that, why don't we turn it over to questions?
spk07: As a reminder, to ask a question, you will need to press star one, your telephone. To withdraw your question, please press the pound key. Please stand by while we comply the Q&A roster. First question comes from the line of Jennifer Bembe. Your line is now open.
spk08: Thank you. Good morning. Congratulations on a good quarter, and congrats on the deposit platform launch. You gave a lot of good information in those slides and in your commentary, so thank you. I want to start with the hotel loan sale. What brought you to do that, and will there be more sales in future periods?
spk00: Yeah, Steve Smith's our chief credit officers here, and I think you could describe it best, Steve. Give that a shot.
spk05: Yeah, so Jennifer, this is Steve Smith. I'll start, and certainly, Chip, you can add some additional thoughts from your perspective. To start with, it's clearly one of our most impacted industries. Chip talked about the COVID-6, and for us, really, it's the COVID-5, if we look at our portfolio, hotels being at the top. And really we had to look at it as not necessarily that we were expecting to take an immediate loss. However, the administrative burden to work these loans through to the other side is a consideration that we thought about. They were certainly, many of them, very highly likely to go to non-accrual before they got better. That would be an impact. And the Need for us to hire additional special assets personnel to focus on this portfolio was a reality. Possible dealing with litigations and bankruptcies and other things. So it was a multi-year administrative burden that we had to pair that against just taking some risk off the table so that we could focus on the rest of the portfolio. And that really was a driver in the decision is really looking at the long-term burden to get them through to the other side and the cost to do that. And we were in a fortunate position where it made sense that we could take that off so we could focus on the rest of the portfolio.
spk00: Yeah, I think that's right. I think it's offense and defense, Jennifer. I mean, we have so many arrows in our capital quiver that just to sit here and slug it out for three years with those $55 million worth of loans, there's no doubt we would have gotten that money back. But better focus on offense and defense. And it's because we could. We had the ability to do so. And we will do that again in the future if necessary.
spk04: I also think that the market was incredibly strong. I think we were pleasantly surprised with the levels that we were seeing on these properties and that factored into it as well. I mean, I think we're not actively out marketing a bunch of other assets in the portfolio, but But we'll be opportunistic to manage risk, as Steve said.
spk08: Very helpful. Thank you. Chip, I know no one here really knows what's going to happen, but do you have any guess as to what your net charge-up levels could look like over the next two to four quarters, based on the level of economic activity we see today?
spk00: So I'll turn that on you, Jennifer. If you can tell me exactly what's going to happen in Washington, D.C., relative to what they're talking about now to help small business, then we can probably tell you that. But the answer is we just don't know. I mean, I would say that are we reasonably confident that something's around the corner for small business America, particularly those that have been affected and have zero revenues in some cases? I mean, I think there's probably more help on the way there. But we, as I said in one slide earlier, we're going to operate this bank as if there's going to be nothing else, and then we'll make those decisions at the time. But I just don't have a clue.
spk08: One more question. Expenses. Huntley, you said you probably need more staff. So what kind of expense trends should we see over the next two or three quarters?
spk04: Yeah.
spk08: expenses coming up in terms of accruals or whatever.
spk04: Yeah, and I can turn this over to Brett, too, for some details. But, you know, on the people front, it's really, you know, we're seeing more loan activity than I think we ever could have anticipated at this time. And so you think about loan closers and underwriters, you know, things like that. That's really where, you know, we're seeing the need for some additional people. So that'll have a modest impact. you know, on the total number. But I don't think there's anything major, you know, accruals up or down that we're expecting on the expense side. And so I think it'll creep up modestly over the next couple quarters, but we're going to fight hard to keep it, you know, to keep it pretty flat if we can. Brad, anything you want to add to that?
spk06: Maybe the only thing I would add is, you know, I think you've seen us and, you know, we've communicated or shown, you know, in actuals in the past when we take on various initiatives such as SBA general lending and, you know, those are expenses that have a future payoff. And this quarter specifically, using that same example, You can see through the loan originations by the SBA generalist how that initial investment paid off. So maybe to Huntley's point on, you know, adding NIE for staffing, et cetera, you know, as we see opportunity, you know, I think one great thing we've done is invested in those, and it does have future returns. So, you know, there could be – modest increases there, quarterly.
spk07: Thank you. The next question comes from the line of Chris Donut from Piper Sandler. Your line is now open.
spk04: Maybe.
spk01: Chris might be on mute.
spk09: Sorry, is that better? Yeah, we got you. Sorry about that. I had nothing to say, but I really do. Anyway, looking at slide 10 and the originations, as we think going forward, and I realize it's kind of like the net charge-off question of if we can tell you what's going on in Washington, then maybe you can tell us what's going on with with originations, but if I think about scenarios where nothing happens, should we expect originations to be sort of like what they were pre-pandemic or do you now have with the deposit platform and the liquidity on your balance sheet and the, you know, assuming the secondary markets where it is, an opportunity to really be meaningfully above where you were with originations pre-pandemic?
spk00: Yeah, as I said a minute earlier, Chris, our pipeline is at an all-time high, right? Trying to be somewhat conservative, do we have the players on the field today that could originate on an ongoing basis two and a half plus maybe as much as $3 billion on an annual basis? I would say the answer to that is probably yes. I'd be loathe to predict anything higher than that.
