LIVE-OAK-BANCSHARES Earningcall Transcript Of Q2 of 2024

James S. Mahan -- Chairman and Chief Executive Officer

Good  morning,  everyone,  and  we're  excited  to  tell  you  about  our  second-quarter  performance.

Firstly,  to  use  a  baseball  analogy,  I'm  instituting  a  line  of  change.  Appropriately,  BJ  Losch,  our

president,  will  be  our  lead-off  batter  today,  Walt  Phifer,  our  CFO,  will  be  on  deck;  and  even  more

appropriately, I will be in the hole to wrap things up before the Q&A. BJ?

BJ Losch -- President, Live Oak Bank

Thanks,  Chip.  Good  morning,  everybody.  Let's  start  on  Slides  4  and  5  together.  Second-quarter

results, as I hope you've been able to take a look at, are reflective of significant efforts by everyone

across the company here at Live Oak to grow our business profitably, and very importantly, control

what we can control.

And it showed up this quarter certainly in strong EPS and PPNR on both a reported and adjusted

basis in healthy loan and deposit growth, higher production and activity, and continued credit quality.

That's  what  we'll  demonstrate  over  the  next  several  minutes.  Momentum  is  building  across

numerous  parts  of  the  company.  On  the  lending  front,  our  teams  delivered  exceptional  production

and balance sheet growth results and healthy spreads in the quarter.

And  yet,  approvals  are  up  30%  from  this  time  last  year  and  pipelines  are  still  near  all-time  highs,

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both of which bode well for continued growth. As you can see on Slide 6, our focus on the basics,

growing  revenues  faster  than  expenses,  while  still  investing  in  good  costs  such  as  new  lenders,

verticals, products, and technology has resulted in exponential PPNR growth, up 33% on revenue

growth  of  11%  on  an  adjusted  basis  since  Q2  of  last  year.  Our  credit  quality  continues  to  be  a

hallmark.  The  result,  as  you  can  see  on  Slide  7,  is  very  healthy  reserve  levels,  low  levels  of

charge-offs, and significant reserve building, well in excess of charge-offs.

Importantly,  with  our  disciplined  credit  box,  deep  understanding  of  the  government-guaranteed

lending process, and an unmatched in-depth servicing and watch list process, results in an ability to

get ahead of borrower stress. And as we've discussed previously, we are proactive with provisioning

for  growth,  for  changes  in  portfolio  performance,  and  for  impairments  of  specific  loans  when

warranted. So we are well reserved if charge-offs occur. Turning to Slide 8.

While I'm certainly pleased with this quarter's results, as a growth company, I'm much more excited

about  where  we're  headed.  Checking  balances,  which  were  immaterial  six  months  ago,  crested

$125 million in the quarter and continue to build. Our new small-dollar SBA lending effort is ramping

up  quickly  and  will  be  a  meaningful  contributor  to  our  results  over  time.  Our  brand  and  reputation

continues to attract and retain the highest quality talent.

And we continue to heavily invest in the future through innovative technology and partnerships. The

flywheel is definitely turning at Live Oak and our ongoing opportunities to serve more of America's

small businesses are vast. So with a big thank you to all Live Oakers and our customers for a strong

quarter, I'll turn it over to Walt for some more highlights.

Walt Phifer -- Chief Financial Officer

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Thank you, BJ. Good morning everyone. As BJ just provided a high-level overview of the quarter, I'll

spend  the  next  few  pages  focusing  on  additional  context  on  trends  related  to  our  balance  sheet

growth, key revenue and expense components, and credit. Slide 11 highlights our loan originations

by vertical and business unit.

As BJ mentioned, we had a strong quarter of loan originations in Q2 with approximately $1.2 billion

of loans closed. This is 45% higher than Q1 and is our second-largest quarter in bank history. Two

items to note on this page. The first is on the bubble chart on the left.

