Live Oak Bancshares, Inc. Q2 FY2023 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Live Oak Bancshares Q2 Earnings Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. This call is being recorded today, Wednesday, July the 26th, 2023. I would now like to turn the conference over to Greg Seward, Chief Risk Officer and General Counsel. Please go ahead.

Thank you, and good morning, everyone. Welcome to Live Oak's second quarter 2023 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 & Presentations tab 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.

Good morning and thank you, Greg. Turning to page three, we are pleased to show significant improvements over the last two quarters. Core revenues were up, expenses were down. Charge-offs were low, and credit quality remained solid notwithstanding a bump in non-accruals regressing us to our historic norm. BJ and Huntley will unpack the details in just a minute. I'd like to pause here at mid-year and reflect on what has happened so far this year and where our industry is headed. Did you know 9,000 banks failed in this country between 1930 and 1934? Moving to slide four, we see the history of FDIC insurance providing stability to our industry. No more Jimmy Stewart's It's a Wonderful Life runs on the bank. That was until March 8th. A Twitter-led run on SVB took place minutes after they announced a $1.8 billion capital raise, exposing their mark-to-market losses in their bond portfolio. $43 billion went out the door on March 9th and it was over. Never had news traveled that fast. Never was a bank able to handle $43 billion worth of withdrawals in a matter of hours. Bank tech has changed. We are getting more efficient daily. AI will continue to fuel that fire. So liquidity reigns. Rates are up 500 basis points. But what about the customer? I have been waiting for this moment for 28 years. It was 28 years ago we put the first bank on the internet. Can you remember or imagine a 28K telephone modem in 1995? I thought then as I think now: why the need for these expensive branches? Let's take a look at arguably the number one brand in banking. This quarter, Bank of America released some data publishing a slide on their consumer bank. The rate paid on all consumer deposits was 22 basis points. The cost to gather those deposits was 137 basis points through almost 4,000 branches and an untold number of tellers and CSRs. On the self-service side, they have 37 million mobile users. BofA is a $2.5 trillion institution, whose deposit beta since 12/31/21 was 35%. Why do you analysts on this call applaud low deposit betas? Are we not as an industry celebrating shortchanging the customer? Our savings rate at Live Oak Bank has been 4% forever for both consumers and small businesses. With Live Oak's simple online account opening technology, aren't these 37 million mobile users vulnerable? I mentioned Bank of America only as a proxy for our entire industry in general. Quick question: if someone had just $10,000 to their name at a money market or savings account, isn't $400 meaningful to them? The fat underbelly of our industry is exposed. Our expensive branch deposit gathering model is broken. Just a word on self-service and full-service. My wife works out with a group of ladies trained by someone wonderful. He saw a billboard in Wilmington with our 4% savings rate and opened a savings account. He was astounded when he had a question and someone answered the phone in our bank. He called us back each of the next two days to test us. We answered the phone in 11 seconds each day. You need to do both. I like our model. For 15 years, we've been the best small business lending bank in America by treating every customer as if they were our only customer. We are marching to the deposit side at precisely the right moment in time. Our competition cannot reprice their entire book of savings and money market accounts. We shall nip at their edges as their customers feel less appreciated. The combination of our next-generation cloud native API technology will allow us to create new products and build a bespoke community bank for each industry we serve. While our industry remains woefully stuck in the mud, supporting and maintaining billions of lines of agent code that they call technical debt. Moving to slide five. Just a word on credit. I call this our CECL slide. Historically, that is pre-CECL, a bank would build a proper reserve, and usually that quarter’s provision was about equal to total charge-offs, not so these days. The complexity of building a model to predict lifetime losses in a bank that is growing the way we have is substantial. Here's a fun fact that as of last Friday, 76 banks have reported, and their collective loan loss reserve to total loans jumped 2 basis points from 1.21% to 1.23%, while we increased our reserve from 183 to 246 to 63 basis points. As you can see from slide six, our provision over the last 3.5 years has been four times our charge-offs incurred. Soundness, profitability, and growth in that order. One last word on production, we were not disappointed with our production numbers this quarter, even though we were a little over $100 million less than last quarter. Since Huntley and BJ do such a wonderful job running the bank day-to-day, I get to spend an extraordinary amount of time on the road visiting customers and prospects. We are getting better looks at the basket; higher quality larger loans are coming our way as the competition seems to be much more discerning, focusing more on existing customers and much less on prospecting for new clients. In our government-guaranteed lending business, it appears that the silver tsunami, or those baby boomers that are of age to sell, have seen prices come down as interest rates have risen. Some deals just do not pencil the way they did a year and a half ago. BJ, over to you.

