Live Oak Bancshares, Inc. (NASDAQ:LOB) Q1 2022 Earnings Conference Call April 28, 2022 9:00 AM ET
Greg Seward – General Counsel
Chip Mahan – Chairman and Chief Executive Officer
William Losch – Chief Financial Officer
Huntley Garriott – President
Renato Derraik – Chief Information and Digital Officer
Steve Smits – Chief Credit Officer
Conference Call Participants
Steven Alexopoulos – JPMorgan
Crispin Love – Piper Sandler
Michael Perito – KBW
Jennifer Demba – Truist Securities
Good day, everyone, and thank you for standing by. Welcome to the First Quarter of 2022 Live Oak Bancshares Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded.
I would now like to hand the conference over to your speaker today, General Counsel, Live Oak Bancshares, Mr. Greg Seward. Thank you. You may begin.
Thank you, and good morning, everyone. Welcome to Live Oak’s first quarter 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 and commentary 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 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 risks and uncertainties. Factors that may cause actual results to differ materially from our expectations are detailed in the materials accompanying this call and in our SEC filings.
We do not undertake to update the forward-looking statements to reflect the impact of circumstances or events that may arise after the date of today’s call. Information about any non-GAAP financial measures referenced including reconciliation of those measures to GAAP measures can also be found in our SEC filings and in the presentation materials and commentary.
I will now turn the call over to Chip Mahan, our Chairman and Chief Executive Officer.
Thanks, Greg. It has certainly been an interesting last few months in the capital markets and Live Oak Bancshares has participated in that volatility. So welcome to our Q1 earnings call or should I say stay the chorus call or better said by Winston Churchill, stay calm and carry on the call.
Greg, let’s go to Slide 5. I cannot tell you how pleased we are with the growth and the core earnings of our business. Variances with PPP and the marks on the Live Oak Bancshares investments make it difficult to understand the true operating earnings of the business. Key in this analysis lies in the understanding the risk in our loan portfolio, at this point in the cycle, I am still proud and amazed that our loans over 30 days past two were just a little over $4 million on a loan book of almost $7 billion.
BJ’s credit quality slide, also notes non-accruals of $25 million, interestingly over half are making payments as agreed or in the process of being placed back on accrual. All expected losses have been charged-off or are properly reserved. This metric tells us more than any other relative to the growth and the true earnings of our business given how we lend money to small business America.
Moving on to the next slide, Slide 6, Greg, this is our best first quarter ever. As you can see, although Q1 is historically our slowest quarter, we grew 29% over last year and over the last four years, our compounded annual rate of growth for the first quarter was a healthy 21%. So just a couple more comments before I turn the call over to BJ and Huntley, okay. I want to talk a little bit of about the future of our business and the future of our industry in general. All $280 billion lines of software code that run every bank on the planet is going to get swapped out over the next decade.
To support this point, we need to look no further than the Microsoft and Amazon recent earnings releases. Amazingly two days ago, a not Microsoft announced earnings of $17 billion on $49 billion in revs, revs on a very large base grew 18% year-over-year and earnings of 8% year-over-year.
Shockingly, the cloud business was up 32% with $23 billion revenue. So $23 million of the $49 million was cloud-based. Microsoft now has 20% of that market up from 7% in 2016. Market leader Amazon Web Services owns 40% of that market, in Q1 Amazon’s cloud infrastructure services business grew a whopping 46%. Relative to taking advantage of these cloud native API first initiatives and building banking products on next-gen core processors, we were first.
The sale of Finxact to Fiserv obviously created a $120 million gain, $125 million in pre-tax cash. We’ve started that business with the Sanchez Brothers in December of 2016, with the help of Frank Bisignano, who at the time was CEO of First Data. First Data sales to Fiserv, Frank assumes the helm there and immediately acquires the company as Fiserv’s next-gen core processing platform.
Fiserv will provide the Sanchez Brothers the capital over a $100 million and importantly related implementation capabilities to allow the beginnings of the digitization of our industry. For affirmation to change in our industry, one needs to look no further than the Wall Street Journal article last week outlining the efforts of one William Hockey. William is the Co-Founder, Plaid, a FinTech payments company. The article is titled Plaid Co-Founder Takes Aim at Rickety Banking Tech. He bought Northern California National Bank for $50 million. He renamed the bank column. He developed his own banking platform from scratch over the last three years primarily to serve fintechs.
