Live Oak Bancshares, Inc. Q3 FY2025 Earnings Call

Thank you. Good morning, everyone. Welcome to Live Oak's Third 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 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, all, and BJ is going to kick us off.

Good morning, everybody. Let's get started with a big shout out to all of Live Oakers and our customers on Slide 4. We're proud to be recognized as the #1 SBA 7(a) lender for 2025 and by an impressive margin. Not only did we provide over $2.8 billion of loans to small businesses, but we also increased our production by 44% over last year, and our market share increased from 6.4% to 7.7%, and yet we still have plenty of room to grow in the program. Turning to Slide 5. We know what we are good at, and we're keeping the main thing, the main thing by ensuring our existing vertical lending and deposit gathering activities are our #1 priority. This performance is top of the class from a growth perspective. Loan production up 22%, loan outstandings growth up 17%, customer deposit growth up 20% and PPNR up 24%. These results reflect the hard work all our teams have done to create outcomes that are more consistent and sustainable over time. That's our goal. To ensure our profitable growth trajectory continues over the medium term, we are extending our customer product offerings by adding checking and small dollar SBA loan capabilities. Both of these efforts launched in early 2024. And in a little over 18 months, our teams have made significant gains in winning customer checking relationships and serving more small business borrowers. On the checking front, we ended the quarter with $363 million of checking balances or 4% of our total deposit base, up from only 2% this time last year. This increase is even more impressive when you consider that our total deposit base grew 17% year-over-year. We have about 1/3 of our new loan customers opening a checking account with us each quarter, and we expect that percentage to increase as we add more capabilities such as merchant services. At the beginning of 2024, only roughly 6% of our customers had both a loan and deposit relationship with us. Today, that percentage is 20%. All this is leading to deeper relationships with customers, better insight into customer cash flows and meaningful reductions in the cost of deposits, both now and over time. On the small dollar 7(a) front, what we call Live Oak Express, production is ramping up meaningfully and will continue to do so. These loans are also very desirable on the secondary market and are leading to a nice gain on sale increase. We are continuing our efforts to make it simpler, easier, faster and more efficient for our people to serve our customers. And in Live Oak Express, we will be piloting an AI-enabled loan origination solution to do just that, which will significantly improve our speed to close for the borrower and the efficiency of our process from the lender all the way through to servicing and loan operations. The tangible result of our efforts is showcased on Slide 6. As you can see, the true earnings power of the company is strong in PPNR, revenue and pretax income on both a quarter-over-quarter and year-over-year basis. We continue to be very focused on building more consistent and sustainable profitability. Healthy revenue growth continues and with appropriate supportive expense growth, operating leverage is strong. With credit impacts moderating in line with our expectations, a significant improvement is evident in our pretax income results. In short, our momentum continues with more to come. So with that, Walt, how about running through some of the financial highlights.