Excellent. Thanks, Chip, that's a great setup. Good morning, everybody. It's great to talk to you this morning. Let's start on slide eight with a high-level earnings summary for Q2. While weathering the banking earthquake in the first quarter, as Chip talked about, we positioned ourselves to not only survive the aftershocks that we saw coming and know are coming, but to thrive. The key commitments we made about what we would do in the second quarter, such as strong deposit growth and liquidity, net interest margin performance, continued loan growth, stable credit quality, and moderating expenses were all exceeded. And while we can't predict with certainty what the economic outlook may bring, the actions we took in the first quarter, our performance in the second quarter, and the ongoing strength of our business model have set us on a strong path towards continued consistent earnings and customer growth over the next several quarters. To put some numbers to it, in Q2, we earned $0.39 of EPS, driven by strong 41% improvement in PPNR, both revenue growth and expense reduction, as well as continued strong credit quality, resulting in lower provision versus the first quarter. As Chip mentioned, loan production was still healthy at $860 million, but down from Q1 as activity was steady, but we had some loan closings moved past the end of the quarter. Pipelines have grown steadily throughout the quarter, which is encouraging for the second half of the year. Deposits were up nicely as well. Our customer deposit growth was up almost 7% in the quarter with fantastic business deposit inflows of 22% on a linked quarter basis. On our last earnings call in April, I shared our expectations for our net interest margin and I’m really pleased to say that while our forecast in April for the second quarter NIM was a decline into the range of 320 to 325 with the risk of further compression if we held excess liquidity, we actually ended the quarter with a 329 NIM even with about 12 basis points of drag from that excess liquidity. I'll get into a bit more detail on the reasons for our NIM resiliency in a few minutes and the positive net interest income growth expectations for the second half of the year. In short, it's due to the excellent efforts of our lenders along with our deposit and treasury teams to remain competitive with our customer offerings and disciplined on our pricing. Fee income was improved linked quarter with relatively steady gain on sale premiums. Expenses declined quarter-over-quarter, and we expect continued discipline here throughout the rest of the year, and provision declined as expected with only $1 million of net charge-offs and continued reserve build for both growth and to maintain sound portfolio management. Turning to slide 10, loan production in the quarter was again diverse across multiple areas with particular strength in our middle-market sponsor finance vertical, our solar business, and our general lending small business verticals. As others pull back on lending, we expect to see good opportunities for new business going forward and we look forward to capturing those opportunities. Let's turn now to our net interest income and margin trends on slide 11. As I mentioned earlier, our Q2 NIM outlook three months ago was a decline to the 320 to 325 range, with risk of further compression with excess liquidity, we ended at 329 even with that 12 basis points drag. We expected to see downward pressure on the NIM in the first half of the year because of the accelerated deposit repricing from the Fed's rate increase cycle, and that would be expected to be more rapid than the loan repricing. But in the back half of the year as our loan repricing flowed through the balance sheet and the Fed near the end of its rate increase cycle, we would expect NIM expansion. All of those things are still true, but we were able to both grow deposits and hold our savings rate flat since March due to our already strong rate offering while loan repricing tailwinds continued and our lenders remained very disciplined on new production yields, which should help with NIM expansion and net interest income improvement in the back half of the year. First on the deposit side, you see that we again provided information on both Live Oak and the top digital competitors as it relates to deposit pricing in betas along with the National Savings Rate and ending Fed funds upper rate for reference. As we discussed on the last earnings call when the industry crisis hit in mid-March, we saw customer outflows. We decided to move proactively and aggressively to reverse the trends we were seeing, moving the savings rate up a full 50 basis points to move modestly ahead of top digital competitors. And as you can see, it worked quite well to put us back on a positive customer deposit growth path. And even though the Fed moved another 25 basis points in the quarter, we were already in a highly competitive position to attract customer deposits, particularly on the business side, such that we were able to show outstanding deposit growth while holding flat on savings rates the entire quarter. And our through-the-cycle beta of 70% is exactly what we communicated all along as our expectation. Now let's take a look at the loans side. Our loan yields have been moving up nicely as you can see in the table, but we hadn't been moving nearly as rapidly as the deposit betas we just discussed, but two points we made on loan yields last quarter continue to hold true. Loan production yields are currently being booked at rates 175 basis