Let’s review the success of his first company founded in 2013 while a student at Emory University, raised capital in July of 2013 at a $13 million valuation. Two years later, $53 million, June of 2016, $225 million, December of 2018 value of the business is $2.6 billion, tried to sell the Visa for $5 billion that was canceled in January of 2020 raised one year ago, $425 million in cash at a $13.4 billion valuation.
For our industry to take an OCC regulated Silicon Valley startup lightly would be a mistake. The point is we have been building toward this since 2016. We are going to stay the course BJ and Huntley are going to tell you just where we have been and how we’re going to do it. BJ?
Great. Thanks, Chip. Appreciate that. Good morning, everyone. Look at the quarter and talk about how we did and what we’re looking like going forward. So starting on Slide 5, you’ll see that our first quarter earnings per share were $0.76 a year-over-year basis, we generated 91% growth and adjusted PPNR driven by 44% revenue growth on 24% expense growth.
The revenue growth was driven by loan production of $865 million, as Chip said, up 29% from Q1 last year and our highest first quarter of production ever. We generated 30% loan growth on the balance sheet and the outstanding core business performance along with continued success with our ventures investing resulted in 19% year-over-year growth, intangible book value per share, excellent value creation.
We delivered and continue to do so on key accomplishments across the three dimensions of our business. Verticality our core lending business scalability, which is growth in our lender platform, our products and our technology and our optionality, which is our FinTech ventures activities that foster innovation and create organic capital.
Turning to Slide 9. You’ll see more detail on our adjusted earnings highlights on a linked quarter basis adjusted PPNR was down 5% on revenue growth of 3% and expense growth of 10%. I’ll get into revenue and expense growth drivers in more details starting on the next slide. The loan loss provision was again modest and credit quality remains strong.
Turning to the revenue slide. On Slide 10, you’ll see total revenue growth of 3% linked quarter and 44% year-over-year was driven by the strong loan growth and resulting net interest income, which was up 5% linked and 44% year-over-year. Net interest margin expanded again up another basis point – 8 basis points linked quarter to 391 with a reported net interest margin of 402. On the fee income side, we saw healthy sale premiums on our guaranteed loan sales in the first quarter with the average net gain of 109%.
As you can see in both the table in the bottom left and the commentary in the bottom right, we sold $220 million of total guaranteed loans in the quarter disproportionately waited towards SBA sales. Two things we saw during the quarter led us to lean to end SBA sales this quarter. Number one, as you can see in the table USDA volume was very light, eligible, USDA sales volume shifted out of the first quarter into future quarters.
And secondly, while premiums remained relatively stable with recent trends during the first 45 to 60 days of the quarter, we did start to see some meaningful changes in demand and pricing due primarily to shifting market sentiment on the Fed’s rate and economic outlook. So with the FinTech gain of $120 million booked in the second quarter, we will take the opportunity to moderate our guaranteed sales in the second quarter and allow the markets to further digest the Fed’s rate moves.
Turning to expenses on Slide 11. As we discussed on the Q4 call, we anticipated another strong hiring quarter and we had one, we added 44 net new Live Oakers in the first quarter. And as we discussed on the last few earnings calls, we’ve been working hard to help our lender support teams, underwriters, and closers, primarily to catch up to the significant ramp up in volume we saw in 2021.
Good news on that front, we have caught up and have already seen a 10-day improvement in average time to close from last year’s level. In 2022, there will be more of a hiring emphasis on technology talent, which you can see in the chart on the left, 35% of our net new hires in Q1 were in technology with 45% in lender and lender support. Huntley is going to give you a little more color on the tech hires in just a moment.
Turning to the balance sheet and returns on Slide 12, growth was again strong both linked and versus prior year quarter as were returns on equity and assets and tangible book value growth year-over-year. Slide 13 has more information on originations which Chip discussed and Huntley will cover in a bit more detail.
Turning to Slide 14. This shows a waterfall of our loan growth quarter-to-quarter where it came from with net loan growth before sales at 7% linked quarter, very solid performance.
Turning to Slide 15. Strong loan and deposit growth has been achieved with well disciplined pricing. Average core loan yields have remained stable in our deposit cost declined over the course of 2021, leading to strong net interest margin expansion of 45 basis points adjusted for PPP, the 391 and a reported name of just over 4%. So while we’re clearly headed into a much different interest rate environment, a NIM starting point of 4% is surely a nice one to have.
