Q1 2023 Live Oak Bancshares Inc Earnings Call
Okay.
Good morning, ladies and gentlemen, and welcome to the Q1 2023 live Oak Bancshares earnings call. At this time all lines are in listen only mode. Following the presentation. We will conduct a question and answer session. If at any time. During this call you require immediate assistance. Please press star.
Zero for the operator.
Call's being recorded on Thursday April 27th 2023, I would now like to turn the conference over to Mr. Greg Seward Chief Risk Officer, and General Counsel. Please go ahead.
Thank you and good morning, everyone. Welcome to live Oak's first quarter 2023 earnings conference call.
Webcast live over the Internet and this call is being recorded.
Access the call over the Internet and review the presentation materials that we will reference on the call. Please visit our website at Investor bilateral bank Dot com and go to the events and presentations tab for supporting materials. Our first 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.
<unk> 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.
Now I'll turn the call over to chip Mahan, our chairman and Chief Executive Officer.
Thanks, Greg and welcome to our Q1 earnings call. We are obviously not pleased with a penny a share but lets look under the covers and see if there is more moving to slide four I'll make a few comments relative to these questions.
Deposits look like how liquid are you.
<unk> credit.
Happened with earnings this quarter are you on a path to grow.
Then turn the call over to Huntley and BJ to dig in.
It is my belief that the events surrounding the closure of Silicon Valley Bank and signature bank will prove to be a seminal moment for this industry.
It has been almost 28 years ago October of 1995 that we launched the first pure Internet bank in the United States. Since then I have never seen the need for physical branches and the inherent cost to support that particular deposit franchise.
Technology that effects bank infrastructure support has made exponential gains over the last several years.
It almost feels like Moore's law is creating banking too.
Many will recall the Gordon Moore, the cofounder of Fairchild semiconductor is a former CEO of Intel predicted of $19 65, but fundamentally computing power or the number of components on an integrated circuit with double every year if you will.
Revised that at $19 75 to double every two years he.
He was right.
It feels like this decade long presence of cloud native API for our solutions is finally creeping into the day to day operations of commercial banks <unk>.
Four years ago, we spent a great deal of time perfecting online account opening at live Oak Bank.
Most banks can now do the same.
It is so easy to move money digitally quality of your money to bank that offers less than market rates.
Posit betas increase as rates continue to rise we were thankful the potential repricing of an entire book of lower cost deposits is not part of our business model.
That trend has begun and it is irreversible.
The customer deserves and we'll find market rates for their savings and operating accounts.
Inside our own canopy initiative that has raised over $1 $5 billion from 70 banks, we see it everyday nextgen Fintech companies are building software in a cloud native API first environment that can get to market very quickly and provide a wide range of solutions to everyday by customers. Additionally.
Additionally, there is a massive amount of capital sitting on the sideline to reward the winners in this space.
It is fun to have a front row seat.
So yes, we'll do deposits look like and how liquid argued.
After the SBB and signature amount. It was published at the average Bank of America had uninsured deposits of 44% of their total deposits.
We were 18%.
Many banks were scrambling to prepare for a run on their back in a matter of hours, we have between three and four times the amount of all uninsured loss of deposits in cash.
Check that box relative to deposits in general Huntly, and BJ, you're going to describe our growth for the quarter and immediately thereafter.
That box.
Relative to credit quality in all metrics remain positive.
Non accruals are 65 bps in over 30 day past dues are only 13 bps, which in dollar amount is just under $7 million for $10 billion bank not bad.
Box.
Lastly on earnings and growth.
Wish I had not taken accounting pass fail in college.
You had the best quarter ever for loan originations, which in large part cost another quarter with an outside seasonal provision the last weeks of the quarter impacted fair value and servicing asset revaluations by $6 3 million.
And here's another $3 million, one time increase in the reserve for unused lines of credit.
Accounting black boxes, mumbo jumbo that translates into excuses.
Tom Brown as a consulting firm in a hedge fund that issues weekly letter read but most of US on this call last week you did a piece on my friend Terry Turner co founder of Pinnacle back in Nashville.