points higher than the portfolio rates. See the 9.12% on new loan production yields in the upper right of the slide versus the 7.37% on portfolio loan yields in the upper right of the table. And secondly, the majority of our variable-rate loans are quarterly, not monthly adjusting. That means that unlike deposit rate changes, which happened intra-quarter, we don't see intra-quarter increases in loan yields. They move up the full change in the prime rate over the prior quarter on the first day of the following quarter. So as of July 1st, our quarterly adjusting loans saw another 25 basis points increase in rate, and about 46% of our total loan portfolio now is variable rate, and almost 90% of our current production is variable rate. Therefore, as our newer loans replace older loans over time, our portfolio yields will continue to rise, supporting stabilization and improvement in our net spread. So what's all this mean for the NIM? It means we still hold the belief that this should be the bottom for our NIM, and we should see some margin expansion in the second half of the year. This remains in an uncertain environment, so let me be very clear and transparent with our current assumptions here. First, the Fed, we believe, moves 25 basis points this afternoon and pauses for the rest of the year. Deposit betas move in the 70% range for that increase. Deposit growth for us continues on pace with the above beta assumptions and at levels that support our loan growth. Healthy loan growth continues on pace with current pricing and no further major industry disruption related to deposits or liquidity. And remember that if we do decide to hold more on-balance sheet liquidity, it may have an impact on the NIM but will have minimal impact on net interest income. So to recap, we had better than expected NIM resiliency in Q2 and we expect NIM and net interest income improvement in the back half of the year as deposit costs moderate, loan yields continue to improve, and earning assets continue to grow. Turning to slide 12, let's take a quick look at non-interest income trends. As I mentioned before, we had been seeing improvement in secondary market conditions with premiums and valuations before the mid-March events being steady to improving, and we were hopeful that premiums would hold at least steady after mid-March. Our SBA sales activity increased in the second quarter and the gain on sale premiums did in fact remain fairly steady. Though the majority of what we sold was variable rate, we did see some fixed-rate SBA sales activity, which was again encouraging. And as you know, our servicing asset revaluation and fair value mark on our held-for-sale loan portfolio, our mark-to-market assets and valuations are based on spot rates at the end of the quarter. While there will be continued variability as these assets are valued quarterly, we saw much lower volatility versus Q1 as we expected. Just to highlight a few more points on deposit trends on slide 13, you will see our deposit growth even through the events in March were very strong relative to the industry. As discussed, our repricing has been exactly where we expected it to be given the rapid rate increases, so we have not had to pay up for the excellent deposit growth that we've experienced this quarter. Quickly on slide 14, you see our key liquidity trends, which have been and continue to be very strong relative to the industry. Turning to expenses on slide 15. We are doing exactly what we said we would do. We are moderating our expense growth while continuing to grow revenues going forward. While we will always be opportunistic with hiring revenue producers, we are tightly managing our expense growth, and we are confident in our ability to consistently improve our PPNR and our efficiency ratio over the next several quarters. Our expenses are down linked quarter, and as you can see, we have held salary and employee levels steady for the past couple of quarters even while continuing to invest in next-generation technology as evidenced by the continued increase in tech-related expenses versus our total expenses. And we expect these trends to continue. Turning to credit trends on slide 16. As Chip discussed earlier, credit metrics remained strong. We continue to actively monitor the existing portfolio and do not currently see any glaring weak spots. Past dues are low, and non-accruals remain quite manageable as well. You can see that the credit quality trends across our three business segments are quite strong as well. As expected in the current environment, we've moved more loans to non-accrual status during the quarter, but on the bottom left of this slide, you see a five-year trend of our non-accruals. So, while Q2 of 2022 was an abnormally low quarter for non-accruals, you can see that this quarter's non-accruals to total loans of 109 basis points are consistent with the past several years. We only had a total of $1 million of net charge-offs in the quarter across an $8 billion-plus loan portfolio, very strong performance. And as expected, the provision declined even as our coverage increased. Our reserves to unguaranteed loans remain well above the industry as you can see. Slide 17 shows our overall capital strength, which continues to give us great comfort. We are well positioned to thrive in whatever environment lies ahead and continue providing growth capital to our small business customers. So with that, let's see if Huntley would like to wrap up with a few thoughts on our priorities for the second half of the year. Huntley?