Thanks, BJ. Good morning, everyone. Let’s dive into the quarter. Our earnings per share for Q3 reached $0.55, reflecting an 8% increase from the previous quarter and nearly doubling compared to Q3 of last year. This remarkable growth was supported by a 7% improvement in core operating leverage and a lower quarterly provision expense. The core operating leverage gain was driven by a 6% rise in net interest income, influenced by a $551 million increase in loan balances and a 5 basis point margin expansion to 3.33%. On the growth front, our small business and commercial banking teams are successfully generating high-quality loans while replenishing their pipelines. Our deposits continue to fund the bank in a fiercely competitive environment. We are optimistic about our initiatives to grow noninterest-bearing business checking balances and originate small dollar SBA loans through our Live Oak Express product. Our quarterly provision expense was $22 million, marking the fourth consecutive quarter of decline. This reserve level and resulting expense were shaped by strong loan growth and our navigation of the small business credit cycle. On the capital side, we raised $100 million through our first preferred offering, enhancing our growth capital. In the upcoming quarter, we anticipate a $24 million gain from the Apiture sale, which will also eliminate about $6 million in annual losses from our income statement. The financial snapshot on Page 9 shows improvement across all major metrics. I want to point out two items. First, in Q3, certain noncore items negatively impacted our earnings by about $1.5 million. Second, we experienced a seasonal increase in the effective tax rate due to compensation-related accounting treatment. On Slide 10, our Q3 loan originations were around $1.65 billion, an 8% increase from the previous quarter, primarily driven by our Commercial Banking segment. Loan production remains strong, with most of our verticals experiencing growth compared to last year. The trends in our loan portfolio are positive, showing double-digit yearly growth across segments. Slide 11 illustrates that our total loan portfolio increased by about 5% from the previous quarter, and 17% year-over-year, which is rare in today’s market. We also saw a 3% increase in customer deposits this quarter, maintaining last quarter's growth rate, while year-over-year deposits rose by an impressive 20%. In the second half of the year, we generally see slower deposit growth, and we expect this trend to continue. The rise in customer deposits has largely been supported by our competitive consumer and business savings products. Our business checking saw a significant uptick in Q3, with balances growing 26% from the previous quarter to $363 million. Low-cost deposits have also increased substantially, now constituting about 4% of our total deposits, reflecting a 2% annual rise. Adding noninterest-bearing deposits enhances our earnings profile and strengthens our funding resilience, making it a strategic priority as we move into 2026. Slide 13 highlights net interest income and margin trends. In Q3, our net interest income rose by $6 million or 6% from the previous quarter and by $23 million or 19% from the same quarter last year, with the margin expanding 5 basis points to 3.33%. We have an asset-sensitive balance sheet, with two-thirds of our loans being variable. The recent Fed cuts are expected to affect our net interest income and margin trajectories. Our focus is to ensure that we support loan growth while adjusting pricing to enhance margins. We anticipate further Fed cuts in the coming months, which could lead to margin compression in the near term. However, historically, we've seen our margin recover quickly due to the nature of our funding base, and our strong growth supports resilient net interest income performance. Moving to Slide 14 on guaranteed loan sales, the secondary market remains a steady source of earnings and liquidity. Our gain on sale is still driven mainly by larger SBA loan sales, consistently yielding between $13 million to $15 million quarterly. Our focus on small loan SBA sales is beginning to yield results, with significant gains compared to last year. On Slide 15, our noninterest expenses for Q3 were reported at $87 million, a decrease of about $2 million from the previous quarter. We are committed to maintaining growth while enhancing efficiency. Our concentrated efforts since Q3 2023 to improve revenue growth outpacing expense growth are evident in our results. We are working to leverage technology and automation across the board to optimize experiences for both customers and employees. Moving to credit on Slide 16, our over 30-day past dues remain low, and nonaccrual loans have slightly increased but remain manageable. Our provision expense was positively influenced by strong loan growth. Lastly, on Page 17, our capital position improved with the recent preferred issuance, significantly bolstering our risk-based capital ratios. We expect further capital accretive events with Apiture's upcoming sale closing soon. Thank you for joining us this morning. I’ll now hand it back to BJ for his final remarks before we move to Q&A.

Great. Thanks, Walt. Momentum is building. We're focused on the biggest and best opportunities, and we're modernizing our activities to take full advantage of the AI-driven possibilities that are right in front of us. So with a big thank you to all Live Oakers and our customers, let's take some questions.

Your first question is from Dave Rochester from Cantor.

Can you provide more details about the increase in NPAs this quarter and discuss the new default trends? Also, regarding charge-offs, I assume you're anticipating a decline, but if there are reasons for them to remain high, I would like to know.

Yes, this is Mike Cairns, Chief Credit Officer. I'm happy to address that. I view this quarter as a continuation of last quarter. Thankfully, credit metrics don’t always change in a straight line. We did see a slight increase in nonaccrual balances, but they remain manageable and primarily stem from our SBA portfolio. This wasn’t unexpected; we’ve been monitoring these loans which relate to the ongoing challenges faced by small business owners over the past few quarters, a topic we’ve discussed extensively. In terms of nonaccruals, not all of them are alike. While the default count has risen, it’s not a substantial increase. I also focus on past dues. With our large SBA portfolio, having 14 basis points of past dues is something I take great pride in and reflects how well our team has managed it. This shows that our servicing team is engaged and attentive to the portfolio. Reserve levels have decreased, indicating that not all nonaccruals have turned into charge-offs. While reserves have dipped, we still maintain strong coverage on the portfolio, and I feel confident about our reserve position. Despite the economic uncertainty highlighted by other banks, we concentrate on what we can control: maintaining sound underwriting, which we are committed to. I mentioned this last quarter, and we're dedicated to preserving credit quality without stretching it and focusing on servicing our portfolio. For instance, we are currently conducting our annual risk rating review for the entire SBA portfolio. This involves a servicing team member and a credit officer evaluating the risk rating for each significant balance in that portfolio, which goes beyond our regular servicing activities, such as engaging with customers, collecting financial information, analyzing it, and conducting site visits. We have a lot of attention on the portfolio, and as I reflect today, it appears that although there have been cyclical trends in the SBA sector, our small business owners have shown impressive resilience despite these challenges.