Points out that pinnacle in its first decade provided the second best total return to shareholders of publicly traded banks.
<unk> first quarter call you made the point that analysts go from one <unk> to another while Pinnacle bank keeps running the company with its core principles.
It feels remarkably the same here.
Here's what I can tell you we had the most.
Technologically advanced small business lending franchise in America.
The platform for growth is proven.
The technology is proven the results are proven the culture is prudent.
This next generation technology, and our folks walk across the balance sheet to the liability slash deposit side, our future results will speak for themselves.
Huntley and BJ for more details.
Thanks Chip.
Chip highlighted some of the questions in the industry right now around deposits liquidity and credit and we're going to try to unpack those for you a little more detail. This morning, I'm going to start with safety and soundness, focusing primarily on what happened since the middle of March and how we're positioned before turning over to BJ to go through the quarter and the outlook. So starting on page <unk>.
On slide five the stress that we've seen in the industry in the last six weeks highlighted what we've consistently said that safety and soundness comes first always we talk a lot about conservative credit underwriting, let's say.
<unk> is also means making sure we have ample liquidity to protect our depositors, our borrowers our employees and our shareholders.
You can see some of the highlight metrics here.
Around the strength of our balance sheet, we ended the quarter with over $4 billion of cash and available liquidity as chip mentioned over three times coverage for our uninsured deposits minimal borrowings low overall levels of uninsured deposits are no pledged securities.
And despite the events of late March we ended up growing our customer deposit portfolio for the quarter and we've seen solid growth thus far in April .
Well talk a little more about credit metrics here shortly but overall trends are consistent with our expectations as chip mentioned NPA as in past dues are basically flat over the past year on a percentage basis at 65% and 13 basis points. We did see a couple of charge offs in the quarter that BJ will talk about but overall, we continue to feel really positive about how our borrowers are navigating this.
Environment.
As concerns have grown around investor commercial real estate, specifically in office buildings. We thought we would highlight that we have basically no exposure there our CRA CRE is over 70% SBA and USDA and virtually all owner occupied or in specific operating categories like senior housing and self storage.
After liquidity and credit comes capital and our ratios remained solid across the board.
You've all seen us talk about the main hand ratio before.
Tier one capital plus fair value marks plus reserves on guaranteed loans that ratio at over 20% continues to give us a lot of comfort that we continue to support small businesses through an uncertain economy.
When BJ go through the quarter Youll see both.
<unk> built and a fair value adjustment on loans and while both of those impact earnings for the quarter Theyre noncash item that further support our capital position.
On page six just a quick recap of a few more liquidity metrics, we've covered especially when compared to the broader banking industry. We feel like we're in a really solid place will probably continue to run cash balances and liquidity a little higher than usual for a while which will impact margin a little bit but feels like the prudent course.
On page seven we highlight some additional details on our deposit franchise you can see on the top right through mid March we were growing largely as planned with customer deposit growth up over 6% with no changes in our savings rates and you can also see the planned run off of some of our broker deposits.
The back half of March we saw just over $250 million of runoff of uninsured customer deposits funds shifted to banks deemed either too big to fail or into money markets.
As a result of the increased competition in the market, we increased our savings rate 50 basis points in late March and added additional wholesale deposits to make sure we have ample liquidity to maintain our growth trajectory.
We ended the quarter with customer deposits up two 7% linked quarter.
And that outflow had reversed itself by the end of March we've seen solid customer growth so far in April .
Growth up over one 3% month to date the.
The most significant contributor to that growth has been our business savings accounts, which have doubled since the start of 2022 and the balances now exceed our consumer savings accounts.
Our unique funding model as chip talked about gathering deposits, primarily through branch list savings and Cds has been a highly efficient way to support the growth of our loan portfolio without the cost of our branch network. We are always focused on paying a competitive rate to our deposit customers. So the implications of our replacing our market based savings accounts with alternative sources.
Whether they would be wholesale deposits or borrowings has been much less impactful for us as others in the industry.
Our model has also been built an extremely granular diversified portfolio of deposit customers with low average balances and overall low level of uninsured deposits on.