Turning to credit on Slide 16. Our longstanding practice of frequent contact with existing customers and strong underwriting remains a top priority. As Chip talked about, you’ll see that our non-accruals and past dues remain low, and we had very low net charge-offs again in the quarter.
On Slide 17, you’ll see in the upper right capital ratios remain strong, note the green 21.3% bubble we call out on the graph, which is the capital plus reserve coverage of the unguaranteed portion of our loan portfolio, which is almost 2 times higher than most other banks. This plus the $2.9 billion of highly liquid guaranteed loans on our books, give us both comfort and balance sheet flexibility.
Slide 18 shows continued top quartile performance versus industry peers and soundness profitability and growth metrics. And before I hand it over to Huntley, I just wanted to wrap up with a few slides that might help provide some context for the future environment. Sometimes it’s helpful to take a look back before we take a look forward.
So on Slide 19, as I talked about a little earlier related to premiums in what we’re seeing in the gain on sale market. Here, we provide two views of the SBA secondary market and gain on sale premiums over a several year period, including 2016 through 2018, which was a period where the Fed funds rate moved up 200 basis points. The first – the top half or the first graph in the upper left is for variable rate product and the second is for five-year fixed product, two of our most common guaranteed SBA sales.
So few takeaways here. Number one is the variable rate product due to its relatively steady spread characteristics and pooling ability tends to have relatively steady gain on sale premiums through various rate cycles. The second takeaway is gain on sale premiums for fixed rate product tend to fluctuate a bit more in different environments. As you can see, driven by a combination of wider spread variability, prepay speeds and due to its lack of pool ability will be more susceptible to changes in demand due to a smaller set of buyers.
So what’s the point? The point is in an unsettled market with large moves and funding costs and appetite, we have to continue to be discerning about what we sell versus hold on the balance sheet, particularly until markets digest, the large anticipated moves and rates due to the Fed actions.
Wrapping up on Slide 20, perspective on long-term performance is helpful as well. And as you can see, Live Oak through both rising and falling rate cycles has been consistent in delivering strong credit quality, growing loan originations on our balance sheet, leading to healthy NII growth we’ll continue to strive to do the same going forward.
So with that, I’ll turn it over to Huntley to give a little bit more color on where we’re growing and investing. So over to you, Hunt.
Thanks, BJ. Another busy quarter here. You can see some of the highlights on point two. I’m going to touch on a couple of key themes this morning, again, the strength of our core lending business, the talent acquisition, and the strategy there, and then our technology and product roadmap. So if you look on 2023 on the lending side, we continue to do what we do best, which is provide capital to small businesses.
As chip mentioned, the first quarter does run traditionally a little slower than the rest of the year, but we still originated $865 million across the franchise up 29% from last year. Small business division had a great start to the year. As you can see in the bubbles led by some of our flagship verticals, healthcare, veterinarian, investment advisors, and then support from our generalist strategy.
We’ve also seen some success in some of our newer verticals like RV Parks, and we have a handful more that were in the early stage of exploring. The generalist strategy for us has been one. I’ll talk about it more in a minute. That’s been quite exciting as we continue to add folks around the country, focused on business acquisitions. The demographic trends of the aging and retiring small business owners continues, the silver tsunami as they call it. And we think we’re well positioned to support business owners in those change of control transactions.
Our specialty finance business was similarly strong led by our middle market sponsor and our government contracting teams. And as a reminder, we tend to focus on companies with EBITDA between $2 million and $10 million in that sector. And we continue to follow the flows of equity capital that are coming into that space. The renewable energy business was off to a slow start this year with some construction projects impacted by supply chains and some pressure on certain environmental attributes.
Overall though, the demand for and in the investment in Clean Energy continues to accelerate. And we feel really confident about opportunities for us there and the pipeline there look really good.
So turning to page, we’ve talked about this in the past. This is a quick map of the U.S. and the dots are where we have generalists scattered around the country, working in those markets and around those markets on business acquisition loans. As you can see, we’ve got 24 of those lenders currently year-to-date. We’ve hired seven folks in towns like Cincinnati and Minneapolis. And there’s a lot of great, great markets that we haven’t touched yet. And we will continue to look for putting great people on the field.
All in all, the momentum feels really strong. And look, we don’t see it in our numbers as it relates to credit or pipelines or anything, but we also are cognizant that we’re headed into a more uncertain macro environment with interest rates and the economy. So as we prepare for these environments, I think it’s worth noting that our SBA expertise has an element of countercyclical to it. In the past, we’ve seen conventional lenders tighten their credit boxes and the SBA products become more prominent in certain markets and oftentimes with enhanced government guarantees. So we think we’re ready for whatever comes our way.
