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Live Oak Bancshares Inc
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Good day ladies and gentlemen and welcome to -- pardon me. Thanks for calling ladies and gentlemen and welcome to the Q1 2018 Live Oak Bancshares Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded.
I'd now like to introduce your host for today's conference Mr. Greg Seward, General Counsel of Live Oak Bancshares. Sir, you may begin.
Thank you and good morning everyone. Welcome to Live Oak's first quarter 2018 earnings conference call. We are webcasting live over the Internet and this call is being recorded. To access the call over the Internet and to 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 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 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.
I will now turn the call over to Chip Mahan, our Chairman and Chief Executive Officer.
Thanks Greg and good morning all. I'm going to talk about for a few minutes the future of our platform, a few industry observations, and then going to turn it over to Neil Underwood to discuss next generation technologies, and Scott Custer will take us home and talk about our wonderfully profitable bank.
First of all, let me unpack the first slide, scalable business model that we show every time. And before we do that, a comment on where we are in this cycle. I think this is La La Land, we see banks throwing money at small businesses. Everybody is in the SBA lending business. I was speaking with the Head of our Trade Association yesterday and we started this business, the annual conference, had about 400 attendees. This year's conference may have 1,200 attendees.
So, everybody is out there and so specifically, we saw a few weeks ago, a money-center bank, veterinary loan, 100% financing, 20-year loan in the mid-fours. Regional bank done deal, 100% financing, 25-year and 15-year balloon in the low fives, ladies and gentlemen, we are not in that business. We will never be in that business.
Okay so what is the plan for success? More verticals? Yes. If you look in this slide and 3.0, you see in the last 15 or 16 months, we've added six new verticals under Jason Lumpkin's leadership.
Last time we talked about an R&D project. So, is it possible to address the 4,800 SBA lenders affectionately called by our industry BDOs, Business Development Officers, which I personally can't stand? So, can we hire folks that are incredibly experienced, that understand both safety and soundness and the rules of the SBA 7(a) program and become a big part of our culture not commission sales folks, but understand taking care of the customer like they're the only customer of the bank and making sure we lend money to folks that have [the tiger]. Case brought on five of those folks in the recent past and as12 in the pipeline. So, can we grow this business? The answer is yes.
Now, if you look at production which we typically do on this slide, I would focus on where we are as of tonight. So, last year and 2017 that number of $583 million goes to $587 million and so far year-to-date that $554 million goes to $563 million. So, there's a couple of billion dollars in originations in our feature, sure. Is that pretty good for a $3.5 billion bank originating $2 billion here? Absolutely. That said, we're much more of a recurring revenue bank than we had been in the past and you'll see more of that in the future which Caines talks about in his comments last night.
Now, to do all this, we need a deeper bench. We're incredibly excited on looking across the table at Susan Janson many years' experience, both in the banking business and with the Federal Deposit Insurance Corporation as well as [Indiscernible] joining us in the fall.
And moving onto the next slide, the only thing that I want to point out here is again the operating leverage. So, if you look at the Vertical 1.0 section. Started off with the vets, all the way to chickens in 2014. Each of those verticals has somewhere between on the low end five or six folks and family entertainment maybe up to 20 folks in the health care division.
Obviously, if you add up all the revenues from interest income on unguaranteed paper, the servicing revenue to gain on sale dollars, nowhere near the operating expense involved in those groups.
So, just a word or two about what's going on out there and in our humble opinion, I could not help moving onto the next slide -- in the middle section of this slide. "Goldman Sachs' stock fell Tuesday after it reported earnings when management explained that it would suspend share buybacks for the quarter." So, you, the bank stock investor, provide us precious, capital certainly as you did in the fall of last year. I can assure you one thing; we will not give you your money back. We will deploy that capital in a thoughtful fashion.
It gets better. Let's turn the page to the next slide. The current obsession with deposit betas. The last line, "Morgan, Wells, get fat profits by skimping on savers as rates rise." Move up a section. "The metric to watch is the deposit beta. Essentially the percentage of each Fed rate hike that gets passed along to customers. The higher the number, the better it is for savers; the lower the number, the better it is for bank profits."
