Ladies and gentlemen, thank you for standing by and welcome to the Live Oak Bancshares Incorporated Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] I would now like to hand the conference to your speaker today, Greg Seward General Counsel of Live Oak Bancshares. Please go ahead, sir.

Thank you and good morning everyone. Welcome to Live Oak's Third Quarter 2019 Earnings Conference Call. We are webcasting live over the Internet and this call is being recorded. To access the call over the Internet and review the presentation materials and commentary that we will reference on the call, please visit our website at investor.liveoakbank.com and go to today's call on our event calendar for supporting materials. Our third quarter earnings release is also available on our website. Before we get started today, I would like to caution you that we may make forward-looking statements during today's call that are subject to risks and uncertainties. Factors that may cause actual results to differ materially from our expectations are detailed in the materials accompanying this call and in our SEC filings. We do not undertake to update the forward-looking statements to reflect the impact of circumstances or events that may arise after the date of today's call. Information about any non-GAAP financial measures referenced including reconciliation of those measures to GAAP measures can also be found in our SEC filings. I will now turn the call over to Chip Mahan, our Chairman and Chief Executive Officer.

Good morning and thanks Greg. As I was thinking about how to kick off the call this morning, I thought of that thing [ph]. The beat goes, life is about doing what you say you're going to do and we've done that for four straight quarters. But there is a lot to unpack here and hopefully at the end of the call, we will convince you as we believe our sales that this is the best quarter in our history. I'm going to talk a little bit about high growth in recurring revenues, we always kick off talking about safety soundness and strong credit quality, but I really want to try to convince you what the real earnings of your bank are and that which should stay at holding company activities. And then Huntley will clean up everything's toward the end. So let's move on to Slide 4. There is a lot here, so obviously, we're very proud of almost 50% growth in the loan portfolio year-over-year. What we affectionately call the treasure chest is up from the beginning of our strategic pivot from a couple of $100 million today to almost $850 million almost 4X increase there. Net interest income year-over-year is up $10 million and as I went back and looked at expenses a year ago taking out $2.6 million of goodwill impairment. Expenses are up about $4 million bucks. So, year-over-year on the quarter, up about $6 million, [indiscernible] is $24 million, which is about $0.58 a share, not bad. We're excited about that and even though we changed the business model and don't really focus as much as we used to on quarter-over-quarter loan production, we were excited about $562 million of production this quarter almost a record and still highly confident that we will originate…

All right. Thanks. Chip. You’re always a hard act to follow. I'm going to provide some more detail across four main themes: business momentum, credit, expenses and then finish with a few thoughts on our technology road map. So Page 11, the highlights. You've seen the format before. Continued momentum across the franchise, loans up 9% linked quarter, manager’s income up 11% linked quarter. We’re three full quarters into our strategic decision to hold more loans. We've stayed on track retaining roughly two-thirds of our eligible production. And we still have $3 billion of loans that we've sold and are servicing on behalf of others, and as they continue to migrate back on our balance sheet quarter-over-quarter, as Chip mentioned, we're adding $2 million to $3 million of core earnings, each quarter. Turning to Page 12 on the lending side. The story remains really positive. Chip mentioned $562 million of production, but more importantly, we continue to make great loans to great small businesses every day. Our vertical expertise truly differentiates us in the market, and we've seen early success from our general strategy in the M&A space. Our pipeline remains robust at about $2 billion and we continue to find new ways to reach customers in some of our more established verticals, and our newest verticals continue to build really nicely. The portfolio remains incredibly diversified and granular. In the quarter, we made over 300 loans across almost 30 industry verticals in 43 states with an average balance of $1.7 million. Almost 60% of our origination were SBA 7A, so that continues to tick down a little bit as our more diversified products that continue to offer us opportunities outside of that SBA program. While we continue to see competition across all our markets, we have successfully maintained our…

Thank you. [Operator Instructions] Our first question comes from Aaron Deer with Sandler O'Neill & Partners. Your line is now open.

Hi, good morning everyone.

Morning, Aaron.

I guess starting with the credit, the -- I was curious about the loan repurchase that you made in the quarter. It sounds like that was for the turkey loans. What was the volume of the actual loans that were repurchased and is the 1.8 -- I think it was 1.8 and maybe it was less, but was the purchase amount associated with that that was expensed in the quarter, should we think about that as being a loan loss on those repurchases and is that repurchase what drove the non-performers higher in the quarter?

