Q4 2019 Earnings Call
This time, all participants are in a listen only mode. After the speaker presentation. There will be a question answer session asked a question. During this session do you want me to press Star one on your telephone if your for any further assistance. Please press star Zero I would now like to have the conference or what your speaker today, Greg Seward General Counsel of life Bancshares. Please go ahead Sir.
Thank you and good morning, everyone. Welcome rely books fourth quarter 2019 earnings Conference call. We're webcast live over the Internet and this call is being recorded to access the call over the Internet and review the presentation materials has been commentary that we reference on the call.
That are website at investor.
<unk> Dot com and go to todays call an hour event calendar for supporting materials.
Fourth 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, but 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 interestingly filings, we do not undertake to update the forward looking statements to reflect the impact of circumstances or events may arise.
It's after the date of today's call information about any non-GAAP financial measures reference, including reconciliation of those measures to GAAP measures can also be found that are actually see filings I will now turn the call over to chip mehan, or chairman and Chief Executive Officer.
Thanks, Greg and good morning, all so I'm going to kick off today's call than reflect on our accomplishments over the last four years.
Discuss our excitement about this year and then we're going to have some fun and put ourselves in your shoes and discuss our views are the community bank of the future versus other bank stocks you can assume.
Then deals going to explain how we're going to accomplish this from a technical standpoint before he takes us home on the banks financial performance in 2019.
Moving to slide three.
Whereas a were tickled to death was this year's results here at live Oak, we often referred to marathons and not spreads.
It was fun for us to go back and reflect on our first full year as a public company 2016 that was so beginning in 2016, we grew assets almost five fold until the end of this year the capital account over doubled from 200 million to over 530 million recurring dependable.
Revenue quadrupled from about $40 million to almost 170, while non interest expense was up 130% in the four year period.
Well by the way and along the way we originated $7 billion of mostly government guaranteed loans, we sold $3 billion to avoid dilution and charged off just $14 million in four years compared to having almost $55 million to the loan loss reserve.
Moving to slide four we're proud to show this slide every quarter the loan portfolio grew 43%.
Credit quality improved net interest income was up 32%.
Most importantly, we grew the government guaranteed book from 357 million to almost a billion dollars.
As a shareholder you should view that as a credit quality buffer.
We were excited to continue to grow that this quarter about $90 million, which was off a bit USAA was behind a little bit this quarter.
And as we think about originations in the future. We're happy that we originated about $2 billion loans in 19, and we think that would rather increase 10 plus percent 2020.
Moving on to slide five.
Another recurring earnings call slot and the beat goes on so this quarter we.
The $269 million and high quality loans, the spread was a bit less as we suffered a couple.
Down.
Challenges there as we all know so weve.
Put a nickel a share EPS on the books this quarter would annualize that 20 cents last quarter was 25 cents. So we charge on to a buck a share of wonderful recurring ABS.
Moving on to slide six the credit quality slide again, good news on safety and soundness charge offs were million dollars less in 19 than 18, that's 3.8 million versus 4.8.
Nonperformers as a percent of tier one capital in the loan loss reserve declined to 3.6% inline with our historical norms.
And this is a bit frustrating its rumored out there that you people talk and there is talk that you are number one SP a lender in the country will lead the league when a recession occurs I'm here to tell you today that that cannot be further from the truth.
See so we typically went into each vertical and the theory of Verticality range. So we used SBH historic loss ratio for all their banks and at the end of for years, we trued up with our actual losses.
In so doing we added back $12 million over the last four or five years to the loan Ross loss reserve doing it this way.
This will no longer be the case in the future.
The Cecil and Steve Smith, our Chief Credit Officer is here. This morning, and he can certainly talk about that in the queue in a here shortly.
Now.
In preparing for this.
Call.
Try the but we try to put ourselves in your shoes. So you only have three options today.
You are consuming data and you're trying to decide whether you're going to buy more reliable shares sell irobot shares or hold onto what you got.
So.
What would be your alternative so we did some work on the traditional community bank and whether you want to above that stock or hold on to our so let's talk a little bit about the bank of the future versus the past.
So in preparation for this call again had some fun and looked at 15 investor presentations.
Thanks, roughly our value of banks that traded between 140, a tangible book 180 of tangible book.
And for those of you that are professional bank stock analysts shocking.
Shocking all investor presentations were exactly the same.
There was a little map of the location of officers section to talked about a diversified loan portfolio single family residential real estate.
C R E. Thank real estate.
Multifamily real estate again, construction and land development real estate, some cnine loans very little consumer from a dollar standpoint, and then we had to go to the deposit mix lower cost of funds back to the branches.
