Live Oak Bancshares

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Live Oak Bancshares, Inc. operates as a digitally-focused, Federal Deposit Insurance Corporation (FDIC)-insured bank serving small business owners in targeted industries across the United States. Its lending activities, primarily SBA and USDA loans, drive its revenue, supplemented by some fee income.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Live Oak Bancshares operates with a unique model, specializing in lending to specific industries often underserved by larger banks. This specialization allows them to develop expertise and industry knowledge, resulting in strong relationships with borrowers.

  • Revenue Distribution: Revenue is primarily driven by net interest income (the difference between interest earned on loans and interest paid on deposits) and noninterest income, which includes gains on loan sales, service charges, and other fees.
  • Targeted Industries: Their industry specialization spans healthcare, renewable energy, agribusiness, government contracting, and other sectors where they believe they can develop superior expertise and underwriting capabilities.
  • Loan Portfolio: The company focuses on originating Small Business Administration (SBA) 7(a) loans and USDA loans, which, while offering lower interest rates, carry government guarantees.

Financial Overview

Let’s delve into a more comprehensive look at Live Oak Bancshares’ financial performance.

  • Q3 2023 Performance: The company faced a challenging third quarter in 2023, marked by a net loss of $2.5 million, or $0.04 per diluted share. This was a significant dip compared to the net income of $38.7 million reported in the same period the previous year. The results were influenced by a few key factors:
  • Net Interest Income: Decreased by $18.4 million due to higher funding costs and a lower loan yield, partly offset by growth in average earning assets.
  • Noninterest Income: Dropped by $22.6 million, primarily driven by lower gains on sales.
  • Noninterest Expense: Increased by $2.9 million, driven by factors such as FDIC insurance assessments and other operational costs.
  • Net Interest Margin: A significant indicator of profitability, this fell to 2.74% from 3.45% due to the increased costs of funds and lower loan yields.
  • Loan Originations: Loan originations were down to $641 million.
  • Loan Portfolio: Total loans decreased from 3.56 billion as of December 31, 2022 to 3.02 billion as of September 30, 2023.
  • Earnings Calls Discussion Management seems to acknowledge the need for better communication of financials to investors. They are now planning to create a simpler financial structure to better help the investors in the future.

A major part of Live Oak’s business is reselling the SBA/USDA loans. This helps it generate the capital to reinvest in more loans. It’s worth noting that the interest rate that these loans get is lower than the average, so the bank gets capital from them to reinvest. Therefore, if Live Oak starts holding more and selling less, they will likely run into liquidity/profitability issues, so the management needs to be careful about this balance.

Recent Controversies: As of late 2023, Live Oak is dealing with a class action lawsuit filed against them. The lawsuit alleges that they “violated provisions of the Securities Exchange Act of 1934.

Competitive Landscape

Live Oak Bancshares operates in a competitive industry, with community banks, regional banks, and national lenders all vying for small business clients.

  • Differentiation:
    • Industry Expertise: The bank differentiates itself through specialized knowledge of specific industries that it serves. The management claims they have more focused expertise than generalist banks.
    • Digital Platform: LOB positions itself as a tech-savvy bank with a strong digital platform to serve customers nationwide, which contrasts some traditional brick-and-mortar banks.
    • SBA/USDA Focus: Their government-guaranteed lending niche provides a relative advantage compared to conventional loan products due to lower risk and standardized processes.
  • Competition:
    • Larger National Banks: Major banks have significant resources and established customer bases.
    • Regional and Community Banks: These banks operate in specific markets and can provide personalized services.
    • Fintech Lenders: Online lenders like Kabbage or Funding Circle focus specifically on small business clients, can disrupt with innovative technologies and faster processes, and can disrupt the market.

Moat Assessment

  • Specialized Expertise (2/5): Live Oak’s niche focus in specific industries creates a level of expertise that is not easily replicated by generalist banks. This specialized skill sets them apart.
  • Government Guarantee (2/5): Focusing on government-guaranteed loans provides lower risk than traditional lending, but simultaneously limits profitability.
  • Brand Reputation (-/5): While a strong brand exists in the sectors served, LOB does not have meaningful national brand recognition.
  • Technology (-/5): Claims of technological advantages are hard to verify, so LOB doesn’t have a clear advantage from technology.

Overall Moat Rating: 2 / 5. LOB has a narrow moat due to industry specialization and SBA loan focus. However, a broad and defensible moat based on brand, scale, or network effects is lacking.

Legitimate Risks to the Moat

  • Economic Downturn: A severe economic downturn would increase loan defaults and reduce demand for loans, hurting Live Oak’s revenue and profitability.
  • Government Policy Changes: Changes or eliminations in SBA/USDA loan programs could significantly negatively affect LOB’s lending strategy.
  • Competition: Larger banks or fintech lenders could increase focus on small business lending or industry-specific lending. This creates more competition that could erode LOB’s advantage.
  • Technology Disruptions: Emerging technologies in the financial sector could reduce LOB’s technology advantage over time.

Business Resilience

Live Oak has some business resilience, though not high. Its specialisation and niche focus provide some amount of stability during good times. However, an external shock like the housing market crisis would severely negatively affect the banks, thus its business resilience is only moderate.

Understandability Assessment

Understandability Rating: 3 / 5.

Live Oak’s business model is relatively straightforward. However, certain aspects such as structured lending, niche industries, SBA / USDA lending programs, and their technology strategies add to the understanding.

Balance Sheet Health

Balance Sheet Health: 4 / 5

  • Capital Adequacy: The company has adequate capital ratios to meet regulatory requirements and absorb potential losses.
  • Asset Quality: Asset quality metrics, such as nonperforming loans, remain within reasonable levels. LOB was able to significantly reduce their past due loans ( 30-89 days past due) from 143 million to 18 million over one year. This means their assets are more safe now and more reliable than before!
  • Liquidity: The company maintains enough liquidity to meet its short-term obligations and fund its operations. LOB was able to substantially increase its cash from 200 to 350 million, indicating more capital than the previous year.
  • Leverage: LOB’s leverage metrics should be low enough in relation to their industry for there to be limited long-term risks.

Summary

Live Oak Bancshares has a niche business model that specializes in specific industries, giving it expertise that is difficult to replicate. However, recent performance is poor. It’s also worth noting that a class action lawsuit was filed recently, and it will create uncertainty for the business. It has moderate understandability and a strong balance sheet.