Live Oak Bancshares - Q2 2023

Transcript

Operator (participant)

Good morning, ladies and gentlemen, welcome to the Live Oak Bancshares Q2 earnings conference call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded today, Wednesday, July the 26th, 2023. I would now like to turn the confe rence over to Greg Seward, Chief Risk Officer and General Counsel. Please go ahead.

Greg Seward (Chief Risk Officer and General Counsel)

Thank you, and good morning, everyone. Welcome to Live Oak Bancshares' second quarter 2023 earnings conference call. We are webcasting live over the internet, and this call is being recorded. To access the call over the internet and review the presentation material that we will reference on the call, please visit our website at investor.liveoakbank.com and go to the Events and Presentations tab for supporting materials. Our second quarter earnings release is also available on our website. Before we get started, I would like to caution you that we may make forward-looking statements during today's call that are subject to risks and uncertainties. Factors that may cause actual results to differ materially from our expectations are detailed in the materials accompanying this call and in our SEC filings.

We do not undertake to update the forward-looking statements to reflect the impact of circumstances or events that may arise after the date of today's call. Information about any non-GAAP financial measures referenced, including reconciliation of those measures to GAAP measures, can also be found in our SEC filings and in the presentation materials. I will now turn the call over to Chip Mahan, our Chairman and Chief Executive Officer.

Chip Mahan (Chairman and CEO)

Good morning, and thanks, Greg. Turning to Page 3, we are pleased to show significant improvements over the last two quarters. Core revenues were up, expenses were down, charge-offs were low, credit quality remained solid, notwithstanding a bump in non-accruals, regressing us to our historic norm. BJ and Huntley will unpack the details in just a minute. I'd like to pause here at midyear and reflect on what has happened so far this year and where our industry is headed. Did you know 9,000 banks failed in this country between 1930 and 1934? Moving to Slide 4, we see the history of FDIC insurance providing stability to our industry. No more Jimmy Stewart's It's a Wonderful Life runs on the bank. That was until March 8.

A Twitter-led run on SVB took place minutes after they announced a $1.8 billion capital raise, exposing their mark-to-market losses in their bond portfolio. $43 billion went out the door on March ninth. It was over. Never had news traveled that fast. Never was a bank able to handle $43 billion worth of withdrawals in a matter of hours. Bank tech has changed. We are getting more efficient daily. AI will continue to fuel that fire. Liquidity reigns. Rates are up 500 basis points. What about the customer? I have been waiting for this moment for 28 years. It was 28 years ago, we put the first bank on the internet. Can you remember, or much less imagine, a 28K telephone modem in 1995? I thought then, as I think now, why the need for these expensive branches?

Let's take a look at arguably the number one brand in banking. This quarter, the Bank of America released some data publishing a slide on their consumer bank. The rate paid on all consumer deposits was 22 bips. The cost to gather those deposits was 137 bips through almost 4,000 branches and an untold number of tellers and CSRs. On the self-service side, they have 37 million mobile users. BofA is a $2.5 trillion dollar institution whose deposit beta since 12/31/2021 was 35%. Why do you anointed analysts on this call applaud low deposit betas? Are we not, as an industry, celebrating screwing the customer? Our savings rate at Live Oak Bank has been 4% forever for both consumers and small businesses.

With Live Oak's simple online account opening technology, aren't these 37 million mobile users vulnerable? I mention Bank of America only as a proxy for our entire industry in general. Quick question: If someone had just $10,000 to their name in a money market or savings account, is not $400 meaningful to them? The fat underbelly of our industry is exposed. Our expensive branch deposit gathering model is broken. Just a word on self-service and full service. My wife works out with a bunch of ladies trained by a wonderful professional. He saw a billboard in Wilmington with our 4% savings rate and opened a savings account. He was astounded when he had a question and someone answered the phone at our bank. He called us back each of the next two days to test us. We answered the phone in 11 seconds each day.

You got to do both. I like our model. For 15 years, we've been the best small business lending bank in America by treating every customer as if they were our only customer. We are marching to the deposit side at precisely the right moment in time. Our competition cannot reprice their entire book of savings and money market accounts. We shall nip at their edges as their customers feel less appreciated. The combination of our next generation cloud-native API technology will allow us to create new products and build a bespoke community bank for each industry we serve. While our industry remains woefully stuck in the mud, supporting and maintaining billions of lines of ancient code that they call technical debt. Moving to Slide 5, just a word on credit. I call this our CECL slide.