Approximately 60% of our verticals have had a year-to-date loan origination volume at or above prior

year levels. The second is the strong performance by our SBB's specialty business units in Q2 2024

compared to Q2 2023. You can see this on the bottom right-hand side of the page as the Q2 2024

originations  for  Small  Business  Banking  and  Specialty  are  up  30%  and  88%  year  over  year

respectively. Our Energy & Infrastructure business unit has had a slow start in the first half of 2024

due to delays in loan closing timeline, yet that team has closed approximately $80 million of loans

thus far in Q3 and the pipeline remains strong.

Slide  12  illustrates  the  strength  and  consistency  of  our  balance  sheet  group  over  the  past  five

quarters.  While  many  banks  across  the  industry  are  seeing  minimal,  if  any,  loan  growth,  our  loan

balances were up 3% linked quarter and 14% compared to the prior year and this growth is net of

our loan sales and participations activity. Deposit growth is fueled by our customer deposit platform,

specifically our business deposits, which are up 8% linked quarter and 29% compared to prior year.

This is an outstanding story given how competitive the customer deposit market is today with many

banks  across  the  industry  struggling  to  grow  or  even  maintain  their  deposit  base,  especially  their

non-interest-bearing deposits.

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Slide  13  gives  a  little  more  detail  on  our  quarter-over-quarter  loan  growth  by  component.  The  key

takeaway from this page is that prior to our typical sales and participations activity, our loan portfolio

growth  was  7%.  That's  right,  7%  linked  quarter  as  new  fully  funding  originations  and  construction

loans  continue  to  drive  balance  growth.  Slide  14  unpacks  our  net  interest  income,  NIM,  and  yield

trends.

Our net interest income increased 1% linked quarter and is up 80% compared to Q2 2023. This is

primarily  driven  by  our  loan  growth.  Our  net  interest  margin  compressed  5  basis  points

quarter-over-quarter  due  to  a  full  quarter  of  interest  expense  related  to  a  $100  million  term  loan

added at the end of Q1 for growth capital of the bank. Absent this borrowing, our net interest margin

would have been flat quarter over quarter.

That's a great outcome. Now there are things we can't control and things that we can control. Some

things we can't control or when the Fed will reduce rates and by how much, the competitiveness of

the  deposit  market  or  other  macroeconomic  or  political  impact.  Now  these  types  of  things  will

certainly have impact on the slope of our NIM trajectory, yet we feel really good about the things we

can control, all of which will help our NIM performance going forward.

As  I  just  mentioned,  our  loan  growth  momentum  and  pipeline  remains  robust.  Growth  will  be  an

essential  component  of  our  net  interest  income  and  NIM  expansion.  We  continue  to  demonstrate

good  pricing  discipline  on  new  loan  originations.  Averaging  prime  plus  60  basis  points  or  9.1%  in

Q2,  thus  remaining  accretive  to  our  loan  portfolio  yield,  which  currently  averages  7.79%  and  our

increasing  cost  of  funds  since  Q2  2023  has  largely  been  driven  by  maturing  CDs  renewing  into  a

higher priced offering.

You  can  see  in  the  middle  of  the  page  the  substantial  headwinds  this  has  generated  in  2023  and

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2024,  as  that  portfolio  is  approximately  26%  of  our  deposits.  The  fact  that  we  have  been  able  to

maintain our margin over the last five quarters with this level of volume repricing at those significant

increases  is  a  great  outcome.  These  headwinds  have  slowed  in  Q2  2024  and  we  expect  our  CD

portfolio  repricing  to  provide  tailwinds  over  time  once  the  Fed  reduces  rates.  Quarter-over-quarter

fee income is outlined on Slide 15.

We sold $250 million in Q2 2024 for an average premium of 6%, largely in line with Q2 2023. Two

important things to note on our Q2 sales volume. We sold our first batch of small loan SBA 7(a) to

only $9 million in loans sold for an average premium of 11%. We continue to be excited about the

profitability opportunity on the small loan front.

The other item to note is given the improvement in the secondary market in general, we were also

able  to  sell  approximately  $40  million  of  season  loans  that  were  previously  underwater,  another

great  outcome  for  the  quarter.  Turning  to  expenses  on  Slide  16.  Our  Q2  2024  expenses  of  $78

million  were  flat-linked  quarter  and  increased  3%  compared  to  Q2  2023.  Our  teams  have  shown

great  expense  discipline  over  the  last  year,  even  while  adding  20  growth-oriented  FTEs  in  our

lending  verticals,  five  FTEs  in  our  treasury  management  department  to  support  our  business

checking initiative, and continuing to invest in the technology side of the house.