So as it relates to people across the bank, we just continue to attract incredible folks here. And as BJ said, our primary focus has been on lenders, lender support, and increasingly in building out our technology team, but it’s really across the company. In a competitive talent market, we’re competing not only with banks, but Fintech companies, private equity firms and lots of others.
So we brought on 48 net new folks in the first quarter, that pace will likely moderate a bit in the back half of the year, but we’ll continue to take opportunities to bring the best and brightest folks together here and we think it’s a real competitive advantage for us. In that vein, we brought on someone this quarter to launch our first deposit vertical. So that’s in the 1031 exchange space, and we’re excited about more to come on that space as well.
So turning to 25, Chip went through the rationale of the Finxact sale, but unlocking $120 million of capital allows us the ability to do a few things. First and foremost, it allows us to keep growing our balance sheet without having to raise dilutive equity, which is pretty unique among high growth banks. The second is it allows us to accelerate some of our technology initiatives and redeploy some of the capital into Fintech investing.
And then the third, it allows us to give a little bit of it back. As in the past, we’ve shared a portion of special gains, whether it’s from PPP or Greenlight with our teammates, we intend to do that again. And we also plan to give a portion of it back to our community to continue the work we’re doing to help support underserved small businesses and other community efforts.
So turning to technology and product, our small business checking account, which we call title went live recently. And we have a little over 300 small businesses and a couple million of deposits. Pretty early days, but that’s with a basic first gen product and basically no marketing. But what we have is a baseline to build off of and the ability to add features at a pace that few banks can match.
One important feature is an efficient working capital solution, which our customers consistently ask for. And we believe will be important to drive adoption of our overall operating account. We’ll start rolling that product out in early Q3 along with incremental checking account features. And you’ve heard us and a lot of folks in the industry talked about embedded banking. Let me spend a minute on what that means to us. At a high level, all the work that we’ve done to build a cloud-based API first bank will allow us to create not only unique products and solutions, but also to deliver them in unique locations. And we’ll do all that leveraging our deep industry expertise.
In this context, if you look at companies that have been successful like Plaid or Stripe that have made it really easy for technology first companies to embed financial services solutions, data in the case of Plaid, payments in the case of Stripe. And they embed those into product offer rings through a simple developer portal with well-structured APIs. In the small business space, there are literally thousands of verticalized software companies, many of which we know well through the verticals we serve.
At the end of the day, embedded banking will provide us with two critical elements. The first is unique distribution channel. You can think of each of these software companies as a branch that will allow us to source low cost customer acquisition of these small businesses. The second is increased stickiness of these customers as their financial services embedded in their day-to-day business.
So aside from embedded banking, we also see a lot of opportunity and what we call platform banking, where we can leverage this technology stack to allow third party Fintech companies to build and launch products faster and easier than with their current providers on legacy architecture. We call it platform banking, people have other names for it. We’ve got a small, but growing pipeline there, and we’re excited about opportunities as well.
So we’ll continue to build and invest in this platform all anchored on the Finxact Core. Ironically, the gain from the Finxact sale to Fiserv will allow us to accelerate our development by continuing to hire world class technology talent. With this gain, we’re able to invest in incremental $10 million to $15 million per year in technology, some of which is already showing up in our first quarter numbers. These investments will be spread across all aspects of specifically around development, cyber, data, and leadership.
The major areas of this technology investments for us include customer acquisition, where we already see the benefits of having easy account opening, where we’ve opened over 10,000 small business savings and CD accounts. And the growth in those balances is over 70% in the last year. Customer experience is another critical area, where the challenger banks have truly excelled and it’s critical for us, both offensively and defensively to be best in class.
And as we fully get onboarded onto this new technology system, there are meaningful opportunities for us to improve efficiency, specifically around data quality, data entry. And finally, we’re always thinking about disruption. We think we’re still in the early stages of some tectonic shifts that are set to occur in the way small businesses bank, the ease with which they open accounts. They access capital, they move money and they receive actionable information, where they choose to bank namely within the software they used to run their business.
So we think of this as effectively building a challenger bank for small businesses within Live Oak Bank, leveraging our deep domain expertise, our incredible teammates and this next generation platform. And while this investment has taken longer than we expected to deliver, we’re still equally as excited for what’s to come in the back half of this year and beyond. I think we’ve proven to be reasonably good stewards of capital as it relates to technology investments over time from nCino, Apiture, Finxact and we view this the same way.
To be turned to Page 27, you look at our investment strategy. We continue to have two main areas of focus for our external investing. One Live Oak Ventures, which is our direct investing arm will continue to support the existing investments in our portfolio. We’ll augment that with investments in banking infrastructure, similar to what we’ve done in the past, like Finxact, companies where they’re just strategic overlay like these verticalized software companies that support small business.
And then third, we’ll also look to incubate businesses internally. In Q1, we made one incremental investment in that middle category in the partnership space, and we have more in the pipeline. The other area we continue to be active is in canopy, where we plan to invest $20 million into the second fund that’s currently being raised. The first fund is made 18 investments in some fantastic Fintech companies, many of which we’re using or evaluating for use in our technology stack today.
So turning to page 28 and wrap this up a little bit. Regardless of the economic environment, we have the same core components of our strategy, great people that understand and truly want to serve small businesses, a technology platform purpose built for them. And on the technology front, we’re willing to admit that we’re playing the long game. And that at times is in favor and at times less in favor with investors. But in the near-term, we have a rock solid balance sheet, a small business lending franchise that’s second to none, the best team on the planet. And it allows us to simultaneously grow our core business and drive profitability there and also invest for the future. We have an enormous sense of urgency to do all this and confidence we’re on the right track.
So with that, why don’t we turn over for questions?
Thank you. Ladies and gentlemen, we will now conduct a question-and-answer session. [Operator Instructions] Our first question is coming from Steven Alexopoulos of JPMorgan. Your line is open. Go ahead.
Hey, good morning, everyone.
Good morning, Steve.
BJ, I wanted to first follow-up on the commentary to moderate loan sales in the second quarter. Is this only the second quarter, where you plan to moderate sales and maybe how should we think about the level of gain on sale revenue for 2Q and then for the full year.
Yes. So Steve, as I said during my commentary, particularly on the fixed rate product, if you think about what’s going on there and how we price those loans that then go into the secondary market. They are largely based on a prime plus type rate quote. So prime hasn’t moved up as substantially as we know it’s going to both the funding markets have clearly anticipated that. And so spreads on that product and yields on that product relative to have been compressed.
So the point was, is that gain on sale premiums, particularly around fixed rate products are under quite a bit of pressure until the market moves through the rematch, if you will, of the appropriate spreads between yields and funding costs. So what we’ll do is we’ll continue to look at the mix of what we want to sell variable versus fixed rate and respond accordingly, particularly in the second quarter.
Yes, we do plan to moderate the sales for two reasons. One is, the one I just said, let the market settle a little bit, because gain on sale premiums have compressed probably a bit more than what we think they’ll ultimately settle at. But then secondarily, because we anticipated the Finxact gain, which flows through non-interest income, we didn’t feel the need to be selling into an environment that wasn’t favorable to us. So we’ll moderate the second quarter and then we’ll evaluate third and fourth as we see what the market’s shaping up to be.
Okay. So I take you choose not to give us a range, where you think gain on sale revenue could move to.
That would be correct.
Yes, that would be correct. We’ll see where the markets are in the second quarter and then we’ll go from there.
Okay. So does this imply more on balance sheet loan growth? I mean, should we be gain on sale margins going down? So if we think about year-over-year roughly 30% growth in the origination. Should we be dialing up the long growth expectations for this year?
Yes. So I think we start with what our outlook is for production, right, which we still feel very strong about. So again, first quarter was very strong record quarter relative to other Q1s, our pipelines are very, very strong. Not quite at records that we saw at the second half of last year, but pretty close. And so we’re very encouraged by that. So our production outlook still looks pretty strong. And to your point, if we’re not selling through to the secondary markets, we do maintain more balance sheet, which will obviously generate more carry income over time.
So, yes, I mean, it’s kind of nice to have the flexibility that we do with the balance sheet plus, a very liquid secondary market to manage both gain on sale income and interest rate risk. So we do still feel pretty good about originations at this point.
Okay, good enough. That I think the prior expectation was about $4 billion for 2022. Is that still intact, BJ?
Yes, I think we still feel pretty good about that.