Let's move to the next slide. Really. Could it be that our model is broken? Could it be that the distribution system of tellers and CSRs and branches is under scrutiny? Let's think about for a minute cell self-service and full service, right. So, I would ask you this question. When is the last time you called the call center at Apple? At Uber? At Amazon? So, if you look at the Amazon Web Services slide, you see that the richest man in the world created an overnight wonder beginning in 2006. And it looks like in 2018, that business will generate in excess of $20 billion in revenues by letting others use their cloud-based services platform. Is he investing in the future? $10 billion worth of capex in 2017. Now that's not just Amazon Web Services, that's the entire company, he does not split that out.
So, I have never seen the glee in the eyes of our software developers as I have that Apiture, Finxact, Payrailz, and others that Neil and I talked to. And it is true that our Payrailz team 40 price decreases from Amazon Web Services in the last 18 months.
Moving on to my last slide before I hand this over to Neil. Things are going swimmingly at our joint venture with First Data. That company has been renamed Apiture. That business services about 550 banks in a data center in Austin, Texas. So, you should think of guys and gals walking in with badges and blinking lights and servers. It is our estimate that that data center cost us $6.5 million today.
Neil and his team are in the process of taking that 20-year old technology, lifting it out of that data center, putting it on the services of Amazon Web Services and the cost goes to $750,000. Not so fast.
When Neil finishes writing the new code, the cost goes to $100,000. That's right. $6.5 million to $100,000. So, can we as an industry elegantly serve our customers in a fully digital fashion? Neil is going to tell you about that.
So, point of clarification, I'm actually not writing the code myself. We have a fantastic team that's doing it. Thanks Jeff. Turning on to the next slide, you're going to hear a term out there by the name of cloud native or server lists, or born in the cloud. And it's a new highly scalable way to deploy code. I think we're at another inflection point when it comes to cloud computing. And when you look at total cost of ownership of a financial institution and certainly ours who have to operate digitally, this must be considered.
The old way of starting a data center, you had to consider peak loads and have tons of excess capacity. You then had to double everything in considerations for business continuity and fault tolerance. This architecture just allows us to pay for what we use, kind of like cell phone minutes and allows us to scale at massive levels. And you get that Amazon is right at the center.
Moving on to the next slide. This slide demonstrates Live Oak Bank's digital deployment plan, all cloud native. You can see these companies, by the way, many of which were inspired and incubated by Live Oak Bank and/or Live Oak Ventures to solve the problem.
It's a busy year at Live Oak Bank relative to these platforms. While nCino and Apiture are been deployed for some time and are driving massive efficiencies, we were really busy deploying Finxact, which is a next-gen core-as-a-service on top of AWS and Payrailz, which is a payments platform also on top of AWS. We intend to have these projects live by year end and should be seeing some of these efficiencies in 2019.
I love this next slide because it demonstrates the power of the platform and how our deposit engine is humming. Last year our total deposit originations were $839 million. As you can see, we originated $515 million in Q1 alone. And Q1 of last year, the total combined is $1.35 billion, but I think the interesting point is we only had to hire six people to support that $1.35 billion.
We are laser focused on efficiencies and transfer account openings per FTE are very positive. In addition I'm proud to say that as of yesterday, we won Bankrate's Best Online Savings Account for Ease of Use Award and I'll share an excerpt from that award with you.
"While other online banks may offer higher APYs, Live Oak Bank's online and mobile tools have great functionality. All functions are available on both the app and online portal. And get very high ratings from users both iOS and Android versions. Among other great features like mobile check deposits, you could view balances on external non-Live Oak accounts on the bank's app, a highly unusual feature." And maybe my favorite excerpt.
Typically, the mega banks are seen as the organizations with the kinds of resources and organizational heft needed to build great technology. Live Oak Bank has partnered with FinTech giant First Data Corporation in a joint venture named Apiture to develop technology solutions for financial institutions and its customers. The point in all of this being we don't always have to pay a higher rate and client experiences matter in our mission of treating every customer like they are the only customer in the bank.
Scott, over to you.
Thanks Neil. And before you move on and pass that slide 11, the power of the platform, just one final comment on it. For a traditional banker like me those are really almost staggering numbers in terms of deposit growth, new deposit, new deposit account acquisition in a quarter and maybe that number there doesn't get as much airtime as in the middle of the page and that's the 78% renewal rate in our CD book.
And you say okay, we're an online digital bank, we're just growing that with price and we're just out there top of the market. But we're also keeping and retaining almost 80% of our of our CD book which is an amazingly good percentage if you were in a traditional branch bank and customers were walking in and talking to somebody across the desk.
So, I think we are cracking the code on not only efficiently growing deposits, but delivering a level of customer service through that channel that really has not been seen before and to me, that's -- as the slide says, that's the power of the platform.
Now, moving onto the bank and how it performed in the quarter and maybe in one simple sentence -- I've got three slides to cover, but in one simple sentence is the power of the business model, the momentum in the company continues. The trajectory of our earnings and the earnings power of the company is reflected here on slide 12. I would call your attention to three key metrics that I believe are important.
First top middle 45% growth in net interest income. I'll touch on that in a moment, but that is the ability of the company to retain more on balance sheet to create a more stable source of revenue. And you're seeing that growth year-over-year at almost 50%. Exceptional.
We're doing that while not really losing momentum on our non-interest income and our ability to grow our guaranteed loans that are sold and that number is up 18%, almost 20%. So, we're not really sacrificing that, so we had $247 million of growth there. So, -- excuse me, $247 million of revenue created on our loans that were -- guaranteed loans that were sold. So, both of those factors working together give us a robust revenue picture and if you really look at Q1 revenue 2017 to Q1 revenue 2018, total revenue on the business is up about 35%. I know most companies would gladly trade for those percentage increases.
Bottom right, I think you continue to see the business becoming more diversified. We're now below 70% of our loans on the books that are SBA loans to total originations as we begin to find new and different ways to grow our business and I think you'll continue to see that diversification continue as we move along.
The next slide is one we've begun to show each quarter because it does begin to show that indeed Live Oak is not a one trick pony. We're not just an SBA 7(a) lender and living on the gain on sale that we get quarter-to-quarter. But indeed we've now created a stable source of revenue. We're a bank that's $3 billion plus in assets. We've grown the balance sheet nicely. In a moment, we'll talk about how we're growing it prudently and safely.
But this slide -- this is under the heading that a picture is worth a thousand words. If you can grow recurring revenue 45% year-over-year, you can grow your balance sheet 43%, that speaks to an absolute sustainable business model and a -- and importantly for me, a consistent earnings trajectory that you can really forecast into the future.
So, you say with that kind of growth, what's happening to the credit quality of the company, are we still paying attention to safety and soundness? And as Chip always says, this really is job one. So, it's probably appropriate that it's the last thing we speak to. And it is a story that continues to be one of exceptional credit quality. We have a risk management framework and infrastructure here that every single Live Oak employee takes seriously and the results are right there.
I don't need to say much other than you get 15 basis points of charge offs. If you're a non-performing loans are the leading indicator of future losses, we've got a whopping $7.5 million of non-performing loans against our unguaranteed book only 22 basis points, again I would say just about every bank in the country would swap those numbers for their own. So, credit quality continues to hold very nicely and we're pleased with the results for the quarter.
Chip, that's it on your bank.
Thanks Cuss. And certainly open to any questions on the line.
[Operator Instructions]
Our first question comes from Aaron Deer with Sandler O'Neill. Your line is now open.
Hi good morning everyone.
Good morning Aaron.
Chip the loan origination numbers were down in the quarter, but based on the slide deck here, it looks like the first few weeks of this quarter anyway have been very strong. As you're looking at the pipeline and out through the year, it sounded like maybe you intimated that you expect to do about $2 billion in originations for the year, is that -- does that sound right?
Yes, I mean I think it's plus or minus 5% or 10% on that. Cuss, you might have a comment on that. You're a bit closer than I.
Yes, Aaron I'd say your point is well taken. We obviously know where production was for the quarter, it wasn't exactly where we wanted it. I can draw you six pictures on the scorecard as to why. But the important thing is that we're making all the sort of the mid round adjustments here that we need to make. The SBA SOP changes have affected the business, there's no doubt. Chip referenced some of the crazy competition that's making a difference no doubt. But when you take a look at the new verticals that we launched, where we just brought in new bankers that are bringing pipelines of business. When you look at the current pipelines, I feel very good about the -- about this quarter, about the rest of the year.
