Q4 2021 Live Oak Bancshares Inc Earnings Call

January 26, 2022

Thank you and good morning, everyone welcome to <unk> fourth quarter 2021 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 and commentary that we will reference on the call. Please visit our website at Investor Day at live Oak Bank Dot Com and go to today's call on our event calendar for supporting materials. Our 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. They 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 and commentary.

I will now turn the call over to chip Mahan, our chairman and Chief Executive Officer.

Thanks, Greg and good morning to all who have joined to review our performance for 2021.

I am speaking to you by recording a cell coverage in my current location is a bit spotty.

I'll kick things off with a few brief overarching comments on the state of our business with a peek into the future and then turn things over to BJ and Huntley to describe our best quarter and best year since inception.

We're going to talk a lot about growth today, both in the past and in the future.

That said, we've never strayed from our guiding principles of soundness profitability and growth in that order. We are beginning to see a few things our government guaranteed lending platform is scalable we have grown from lending money to veterinarians one industry one vertical amounts 35, we will.

Complice this credit quality for these small businesses with very little or no capital is unprecedented total non accrual loans and this bank today are $23 million or 67 bps on the total and guaranteed portfolio at year end of $3 5 billion.

$15 million of our non accruals are continuing to pay as agreed. This is remarkable in this segment. It has taken US 14 years to prove it.

And more recently over the last few years, we've expanded beyond our theory of verdict Galaxy.

Our general lending group has grown from eight highly skilled wells Fargo lenders to 'twenty, two adding similar quality individuals from other banks.

So where does that leave us on the loan side of the balance sheet in terms of the future SBA opportunity.

In the last 24 months 1800 banks have made an SBA loan. My guess is that there are at least 4000 SBA lenders trained with primarily two skills.

One is it a good loan.

As my bank want to lend money to small business operator that has no capital.

The SBA prefers that their banks proved that the borrower can not found credit elsewhere.

Secondly, theres alone meet the highly technical and stringent requirements of the SBA 500 page standard operating procedure book.

My guess is that 100% of the 4000 lenders in this country you have heard of Lubbock Mac by secondary guess is that their view of us in all likelihood is favorable given that we're going to launch a new business unit to determine who are the best and the brightest of this lot and yes, we will be searching for the appropriate.

Support staff of underwriters closers and Servicers.

This group will also support growth in our conventional specialty lending group that has grown nicely following our customers' upmarket.

You've got to spend money to make money. We've proven we can do that over the last 14 years and more recently with our general lending expansion and we're going to do a lot more of it.

But is it worth it.

Here's how we look at it.

Summa lender can produce $30 million of loans a year in five years that lenders portfolio has grown to $150 million.

Expected payoffs begin in six years, let's assume the portfolio levels out of the 150 tons, a 4% net interest margin yields pretax pre provision earnings of 6 million Bucks.

This is a highly liquid highly profitable book of business supported by our staff of only five lab ogres now on the phase II, what about deposits here's the way, we're thinking about the future of the liability side of the balance sheet Huntly and Ronaldo will tell you where we are on completing the cycle of the total fins that conversion.

That is door number one and essential to create the product factory that we have discussed before.

Door number two is to build out a bespoke bank for each of our deposit heavy verticals.

Door number three is our developer portal, which will make banking as a service the easiest to use in the industry today.

So, yes, creating noninterest bearing deposits at scale is just around the corner, but what does it mean.

Here's what I think take first Republic Bank, Jim Herbert has created an organic growth machine.

Creating unmatched service to the right customer those customers grow on their own and then refer lifetime friends, which enhances that growth.

Only a small percentage of frc's growth comes from strangers.

As Jim says spend more money on service not advertising all of that for his bank translates into the NPS score of 73.

Our overall lending NPS score is 67, our overall deposit scores 42, the combined is 47.

So what's going on here.

Our loan repeat customers are 20%.

But Hawaii.

We're an SBA lender the agencies claimed lender of last resort.

Our borrowers want to graduate we're building more that they can graduate to.

FRC surrounds you with service from day one.

Most interaction is on the deposit side wires overdrafts, notary work et cetera et cetera.

Imagine opportunities to excel luminato fully digitizes, our customers experience by tying together bank stuff like loans access to the payment system, plus elegantly interfacing with practice management software plus budgeting and forecasting plus tax prep, plus payroll et cetera et cetera.

Yeah.

So many touch points so much stickiness.

And remember a recent Mckinsey study reminds us the loan to deposit ratio of small businesses with revenues under $5 million is 20%.

That's right.

Deposits are five times, what they borrow.

Our industry has done a terrible job of taking care of these businesses, we have the capital and the earnings power to finish our mission and build this new platform to enhance the performance of small business America.

P J and Huntley will provide details on our financial performance for last year, and how we're going to get there P. J overdoing first.

Excellent. Thanks chip good morning, everybody as Chip said, we finished 2021 on quite a high note building on the significant momentum we've seen really over the last two years in production profitability growth and talent acquisition, our quest to be <unk>.

<unk> small business Bank continues in 2021 with a year that saw a significant milestones towards that goal 2022 will be more of the same.

The unique power of our core lending model dedicated this small business create significant revenue that allows us to both deliver meaningful current earnings and growth while also aggressively investing for the future.

As you can see starting on slide five 2021 earnings per share were $3.71, we generated 75% growth year over year and adjusted P. PNR driven by 37% revenue growth.

19% expense growth the revenue growth was driven by outstanding loan production of $3 9 billion up 46% from the prior year, even with selling about 35% of our guaranteed loan volume, we still generated 32% loan growth on the balance sheet.

This outstanding core business performance, coupled primarily with the benefit of a $44 million gain on one of our ventures investments resulted in 23% growth in tangible book value per share excellent value creation we.

We delivered key accomplishments across the three dimensions of our business vertical <unk> scalability and Optionality.

First in our core lending model focused on small businesses founded and built on the theory of Verticality and knowing your customers and their business is deeply we saw high quality profitable balanced and sustainable loan growth across our small business specialty finance and energy and infrastructure groups.

We continue to scale, our capabilities talent product and technology wise, which will enable further growth deepen customer relationships increase retention and provide both a high touch and a high tech experience for our customers on a next generation technology platform.

Thirdly, we are uniquely positioned to thrive in the future banking landscape, we have proven capabilities, our focus on innovation and strategic investments in <unk> technology that we use for both improvement in customer experience and is a source of growth capital.

Turning to slide seven let's take a look at some highlights from the fourth quarter reported EPS was <unk> 66 cents in the quarter on 11% growth in pre tax income and 8% growth in adjusted PNR. You May have noted that both net income and EPS for the quarter were impacted by a much higher than normal.

<unk> tax rate of 37% versus a full year effective tax rate of 21%.

This was roughly a <unk> <unk> impact to EPS in Q4.

Investment tax credits associated with renewable energy investments that were anticipated to close in 'twenty, one and reflected in our tax rates reported in the first three quarters were delayed by supply chain issues related to the pandemic. Therefore, the Q4 effective tax rate was adjusted for this full year impact these Craig.

<unk> are expected to close in the first half of 2022.

Quick highlights on the fourth quarter strong pretax earnings in PNR growth continue to be driven by outstanding loan production and balance sheet growth, we experienced our third consecutive $1 billion loan origination quarter, resulting in 7% loan growth excluding PPP.

Credit quality continues to be very healthy with virtually no net charge offs in the quarter and a reduction in non accruals, we continue to attract talent, particularly in our lending and technology groups. We introduced our operating account called title and made loan servicing enhancements that continue to improve our customer experience all.

Moving us towards our goal of building that community bank of the future.

And live Oak ventures made one investment during the quarter.

The Fintech space remains very active overall, and we see a lot of exciting innovation occurring across the fintech landscape, but apparently and Neal will give you lot more color on these last two topics in a moment.

Turning to slide eight you will see more detail on our adjusted earnings highlights.

It <unk> in our growth of 8% linked quarter was made up of both revenue and expense growth of 8%.

The net interest margin expanded nicely again up eight basis points linked quarter to 383 and due to the strong positive operating leverage in our business. We again saw a decline in the adjusted efficiency ratio, which has declined 700 basis points since <unk> 2000 <unk>.

Diving a bit deeper into the revenue drivers on slide nine Youll see the total revenue growth of 8% linked quarter and 40% year over year was driven by the strong loan growth and resulting net interest income, which was up 7% linked quarter and 50% year over year on the fee income side, we continue to see healthy sale.

Premiums on our guaranteed loan sales with the average net gain in the fourth quarter of 110%.

