Live Oak Bancshares, Inc.

Good morning ladies and gentlemen and welcome to the Q1 2025 Live Oak bank shares earnings call. At this time all participant lines are in the listen only mode. Following the presentation we will conduct a question and answer session and if at any time during this call you require immediate assistance please press star zero for the operator. Also note that this call is being recorded on Thursday April 24, 2025. I would now like to turn the conference over to General Counsel and Chief Risk Officer, Greg Seward. Please go ahead, sir.

Thank you. Good morning, everyone. Welcome to Live Oak's first quarter 2025 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 first quarter earnings release is also available on our website. Before we get started, I would like to caution you that we may make forward-looking statements during today's call that are subject to risks and uncertainties. Factors that may cause actual results to differ materially from our expectations are detailed in the materials accompanying this call and in our SAC findings. 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. As was our custom last time, I'll be handing the mic over to B.J. Loesch of All Fifer for their prepared comments. Chief Credit Officer Michael Carnes and I will be joining for the Q&A. Let's go, B.J.

Thanks, Chip. Good morning, everyone. Thanks for joining the call. Let's get started on slide four. Strong momentum continued in the first quarter in many areas across Live Oak as we continue to be proactive with credit reserving and navigate an uncertain environment. As you see on slide five, our strong PPNR growth continues with excellent loan and deposit production leading to strong revenue growth, well in excess of expenses. And I expect this to continue. Key growth initiatives such as Live Oak Express, which is our small dollar SBA loan program, and acquiring checking relationships are continuing to ramp. On slide six, you see evidence of our focus on building full relationships with our customers through primary checking relationships. Our checking balances stood at $279 million at quarter end, more than four times the levels of just one year ago. As you can see, we are adding incremental checking and savings accounts as we add loan customers, with the percentage of customers with full relationships, both a loan and a deposit, doubling from last year. Much more is to come on this front over the next several years, which will create deeper relationships, more stability for our cost of funds and MIM, and provide much greater real-time insight into our borrowers' cash flows. We remain quite proud of the unique diversification of our lending portfolio. And as you see on slide seven, 33% of our loans are government guaranteed, which provides significant comfort and quality of our risk profile. And in addition, our portfolio is well diversified with low average loan sizes. Nevertheless, elevated provision as shown on slide eight continues to weigh down our current profitability. As we've discussed before, With our loan growth continuing at a high double-digit pace, CECL requires us to book estimated life of loan provision on day one before we make a penny of income. Trying to look at this glass half full, we call this good provision, which usually makes up anywhere between 15 and 30 percent of our provision each quarter, which is not an insignificant amount. In addition, we continue building reserves as we work through a small business credit cycle we entered in the latter part of last year. And as a result, you can see on our chart, our provisioning in excess of charge-offs has resulted in an increase to the allowance for credit losses of $51 million over the last five quarters. That feels quite healthy. We have started to see reasons for optimism in the first quarter, which Walt and Michael will discuss further, but the uncertainty of the current economic environment keeps us cautious and conservative in the near term. We take great pride in our credit quality focus and always strive to be better, but it is also important to have perspective beyond our four walls. And as you can see on slide nine, our default rates and track record on charge-offs relative to the SBA industry remain best in class. On slide 10, I wanted to highlight the strength of our capital position because of the uniqueness of our balance sheet. Starting with the fact that over 40% of our assets are cash or government guaranteed, far in excess of industry peers, CHIP has always reminded us to remain focused on the importance of understanding the true risk on the balance sheet, the unguaranteed loans, and what our reserve and capital coverage is relative to those loans. We affectionately call this the mayhem ratio. And as you can see, at almost 17%, it is quite strong. in addition to our healthy regulatory ratios and gives us great confidence in any operating environment. Finally, on slide 11, there's been a lot of news on government agencies lately, including the SBA. Here's what we know. A, the SBA is alive and well. We have not yet seen impacts from DOGE-related staffing changes at the SBA, though we have heard positive early feedback on the DOGE efforts related to future technology upgrades at the agency. As expected, rule changes implemented during the prior administration will be rolled back, including reinstatement of small-dollar borrower fees and several other changes. None of them are surprising or onerous to us. In fact, we believe that it may give us a competitive advantage given how we currently do business relative to other participants in the industry. With that, Walt, how about running through some of the financial highlights for the quarter?