So if you go to slide nine.
In the tiny follow that you can you read there are 10 banks represented here. They had an average number of almost 40 branches. They had 250 will more than we do roughly the same net interest margin very little discussion on the cost to operate those branches, which we estimate between one and 2% which would need to be a deduct for that 360.
Three.
Fantastic, let's focus on the rubber really meets the ROE.
So you have a real estate play in a geographic area with a traditional community bank and you're paying 160 of book for that company versus 144 book for our company and.
And we grow at almost seven times their rate and a diverse high quality asset Huntley is going to describe layer.
Now, let's let's let's talk about the state of play today and maybe the state of play Tomorrow.
So earlier this week Penny crossman from the American banker.
Interviewed Adam Dell Who's the founder and CEO of cleared money Baltimore Goldman.
And this gentleman run to the Goldman markets product.
And she says and several recent article headlines. It has reported you say banks are screwed.
That come out a little stronger than you intended.
Adam says, yes, the text to my comments were not relate in the press my comment really was around the notion of the empowerment of the consumer and how important it is that banks appreciate the greed, which the consumer is now empowered to understand the value they are getting from their financial relationship.
Historically, if you're an average consumer in the U.S. It is very difficult to understand the fees that you pay to your bank the interest rate. They pay you for deposits that lack of transparency is a thing of the past.
In the consumers now how do you have a wide array of tools available to them to understand the financial arrangement they have with their bank.
And then he goes on to say just love this love it.
Inertia is the most harming ailments piece, the consumer who is feeling to address financial well being now. This is consumer focus were small business focus would if you move to slide 10.
So what is the state of play today right.
So if you look at the box at the bottom.
And you think about a small business and you think about a veterinarian and we do business with a thousand up.
She has a checking account.
Most likely a money market account or a savings account.
She probably funds or business with a personal credit card or maybe a business credit card.
And if she is lucky she has a lot of credit from her back.
So lets unpacked that.
How do we use an industry how did those banks that you have an opportunity to pay 160, a book bore versus us at 140 a book.
Well on the checking account.
Kind of screw or Adams works.
Luckily fees transaction fees, and if the NSF fees wire fees.
The evade pays three bits on the savings account, we paid 200 Bips credit cards are always 18%.
Last credit who knows.
All these systems.
Our run separately and they don't talk to each other.
Neil is going to describe how in a nexgen core processing system core processing system with our ecosystem. We can bring this all together in one account.
So at the end of the day.
To Dr. So and so.
If you have zero to $5000, we might not pay you anything five to 15, we might pay you 1% over 25, we might pay at 2%.
If you need to bar, we're not going to lend into you they prepaid 10%, we're going to be fair.
Yes, there'll be cashback rewards and all those sort of things.
And if in fact, we can do that understanding at only 2% of small businesses move their deck and account today. Our research indicates that with this account it might be substantially higher might we bring our cost of funds down substantially.
20, Bobbitt's 50, Bips 75, Bips on a $5 billion bank, that's meaningful Neil takeover.
Thanks Chip.
Your point as you've been following a live Oak Bank journey ended at one of our core theme centers around financial services technology. This next slide as a reminder, fintech investing over the years as you can see we've been pretty busy from the spin out of Encino to the joint venture with aperture to lever ventures, and assembling strategics investing and mission critical banking applications, we still have a bank.
On the forefront of digital transformation.
We're excited to announce our journey continues in this latest endeavor canopy, which you might have read about a fintech venture fund built by bankers for bankers turning on the next slide is close to 600 million dollar Fintech fund is unique and at the limited partners are highly progressive banks, who are deeply interested in understanding the fintech landscape.
These include 30 regional and Super regional banks as well as the VA and the ex DVA.
While we think this is a major milestone for the industry the benefits land bank or significant in addition to fee based income connected to the.
On the also receives carry which comes with the long term harvesting of a fund, but even more strategically we get to see every fintech deal in the market with unprecedented clarity and we feel this will keep life of bank.
Adding entered digital transformation.
Turning to page one of the numbers as you can see Burger the fintech activities into three buckets for greater clarity aperture labor ventures and canopy.
Given our ownership an amateur we follow equity method accounting and while we do not consolidate aperture our pro at a portion of washes losses do flow through our income statement as you can see we're investing heavily in the platform and we'll continue to invest in 2020.
Well I have a ventures, we had a relatively neutral year year were write ups of one company evaluation offset the flow through losses of the others. We feel this neutrality will continue in 2020 and beyond.
Lastly, it cannot be we're excited given the funds approval and before we begin to receive fee based income which will continue through the funds tenure existence. This is an offset to expenses that already exists in the business.