Turning to expenses on slide 10, as we discussed on the Q3 call we anticipated having a strong hiring quarter and we did we added 39 net new lives <unk>, which was the driver of our expense growth in the quarter and over the course of 2021, we on boarded 164 net.

New people growing our employee base by 26%.

<unk> over 80% of those new hires were revenue generating lender or lenders support personnel.

Turning to the balance sheet and returns on slide 11%, both linked quarter and year over year loan growth and deposit growth were excellent loan growth, excluding PPP was up 7% and 32% linked quarter and prior year quarter, respectively.

That strong loan growth was driven by our third consecutive quarter of greater than 1 billion in originations across our lending platforms, well balanced among SBA and conventional products as you can see on slide 12, and on slide 13, you can see that the strong originations with 54% of that volume.

We funded in the quarter more than offset prepayments and continued PPP runoff, resulting in that 7% net loan growth before loan sales.

Our efficient deposit platform continues to provide fuel for our loan growth with both strong retention and new balanced growth as you can see on slide 14.

Introduction of our new business checking account will positively impact our funding mix over time as well.

This strong loan and deposit growth has been achieved with well disciplined pricing average core loan yields have remained stable deposit costs declined nicely over the course of 2021, leading to that strong net interest margin expansion of 50 basis points to.

<unk> three <unk> three in almost 70 basis points on a reported basis to just over 4%.

Turning to credit on slide 16, our longstanding practice to frequent contact with existing customers and prudent underwriting remains a top priority you see that our non accruals declined past dues remained very low and we had virtually zero net charge offs in the fourth quarter.

On Slide 17, you see in the upper right. Our capital ratios remained very strong note. The green, 22% bubble, we call out on the graph, which is the capital plus reserve coverage of the guaranteed portion of our loan portfolio, which is almost two times higher than most other banks.

This plus the $2 $9 billion of highly liquid guaranteed loans on our books give us comfort and balance sheet flexibility wrapping.

Wrapping up on slide 18, with a look at our performance versus industry peers as chip said earlier soundness profitability and growth in that order is what we strive for and we're hitting on all cylinders with that I'll turn it over to Huntley and Neil to give you a little bit more color Holly. Thanks P. J, it's chip and <unk>.

Jay mentioned, our 2021 performance it really was a phenomenal year and we think it sets us up incredibly well for the future core revenue growth of 37% expense growth of 20% drove 75% increase in <unk>, its pretty amazing operating leverage let's spend a few minutes talking about.

The strength of our lending franchise, and then about our technology platform and how we think all that fits together. So if you look at our lending franchise on page 21 small business lending continues to be the major driver of growth and profitability for us.

And that success has allowed us as BJ mentioned to invest heavily into developing our next generation technology platform from our route to the SBA seven lender across just a handful of industry verticals, we've diversified into over 35 verticals that you can see on the left hand side across three distinct business segments small business specialty finance.

In energy and infrastructure.

On the right hand side of the page you can see that over half of our origination volume in 2021 still comes from that traditional SBA customers, but increasingly we're serving a broader mix of customers with a broader suite of lending products.

As we've grown as a company we've also grown with our customers increasingly following them up market and into the covering the institutional capital providers that serve them and our specialty Finance division. We serve business is primarily in the $2 million to $10 million EBITDA range, and we continue to see significant capital flows and great financing opportunities there.

There whether it be from founder owned companies small institutional sponsored search funds are self funded acquisitions.

Our work with DSO the consolidators in the dental space is a perfect example of how we've grown in an industry and we plan to expand that model into other sectors like veterinarians and medical.

Especially finance accounted for almost 30% of our loan origination in 2021, and we expect it to be an important driver of our balance sheet going forward.

One of the most significant tailwind in our lending across small business in specialty finance has been the amount of business acquisitions that we're seeing in the market. These transactions account for a little under half of our overall volume and we believe the macro trends will continue as baby Boomers look to continue this trend of transition transition.

Ownership.

Our third lending division as the renewable energy in the infrastructure space, where we're really proud not only of the impact we're having on carbon reduction, but also our position in the industry and we're really excited about the future growth potential investment capital continues to flow into the renewable space with private equity and venture capital and renewable energy and clean tax hitting another.

Record in 2021, the legislative environment remains accommodative, both at the federal and the state level and we see the potential for meaningful increase in investments if the triple B Bill passes.

We also have a dedicated team serving rural markets and helping to support the infrastructure and businesses. There are sweet spot in this space remains the USDA lending, but we're increasingly spending time across a broader range of customers and technologies with a broader suite of lending products at just 15% of our total origination we believe there is meaningful opportunity for.

To grow in this business.

Our overall growth prospects across all of our lending platforms come down to three elements. One is chip mentioned finding the top talent to join us to providing them with the best platform and that culture benefits technology support and then three it's continuing to enter into new verticals and markets, where we see opportunity.

Despite our lending success, we recognize that we still have areas to improve our focus has and always will be on credit quality, which remains really solid but we're also laser focused on improving our customer experience, which primarily means getting faster.

Lending volume this past year was significantly greater than we anticipated you all may recall at the start of last year, we expected a little over $3 billion in origination volume. We ended the year just shy of $4 billion, that's definitely a high class problem, but we got behind in our support infrastructure and we had to lean hard into hiring folks to catch up.

We now have that infrastructure in place and our growth will be more proportionate as we go forward.

In 2022, we'll continue to focus on attracting talent. We will also focus on reengineering, our lending technology and our processes as we rollout a new onboarding experience for customers and improve our document and data management capabilities will be leveraging the latest generation of <unk> for that loan origination work and we're also working to unify our customer experience across.

All of our product and channel, which will ultimately set the stage as chip mentioned to convert our loan customers to defend that core.

Turning to our technology platform. This past year was truly a remarkable one for us as it relates to the build out of our capabilities. After years of hard work, we successfully completed our deposit conversion onto our next Gen core and launched our small business checking account just 10 weeks after that deposit conversion so pretty remarkable.

And something that I think will be but.

Virtually impossible on a legacy core.

And this foundation has set the stage for our entire technology roadmap, where we will add features designed products and integrate offerings at a pace that's far superior to what we could do on legacy platforms.

Importantly, as we head into this year, we're focused on enhancing loan origination processes, adding more features of small business checking and launching a score based small balance lending product.

BJ talked about the investments we've made primarily hiring and that will continue it will continue to be predominantly tied to revenue, including additional talent in our lending areas building out some new deposit verticals and technology talent on.

On the technology side, we've kept our keen lean by design, leveraging our ecosystem partners like <unk> and aperture as much as possible.

With our core live now we've reached the stage, where we can further build out our own team focusing not only on enhancing our customer experience, but importantly on delivering technology designed to drive revenue for example building out Apis as a service capabilities along the lines of what Plaid and stripes are done, but specifically for small business banking.

We're expanding to seven sprint teams across lending deposits infrastructure and data that will roughly double the size of our development team and dramatically accelerate the pace of our innovation two of the slides will be 100% focused.

On improving our existing efficiency and velocity of our core business and the rest designed to build out the net new opportunities.

As you all have heard by now we launched our small business checking account product title that compliments, our business savings and Cds.

One of the key features of this digital Onboarding for small businesses has a loan driven our business savings and CD balances to over $1 $3 billion in just over a year.

And in the last month of our launch we put on about 100 small business checking accounts without any marketing.

Page 23 lays out the features that we believe small businesses are looking for as it relates to banking.

What we've witnessed in the market is the creation of some really innovative products around some of these primarily coming out of the fintech space like margin Pls invoicing expense management et cetera, and all of these products have a really important role in there, helping small businesses, but very few of them are able to integrate and centralize these products together.

To make life easy for the small business owner.

Our product today out of the gate is basic by design and serves the needs of our smallest businesses, but our roadmap is clear and with the ability to build or buy each of these point solutions will quickly and methodically enhance the functionality to better serve a broad range of small businesses upcoming releases will include Quickbooks integration merchant capabilities.

And working capital product.

Perhaps the most important piece of this roadmap our small balanced working capital product, which sits at the top of almost all of our small business customers wishlist, when we ask them what they need.

The industry overall has struggled to make quick credit decisions for small businesses and efficiently fund. These loans when we roll out this product in the middle of the year Youll see the tangible benefits of our new platform seamless customer experience limited data entry and integrated product offering and lightning fast delivery.

We think all of these products and services come together to deliver what we call the community bank of the future and what do we mean by that we think community banks have and will continue to play a vital role, especially supporting small businesses by combining local knowledge and personalized service.

Where many community banks have struggled is in delivering a world class digital experience.

We think increasingly communities are defined not by geography, but by shared interest like veterinarians.