Thanks, BJ. Good morning, everyone. Let's get started on slide 14 with an overview of our Q1 performance. Our commentary and expectations we set forth in our last earnings call noted that we expected our top-line growth momentum to continue into 2025, driven by strong loan production and balance growth, margin expansion, and secondary market sales, aided by our efforts to expand small loan SBA origination. This top line growth will continue to drive our favorable core operating leverage growth. As we have experienced in prior years, we expected our expenses to increase in Q1 compared to Q4 as annual salary adjustments took effect. And we expected our provision expense to remain elevated as we continue to work through the small business credit cycle. All of these expectations held true in the first quarter. Our earnings per share of 21 cents was similar to last quarter, and was the result of a healthy PPNR and growth quarter offset by an elevated provision. As BJ noted, our core PPNR of $50 million was up 27% year-over-year, driven primarily by an increasing net interest income eased by strong balance growth, a strong and consistent secondary market generating reoccurring gain on sale, and continued focus on expenses. As BJ just highlighted, we typically see our core PPNR set down from Q4 to Q1 each year before continuing on its up and to the right trajectory, and we expect 2025 to be no different. A few key highlights to note within our Q1 PPNRs. Loan balance growth from strong production activity, coupled with better than expected margin expansion, enabled our net interest income to grow 3% in the quarter and 12% compared to Q1 of 2024. Our secondary market sales increased quarter over quarter in Q1, as our lending teams continue to demonstrate disciplined pricing while also focusing on small loan SBA origination. And our core operating expenses were up quarter over quarter, driven primarily by annual salary adjustments, seasonal taxes, as well as good costs related to incremental volumes. Growth on both loan and deposit fronts remained strong. Q1 2025 loan originations of $1.4 billion was our largest Q1 of loan production in bank history. This resulted in a late quarter loan growth of just below $500 million, or approximately 5%. And our pipeline remains healthy, indicating that despite the economic uncertainty, we have not yet seen a decline in potential borrowers' appetite. The first quarter has historically been a strong growth quarter for our customer deposits, and 2025 has continued this trend with our customer deposits growing approximately 8% in late quarters. As BJ highlighted, we also continue to build momentum with our business checking products, as these non-interest-bearing balances have increased 31% in the quarter. The major themes influencing our provision expense in the first quarter are consistent with comments made by both BJ and I on our last earnings call. We are a growing bank, and as such, our group provision, as BJ just noted, will increase nationally with our growth. And this is a difficult environment for small businesses. Even with the 100 basis points Fed cuts in the second half of 2024, rates still remain elevated for many borrowers that originated their loans back in 2020 through 2022. Inflation levels have proven to be more stubborn than expected. COVID-era government stimulus benefits are dwindling, and now they face a potential new challenge with tariffs. We continue to work with our borrowing base to help them navigate this environment, while also ensuring that our reserves adequately consider the potential risks at hand. Now let's unpack the quarter performance a bit more on the following slides. Slide 15 highlights our loan originations by vertical and business units. As shown on the right-hand side of the page, Our Q1 2025 loan origination totaled approximately $1.4 billion, relatively flat in Q4 of 2024, and 73% higher than Q1 of 2024. 60% of Q1's loan production came via our small business banking team, primarily in the form of SBA 7A loans, a 55% increase year-over-year. And 40% of our Q1's loan production came via our commercial lending team, a 110% increase compared to the prior year. You can see the year-over-year vertical view on the left-hand side of the page, with more than half of our verticals originating more production in Q1 of 2025 than they did in Q1 of 2024. Slide 16 illustrates the quarter-over-quarter loan and deposit balance growth, highlighting the strong, consistent growth trends on both fronts. Loan balances were up 5% in the quarter and 20% compared to the prior year, continuous consistent loan growth. As I mentioned, we had a very strong Q1 in terms of customer deposit growth. The approximately 8% quarter-over-quarter growth was nearly double the Q1 growth we experienced in Q1 of 2024. Net interest income and margin trends are highlighted on slide 17. In Q1 2025, we saw our quarterly net interest income eclipse $100 million for the first time in bank history, with