Live Oak Bancshares (LOB 1.55%) isn't exactly a household name, but it is one of the more interesting names in the banking industry. If you aren't familiar, Live Oak is one of the largest small business lenders in the United States and operates a high-yield deposit platform for both businesses and individuals. Indeed, 42% of the bank's 2022 loan production consists of loan types guaranteed by the U.S. Small Business Administration (SBA), while the average bank has just 4% of its portfolio in government-guaranteed loans.
In the recent market downturn, Live Oak hasn't been a strong performer -- far from it. The stock is nearly 70% below its peak, mainly due to fears that inflation and a potential recession could lead to sluggish loan demand and a spike in loan defaults.
However, Live Oak's fourth-quarter earnings show the business is quite strong. This means it could be worth a closer look at the current rock-bottom valuation.
Live Oak's business is doing very well
Live Oak's lending business continues to grow nicely despite the challenging environment, with 17% year-over-year growth in loan originations in the fourth quarter. The company's loan portfolio is now $7.9 billion in size, 24% larger than at the end of 2021, excluding PPP loans.
Not only is Live Oak's loan portfolio growing, but the deposit platform has been very successful in attracting inflows as yields rise. Live Oak's deposit base has grown to $8.88 billion, reflecting 25% year-over-year growth and providing a source of low-cost capital for the lending side of the business.
Asset quality is a major concern among most bank stock investors, and Live Oak is seeing a slight uptick in charge-offs. Unguaranteed (non-SBA) loans had a 0.27% nonperforming rate, still well below most other banks, but four basis points higher than the end of the third quarter.
The bank's net charge-off rate is well below pre-pandemic norms. Plus, Live Oak's allowance for credit losses is equal to 1.41% of its loans held for investment (and 2.22% of its unguaranteed loans), so this is a very manageable delinquency rate.
The negatives and what to watch for
Not all the earnings news was great. For one thing, Live Oak's bottom-line profitability declined significantly (but was still positive) in the fourth quarter due primarily to lower noninterest income, including a revaluing of the loan portfolio and lower premiums on sold loans. Plus, Live Oak's provision for loan losses was 39% higher than it was in the third quarter, which also contributed to the lower bottom-line performance.
Unlike many other banks, Live Oak's net interest margin actually declined by eight basis points compared to the third quarter, despite the rising-rate environment. In a nutshell, the interest Live Oak is paying on deposits is growing faster than the average yield of the loans on its balance sheet. Even so, a 3.76% net interest margin would make most other banks very jealous, so it's important to realize Live Oak is a very profitable institution.
Excellent risk-reward dynamics
To be perfectly clear, Live Oak isn't without significant risk. Its business could certainly slow down if the economy worsens in 2023, and we're likely to see an uptick in defaults this year as well. However, Live Oak is doing an excellent job preparing for whatever comes, and the SBA-guaranteed nature of much of the portfolio provides somewhat of a safety net.
Plus, 2023 could actually be a very exciting year for Live Oak. It aims to rapidly scale its small business checking account product (launched less than a year ago), which could help deepen its relationships with its customers (and grow the deposit base even further). And Live Oak is expecting "meaningful growth in net interest income" this year, as well as a stronger secondary market for loans in the second half of the year.
With shares trading at less than 8 times trailing-12-month earnings despite strong growth in the business, Live Oak could be an excellent stock for patient long-term investors.