Hey, Aaron. This is Brett. Regarding the repurchases, that -- as Huntley indicated, that was $1.2 million when -- and then those are all guaranteed dollars. When a loan needs some sort of modification that's installed in the secondary market, typically you work with the investors to try to make those modifications. If the investor’s not interested in modifying the note, the way a lot of things the things that should be modified to help the borrowers survive, we have the authority to repurchase those from secondary market. So those were borrowed back on book during the third quarter. And when those came back just the nature of those loans, the way they're structured with -- for payments back from the turkey farms, those are annual pay. When you repurchase the loan, you bring the investor current on interest. So that was the bulk of that extent. That expense line as shown in our P&L did increase1.8. The other increase there, a lot of that is associated with just general growth and the owned book guarantee portfolio where we pay the roughly 50 basis points for the ongoing guarantee. And I believe that was the second part of your question.

But Brett, just to be clear, so that borrower was paying as agreed and we took that interest and applied it to principal, and that's the gap. Correct?

Yes. Those lines are non-accrual on our book. So all payments being made by the borrowers, which were being made, we’re going to pay on principal rather than interest.

That’s my point. And then we had to true that up and that’s the negative. Correct?

And then to -- I think there was another part of that question about non-performing and maybe you were asking [indiscernible].

Yes, was bringing those loans back on the book, is that what drove the non-performers higher or was it other credits that drove that higher?

So this is Steve Smits. Yes, that was part of what drove it up, coupled about nine relationships actually went to non-accrual this quarter, some actually were rehabilitated, went back to accruing, some refinanced and paid off, but a good portion of that was actually bringing that guaranteed portion back on book.

Okay. And then obviously the loan pricing has not been exhibited in the -- well the loan re-pricing that we would expect to see here come through in the fourth quarter wasn't exhibited in the third quarter margin. Can you give us a sense of what the -- what percentage of the portfolio I guess do you expect to re-price this quarter and where do you expect loan yields to end or average loan yields to be in the fourth quarter relative to the third quarter?

Aaron, this is Brett. So our own book portfolio just a touch over 60%, I believe it’s 62% re-prices on a quarterly or more frequent basis. We have a couple of monthly adjusting lines. But as of October 1, that's when roughly 60% of our portfolio will re-price based on those -- or did re-price based on those Q3 Fed cuts.

Okay. And then I'm trying to understand too the negative fee income related to some of the start-up investments. Can you give us a sense of how long do we expect this situation to be the case and when we can expect some improvement on that front?

It’ll be a while. I mean Neil is here with me, right, you're referring to Live Oak venture investments, right Aaron?

Presumably, yes. The slides that you guys presented this morning would have been helpful last night in trying to understand some of some of this, but it's -- but yes, I mean the degree to which we've seen some changes there I guess is a little surprising to me.

Well in ventures this quarter, Greenlight completed a round of financing at a $200 million valuation, right Neil? And we picked up $3.7 million on that, which offset both cost method and equity method write downs in the other businesses and that's why we’ll split that out in the future and talk about more of those.

Yes. I mean and just so you no Aaron, that was always in the income statement. We are just now breaking it out to demonstrate the difference between operating income and some of these investments. Again the Canapi should be -- I think as you look out over the years, Canapi in that income statement should be kind of net neutral. So that goes away given future revenue that's going to hit the income statement. And who knows how to project the warrant options that Chip talks, and as we go out and raise more capital or write-offs that happened there, there'll be some probably chalkiness there. The OpEx that floats through the income statement banks that some of these others is something that we’ll continue until we sell down. But again if we continue the offsets are, as we continue to raise capital at higher valuations and/or these companies continue to grow, that there'll be an offset for them as well.

Okay. I guess, I mean the equity method losses last year were maybe run in between $50 million to $100 million a quarter, and this year they're more closer to $2 million a quarter. And so I'm just, it sounds to me like that's going to continue to be the case for a while.

Yes that's specifically at mature and I would view that we certainly don't want to take on anymore. So again, we should see that is those as relatively, as you project this out relatively flat. And we'll talk about this in this next financing around, we will on a little bit bigger portion in the successive round at the bank. And so you'll see some of that flow through to the income statement, but at a minimum we're going to continue to break it out for you so that you can see and track and we're going to be cognizant of it.

All right. And then with the, solar investment in the leasing business, I guess you gave some guidance in terms of what the impact that's going to have on the tax rate for this year. Just as we look out to next year, is that, are you curtailing that indefinitely. I guess, particularly now that the benefit of those investments is going to be declining and what does that mean for the income and expenses related to, I guess the equipment expense on the expense side and the lease income on the revenue side, are those going to flat line at this point. And then what do prospectively expect, this your tax rate to look like in 2020 as a result.

Aaron, this is Brett. I'll start out adjusting the income statement pre-tax question. So the way those leases are structured any expenses associated with those is nearly net it out with the lease income. I think you're looking at a neutral pre-tax income statement impact just based on what is existing in incoming lease payment and then related to the forward path. We're in a bit of I'd say assessment mode for 2020. Putting a lot of fold into continue to layer in that assets, of course there is DTA considerations. As Tommy mentioned in his comments, there is market dynamics considerations, all these things that we're thinking about going into 2020. We did provide a bit of guidance in the CFL highlight related to where we think our tax rate will be for this year. And I'd say, more to come on 2020 at this point.

