Executive Summary / Key Takeaways

• Live Oak Bancshares is executing a high-growth strategy focused on serving America's small businesses, leveraging specialized vertical expertise and a differentiated technology platform.
• Recent performance demonstrates strong operational momentum, with record loan originations and robust deposit growth driving significant PPNR expansion, despite near-term pressure on net income from elevated credit provisioning.
• The company is proactively managing a small business credit cycle influenced by elevated rates and inflation, increasing reserves and focusing on early identification and resolution of problem loans, while maintaining credit quality metrics well below industry averages.
• Strategic initiatives like Live Oak Express (small dollar SBA lending) and building full customer relationships (business checking) are gaining significant traction, expected to be material contributors to future growth and funding stability.
• Live Oak's ongoing investment in technology, including embedded banking capabilities and AI applications on a proprietary fintech core, provides a competitive moat and is central to its long-term strategy for efficiency, scalability, and new revenue streams.

The Live Oak Story: Building America's Small Business Bank

Live Oak Bancshares, Inc. (NYSE:LOB) was founded in 2008 with a clear mission: to provide essential capital to America's small businesses. From its inception, the company differentiated itself by focusing on specialized lending within carefully selected industries, or "verticals," leveraging government programs like the SBA 7(a) and USDA loan programs. This vertical expertise, coupled with a commitment to understanding each customer's unique business, became a foundational strength, setting Live Oak apart from traditional, generalist banks.

The company's history is marked by strategic investments and a willingness to embrace technology. Early investments in fintech companies like Finxact and Payrailz not only yielded significant financial returns but also underscored a strategic vision to be at the forefront of financial technology. The gains from these investments were reinvested back into the business, accelerating the development of Live Oak's own technology infrastructure and enhancing capabilities in critical areas like cyber security and data management. This period saw a deliberate effort to build out the necessary personnel and technology to support an accelerating pace of loan production growth.

Live Oak's overarching strategy centers on being the premier bank for small businesses, prioritizing soundness, profitability, and growth in that order. This involves not only originating high-quality loans but also deepening relationships by becoming the primary bank for its customers, particularly through the expansion of its deposit offerings.

Within the competitive landscape, Live Oak operates alongside larger regional banks like First Citizens BancShares (FCNCA), Truist Financial Corporation (TFC), and Regions Financial Corporation (RF), as well as various community banks and increasingly, fintech firms. While larger rivals like FCNCA and TFC possess greater scale and broader market presence, often achieved through acquisitions, Live Oak distinguishes itself through its specialized vertical knowledge and a technology-first approach. Its focus on niche small business segments, particularly leveraging government-guaranteed programs, provides a degree of differentiation. Compared to traditional banks, Live Oak offers greater agility and efficiency in certain processes, such as loan approvals, and its mission-driven brand resonates with its target market. However, its smaller scale relative to major regional players can result in lower overall profitability margins and makes it more susceptible to economic downturns. Fintech competitors offer speed and lower costs in specific areas like digital lending, potentially pressuring margins, but often lack the comprehensive relationship banking and specialized expertise that Live Oak provides.

Central to Live Oak's competitive positioning is its investment in and application of technology. The company is not merely a consumer of off-the-shelf banking software; it is actively building and leveraging differentiated technology. This includes developing a robust API-driven technology chassis and a world-class developer portal to support initiatives like embedded banking. This proprietary fintech core provides a significant advantage, enabling the creation of services that cannot be easily replicated on traditional banking systems, thereby creating an enormous barrier to entry for competitors in these emerging areas. The company is also exploring and implementing AI applications to streamline manual processes across the bank, from data entry to document collection, aiming to enhance efficiency and allow personnel to focus on higher-value activities like prospecting and underwriting. In its Live Oak Express small dollar SBA lending program, technology is being built to enable significantly faster processing, targeting approval times of 4-12 business days, a tangible benefit for small business borrowers seeking quick access to capital. This technological focus contributes directly to Live Oak's competitive moat, driving operational efficiency, enhancing the customer experience, and positioning the bank for scalable growth and potential new revenue streams in the evolving financial services landscape.