Thanks, BJ. Yes, just a few thoughts on my end on page 18 and then we'll get to Q&A. Through a turbulent first half of the year, we really continue to demonstrate our resiliency. The balance sheet remains solid, Chip and BJ talked about it. Liquidity, credit, and capital all check the soundness box. As the banking industry tightened standards on lending and preserved capital, we're continuing to find opportunities to provide that capital to small businesses, and our teammates continue to go above and beyond in serving those small businesses and preparing us for the future. On the earnings front, BJ did a nice job talking about the solid results this quarter, and we really believe we're setting a new baseline for performance in the future with confidence in our margin, secondary markets and a focus on expense control that will generate operating leverage for profitability. As for growth, pipelines do remain healthy despite rumors to the contrary across America. Small businesses continue to thrive, and we continue to help them grow. As Chip referenced, we're really excited to announce that our full-service checking account is live, has been well received by our small business customers, and it allows us to transition to becoming a full-service small business bank. At the same time, we continue to invest in our future. We've upgraded our small business loan origination platform, which will allow us to better serve these customers and improve efficiency. We continue to build out embedded banking solutions to help the software power small businesses, provide banking services, and while there's a lot of chatter in that space lately, we're really excited that our straight-through API-powered solution avoids a lot of abstraction layers in the FBO accounts and the complexity that's caused some challenges in the industry to date. All of this is part of a multi-year journey to modern digital technology that will provide us with real sustainable competitive advantages as Chip laid out in his intro, but we're not holding out for the end state. Along the way, we will seek to deliver value and delight our short customers and our shareholders. The art for us is being able to achieve that future state while still continuing to deliver value for our small business customers every day and strong financial results for you, our investors. With that, let's go to questions.