Okay. And then finally, it’s interesting with your stock. I think you’re more than double my typical bank in terms of short interest. And the thesis has been gain on sale margins are going to collapse as rates rise in the nimble, shrink is rates rise. And I think you’re telling us that yes gain on sale margins are going to shrink a lot in the second quarter. Maybe could we at least level set on net interest margin, right, strong starting point, but assuming the fed does go maybe 50 basis points per meeting? Can you walk us through where that would take net interest margin to? Thanks.
Say that last piece again, Steve, if you could.
So if the forward curve plays out, let’s just say, we get 50 basis points at each of the May and June meetings. Where should we expect net interest margin to move to?
Yes. So I’ll start with what I think I said last quarter on the call, when we thought maybe three rate increases were on the horizon for this year. And we thought at that point that we – that our net interest margin would float down more towards, where we were seeing our core margin at that point, which was the 3.75, 3.80 range. I think with faster rate increases and more rate increases. I think funding costs go up more quickly than loan yields reprice.
And so there’s more pressure on that in the near-term. So if rates rise faster, I think we’re below that 3.75 range above 3.50, but below the 3.75 range. And then once rates start to settle out, we start to see more yield and spreads kind of normalize, then we should start to see a steady increase from there.
Okay. And this is – I’m sorry to monopolize the call. This will be my last question. And this might be a dumb question, but I’m going to ask it anyway. So if you look at the industry more broad, the asset sensitive banks, whether it be a [indiscernible] KeyCorp, Huntington, they’re all increasing their use of swaps to pull some of the benefit forward, right. So they’re doing receive fixed swaps to reduce their level of that sensitivity. Why can you guys be on the other side of that exact trade increasing your asset sensitivity?
Yes. We’re looking at different things to do that. It obviously depends on how quickly you think rates are going to rise. But yes, we’re looking at different options to be able to capture some of that.
Okay. Thanks for taking my questions.
And our next question is with Crispin Love of Piper Sandler. Please go ahead.
Thank you. Good morning. So last quarter and also this quarter, you talked about investing back into the business and increasing headcount. But I’m just curious, have you had any recent issues with recruiting new employees, retaining employees, and then just the impact of having to pay up for employees based on Huntley’s comments? It didn’t really seem like you had too much trouble adding, but just would appreciate if there’s – if you have any more color there, any more detail?
Yes. Hi, good morning, everyone. This is Renato Derraik. We are actually seeing the opposite of what people would typically expect. Every single position we’re opening in the technology space has a range of 60 to 90 people apply, 60 to 90 driven by how modern our architecture is, the fashion that people have for the velocity unless bureaucracy. And also by the great culture that the organization brings and the new leaders that we brought into the organization. So we are actually seeing the opposite effect and our organization continues to grow, and we have a very large talented pool of folks that are really interested in Live Oak to leverage.
Renato, how many folks have you hired since you – when did you join exactly what day?
Yes. Joined in June – second week of June of last year. We hired 30 – approximately 30 engineers, leaders in data, technology, cyber across our organization.
I think a similar trend across the lending side of the franchise too, we’ve got a lot of momentum of people that want to be a part of the platform, the culture. And look, we pay competitively and we will have to do that. And that’s a fact that everybody is dealing with, we’ll continue to be competitive, but we’re seeing great folks across the franchise right now.
All right. Thank you. That’s all helpful color. And I heard your color on overall production, but I’m just looking to get a little bit more detail on SBA. So SBA originations were down sequentially in the quarter, and I think that’s likely due to some seasonal aspects of concerning they were up year-on-year. But curious what your SBA origination expectations are for 2022, at least qualitatively SBA had a really strong 2021. But would you expect a pullback in SBA in 2022, as there were some tailwinds in 2022 that helped 2021 production? Or just how are you thinking about that.
I’ll start Huntley or you starting out then I’ll point out.
Yes, look, I think there’s a couple of things. I think the – from a – we definitely had a tailwind last year in terms of the SBA enhancements and those aren’t around, so got that. I think we also look as rate rise that does affect the eligible market for some deals that don’t cash flow as well in a higher rate environment until prices of acquisitions settle out. So again, you could say there’s a couple of headwinds. At the same time, we continue to see just, I mean, like BJ said, our pipelines are at or near records, we’re bringing on people. We’ll bring on a general lender in a market, who’s got a 20-year experience and that person will do $40 million of SBA lending for us in a 12 month year.