On page eight chip highlighted.
These metrics in his introduction as in quarters past the significant amount of government guaranteed loans in our portfolio our track record of credit quality with the SBA and our loan loss reserves, all significantly better than the industry.
We also added a few thoughts on our credit philosophy, and how we take care of our portfolio. We continue to focus on government guaranteed lending and lending to low risk industries like professional services that are less cyclical and concentrated we stay really close to our customers no one talks to them as often as we do and we believe that our lack of sales commissions lead to better outcomes for our customers and our.
Folio all in all we continue to feel confident in the quality of our borrowers and their ability to navigate and economic environment punctuated with higher interest rates and slower growth.
On page nine.
Credit normalization is a phrase that we've heard a lot this earnings season Youll.
Youll see a time series of our provision or charge offs.
Our allowance as a percentage of on guaranteed loans Covid created an unusual period, where reserves quickly built up only to decline as a percent of loans given the government's efforts to stabilize the economy and support small businesses.
Over the last year, we've largely seen our reserve levels returned to pre pandemic levels, although given our growth we did not release any reserves like many in the industry again in this quarter, our provision significantly outpaced our charge offs, primarily to support our continued loan growth overall.
Overall, we feel like we're reaching a stable level of reserves given what we see in the macro environment.
Over the past few months bank's balance sheets have been tested and I am proud to say that we passed the test with flying colors, while we expect to see some increased competition in the near term on deposits overall the opportunity for us to serve small businesses is as robust as ever and were excited as ever to continue on our mission Youre talking BJ.
Right. Thanks Huntley chip.
Chip good morning, everybody.
Let's start.
A discussion on earnings on Slide 11, with a recap of the major drivers in Q1 and to state. The obvious this was quite a quarter for the banking industry and for live Oak. It was really the tail.
Two distinct phases January 1st through about March eight and March eight through March 31, and.
In the first phase III early March we saw continued strong customer loan and deposit growth continued improvement in the secondary market environment for gain on sale premiums and asset marks good expense discipline and stable credit quality.
And the second phase post the industry panic of the SBB and signature issues, we saw significant reversals of secondary market pricing improvement we had been experience.
Experiencing and we took action to further ensure the safety of our customers and our balance sheet. So all of that netted to not a lot of earnings in the quarter, but actions, we've taken to ensure safety and soundness, coupled with our strong customer growth puts us on a path to much improved earnings trajectory going forward.
I'll quickly hit some highlights here on slide 11, but get into a bit more detail on each over the next several slides our loan production engine continues to generate profitable growth with the 1 billion in loan production in the quarter being the highest Q1 production level in the history of live oak at average yields.
854% versus current portfolio yields of 7% and driving loan growth up 4% quarter over quarter and 21% year over year.
As Henry said deposit growth was up nicely as well the customer deposit growth was still up almost 3% in the quarter. Despite the March disruption and continues to grow nicely even through April tax season.
I'll get into a bit more detail on our NIM compression this quarter in a few minutes, but we will say that while through while that.
The trial of the NIM is now lower due to industry stress in March the resiliency of our NIM and resulting net interest income in the second half of the year should be aided by the strong net loan growth higher loan production yields were booking and an anticipated flattening of deposit costs.
Expenses are moderating as we discussed on the fourth quarter call and we expect further discipline here throughout the rest of the year on.
On reserves, we leaned into the provision for both growth, which I consider good provision.
And conservatism given the economic environment and finally, the impacts of those notable items, which I'll hit on the next slide had a pretty outsized impact of about <unk> 20 in the quarter.
Turning to slide 12, let's take a look at those notable items that added up to that 20.
And noninterest income we had two notable items the largest of which was for our loans held at fair value, which are marked at the end of each quarter.
Given the disruption in March we saw a significant swing in that valuation.
Just 30 days, we now have roughly a 5% mark on that portfolio over <unk>, our current allowance for credit loss this seems quite conservative.
And noninterest expense, we refined our assumptions to be more conservative in how we reserve for unfunded commitments, resulting in a one time step up to $4 million.
