As James “Chip” Mahan III tells it, Live Oak Bancshares was everything a regulator would hate when it started up in 2008. The Wilmington, North Carolina-based banking company would go branchless, lend on a national scale to only one industry, and raise deposits by paying top rates. “They fundamentally hated all that,” Mahan, one of the founders, says.
Nowadays, Mahan and his team say the $8.2 billion banking company’s relationship with the regulators has improved. On top of that, niche lending on a national platform isn’t a new concept anymore. Investors, in particular, seem drawn to the bank lately. As of Sept. 22, Live Oak was trading at 385% of tangible book value and 22.8 times price to forward earnings, according to S&P Capital IQ.
The market views Live Oak as a successful cultivator of technology companies, with a venture capital arm currently invested in growth companies such as digital banking platform Greenlight and core provider Finxact, says Christopher Donat, an analyst and managing director at Piper Sandler & Co.
There may be other reasons, too. Investors think Live Oak is a niche bank like a SVB Financial Group or First Republic Bank, both based in California, says Jennifer Demba, managing director at Truist Securities, who follows the bank. “Niche banks growing faster than their peers tend to trade at premiums,” she says. And growing it is. Live Oak’s compound annual growth rate for noninterest and interest income from 2011 to 2020 was 25.9%, according to its 2020 annual report.
The Live Oak team’s journey to niche, digital bank started out with a simple enough concept. Vice Chairman Lee Williams III and Mahan had previous experience with Small Business Administration lending and banking, and wanted to start a bank focused on it. They worked with a company in Cleveland called Government Loan Solutions, which gathered loan performance data from the SBA by filing public records requests. Live Oak scoured this data to find out which industries had the best loan performance. Guess who did? Veterinarians. Not only did they have love animals, but they loved paying their loans on time.
As Live Oak grew, it expanded to more small businesses the team felt were overlooked by banks: smaller businesses that many banks didn’t focus on, usually with less than $5 million in annual revenues. Live Oak created a digital lending platform that would deliver those customers a decision on their loan approval quicker.
Live Oak eventually bought Government Loan Solutions, but it’s not only focused on technology. It’s also focused on talent, recruiting top SBA lenders from other banks. While other banks tend to offer SBA lenders complicated compensation structures based on commission, Live Oak doesn’t pay commissions. Instead, it offers lenders their total pay at their current jobs as a base pay, plus 100% coverage of family health care costs. “They are the bank of choice for an SBA lender to work at,” Demba says.
Among banks in the SBA’s signature 7(a) program for fiscal year 2021, Live Oak was the No. 1 lender in terms of dollar volume. When the coronavirus pandemic hit, Live Oak was vulnerable to risky sectors of the economy, including restaurants, hotels and entertainment businesses, says Donat. The bank took $19.4 million in net charge offs in 2020 related to the pandemic and hotel loans it chose to sell, according to its 2020 annual report. Its profitability also took a hit in 2019 and 2020 as it transitions to holding more SBA loans on its balance sheet; previously it had generated fees selling SBA loans, according to Demba. Moving forward, that may make Live Oak’s profitability less volatile.
Despite the pandemic, the bank’s credit quality has been good and its opportunities to grow are numerous, Demba says. It could improve future profitability by generating more noninterest bearing deposits through more attractive deposit products for small businesses. Mahan describes a future where the bank is “embedded” in small business operations, from payroll to cash management to accounting software. “We’re going to create, in every industry that we lend to, everything that that business needs to operate,” Mahan says. That’s part of the reason why investors are willing to make their bets on Live Oak.
“It’s a unique company, and they are very forward thinking, and I think they are more nimble than their traditional bank peers,” Demba says.