On our next generation technology stack will create bespoke banks for each of these industry verticals as well as new verticals and it's called these community banks. Each one dedicated to serve a specific constituency with specific product integrations and like Lego blocks, we will add to remove these products to create a tailored experience for these customers.

The banking features and inside your acquired around a dental practice are very different than those required around our restaurants.

Our ability to customize that is at the core of why we built this new technology stack.

Our deep domain expertise in these areas coupled with this flexible technology will allow us to deliver these bespoke community bank quickly and cost effectively.

A key element of delivering this community bank is our ability to embed our banking partners that serve the small businesses in many industries small businesses rely heavily on practice management software for appointments building inventory.

With an API enabled banking solution will integrate banking product directly into the software and partners that our customers use improving their experience leveraging rich datasets to inform credit decisions and provide targeted insights to customers as well as driving low cost customer acquisition.

Each industry vertical has its own community bank and each partnership with practice management software application can be considered a branch in this digital community bank.

This embedded banking opportunity as we call it as a critical component to our strategy become America small business Bank and we're really excited to see it come to life.

The strength of our core lending business continues to provide us the opportunity to invest in what we believe is the future of the industry and our company.

This final slide we think of as the flywheel, it's central to the success at live Oak at its core it's all about the people attracting retaining and developing an engaging them. That's mission one that all we ask is that they take care of their customers to do that we build the proper technology infrastructure, we deliver products and services and we have deep daily.

<unk> expertise to serve our customers.

All designed to truly help them. The customer then gets the best of both worlds the high Tech and the high touch.

With that I'll turn it over to Neil to talk about the investing side of the business, which continues to be a meaningful driver of our strategy.

Thank you Holly so moving on to slide 31, I really like this slide because it talks to the evolution of Fintech investing in live Oak Bank. After receiving a success, we formed live Oak ventures and the goal is to directly invest in best in class apps for our customers and employees you've seen some of those slides previously.

I know that live Oak ventures continues to flourish.

We see directing investing is a core strategy of the bank. Great example of that by the way is our latest investment in an early stage company by the name of able to AI and these guys are great Theres 10, Tenex, Stanford engineers implementing real AI around document ingestion and classification across the entire lending continuum.

This solution will arm, our lending team with yet another weapon to speed up the lending process.

Moving to the right you guys know about cannot be fund one we launched it three years ago $650 million have been super active I mean actually to the point, where we are now coming to a close as we've invested the lion's share of the capital in the company as you see here and this thesis is working we're winning the lead against the Blue chips in New York and Silicon Valley, we're getting greater.

<unk> better economics, and we're sitting on boards and really we're right in the middle of all the information flow, which is super important.

We're excited to announce the.

The launch of cannot be fund two we are targeting $750 million, we are receiving very positive feedback and responses from our current bank Lps. We expect the first close actually in March and like fund one the.

The bank will share in the $2 <unk> economics.

Moving on to the next slide nothing really new to see here just a few minor adjustments to the positive and important thing is we'll continue to track this.

In the live Oak ventures portfolio broken down by the original cash investment carrying value and implied value.

And the next slide again is just to emphasize that live Oak ventures will continue to remain very active in direct investing with dedicated resources at the bank and that will be comprised of obviously follow ons to support the existing portfolio of companies and then net new investments.

<unk> is as follows one that helps the bank like bank infrastructure Abel is actually a great example of this.

The second category are those that help our SMB customers. So huntley really mentioned investing or practice management software to support embedded banking thats going to be really important we think there will be investment opportunities there as well and then lastly across the spectrum.

Incubation, where we will continue to create net new companies pre product pre revenue and we will continue to update you on these.

At a time as they rollout so vijay back to you.

Right. Thanks, Neil Huntly, and I think we can open it up for questions.

Ladies and gentlemen, if you have a question or comment at this time. Please press. The Star then the one key on your Touchtone telephone. If your question has been answered you were seeing with yourself from the queue. Please press the pound key.

Our first question comes from Jennifer Dumbo with <unk> Securities.

Hey, Thank you good morning.

So with the hires you've made over the last.

Several months.

<unk>.

And 'twenty, two what kind of loan origination.

Outlook.

The company has over the next few quarters.

Hey, Jennifer Vijay I'll start and Huntley can certainly jump in but.

We finished the year quite strong and we're very pleased with that and we're very optimistic about the outlook as well.

The.

Lines that we see are still.

Quite strong the new lenders that we hired last year.

Had a partial positive impact and theyre going to have even more of an impact.

On a full year in 2022, and we will be continuing to add incremental net new lenders in 2022 as well so.

$3 nine was a good year, we certainly see origination volume over four.

For 2022 and with the incremental.

New hires that we have plus the momentum that we've seen in the business. We continue to think that that could even even move move higher.

Build back better could also certainly help that's still moving through the process in DC of course, we don't assume.

That we're going to get continued enhancements there, but that would be gravy on top of.

What we currently see as very positive outlook.

Well said.

Thanks, Vijay what kind of hiring plan do you have budgeted for this year versus what they are.

64.

New hires last year.

Yes, I think.

You'd expect probably a similar pace.

And I think it is.

Like we said.

The majority of that will be revenue producing in the lending side, we talked about the technology side to probably a quarter of that will be in the technology side, and then and then a bit scattered around that but pretty similar I think net numbers.

Okay.

And just one more question for you.

Jay.

Higher fed funds likely over the next several quarters.

Do you think that does total net interest margin outlook <unk>.

Given.

Positive mix now and how it may be changing over the next couple of years.

Sure Yes.

So Jennifer we put a few characteristics on our on our margin page.

Kind of outline.

Some of the dynamics that we will see but if we start Q4 'twenty one with a four O two margin reported and $3 83 on an adjusted basis.

See over the course of 2022 that those should converge.

More towards the adjusted NIM number.

By the end of the year so.

We still see very very healthy net interest margins, but as rates start to increase particularly in the back half of the year.

We would see that that conversion happening accordingly.

Okay. Thanks, so much.

Sure.

Our next question comes from Steven Alexopoulos from JP Morgan.

Good morning, everyone.

Hey, Steve.

I wanted to first follow up on Chip's comments that you need to spend money to make money. So expenses were up almost 20% in 2021, what's the outlook for 2022.

Yes, I'll start and highlight can certainly jump in.

First I think it's really important to say that we fully expect to grow revenues much faster than expenses and as I said at the beginning.

We are very fortunate here to have the core business lending model as a significant revenue growth engine that allows us to invest in new lenders new technology, that's going to propel us into the future. So positive operating leverage should definitely continue.

With that though on the expense side.

What I would say is we saw a 26% growth in.

In head count over the course of 2021.

If you annualize that.

That for our salary and benefits impact that's probably a good.

Good proxy for salary and benefit increases from 'twenty one.

'twenty two plus.

Little bit more for partial year incremental hires that huntley talked about.

We will have those investment tax credits.

And that flow through the expense line, but that have a benefit on the tax line that will come through as I talked about in the first half of 2022, and then pretty much all of the other line items generally speaking should grow with inflation.

So that gives you I think hopefully Steve a pretty good.

Men of color on how to think about the expense growth for next year.

So said another way it sounds like it's a similar outlook for 2022 than what we saw in 2021.

Yes, Steve.

Steve can you Jeff this is chip.

Hey, guys can you can you hear me loud and clear runway.

Yes, Sir.

Yes.

No.

I'll end up screwing bjs comments, probably so here's an example, right.

The M&A in this business is the gift that keeps on giving.

So the old Compass Bank became BBVA was purchased by <unk> in Chile.

We did a wee bit of a lift out down there now I think we have 12 14 folks lenders closures underwriters.

And as all that continues across the country, just who knows I mean, we now have a group that is totally dedicated to recruiting and if we can replicate that.

Seemed to be a 100 cities in the United States over the next three to five years of the best of the broadest SBA lenders as I alluded to in my opening comments, we're going to do that we're going to find the best and brightest and how you budget that I mean as articulate as BJ was we did another lift out of 15 or 20 years.

Putting expenses in front of revenues.

Yes.

Okay.

You will clearly remain opportunistic but from a core basis strip, we don't know whats going to happen on the hiring side. It sounds it sounds like a fairly similar setup.

But it could be a little higher if more revenue opportunities present themselves. Okay.

That's fair Steve.

Got it okay BJ I wanted to understand your commentary around the margin. So if the forward curve plays out so we see four hikes in terms of the core margin X.

PPP fees it sounds like Youre expecting the core margin to lift does that correct.

Yes, I think again, we start the core margin at $3 83 right.

Alright.

The.