Thank you for that. How are you considering the possibility of an extended government shutdown and its impact on loan growth and credit? When might things start to become challenging, and what concerns do you have regarding this situation?

Hey, Dave, this is Walter Phifer, CFO. I'll start with loan growth and the secondary market, then Michael can talk about credit. Unfortunately, we've dealt with government shutdowns before, so we have a solid plan in place. When a shutdown seems likely, our first step is to review our pipeline, especially for SBA loans, and start pulling PLPs to secure that funding. Leading up to this shutdown, our team worked hard in September to pull about $900 million in PLPs to ensure we can keep operating and support small businesses. From a growth perspective, that's promising. However, if the shutdown lasts longer, especially into the end of the quarter, we may start to see some PLPs expire, and Michael's team will evaluate bridge loans as needed. Another significant effect for us is on the secondary markets. Typically, we don't sell loans in the first 30 to 45 days of a quarter, so we haven't felt any impact from the current shutdown yet. Once the shutdown is over, the secondary market will rebound quickly, and we can resume our loan sales and settlements. If the shutdown goes past Thanksgiving, it might affect our execution in Q4 regarding secondary market sales. However, when the market reopens, we'll catch up later in the quarter or into the first quarter of next year.

Appreciate all the color there. Maybe just one last one, if I could. Just switching gears to the AI enhancements you've been talking about in terms of processing times and whatnot. Can you just quantify what those benefits could be? And then it sounds like you guys just overall look very favorably at what AI can do to the expense base and how you can potentially keep that more stable. If you could just talk about that a little bit, that would be great.

Certainly. Live Oak's journey has been characterized by innovation and a focus on future technological advancements. We believe that AI could surpass the significant technological shifts we've seen with the Internet and cloud computing. While those were impactful, we think AI has even greater potential. To capitalize on this, we're dedicating substantial efforts to educate our team on the various available tools. Our developers are utilizing cursor and learning how to code in AI, while the rest of the organization is being trained to use prompts and develop agents for specific tasks. For instance, our insurance group is creating their own agents to automate follow-ups with insurance companies, ensuring our borrowers have the necessary coverage, all done at an individual level. Renato Derraik and his technology team are leading the way in developing significant Agentic AI solutions, both independently and with partners, to benefit the entire company. At Live Oak, we are experiencing rapid growth, and while there is excitement and some concern regarding the impact of AI on our workforce, we believe that AI will enhance our employees' productivity in the long run. This might mean we need to expand our workforce and expenses less than others in the industry, especially those facing slower growth and using AI primarily for cost reduction. Therefore, our operational leverage, driven by AI, could significantly boost our profitability while simplifying processes for our team, enabling them to serve customers better and enhance their experience. The opportunities before us are vast, and we are actively working to seize them. I realize I've shared a lot, but I'm really enthusiastic about this. We've been piloting various initiatives, particularly around our loan origination platform, starting with small dollar loans, and we are developing a fully AI-driven platform that is exceptionally user-friendly, from lending to servicing and operations. More details will follow, but this is just one example of how we are already implementing major advancements that will benefit us in the future.

Sounds like that will be a pretty solid competitive advantage for you guys.

Your next question is from Tim Switzer from KBW.

First question I have is on the trajectory for the margin. We're reentering the rate cut cycle. And I think you guys are long-term beneficiaries from rate cuts as long as assuming we get a steeper yield curve. But assuming we get 1 or 2 more in the back half of this year and maybe another one next year, how does that impact the near-term NIM? And then maybe what's the time line for when we start to see it rebound and inflect back higher?

Hey, Tim, this is Walt. I'll take that one. You should consider a lot of the earlier comments I made. If you look at the models available, they were accurate prior to the October cut. Now that we have the October cut, we need to incorporate that. Specifically regarding margin, as an asset bank, we experience some margin fluctuation, and alongside our growth, that limits how quickly we can reprice deposits. Our approach is to observe market movements and position ourselves accordingly to ensure we can sustain our growth while also supporting profitability in the long run. Historically, whenever the Fed has eased, we've seen a fairly quick recovery. You can see this illustrated on page 13, where net interest margin compressed but then rebounded quickly, returning to growth within a year. This underscores the strength of our deposit and treasury teams, as well as our reliance on short-term funding since most of our CDs and brokered deposits have terms of about a year. Recovery happens relatively fast. However, it’s important to focus on net interest income and growth. BJ always says you can’t spend margin, which resonates with me. A margin of 3.33% is quite healthy, and if we can increase our net interest income quarter-over-quarter despite margin fluctuations, that’s a great story in my opinion. So, we consider both margin and net interest income in our strategy.