spk04: We are seeing opportunities right now that six months ago we weren't seeing, right? Very clearly where competition has pulled back in places, you know, and so we continue to see that. I think how long that lasts is an open question as well. We will run hard as long as we see it and continue to have some of these businesses mature. That'll help support that. But you know, feels good right now and will continue. But to Chip's point, you know, I think those numbers are good in terms of what we can visibly see.
spk09: Okay. And then just with the six-month P&I program with the SBA, assuming we don't see anything like that again, I mean, I thought I heard the comment from Chip that that was like a third of was sort of to take advantage of that deadline, or did I mishear that one?
spk00: Yeah, I think that's probably right. I mean, if you didn't have that, I mean, we would not have done a billion dollars. But we probably would have done $600 million or $700 million in the core.
spk04: Yeah, I think that's fair. You know, look, the majority of our origination benefited from that, right, which is great because it helps support the borrower. But how many loans would have not happened without that subsidy I think is probably closer to a third or less. Most all of the customers had the opportunity to expand business acquisition, et cetera, and it was a nice-to-have, not a have-to-have. So I think that's the right way to think about it.
spk00: Well, and we took some business away from conventional lenders because when the borrower did the math on an SBA loan at a higher rate, then he came with us because of the P&I payments. And, you know, that would be a one-time situation as well.
spk09: Okay. And I just want to ask one more on compensation. I think you've been pretty clear on the creeping up part, but is there any benefit you have from say, the investments you had made in launching the deposit program, do you have some expenses that drop off in that regard? Or should I think about you as you got to, like, the early stages here with the deposit platform, and now you have a lot of other things you want to add to it, so there will be continued expenses with that?
spk04: That's a great question. The benefits that we'll see will happen at deposit conversion, let's call that first part of next year, and then ultimately loan conversion, which will take a little more time. And those will be relatively modest, actually, just given we don't have the scale of units that some really big banks do, but it will be meaningful. But really, to your point, it's about growth. It's about new product development. So we'll likely reinvest that savings in, you know, continued products. I don't think you'll see a big move either way as it relates to technology spend over the next 12 to 18 months.
spk00: Well, it will be 20 and up. In other words, we have a number of people that were doing a lot of things to get us to this point, and that job will be done. Then on the other hand, You know, if you think about 100 and whatever we have on the lending side, right, we may have not that, but a whole lot of folks on the deposit side calling on practice management software companies to generate new relationships that we have been talking about now for years, and now it's around the corner.
spk09: Okay. All right. Thanks very much, Simon.
spk07: Next question comes from the line of Amar Salma from Raymond James. Your line is now open.
spk03: Hey, good morning. Congrats on a very good quarter. Thanks, Amar. Welcome to the call. Thank you. I appreciate that. So maybe starting on the all-in reserve coverage, it was down to about 266 from the 309 last quarter. Can you talk a little bit about the underlying unemployment and GDP forecast in your model, and then maybe just your overall comfort with the reserve at these levels moving forward?
spk05: So this is Steve Smits, Chief Credit Officer, so I'll start. First of all, my confidence in our strategy, very confident. And talk a little bit about unemployment. You hit on a metric that's very important to our model for our general reserves. So we, and reminder that we heavily reserved in the early half of this year. We've seen some improvements in the forecast for unemployment that impacts our model. Also, I'll point out, if you reflect on the slide that Chip discussed on our stress measures, that is important because we use that strategy to put a mark on the level of that flows right into our model for what we're reserving against. So we are taking a micro loan level, so we're very fortunate in that we have a very robust servicing platform, it bodes very well in environments like today with uncertainties. So we reach out to every single borrower on a loan level. We place a mark based on their level of stress, based on some very specific challenges that they may be finding, and that rolls into a qualitative factor that we plug into our provisioning model. And that correlates very closely to what we're seeing in unemployment. So that gives me confidence that it's doing what we expect it to do.
spk03: Okay, great. And then maybe a bigger picture follow-up question. Has the pandemic opened up any opportunities to maybe lend to new verticals? Maybe remind us of the process behind entering a new vertical, and are there any plans in the pipeline right now?
spk04: So, great question. Look, in terms of new verticals, we do analysis, we research around the market, the credit characteristics, and then importantly, the market structure. So, are there referral sources, influencers, experts, et cetera? How can we have somebody either in-house or that we're very close to with that expertise in that industry to to help us drive, you know, success. And so, you know, we really, I think, hit the pause button on that for the last several quarters as we've had a lot of them that were maturing and we wanted to sort of see that through. You know, I think that what has COVID done and has it opened up anything? You know, we look at our verticals and I think some of them have more opportunity either because of less competition or because of the market they're in. So I think we sort of like the breadth of what we have. Our generalists and our sponsor are seeing some transactions in certain sub-industries that may be taking place as a result as well. I see a little more technology, a little more services stuff. But overall, I think we really like the footprint that we have, and some are growing. The diversification of that allows some to thrive a little more than others in this time.
spk03: Okay, very helpful. Thanks a lot. I appreciate the time.
spk00: Thanks, Marv.
spk07: There are no further questions at this time. Mr. Chip Mayhem, please continue.
spk00: Yes, we thank everyone for joining us today and look forward to seeing you 90 days from today.
Disclaimer