Reported NIM at 402, and so I would say converging down to the 383. So yes, I think we see the adjusted margin as being fairly stable.

Just under 50% of our portfolio is variable we do think that the first handful of moves.

Will.

A lot of that deposit lag will occur so again by the end of the year, maybe it's converging, but we still see the adjusted NIM staying pretty pretty stable throughout the course of the year okay.

That's helpful and then finally.

Appreciate the optimism that originations can stay above $4 billion.

2022.

Should we think about if that plays out should we think loan sales stay pretty consistent around this $200 million per quarter range and whats the outlook for gain on sale margin for 2022.

Yes, so we we generally.

Generally target about 35% of eligible SBA volume that generated in any given year to be sold and thats exactly what we did in 2021. So it might fluctuate every quarter based on the opportunities that we see but generally we think.

35% of SBA and about 100% of the U S da volumes. So we'll keep that as a consistent framework, but as production is growing that also means that eligible sales are growing as well and so we do think that gain on <unk>.

Sale.

Dollar amounts will be growing through 2022 at a pretty healthy clip.

The other thing I would add to that is we had a fair amount of construction.

Projects that we've entered into over the last couple of years.

The USDA projects, largely and then some across our SBA as those projects finish. They then become eligible for sale. So just the amount of production. We've had in the last couple of years, you'll see a bit higher eligibility coming from prior production until that I think will flow through.

Yes, that's a great point and.

In terms of premiums to <unk> point.

We'll be average net premiums around maybe 100 and.

9% or 110%.

The USDA is usually in the 115% range or so so again I think we see.

Pretty healthy premiums going into next year, maybe a bit of.

Modest decline, but higher eligibility for sale, maybe a little bit more mix towards USDA, which has generally higher premiums and therefore, the dollar amount of gain on sale seeing a pretty.

Pretty continuous increase.

Perfect. Thanks for all the color.

Sure. Thanks, Steve.

Our next question comes from Michael Perito with <unk>.

Yes.

Hey, good morning.

Thanks for taking my questions I wanted to just spend another second on the topics you guys were just discussing so just to summarize make sure I kind of capturing it accurately I mean, it sounds like the.

The originations you guys are are via the pipeline suggests that you guys are comfortable or hopeful that you can do another four plus billion dollar a year, but I guess is it fair to assume that the.

Trends in the back half of this year with the conventional lending group being a larger percentage of that.

Okay.

That will continue.

And make up for maybe some losses.

General volume not just obviously I know you guys expect to gain market share, but just general volume at the SBA.

<unk> approved fundings come down a bit from a very elevated 2021 is that currently a fair way to summarize it setup.

Yes, Michael I think that's right I think we continue to see a lot of.

Of opportunity on the SBA side, and even if the market is down a bit where we play in primarily business acquisitions and expansions we continue to see.

Real momentum in that space. So we think a little bit were less.

Maybe less volatile to the total SBA market.

And we'll continue to drive that but I think the mix should be probably about about consistent across across the product set as we look into this year.

Okay, and when you guys say that you guys have.

I hope to see continued growth in the gain on sale for next year.

That.

I guess can you compartmentalize that a bit more for me is that year on year is that.

Based off the run rate you guys had at the back half of the year, which seemed a little higher than what was normal or.

Color you can provide there.

Yes, I think.

Steve.

Excuse me Mike.

If you look at Q3 to Q4, we sold about the same amount of guaranteed loans.

But we had maybe a million and half more.

Gain and Thats simply related to the mix of what we sold I think we sold about 60%.

In the quarter that was.

Variable versus 40% fixed or fixed suggesting.

SBA versus USDA is going to make a difference, but overall I think growing if you take Q4 and then just look forward. We do think that there is incremental growth quarter over quarter in 2022 from an aggregate gain on sale perspective because of what.

And I just talked about continuing to grow the SBA eligible sales number one and number two more volume.

USDA product that will be coming on eligible for sale at a higher premiums.

And on that last point, so I mean, if we look back kind of pre pandemic. I mean, you guys I think that the margins were in the 8% range.

To put some numbers around it I mean, you guys are saying that.

So without getting too specific I mean, it could very well remain north of that 9% you guys have been doing just because you're selling more USDA loans than you.

Might have been two years, two plus years ago relative to the mix of loans sold.

Yes.

Fair to say.

Okay.

Thanks for that and then on the.

Embedded finance initiative.

And the banking as a service stuff that Huntley was mentioning in his prepared remarks. So just.

Wondering if you guys could break down a little bit more.

What that could look like I think historically you guys have said that you want to live Oak brand incorporated youre not so much into kind of the sponsorship model.

The name is just on the back of a debit card or something like that but obviously there are some funding opportunities out there and those types of relationships and it seems like from a tech stack standpoint, there really has not been holding you guys back from exploring some of these opportunities. So I'm just curious if you could maybe break out a little bit more whats generally with some of those opportunities could look like I'm sure you can't be too specific but my guess is some.

And the works if you're planning on launching this year. So just would love a little more color. If you can provide it.

Sure I'm happy to and I can start and if we want to get technical Ronaldo tier two from a from a go to market strategy. As we look at this we're really focused still on the small business customer and helping them and our ability to integrate into the practice management software the networks The association the <unk>.

<unk> groups the wholesalers all of these different application service providers.

That deepen their relationship with the small business.

And where we can embed our banking product that that is really our primary mission.

And where we are going to market. We do believe as you would think about banking as a service and providing bang.

Banking product, whether it's a fintech or otherwise.

Do think we have a cost advantage of flexibility advantage and it is an overall a technology advantage and so we're looking at that and maybe a couple of little things pop up here and there that we want.

We want to do but that isn't our primary focus as we as we think about it right now it's really focused on what what software and what applications touch the small business and how can we deepen those relationships with with integration.

So as you are.

Is your expectation that anything you do in this in this arena.

Would it be something more tilted towards trying to generate lower cost funding at this point I mean.

Whatever it looks like I guess, we will have better color when you announce something but is it fair to assume that thats, where the focus is yes, I think there's three primary places we think that this need for small balanced credit is a real.

Opportunity and with better data and credit decisions.

That that is.

It will be a driver and that's a great product that we want to offer.

That typically comes with the operating account and so then those noninterest bearing deposits, especially now that rates are starting to rise the value proposition and that continues to increase.

And then third it puts us squarely in the middle of payment flows and we think theres a big opportunity around that too. So that's how we're thinking about it Mike definitely the the checking balances as an important driver, but there is really I think three main categories that were that were pushing on.

Helpful. And then maybe a question for Neil kind of on that last point that you brought up.

For the fund to within canopy.

Any broader thoughts of where you think the focus of that fund could shift I mean, theres a lot going on.

In the payment stable coin blockchain based real time payments BTB payments world.

I imagine you guys are looking at that stuff, although I don't know that a lot of formerly has been announced for LIBOR, but just curious if you can maybe provide.

Any thoughts about where you think that one could trend if those are areas of focus that there could be overlap.

Yes, I think there are canopy, we haven't announced yet.

A large investment in our company.

That helps that helps banks b, a custodian of crypto so.

Holding onto bitcoin trading bitcoin and so there is obviously you've seen a lot of activity on that side of it we tend to stay away from tokens and maybe in Ftes, we tend to really like anything around <unk> b.

Fraud prevention, and obviously the infrastructure of the custodian side of.

All of that is crypto crypto means many things to many different people. So we love blockchain, we love infrastructure. There are some things that we are staying away from but all of it makes banks be better on behalf of customers and relative to the actually overall strategy for fund to look there is 250 billion lines of.

COBOL code that drive financial services right now I think we're 20% through the total retooling moving it to API first cloud native and so we're going to continue to invest in companies that help evolve those strategies and the API stuff is really important because it supports the embedded banking strategy. So as we embed our.

Bank and the practice management software providers.

Great question I mean, it's going to have we think pretty significant effects on.

The cost of funding.

Over the next one.

There are many years to come none of that we could have done without a brand new core within that because you just can't scale in the API sets are not rich enough in some of the 30 or 40 year old.

Code out there so.

So more of the same in canopy, two we'll probably do bigger investments larger just given the fund size is going to be bigger.

But with all of our bank Lps in mind.

Got it.

And then sorry, I missed sneak one more in I apologize if I missed this I was kind of jumping between stuff. This morning, but just I heard the commentary about why the tax rate. We are still high but was there anything about what you guys expect it to be next year.

Yes, I think Mike it a good.

Assumption is in the 'twenty to 'twenty, one 'twenty, 2% range.

If we do do.

More investment tax credit business, which we.

Which we expect to do.

It certainly could go lower but I think.

