Live Oak Bancshares - Q4 2022

Transcript

Operator (participant)

Welcome to the Q4 2022 Live Oak Bancshares Inc earnings conference call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during that session, you'll need to press star one one on your phone. You will then hear an automated message advising that your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Gregory Seward, Chief Risk Officer and General Counsel. Sir, please go ahead.

Gregory Seward (Chief Risk Officer and General Counsel)

Thank you and good morning, everyone. Welcome to Live Oak's Q4 2022 earnings conference call. We are webcasting live over the Internet, and this call is being recorded. To access the call over the Internet and review the presentation materials that we will reference on the call, please visit our website at investor.liveoakbank.com and go to today's call on our event calendar for supporting materials. Our Q4 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)

Thanks, Greg. Good morning to those dialing in today. If I had your job, bank analyst extraordinaire, my first question would be, tell me about your loan loss provision. Moving to the next slide, Michael. Before we unpack the provision, in our last quarterly call, we talked about some very famous folks predicting a recession. Are the last two substantial increases in the provision a proxy for the future? Let's drill down. Next slide. Let's go way back to pre-CECL. The provision in 2018 and 2019 was between $0-$7 million, mainly in the $2 million-$5 million range. In Q1 of 2020, we implemented CECL at the beginning of the pandemic. We were predictively conservative, providing $10 million per quarter during the COVID peak.

We were equally predictable as the government provided PPP funding. Our provision came down in 2021, as you can see from this slide. The title of this slide is Regression to the Norm. We are about back to where we were three years ago as our allowance for credit losses are 2.2% of unguaranteed loans, compared to 2.4% in 2019. We do not see the Q4 provision as a proxy for the future at this point in time. Moving to slide six. In the old days of running banks, we typically added to our loan loss reserve that which we charged off that quarter. Not anymore. As you can see, our addition to the reserve has far exceeded actual net charge-offs.

BJ will be walking you through some calculations on how growth in the loan portfolio has a great deal to do with these differences. Let's move to slide seven, Michael. As always, back to credit quality and the underpinning of a building of a healthy allowance for loan losses. Once again, soundness, profitability and growth in that order. Here are the facts. Watch list is down year-over-year. Past dues are flat. Non-accruals are down 10 basis points. As we discussed last quarter, surprisingly, of the total non-accruals at year-end of $26 million, over half or $15 million were paying as agreed. Charge-offs in 2021 were $9 million and then $10.7 million in 2022. De minimis on a loan book of $4.1 billion of unguaranteed paper. Slide eight.

Now that we have examined the past and reconciled the history of our loan loss reserve and our current credit quality ratios, what does the future look like? What better place to turn than our customers? I have known John Barlow for a long time. John started his data-driven consultancy 43 years ago. We asked John and his team to ask our customers a number of questions about the future of their businesses. After a thorough review and list cleaning, 4,600 loan relationship customers were invited to participate in an online survey between late September and early November. 768 customers or 17% of the total responded. As you can see from this slide, most were upbeat and over 60% thought they could grow their revenues in 2023.

Nearly 25% of our customers plan to borrow money to finance that growth over the next 12 months. Relative to customer challenges, difficulty in hiring and increased material and supply costs topped the list. Half of our customers believe they are understaffed. Over the past 12 months, most customers have increased their prices over 10%. Over the next five years, 25% of our customers believe they could sell their business. This doesn't feel like a recession, does it? Over to you, BJ.

Speaker 9

Thanks, Chip. Good morning, everybody. Thanks again for joining us. Let's start on some full year 2022 highlights on slide 10. Earnings per share were $3.92. From a core earnings results perspective, they were driven by healthy production growth, $4 billion of production in the year, leading to strong loan growth. This, combined with net interest margin resiliency, led to excellent net interest income growth. Then, of course, we had significant gains from successful exits of two Ventures investments, which gave us the flexibility to moderate our guaranteed sales activity due to market dislocation and continue investing in our people and technology while adding meaningful organic capital.