And you think about their ability to do that. We put seven people on the field so far this year, and our ability to do that, we add a couple more verticals. It feels like we’ve got a lot of winds still at our backs to offset that, the macro trends of expansion in certain areas and business acquisition continues to be really strong. And we just continue to try to get faster and better at what we do. And I think we’re – we feel really good about where we are.
The only thing I would add to that question would be, you have to bifurcate that, which was ostensibly Huntley touched on. You have – the theory of verticality in 33 verticals and people in your business have typically asked us, what is the organic growth per vertical? Doesn’t work that way, right? You just can’t map that, it’s up one year, it’s down one year. That said on the other side and the general side is completely different. That is where the growth is going to come. 100% of the SBA lenders in this country have heard of Live Oak Bank.
And we are actively attacking probably at least 50 markets. We’re in 20 some odd markets today. I would be shocked if we didn’t have well over 100 lenders in a meaningful short period of time from the 24, what it was on that earlier slide. So we are becoming the platform of choice for these very experienced, not only sound this and profitability and growth and debt service coverage ratio and like you do in analyzing a normal credit, but also in understanding how to architect the deal in lines with the SBA guidelines.
All right. Thank you. Thanks for taking my questions and for all the color.
Our next question is from Michael Perito of KBW. Please go ahead.
Hey, everyone morning,
I wanted to drill down on the operating expense line for a second here. So you guys were at just over $65 million in the first quarter. You – Huntley, you mentioned the $10 million to $15 million of annual kind of investment because of the Finxact gain, which some of which was in that run rate. So I mean is it reasonable to add maybe another million or two to that run rate for the to accelerate tech investment and then grow that kind of low-double digits moving forward as you guys continue to hire and grow or would you frame it differently?
Yes. I mean I’ll start and Huntley can give a little bit more color, but two things. One is last quarter, we did talk about what we thought expenses would grow at. And so I kind of said the fourth quarter was kind of a good jumping off point and we had fourth quarter 2020 to fourth quarter 2021, I think it was growth of 25%-ish in salary benefits. And so I think that that’s probably still a good pace for us at this point. It may be a little bit heavier because we’re leaning into technology investment because of the Finxact gain. So I think that that’s still a good number, all the other operating expenses generally growing with inflation. But really the bulk of our expense growth is going to be on the salary and benefit side.
I think the other way to look at this as well, and Huntley might give a little bit more color on this, $10 million to $15 million in incremental annual run rate for technology investment that is going to have what we believe large payoff in the future also means that, the core expense line is much lower. It’s $10 million to $15 million lower. So if we were simply just running a company for the short-term, we have far less expenses relative to the revenue that we’re generating, which obviously would be nice short-term, but we’re building something for the long-term. And so this investment we think is absolutely appropriate.
Understood. That’s helpful. Thank you. So and then secondly, really appreciate Huntley your comments on around platform banking and embedded banking and the business checking and all these initiatives you guys have going on, which seem to be on track. I guess the question is, when you guys talk about some of the benefits of these initiatives, it would seem to me that that one financial benefit over time would be the ability to have lower deposit data and lower funding costs relative to what historically have performed at. And I guess the question is, is that more of a next cycle benefit at this point though? Or do you think some of these initiatives as they launch over the course of this year could grow fast enough where you could see some benefits to the deposit equation towards the middle to latter half of this tightening cycle?
Yes, Mike, good question. And obviously as rates start to go up, the value equation gets larger and more attractive for lowering deposit costs. We talked for a while about our funding costs in a zero interest rate environment was about as good as anybody. And now we have the ability to capture some real value. I think that what we’re doing here in the back half of the year is going to set us up really nicely. And I think that we will see benefit next year in our cost of funds and in our balances, we are working every day towards it. And it’s a little bit of a race against the clock here, but we feel really good about where we are. And I do think that in this cycle, we’re going to see some impact on our balance sheet.
Michael, just a thing though. Huntley, I thought you had a good point a minute ago about embedded banking and branch. So if you think about the Bank of America, where Michael used to work, you sitting across the table, if 5,000 branches took them a hundred years to build 5,000 branches. So we’re not – when you think about the architecture that you have created here, and you think about Huntley’s earlier comment about Plaid and Stripe and how fast those companies grew in a developer friendly environment. Maybe take a minute and explain to Michael Perito what you built from an architectural standpoint and the speed with which it might answer his question.