Having that range is your current assumption is probably a good one.

Got it great. Thank you guys for taking all my questions sure.

Sure. Thanks, Mike.

Our next question comes from Chris Donat with Piper Sandler.

Good morning, everyone. Thanks for taking my questions.

Neil wanted to start with you and I will ask the question and I suspect you're not going to answer it the way I want to but we'll understand with the <unk>.

<unk> debentures remaining active can you quantify how much capital is expected to be committed there I know you said opportunistic so I imagine it will depend on a lot of things, but any range or a ballpark based on historical activity would be helpful.

Yes.

I think that.

<unk>.

Probably not right now I think we're talking with the board about interesting.

<unk> to downstream capital also investing at the bank I think the thing to think about though and I think the thing that makes it really interesting is that many of these companies stable is a great example of really early stage. So we don't need to invest.

It really large sum of money to own a meaningful piece just given the stage in maturity and that allows us to be really efficient with our capital and still get.

Significant upside assuming these companies go with the right trajectory. So maybe look at it through that lens instead of at some point, we may be prepared to talk about some ranges.

But but that's how it responds.

Okay.

That's helpful.

Once he said opportunistic it seems like.

There is a lot that will dependent to understand that and then wanted to just go back to one issue on.

The sale P J.

Is there anything we should be watching with the potential mix.

Originations on the SBA side with rising rates in terms of the percentage of fixed versus variable or is that.

Not something that should really change that much.

Rising rate environment, Yes, that's a good good question Chris.

Yes.

Think.

Shay Davis and wildfire <unk> in our in our Treasury group and our secondary group do an excellent job really kind of trying to study the market and seeing how we can.

Maximize what we're doing from a sale perspective, and they look at the mix of variable fixed fixed suggest an SBA USDA et cetera.

To see what what makes the most sense I do think that generally speaking we're looking at.

Trying to yes.

Cell product that maybe has a higher propensity to prepay.

We're also looking at maybe selling some.

More fixed or fixed adjusted at certain points in time to manage our balance sheet and our interest rate risk. So.

Lot of a lot of things go into the Rubik's cube of how we look at.

What we should sell and what we should retain on balance sheet for the carry income.

But back to my earlier comments I think looking at all of that sitting here today, we do still continue to see.

Pretty healthy opportunity to increase gain on sale each.

Each quarter going into next year.

Okay, and then just wanted one.

Clarification on expenses, just looking at away from compensation.

You have had increases in professional services and data processing.

I thought I heard the comment that basically all other expense lines other than comps should be kind of with inflation is that.

That effect that covers professional services and data processing right.

It does I think yes to put a little bit of a finer point on it Chris you're right.

Data processing probably.

It continues to go up maybe it's a little bit more than inflation because of the technology investments that we're making.

Loan.

Loan expenses as it relates to originations will maybe go up more with production professional fee should likely come down some of the other line items come down so.

In General I was.

I was trying to say.

The rest of it growth with inflation. The biggest driver of course is going to be our salary and benefits line as we continue to add talent.

Okay. That's helpful. Vijay Thanks, I appreciate it.

Thanks, Chris.

And I'm not showing any further questions at this time I would like to turn the call back over to our host for any closing remarks.

Great well, we really appreciate everybody's time and their interests. We are here for any follow up that you would like and <unk>.

Hope you have a great rest of the day.

Yes.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.

[music].

Thank you and good morning, everyone welcome to live Oak's fourth quarter 2021 earnings Conference call.

Webcasting live over the Internet and this call is being recorded to access the call over the Internet and review the presentation materials and commentary that we will reference on the call. Please visit our website at Investor Day at live Oak Bank Dot Com and go to today's call on our event calendar for supporting materials. Our 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 that are subject to risks and uncertainties.

I will now turn the call over to chip Mahan, our chairman and Chief Executive Officer.

Thanks, Greg and good morning to all who have joined to review our performance for 2021.

Speaking to you by recording a cell coverage in my current location is a bit spotty.

I will kick things off with a few brief overarching comments on the state of our business with a peek into the future and then turn things over to BJ and hotline to describe our best quarter and best year since inception.

We're going to talk a lot about growth today, both in the past and in the future.

Accomplish this credit quality for these small businesses with very little or no capital is unprecedented total non accrual loans and this bank today are $23 million or <unk> 67 bps on a total AUM guaranteed portfolio at year end of $3 5 billion.

$15 million of our non accruals are continuing to pay as agreed. This is remarkable in this segment. It has taken US 14 years to prove it.

And more recently over the last few years, we've expanded beyond our theory of verdict Gallery.

Our general lending group has grown from eight highly skilled wells Fargo lenders to 'twenty, two adding similar quality individuals from other banks.

So where does that leave us on the loan side of the balance sheet in terms of the future SBA opportunity.

In the last 24 months 1800 banks have made an SBA loan. My guess is that there are at least 4000 SBA lenders trained with primarily two skills.

One is it a good loan.

Does my bank want to lend money to a small business operator that has no capital.

The SBA prefers that their banks prove that the borrower can not found credit elsewhere.

Secondly, theres alone meet the highly technical and stringent requirements of the SBA 500 page standard operating procedure book.

My guess is that 100% of the 4000 lenders in this country you have heard of live Oak Bank by secondary guess is that their view of us in all likelihood is favorable given that we're going to launch a new business unit to determine who are the best and the brightest of this lot and yes, we will be searching for the appropriate.

Support staff of underwriters closers and Servicers.

This group will also support growth in our conventional specialty lending group that has grown nicely following our customers' upmarket.

You've got to spend money to make money. We've proven we can do that over the last 14 years and more recently with our general lending expansion and we're going to do a lot more of it.

But is it worth it.

Here's how we look at it.

Summa lender can produce $30 million of loans a year in five years that lenders portfolio has grown to a $150 million.

Expected payoffs begin in six years, let's assume the portfolio levels out at the 150 tons, a 4% net interest margin yields pretax pre provision earnings of 6 million Bucks.

This is a highly liquid highly profitable book of business supported by a staff of only five lab ogres now on to phase III, what about deposits here's the way, we're thinking about the future of the liability side of the balance sheet Huntly and Ronaldo will tell you where we are on completing the cycle of the total thing Zach conversion.

That is door number one and essential to create the product factory that we have discussed before.

Door number two is to build out a bespoke bank for each of our deposit heavy verticals.

Door number three is our developer portal, which will make banking as a service the easiest to use in the industry today.

So, yes, creating noninterest bearing deposits at scale is just around the corner, but what does it mean.

Here's what I think take first Republic Bank, Jim Herbert has created an organic growth machine.

Creating unmatched service to the right customer those customers grow on their own and then refer lifetime, France, which enhances that growth.

Only a small percentage of frc's growth comes from strangers.

As Jim says spend more money on service not advertising all of that for his bank translates into the NPS score of 73.

Our overall lending NPS score is 67, our overall deposit score is 42, the combined is 47.

So what's going on here.

Our loan repeat customers are 20%.

Why.

Or an SBA lender the agency's proclaimed lender of last resort.

Borrowers want to graduate we're building more that they congratulate too.

FRC surrounds you with service from day, one most interaction is on the deposit side wires overdrafts notary work et cetera et cetera.

Imagine opportunities to excel, we're not to fully digitize our customers experience by tying together bank stuff like loans access to the payment system, plus elegantly interfacing with practice management software plus budgeting and forecasting plus tax prep, plus payroll et cetera et cetera.

Yeah.

So many touch points so much stickiness.

And remember a recent Mckinsey study reminds us the loan to deposit ratio of small businesses with revenues under $5 million is 20%.

That's right.

Deposits are five times, what they borrow.

Jay and Huntley will provide details on our financial performance for last year, and how we're going to get there.

Jay over to you first.

Excellent. Thanks.

Good morning, everybody as chip said we.

We finished 2021 on quite a high note building on the significant momentum we've seen really over the last two years in production profitability growth and talent acquisition.

Our quest to be America's small business Bank continues in 2021 was a year that saw a significant milestones towards that goal 2022 will be more of the same.

As you can see starting on slide five 2021 earnings per share were $3 71.

We generated 75% growth year over year, and adjusted PNR, driven by 37% revenue growth and 19% expense growth. The revenue growth was driven by outstanding loan production of $3 9 billion up 46% from the prior year.

<unk>, even with selling about 35% of our guaranteed loan volume, we still generated 32% loan growth on the balance sheet.

We delivered key accomplishments across the three dimensions of our business vertical Eddie scalability and Optionality first in our core lending model focused on small businesses founded and built on the theory of Verticality and knowing your customers and their business is deeply we saw high quality profitable Bally.