Put some numbers behind the highlights. The full year 2022 net interest margin of 3.87% held up incredibly well, ahead of expectations. This is a testament to the excellent discipline our lenders demonstrated to balance production and profitability, along with the great work by our deposits team to manage deposit pricing in a very highly competitive, rapidly rising rate environment. Our adjusted net interest income growth was up 31% year-over-year on that $4 billion of loan production and 24% loan growth ex PPP, along with 25% deposit growth. This balance sheet growth was made even stronger by the guaranteed loans we did not sell.

While gain on sale income was down meaningfully from last year due to secondary market dynamics, that income was not lost forever. Those loans that we kept will be a strong tailwind to our balance sheet and NII growth in 2023. As Chip said, credit quality remains quite strong despite the uncertainty of the economic outlook. Of course, our history of successful incubation and investment in fintech ventures again served us well, generating significant gains in organic capital for future growth. All of this led to significant tangible book value per share growth as well, 12% year-over-year.

As we look at slide 11, we also know that our 2022 results had a lot of moving parts that didn't make it easy for investors. A few comments on these as we head into 2023. I'll make five quick points. Number one, PPP loans and associated impacts are immaterial at this point and won't be a factor going forward. Number two, while we will continue to mark our servicing asset each quarter as required, we are working on ways to better forecast and minimize its impact on our quarterly results. Number three, while we will continue to make tax credit investments when attractive, we are modifying our strategy to lessen the earnings volatility associated with those investments.

Number four, we plan to keep gain on sale income as a percentage of total revenues more in current ranges, which will afford us additional flexibility and stronger recurring spread income growth. Number five, while we continue to find our existing Live Oak and Canapi Ventures investments attractive and will continue to make further investments, we are not currently anticipating any exits in the near term. Turning to slide 13, let's take a quick look at Q4 2022 performance, where you see our adjusted results and the notable items that make up those adjustments. Adjusted PPNR was down 12% quarter to quarter as continued strong net interest income growth of 4% linked quarter was offset by lower gain on sale income and continued investment in people and technology. As Chip discussed earlier, our credit remains quite healthy.

We did build our provision proactively in anticipation of a potential recession in 2023. I'll get into credit trends a little bit more fully in a few minutes. Turning to slide 14, we generated almost $1.2 billion of loan production in the quarter and $4 billion for the year. You see our loan originations remain quite diverse across our multiple areas, with particular strength in numerous small business verticals and our middle market sponsor finance vertical. In energy and infrastructure, solar remains quite strong, while bioenergy lending was down from last year. Both of those verticals should benefit from the clean energy incentives in the recently passed Inflation Reduction Act. Breaking down the components of revenue on slide 15, we see very strong and encouraging revenue trends, particularly in net interest income.

While linked-quarter revenue was down modestly as continued NII growth was offset by lower gain on sale income, total revenue growth was up 16% year-over-year, even with significantly lower gain on sale income, thanks to 31% year-over-year growth in net interest income. Given the fact we held more loans on the balance sheet and expect a continued healthy NIM, we are optimistic about continued strong NII growth in 2023. Secondary market for SBA and USDA fixed rate sales remain unattractive, and pricing for variable rate SBA is recovering but still not quite at normalized levels. We expect to continue to hold more assets on the balance sheet. Again, it's important to understand that lower gain on sale income is not income that is permanently lost. We simply earn it over time in the form of spread income.

Because of the flexibility we have with strong capital and liquidity levels, we are more than happy to hold these high-quality assets and will remain patient with secondary market sales until further normalization. Digging deeper into net interest margin trends on Slide 16. Margin again held strong in Q4 at 3.76%, and for the full year at 3.87% versus last year's 3.86%. While we still expect some downward pressure as deposit competition shows no signs of easing, we continue to be very encouraged by the resiliency of our margin due to the excellent work by our lenders in adjusting loan pricing commensurate with market funding costs. Turning to expenses on Slide 17. We have been incredibly pleased with the quality of talent that has joined Live Oak in our various groups across the company.