approximately $101 million of net interest income Our net interest margin also expands five basis points to 3.20%. A few other highlights from this page. Consistent with commentary from our last earnings call, in addition to Fed actions, our loan growth will continue to be the driving factor influencing our net interest income going forward. Our margin continues to be supported by the great pricing discipline of our lending teams. Our loan production yields of approximately 8.14%, noted in the second bullet on the top right, are approximately 80 basis points above our current portfolio yield of 7.35%, as shown in the top of the table in the middle of the page. There are two primary factors driving our cost of funds. First, our growth. We continue to put up strong loan growth results each quarter, and the pipeline is not slowing down. As such, we must position our products in the market to remain competitive to support our strong loan origination. Secondly, while we have seen more downward repricing activity in both the consumer and business savings markets, the funding market in general remains competitive, and there continues to be an influx of new market entrants. Our 20% downwards beta on consumer savings has been intentional, as that is where we are seeing the most robust growth thus far. Meanwhile, we have been able to reprice our business savings down over time, now at a 50% beta, which is largely in line with the broader business savings market betas. We are continuing to focus on strategies to lower our savings rates faster while still achieving the growth needed. Lastly, on this page, the CD market has continued to provide near-term tailwinds as our CDs have renewed into rates approximately 84 basis points below their maturing rates, as highlighted in the middle of the page. Guaranteed loan sale trends are shown on slide 18. The demand for government-guaranteed SBA loans on the secondary market remains strong. providing consistent gain on sale revenue and recycling liquidity back into the bank. We sold $266 million of SBA loans in Q1 for a 7% average premium, generating approximately $19 million of gain on sale. We are also beginning to see the benefits of our focus on small loan SBA origination, as small loan SBA sales provide for approximately 18% of the loans sold and 22% of our Q1 gain on sale. Expense trends are detailed on slide 19, With expenses increased approximately 4% in late quarter, as expected, this increase was due to the both annual salary adjustments taking effect, typically the largest driver of increases from Q4 to Q1 each year, seasonal increase in FICA payroll taxes, as well as good costs that are growth-driven. No change to our expense management strategy since our last earnings commentary. We are focused on achieving a positive annual operating leverage by aligning both current expenses with current revenues. Yeah, we are cognizant that we are a growth bank, and as such, we will continue to focus on good calls to support our lending and funding growth, invest in our back office to support our complexity, and involve our technology and product strategy. Credit quality trends are detailed on slide 20. Our current loan portfolio is split 65%, 35% in favor of small business banking over a commercial lending segment, with, as BJ noted, approximately one-third of the total portfolio government guaranteed. Despite the elevated provision expense for the quarter and us still working through the small business credit cycle that we discussed on our last earnings call, we are starting to see some positive signs as we aggressively monitor our portfolio. Past dues remain low in Q1 of 2025 at $10 million, or approximately nine basis points of our total held for investment loan portfolio. That is the second consecutive quarter of low past dues and is a good trend. Although not accruing classified loans increased quarter-over-quarter, the rate at which they have increased has slowed compared to the second half of 2024. Total classified loans increased five basis points quarter-over-quarter, much less than the increase in the second half of 2024. This is encouraging as we did not see a substantial deterioration in the portfolio and downgrade migration within the quarter. Now, while our net charge-offs historically have been choppy, we continue to actively identify impairments and generally reserve for them ahead of charge-offs. Said another way, you may see instances of larger net charge-offs in future periods, yet generally the bulk of those charge-offs have already been reserved for prior to the charge-off event. We still have some road to cover within the current small business credit cycle and are monitoring the macroeconomic uncertainty and potential impacts, yet we believe that our current reserve levels are healthy and well-positioned given the risk within the portfolio. Thank you all for your time, and with that, I will turn it back over to BJ for his closing comments before we head to Q&A. Good deal.