<unk> and sustainable loan growth across our small business specialty finance and energy and infrastructure groups.

We continue to scale, our capabilities talent product and technology wise, which will enable further growth deepened customer relationships increase retention and provide both a high touch and a high tech experience for our customers on a next generation technology platform.

<unk> tax rate of 37% versus a full year effective tax rate of 21%.

This was roughly a <unk> <unk> impact to EPS in Q4.

<unk> are expected to close in the first half of 2022.

A few quick highlights on the fourth quarter.

Strong pre tax earnings.

PNR growth continued to be driven by outstanding loan production and balance sheet growth, we experienced our third consecutive $1 billion loan origination quarter, resulting in 7% loan growth excluding PPP.

Moving us towards our goal of building the community bank of the future.

And live Oak ventures made one investment during the quarter.

The Fintech space remains very active overall, and we see a lot of exciting innovation occurring across the Fintech landscape. Both currently and Neal will give you lot more color on these last two topics in a moment.

Turning to slide eight you will see more detail on our adjusted earnings highlights.

<unk> <unk> growth of 8% linked quarter was made up of both revenue and expense growth of 8%. The net interest margin expanded nicely again up eight basis points linked quarter to 383.

And due to the strong positive operating leverage in our business. We again saw a decline in the adjusted efficiency ratio, which has declined 700 basis points since <unk> <unk>.

Diving a bit deeper into the revenue drivers on slide nine you'll see the total revenue growth of 8% linked quarter and 40% year over year was driven by the strong loan growth and resulting net interest income, which was up 7% linked quarter and 50% year over year on the fee income side, we continue to see healthy.

<unk> premiums on our guaranteed loan sales with the average net gain in the fourth quarter of 110%.

Net new people growing our employee base by 26% importantly over 80% of those new hires were revenue generating lender or lenders support personnel.

Turning to the balance sheet and returns on slide 11, both linked quarter and year over year loan growth and deposit growth were excellent loan growth, excluding PPP was up 7% and 32% linked quarter and prior year quarter, respectively that.

That strong loan growth was driven by our third consecutive quarter of greater than 1 billion in originations across our lending platform well balanced among SBA and conventional products as you can see on slide 12, and on slide 13, you can see that the strong originations with 54% of that volume.

We funded in the quarter more than offset prepayments and continued PPP runoff, resulting in that 7% net loan growth before loan sales.

Our efficient deposit platform continues to provide fuel for our loan growth with both strong retention and new balanced growth as you can see on slide 14.

Introduction of our new business checking account will positively impact our funding mix over time as well.

To 383 in almost 70 basis points on a reported basis to just over 4%.

Turning to credit on slide 16, our long standing practice to frequent contact with existing customers and prudent underwriting remains a top priority you see that our non accruals declined past dues remained very low and we had virtually zero net charge offs in the fourth quarter.

On Slide 17, you see in the upper right. Our capital ratios remained very strong note. The green, 22% bubble, we call out on the graph, which is the capital plus reserve coverage of the and guaranteed portion of our loan portfolio, which is almost two times higher than most other banks.

This plus the $2 $9 billion of highly liquid guaranteed loans on our books give us comfort and balance sheet flexibility wrapping.

Wrapping up on slide 18, with a look at our performance versus industry peers as chip said earlier soundness profitability and growth in that order is what we strive for and we are hitting on all cylinders with that I'll turn it over to Huntley and Neil to give you a little bit more color highlighting.

Thanks P. J, it's chip and BJ mentioned, our 2021 performance. It really was a phenomenal year and we think it sets us up incredibly well for the future core revenue growth of 37% expense growth of 20% drove 75% increase in <unk>, that's pretty amazing operating leverage.

Spend a few minutes talking about the strength of our lending franchise, and then about our technology platform and how we think all of that fits together. So if you look at our lending franchise on page 21 small business lending continues to be the major driver of growth and profitability for us.

And that success has allowed us as BJ mentioned to invest heavily into developing our next generation technology platform from our roots as an SBA seven lender across just a handful of industry verticals, we've diversified into over 35 verticals that you can see on the left hand side across three distinct business segments small business specialty finance.

In energy and infrastructure.

On the right hand side of the page you can see that over half of our origination volume in 2021 Dell comes from that traditional SBA customers, but increasingly we're serving a broader mix of customers with a broader suite of lending products.

As we've grown as a company we've also grown with our customers increasingly following them up market and into the covering the institutional capital providers that serve them.

Our specialty Finance Division, we serve business is primarily in the $2 million to $10 million EBITDA range, and we continue to see significant capital flows and great financing opportunities there whether it be from founder owned companies small institutional sponsors search funds are self funded acquisitions.

Our work with Dsos the consolidators in the dental space is a perfect example of how we've grown in an industry and we plan to expand that model into other sectors like veterinarians and medical.

Especially finance accounted for almost 30% of our loan origination in 2021, and we expect it to be an important driver of our balance sheet going forward.

One of the most significant tailwind in our lending across small business in specialty finance has been the amount of business acquisitions that we're seeing in the market. These transactions account for a little under half of our overall volume and we believe the macro trends will continue as baby Boomers love to continue this trend of transition transition.

The ownership.

Record in 2021, the legislative environment remains accommodative, both at the federal and the state level and we see the potential for meaningful increase in investments if the triple B Bill passes.

We also have a dedicated team serving rural markets and helping to support the infrastructure and businesses. There are sweet spot in this space remains the USDA lending, but we are increasingly spending time across a broader range of customers and technologies with a broader suite of lending products at just 15% of our total origination we believe there is meaningful opportunity for.

To grow in this business.

Our overall growth prospects across all of our lending platforms come down to three elements one as Jim mentioned, finding the top talent to join us to is providing them with the best platform and that culture benefits technology support and then three if continuing to enter into new verticals and markets, where we see opportunity.

We now have that infrastructure in place and our growth will be more proportionate as we go forward.

In 2022, we'll continue to focus on attracting talent we will.

Also focus on reengineering, our lending technology, and our processes as we rollout a new onboarding experience for loan customers and improve our document and data management capabilities will be leveraging the latest generation of <unk> for that loan origination work and we're also working to unify our customer experience across all our product and channel, which will ultimately set the stage as chip.

Mentioned to convert our loan customers to defend that core.

And something that I think will be.

Virtually impossible on a legacy core and.

BJ talked about the investments we've made primarily in hiring and that will continue it will continue to be predominantly tied to revenue, including additional talent in our lending areas building out some new deposit verticals and technology talent on.

On the technology side, we've kept our team lean by design, leveraging our ecosystem partners like <unk> and aperture as much as possible.

With our core live now we've reached the stage, where we can further build out our own team focusing not only on enhancing our customer experience, but importantly on delivering technology designed to drive revenue for example building out Apis and service capabilities, along the lines of what Plaid and stripes are done, but specifically for small business banking.

On improving our existing efficiency and velocity of our core business and the rest designed to build out the net new opportunities.

As you all have heard by now we launched our small business checking account product title that compliments, our business savings and Cds.

One of the key features of this digital Onboarding for small businesses has alone driven our business savings and CD balances to over $1 $3 billion in just over a year.

And in the last month of our launch we put on about 100 small business checking accounts without any marketing.

Page 23 lays out the features that we believe small businesses are looking for as it relates to banking.

What we've witnessed in the market is the creation of some really innovative products around some of these primarily coming out of the fintech space like margin Pls invoicing expense management et cetera, and all of these products have a really important role in helping small businesses, but very few of them are able to integrate and centralize these products together.

To make life easy for the small business owner.

Our product today out of the gate is basic by design and serves the needs of our smaller businesses, but our roadmap is clear and with the ability to build or buy each of these point solutions will quickly and methodically enhance the functionality to better serve a broad range of small businesses upcoming releases will include Quickbooks integration merchant capabilities.

And working capital product.

Where many community banks have struggled is in delivering a world class digital experience.

We think increasingly communities are defined not by geography, but by shared interest like veterinarians.

The banking features and inside your acquired around a dental practice are very different than those required around the restaurant.

Our ability to customize that is at the core of why we built this new technology stack.

Our deep domain expertise in these areas coupled with this flexible technology will allow us to deliver these bespoke community bank quickly and cost effectively.

A key element in delivering this community bank is our ability to embed our banking partners that serve the small businesses in many industries small businesses rely heavily on practice management software for appointments building inventory.

Each industry vertical has its own community bank and each partnership with practice management software application can be considered a branch in this digital community bank.

This embedded banking opportunity as we call it as a critical component to our strategy become America small business Bank and we're really excited to see it come to life.