And we'll be a net positive to the income statement.
So moving onto the next slide and connecting it to chips. One account concept why would we go through all this pain over the years investing incubating company starting funds. It really takes a ton of energy and to US is quite simple it all comes down to the customer.
The customer now demands more superior customer journey and digital journey and this is demonstrated by the millions of customers flocking to fintechs.
Sadly, we feel the banking sectors broken an old soft with old saw fertile tools and somebody has to fix it.
Not us.
So as you can see by this picture, we deconstructed the entire stack created incubated and invested an entirely new approach with new companies and this has been difficult and yes, it's taken longer than we've expected, but the platform will last for decades to come and allow us to bring new products to the market just like the one account that chip referred to earlier addition describe.
Happy approach has had little effect on our income statement if anything we benefited from the write ups associated with our equity investments over the years and lastly, I am excited to say that after a three year build including an entirely new core.
Ecosystem, we're rolling out first products with limited availability this quarter and general General building next quarter and certainly we invite you to open up a new account as we feel the experience will set the new standard currently over to you.
Thanks, Neil Thanks Chip turning to the bank on Slide 17, we're extremely proud of the accomplishment to the bank. This past year, which is a direct result of the dedication of our entire team and Q4 really punctuated just a great overall year, we knew that by holding more of our loans on our balance sheet, we've reduced our near term earnings, but then it would just.
Result in a stronger franchise as you can see over the course of the year. We grew our loan portfolio by over 40% and ended the year with the balance sheet of $4.8 billion.
Day traders holding 60 Patterson.
Government guaranteed Liberty.
Our net interest.
Despite three rate.
Here and we remain disciplined expense side.
Despite providing over $2 billion of credit to over 1100 small businesses nationwide.
And working to build the next generation of technology and banking.
On slide 18 lending franchise, the strong across the board.
Last year, with our $2 billion origination spread across geography and industry.
As you can see are more establish verticals continue to perform well and the newer verticals are maturing nicely.
Overall small business activity remained solid throughout the year, despite the volumes being down industry wide.
In the SBH space in 70 lending we are proud once again to be the nations largest SDN lender this year extending our lead in that category. The Testament to our model, which combines deep vertical expertise and efficient technology platform and the dedication of our people to serve the nation small business owners and entrepreneurs.
We also ended the year on top of the U.S. da lending list, which is an area. We continue to see a lot of opportunity, especially with some of the changes in the recent farm Bill.
Chip mentioned growth in the guaranteed portfolio slowed a bit in the fourth quarter as we originated less renewable energies in the quarter, which is really more timing issue than anything else.
We're also methodically looking up market and opportunity to lend beyond our traditional government programs a lot of people talk about the lower middle market, which seems like an increasingly competitive space to us, but we think theres a lot of opportunity in the upper little market targeting companies in industries, we understand what typically less than $5 million in EBITDA.
While this strategy will modestly increase our average loan size, we aren't going to compromise our conservative diversification and granularity across the portfolio perspective, we still have no loans over $20 million, an exposure and all the handful over Ken.
Overall, we continue to see great lending opportunities across our 33 verticals and our pipeline remains robust.
On slide 19, we show our existing $3.6 billion loan portfolio and the diversification of it as well.
45% as government guarantee as chip mentioned, which we think serves the great source of contingent capital and liquidity.
It's also worth noting is the $3 billion of loan that we service for others that puts our managed loan portfolio over $6.5 billion.
Overtime, we expect to replace the majority of those loans with loans on our balance sheet as we continue to work with our existing borrowers more proactively to keep them on our books.
Turning to credit overall, our loan portfolio continues to perform very well and inline with our expectations as chip mentioned nonperforming loans and charge offs were both slightly improved on the quarter and the watch list is basically flat we remain guardedly optimistic in this late cycle economy, and while we aren't seeing any macro deterioration in the portfolio, we're cautious especially in play.
This is where competitive pressure as high like the craft beverage industry or where they're more sickle concerns like hospitality.
The obligatory Cecil comment.
Yet mentioned, while the new methodology is certainly more sophisticated and it's more weighted towards quantitative factors, we expect our allowance to stay roughly the same relative historic levels.
And it largely leverages our existing models that we have in place that used to Sta data and then migrating towards our own around data.
On the funding side on page 21, our direct deposit model continues to perform extremely well growth was in line with our expectations in our balance sheet needs for the quarter average balances were up about $200 million in total deposits and 515 hundred new retail accounts, which brings our total to right at 50000 retail accounts.
