Since the pandemic started, Live Oak Bancshares' (LOB 0.15%) stock has been on a tear, rising from less than $10 in March 2020 all the way to $96 in November 2021, and now trading around $65 at Wednesday's prices. During that time, Live Oak's earnings have soared. Diluted earnings per share (EPS) of $3.71 in 2021 grew 160% from 2020.

While earnings are expected to normalize this year after some nonrecurring tailwinds wind down, investors should keep their eyes on the bigger opportunity ahead. Here's why.

Why earnings may normalize

Live Oak has only $8 billion in assets, but many in the banking world know the company because of its innovative strategy, which has made it the largest Small Business Administration (SBA) lender in the country.

That became especially valuable early in the pandemic. Among the stimulus initiatives rolled out during the widespread economic shutdowns was the Paycheck Protection Program (PPP), an emergency loan program for small businesses that was administered by the SBA. While any bank could participate, banks like Live Oak that knew the niche well and had the systems and processes already in place had an immediate advantage.

Person holding chart and showing it to another person.

Image source: Getty Images.

And take advantage Live Oak did. The bank originated $2.3 billion of loans through the multiple phases of PPP, which provided a huge boost to its net interest income, the money banks make on loans and securities after covering the cost of funding those assets. From that $2.3 billion of originations, Live Oak will collect more than $80 million of fees that benefit net interest income.

At the end of 2021, only about $268 million of those $2.3 billion in loans had yet to be forgiven, and the bank only had about $6.5 million of net deferred fees remaining, so the tailwinds from PPP are coming to an end. Live Oak is still performing incredibly well and should perform well this year. But management said to expect the net interest margin (NIM) -- which essentially looks at the difference between what banks make on interest-earning assets such as loans and payout on interest-bearing liabilities such as deposits -- to trend down from above 4% at the end of the fourth quarter of 2021 more toward the 3.83% the bank reported for adjusted NIM without the impact of PPP.

The bigger opportunity

Live Oak Bank did not become the largest SBA lender in the country just because of its experience; it did so by developing innovative technology specifically geared for small-business banking. In fact, management ultimately wants to be America's small-business bank. The bank's plan is to take its interactions with SBA borrowers and turn them into more holistic banking relationships. 

Live Oak is one of the first banks to transition from legacy core processing technology to Finxact's open-banking core processing technology, which is driven by application programming interfaces (APIs). Core processing helps banks run their daily operations and carry out common banking functions like daily deposit and loan transactions. The Finxact core will enable Live Oak to better leverage its data and roll out new digital banking products much more quickly.

Those include small-business checking accounts and, eventually, other products that small businesses have struggled to gain access to in the past, like smaller-balance commercial lines of credit. Banks haven't always offered this kind of product because it can be hard to make a profit on, leaving small businesses to use personal credit cards or personal loans to access smaller amounts of working capital. But now Live Oak is positioned to fill this hole in the market.

Additionally, Live Oak intends to provide small businesses with payment products and the ability to integrate tools they use in their everyday operations, such as QuickBooks, payroll, and expense management. Live Oak will also be able to offer small businesses banking-as-a-service (BaaS), which enables non-bank businesses to offer banking products, like checking accounts and debit cards, to their customers. Live Oak President Huntley Garriott said on the bank's most recent earnings call that Live Oak's BAAS capabilities are "along the lines of what Plaid and Stripe have done, but specifically for small-business banking." 

This strategy will incentivize more small businesses to do more with Live Oak, creating more profitable relationships. It will also help the bank greatly improve its deposit base.

Currently, Live Oak only has a very small amount of its total deposit base in non-interest-bearing deposits, which a bank doesn't pay any interest on and which therefore improve loan margins. Live Oak CEO Chip Mahan said that "creating non-interest-bearing deposits at scale is just around the corner." The bank has now converted its deposit conversion over to the Finxact core and launched its small-business checking account product, which can start to generate non-interest-bearing deposits.

Focusing on the strategy

Live Oak's stock has run up to a high valuation, so it's certainly not uncommon to see investors worried about potentially lower earnings. But remember, the bank got an unprecedented bump from PPP loans. Additionally, while all the pieces seem to be in place, it is still early innings on Live Oak's small-business banking bundle and BaaS capabilities -- and, ultimately, all the other products and services it plans to roll out to small businesses. I continue to see the potential of what Live Oak is building as far greater than near-term earnings trends.