Operational Momentum and Financial Performance

Live Oak's strategic focus on growth and efficiency is evident in its recent financial performance. The company has demonstrated strong operational momentum, particularly in loan production. Q1 2025 saw the largest first-quarter loan production in the bank's history at $1.4 billion, a 73% increase year-over-year. This follows a record year in 2024 with $5.2 billion in originations. The loan pipeline remains healthy, signaling continued strong origination activity despite the prevailing economic uncertainty. This robust production has translated into consistent balance sheet expansion, with total loans and leases held for investment and sale reaching $11.06 billion by March 31, 2025, a 4.6% increase from year-end 2024 and a significant increase compared to prior years.

The company's deposit gathering efforts have also been successful, fueling this loan growth. Total deposits grew to $12.40 billion in Q1 2025, up 5.4% linked quarter. A key strategic focus has been on growing business deposits and acquiring full customer relationships (loan and deposit). Business checking balances have seen remarkable growth, reaching $279 million in Q1 2025, more than four times the level of just one year prior. The percentage of customers holding both a loan and a deposit account has doubled year-over-year, contributing to a stickier deposit base with a lower blended cost of funds compared to the bank's overall funding cost.

Net interest income has benefited from the expanding balance sheet, increasing to $100.5 million in Q1 2025, up 12% from Q1 2024. However, the net interest margin compressed slightly to 3.20% in Q1 2025 from 3.33% in the prior year quarter. This compression reflects the dynamics of the current rate environment, where the cost of funds has increased, although the pace of increase has slowed. New loan production continues to come on at yields (averaging around 8.14% in Q1 2025) that are accretive to the overall portfolio yield (7.30%). The company anticipates tailwinds from its CD portfolio as maturing, higher-rate CDs are replaced by lower-rate offerings (approximately 84 basis points lower in Q1 2025). As an asset-sensitive bank, the timing of potential future Fed rate cuts will influence the NIM trajectory, with loans repricing faster than deposits initially, but deposits expected to catch up and drive NIM expansion over time.

Noninterest income, while decreasing slightly overall in Q1 2025 compared to Q1 2024 ($25.6 million vs $26.1 million), saw strong performance in net gains on sales of loans, which increased 62.1% year-over-year to $18.6 million, driven by higher loan sale volume and stable premiums. Loan servicing revenue also grew. The decrease in total noninterest income was primarily due to lower gains from fintech investments and other miscellaneous income compared to a strong Q1 2024 that included a gain from equity warrant assets.

Operating expenses increased by 8.1% year-over-year in Q1 2025, primarily due to annual salary adjustments and growth-driven variable costs. However, management remains focused on expense discipline and achieving positive operating leverage, noting that core PPNR grew 27% year-over-year in Q1 2025, outpacing expense growth. Management also highlighted that operating earnings, excluding non-routine items, increased 27% year-over-year for the 12 months ending Q2 2024, demonstrating the underlying profitability trend.

Credit Quality and Risk Management

While operational performance has been strong, Live Oak's net income in Q1 2025 ($9.7 million) saw a significant decrease compared to Q1 2024 ($27.6 million), primarily due to an elevated provision for credit losses. The provision for credit losses increased by $12.6 million, or 77%, to $29.0 million in Q1 2025. This elevated provisioning reflects both the significant loan growth experienced by the bank, which requires day-one provisioning under CECL, and the impact of a small business credit cycle that began in the latter half of 2024. Elevated interest rates and inflationary pressures have placed financial strain on some small business borrowers, leading to an increase in nonperforming assets and classified loans.

Total nonperforming assets (excluding loans measured at fair value) increased to $425.0 million at March 31, 2025, up 38.8% from year-end 2024. The unguaranteed portion of nonperforming loans also increased, reaching $100.3 million. Criticized and classified loans totaled $1.14 billion, an increase from $1.04 billion at year-end 2024, with the increase primarily driven by small business borrowers affected by challenging economic conditions. Key verticals contributing to this increase include General Lending, Senior Housing, Bioenergy, and Healthcare.