The strength of our core lending business continues to provide us the opportunity to invest and what we believe is the future of the industry and our company.

This final slide we think of as the flywheel, it's central to the success at live Oak at its core it's all about the people attracting retaining developing and engaging them. That's mission one that all we ask is that they take care of their customers to do that we build the proper technology infrastructure, we deliver products and services and we have deep delay.

<unk> expertise to serve our customers all.

All designed to truly help them. The customer then gets the best of both worlds the high Tech and the high touch.

With that I'll turn it over to Neil to talk about the investing side of the business, which continues to be a meaningful driver of our strategy.

So moving on to slide 31, I really like this slide because it talks to the evolution of Fintech investing live Oak Bank. After Encino success Reformed live Oak ventures, and the goal is to directly invest in best in class apps for our customers and employees you've seen some of those slides previously it's important to note that live oak venture.

<unk> continues to flourish as well.

This solution will arm, our lending team with yet another weapon to speed up the lending process.

Moving to the right you guys know about cannot be fund one we launched three years ago $650 million have been super active I mean actually to the point, where we are now coming to a close as we've invested the lion's share of the capital in the company as you see here and the thesis is working we're winning the lead against the Blue chips in New York and Silicon Valley, we're getting greater allocate.

And better economics, and we're sitting on boards and really we're right in the middle of all the information flow, which is super important.

We're excited to announce the law.

Launched of cannot be fund two we are targeting $750 million, we are receiving very positive feedback and responses from our current bank Lps. We expect the first close actually in March and like fund one.

The bank will share in the $2 <unk> economics.

Moving on to the next slide nothing really new to see here just a few minor adjustments to the positive and important thing is we'll continue to track this.

And the live Oak ventures portfolio broken down by the original cash investment carrying value and implied value.

Categorized as follows one that helps the bank like bank infrastructure Abel is actually a great example of this.

The second category are those that help our SMB customers, So really mentioned investing or practice management software to support embedded banking thats going to be really important we think there will be investment opportunities there as well and then lastly across the spectrum incubation.

Incubation, where we will continue to create net new companies pre product pre revenue and we will continue to update you on these as is.

As they rollout so BJ back to you.

Right. Thanks, Neil Huntly, and I think we can open it up for questions.

Our first question comes from Jennifer Dumbo with <unk> Securities.

Hey, Jennifer Thank you good morning.

So with more hires you've made over the last seven.

For months.

<unk> and 'twenty, two what kind of loan origination.

Outlook.

Anthony handle next few quarters.

Hey, Jennifer Vijay I'll start and Huntley can certainly jump in but we finished the year quite strong and we're very pleased with that and we're very optimistic about the outlook as well.

The pipelines that we see are still.

Quite strong the new lenders that we hired last year.

<unk> had a partial positive impact and theyre going to have even more of an impact.

On a full year in 2022, and we'll be continuing to add incremental net new lenders in 2022 as well so.

$3 nine was a good year, we certainly see origination volume over four.

For 2022 and with the incremental.

New hires that we have plus the momentum that we see in the business. We continue to think that that could even even move move higher.

Build back better could also certainly help that's still moving through the process in DC of course, we don't assume.

That we're going to get continued enhancements there, but that would be gravy on top of.

What we currently see as very positive outlook.

Well said.

Thanks, Vijay what kind of hiring plan do you have budgeted for this year versus what was the 164.

New hires last year.

Yes, I think you should expect probably a similar pace of them.

And I think it is.

Like we said.

Okay.

And just one more question for you.

P J.

Higher fed funds likely over the next several quarters.

Do you think that does total net interest margin outlook <unk>.

Kevin.

Was it mix now and how it may be changing over the next couple of years.

Sure Yes.

So Jennifer we put a few characteristics on our on our margin page just to kind of outline.

Some of the dynamics that we will see but if we start Q4 'twenty one with a four O two margin reported in 383 on an adjusted basis.

See over the course of 2022 that those should converge.

More towards the adjusted NIM number.

By the end of the year so.

We still see very very healthy net interest margins, but as rates start to increase particularly in the back half of the year.

We would see that that conversion happening accordingly.

Okay. Thanks, so much sure.

Yes.

Our next question comes from Steven Alexopoulos from Jpmorgan.

Good morning, everyone.

I wanted to first follow up on Chip's comments that you need to spend money to make money.

<unk> expenses were up almost 20% in 2021, what's the outlook for 2022.

Yes.

Start and highlight can certainly jump in.

First I think it's really important to say that we fully expect to grow revenues much faster than expenses and as I said at the beginning.

With that though on the expense side.

What I would say is we saw a 26% growth in.

In head count over the course of 2021.

If you annualize that.

That for our salary and benefits impact that's probably a good.

Good proxy for salary and benefit increases from 'twenty one.

'twenty two plus.

Little bit more for partial year incremental hires that huntley talked about.

We will have those investment tax credits.

That flow through the expense line, but that have a benefit on the tax line that will come through as I talked about in the first half of 2022, and then pretty much all of the other line items generally speaking should grow with inflation.

So that gives you I think hopefully Steve a pretty good.

Men of color on how to think about the expense growth for next year.

Okay. Vijay So said another way it sounds like it's a similar outlook for 2022 than what we saw in 2021.

Yes, Steve.

Steve This is chip.

Hi, guys can you can you hear me loud and clear runway.

Yes, Sir.

Yes.

No.

I'll end up screwing up bjs comments, probably so here's an example, right.

The M&A in this business is the gift that keeps on giving.

So the old Compass Bank became BBVA was purchased by <unk> in Chile.

We did a wee bit of a lift out down there now I think we have 12 14 folks lenders closures underwriters.

And as all that continues across the country, just who knows I mean, we now have a group that is totally dedicated to recruiting and if we can replicate that.

Soon to be 100 cities in the United States over the next three to five years of the best of the broadest SBA lenders as I alluded to in my opening comments, we're going to do that we're going to find the best and brightest in how you budget that I mean as articulate as BJ was a beat if we did another lift out of 15 or 20 years folks.

Putting expenses in front of revenues.

Yes.

Okay.

You will clearly remain opportunistic but from a core basis strip, we don't know whats going to happen on the hiring side. It sounds it sounds like a fairly similar setup.

But it could be a little higher if more revenue opportunities present themselves. Okay.

That's fair Steve.

Got it Okay P. J I wanted to understand your commentary around the margin. So if the forward curve plays out so we see four hikes in terms of the core margin X.

PPP fees it sounds like Youre expecting the core margin to lift does that correct.

Yes, I think again, we start the core margin at $3 83 right.

Alright.

The.

Reported NIM at 402, and so I would say converging down to the 383. So yes, I think we see the adjusted margin as being fairly stable.

Just under 50% of our portfolio is variable we do think that the first handful of moves.

Will.

A lot of that deposit lag will occur so again by the end of the year, maybe it's converging, but we still see the adjusted NIM staying pretty pretty stable throughout the course of the year okay.

That's helpful and then finally.

I appreciate the optimism that originations can stay above $4 billion.

2022.

Should we think about if that plays out should we think loan sales stay pretty consistent around this $200 million per quarter range and whats the outlook for gain on sale margin for 2022.

Yes, so we we generally.

Generally target about 35% of eligible SBA volume that's generated in any given year to be sold and Thats exactly what we did in 2021. So it might fluctuate every quarter based on the opportunities that we see but generally we think.

Sale.

Dollar amounts will be growing through 2022 at a pretty healthy clip.

The other thing I would add to that is we had a fair amount of construction.

Projects that we've entered into over the last couple of years.

Yes, that's a great point.

In terms of premiums to <unk> point, SBA will be average net premiums around maybe 109% or 110%.

The USDA is usually in the 115% range or so.

So again I think we see.

Healthy premiums going into next year, maybe a bit of.

Modest decline, but higher eligibility for sale, maybe a little bit more mix towards the USDA, which has generally higher premiums and therefore, the dollar amount of gain on sale seeing a pretty.

Pretty continuous increase.

Okay.

Perfect. Thanks for all the color.

Sure. Thanks, Steve.

Our next question comes from Michael Perito with <unk>.

Hey, good morning.

Thanks for taking my questions I wanted to just spend another second on the topic. We just you guys were just discussing so just to summarize make sure I kind of capturing it accurately I mean, it sounds like the.

The originations you guys or are the pipeline suggests that you guys are comfortable or hopeful that you can do another four plus billion dollars a year.

Yes.

Is it fair to assume that the.

Trends in the back half of this year with the conventional lending group being a larger percentage of that.

Well that that will continue I imagine and make up for maybe some loss.

General volume not just obviously I know you guys expect to gain market share, but just general volume that the SBA.