I'll just add one, more thought because know these are a relatively small investments. If you think about them like loans $5 million or $10 million of these lease projects will move the needle in a quarter because you take all of the accelerated tax credits upfront and then you end up with as Brett mentioned in asset that where the expenses in the income kind of offset each other. So, you end up making if it's an asset that has a I'll make us of an 8% total sort of yield for the life of the project, you will end up taking most of the income through the first period in the interest expense. So it's a little bit of a front-end loaded period. So we're trying to make sure we like the product where the market is, changes in tax rules, et cetera, but recognize that it does swing the income statement, a bit more than if we made that equivalent amount of loans for example.

Okay and then lastly on the capital front. TC ratio is coming down as the balance sheet. It's been growing at a pretty good clip here, obviously just got very strong capital levels. But if you continue to grow the balance sheet at this space at what point do you guys think you might need to come back to raise capital, particularly for not seen any material improvement in the profitability?

Somewhere down the road.

Yes. We expect to have material improvement in the profitability to help offset some of that, but we've got, a lot of capital now will continue to deploy and we think this is the best way to put it to work right now is through growth in the balance sheet. And if we're fortunate enough to continue to find great opportunities beyond that then we'll assess it.

Okay. I'll step back. Thanks.

Thank you. Our next question comes from Jennifer Demba with SunTrust. Your line is now open.

Huntley, what kind of expense growth do you expect next year and how many revenue producer hires have been made year-to-date?

So we are in the process of calibrating that next year. And I do think to some extent we're in a unique position where we're pretty fortunate, a lot of people like our platform. A lot of people would love to come join us and so we can modulate our growth and that obviously has a ripple effect on expenses, not only in the producers. But then in the amount of underwriters and credit and closing and everything else, you need to support that. So that's a big. We have a variability around that will come back to folks and we sort of lay out our plans to finalize that for next year. I think that we've got, we believe we've got a lot of opportunity to continue to make great loans and to grow with the team we've got on the field right now. So I don't think you'll see us grow to the same extent that we have this year. I'm trying. I don't have the total number of producers that we've put on the team this year, but it's probably north of a dozen in less than 2000 if I had to guess.

I was going to say 15. If you just looked at the vertical and the generals would be somewhere in that area.

Okay. And Brett, what are we looking at in terms of a seasonal loan loss reserve adjustment at the beginning of next year?

I had a feeling you were going to ask about that, we aren’t planning to disclose adjustment based on CECL yet. We have been running the model in parallel with 2019. We feel really good about where we are, we're using the discounted cash flow method. Looking at all the inputs going into that there is a, one of the more material inputs that we're leaning on is forecasted levels of employment is kind of the economic variable. So a lot of work going into it. We're very pleased with our progress. As we've indicated in the prior calls and plans to adopt in January 1, 2020.

Okay. Question on credit quality, we've seen cracks from the banks here and there. Just wondering what you're seeing kind of, in terms of industry stress as you look at the Live Oak portfolio, just underneath, what we really can't see as outsiders?

We get asked that a lot. And I think appropriately. So given the geographic nationwide situation, Steve, you may want to comment on that.

So Jennifer this is Steve. So pay special attention to the industries that may be impacted in a slower growth economy. So and that's kind of where are kind of echo chips comments earlier about our servicing platform that's where it bodes us really well, our special assets group and our business analyst group servicers are best in class. So we strive to collect 100% financials from everybody and folks that don't provide us updated financials, we got, we visit them. So that gives me great confidence that our portfolio overall is risk rated really well and can react real quickly. So if you think about it, it's the industries that have discretionary spend tied to the revenues that we pay special attention to, entertainment centers that’s a very small portfolio for us. We have $40 million in total exposure but we focus on their topline revs and competition around them. If the economy starts to see a slower growth our wine craft, it's really-- the breweries that we focus on because of the changing model and then we do what we do best. We provide resources consultants and others to help them adapt to the changing economy or their change in industries. So feel pretty good. And again, we are very anemically low levels, we expect to see 75 to 100 bps as far as losses and we're well below that’s we're in a really good position right now.

Okay, last question. Your loan originations have been really good last two quarters. I'm assuming you can get, if they can stay pretty strong, given you're hiring has been good and as you said the economy is still pretty good.

Yes. Jennifer, we feel, we feel really good. We've got our pipeline strong. Look, there's a lot of competition and we're not going to chase our tails here on pricing or structure. But as we sit here right now continues to feel like we've got really good momentum to keep making great loans.

Thank you.

Thank you. I'm not showing any further questions at this time, I would now like to turn the call back over to Chip Mahan for any further remarks.

Thank you all very much for attending. We will see in 90 days.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.