On Live Oak Bancshares' (LOB -2.99%) most recent earnings call, J.P. Morgan analyst Steven Alexopoulos noted that the bank has double the short interest of the typical bank he covers, meaning investors expect the stock to decline much more than its peers.
Live Oak stock is currently down nearly 57% this year, and while the bank does have a much higher valuation than the typical bank of its size, I still think this company has a great long-term vision that is going to pay off. Here's why.
Why the short call?
Live Oak Bancshares is the country's largest originator of loans in partnership with the U.S. Small Business Administration (SBA). These are loans made to businesses that likely wouldn't qualify for a traditional bank loan, so the SBA guarantees a large chunk of the loans, making them much more appealing to banks. Because Live Oak originates so many of these loans and only has roughly $8.6 billion of assets, the bank will sell many of these loans to investors in the secondary market.
In 2021, ideal conditions driven by stimulus money increased volume and the gain-on-sale margin (the profit margin) Live Oak made on those loans. Last year, the bank made nearly $67.3 million from selling loans to investors, up 36% from 2020 and 132% from 2019.
In 2021, Live Oak's average net gain-on-sale premium was 110%. In the first quarter of 2022, the net gain-on-sale margin hung in at 109%.
But as Alexopoulos noted on the earnings call, the short-sellers' thesis is that rising interest rates will bring down gain-on-sale margins significantly, as investors look for safer assets, which now yield more because the Federal Reserve has and will continue to aggressively raise interest rates. Short interest in Live Oak has risen a good amount this year.
As a percentage of the stock's free float, short interest is now about 9.2%. Now, that might not get a meme-stock investor excited, but as Alexoupolos noted, it's pretty high for a typical bank.
The bigger picture
Live Oak isn't just in the business of SBA lending; it is on a mission to be America's small-business bank. In serving so many SBA-associated entities and small businesses all over the country, the bank has made lots of relationships with businesses that it believes it can serve in a much more holistic manner through embedded banking, as shown below.
Essentially, small businesses will be able to use Live Oak's platform to manage all of their needs -- including deposits, payments, capital, and integration tools that help them with their operations. As you can see, the bank has rolled out some of its small-business products but plans to launch many more for small businesses and niche software companies, which will give it two big advantages.
On the most recent earnings call, Live Oak's president, Huntley Garriott, said: "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."
Additionally, Live Oak is getting into what it calls "platform banking," or what some might call banking-as-a-service, where it can extend its tech stack to allow fintechs to build and launch products more efficiently than on their current legacy-technology providers.
All of this is made possible because Live Oak has spent years doing the hard work needed to greatly improve its own technological capabilities. It took on the difficult task of migrating the bank to a new core banking processor, which is the system that helps power daily banking transactions and activity.
Not only did Live Oak choose a new platform, but it also chose the next-generation cloud-based Finxact core processing system. This kind of technology is much more nimble than legacy architecture and will allow Live Oak to leverage data better and launch new and unique products much quicker than your standard bank running on legacy core processors.
The Finxact core is a big reason Live Oak can launch these unique embedded and platform banking initiatives. Like it or not, most banks will need to move to cloud core-processing systems eventually to remain competitive, and Live Oak is already way ahead of the curve.
A great long-term vision
Despite some potential near-term headwinds like falling gain-on-sale margins, I am much more interested in Live Oak's long-term vision to become America's small-business bank. And I'm convinced that it has done the necessary work from a technology standpoint to serve small businesses and fintech companies in the way they would like. Trading at about 15 times forward earnings and 236% to its tangible book value, or net worth, Live Oak is not cheap for a small bank stock.
But it has also developed a vision that is much different from your typical small bank, which is why I think the investments it has made (and continues to make), along with its vision for its future, make Live Oak a good long-term buy.