And look $3 billion plus bank, as Chip said, doing $2 billion worth of originations in a year that is exceptional. And we're going to hold to our standards both with respect to pricing, with respect to discipline around the tight business we go after and more importantly, the discipline around credit quality.
Okay, that's helpful. And then based on the kind of that production outlook and what's funding up in the book as well. And then how you want to retain versus sell, is it your thinking at this point that you'll probably sell something similar to the levels that you did in the first quarter as you look out through the year, so $250 million a quarter is that kind of a reasonable run rate on those sales?
Brett, help us out.
Yes. I would say I guess as you're thinking about your modeling, we'll continue to target as we've said we'll continue to target holding roughly 25% of what becomes available. That will ebb and flow on a snapshot basis of a quarter just based on timing of closing and timing of lend sales. But going forward, the volume we sold in Q1, I would say you probably won't see much growth over that volume throughout the year. I'd say it would bounce around that amount rather than forecasting any substantial increase in that sold volume.
Okay. And then maybe one for Neil with Finxact set to come online at year end and some of the cost saves that you -- if there's a correlation between any sort of cost saves that you've eliminated with the First Data data center what kind of cost saves might we expect as you shift over the core system to Finxact's as we go into 2019?
I think it's a great question. A couple of points. One as you know, the Apiture dev team, we're still supporting. So, when you think about that cost going away from 2019, there's one bucket.
The truth is I don't know the answer to the Finxact question. But my sense is it will probably follow the experience that Chip mentioned and possibly be 10% to 20% of what we're paying for today.
That said we are replacing a core system. So, I want to tamper, I added 90 days of contingency and we're trying to get friends and family Q3, but it is a new core and there are new things.
So, I don't know how much that model cost takeout relative to the core in 2019. I would draw your attention though as you calculate cost to funds and efficiencies to the power, even the current platform that's in place. The fact that we were able to put on a $1.3 billion with the six FTE and I think we'll continue to see that trend more favorably over time.
Okay. And then I guess related to that is -- where are the incremental deposit costs coming on at this point and how are you guys thinking about the funding that you've built, how is that going to be -- I mean can you kind of throttle back on what you've done in terms of the deposit pricing? Will you look to deploy liquidity such that we should see some pretty strong margin expansion here over the next couple of quarters?
Well, I'll defer -- I'll make a comment and then defer to Brett. I think NIM compression happened as a result of our increased liquidity. We don't see that continuing to go up and as was identified in the award that we received we don't have to pay top of market given the way the solution is being received. So, my sense is that NIM compression that you saw was a more like a Q1 type situation and I'll turn it over to Brett to add color.
Yes, maybe what I would add to that is as you're thinking about deposit rates, its -- I think that the environment we're in, it's a bit hard to forecast what those rates are going to do. It’s a very competitive environment currently for deposits. You can see online where our rates are relative to other folks and that's something that you can track in real-time throughout the quarter or even see where we've been over the past quarter.
Related to net interest margin, I would echo what Neil said the compression we saw from the end of Q4 through the end of Q1 was largely driven by the increase in liquidity. We felt like it was a smart and prudent time to strengthen our liquidity profile. We do plan to maintain a strong liquidity profile going forward, but we don't have I guess sort of maintain mode then strengthening mode, now it's just maintain that strength.
Okay, terrific. Thank you for taking my questions.
Thanks Aaron.
Thank you. And our next question comes from Jennifer Demba with SunTrust. Your line is now open.
Hey guys, it's actually Steve on for Jenny. First question here kind of just piggybacking on that last question here. Can you go through what made you guys so successful in generating deposits; was it just the online bank? I know there were some other initiatives you guys have been talking about to generate some of these deposits from your loan customers. What's the status on those?
Yes, I would say specifically the online bank those numbers, the $515 million were specifically tied to online CD originations and online savings originations. So, right now we're looking to continue to build out the platform and have alternative sources like non-interest-bearing checking. But given the move to Finxact and Payrailz, don't feel it's crude to do that given the conversions we acquired if we were to put it on the core platform. So, we're going to continue to diversify the products that are on top of the new cloud native platforms that I was referring to earlier.
So, this is a guess and only a guess. But that thing that you mentioned that came out last night at Bankrate.com that we're really the best of the best. I would assume that there are chat boards out there, these people that are shopping rates and online banks probably know that and talk to each other. That's probably helpful as well.
The banks that are on Bankrate and certainly looked at this kind of thing are Goldman Sachs, [Markus], [Indiscernible] Synchrony, all the usual suspects that are there and the [Indiscernible] pretty proud that our team was able to put something together to make that much of a difference.
I don't think it's going to be something where we don't have to be at the top, but we are going to still pay up as compared to non-interest-bearing account. So, that's why we're aggressively seeking completion of the cloud-based platform so we can offer non-interest-bearing checking accounts both to our customers, but also as I mentioned in the last earnings call to other e-commerce partners out there driving deposits as scale.
Okay. So, we should expect I guess that non-interest checking account sometime next year, right?
Yes, I think that's right, because we do want to put it on -- the alternative would be insert core here putting it on their payment platform like a CheckFree, on pay or their antiquated core and then we'd have a conversion right thereafter. And so we're going to keep writing this engine, keep investing in this engine until those other back office systems are there upon which point we'll launch additional products.
Okay. I guess other question also following up on what we just heard is -- so with just this online kind of deposit gathering and you guys winning these Bankrate Awards, it seems like you're pretty desirable as a place to go. How do you stop people I guess keep the liquidity kind of in line with loan growth?
Yes, you want to take that one Scott?
Well, I think you just -- it's like anything else. I mean you have two minds, it's a bit of a high class problem and you can manage it with rates, you can manage it with how you market the product. And so if we believe we're getting too much and we can just -- as Brett said, it becomes more of a maintained strategy than a grow. And then -- at this point though, we're still a loan origination machine and being able to fund ourselves with very reliable sources of funds is a good thing and I think we're proving we can do that.
Yes. The thing I'd add to that Scott us as rates go up, which they will, we don't have to be that sensitive. But at some point there are going to be those that care just about the rate. So, we could -- very manageable deposits to tell you it's a very manageable situation. We're going to pay up now, but at some point -- so we just throttle back right by not modifying the rates.
Okay. I guess this is more for Chip, can we talk about Live Oak Ventures, are you guys kind of looking to actively expand that portfolio? Kind of any other FinTech, either partnerships or acquisitions you would be looking at?
Yes, but I can't go into further detail.
The only thing I -- I'm not going to say anything, don't worry me. But the only thing that I would add is we've been consistent in talking on earnings calls about Live Oak Ventures being very small investments in technology companies. So, as not to use our beautiful Tier 1 capital that will fuel organic growth. And so I just want to remind you that these are minor investments up to this point.
Okay. So, should we think more partnerships than kind of full out acquisitions or?
Not acquisitions, but we'll continue to do what we've done in the past, make small bets. We always talked about the unbelievable nature of Amazon Web Services and the cost and how the software developers who love to develop on that platform and the feature functionality and we'll make small bets the folks have done for.
Okay. And then just kind of the final one, looking at kind of some of the verticals you guys are in now, where do you think kind of what innings are we in? I mean it's kind of Live Oak 1.0 kind of just static now, we're kind of there at just maintaining that kind of growing 2, 3, 4.
Well, I'll start and Cuss can clean up here. But right so; there are 1,100 industries that the SBA allows you to lend to. And we're in 20-ish, right. There are 4,800 SBA lenders and case hired three with 12 in the pipe. I think it's like 1.1 maybe I mean maybe second pitch first inning. I mean if I were you, I'd say like why are you only in 20. I mean that's the United States of America 50 states three times [Indiscernible] why can't you get to 200. Scott?
Four times, [Indiscernible]. I couldn't add anything to that. You're right. It's a -- we're very -- even though Live Oak has been at it 10 days, and many ways this is very early days in terms of what this business can be. And I'm encouraged by the comment I made in the fact that it's not just about verticals that lend themselves to SBA, that's always going to be a core strategy. But 70% -- less than 70% of our origination now is SBA 7(a). We're getting 32% of our business from non-SBA type business and I think you'll continue to see that grow.
Perfect. Thanks guys.
Thank you. And I see no further questions in the queue at this time. I'd like to turn the call back over to Chip Mahan, CEO for any closing remarks.
No closing remarks. See you next quarter, folks. Thanks for dialing in.
Ladies and gentlemen, thank you dialing in. This does conclude your program. You may all disconnect. Everyone have a great day.