And finally, we had a discrete tax item of $2 8 million, which resulted in an abnormally high effective tax rate in the quarter.
Which we expect will normalize into the 15% to 20% range.
For the course of the year.
Turning to slide 13, our 1 billion of loan production in the quarter was again diverse across multiple areas with particular strength in our middle market sponsor finance vertical solar vertical and numerous small business areas.
As others pulled back on lending, we expect to see good opportunities for new business going forward.
Let's turn to our net interest income and margin trends on slide 14, given the market disruption and the decline in our NIM. This quarter I'll go through the dynamics in a bit more detail than usual.
You may recall that in our response to a question on the fourth quarter earnings call about our NIM in 2023, Ive said that deposit pricing ramped up significantly in the back half of 'twenty, two and showed no signs of slowing.
Therefore, we expected to see downward pressure on the NIM in the first half of the year because of the accelerated deposit pricing would be more rapid than the loan repricing in the back half of the year. However, as our loan repricing flowed through the balance sheet and the fed neared the end of its rate increase cycle, we would expect NIM expansion.
All of those things are still true, but the March industry stress further increased deposit pricing pressures in the near term, but the loan repricing tail wins are still to come which should help with NIM improvement in the back half of the year.
Said, a different way, while we expected a V shape to our NIM trajectory in 2023, given recent events and our desire to ensure continued customer deposit growth. The decline is steeper than we expected in the first half. However, we still anticipate steady improvement in the NIM and net interest.
Income in the second half of 'twenty three.
So let's put a few data points behind what I just said.
Let's take the deposit side first you see that we provided more information on both live oak and the top digital competitors as it relates to deposit pricing and betas, along with the ending fed funds upper right for reference two things you will notice in the first half of 2022.
Our quarterly and cumulative savings betas, we're tracking with the top digital competitors through the first half of 'twenty two.
And second it was at a lower beta about 40% than what we have been consistently sharing with you about our expected through the cycle beta of about 70%.
In the second half of 2022 deposit competition, starting to heat up significantly.
Take a look at the two gray boxes on this slide.
In the third quarter top competitors started moving much higher at a 78% beta in Q3 'twenty two as you can see in the Gray box our deposit growth trajectory. However was still strong and fully supportive of our loan growth. So we remain disciplined about rate increases and our and our beta <unk>.
<unk> lower at 63%.
In the fourth quarter, However, top competitors moved up at almost 100% beta.
We had to move accordingly to maintain our balanced growth.
And in the first quarter, we saw moderation in deposit rate movements from competitors with very little movement through mid March and we were growing our customer deposits on our desired pace. So we had no expectation of moving deposit rates up in Q1.
When the industry crisis hit in mid March and we saw customer outflows, we decided to move proactively and aggressively to reverse the trends we were seeing moving savings rates up a full 50 basis points to move modestly ahead of top digital competitors as you can see it worked.
Quite well to put us back on a positive customer deposit growth path. So we sit here today at a modestly higher through the cycle beta of about 74%.
Versus the 70% or slightly less we had expected.
But are back on track for healthy customer deposit growth to support our continued loan growth.
Now, let's take a look at the loan side.
Here, we provided you with an additional data point, our loan production yields from Q1, a referenced that in a minute our loan yields have been moving up nicely as you can see in the table, but obviously cannot move as rapidly as the deposit beta as we just discussed is about 40% of our current loan portfolio.
It is variable rate.
But two points to make on loan yields going forward.
Number one loan production yields are currently being booked at rates greater than 150 basis points higher than our portfolio rates.
See the $8 50 for on new loan production yields in the upper right at this slide versus the 7% portfolio loan yields in the upper right of the table.
The majority of our variable rate loans are quarterly not monthly adjusting this means that unlike deposit rate changes, which happened intra quarter, we don't see intra quarter increases in loan yields they move up the full change in the prime rate over the prior quarter on the first.
<unk> of the following quarter. So as of April one our quarterly adjusting loans saw another 50 basis point increase in rate.