Historically, that is pre-CECL, a bank would build a proper reserve, and usually, that quarter's provision was about equal to total charge-offs. Not so these days. The complexity of building a model to predict lifetime losses in a bank that is growing the way we have, is substantial. Here's a fun fact, that of last Friday, 76 banks have reported, and their collective loan loss reserve to total loans jumped two basis points from 1.21%-1.23%, while we increased our reserve from 183-246, or 63 basis points. As you can see from Slide 6, our provision over the last three and a half years has been four times our charge-offs incurred. Soundness, profitability, and growth in that order. One last word on production.

We were not disappointed with our production numbers this quarter, even though we were a little over $100 million less than last quarter. Since Huntley and BJ do such a wonderful job running the bank day-to-day, I get to spend an extraordinary amount of time on the road visiting customers and prospects. We are getting better looks at the basket, higher quality, larger loans are coming our way as the competition seems to be much more discerning, focusing more on existing customers and much less prospecting for new clients. In our government-guaranteed lending business, it appears that the silver tsunami, or those baby boomers that are of age to sell, have seen prices come down as interest rates have risen. Some deals just do not pencil the way they did a year and a half ago. BJ, over to you.

William C. Losch (President)

Excellent. Thanks, Chip, that's a great setup. Good morning, everybody. It's great to talk to you this morning. Let's start on Slide 8 with a high-level earnings summary for Q2. While weathering the banking earthquake in the first quarter, as Chip kind of talked about, we positioned ourselves to not only survive the aftershocks that we saw coming and know are coming, but to thrive. The key commitments we made about what we would do in the second quarter, such as strong deposit growth and liquidity, net interest margin performance, continued loan growth, stable credit quality, and moderating expenses, were all exceeded.

While we can't predict with certainty what the economic outlook may bring, the actions we took in the first quarter, our performance in the second quarter, and the ongoing strengths of our business model, have set us on a strong path towards continued consistent earnings and customer growth over the next several quarters. To put some numbers to it, in Q2, we earned $0.39 of EPS, driven by a strong 41% improvement in PPNR, both revenue growth and expense reduction, as well as continued strong credit quality, resulting in lower provision versus the first quarter. As Chip mentioned, loan production was still healthy at $860 million, but down from Q1 as activity was steady, but we had some loan closings move past the end of the quarter.

Pipelines have grown steadily throughout the quarter, which is encouraging for the second half of the year. Deposits were up nicely as well. Our customer deposit growth was up almost 7% in the quarter, with fantastic business deposit inflows of 22% on a linked-quarter basis. On our last earnings call in April, I shared our expectations for our net interest margin, and I'm really pleased to say that while our forecast in April for the second quarter NIM was a decline into the 3.20-3.25 range, with risk of further compression if we held excess liquidity, we actually ended the quarter with a 3.29 NIM, even with about 12 basis points of drag from that excess liquidity.

I'll get into a bit more detail on the reasons for our NIM resiliency in a few minutes, and the positive net interest income growth expectations for the second half of the year. In short, it's due to the excellent efforts of our lenders, along with our deposit and treasury teams, to remain both competitive with our customer offerings and disciplined on our pricing. Fee income was improved linked quarter, with relatively steady gain on sale premiums. Expenses declined quarter-over-quarter, and we expect continued discipline here throughout the rest of the year. Provision declined as expected, with only $1 million of net charge-offs and continued reserve build for both growth and to maintain sound portfolio management.

Turning to Slide 10, loan production in the quarter was again diverse across multiple areas, with particular strength in our middle market sponsor finance vertical, our solar business, and our general lending small business verticals. We expect to see good opportunities for new business going forward, and we look forward to capturing those opportunities. Let's turn now to our net interest income and margin trends on Slide 11. As I mentioned earlier, while our Q2 NIM outlook three months ago was a decline to the 320-325 range, with risk of further compression with excess liquidity, we ended at 329, even with that 12 basis points drag. We expected to see downward pressure on the NIM in the first half of the year because.

of the accelerated deposit repricing from the Fed's rate increase cycle, that would be expected to be more rapid than the loan repricing. In the back half of the year, 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, we were able to both grow deposits and hold our savings rate flat since March due to our already strong rate offering, while loan repricing tailwinds continued, and our lenders remained very disciplined with new production yields, which should help with NIM expansion and net interest income improvement in the back half of the year. A few highlights to point out.

On, first, on the deposit side, you see that we again provided information on both Live Oak and the top digital competitors as it relates to deposit pricing and betas, along with the national savings rate and ending fed funds upper rate for reference. As we discussed on the last earnings call, when the industry crisis hit in mid-March, we saw customer outflows. We decided to move proactively and aggressively to reverse the trends we were seeing, moving savings rate 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.

Even though the Fed moved another 25 basis points in the quarter, we were already in a highly competitive position to attract customer deposits, particularly on the business side, such that we were able to show outstanding deposit growth while holding flat on savings rates the entire quarter. Our through the cycle beta of 70% is exactly what we've communicated all along as our expectation. Now, let's take a look at the loan side. Our loan yields have been moving up nicely, as you can see in the table, but we hadn't been moving nearly as rapidly as the deposit betas we just discussed. Two points we made on loan yields last quarter continue to hold true. Loan production yields are currently being booked at rates 175 basis points higher than the portfolio rates.

See the 9.12% on new loan production yields in the upper right of the slide versus the 7.37% on portfolio loan yields in the upper right of the table. Secondly, the majority of our variable rate loans are quarterly, not monthly adjusting. That means that unlike deposit rate changes, which happen intra-quarter, we don't see intra-quarter increases in loan yields. They move up the full change in the prime rate over the prior quarter on the first day of the following quarter. As of July 1st, our quarterly adjusting loans saw another 25 basis points increase in rates, and about 46% of our total loan portfolio now is variable rate, and almost 90% of our current production is variable rate.

Therefore, as our newer loans replace older loans over time, our portfolio yields will continue to rise, supporting stabilization, then improvement in our net spread. What's all this mean for the NIM? Same as what we believed a quarter ago. This should be the bottom for our NIM, and we should see some margin expansion in the second half of the year. This remains an uncertain environment, so let me be very clear and transparent with our current assumptions here. First, the Fed, we believe, moves 25 basis points this afternoon, then pauses for the rest of the year. Deposit betas move in the 70% range for that increase. Deposit growth for us continues on pace with the above beta assumptions and at levels that support our loan growth.

Healthy loan growth continues on pace with current pricing, no further major industry disruption related to deposits or liquidity. Remember that if we do decide to hold more on-balance sheet liquidity, it may have an impact on the NIM, but will have minimal impact on net interest income. To recap, we had better-than-expected NIM resiliency in Q2, and we expect NIM and net interest income improvement in the back half of the year as deposit costs moderate, loan yields continue to improve, and earning assets continue to grow. Turning to Slide 12, let's take a quick look at non-interest income trends. As I mentioned before, we had been seeing improvement in secondary market conditions with premiums and valuations before the mid-March events, being steady to improving, and we were hopeful that premiums would hold at least steady after mid-March.

Our SBA sales activity increased in the second quarter. The gain on sale premiums did, in fact, remain fairly steady. Though the majority of what we sold was variable rate, we did see some fixed-rate SBA sales activity, which was again, encouraging. As you know, our servicing asset revaluation and fair value mark on our held-for-sale loan portfolio are mark-to-market assets, and valuations are based on spot rates at the end of the quarter. While there will be continued variability as these assets are valued quarterly, we saw much lower volatility versus Q1 as we expected. Just to hit a few more highlights on deposit trends on Slide 13, you'll see our deposit growth, even through the events of mid-March, were very strong relative to the industry.

As discussed, our repricing has been exactly where we expected it to be, given the rapid rate increases, so we have not had to pay up for the excellent deposit growth that we've experienced this quarter. Quickly on Slide 14, you see our key liquidity trends, which have been and continue to be very strong relative to the industry. Turning to expenses on Slide 15, we are doing just as we said we would do. We are moderating our expense growth while continuing to grow revenues. Going forward, while we will always be opportunistic with hiring revenue producers, we are tightly managing our expense growth, and we are confident in our ability to consistently improve our PPNR and our efficiency ratio over the next several quarters.

Our expenses are down link quarter, and as you can see, we have held salary and employee levels steady for the past couple quarters, even while continuing to invest in next generation technology, as evidenced by the continued increase in tech-related expense versus our total expenses. We expect these trends to continue. Turning to credit trends on Slide 16. As Chip discussed earlier, credit metrics remain strong. We continue to actively monitor the existing portfolio and do not currently see any glaring weak spots. Past dues are low, and nonaccruals remain quite manageable as well. You can see that the credit quality trends across our three business segments are quite strong as well. As expected in the current environment, we've moved more loans to nonaccrual status during the quarter. On the bottom left of this slide, you see a five year trend of our nonaccruals.

While Q2 of 2022 was an abnormally low quarter for nonaccruals, you can see that this quarter's nonaccruals to total loans of 109 basis points are consistent with the past several years. We only had a total of $1 million of net charge-offs in the quarter across an $8 billion plus loan portfolio. Very, very strong performance. As expected, the provision declined even as our coverage increased. Our reserves on guaranteed loans remain well above the industry, as you can see. Slide 17 shows our overall capital strength, which continues to give us great comfort. We are well positioned to thrive in whatever environment lies ahead and continue providing growth capital to our small business customers.

With that, see if Huntley would like to wrap up with a few thoughts on our priorities for the second half of the year. Huntley?

Huntley Garriott (President)

Thanks, BJ. Yeah, just a few thoughts on my end, kind of on Page 18, and then we'll get to Q&A. You know, through a turbulent first half of the year, you know, we really continue to demonstrate our resiliency. You know, the balance sheet remains solid. Chip and BJ have talked about it, liquidity, credit, and capital. You know, check the soundness box. As the banking industry, you know, tightens standards on lending and preserves capital, you know, we're continuing to find opportunities to provide that capital to small businesses. Our teammates continue to go above and beyond in serving those small businesses and preparing us for the future.

On the earnings front, I think BJ did a nice job talking about the solid results this quarter, and we really believe we're setting a new baseline for performance in the future with confidence in our margin, secondary markets, and a focus on expense control that will generate operating leverage, so profitability. As for growth, you know, pipelines do remain healthy. Despite rumors to the contrary, across America, small businesses continue to thrive, and we continue to help them grow. And as Chip referenced, we're really excited to announce that our full service checking account is live. That's been well received by our small business customers, and it allows us to transition to becoming a full service small business bank. At the same time, we continue to invest in our future.

You know, we've upgraded our small business loan origination platform, which will allow us to better serve these customers and improve efficiency. We continue to build out embedded banking solutions to help the software that power small businesses provide banking services. While there's a lot of chatter in that space lately, we're really excited that our straight-through, API-powered solution avoids a lot of the abstraction layers, and the FBO accounts, and the complexity that's caused some challenges in the industry to date. All of this is part of a multi-year journey to a modern digital technology that will provide us with real, sustainable competitive advantages, as Chip laid out in his intro. We're not holding out for the end state. Along the way, we'll seek to deliver value and delighters to our customers and our shareholders.

The art for us is being able to achieve that future state while still continuing to deliver value for our small business customers every day, and strong financial results for you, our investors. With that, let's go to questions.

Operator (participant)

Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. If you would like to ask a question, please press star, followed by the number one on your telephone keypad. If your question has been answered and you would like to withdraw from the queue, please press star followed by the number two. If you are using a speakerphone, please lift your handset before pressing any keys. One moment, please, for your first question. Your first question will come from Crispin Love at Piper Sandler. Please go ahead.

Crispin Love (Director and Senior Research Analyst)

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

William C. Losch (President)

... Yeah, I think, Crispin, and kind of as I said earlier, a lot of that will be dependent, I think, on how much excess liquidity that we, that we carry. We were obviously very pleased that we could swallow 12 basis points of NIM contraction with excess liquidity this quarter, and yet still be above what we discussed with you all last quarter. You know, I expect the net interest margin, and more importantly, the net interest income, to improve in the second half of this year. Assuming that the Fed moves today, you know, that creates a little bit more of a back-endedness to that improvement, if you will, because of the nature of our quarterly adjusting, variable rate loans.

You know, by and large, we believe that we're still on that type of trajectory by the end of the year.

Crispin Love (Director and Senior Research Analyst)

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

Chip Mahan (Chairman and CEO)

I'll give you two quick examples. Last Thursday, I went to California with our account officer in the ESOP division, so to speak, and met with two gentlemen that started an HVAC business 20 years ago when they were 23. They tried to get an SBA loan, couldn't. After six months, the bank couldn't even fill out the paperwork. They put up $2,000 and started their own business. Today, it's an $80 million revenue business, dropping $8 million to the bottom line, and we're going to do an eight plus figure ESOP loan to them. The headline there is, it's awfully difficult for them to find help. Do you know that an HVAC experienced person with 10 years experience makes $100 an hour?

Yesterday, I went to Minneapolis and spent a better part of the day with a roll-up private equity group out of New York, buying an asphalt company. You know, asphalt business is kind of interesting in Minneapolis. Six months of the year, you don't work, and six months of the year, you do work. An asphalt person makes $160,000 a year. Same thing, really hard to find talent. That usually happens for me at least a day or two a week, both those businesses are thriving. Margins are up way beyond their expectations, if they can just find people. I don't know that I actually answered your question, but I could go on and on.

Crispin Love (Director and Senior Research Analyst)

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

Chip Mahan (Chairman and CEO)

Thanks, Crispin.

Operator (participant)

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

Steven Alexopoulos (Equity Analyst)

Hey, good morning, everyone.

Chip Mahan (Chairman and CEO)

Hey, Steve.

Steven Alexopoulos (Equity Analyst)

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

Chip Mahan (Chairman and CEO)

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

Steve Smits (Chief Credit Officer)

Yes, Steve, how are you doing? This is Steve Smits. Two credits. The first one is in our senior housing portfolio. It's a memory care facility. It is collateralized. Project-level challenges, while they're seeing good occupancy, they're struggling with cash flow, which put them behind on payments. I will add that we did reserve, given the uncertainties with commercial real estate valuations, we did put a reserve, so we're protected on that side. Talked to the team, they're very confident that we're going to be able to trade out, you know, that somebody will have an interest in buying this real estate. I'm cautiously optimistic that we will most likely not see a loss on that credit.

Second one is we are actually a participant in another lender's credit facility, and it appears that our borrower had fraud perpetrated against them from a primary supplier. This all came to fruition in the final days of the quarter. We had to act real quickly. We placed it on nonaccrual. We put a pretty healthy reserve against it due to the uncertainty of fraud. I would say way too early to conclude how that's going to play out. It was a collateralized loan. However, with fraud, you never really know. That's gonna have to play itself out before I have a feel for whether we'll see any losses associated with that credit. As I pointed out, we put healthy reserves against them. I feel that we did the prudent thing.

I'll also point out, Steve, that if you pull these out, our nonperformers would have been flat, which I think is how I look at the portfolio as a whole. We're just seeing very much stable and consistent, with just a couple of outliers here. Don't see anything systemic. We continue to watch loans that we originated at the top of the market, specifically in change of ownership, so 2019 or early 2020 originations, just to make sure these new owners-

Huntley Garriott (President)

continue to be able to weather the additional challenges associated with the last couple of years that we went through. Overall, I feel pretty good that the portfolio is very stable.

Steven Alexopoulos (Equity Analyst)

Got it. Okay, that's a very helpful color. BJ, I had a question for you on the NIM outlook. You've mentioned excess liquidity a few times, sort of putting that aside as a variable around NIM. In terms of getting into the 3.50%-3.75% range, do you need to draw down that excess liquidity to get into that range? Or could you get there if you maintain this liquidity through the rest of the year?

William C. Losch (President)

Obviously, it would be more helpful to get there if we drew down excess liquidity. We have more than a reasonable chance to try to chin that type of level, even if we're carrying excess liquidity. It all depends on, you know, how competitive deposit rates get after this next move, and if the Fed actually stands flat and, you know, we start to see some moderation. I think the point that I want to make sure we get across is, and we talked last quarter, and I've talked a little bit this quarter, that, you know, we would see a V shape to our NIM, right? That our NIM would compress into the second quarter, but then start to improve in the back half of the year.

That dynamic is still intact, whether it's, you know, up to a 350 level or just, you know, up 10, 15, 20, 25 basis points, either way, it's margin expansion, and I think that's what.

Steven Alexopoulos (Equity Analyst)

Yeah

William C. Losch (President)

That's what we're, what we'll see.

Steven Alexopoulos (Equity Analyst)

Got it. Okay. On the deposit side, I'm looking at Slide 11, and, right, you guys didn't change your savings rates in the quarter. CD rates are up a bit, but the rate has slowed, but you had very strong deposit growth. Can you give a sense, what's driving such strong deposit growth without needing to lean on rate? Do you think I think your deposits are up somewhere around 20% year-over-year. Do you think we finish the year now in that range?

William C. Losch (President)

Yeah. I mean, it's, you know, we have quite a strong brand on both the consumer savings and the small business savings side. We offer the same rate to both. The dynamics of our competition are a little bit different in each. You know, I think we're a little bit more at the top of the market with the business savings side, and that aligns with who we are as a, you know, America's small business bank, obviously. So, I think the combination of us being towards the top already, combined with our brand reputation in small business, and our marketing efforts, have all led to very, very strong inflows from a business deposit perspective.

The other thing I'll mention as well is, over the last several months, in particular, getting ready for our checking account launch, our lenders have been doing a really good job of starting to think more about selling deposits. Selling savings accounts first has been kind of step one to try to build that muscle, with step two being, obviously, checking accounts. I think the tailwinds of our lenders doing a really good job selling savings accounts has certainly been helpful as well.

Huntley Garriott (President)

Yeah. Hey, Steve, I'll add just one thing. I think Chip touched on this in his outset. I think especially for business customers, there's been a great awakening over the last six months about: Is my money safe? What is my money earning? I think that there's just a flow of business owners and finance folks at businesses who are realizing that they can earn on business savings, which just hasn't really been in the dialogue in a while. I think we're seeing we're a beneficiary of that kind of macro flow right now.

Steven Alexopoulos (Equity Analyst)

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

William C. Losch (President)

Yeah. I mentioned briefly that pipelines were still pretty healthy. You know, Steve, probably up until the last Two weeks of the quarter, we thought we were going to be at $1 billion. In terms of production, we ended at $860 million, the vast majority of those loans, well over 90% of the loans that we thought were going to close by 6/30 that didn't, have already closed in July. It just did move to the right. All of that to say is, you know, we feel like pipelines and production are still going to be pretty healthy in the second half of the year, and that should drive, you know, the continued loan growth. Whether it gets to the upper end of the range that you commented on, probably not.

You know, it's probably in the low teens, maybe mid-teens, by the end of the year.

Steven Alexopoulos (Equity Analyst)

Got it. Okay. Thanks for taking all my questions.

William C. Losch (President)

Thank you.

Huntley Garriott (President)

Thank you.

Operator (participant)

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

David Feaster (Director)

Hey, good morning, everybody.

Huntley Garriott (President)

Hey, David.

David Feaster (Director)

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

Huntley Garriott (President)

Yeah, it's a good question, David. I think agree with your sentiment that we're open for business, and we do have, you know, the opportunity and lots of folks call us and are interested in maybe joining what we're doing. At the same time, I think we recognize, you know, with what's going on in the industry and where we are, that we do want to be more mindful around adding folks. We're going to be really selective. We're going to add great folks when it's the right time and place to do that in specific spots. I don't think as we sit here now, we have an ambition to kind of go on a great talent land grab as we sit here.

I think we feel really, really good about the team, that we've got, and, you know, if we find a few opportunities, we'll lean into those.

David Feaster (Director)

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

Huntley Garriott (President)

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

I think the third phase is where we go blast out to everyone kind of outside of our existing customers and, you know, and prospects.

David Feaster (Director)

Okay. Then last one from me. You know, you've obviously got a incredibly diverse production engine. You got loans across the country in a lot of different verticals. You've got a really good pulse on the market. I'm just curious, you know, as you talk to borrowers, it's tough out there. It sounds like you're pretty cautiously optimistic, if I'm hearing you, Chip. At the same time, you know, you talked about, you know, higher rates, slowing demand. I'm just curious, maybe as you look into your crystal ball and what you're seeing, how do you feel about the economy?

Are there any segments that you're looking at as you see these, that you're maybe seeing a bit more pressure that's, you know, maybe any red flags that you're seeing? Just where from a growth side, are you seeing the best risk-adjusted returns right now?