We have now largely worked through our hiring bubble to right size our lender support to accommodate the significant step-up in production and balance sheet growth over the past two years. In addition, as we have discussed, we accelerated our technology hiring in 2022, thanks to the FinTech gain. That is now also largely complete. Going forward, while we will continue to be opportunistic on hiring, particularly for revenue producers, we expect to see our expense growth moderate considerably into 2023 and significantly improve our operating leverage and PPNR growth going forward. Few more points on credit trends on Slide 18. As Chip discussed earlier, credit metrics remain quite strong. We continue to actively monitor the existing portfolio and do not currently see any glaring weak spots. Net charge-offs and non-accruals remain quite low. 30-day past dues remain low as well.

In fact, the Q4 dollar amount of $19 million you see in the upper right is down to only about $3 million as of yesterday. Yet we grew the provision well in excess of the $1.4 million of net charge-offs we experienced in Q4. As you can see in the upper left, 40% of that provision was due to strong balance sheet growth. To me, that's good provision. 55% of the growth was continued proactivity in building appropriate reserves for a less certain outlook and regressing to the norm. With what we see, combined with a conservative outlook, we currently feel very well-positioned with our current reserve coverage and levels.

Slide 19 shows the advantages of the Live Oak business model. Having 42% of your total loan portfolio government-guaranteed, a stronger net interest margin than most, and reserves over twice the industry average is quite unique and comforting. Add to that our overall capital strength on Slide 20, we believe we're incredibly well-positioned to thrive in whatever environment lies ahead. With that, I'll turn it over to Huntley for a little more color on our outlook and areas of focus for 2023. Huntley?

Huntley Garriott (Peresident)

Thanks, BJ. I'll try to wrap all this up on page 22. Despite what was admittedly a noisy quarter and the continued sort of macro uncertainties, we head into 2023 with a lot of momentum. From day one of Live Oak, you've heard Chip articulate our priorities as a company, safety and soundness, profitability and growth in that order. We remain committed to that. Our balance sheet, as BJ went through, is really well-positioned with ample capital, significant loan loss reserves, and the flexibility that we require to support our growth. Our loan portfolio remains healthy, and we're committed to staying close to our existing small business borrowers. We're optimistic as they navigate a slower growth economy.

That said, we still see tremendous opportunity to continue to lend prudently, especially if history repeats itself and lenders pull back from small businesses in choppier times. In 2022, we demonstrated our ability to maintain our net interest margin despite the rapidly rising rate environment. That, coupled with continued loan growth, should position us for significant net interest income growth. As BJ mentioned, we've been spending a lot of time focusing on how to reduce the volatility in our earnings to make your jobs as investors easier to see our core fundamentals and expect to demonstrate that in 2023 as well. On the expense side, our team is firmly in place as we start the year. Our headcount growth will dramatically slow versus the last couple years. Our lending franchise is stronger than ever.

Our technology team is fully built out with clear roadmap, and we're seeing tangible efficiency gains in both our technology investments and our operational improvements. All that should allow our revenue growth to significantly outpace our expense growth and result in strong PPNR growth throughout the year. On the technology front, you'll see continued improvements in our origination and servicing platforms designed to speed up our lending process and improve our customer experience. You'll also see our embedded banking developer portal that will drive customer acquisition and deeper banking relationships through software providers that serve small businesses. I'll wrap up with a topic that I'm sure you've all been waiting for, an update on checking.

As you all know, we currently have a checking product in the lower end of the small business market with about 2,000 accounts, but it doesn't have all the capabilities that we need to serve our core customers, the veterinarians, the professional services firms, and the rest of small business America that require some version of entitlements and money movement. In the next couple weeks, we're gonna onboard our first customer on our fully functional business checking account that's complete with treasury management capabilities.