As  we  have  been  over  the  last  five  quarters,  we  remain  focused  on  adding  good  costs  where

needed,  while  continuing  to  identify  expense  efficiencies  where  possible  so  we  can  continue  the

positive PPNR trends that BJ just spoke on. Key credit trends are included on Slide 17. We continue

to be pleased with the performance of our credit portfolio in what's been a challenging environment.

Our Q2 $12 million provision was primarily due to loan growth, what we refer to as good provision.

And our linked quarter credit trends are generally favorable with non-accruals and classified asset

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ratios trending downwards. As you can see in the top left graph, our over 30 day past dues were up

linked  quarter.  This  was  largely  a  result  of  two  loans  with  a  total  of  $15  million  of  unguaranteed

balances. We are currently unconcerned about further deterioration of those loans at this time.

Given  our  highly  attractive  portfolio  characteristics  and  our  significant  credit  monitoring  activity  as

outlined  in  our  last  call,  we  remain  confident  in  our  reserve  and  the  portfolio's  credit  strengths.

Lastly,  Slide  18  highlights  our  capital  strength,  which  remains  positioned  well  to  help  support  our

growth going forward. Overall, as BJ said, it was a fantastic quarter. We were very pleased with the

outcome and we are looking forward to the continued momentum.

I will now turn it over to Chip to add his final comments before Q&A.

James S. Mahan -- Chairman and Chief Executive Officer

Thanks, Walt. Thanks, BJ. How do you hold us accountable, right? And I've been thinking about that

and reflecting on the last several years. And as I look back, yes, PPP, interesting.

We generated $80 million of fee income. Yes, we invested $13 million in Finxact and got back $135

million.  And  we  sold  the  business  to  Fiserv.  Yes,  we  invested  about  $3  million  or  $4  million  in

Payrailz and got back about $35 million.

And then we invested that money. We were a bit behind. Renato today has 130 folks. We needed to

beef up cyber, we needed to beef up data.

He  is  constantly  extending  our  moat  reference  to  the  express  product,  more  to  come  there.  So

where  does  that  actually  leave  us  and  how  do  you  --  how  should  you  hold  us  accountable?  Bank

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accountants create, in my judgment, a lot of mumbo jumbo. For instance, typical list of adjustments

to  revenues,  an  PPP-related  impacts,  servicing  asset  revals,  loans  accounted  for  under  fair  value

option impacts, any one-time gains from sale of fixed assets. Like this quarter, we sold an airplane

and had a gain of $6 million or $7 million.

Any  gains  from  investment  portfolio  sales,  fintech  investment  activities,  valuations,  and  realized

gains  and  losses  from  sales,  non-cash  gains  and  losses  from  investments  in  venture  funds.  Now

let's move to the expense side. Non-routine employee bonuses related to fintech gains, impairments

or  losses  from  sales  of  long-term  fixed  assets,  renewable  energy  tax  credit  impairments  and

wrapping up with litigation settlement expenses. You need to take all that noise out to see how this

business is doing.

So  I  thought  it  would  be  interesting  to  go  back  12  months.  So  from  6/30/2023  to  6/30/2024,  what

were the operating earnings of this business with all that noise out? $174 million. What was it the

previous  12  months?  6/30/2022  to  6/30/2023  $137  million.  I  don't  know  any  other  bank  that

increases operating earnings 27% year over year.

And to me, and lastly, the most exciting thing, BJ alluded to the wonderful origination quarter that we

had, which matched our previous high, which was Q4 of 2022. We left Q4 of 2022 with a pipeline of

$2.4  billion.  Today  it's  $3.6  billion.  So  those  good  costs  and  those  revenue  producers  that  have

finally learned the Live Oak way are out there generating high-quality loans.

And with that, we will be happy to entertain questions.

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Questions & Answers: