Live Oak Bancshares, Inc.

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.

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.

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.