That will allow us to serve all of our existing small business clients and the broader small business market as well. It's been a long wait for everyone, but we're excited to finally prove our ability to drive low-cost deposit growth at Live Oak. We remain laser-focused on our mission to become America's small business bank, we look forward to translating that into predictable earnings growth throughout 2023. With that, let's turn it over to questions.

Operator (participant)

Thank you. As a reminder, to ask a question, please press star one on your phone and wait for your name to be announced. To withdraw your question, please press star one again. Stand by as we compile the Q&A roster. Our first question will come from Steven Alexopoulos of J.P. Morgan. Your line is open.

Steven Alexopoulos (Managing Director and Senior Equity Research)

Hey, good morning, everybody.

William C. Losch III (CFO)

Hey, Steve.

Steven Alexopoulos (Managing Director and Senior Equity Research)

I want to start. BJ, you guided the NIM several quarters ago to 350-375. In the Q4, you're at 376. I think you won both showcases with that forecast. What do you see as the range one year from now for Q23?

William C. Losch III (CFO)

Yeah, I think, you know, I would probably still say the $350-$375, you know, hopefully again, under promise and over deliver. You know, as I talked about earlier, feel really good about how quickly our lenders adjusted loan pricing and still put up record loan production as well. It's not like we sacrificed quantity for profitability. Very pleased with that. The deposit pricing was very well managed by our team in the H1 of 2022, and then it significantly ramped up in the back half and shows no signs of slowing. I do expect in 2023, particularly in the H1 of the year, to see downward pressure on the NIM as it relates to deposit pricing, because we won't see quite as much loan repricing, that was helpful to us. In the back half of the year, I see us continuing to build our margin as potentially the Fed stops raising rates and rates in general are more stable. Still feel really good about the margin and our ability to produce. Happy with what we've seen so far.

Steven Alexopoulos (Managing Director and Senior Equity Research)

BJ, if the Fed does not cut rates the way the market thinks, and they move up a couple more hikes and then pauses, do you still think NIM can hold in that range, or is it really contingent on seeing rate cuts the back half?

William C. Losch III (CFO)

No, it's a good question. We essentially are assuming what, the market forward curve looks like. Another two or three Fed moves of 25 basis points and then a cut either late December 23 or early 2024. You know, our margin assumptions for 23 really don't have any rate cuts that would have a meaningful impact.

Steven Alexopoulos (Managing Director and Senior Equity Research)

Okay, that's helpful. Then to follow up on the comments around dialing down the expense growth, can you help us think about what's a reasonable range for 2023?

Huntley Garriott (Peresident)

It's a good question. Steve, look, I think if you look back in 2021, that's really in that sort of, post-pandemic or, you know, sort of capital flows and our lending volumes really stair-stepped up. So we hired a bunch of lender support to keep up with that opportunity. Then into 2022, it was really in the technology side, where we really invested heavily, and we talked about that as it relates to some of the gains that we had that allowed us to accelerate that. Both of those are really in place. So, you know, I think that if you thought about from a headcount perspective, we may still grow a little bit, but it'll be, you know, certainly less than 10% across the board. That's, you know, assuming that our production still looks like it'll be, you know, at or above where we came in last year with everything we see right now. That's obviously the driver. The largest driver of our expenses is on the people side.

Steven Alexopoulos (Managing Director and Senior Equity Research)

Are you saying only high single digit? Is that about what you're implying?

William C. Losch III (CFO)

If you look at 21 to 22, so take out kind of, you know, some of the noise or the 1x, that kind of thing. We had, you know, about 25% expense growth from 21 to 22. You know, I would see that more in the, you know, mid-teens range this year as we, you know, put more of that investment in people and technology to work.

Huntley Garriott (Peresident)

I think, Steve, the other way to think about it is we had a lot of growth throughout last year. Looking at Q4, and that sort of core expense number, I think we'll be in the, you know, high single digits or mid-single digits of growth over that, you know, kind of call it less than 10% growth on that number. To BJ's point, that'll translate year-over-year, higher just given the ramp up over the course of last year.

William C. Losch III (CFO)

Steve, I think the only thing that could upset that, right, is back to your earlier point, right? If this is a true recession, and if the credit guys end up running these banks, and if there are opportunities to hire other lending officers, we will be in that hunt. That is not predictable at this time.

Steven Alexopoulos (Managing Director and Senior Equity Research)

Yep. Yep. Yep. If I could squeeze in one last one. Just on credit, the commentary around a small number of relationships, you talked about impacting credit quality. Anything to read into there? Any industry one-offs? Just give a little bit of color there. Thanks.

William C. Losch III (CFO)

Yeah, Steve, this is Steve Smith, Chief Credit Officer. No, no systemic or anything to read into it. I would say that's based on, you know, a handful of relationships that are going through some turmoil with their management teams. Still paying as agreed. However, we opted to, you know, reserve against those because we'll be potentially navigating some uncertain times. We'll, you know, I don't suspect that that is going to turn into losses, but it's kind of a conservative approach. Let's reserve against that because, you know, and see if these management issues with our borrowers escalate, we'll be prepared and ready for it. It's kind of a conservative approach, but not anything systemic that jumps out. These are, you know, unrelated into, you know, issues.

Steven Alexopoulos (Managing Director and Senior Equity Research)

Got it. Okay. Thanks for taking my questions.

William C. Losch III (CFO)

Thank you.

Operator (participant)

Thank you. One moment please for our next question. Again, one moment for our next question. Our next question will come from Crispin Love of Piper Sandler. Your line is open.

Crispin Love (Director and Senior Research Analyst)

Thanks, good morning, everyone. First one is on SBA gain on sale margins. They were at 5% in the quarter, well below recent quarters, but you did sell more SBA in the Q4 than you did in the third. I'm just, can you speak a little bit to your strategy there and why you didn't balance sheet more loans in the Q4, similar to what you did in the Q2? Just your expectations for selling versus holding on the balance sheet in early 2023?

Speaker 9

Sure, Crispin. Hey, it's BJ. One thing that has been particularly surprising and impressive about what our lenders have been able to accomplish is beginning of the year, about 30% to 35% of our production was variable rate, so 65% to 70% was fixed rate. That, you know, obviously was, as we talked about, difficult to sell. By the end of the year, we were over 50% variable rate in terms of the production that we were booking. Variable rate market was still relatively healthy, from a gain on sale perspective, and so we had more capacity and more eligible loans for sale that were attractive to investors.

As we looked at, you know, where we would want to manage interest rate risk, what kind of, you know, balance sheet we wanted and what kind of gains that we felt we could take in the Q4 from SBA sales, we decided to, you know, sell a little bit more of the variable knowing that we had quite a bit of it on the balance sheet already. That was part of the math there.

Crispin Love (Director and Senior Research Analyst)

Okay. Thanks, BJ. That's helpful. Do you have any early reads on the Q1 for margins? Have they begun to firm a little bit, or do you expect a little bit more of the same for near-term trends?

Speaker 9

Yeah. I'd say that, you know, the variable rate SBA market continues to heal. It's probably, you know, still, you know, 200 basis points from, quote, "normal levels." There's healthy activity and there's buying if we choose to be in the market and sell. USDA and SBA fixed rate product is still virtually nonexistent from a buying perspective, so, you know, we'll be holding those. Like I said at the opening, we're just expecting pretty muted activity from a gain on sale perspective in the H1 of the year and hoping it opens up in the H2.

