If you had looked at Live Oak Bancshares (LOB 1.55%) at the start of 2020 (before the pandemic), on the surface it would have looked like a lot of other bank stocks. Live Oak stock traded at less than $20 per share and was valued at about 150% to tangible book value (TBV), which is what a bank would be worth if it were liquidated and what banks tend to trade relative to.
Fast-forward to the present, and Live Oak trades at more than $93 per share and at nearly 600% to TBV. Banks don't normally get that high of a valuation -- at least not since the Great Recession. So how did this happen?
Well, investors stopped valuing Live Oak as a bank and started looking at it as the burgeoning fintech company that it really is. Let me explain.
Image source: Getty Images.
From bank to fintech
While Live Oak's share price may have shot up during a very short time frame, management has been working on this transition for many years now. Contrary to popular belief, many banks do understand the necessity of technology, but it takes time to make big changes.
Live Oak is a branchless bank that specializes in serving small businesses, primarily through the U.S. Small Business Administration's (SBA) lending program. In this program, banks work with the SBA to make loans that are partially guaranteed by the government. Live Oak also makes conventional loans and participates in other government-guaranteed lending programs like those in the U.S. Department of Agriculture.
Despite having far fewer assets and resources, Live Oak is the largest SBA lender in the U.S., regularly beating out some of the largest banks in the country that also do this type of lending. It is able to achieve this because it has a technology-based platform that serves small businesses nationally. The bank, according to its annual report, uses this platform to "optimize the company's loan origination process, customer experience, reporting metrics, and servicing activity."
During 2020, Congress implemented the Paycheck Protection Program (PPP) as part of larger stimulus bills to aid small businesses severely impacted by the pandemic. PPP was built based on the SBA lending program, which gave Live Oak a once-in-a-lifetime opportunity, of which the bank took full advantage. Live Oak originated $2.3 billion in PPP loans, which will collectively have brought in more than $80 million in net deferred fees once the loans have all been forgiven.
But Live Oak's success can't be entirely attributed to the fact that it already knew the SBA lending space -- tons of lenders make SBA loans. It's the tech platform that differentiates Live Oak by making the SBA loan origination process much more efficient. It also enables Live Oak to manage and engage a national network of small businesses without the legacy infrastructure.
Making a next-generation tech platform
Several years ago, Live Oak began directly investing in fintech companies because it knew the space well and it wanted to stay on top of innovation that could revolutionize banking. Now, the bank has taken a lot of those successful investments and added them to its own tech stack.
One of those companies was Finxact, a company that makes a cloud-based, real-time core banking system that enables open banking. Most banks use old legacy core systems to carry out their daily banking functions, which are clunky and make it difficult for banks to innovate. During Q3, Live Oak successfully converted all of its retail and commercial deposit customers to the Finxact core platform.
Live Oak's President Huntley Garriott said on the bank's Q3 earnings call that the new tech stack the bank is building on Finxact will give Live Oak the ability to create new products and enhance existing ones much faster and in a much more cost-efficient manner than banks using legacy core banking platforms. The Finxact platform also provides a data advantage, according to Garriott, adding: "Our data lives in one place with multiple positions in a single account, not siloed in legacy systems. That gives us the ability to better understand our customers, to provide them with rich insights, and to help them with their financial decisions."
Here you can see the platform that Live Oak is developing. A lot of the fintech firms that will make these capabilities possible are powered by fintech start-ups Live Oak previously invested in.
Image source: Live Oak Bancshares Q3 investor presentation.
Can Live Oak Stay on its new path?
Since the pandemic began, investors have seen the payoff of Live Oak's investments. Adjusted pre-provision net revenue at the bank, a good indicator of operating profits, grew nearly 150% between the first quarter of 2020 and the third quarter of this year. Loan originations have topped $1 billion in each of the last two quarters, which is a lot for a bank with total assets of $8.1 billion. With fast-growing profits and future innovation ahead, Live Oak trades at 600% to TBV and at nearly 25 times earnings. It's no longer being valued like a traditional bank and is now seen as a fintech company.
Given this new designation, I certainly think Live Oak can keep moving higher. Even with PPP all but over, Live Oak likely met tons of new customers as a result of PPP. Excluding PPP loans, total loan balances at the bank are up nearly $1.5 billion year over year during a time when loan growth was difficult to come by for most of the sector. While the company may not do $1 billion in loan originations every quarter, management seems very optimistic about the pipeline going forward. The new tech platform and rollout of new products should enable the bank to further penetrate its existing customer base and appeal to more small businesses, giving Live Oak stock plenty of runway for further growth.