<unk> approved fundings come down a bit from a very elevated 2021 is that currently a fair way to summarize it setup.

Yes, Michael I think that's right I think we continue to see a lot of opportunity.

Of opportunity on the SBA side, and even if the market is down a bit where we play in primarily business acquisitions and expansions we continue to see.

Real momentum in that space. So we think a little bit were less.

Maybe less volatile to the total SBA market.

And we'll continue to drive that but I think the mix should be probably about about consistent across across the product set as we look into this year.

Okay, and when you guys say that you guys have.

I hope to see continued growth in the gain on sale for next year.

That.

I guess can you compartmentalize that a bit more for me is that year on year is that.

Based off the run rate you guys had at the back half of the year, which seemed a little higher than what was normal or.

More color you can provide there.

Yes, I think.

Steve.

Excuse me Mike.

If you look at Q3 to Q4, we sold about the same amount of guaranteed loans.

But we had maybe a million and half more in.

Gain and Thats simply related to the mix of what we sold I think we sold about 60%.

In the quarter that was.

Variable versus 40% fixed or fixed suggesting.

And I just talked about continuing to grow the SBA eligible sales number one and number two more volume.

USDA product that will be coming on eligible for sale at a higher premiums.

And on that last point, so I mean, if we look back kind of pre pandemic. I mean, you guys I think that the margins were in the 8% range.

To put some numbers around it I mean, you guys are saying that.

So without getting too specific I mean, it could could very well remain north of that 9% you guys have been doing just because you're selling more USDA loans.

Might have been two two years, two plus years ago relative to the mix of loans sold.

Yes.

Fair enough.

Okay.

Thanks for that and then on the.

Embedded finance initiative.

And the banking as a service stuff that Huntley was mentioning in his prepared remarks. So just.

Wondering if you guys could break down a little bit more.

What that could look like I think historically you guys have said that you want to live Oak brand incorporated youre not so much into kind of the sponsorship model.

And the works if you're planning on launching this year. So just would love a little more color. If you can provide it.

I'm happy to and I can start and if we want to get technical Ronaldo tier two from a from a go to market strategy. As we look at this we're really focused still on the small business customer and helping them and our ability to integrate into the practice management software the networks The association the <unk>.

<unk> groups the wholesalers all of these different application service providers.

That deepen the relationship with the small business.

And then where we can embed our banking product that that is really our primary mission.

And where we are going to market. We do believe as you would think about banking as a service and providing bang.

Banking product, whether it's a fintech or otherwise.

We do think we have a cost advantage of flexibility to vantage and just an overall a technology advantage and so we're looking at that and maybe a couple of little things pop up here and there that we want that we want to do but that isn't our primary focus as we as we think about it right now it's really focused on what what software and what.

Patients touched the small business and how can we deepen those relationships with with integration.

So is your is your expectation that anything you do in this in this arena.

Would it be something more tilted towards trying to generate lower cost funding at this point I mean, whatever it looks like I guess, we will have better color. When you announce something but is it fair to assume that that's where the.

Our focus is yes, I think there is three primary places we think that this need for small balanced credit is a real opt.

Opportunity and with better data and credit decisions.

That that is.

Will be a driver and that's a great product that we want to offer.

That typically comes with the operating account and so then those noninterest bearing deposits, especially now that rates are starting to rise the value proposition and there continues to increase.

And then third it puts us squarely in the middle of payment flows and we think theres a big opportunity around that too. So that's how we're thinking about it Mike definitely the checking balances as an important driver, but there is really I think three main categories that were that were pushing on.

Helpful. And then maybe a question for Neil kind of on that last point that you brought up one for the fund to within canopy.

Any broader thoughts of where you think the focus of that fund could shift I mean, theres a lot going on.

In the payment stable coin blockchain based real time payments BTB payments world.

You guys are looking at that stuff, although I don't know that a lot of formerly had been announced for LIBOR, but just curious if you can maybe provide.

Any thoughts about where you think that one could trend if those are areas of focus that there could be overlap.

Yes, I think there are cannot be we haven't announced it yet.

Large investment in our company.

That helps that helps banks b, a custodian of crypto so.

Fraud prevention, and obviously the infrastructure of the custodial side.

Of all of that is crypto crypto means many things to many different people. So we love blockchain, we love infrastructure. There are some things that we are staying away from but all of it makes banks be better on behalf of customers and relative to the actually overall strategy for fund to look there is 250 billion lines.

A cobalt code that drive financial services right now I think we're 20% through the total retooling moving it to API first cloud native and so we're going to continue to invest in companies that help evolve those strategies and the API stuff is really important because it supports the embedded banking strategy. So as we embed.

Our bank in the practice management software providers you asked a great question I mean, it's going to have we think pretty significant effects on the cost of funding.

Over the next.

Over the many years to come none of that we could have done without a brand new core within that because you just can't scale in the API sets are not rich enough in some of the 30 or 40 year old car.

Code out there so.

So more of the same in canopy, two we'll probably do bigger investments larger just given the fund size is going to be bigger.

But with all of our bank Lps in mind.

Got it.

And then sorry, I missed sneak one more in I apologize if I missed this I was kind of jumping between stuff. This morning.

I heard the commentary about why the tax rate was still high but was there anything about what you guys expect it to be next year.

Yes, I think Mike it again.

Good assumption is in the 'twenty to 'twenty, one 'twenty, 2% range.

If we do do.

More investment tax credit business, which we.

Which we expect to do.

It certainly could go lower but I think having that range is your current assumption is probably a good one.

Got it great. Thank you guys for taking all my questions sure.

Sure. Thanks, Mike.

Our next question comes from Chris Donat with Piper Sandler.

Good morning, everyone. Thanks for taking my questions.

Neil wanted to start with you and I'll ask the question and I suspect you're not going to answer it the way I want to but we'll understand with the <unk>.

Yes.

I think that.

<unk>.

Probably not right now I think we're talking with the board about interesting.

<unk> downstream capital also investing at the bank I think the thing to think about though and I think the thing that makes it really interesting is that many of these companies stable is a great example of really early stage. So we don't need to invest.

It really large sum of money to own a meaningful piece just given the stage in maturity and that allows us to be really efficient with our capital and still get.

Significant upside assuming these companies go with the right trajectory. So maybe look at it through that lens instead at some point, we may be prepared to talk about some ranges.

But.

Howard respond.

Okay.

Thats helpful.

Once he said opportunistic it seems like.

There is a lot that will depend.

And then wanted to just go back to one issue on.

Gain of sale P J.

Is there anything we should be watching with the potential mix.

Originations on the SBA side with rising rates in terms of.

The percentage of fixed versus variable or is that not something that should really change that much.

Yes.

Rate environment, Yes, that's a good good question Chris.

I think.

Shay Davis and wildfire in our in our Treasury group and our secondary group do an excellent job really.

Trying to study the market and seeing how we can.

Maximize.

What we're doing from a sale perspective, and they look at the mix of variable fixed fixed suggest.

SBA USDA et cetera.

To see what what makes the most sense I do think that generally speaking we're looking at.

Brian too.

So.

That may be has a higher propensity to prepay.

We're also looking at maybe selling some.

More fixed or fixed adjusted at certain points in time to manage our balance sheet and our interest rate risk. So a lot of a lot of things go into the Rubik's cube of how we look at what we should sell and what we should retain on balance sheet for the carry income.

But back to my earlier comments I think looking at all of that sitting here today, we do still continue to see.

Pretty healthy opportunity to increase gain on sale each.

Each quarter going into next year.

Okay, and then just wanted one.

Clarification on expenses, just looking at away from compensation, but you have had increases in professional services and data processing.

Thought I heard the comment that basically all other expense lines other than comps should be.

With inflation is that data.

That effect that covers professional services and data processing right.

It does I think yes to put a little bit of a finer point on it Chris you are right.

Data processing probably.

It continues to go up maybe it's a little bit more than inflation because of the technology investments that we're making.

Loan.

Loan expenses as it relates to originations will maybe go up more with production, but professional fee should likely come down some of the other line items come down so.

In General I was I was trying to say.

The rest of it grows with inflation. The biggest driver of course is going to be our salary and benefits line as we continue to add talent.

Okay. That's helpful. Vijay Thanks, I appreciate it thanks, Chris.

And I'm not showing any further questions at this time I'd like to turn the call back over to our host for any closing remarks.

Great well, we really appreciate everybody's time and their interests. We are here for any follow up that you would like and <unk>.

Hope you have a great rest of the day.

Yes.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.

Q4 2021 Live Oak Bancshares Inc Earnings Call

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