Got you. That was very helpful. And I also want to ask about kind of the competition you're seeing broadly in the SBA space with, I guess, the government shutdowns impacting things. You obviously have the credit cycle that seems to be hitting some of your competitors harder than you and all the rule changes that were implemented, I guess, almost 2 quarters ago. So have you seen easing competition at all? And has that created some opportunities for you?

Yes. Tim, this is BJ. The way I would describe it is this is what we do. This is how we grew up, and we know the SBA market, we think, better than anybody. And we've seen tons of things. We've seen SOP changes. We've seen government shutdowns. We've seen nonbank lenders come into the market. We've seen nonbank lenders go out of the market. We've seen big banks try to do SBA. We've seen them pull out of SBA. All the while, all we're doing is growing the number of verticals and the number of customers that we serve through the SBA. So we don't believe that we have a peer in SBA lending. We will see different pockets of competition in different verticals and some competitors are better than others in those verticals. But by and large, we actually just control what we can control in terms of making ourselves better all the time every day. And so I think, obviously, it's showing up in our results and in our numbers, and we'll continue to do that.

Got it. And then the last question I have is, it seems like previously most of your commentary around the credit performance was that it was pretty broad-based and more related to certain vintages rather than industries. But now that we're a little bit longer time for the kind of the impact of tariffs and everything else going on, have you seen any industries that are maybe struggling or under a little bit more pressure than others?

Yes, Tim, on the tariff side, there's really very little impact. The rise in rates along with the vintages from '21 and '22 have shown some significant stress. We are seeing more stress in a few areas where companies don't have much pricing power but are experiencing rising costs of goods sold. They are struggling to maintain profitability, which is where we've noticed some stress. However, as Michael mentioned, nothing is surprising us at this point. We understand where the tension lies, and overall, everything is performing according to our expectations.

Your next question is from David Feaster from Raymond James.

I wanted to discuss the aspects of credit and technology. You mentioned maintaining strong underwriting and updating some risk weighting. Given the current uncertainty and various pressures, including tariffs, have you changed your underwriting standards or criteria? Additionally, regarding the use of technology and AI, we've discussed growth and enhancing profitability, but are there opportunities to leverage technology or AI to assist with underwriting or early credit identification to help reduce credit risk?

Yes. I'll start and Michael will likely add in. Regarding underwriting standards, we aim to remain consistent so that our customers and lenders clearly understand our interests. However, there will be instances where we adjust our credit criteria. For example, we might insist on direct management or operating experience in specific sectors to ensure successful business operations. We continually refine our approach across our 40 sectors, as we have always done, and this will carry on. As for AI, we are exploring its application in a new loan origination and servicing platform, specifically in how it can process documents and generate credit memos. For instance, if we receive documentation from an HVAC company, AI can analyze that information alongside market analysis generated by tools like Copilot or ChatGPT. This analysis would include assessing market demand and industry performance in relation to our financial data and existing HVAC contractor portfolio. These are the types of AI applications we are piloting. While AI does not replace the need for human review, it will significantly streamline our capabilities in data analysis, data entry, competitive analysis, and trend understanding. This is going to enhance our efficiency in closing loans and provide a better experience for our customers.

Okay, that's helpful. I was hoping you could elaborate on the government shutdown and how it affects you. I appreciate your previous commentary on this. It sounds like if this gets resolved quickly, you believe you can maintain your pace of organic growth quarter-over-quarter. Does this suggest that the SBA will process the backlog of loans swiftly once operations resume? Or will you compensate for some of that gap with more conventional lending in the short term? Is it primarily a timing issue, and might this quarter be somewhat weaker, with some slippage into 2026? I'm curious about your perspective on all this uncertainty, so any insights you can provide on how you see it playing out would be appreciated.

Hey, David, it's Walt. I'll start. From the SBA's perspective, once the government reopens, they tend to catch up quickly. If the shutdown resolves in the next week or two, I don't anticipate any significant impact on our SBA growth or production for the quarter. This is mainly due to the PLPs being pulled towards the end of September, and the funding remains strong. We'll be able to get back on track pretty quickly.

Okay, that's helpful. I wanted to get an update on the progress of the embedded finance build-out and its growth potential. Additionally, since you are ahead of the curve on many aspects, how do you view the expanding market for stable coins? Are there opportunities there, and could it potentially lead to deposit growth for you? I wanted to discuss these two topics.