Chip Mahan (Chairman and CEO)

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

Huntley, maybe you have another.

Huntley Garriott (President)

I think you said it perfectly. We just don't see a macro issue. I think there are still some pockets, and I think as Chip said in his intro, business acquisition is a big part of what we do, and those deals, you know, buyer-seller, interest rates, trying to figure out the right deal structure. We've seen that a little bit slow, but there are still really good deals out there. Then everybody talks about real estate. We obviously don't do, you know, sort of office real estate, which is, I think, what everybody's most concerned about. We have seen situations where it feels like banks are pulling back from all real estate, and so we see some more opportunities in places that are secondary, tertiary, related to that.

In some ways, we see some, you know, maybe some interesting opportunities there.

David Feaster (Director)

I guess, you know, kind of with the whole idea that the, you know, So you know, most of the conventional lending in slowing and a lot of banks kind of pulling back, do you expect that to push more folks into the SBA?

Chip Mahan (Chairman and CEO)

Mm-hmm.

David Feaster (Director)

Ultimately, we could really potentially see growth accelerate kind of into next year and through next year?

Chip Mahan (Chairman and CEO)

I would say it'd be more in our conventional space, BJ, that you spent some time in. I don't know that the SBA space is going to be much different than it always has been. I will say that, you know, I want to get my hands on every great SBA lending officer in the country. As we can get the qualified A and B players, you know, we'll continue to hire those folks.

William C. Losch (President)

... sponsors that we do business with are, you know, primarily focused on the $5 million-$10 million EBITDA businesses. Those folks have a lot of capital. We're seeing that area grow substantially.

Huntley Garriott (President)

Yeah. Look, I do think, though, the more you read, we haven't seen this maybe in practice yet, but if banks do start to tighten up, pull back, et cetera, it ought to open up the market for SBA, right? In theory. We haven't seen it, you know, in practice yet, but we like your thesis, David. We're ready for it.

Steven Alexopoulos (Equity Analyst)

All right. Sounds good. Thanks, everybody.

Operator (participant)

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

Brandon King (Managing Director and Senior Equity Research Analyst)

Hey, good morning. Thanks for taking my questions.

William C. Losch (President)

Hey, Brandon.

Brandon King (Managing Director and Senior Equity Research Analyst)

Yeah. BJ, I wanna get your updated outlook on the secondary market. You mentioned how premiums were stable quarter-over-quarter, but, what are you kind of expecting or baking in for the second half of the year?

William C. Losch (President)

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

Brandon King (Managing Director and Senior Equity Research Analyst)

Okay. You also mentioned that there was a little uptick in fixed rate in the secondary market as well. Just curious, were the premiums on those, you know, attractive enough to kind of restart that engine going? Or just wanna get more color and context around that?

William C. Losch (President)

Yeah, probably not. You know, I mean, the vast majority is still variable rate. You know, we did sell a little bit of fixed, which is encouraging. We actually sold a little fixed in the first and the second quarter. It's certainly not where it used to be. Most of the volume that we sell is gonna be variable.

Brandon King (Managing Director and Senior Equity Research Analyst)

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

Huntley Garriott (President)

Yeah. Brandon, look, again, we like where we are positioned. We like, you know, our team, we like the folks we do business with. We feel really good about where we are. I think, you know, we certainly see competition all the time, and we see it from banks. Based on wherever the SOP may fall out, we might see it from technology companies, and we'll be fine. You know, we're pretty comfortable with levels of competition, and we'll do our best against it.

Brandon King (Managing Director and Senior Equity Research Analyst)

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

Operator (participant)

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

Michael Perito (Managing Director)

Hey, good morning, everyone. Thanks for taking my questions.

William C. Losch (President)

Hi.

Mike.

Michael Perito (Managing Director)

I just had a couple quick ones. Obviously, a lot's been asked already here. I just want to clarify on the expense side, just to put some numbers around it. You guys expect to hold steady, kind of around $77 million a quarter near term. You know, just to follow up, you know, what, I guess, do you guys need to see to, you know, I realize I can't really, it's hard to tell me what, like, a growth rate looks for 2024 would be. I guess, what do you guys need to see macro or other, to kind of re-accelerate the investment rate? Because I imagine this is more of just kind of a temporary pause, given some of the revenue challenges.