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. Your first question will come from Crispin Love at Piper Sandler. Please go ahead.

Thanks. Good morning, everyone. First BJ, just putting some numbers around what you said earlier on the NIM. I think last quarter you said in the second half of the year that the margin could increase to the lower end to the midpoint of the prior 3.5% to 3.75% range. So, first, I want to make sure that still stands and then if you have any comments on the cadence of what you might expect the NIM to do in the back half of the year.

Yes. I think, Crispin, kind of, as I said earlier, a lot will be dependent I think on how much excess liquidity that we carry. We were obviously very pleased that we could absorb 12 basis points of NIM contraction with excess liquidity this quarter and yet still be above what we discussed with you all last quarter. And so I expect the net interest margin, and more importantly, the net interest income to improve in the second half of this year, assuming that the Fed moves today, which will create a little bit more of a back-ended improvement for that, if you will, because of the nature of our quarterly adjusting variable-rate loans. But by and large, we believe that we're still on that type of trajectory by the end of the year.

Great, BJ. That's helpful. And then Chip, you mentioned earlier in the remarks just being on the road with customers. So, I'm just curious from where you sit, can you provide an update on how you're seeing the health of small businesses currently, their demand for loans, and if there's been any major changes versus recent quarters?

Well, I'll give you two quick examples. So last Thursday, I went to California with our account officer in the ESOP division and met with two gentlemen who started an HVAC business 20 years ago when they were 23. They tried to get an SBA loan, couldn't. After six months, the bank couldn't even fill out the paperwork. They put up $2,000 and started their own business. Today, it's an $80 million revenue business and $8 million to the bottom line, and we're going to do an eight-plus figure ESOP on them. The headline there is it's awfully difficult for them to find help. Do you know that an HVAC-experienced person with 10 years’ experience makes $100 an hour? Yesterday, I went to Minneapolis and spent a better part of the day with a roll-up private equity group out of New York buying an asphalt company. Well, you know, the asphalt business is kind of interesting in Minneapolis, so six months a year you don't work and six months a year you do work, and an asphalt person makes $160,000 a year. Same thing, really hard to find talent and that usually happens for me at least a day or two a week, and both those businesses are thriving. Margins are up way beyond their expectations if they can just find people. I don't know that I actually answered your question, but I can go on and on.

No, I think that's helpful, Chip. I appreciate the color and that's all from me.

Thanks, Crispin.

Your next question comes from Steven Alexopoulos at JP Morgan. Please go ahead.

Hey. Good morning, everyone.

Good morning, Steve.

I want to start on credit and the increase in the unguaranteed NPLs. Could you just give us more color on what you call the two credits? What are the size of each credit, the industry, anything systemic, a little more color there to start?

Steve Smits, our Chief Credit Officer, is on point.

Yes, Steve, how are you doing? This is Steve Smits. Two credits, the first one is in our senior housing portfolio, it's a memory care facility. It is a collateralized project-level challenge, while they're seeing good occupancy, they are struggling with cash flow, which put them behind on payments. I will add that we did reserve due to the uncertainties with commercial real estate valuations. We did set a reserve, so we're protected on that side. I talked to the team; they're very confident that we're going to be able to trade out that somebody will have an interest in buying this real estate. So, I'm cautiously optimistic that we will most likely not see a loss on that credit. The second one is we are actually a participant in another lender's credit facility and it appears that our borrower had fraud perpetrated against them from a primary supplier. This all came to fruition in the final days of the quarter. We had to act quickly, so we placed it on non-accrual and set a pretty healthy reserve against it due to the uncertainty of fraud. I would say it's way too early to conclude how that's going to play out; it was a collateralized loan, however, with fraud you never really know. So, that's going to have to play itself out before I have a feel for whether we'll see any losses associated with that credit. As I pointed out, both, we put healthy reserves against them. So, I feel that we did the prudent thing. I will also point out, Steve, that if you pull these out, we would have seen our non-performers remain flat, which I think is how I look at the portfolio as a whole. We're just seeing very much stability and consistency but just a couple of outliers here. I don't see anything systemic. We continue to watch loans that we originated at the top of the market, specifically in change of ownership of 2019 or early 2020 originations just to make sure these new owners continue to be able to weather the additional challenges associated with the last couple of years that we went through. But overall, I feel pretty good that the portfolio is very stable.

Got it. Okay, that's very helpful color. BJ, I had a question for you on the NIM outlook. You've mentioned excess liquidity of your time, kind of putting that aside as a variable around NIM, but in terms of getting into the range of 350, 375 range. Do you need to draw down that excess liquidity to get into that range or could you get there if you maintain this liquidity through the rest of the year?

Obviously, it would be more helpful to get there if we drew down excess liquidity, but we have more than a reasonable chance to try to reach that level even if we're carrying excess liquidity, but it all depends on how competitive deposit rates get after this next move and if the Fed actually stands flat and we start to see some moderation. So, the point that I want to make sure we convey is we've talked last quarter and I've talked a little bit this quarter that we would see a V-shape to our NIM, right? That our NIM would compress into the second quarter but then start to improve in the back half of the year. That dynamic is still intact. And so whether it's up to a 350 level or just up 10, 15, 20, 25 basis points, either way, it's margin expansion, and I think that's what we'll say.