Our digital platform remain highly scalable as we've said in the past the lower cost operate translate to higher rate for customers, which leads to better customer acquisition and there seems to be plenty of room for growth as the leading players in the space or many multiples larger than we are.
Overall, the market for online savings and Tds has remained rational most of the major digital banks remain within 10 to 15 basis points of each other.
On the saving side fed rate the fed cut rate three times in the back half the year and Weve repriced, our savings down a total of 45 basis points, we're still enjoying extremely low savings attrition rate and CD renewals are running over 70% with a stable fat outlet customer preference has shifted more towards Cds, which is good for us as we have $800 million of CD.
These rolling over in the first quarter with an average rate rolling off of about 255 enrolling on at about two o'five. So about 50 basis point to pick up there.
Turning to net interest income on slide 22, net interest income grew nicely over the year. Despite three rate cuts in the back half of the year two of those cuts hit our loan book in Q4, causing eni to be roughly flat for the quarter. Despite almost 7% linked quarter increase in earning assets those rate cuts compressed our NIM to 355 for the quarter.
Despite the continued competitive lending environment loan spreads remained roughly flat during the quarter on our new loan production.
Looking forward, we expect margin to be roughly flat in Q1 with the Q4 rate cut offset largely by CD rollover and the margin should trend up modestly from there over the course of 2020, assuming constant rate environment.
As we mentioned we stay true to our target this year and sold roughly one third of the government guaranteed loans the became available for sale as we typically so all of our U.S.J. production given the long fixed rate nature of the product.
That means we sold only about a quarter of our eligible SPJ loans as a secondary market for 70 lung continued to strengthen throughout the year. We continue to evaluate our hold versus sell decision and decided to make a slight revision to our targets going forward, we'll continue to sell virtually all of our U.S.J. production and target a third of our eligible Sta production yes.
Actively relatively modest, but we'll look to capitalize on the strong market and can serve a little bit more capital in the process.
On slide 24 chip Rep chip referenced the growth in the company since the IPO at that point, the servicing asset with over a quarter of the capital base at the company and the resulting earnings volatility was significant today, we sit with a servicing asset at 6.6% of capital and the impact of a quarterly revaluation is a fraction of what used to be.
We're getting close to the point, where new production will offset the amortization and we expect the asset to stabilize in size as we go forward, but continue to decline as a percent of capital and earnings as we grow.
On the expense side, we're really pleased with the story last year, especially relative to our growth and clients and balance sheet normalizing for the performance bonuses expenses increased less than 5% year over year, while the fourth quarter saw an unusually large FDIC insurance assessment is offset by a reduction in some of our professional services costs largely with.
Completion of canopies, we did increase our lending teams by about 25 people over the course of last year, which we expect to help drive continued lending growth in 2020.
Given we knew we were managing this pivot yearend earnings we delayed some hiring until the end of the year. So we'll see a bit of a higher run rate in 2020 in the expense side, but we'll still see significant operating leverage and we'll continue to remain focused on balancing extent discipline with investing to support the growth of our franchise.
Summing it all up with me on this slide every quarter of the year and we'll continue tail could you can see the progress we've made over the course of the year across the key metrics or looking at in 2020 will continue on the same course, focusing on providing capital to small business owners the doors of the economy.
And with continued momentum in our core banking franchise will continue to focus on our future technology build and delivering a new broad suite of products across the next generation infrastructure.
With that shipper, Neil can open up for questions, let's do it.
Thank you as a reminder to ask the question the press Star one on your telephone, which all your question press the pound Keith Please standby wildly compiler Johnny roster.
Our first question comes from Jennifer Demba of Suntrust. Your line is open.
Thank you.
Good morning.
Good morning, Jennifer Hi.
So.
He said you.
Our pretty optimistic on the economy and credit quality that you you're being a little bit more cautious on hospitality and craft beverage can you kind of expand on those thoughts.
Jennifer This is Steve Smits happy too.
Yes again, we're looking at those are two examples of industries that we've got our ion.
How competition for example may impact the craft beverage space, making sure that.
You know, it's impacting their revenues and really it's about just remaining disciplined in our credit decisions businesses have solid plans.
And then we look closely at contingencies.
That the business has to deal with unexpected pumps balance sheet strength cash on the balance sheet, a proven ability to raise equity when its needed global support. So just remaining very disciplined on that front hospitality again.
Seasonality, so where we focus on his strong projects.
Very disciplined loan to values.
Almost our entire portfolio our loan to values are less than 65% I would say across the entire portfolio our weighted loan to value.
Is about 40% to 45% so we're very disciplined very conservative in that space.
Have you seen any credit deterioration and either one of those loan buckets.
Nothing that rises to grave concern we've seen a handful of.