Therefore, as our newer loans replace older loans over time, our portfolio yields will continue to rise supporting stabilization than improvement in our net spread.
So what does all this mean for the NIM and how does that relate to the $3 50 to $3 75 range that had been discussed.
Pre crisis, we would have expected NIM to bottom out in the $3 50 to $3 $55 range in Q1, and Q4 dollars 23 in the $3 75 to $3 80 range, resulting in a full year 2023 <unk> in the 365 range.
With the March events, driving deposit costs higher than anticipated, we now expect NIM to bottom out at about 25% to 30 basis points below the prior range one quarter later in Q2 and Q4 dollars 23 in the lower to middle part of the $3 50 to $3 75 range.
This remains an uncertain environment, So let me be crystal clear and transparent with our current assumptions here.
The fed moves 25 basis points in May then pauses for the rest of the year.
Deposit betas move in the $60 to 70% range for that increase then flatten.
Deposit growth continues on pace with the above beta assumptions.
Healthy loan growth continues on pace with current pricing.
And no further major industry disruption related to deposits where liquidity.
Remember that if we do decide to hold more on balance sheet liquidity and may have an impact on the NIM, but we will have minimal impact on net interest income.
So to recap.
<unk> and NIM trajectory in the first half of the year for more rapid deposit rate changes due to the industry stress events, but NIM and net interest income improvement in the back half of the year as deposit cost moderate loan yields continue to improve and earning assets continue to grow hoped.
This helps.
Let's turn to slide 15, and take a look at noninterest income trends.
As I mentioned before we had been seeing improvement in secondary market conditions premiums and valuations before the mid March events are.
Our SBA sales activity increased in Q1 as did our gain on sale premium, resulting in $10 million and net gain on sale income versus $7 million in Q4.
Though the majority of what we sold was variable rate, we did see some fixed rate SBA sales activity, which was encouraging and all of our sales activity occurred before mid March.
As you can see in the upper right from February 28th to March 31.
Our servicing asset rebuilt and fair value Mark was down almost 6 million or over $6 million reversing a net gain position we had on those assets as of the end of February .
While there will be continued variability as these assets are valued quarterly based on market pricing.
Spot rates on $3 31, we're obviously heavily heavily influenced by the events in March but we do not expect this level of volatility going forward.
Turning to expenses on slide 17, as we discussed on the fourth quarter call. We have worked through what I call. Our hiring bubble first to rightsize, our lender support to accommodate that significant step up in balance sheet growth over the past few years and second to accelerate our technology build out in 2000.
22, thanks to the things that gain going forward, while we will continue to be opportunistic on hiring for revenue producers, we are tightly managing our expense growth to improve our operating leverage.
Our core expenses were essentially flat to Q4 with our head count up only seven people or 1%. We expect continued lower levels of hiring and strong expense discipline going forward.
Turning to credit trends on slide 18, as chip and Huntley discussed earlier credit.
<unk> remained quite strong we continue to actively monitor the existing portfolio and do not currently see any glaring weak spots.
Past dues are down and non accruals remained quite low you can see that the credit quality trends across our three business segments are quite strong as well.
And five about five of the $6 7 million net charge offs in the quarter were driven by two relationships, leaving only $1 7 million of net charge offs across the entire rest of the $8 billion portfolio. Two relationships is not a trend Steve can speak more on.
These and the overall strength of our portfolio during Q&A.
You have to provision remained flat as we leaned into building reserves for both the new loan growth and continued caution about the future economic outlook, our reserves to on guaranteed loans remained well above the industry.
And about $7 million of our 19 million provision was for net new loan growth that to me is good provision set a different way, if we werent growing loans and customer relationships, our provision would have been $7 million lower.
I'd, rather be growing profitable loan relationships.
With what we see combined with a conservative outlook. We currently feel very well positioned with our reserve levels at over two times industry averages slide.
And to wrap up on slide 19, Here's what we're focused on for the rest of 'twenty three.
And on the growth front, we remain incredibly excited about the power of our business model, our lending businesses continued to provide excellent value to our customers, resulting in strong loan production and growth and we look for opportunities every day to add more revenue producers.