Got it, okay. And on the deposit side of looking at slide 11, you guys didn't change your savings rates in the quarter. CD rates are up a bit, but the rate had slowed, but you had very strong deposit growth. Could you give a sense of what's driving such strong deposit growth without needing to lean on rate? And do you think, I am thinking deposits are up somewhere around 20% year-over-year, do you think we finished the year now in that range?

We have a strong brand in both consumer and small business savings, and we maintain consistent rates for both. The competitive landscape differs slightly between the two, but we are positioned well in the market, particularly for business savings, which aligns with our identity as America's small business bank. Our reputation and marketing efforts have resulted in significant inflows from business deposits. Additionally, in preparation for our checking account launch, our lenders have been focusing on promoting deposits and savings accounts first, which is an important initial step ahead of implementing checking accounts. The success of our lenders in selling savings accounts has contributed positively as well.

Yes. Hey, Steve. I'll add just one thing. I think Chip touched on this at the beginning. Especially for business customers, there has been significant awareness over the last six months about whether their money is safe and what it is earning. Many business owners and finance professionals are realizing they can earn interest on business savings, which hasn't been widely discussed for some time. Therefore, I believe we are benefiting from this broader trend right now.

Got it. Okay. And then final question, I know you said that a few loan deals, it sounds like, were pushed out to the third quarter, but period-end growth about 8% annualized held for investment is a little more muted. How are we thinking about the second half? Because I think prior guidance was mid-to-high teens in that range for full-year. How are you thinking about loan growth now?

Yes. So I mentioned briefly that pipelines were still pretty healthy, Steve, probably up until the last two weeks of the quarter. We thought we were going to be at $1 billion in terms of production; we ended at $860. The vast majority of those loans, well over 90% of the loans that we thought were going to close by June 30 that didn't, have already closed in July. So all of that to say is we feel like pipelines and production are still going to be pretty healthy in the second half of the year, and that should drive continued loan growth. Whether it gets to the upper end of the range that you commented on, probably not. It's probably in the low-teens, maybe mid-teens by the end of the year.

Got it, okay. Thanks for taking all my questions.

Thank you, Steve.

Your next question comes from David Feaster at Raymond James. Please go ahead.

Hey, good morning everybody.

Hey David.

Hey Dave.

Maybe just kind of following up on the growth side, you guys have had a lot of success on the hiring front and attracting folks just given the unique business model and culture. Is the disruption that's going on in the market and you clearly being open for business giving you more opportunity for additional hiring opportunities? And I guess as you think about it, is now a good time for you guys to maybe be a bit more greedy while others are starting to pull back?

It's a good question, David. I think we agree with your sentiment that we're open for business and we do have the opportunity, and lots of folks call us and are interested in maybe joining what we're doing. But at the same time, I think we recognize with what's going on in the industry and where we are, that we do want to be more mindful around adding folks and so we're going to be really selective. We're going to add great folks when it's the right time and place to do that in specific spots. But I don't think as we sit here now, we have an ambition to kind of go on a talent land grab as we sit here. I think we feel really, really good about the team that we've got, and if we find a few opportunities, we're willing to go into those.

Okay, that's helpful. That makes sense. And then maybe just touching on the, you talked about a checking account rollout. We're obviously starting to see some growth in the non-interest-bearing side, which is great. I think last quarter you said you had 10 clients on-boarded. I'm just curious where are you having success? Are you starting to see more clients getting on-boarded there? And then ultimately, how does that play into the conventional lending side too because I know that's been another big initiative? So, just curious what you're seeing on that side as well.

Yes. So I think the last count, we've got 50 customers live and then continuing to make sure everything works, which it does well, and continuing to roll this out. The next step for us is going to be, as BJ said, marrying the deposit accounts with the loan opportunities and having folks on the road every day talking about this. And that's true for conventional lending where there's typically, as you know, larger balances, but it's also true in our day-to-day SBA business as well. So that's really the next phase of this and the third phase is where we go blast out to everyone outside our existing customers and prospects.

Okay. And for my final question, you have a highly diverse production engine with loans spread throughout the country in various sectors. This gives you a strong understanding of the market. I understand that it's challenging for borrowers right now. Chip seems to convey a cautiously optimistic perspective, yet you've mentioned higher rates and decreased demand. Looking ahead, what is your outlook on the economy? Are there specific segments that are facing more pressure or any warning signs you've noticed? Additionally, where are you currently identifying the best risk-adjusted returns for growth?

I got to tell you that over the past 50 calls that I've had on the road, I cannot remember one customer, mainly prospects. I'm focused mainly on prospects, saying the world is coming to an end. They're not saying that to me. Now that said, of our 35 industries, if I'm worried about one, it would be the pharmacy space. Margins in that business had consistently come down over the past 10 years, and while the 23,000 independent family pharmacists make a nice living, that's just about it; right? So, it's a $3 million revenue business with a 2% or 3% margin business, and it's just tough out there with the PBMs. I don't see it, and Huntley, maybe you have another…

No, I think you said it perfectly. We just don't see a macro issue. I think there are still some pockets, and I think as Chip said in his intro, business acquisition is a big part of what we do. And those deals, buyer, seller, interest rates, trying to figure out the right deal structure. We've seen that a little bit slow, but there're still really good deals out there. And then everybody talks about real estate; we obviously don't do sort of office real estate, which is I think what everybody is most concerned about. But we have seen situations where it feels like banks are pulling back from all real estate. And so we see some more opportunities in places that are secondary, tertiary related to that, and so in some ways, we see maybe some interesting opportunities there.

And I guess kind of with the whole idea that most of the conventional lending could be slowing and a lot of banks pulling back, do you expect that to push more folks into the SBA, and ultimately we could really potentially see growth accelerate kind of into next year and through next year?

I would say it would be more on our conventional space, BJ, that you spent some time in. I don't know that the SBA space is going to be much different than it always has been. I will say that I want to get my hands on every great SBA lending officer in the country. So as we can get qualified A&B players, we will continue to hire those folks, but the sponsors that we do business with primarily focused on the $5 million to $10 million EBITDA businesses and those folks have a lot of capital. So, we're seeing that area grow substantially.

Yes.

But I do think the more you read and we haven't seen this maybe in practice yet, but if banks do start to tighten up and pull back, etc., it ought to open up the market for SBA, right, in theory. We haven't seen it in practice yet, but we like the thesis, David. We're ready for it.

Yes. All right, sounds good. Thanks everybody.

Your next question comes from Brandon King at Truist Securities. Please go ahead.

Hey, good morning. Thanks for taking my questions.

Hey, Brandon.

Yes. So, BJ, I wanted to get your updated outlook on the secondary market. You mentioned how premiums were stable quarter-over-quarter, but what do you expect or bake in for the second half of the year?

Yes, I think we kind of see steady as our outlook for the second half. We're a little bit concerned after what happened in mid-March. A couple of the large buyers exited the market for a couple of different reasons, and so we were wondering what that would do to supply and demand dynamics, but the premiums have stayed fairly stable. So we expect that to continue throughout the rest of the year.

Okay. You also mentioned a slight increase in fixed rates in the secondary market. I'm curious if the premiums on those are appealing enough to restart that process, or if you could provide more details and context around that?

Yes, probably not. I mean, the vast majority is still variable rate. We did sell a little bit of fixed, which is encouraging. We actually sold little fixed in the first and second quarter, but it's certainly not where it used to be. So, most of the volume that we sell is going to be variable.

Okay, and then lastly just a broad strategic question. I've seen a couple of reports of other banks trying to push their presence into, let's say, SBA small business lending. Chip, I just wanted to get your thoughts on that and if there's any concerns on your part from more competition in this space or just kind of where they play is different from where Live Oak plays.