Beer businesses that are missing there are on their plan revenue growth and thats due to.
Missions.
Most of those are smaller credits very manageable and we're taking a very like we do.
Take a very proactive approach to dig into their plans and see what theyre doing around that but.
Nothing that I would call a Mac for concern, but there are examples of a micro level of businesses that are.
Struggling a little bit to ramp up and we're keeping a close eye on that.
Okay.
How are you said expense control would continue to be a focus.
What.
What's your thought on hiring this year in terms of more producers you said you might go up market a little bit.
And.
You know as you look at the mix of loan growth over the next couple of years.
How do you see an evolving.
24% of your originations last year, where we're conventional.
How do you see that mix evolving over time.
Sure I think we largely have the lending team on the field that we want right now and we're in like a bunch of great protocols. The generalist team is hitting their stride in a bunch of great market.
And sales, we pick up one or two here in there.
But I don't think you'll see us grow lending side to the extent that we did last year and we're really really love the theme that we've got right now.
In terms of the mix.
We look at will make all the great seven along that we can find and we'll continue to to Chase says I think just generally with the relative size the opportunity set for us in conventional is larger than.
Then it isn't seven AG, we do still think that a lot on the you at the front that we can still do add we brought out across all of the different programs. They offer and so we still think there's more upside in the U.S.K. side.
I think more of your incremental growth is likely to come from the from the conventional side, though barrel totaled a larger credits so they'll move the needle a little bit more on a relative basis.
Okay and.
Neil I think you said, you're rolling out the new deposit product.
Very soon here, yes look is like I said that it takes longer and speaking of you because it had to field your questions on the checking account anytime rolling out the core.
In a banking environment takes.
More time than we expected so what we're rolling out in Q1 is CD and savings Onboarding and servicing.
And Thats, 80% were there and there were very close to the chicken cap thereafter, rather not give you Dave on the checking account, but know that a brand new web mobile onboarding servicing CV savings personal and business.
So offering is coming out limited availability in Q1 in general availability Q2.
Okay. So the checking account sounds like it's probably the second half of the year event. Thanks, Ryan that's right.
Okay. Thank you.
Thank you and our next question comes from Aaron Deer of Piper Sandler Your line is now open.
Good morning, everyone.
More Aaron.
Pardon me if I if you covered this I got on the call late but Neil following up on the.
You are discretionary.
The there was a drop in the data processing costs I'm wondering is that tied to the core conversion that you mentioned and is that.
Our with sustainable run rate on data processing are there other investments happening there that's going to cause that number to come back up.
Yes, I think I think so so I think its thank you can turn it over to Brian relative to that specifically I think one I don't know that we've actually seen the benefit of the core conversion and the financial impact there yet so good news is there's probably more.
Upside James what would you say, yes on the data processing side Erin.
Looking at Q4, I would say thats more of a change in some of the.
Third party services, we were using there was some internal build out that we were doing and that did not repeat and Q4 more came to completion and Q3.
Okay and then.
Also related to.
The the discussion on the deposit.
Products being introduced.
Is that it does the margin guidance to provided in terms of some stability here.
In the in the first quarter and then some expansion.
To your goes on does that incorporate the expectation for.
The deposit flows from these new products or could.
Good success in those products drive even more expansion on the margin.
Well I think certainly this is Brad I think certainly.
Thats there would lead to.
Upside on the margin standpoint.
I do think there's a there's a rollout period for when we have the ability.
To go after the deposit.
So you know if you're thinking 2020.
Favorability there is probably going to be did as volumes of those types of account filled but our but our margin guidance that we just talked about doesn't have any benefit embedded at steady state and theres upside yeah. Okay.
And then.
Brett any.
Obviously as a pull back on the.
On the solar tax investments and the related credits there.
If you didn't already could you give.
An update and your expectations for whatever the tax for its likely to shake out here heading into 2020.
Yes.
Well I guess for starters.
We continue to look heavily at investment type credits Theres still a panel leasing.
As everyone that is that something that.
We did have a good bit of in 2018 Alta early in 2019 pulled back a little bit because of some economic.
However, we started the trends by that could turn favorable again.
So looking at heavily itll probably be.
An update we give laid out in the year, but for now I think as far as you're modeling is concerned.
Something similar to what we fan thank you for.
As a good run rate going forward kind of in that 25%.
Just about 25% effective tax rate.
Okay, great. Thanks for taking my questions.
Okay. Thank you and ladies and gentlemen, this does conclude our question answer session I would now like to turn the call back over to chip Mehan, Chairman and CEO for any closing remarks.
We just thank everyone for attendance, we will see 90 days from now.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.