Live Oak Bancshares, Inc.

Good day and thank you for standing by. Welcome to the Live Oak Bank Shares second quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Greg Seward, Chief Risk Officer and General Counsel, Live Oak Bank Shares. Please go ahead.

Thank you and good morning, everyone. Welcome to Live Oak's second quarter 2022 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 material 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 second 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 Chief Executive Officer.

Thanks, Greg, and good morning to all. Let's move to slide four to kick things off. For today's agenda, I'm going to kick things off with a few overarching comments before repeating our normal quarterly cadence of BJA reviewing our financial performance and Huntley highlighting our operational priorities. Let's move to slide five. Over the next few slides, we will discuss our mission to extend our nationwide government guaranteed lending platform and how that effort has led to an all-time high pipeline. As always, we will discuss the quality of our loans and will reflect on this volatile rate environment and its effect on SBA loan premiums. Clearly the most recent correction in the capital markets has led to deterioration in the valuation of nascent fintech companies. I am proud to report that Live Oak Ventures investments have continued to thrive and grow and seem to have dodged the downturn, at least for now. Huntley and BJ will have much to say about the Finzact sale to Fiserv. I am happy to learn from the Fiserv earnings call on Tuesday that the company for the second straight call puts Finzac's next-gen core processing system at the center of their future strategic plans. Let's move to slide six. This slide highlights the organic growth in our lending business over the past five and a half years. The bottom of this slide shows the growth in our vertical SBA lending units. In 2018, we added seven new industries. And so far this year, we've added three, bringing us to 17 in total. On the lending side, we have added 10 new lenders this year. That gives us a total of 30 generalists in 27 cities. This is a new point of emphasis for us. Recently, we sent 700 emails to SBA lenders at 85 banks. We will approach SBA lenders at an additional 25 banks in the next two weeks. If you are an SBA lender, there is a 100% chance you've heard of us. there is a reasonable chance you've heard good things. In the 700 we contacted, we currently have a pipeline in various phases of 168 folks. Many are happy at their existing bank, and we want to stay in touch. The point is we have built a culture and a technology platform that is scalable in an industry that views SBA lending somewhere in between the portalette of the banking business to just a sidecar to their other small business initiatives. This is what we do. We want the best lenders to know that we are coming to a town near you. Lastly, our pipeline for proposal to close has increased roughly, what, from $1.5 billion in May of 2020 to a little over $3.1 billion today. Again, an all-time high. Slide seven. for some fun facts as we consistently and forever concentrate on soundness, profitability, and growth in that order. In the late 80s, one of our banks and another company I started made their first SBA loan. We had to get five declination letters from other banks before we could qualify the loan. We had to prove we were the lender of last resort. Even today, the SBA has you cannot find credit elsewhere tests. As interest rates rise and beating drums of pending recession get louder, we often have to answer the question, are you at the tip of the spear at Live Oak Bank? Your customers have no capital. Are you worried? Let me answer that. No. Here are the facts. On roughly $7 billion in loans, we had $3.4 million of over 30-day past dues or just nine BIPs. Moving on to worse loans, loans on non-accrual were $16.6 million, or 43 BIPs. That said, of the 16.6, 8.6, or 53% of the total were paying as agreed. I am overwhelmingly proud of our lenders and credit folks who have chosen the right operators and entrepreneurs. So back to slide seven. In the past 10 years, we have averaged 30 BIPs of charge-offs while all other SBA lenders report more than 10 times that at 4%. Almost half our loan portfolio is guaranteed at 44%, while the rest of the industry holds tight at a rounding error of 3%. The pricing of our loans were considerably better with a net interest margin of just shy of 4%, as you can see, while the rest of the industry was nearly 100 bps lower at just under 3%. Since inception in 08, We have originated $19 billion in loans, two-thirds of which were in the SBA 7A program. And as you can see, $14 billion or 74% of our $19 billion in originations were loans to small businesses. Let's go to slide eight. As mentioned a minute ago, the last six months in the capital markets has not been much fun. We often say around here that capital is king, and BJ will cover that shortly. He also likes to talk about optionality. I like to talk about different arrows in our quiver. This is the same slide we showed on our IPO Roadshow exactly seven years ago this week. Many investors were unaware of the tiny SBA loan sales market. As you can see, the pricing has been incredibly stable the last 22 years, save the Great Recession, the pandemic, and now. How fortuitous for us that at precisely this point in time, My friend Frank Sanchez decides to sell Finzact to Fiserv and become their vice chairman. We have said to you many times the 280 billion lines of code the industry runs on is going to get swapped out in the future to a next-gen cloud-native API-first solutions like Finzact. The fact that he and ostensibly we will be partnering with a $67 billion market cap brand name is good for Live Oak Bank. Frank's subsidiary will operate separately and be supplied the necessary capital to attack the broader market. Slide nine. How wonderful for us that the FNZAC $120 million pre-tax gain mirrors the disruption of the 7A premium's decline. The FNZAC gain is one and a half times what we raised in our IPO and also exceeds our secondary offering in 2017. The Finzac profit equals all of our 7A loan sales for the last 14 quarters and exceeds all of our 7A and USDA loan sales over the last eight quarters. So, what did we do or didn't do? We did not fail in what historically seems to be a down market. Bottom left of slide 9 shows what we did in Q1. We sold $211 million in paper at a 110 handle, generating $20 million gain on sale dollars. This quarter, we could not cherry pick enough to get to 110, but we did sell 50 at 108, generating $4 million in pre-tax earnings. Had we chosen to sell 2 million and 211 million in paper, the best we could have done would have been a 105 handle, generating only 12 million in earnings. So let's keep the loans at roughly a 4% spread and generate $7 million in recurring net interest income. We have a long runway to continue to do just this as we wait for the usually predictable seven-day mark to come back to historic norms. And I can't stand it. Just before I turn it over to BJ and Huntley, I want to briefly mention my 14-year torturous relationship with the income statement line item servicing asset revaluation. I often wonder who I love less, lawyers or accountants. So let me see if I got this right. The accountants tell you that your cost of service alone is 40 bps. Then they tell you the average life of the loan is seven years. You need to take the remaining 60 bps of servicing over the next seven years and the net present value of that and take that into income. But we already got paid in cash for the loan yesterday. Huh. Then we go to the black box once a quarter and value the accumulation of all our loans added together. After we took the company public, this servicing asset reval number over three consecutive quarters was One quarter up $5 million, the next quarter flat, down $9 million the next quarter. We decided to sell less loans and reduce the volatility of reported earnings per share. This quarter's negative $9 million, or $0.16 a share, is in the appendix on slide 40. Rest assured, we think the $7 million in servicing revenue we receive annually is worth far more than the $28.5 million the beloved's accountants say it's worth. BJ, over to you.