Just curious if, you know, you can confirm the numbers and then just give a little bit more color longer term about how you're thinking about the rate of investment?

William C. Losch (President)

Yeah. Mike, we've talked about over the last year and a half, that we had two different types of hiring bubbles, right? In 2021, we really had a hiring bubble to catch up our lending support staffing to, you know, to keep up with the increase in loan production we had seen. Hiring a lot of underwriters and hiring a lot of closers and those types of folks. That was kind of 2021. 2022, we accelerated our technology investments of people and actual tech spend, to, again, try to leverage some of the fintech investment gain that we took to move ahead with some of the strategic projects on the tech side that we wanted to get done as quickly as possible. Those two things caused quite an acceleration.

We've always, and will always, to Chip's point, be looking for revenue producers because they are gonna be very accretive to our PPNR, and our earnings, and our growth going forward. Right now, we feel like we've got a lot of the right pieces on the field from a people perspective, in terms of revenue support, as well as the technology side. We've just got to actually put it to work and, you know, make ourselves more productive and more efficient, and drive higher revenues. We do think that, you know, our expense growth will be steady, as we talked about throughout the rest of this year, at these types of levels, while our revenues continue to expand.

From there into 2024, we fully expect to keep that kind of operating leverage momentum and take full advantage of the two years' worth of investments in people and technology that we made.

Michael Perito (Managing Director)

That's super helpful. Thank you, BJ. Just one last one for me for Chip. Just you made a comment in your prepared remarks about, you know, focus on deposit betas and celebration of deposit betas. You know, I guess it's an interesting point of view. I guess my perspective was, I guess historically is a little different. I think, you know, deposit betas for analysts is kind of an imperfect way to measure kind of customer stickiness. I guess my question for you, Chip, is just how do you measure kind of customer stickiness for the Live Oak customer? I mean, obviously, it's not beta. My guess is it's maybe it's more qualitative than quantitative today.

Just kind of, would love your thoughts on that, as the industry clearly is at a moment here where I think that the unit of measurement around customer stickiness is gonna change. Just wondering what your kind of internal view is as you look at that kind of, you know, hard to quantify metric.

Chip Mahan (Chairman and CEO)

Yeah, that's a good question. I'm sitting here in our old boardroom, where you have been, and there's a new addition in our boardroom. We have a indigo chair, and we copied Chick-fil-A because when we got close to the senior management team of that company, they have a red chair in every conference room in that business, pretending that there's a customer sitting there in that meeting room, right? When I think about stickiness of old, right, and deposit betas, it's like, well, the rates went up 0.5%. I'm just too lazy to go down to the branch to move. When you have 500 bips all, you know, roughly overnight, that's as significant as I said in my prepared comments. I mean, if you have $10,000 in the bank, and you're not a wealthy person, do...

You know, you pick up $400 on the couch. My real answer to your question is, you have to earn stickiness every day. That's why I think that our deposit-gathering machine gets a little bit viral because of the 30 people we have in our call center, every one of them actually care about the customer. That's why they answer the phone in 11 seconds, that's why we get email after email saying, "You're different. You're different. You really care about me." You know, a lot of our customers, particularly on the consumer side, you know, are older people and, you know, holding their hands, and some of them don't even have cell phones. I think you have to earn that stickiness on the deposit side every day. On the loan side, you know, we've done that for 15 years, you know, in C&I.

You know, rather thinking from the customer's point of view, that I only care about two things: Am I approved, and when are you gonna give me the money? When I go out there and see these customers, and we're in, you know, competitive situations with other banks, I mean, we just move probably twice as fast as any other bank in getting that answer to those people. We're just gonna keep on keeping on the lending side, and it's gonna be fun as we roll out. You know, for the first time in the history of our company, if you get a loan from us, like, as of next week, we're gonna deposit your loan amount in a Live Oak checking account, which we have never done. We'll see how that goes.

Michael Perito (Managing Director)

Helpful. yeah, it should be interesting to follow how this, you know, the recent events kind of changed the perspective of how people, you know, value deposits. I appreciate that color, Chip, and thanks for taking my questions in the call this morning.

Chip Mahan (Chairman and CEO)

Thank you, Mike.

Operator (participant)

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

Chip Mahan (Chairman and CEO)

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

Operator (participant)

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