Thanks, Walt. It's always a good time to focus on controlling what we can control, and that's exactly what we're doing. Great things are happening at Live Oak, and we will continue to help small businesses manage, grow, and prosper. So with a big thank you to all Live Oakers and our customers, let's take some questions.

Thank you, sir. Ladies and gentlemen, if you do have any questions, please press star followed by one on your touchtone phone. You will then hear a prompt that your hand has been raised. and should you wish to decline from the polling process, please press star followed by two. And if you're using a speakerphone, you will need to lift the handset first before pressing any keys. Please go ahead and press star one now if you have any questions. First, we will hear from Kristen Lund at Piper Sandler. Please go ahead.

Thank you, and good morning, everyone. First, can you just give us your latest thoughts on the margin and NII trajectory? margin expanded in the quarter and in the past you've talked about getting to around a 350 margin by the end of the year early next so curious on any update there and how you'd expect the cadence of the margin to be in this environment which I which I understand is uncertain throughout the rest of the year thanks hey Kristen this is Walt uh thanks for the question um yeah I think you hit on the last part of that this is a extremely difficult environment

I think the best approach right now is just to take a step back and generally look at our interest rate risk position and our profile. We're an asset-sensitive bank with both our lending and our funding primarily tied to the short end of the curve. So as you think going forward, I think the best approach is to take that knowledge and that perspective and apply whatever economic forecast you think may make sense. Our aspiration has always been up and to the right, and that continues. But I think right now with the market and the way it is, you've essentially got to control what you can control, as BJ noted, and kind of go from there.

Thanks, Paul. I appreciate that. And then just one last question for me on loan growth and your pipelines. You continue to put up solid growth in loans and originations, and I know you're a growth bank, but Do you believe that now is the right time to be growing meaningfully, just considering the uncertain macro we're in and the small business credit cycle you've mentioned last quarter, this quarter, and that you're going through?

Yeah, great question, Crispin. You know, we are constantly looking at the quality of the production that we're seeing, and we're still very comfortable with the activity on both the – small business side and the commercial side. We are very active in terms of understanding the credit box being disciplined around what we will approve and what we won't approve. And so we continue to constantly monitor that, but we continue to feel comfortable with the activity and the growth that we're seeing.

Thanks, BJ. I appreciate you both taking my questions. Thanks, Kristen.

Next question will be from Tim Switzer at KBW. Please go ahead.

Hey, good morning, guys. Thank you for taking my questions. You too. I wanted to ask a few about some of the recent changes made at the SBA. My first one being about the impact of the return of the 55 basis points on the lender's annual service fee. Can you walk us through on, does that impact loans that have already been originated? And how is that fee paid? Is that paid by you guys now? Are you able to pass that on to people who have purchased the loan? Meaning that can maybe result in a increase in expenses for you.

Yeah, so it doesn't impact existing loans. And so small dollar loans, borrower fees that are being reinstituted are paid by the borrower as part of the loan. They're still relatively small. They've got a gradation that essentially starts with a lower percentage for small-dollar loans and goes higher as the loan is larger. We don't see a material impact on this as it becomes just part of the lending closing package. It's essentially a rollback to what the Trump administration had prior to the Biden administration. And so that's kind of how we all normally operated before. And so as long as that's very clear to borrowers, we don't see that as a particular issue. We do think that on balance, this is actually going to be better for us than other participants in the industry. As a matter of fact, we've already seen some smaller dollar lenders, particularly FinTech oriented lenders or those that are heavily reliant on simply doing small dollar loans very quickly without a lot of oversight or documentation already backing away because of the changes in the SOP. Because we have always done SBA lending from a full underwrite perspective, we know exactly how to do that, and we're building technology to do it more efficiently and in an automated fashion. So we think we're going to be incredibly well positioned to take advantage of disruption that might be caused by SOP changes.

Okay. I have a follow-up on those. underwriting requirements you've referenced. But I want to be clear on that lender's annual service fee. From my understanding, the SBA says that that cannot be passed on to the borrower. So that 55 basis points that's paid each year that got re-emplaced, can you just explain, I guess, like who exactly is paying that to the SBA? And then if you have any ability to pass that on to anyone else? Yeah.