Yes, absolutely. Huntley mentioned briefly about the developer portal and how we’re basically structuring our APIs so that it’s really easy for third parties to integrate more effectively with us. Our goal is still to allow engineers and Chief Technology Officers from these organizations that we’re partnering with to be able to understand how to connect with us and leverage our services within a period of 30 minutes. That’s a quality of the technology architecture that we’re putting in place. So it can lead to an incredible amount of growth has no incremental acquisition costs for the organization.
Great, thank you guys for all the color there. And then just lastly, and I’ll hop back in the queue. Listen, but just on the platform banking, can you guys give us a sense of what that pipeline looks like or are we looking at FinTechs that are more likely to be like in your venture investment arm, like early mid-stage, or you guys looking at more larger companies, even broader than FinTechs that are looking to offer services or just how do you guys think about that pipeline and the types of opportunities within it? Thanks for taking all my questions.
Absolutely. I’ll start with this one. Look there is at least one company that’s in our ventures investing right now that we’re looking at. I think what we started as a framework is, are there ways that we can help small businesses out and are there FinTech companies that serve small businesses? And that’s a natural extension of what we do. So there’s a body of FinTechs out there clearly that are serving small businesses in one way or another. And can we help partner and leverage that, that’s not exclusively the case.
I think we’ve been less apt to go after the largest FinTech companies in that realm to date and really focus on where maybe we can have a bit more of a strategic relationship, but also drive the economics either on a per unit basis or by generating some low cost funds, et cetera.
And our next question is from Jennifer Demba of Truist Securities. Please go ahead.
Thank you. Good morning.
Wonder if you could kind of give us some more color on where exactly you are with the embedded banking and the plans for the second half of the year roll out where you are. Is it still – is that product still going to be for vets?
Yes. We’re basically in the process of the building our critical foundation in this quarter. It has to do with the safe and secure way of exchanging communications that that the developer portal that I was just describing. And starting in Q3, we’re going to basically be putting specific services in our new portal and establishing the initial partnerships with the companies that Huntley was describing.
And Jennifer, to your point, the first couple of partnerships and companies that we’re – they’re spending a lot of time with are in our traditional vertical. So veterinarian healthcare still the place, there’s some others as well, but it would – will be consistent with, I think what you’ve heard before in terms of those early pilots and partnerships.
When you move on to other industry verticals after you have the vet product rolled out, how fast will the development – how much faster do you think the development can go in those subsequent verticals?
Yes. It can take less than a week for us to board the new partner in the new – with the new technology foundations that we’re creating.
Okay. Okay. And my other question, most of our questions have been asked, but just curious your asset quality’s been terrific. What do you see as the most vulnerable loan buckets as rates go up in terms of below higher…
Steve Smits – in your purview.
Jennifer, thank you. This is Steve Smits. First of all, my comment is have pretty good confidence in the health of our portfolio today also really good confidence. And what it looks is going to look like going forward, because at we know our customers very, very well. So we’ve always been best-in-class and servicing would continue to be do so, if anything we’ve gotten even sharper throughout the past two years.
So we feel like we have a good I would say less about specific verticals because we really don’t see right now any systemic trends to a specific vertical, more about themes that we watch very closely labor market, of course. So we – every vertical to some degree has some challenges around the labor market that we need to understand. So we’re very specific about understanding that with each of our customers and then of course inflation and fuel.
So we have small exposure to businesses that have a heavy reliance on fleet for example, but certainly a few customers that we look at very closely and how they’re navigating, how sensitive is their pricing to their end customers, if they can keep up with the inflation pressures. I would say those are the pressures that we look very closely at and however I will say we feel even with the labor market while they’re all experiencing some degree of stress. I feel really good that they’re navigating quite well. And I don’t have really a huge concern that they’re not doing the right things and that we’re going to be in good shape there.
I would just add to that, Jennifer, I mean, this blast for me, right? But this – you think about and we were a much smaller company in the last recession. It was wonderful for us. Typically in a year we’ll go to 450 trade shows. If we do have a recession and the credit guys are running the bank. We will continue to stay the course. I mean yes, an SBA lender theoretically is the lender of last resort. And yes, somehow our charge-offs have been one-10th of every SBA lender in the country over the last 13 years. But knowing and understanding the industry and staying in the business, when the credit guys run the bank and the sales guys are sitting at home, throw us in that Briar Patch we’re ready.
Great. Thanks a lot.
Right. There are no more further questions on the queue. So at this point, I would like to turn it over the call to Chip Mahan for some closing remarks.
As always my closing remarks are thanks for attending today, and we’ll see you next quarter.