<unk> platform.
And we still remain very confident that our embedded banking platform and all the technology investments that we're making are going to be absolute game changers in this industry with that we can open it up for questions.
Thank you.
Ladies and gentlemen, we will now begin the question and answer session. If you'd like to ask a question. Please press star followed by the number one on your telephone keypad, if you'd like to withdraw your question. Please press star full by two if you are using a speaker phone. Please lift the handset before pressing any keys one moment.
For your first question.
Yes.
And your first question comes from Brandon King from Truest Securities Brendan. Please go ahead.
Hey, good morning.
Hey, Brandon granted.
Hey, So just wanted to start on credit.
Two relationships you could elaborate on that to give us some more context behind those two relationships.
Certainly Brandon this is Steve Smits good morning.
Yes ill talk about the first.
Sure.
Was a direct to consumer e-commerce business.
And had very specific challenges around the opt out most of their marketing.
Was focused on Facebook.
E Commerce marketing so with changes in the opt out rules around that that had a material impact to their revenue.
So I consider that very much isolated I'll also note that we have very small exposure to businesses, whose primary.
Revenue driver is direct to consumer ecommerce less than half a dozen relationships to be more specific.
Every one of those is actually doing quite well with good cash flow.
The second is very specific to supply chain challenges and more specifically lumber cost. So at the height of lumber costs. This business suffered a significant deterioration in their cogs, which they simply were not able to work through so that when we charge them.
So I would conclude that both are very much isolated situations overall I don't see any systemic trends that are concerning to me.
Got it got it and I guess with that not being systemic would you I guess assume that charge offs go lower from here.
Throughout the year.
While I don't have a crystal ball and there is always a chance for an unforeseen right now I feel very confident that the portfolio is quite stable I also feel very confident that we for those folks that are newer to the live oak I did play a stress comments made both by.
Huntley as well as BJ during his comments is our very robust servicing.
Philosophy and methodologies, so we say incredibly close to our customers. So I feel like I have a very good pulse on the health of our borrowers and can say that I feel the portfolio is quite stable and actually doing.
Okay. Thanks.
And then just one more question.
Could you give us the update on the small business checking and Treasury management products.
Sure Brandon its huntley I'll start and others can can chime in so we are as BJ said live with a full service checking operating account for small business with with a full set of Treasury management capabilities. We've got our first 10 customers live on it.
Moving money.
Somewhat strategic in how quickly we came to market because we wanted to make sure. It worked and worked and we're going through that with our first set of customers and throughout the year, we're continue to ramp.
And do more so we really really excited that we've gotten gotten to where we are.
Think about one is as chip said.
We like that on the flip side.
Maybe we haven't seen it yet, but we're really really early days.
Thanks, and good morning, everyone.
First on growth I'm, just kind of curious what your views on growth are in the current environment based on the prepared remarks, you seem to be.
Remaining constructive on growth, but just curious if you would expect any pullback or any deceleration in loan growth given the current environment or should it.
Or do you believe you can still grow at kind of typical historical levels, especially as the SBA can have counter cyclical tendencies.
Well I'll start and then you guys can add on it seems that when we talked to our leaders and the sales division.
They are seeing as late as yesterday, the phones are beginning to ramp.
That is the credit guys run another banks are tightening the screws, we bet and we have seen this from time to time over the last 15 years. So we will be in the market.
I think if we look at the pipe gas it is relatively strong.
These are guys are not backing off their projections from 120 days ago.
Yeah, No that's right I mean, I think we have seen some situations, where a buyer and seller can agree on value given the changing market conditions, where somebody decided to pause on an expansion project. So that is.
A bit of a headwind, but to chip's point, we're also seeing perhaps more opportunities in this space and in some some areas more than others. It hasnt been sort of broad across the board whether it be opportunistic.
Great.
Thanks, Chip and Hanmi I appreciate the commentary there and then.
Just on SBA gain on sale margin trends I'm, just kind of curious from kind of over the first quarter and then through through April April how they've.
How they've been as margins likely compressed kind of following the bank turmoil and then.