Management emphasizes a proactive approach to credit risk management. They are actively identifying impairments and reserving for them ahead of charge-offs. While net charge-offs increased in Q1 2025 compared to Q1 2024, management notes that the bulk of these charge-offs had generally been reserved for in prior periods. They highlight positive signs such as low past dues in Q1 2025 ($10 million, or ~9 basis points) and a slowing rate of increase in non-accruing and classified loans compared to the second half of 2024, indicating no substantial deterioration or widespread downgrade migration within the quarter.

Live Oak's credit quality metrics, particularly default rates and charge-offs relative to the broader SBA industry, remain notably better than peers, a testament to its disciplined underwriting, vertical expertise, and extensive servicing and watch list processes. Management believes its reserve levels ($190.2 million ACL at March 31, 2025, or 1.83% of HFI loans) are healthy and well-positioned.

The company also disclosed a material weakness in its internal control over financial reporting related to the loan review process in its 2024 10-K, citing insufficient oversight, inadequate training, and a lack of effective risk assessment/monitoring. Remediation efforts are ongoing, including enhancing the independent loan review function, increasing reporting to the Risk Committee, and improving internal control training.

Other risks include potential adverse impacts from changes in U.S. trade policies, such as tariffs, which could affect small business borrowers.

Strategic Initiatives and Future Outlook

Live Oak is actively pursuing several strategic initiatives designed to drive future growth and enhance its competitive position. A key focus is the Live Oak Express program, dedicated to originating small dollar SBA 7(a) loans (primarily $500k and below). This initiative is ramping up quickly, with production reaching $125 million in 2024 and management targeting $0.5 billion to $1 billion in annual production over the next couple of years. This growth is expected to be significantly accelerated by the build-out of a new technology platform designed for efficiency and automation, leveraging AI. Management views recent SBA rule changes rolling back some prior administration policies (like reinstating small dollar borrower fees and collateral requirements) as potentially providing a competitive advantage due to Live Oak's existing full underwriting process and technological capabilities.

Another critical initiative is building full relationships with customers by increasing business checking accounts. This effort has seen rapid success, significantly boosting noninterest-bearing deposits and deepening customer ties. This strategy is expected to enhance funding stability and provide valuable real-time insight into borrower cash flows.

The company continues to invest in its embedded banking capabilities, building out its technology chassis and API platform. Having launched its first partnership with Anatomy Financial in the healthcare sector, Live Oak expects to add a second partnership in 2024. This initiative is viewed as a long-term "moonshot" effort leveraging the bank's proprietary fintech core to drive future deposit, loan, and payments growth, creating a significant competitive moat.

Management's outlook reflects confidence in the bank's growth trajectory. They expect PPNR to continue its upward trend after a typical Q4-to-Q1 step down. While acknowledging the difficulty of precise forward guidance in the current environment, they maintain an aspiration for net interest margin to trend "up into the right," targeting the 3.50%+ range sometime in 2025, dependent on the pace of Fed rate cuts and deposit market dynamics. Loan on balance sheet growth is expected to remain in the low double-digit range for the year, with potential upside based on second-half performance. The company is actively hiring revenue-generating talent, including lenders and deposit specialists, to support this growth, particularly targeting opportunities in its local market.

Conclusion

Live Oak Bancshares is a growth-oriented bank executing a differentiated strategy centered on serving the specialized needs of America's small businesses. Its core strengths lie in its deep vertical expertise, a proactive approach to credit risk management, and a strategic commitment to leveraging technology to drive efficiency and innovation. While the bank is currently navigating a small business credit cycle exacerbated by macroeconomic pressures, leading to elevated provisioning and impacting near-term profitability, management's focus on early identification, robust reserves, and disciplined processes provides a foundation of soundness.

The bank's operational momentum remains strong, evidenced by record loan originations and successful deposit gathering efforts, particularly in building valuable business checking relationships. Key strategic initiatives like Live Oak Express and embedded banking, underpinned by ongoing investment in a proprietary fintech platform, are poised to contribute significantly to future growth, efficiency, and competitive differentiation. Despite the challenges presented by the current credit environment and macroeconomic uncertainty, Live Oak's clear strategy, operational execution, and technological vision position it to continue its growth trajectory and enhance its value proposition for both customers and investors over the long term.