That's been going on for years. The 55 basis point trail is that in the origination fees from the program. It was unprecedented on October 31st of 2023 when the Biden administration basically came in and said, every loan under a million dollars, no more origination fee. Every loan under 500,000, you do not have to take all available collateral. And we're just going right back the way it's been for 70 years, right back the way it was in the first Trump administration. We did not make those changes, particularly under loans under $500,000, where we did what we always do, which is take a general security interest in all the collateral of the business as opposed to eliminating that the way some of these charlatan lenders have done. And as BJ said, it looks like some of those folks have lost their funding.

Okay, got it. Thank you. And on the change in the underwriting requirements, I know that the rollback of that was or I guess the lower underwriting requirements is one of the main reasons Live Oak decided to get in to start Live Oak Express and get in the small dollar space because it would be a lot more efficient. How does this change the profitability of those loans for you? I know you get a better gain on sale margin, but now that you have to do the full underwriting, obviously this is your bread and butter, but can you talk about how that kind of changes the profitability of Live Oak Express relative to before?

Yeah, so this is BJ. I really don't think it's going to change the profitability because I think as we've talked about several times, we're building technology to make it simpler, easier, faster, more efficient to do these loans and actually our larger dollar loans over time. I think what it's going to do though, Tim, is instead of being able to close and a handful of days, which was our target because of easing of documentation and tax stock requirements and equity injections and those types of things on the smaller end. We're going to have to require those. So it's going to take a little bit more time to close these loans, but I don't think it's going to impact the profitability because of the automation that we are building. I do think it's going to impact the profitability of those lenders that solely focused on small dollar loans and built their platforms around just taking in applications and sending them through without a lot of oversight. We were doing a lot of this stuff already. even on the small dollar loans. So again, I don't think it's going to impact our profitability, might impact a little bit of the time to close.

Got it. Makes a lot of sense. Thank you for all the color. Thanks, Sam.

Once again, ladies and gentlemen, if you do have any questions, please press star followed by one on your touchdown phone. Next, we will hear from David Feaster at Raymond James. Please go ahead.

Hi, good morning, everybody. Hey, David. You touched a lot and we've touched on it a bit. You guys have been very proactive with credit. There's a lot of uncertainty and volatility in the market. I'm just curious, as you dig into this, where are you focused on? What are you watching more closely? Are there any segments where you're seeing more pressure? Just high level, how do you think about the impacts or what segments may may be more impacted from the trade wars and tariffs or even Doge, and just your approach to managing those.

Yeah, good morning, David. It's Michael Carnes, Chief Trade Officer. Thanks for the question. So, yeah, I guess just to kind of give you some insight into what's been happening here at Live Oak over the last quarter and what you can't see necessarily in the numbers yet today is our servicing team is super dedicated. uh to understanding the portfolio particularly on uh the sba side of the equation our small business borrowers which is what has been impacted and things haven't uh there hasn't been additional stress or pressure we're still navigating all of those things we talked about last quarter with economic challenges over the last few years and interest rates rapidly rising and our teams are dialed in we're looking across the entire sbb portfolio and our commercial portfolio we have a holistic approach so there are industries think about auto dealerships government contracting where we are skeptical of new transactions given the uncertainties related to government action but overall our servicing team is all over the portfolio and additionally I'm inspired every day by the leadership of our servicing team. We have very customer-focused leaders, but also credit-minded. And so I'm cautiously optimistic about where we're headed from our portfolio standpoint. And the other things that give me confidence is things that BJ and Walt have already identified, which is really having consecutive quarters of low past dues is an encouraging sign. And the flat classified long pool and lack of growth there is also very encouraging for me. So I don't think we're out of the woods, but cautiously optimistic about where we're at.

Yeah, I'll just add a little bit, David. Just overall, you know, in my opening comments, I've talked about You know, if you're a believer in Cecil, we are proactively building reserves and have well in excess of our charge-offs over the last several quarters. And you can tell by how we are moving through the portfolio, whether it's looking at classified, whether it's looking at non-accruals, whether it's looking at how we're reserving, how we're tightening down on past dues, we are not kicking the can down the road. We are aggressively getting in front of any of our borrowers that we think may have an issue and helping them through this time. And if we can't, we are moving them through our risk rating system to classified, criticized, and to loss if we need to. So we're not waiting around and hoping things get better. To Michael's point, absent what's going on in the environment with tariffs and inflation uncertainty and everything going on in DC, I would have said we were in the latter half of the innings as it relates to getting through the small business credit cycle that we've been in the last two quarters. Uncertainty in the environment now, You know, who knows? But again, I point to how proactive we've been getting things through our pipeline, what the front end, the past dues look like now, and how healthy our reserves are. So, you know, I'm incredibly proud, like Michael is, of the entire team. We take credit incredibly seriously here, and it shows with how we are making sure that this place stays as safe and sound as it possibly can, and we help small business borrowers exactly when they need us to help them.