Just kind of trends in early April on gain on sale margins and then just Relatedly do you expect any knock on effects.
In SBA secondary markets just from the bank closures earlier in the first quarter.
Could impact SBA gain on sale over the near or longer term.
Hey, Chris It's BJ good morning so.
Yes.
Unfortunately.
Mid March stress is kind of.
Stunted the improvement that we had been seeing over the course of the year in terms of premiums.
Premiums were.
Up probably hunter.
100 to 200 basis points or so from.
Up through mid March, which was encouraging to see and you actually saw from fourth to first quarter.
Net gain on premiums was actually up from quarter to quarter.
That kind of backed up and paused.
As of the end of the quarter.
Still a little bit of uncertainty through April .
There is.
Certain disruption in the secondary markets.
Which which buyers are going to be there going forward et cetera.
But we're hopeful that the <unk>.
Further we get away from mid March things start to normalize we do expect premiums to continue to.
Improve over the second half of the year and Thats, what our expectation is.
Hey, I wanted to make sure I have the new NIM guidance correct.
Down <unk>.
Yes, yes, so whereas.
<unk>.
Whereas we thought the bottom end of the range before was $3 50 to $3 75, we think we bottom out 25% to 30 basis points below that range.
But then come back in the second half of the year and more in the lower to middle part of that $3 50 to $3 75 range.
Okay.
You gave a range for <unk>.
You would think.
Basically it's the exit margin out of this quarter rate, giving you took up savings rates well, let me just ask what do you think over the second quarter margin because it sounds like you think NIM will drop in <unk> and then <unk>.
Prove in the second half right that's the outlook.
Yes, yes so.
<unk>.
The margin will be down in the second quarter because.
<unk> 50 basis point increase we made in mid March is going to have an outsized impact in the second quarter. So.
Second quarter NIM will be down.
But in the second half.
Loan yields will start to flow through the balance sheet deposit costs will flatten is our expectation and by fourth quarter. The margin will go back up towards the <unk>.
Lower to middle part of that $3 50 to $3 75 range.
Okay. That's helpful and then within that.
What level do you assume again, calling out the scenario you're talking about for the fed right one more hike and then they go to pause.
Do you see deposit costs peak.
It sounds like the timing of that well I'm just going to ask you.
Where do you see deposit costs, peaking under that scenario, which is within the guidance you just gave us and what's the timing.
See the peak.
Yes so.
To have this flow through I would see the peak.
Based on my based on the assumptions that I just gave in the third quarter.
Maybe the fourth quarter.
But the real step up would occur.
Second quarter <unk>.
Moderation in third quarter and fourth quarter.
Got it okay.
Curious if you could share with us what does a stress scenario.
Guaranteed portion of your loans looked like and if that played out.
You already reserved for that or would the reserve need to materially increase.
Yes, Steve This is Steve Smits, I will start and BJ you can certainly add because we did run some stress scenarios.
I will say that we feel that we are properly reserved for a rocky or <unk>.
The impact.
I mean, maybe if we stressed it across primarily for different types of stresses one was that prepays declined.
The second was that unemployment spiked over 200 basis points in a year from where we are today.
Would have gone up if all of those things happen Armageddon would be up about.
20%.
So not not.
It is not catastrophic at all so that's it all played out.
If every single one of them played out and played out in the next.
Three quarters, which obviously is highly unlikely so going back to Steve's point we.
We already have what we believe is some conservatism and thumb on the scale around PD LGD is where we think prepays are where we think unemployment is.
Et cetera. So.
We feel very well positioned with the reserve as we sit here today.
Yeah.
That's terrific color to P. J, if I could squeeze one more and just following up on your answer to the earlier question on the gain on sale.
So given that the market appears to be somewhat disrupted at least right. Now do you think gain on sale revenue maybe goes back to where we were.
I don't know what the prior quarter.
<unk> 22 is that what youre thinking.
No.
Okay.
So I do expect in the second half of the year continued premium.
<unk>.
I think that what we are what we are producing is conducive to us being able to sell more in the secondary market and what I mean by that is.