One other thing I did say that I wanted to reiterate, now that we've got our gain on sale as a percentage of quarterly revenue, you know, somewhere in the 7-10% of revenue range and gives us a total revenue mix of, let's say, around 80% spread income, 20% fee income versus historically over the last couple years, we've been more 70/30. I think that's actually a pretty good place for us to be. It minimizes our, you know, our gain on sale and frankly, reliance on gain on sale every quarter, allows us more flexibility to sell more if we see attractive pricing, sell less if we wanna hold more.

Importantly, it gives us much more recurring revenue through NII and balance sheet growth, which we think is certainly more predictable and obviously attractive to us and to investors. You know, this has actually given us an opportunity to kind of reset what our gain on sale strategy is and grow more balance sheet.

Crispin Love (Director and Senior Research Analyst)

Thanks, BJ. I appreciate that. Just one last one from me, kind of dovetailing off your last point, just curious what your outlook is on loan and origination growth. In the past, I think several quarters ago, you've talked about kind of longer term trends of 15% origination growth. Do you think levels like that is still attainable right now, or do you think growth like that needs to come down given the current environment?

Speaker 9

You, you thinking balance sheet or origination growth, Crispin?

Huntley Garriott (Peresident)

origination, but also looking for both as well.

Speaker 9

Yeah.

Huntley Garriott (Peresident)

Yeah. On the origination side, you know, we continued to add lenders last year, and I think we have the franchise in place to do that. you know, we did $4 billion of total origination last year. To think that we could grow that 15% in, you know, sort of a normal, environment seems quite reasonable. I think we're obviously being pretty conservative right now, looking at the implications of a slowing economy, interest rates, you know, construction costs, you know, largely M&A market, things like that. you know, we feel good right now kinda at where we are or up. certainly the franchise is in place to do that sort of 15%.

As we look at just the overall size of the market, the overall trends in the silver tsunami and, you know, the transition of ownership, as Chip talked about, it still feels like there's just a ton of opportunity for us to continue to, you know, expand the lending franchise. We're just gonna do it really prudently, you know, as we kinda look and see what 2023 looks like.

Michael Perito (Analyst)

Thanks, Huntley. Thanks for taking my questions.

Huntley Garriott (Peresident)

Yep.

Operator (participant)

Thank you. Again, one moment please for our next question. Our next question will come from Michael Perito of KBW. Your line is open.

Michael Perito (Analyst)

Hey, guys. Good morning. Thanks for taking my questions. I wanted to start, I've kind of two bigger picture questions. One, just on, you know, how are you guys thinking about, there's been some discussion on this call about expense growth moderating, positive operating leverage, you know, NIM having some more pressure but then hopefully stabilizing, you know, kind of taking it all into sort here. I mean, what's the updated thoughts you guys have on kind of structurally what the targeted ROE, you know, should be for this business? I mean, you guys are, you know, now growing the balance sheet a bit more. Maybe there's a little less gain on sale. Maybe that weighs on a little near term.

Just curious if there's any kind of profitability thoughts you're willing to provide as you guys kinda look out over the next couple years with what you know today in terms of what you think is reasonable or should be targeted, for the type of business you're building.

Huntley Garriott (Peresident)

Yeah, it's a great question, Mike. We talk about that a lot here. You know, we've consistently grown our balance sheet, you know, north of 20% actually. You know, I think over a sustained period of time, we still think that 15%+ balance sheet growth makes sense for us as a franchise as we look at sort of where we're going. You know, the simple math says a 15%+ ROE allows you to self-fund that and continue to grow without having to, you know, sort of tap into capital markets, which is, which is nice. It creates a lot of sort of flexibility for us on that path.

you know, as we look at our franchise, a 15% ROE, I think is quite reasonable, especially as we start to, you know, turn the dial on the, you know, deposit side that we've been talking about and start layering in checking accounts, which is a pretty capital efficient place to grow earnings by lowering, you know, our cost of funds. would love to think that we could turn that dial to be a, you know, 20% ROE and a 20% grower. That's sort of, I think, the, you know, optimistic case. you know, pretty reasonably think that a 15% ROE, you know, to support our growth is pretty reasonable. BJ, do you have anything on that?