And maybe... Yep, sir, go ahead. Sorry, and BJ, I think that if you look back a year ago, we've tightened the credit scripts here a little bit. We are not doing some things that we did a year ago, but the pipeline still continues to fill each quarter with a more discerning situation from the credit department.

And maybe just, just digging into that, you know, one of the things we've spent a lot of time over the past couple of years touching on credit and, and what makes y'all different. And one of the things that I think is really important is kind of that, that, that we've talked about is the verticality of your business and how that gives you not only opportunities for growth, but also helps on the credit side. I, you know, basically as your, as your bankers are sometimes consultants, right. Could you talk about how that's playing out today? Where is that verticality, you know, where are you seeing the most benefit of that verticality to manage risk? And is that playing out kind of how you expected?

Go ahead, Michael. Yeah, I mean, well, one area where we have really leaned in to our vertical experts is with the uncertainties related to tariffs, right? So we take the lead from our lenders who know those industries inside and out as to where the pitfalls could be based on government action or changes in administration's decisions. And so we, in credit, take their lead and provide that data and insight to our portfolio managers and servicing people. And that has made a big difference in just being educated and being able to educate our borrowers as well.

Well, and I think an example too there, Mike and BJ, would be we had our broadband people present to the board the other day. And four or five years ago, we had an expert that came on our payroll to help us understand how we could make SBA loans to rural broadband providers. And now our own Pierce-Furjack knows more about that business than just about anybody on the planet. And we're moving away from SBA loans to conventional loans. So it's the It's the progression and the maturity of the theory of verticality.

Okay, that's great. And then just maybe last one, you know, two initiatives that we've been focused on, you know, one was the syndication side that was supported by the Simply investment and then embedded finance. We've talked about those a bit, but, you know, in the past, I was just hoping you could give us an update on those two initiatives and maybe some, you know, other things on the horizon that you're working on and excited about.

Yeah, we talk about a couple of things here. One is, particularly in this environment, I've said multiple times to our people, let's keep the main thing the main thing right now, which is being a great lender and building out our deposit platform, particularly checking. At the very same time, we have this spirit of innovation from the founders that we're constantly looking for new ideas and things that are going to help us grow and pay off in the next 3, 5, 7, 10 years. Incubation of Simply, like you mentioned, is a great, great example. We had one of our developers that had this idea. He was working closely with our head of syndications at the time. They felt like there was a better way. They came to us. We incubated it internally for a year. And then once it was ready for prime time, we then raised some seed money from some outside investors and spun that out. And that's that, whether it's that or whether it was, you know, some of the embedded banking work or some of the other things that we're doing around Live Oak Express and building a brand new technology platform with a very, very next generation AI driven partner. We're doing a lot of different things to try to build the business for the long term. But I also say, David, it's like a tale of two cities right now. We've got so much momentum from loan production, deposit production, checkings ramping, small dollar loans are ramping. Our revenue is expanding. Our expenses are well controlled. Yet the other city is, you know, we're helping small business borrowers work through a credit cycle. And so, you know, we've just got a lot going on, but we've got to make sure that we're just controlling what we can control right now, get through the environment. And I think once these clouds clear on credit, I think people are going to refocus on the strength and power of the business model that we're continuing to build.

That's great. Extremely helpful. Thanks, everybody. Thanks, David.

Thank you. And at this time, we have no other questions registered, so I'll turn the call over to Chairman and CEO Chip Mahan for final comments.

Thank you, everyone, for attending our Q1 call, and we shall see you in 90 days.

Thank you, sir. Ladies and gentlemen, this does indeed conclude the conference call for today. Once again, thank you for attending. And at this time, we ask that you please disconnect your lines.