I think in the quarter over 80% of our SBA production was variable rate.
Variable rate is still very attractive on the secondary market.
And so as we have more variable SBA eligible loans coming into.
The company, we have more flexibility to sell so we can sell more even if theres a modest backup in premiums if premium comes back we can still sell a little bit more and at a higher premium. So all of that to say is I still feel good about the levels.
Gain on sale income that we're at in the first quarter and hopefully we continue to see growth in improvement over the course of the year.
Okay. Thanks for taking my questions I appreciate it.
Thanks, Steve.
Your next question comes from David Feaster from Raymond James David. Please go ahead.
Hey, good morning, everybody.
Hey, David.
Maybe just moving.
Moving back to the checking into Treasury management initiatives that we talked a bit about earlier.
Have your expect obviously, it's still early.
Spectation changed for that at all.
You talked about maybe a couple of hundred million dollars coming on by.
By year end is that still the target just kind of your in your comments on deposit costs. It sounds like that may be reasonable I'm just curious if.
If that had changed at all.
So you can take this let me just give you a little background on the product itself David.
So this product was created by funds express and $19 97, which is now aperture today. So those guys in Austin, Texas lifted and shifted all that code out of a data center in Austin.
And made it fundamentally cloud native API first to transfer to AWS.
Pinnacle loans right.
Right.
This is over the last two years or three years. So as we we're lifting and shifting that to a next generation environment. We did just that and then they begin to win awards right. So sell others I can't remember the name so that is the product in the marketplace primarily helping.
Larger customers than ours are customers, mainly $2 million to $5 million revenue small businesses.
Pinnacle's customers are substantially larger than that so we have a lot of excess capability as our customers use that software and move up market.
Huntley you clean that up yes, so David to your question look I think that number seems about right. We are excited we're still early days, but if we continue to lend out of $1 billion, a quarter and Thats 500, plus new customers a quarter those are great opportunities for us to convert on a proven platform. So I think.
That makes sense and we've talked about.
The tightening of credit maybe pushing more folks in the SBA, but thank.
Thank you still have a similar concept on the conventional side as well is that something that youre seeing and maybe would you expect the proportion of conventional lending to increase or would you kind of expect it to stay relatively.
The same and then I guess, where are you seeing opportunities.
Obviously specialty finance.
Specifically sponsored finance was really strong just curious where you're seeing opportunities more on the lending side.
You could make a case that we find more SBA opportunity I think you could make a case to the contrary right now it feels like the balance and the mix is about it's about what we're seeing and we'll continue to as we look at pipelines I think the area one of the areas that we think theres going to be some opportunity. Obviously, we're not in as we mentioned the office sort of commercial real estate space.
But there are places that are the secondary and tertiary where some people paint real estate with a giant brush and so maybe that senior housing maybe thats self storage places that fall into our real estate bucket, we look at them much more as operating businesses.
Where we may find some incremental opportunities.
Okay. That's helpful. And then maybe if we could just touch on the tech investment side I'm, just curious what youre seeing there obviously valuations in the market are still a bit challenged.
But I mean look canopy services.
So nice growth this quarter, just curious some of the trends that youre seeing on the tech investments and within canopy.
I would say that the guys at canopy, you're still looking at three to five new opportunities a day.
That said somebody said earlier that those valuations of those businesses have dropped dramatically from 20 times forward revenues to six.
I would say that most of these companies are looking to trim overhead and get the profitability on their own. So we're being very circumspect, but theyre tickled to death that our second fund is in the process of wrapping up. So we have about 800 plus million dollars of dry powder to pick the winners so so far so good.
Does the <unk> b failure impact that business at all or I mean, maybe push more opportunities do you.
To be determined.
Hard to say there okay.
Okay.
Okay, Alright, I appreciate all the color thanks, everybody.
Thanks, David.
There are no further questions at this time I'll now turn it back for closing remarks.
No closing remarks folks will see you in 90 days, thanks for joining us.
Ladies and gentlemen, this concludes your conference call for today, we thank you for participating and ask that you. Please disconnect your lines.