William C. Losch III (CFO)

No, I think that's right. You know, kind of our, you know, arrow in the quiver, so to speak, is, you know, if you, if you normalize some of these, you know, one-time costs and the gains and all this, you know, we're a 15% to 20% ROE business today with a deposit platform that is market rate. As Huntley mentioned, you know, this is our year of checking and really getting focused on that. Over the next several years, as we continue to grow our business and build out a small business bank, we're, you know, anticipating that that, you know, funding cost is going to be, you know, a tailwind to us as we continue to improve profitability.

Michael Perito (Analyst)

Got it. That's helpful. It's fair to think that, you know, on a GAAP basis, it, there'll be a process to build back up to that 15%, right? I mean, over the next year or two as some of those initiatives take hold and rates stabilize, et cetera. Is that fair?

William C. Losch III (CFO)

Yeah, I think that's fair, Mike.

Michael Perito (Analyst)

Okay. you know, kind of dovetailing off that, you guys kind of brought this up, but, I think, BJ, you mentioned that at this point you're not expecting any exits in 2023 on the venture side. You know, kind of from a timing perspective, it feels like 2023 will be a year where the balance sheet growth outpaces the ROE, at least as it looks right now.

I'm just curious on the capital front, particularly with the mindset now of holding more of your production, could you also just maybe remind us internally what you guys are thinking about in terms of capitalization of the bank and what's kind of the target range, and if you were to go above or below that, you know, what would be kind of your priorities to rightsize that?

William C. Losch III (CFO)

Yeah. I think if you look at where we sit today, you know, kind of the Common Equity Tier 1 ratio of 12.5% is quite solid. Where we have, you know, our binding constraint as we continue to grow is really more the leverage side. We are unique in that 40% of our loan book is government guaranteed. You know, leverage is a little bit less relevant to us, but obviously still a, an important and headline ratio. That's one that we continue to watch. We're at 9.3% today from a, you know, holding company or bank shares perspective, which still remains very healthy.

Even if we grow the balance sheet faster than the, you know, retained earnings, we still have, you know, a couple years of runway, you know, before Tier 1 leverage gets down at the bank shares level towards, you know, 7.5% or 7% range. In which case we would probably have to think of something else absent more ventures gains.

Michael Perito (Analyst)

Right.

William C. Losch III (CFO)

You know, we do have some runway as the balance sheet grows.

Michael Perito (Analyst)

Very helpful. Thank you. Just lastly for me, I know it's hard, but any thoughts on a range, on the tax rate for next year, BJ? Just given some of the credit activity you've done already, and are there any guardrails you could give us on that?

Speaker 9

Yeah.

Michael Perito (Analyst)

Sorry.

Speaker 9

Hard. Yeah. No, I know that's a tough one. It's, you know, honestly a tough one for me too. I would say our statutory rate, you know, blended is gonna be around 23%. You know, I would use 20% as an effective tax rate to model. It's gonna, you know, kinda go up and down quarter to quarter, but that's probably the best range. If we are, you know, if we do see attractive tax credit investments, that we wanna make, you know, that could certainly shift and be more positive. Right now, 20 is probably the best place to land.

Michael Perito (Analyst)

Okay. Great. Thank you, guys, I appreciate it.

William C. Losch III (CFO)

Thanks, Mike.

James S. Mahan III (Chairman and CEO)

Yep.

Operator (participant)

Thank you. I'm seeing no further questions in the queue. I would now like to turn the conference back to Chip Mahan for closing remarks.

James S. Mahan III (Chairman and CEO)

Well, this will be brief. See you in 90 days, folks.

Gregory Seward (Chief Risk Officer and General Counsel)

This concludes today's conference call. Thank you all for participating. You may now disconnect and have a pleasant day.