Live Oak Bancshares (LOB -12.77%), which focuses heavily on serving small businesses with its high-touch, technology-driven bank model, has struggled with its stock down about 37% over the last year.
The bank has and will likely continue to deal with near-term headwinds from rising deposit costs and less demand in the secondary market for government-backed loans that it sells to investors.
But Live Oak has always been at the forefront of bank technology and has spent the last couple of years integrating cloud-based, core-processing technology that it will use to power its embedded banking initiative. This longer-term opportunity remains very much intact and is what makes the stock attractive.
Looking at recent results
Live Oak recently missed analyst estimates for the fourth quarter on earnings and revenue in a very convoluted quarter for the bank. One of the big challenges is that Live Oak continued to see smaller gains on the sale of government-backed loans that it originates in partnership with the U.S. Small Business Administration (SBA) and the United States Department of Agriculture (USDA).
Gain-on-sale premiums have declined as investors have faced a higher cost of funding for the loans and credit concerns. In Q4, the total gain-on-sale premium of loans sold by Live Oak was 105%, which is down from 110% one year ago and 108% from Q3.
Management said the secondary market for SBA and USDA loans remains unattractive, particularly for fixed-rate loans because investors have higher funding costs, but the loan yields don't reprice higher. Management can hold loans on its balance sheet, however, until market conditions improve.
Another big issue for Live Oak that will likely persist is the bank's deposit costs. Live Oak does not yet have a sticky deposit base and sources most of its deposits from higher-cost savings accounts and certificates of deposits. As such, the average rate Live Oak is paying on its funding liabilities climbed from 1.55% to 2.40% in Q4.
Embedded banking
Live Oak has always been a tech-forward bank. It only has one branch but owns three corporate planes that it uses to shuttle bankers all over the country to meet a national base of small business clients across many different verticals, including veterinary practices, funeral parlors, fitness centers, and much more. In total, Live Oak's lending franchise serves more than 30 different lending verticals.
But the bank's longer-term vision is to use technology to become America's small business bank and provide small businesses with all of their needs, including lending, cash management, data and insights, risk management, and other specialized financial products and services, such as payment capabilities.
To be able to do this, Live Oak has spent the last several years transitioning over to the Finxact core-processing system, which is a cloud-based, real-time core-processing system built on Amazon Web Services. The core-processing system powers a lot of a bank's daily activities, and Finxact is powered by application-programming interfaces and allows Live Oak to be much more nimble and flexible when it comes to developing new banking products and leveraging data. Live Oak was actually an early investor in Finxact.
Live Oak's goal is to partner with the software providers that its clients use to run their business, which will put its small business solutions right in front of potential small business customers. Live Oak's CEO Chip Mahan has previously said that each software provider will essentially serve "as a branch that will allow us to source low-cost customer acquisition of these small businesses."
Image source: Live Oak Bancshares.
Currently, Live Oak does have a checking account product out there serving about 2,000 of its small business customers. The account looks to have had some decent success as well, with noninterest-bearing deposits -- those the bank pays no interest on, up 117% year over year to roughly $194 million.
That's still a small portion of total deposits, but management said on their Q4 earnings call that over the next few weeks, Live Oak is planning to roll out its specialized business checking account it has been building with treasury-management capabilities.
Eye on the ball
Due to rapidly rising deposit costs and continued potential headwinds in the secondary market for Live Oak's government-backed loans, the stock may continue to struggle over the near term.
But long term, Live Oak looks to be well positioned with its embedded banking strategy that ideally will be able to build noninterest-bearing deposits at scale. Live Oak is already a top SBA lender, so its new tech capabilities will allow the bank to serve the small business customers it already knows quite well in a much more profitable manner.
Mahan for decades has been instrumental in the creation and development of many bank-technology solutions, whether its core processing or fintech companies, which gives me confidence that Live Oak's embedded banking initiative will turn the bank into a long-term winner.