Yes. So, Brandon, we are pleased with our current position and our team. We appreciate the relationships we have with our clients. We're confident in our situation. We notice competition, which comes from banks depending on the VSOP, or from technology companies, but we are prepared for it. We are comfortable with the competitive landscape and will strive to excel in it.

All right, that's all I had. Thanks for taking my questions.

Your next question comes from Michael Perito at KBW. Please go ahead.

Good morning everyone. Thank you for taking my questions. I have a couple of quick ones. A lot has been discussed already, but I wanted to clarify on the expense side. Do you expect to maintain around $77 million a quarter in the near term? Additionally, what do you need to see, whether macro or otherwise, to reaccelerate the investment rate? I understand it's difficult to predict the growth rate for 2024, but I'm curious about your thoughts on the numbers and how you're considering the rate of investment in the long term.

Yes. Mike, we've talked about over the last year and a half that we had two different types of hiring levels, right? In 2021, we really had a hiring bubble to catch up our lending support staff to keep up with the increase in loan production we had seen, so hiring a lot of underwriters and hiring a lot of closures and those types of folks was kind of 2021. In 2022, we accelerated our technology investments in people and actual tech spend to again try to leverage some of the FinTech investment gain that we took to move ahead with some of the strategic projects on the tech side that we wanted to get done as quickly as possible, so those two things caused quite an acceleration. We've always and will always, to Chip's point, be looking for revenue producers because they are going to be very accretive to our PPNR in our earnings and our growth going forward. But right now, we feel like we've got a lot of the right pieces on the field from a people perspective in terms of revenue support as well as the technology side. We've just got to actually put it to work and make ourselves more productive, more efficient, and drive higher revenues. So, we do think that our expense growth will be steady as we talked about throughout the rest of this year at these types of levels, while our revenues continue to expand. And then from there into 2024, we fully expect to keep that kind of operating leverage momentum and take full advantage of the two years' worth of investments in people and technology that we made.

That's super helpful. Thank you. BJ. And then just one last one from me for Chip. Just you made a comment in your prepared remarks about focus on deposit betas and celebration of deposit betas. I guess it's an interesting point of view. I guess my perspective was a little different historically. I think deposit betas for analysts is kind of an imperfect way to measure customer stickiness. My question for you, Chip, is just how do you measure customer stickiness for a Live Oak customer? I mean obviously, it's not beta, my guess is maybe it's more qualitative than quantitative today, but just kind of would love your thoughts on that as the industry clearly is at a moment where I think that the unit of measurement around customer stickiness is going to change, and just wondering what your kind of internal view as you look at that hard-to-quantify metric.

Yes, that's a good question. I'm currently in our boardroom, and we have a new addition to our Board. We have an Indigo chair, inspired by Chick-fil-A, which places a red chair in every conference room to symbolize the presence of a customer. When I think about the stickiness of deposits, it’s notable that rates increased by 0.5%. Many customers may not feel motivated to switch banks for a small change, but a 500 basis point shift is significant. For instance, if someone has $10,000 in the bank and isn’t wealthy, they could stand to gain $400. The truth is, earning customer loyalty is an everyday endeavor. Our deposit-gathering strategy spreads through our call center, where our team genuinely cares about customers, resulting in quick response times and positive feedback. Many of our customers, particularly older individuals, need personalized attention and are not always tech-savvy, which underscores the importance of consistent engagement. Regarding loans, we have been focused on this for 15 years, always considering customer needs related to approval and funding timelines. When competing with other banks, we aim to respond more quickly than they can. We will continue to maintain our momentum on the lending side, and starting next week, for the first time, if someone secures a loan with us, we will deposit their loan amount directly into a Live Oak checking account. We'll see how that approach unfolds.

Helpful. It should be interesting to follow how the recent events kind of change your perspective of how people value deposits. So, I appreciate that color, Chip, and thanks for taking my questions in the call this morning.

Thank you, Mike.

There are no further questions, so I will turn the conference back to Chip Mahan for any closing remarks.

No closing remarks. We'll see you in October.

Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank you all for participating and ask you to please disconnect your lines.