Sure. David, it's BJ. We're actively developing our embedded finance, which we see as a significant opportunity over the next 3 to 5 years. Earlier this year, we changed our approach to building it out, shifting from in-house development to partnering with a company that is more advanced than us. This partnership is aimed at speeding up our growth in embedded banking. Although this shift has delayed our establishment of new relationships, we currently have one live partnership and several others in the pipeline. We plan to share more details about our progress in embedded banking as we achieve milestones. It's still a key part of our strategy. Regarding stablecoins, we have a new Board member, Patrick McHenry, who had an influential role in the GENIUS Act while in Congress. This gives us valuable insights into the evolving situation around stablecoins and their potential applications. We are looking into how we can participate in the stablecoin market and aim to stay ahead of developments in this area.

And your next question is from Steve Alexopoulos from TD Cowen.

This is Bill Young actually on for Steve. Just to circle on the credit mini cycle topic one more time. In recent quarters, you've spoken of being more aggressive on getting ahead of problem loans and writing them off with more aggressive charge-offs in your book. And we did see a bigger step down in net charge-offs this quarter despite the increase in NPAs. So can you speak to your visibility on kind of the future loss trajectory and your confidence level in terms of how far ahead you've gotten on these issues so far this cycle?

Yes, it's Michael here. I’ll take that. In past quarters, we discussed our shift towards being more proactive in writing off loans. Our special assets team aligns with the SBA program, and we do everything possible to assist our borrowers in overcoming their challenges. We are willing to support our customers longer than most and do everything we can to help them. Previously, we held some loans in nonaccrual status without charging them off, but we have changed our approach. We now charge them off when we believe they are unlikely to return to repayment quickly. Even if those loans are not charged off, they remain a priority for us. We actively track these loans and continue to work with our customers. Therefore, I can say we are managing charge-offs appropriately and will remain proactive, ensuring they do not linger on our balance sheet. Overall, I believe we are doing a good job in this area.

Okay. Great. And then it was nice to see the return on tangible common equity return back to double digits this quarter. So can you just maybe lay out what you see as kind of a sustainable path for returns can move to in the next year or 2?

Yes. I think, Billy, what we talk about a lot here is getting to a 15% and 15%, which is consistent and sustainable 15% returns on equity with 15% or more EPS growth a year. And to do that, you've got to make sure that your business model can sustain that kind of performance, which means doing things around the checking portfolio to provide more of a balance for your funding costs. It is always having growth initiatives like Live Oak Express that are going to incrementally move your fee income line up further. It looks like expense discipline and a moderation of credit. All of those things, the senior leadership team talks about constantly is how do we get back not only to those levels, but consistently build a business model that stays at those levels. And so I'm highly confident that we're going to be able to get there in the near term, near medium term, let's say, over the next 18 to 24 months.

Great. And my last question, with your pending Apiture sale and some activity among your peers such as MVB with their Victor sale, as you think about Live Oak Ventures and some potential percolation of activity in Silicon Valley, are you beginning to see a bigger opportunity in the near term to harvest some of your investments?

I'll discuss our ventures portfolio briefly, but Chip has more insight into the overall situation in ventures. So I'll let him take over. Apiture was one of the two largest companies in our ventures portfolio, and we just exited with a significant gain. The other major company we have is Greenlight Technologies, which is excellent. The remaining companies are smaller and still growing. Apiture was likely our most significant exit in terms of returns. The portfolio will likely remain unchanged for some time. We plan to gradually add more venture portfolio companies as we explore new technologies that we want to integrate into the company. That has always been the purpose of Live Oak Ventures. So expect to see more of that from us. However, Apiture was probably the largest exit we will have for a while. Chip, what broader trends are you observing?

Well, I think most of this relates to Canopy. We look at probably 4 companies a day in Canopy. So that gives Live Oak a sneak peek before anybody else if there's anything interesting there that we may want to invest in. I would say that the euphoria of the pricing in that business after COVID has reinstated itself with artificial intelligence. Venture firms are throwing enormous amounts of money at these companies where they're fundamentally pre-revenue. And we're trying to take a bit of a circumspect view there because as you know, at Canopy, we raised $1.5 billion from 70 banks and our bank LPs are right there by our side as we look at interesting opportunities on a daily basis.

There are no further questions at this time. I will now hand the call back over to Chairman and CEO, Chip Mahan, for final comments.

As always, thanks for attending, and we'll see you in 90 days.

Thank you, ladies and gentlemen. The conference has now ended. Thank you all for joining. You may all disconnect your lines.