My last article regarding Live Oak Bancshares (NYSE:LOB) was more than a year ago, in the midst of the banking crisis triggered by the failure of SVB. At that time, no regional bank managed to perform well, but a recovery process gradually began as the BTFP was launched.
At the time I was quite perplexed about LOB’s future, which is why my rating was hold. The cost of deposits continued to rise, high interest rates inhibited loan growth, and other banks were not doing much better. A year later, the stock had a total return of about 76%, a very good performance and one that I honestly did not expect.
After the Q2 2024 release, the market reacted positively, further fueling the strong rally of the past few months. But is it still worth buying LOB or is it too late?
Highlight Q2 2024
The Q2 2024 results showed a rather different situation than I expected. Many banks are struggling to increase their loan portfolios as demand for credit has deteriorated: for LOB, this is not the case.
Live Oak Bancshares, Inc. (LOB) Q2 2024 Earnings Call
Total loans in the previous quarter were $9.22 billion, in Q2 2024 they reached $9.53 billion. If we excluded the sale of some of them, compared with the previous quarter, the growth was 7%. In particular, fully funded originations increased by $447 million, which is quite impressive.
Live Oak Bancshares, Inc. (LOB) Q2 2024 Earnings Call
Comparing loan production and the pipeline in Q4 2022 and Q2 2024 there is a clear difference in favor of the last quarterly, although we are talking about two different macroeconomic contexts.
In the first case, the bank was operating in an environment of high inflation and rising interest rates, but which had not yet peaked. In the second case, we are talking about an environment where interest rates have likely peaked, along with a potential deteriorating of the economy to defeat inflation. In short, it would seem that the second case is more unfavorable for borrowing, yet the loan production was the same and the loan pipeline increased by 41% compared to Q4 2022.
So, this is a sign that the demand for credit is solid, at least that is what is shown in LOB’s figures. At the same time, management has also managed to keep the deposit base solid:
While many banks across the industry are seeing minimal, if any, loan growth, our loan balances were up 3% linked quarter and 14% compared to the prior year and this growth is net of our loan sales and participations activity. Deposit growth is fueled by our customer deposit platform, specifically our business deposits, which are up 8% linked quarter and 29% compared to prior year. This is an outstanding story given how competitive the customer deposit market is today with many banks across the industry struggling to grow or even maintain their deposit base, especially their non-interest-bearing deposits.
CFO Walt Phifer, conference call Q2 2024.
Live Oak Bancshares, Inc. (LOB) Q2 2024 Earnings Call
As you can see from this image, the growth of loans and deposits has been fairly constant over the quarters. Moreover, loan growth has even increased over the previous two quarters although deposit growth has not kept the same pace, and this I think is an important factor to understand the implications on the loan to deposit ratio.
As of today it stands at just under 89%, so not a worrisome figure, but about a year ago, it was just under 85%. Why does management keep increasing it?
Live Oak Bancshares, Inc. (LOB) Q2 2024 Earnings Call
The answer is quite simple and relates to the difference with which the cost of deposits has risen relative to the yield on loans. The former was faster than the latter, and this generated a continuous worsening of the net spread from quarter to quarter. At this point, to prevent LOB from recording a worsening net interest income, it increased its loans more than its deposits.
To date, this strategy has worked, in fact, the net interest margin has remained stable despite the sharp increase in the cost of deposits. The problem is that the more the loan to deposit ratio increases, the less room for maneuver there is to continue to keep the net interest margin high unless the cost of deposits comes to a halt. Personally, I would not be surprised if the loan to deposit ratio goes above 90% in the next quarter.
As for the net interest margin, the target would be to reach about 3.50% by the end of the year, so about 20 basis points to go. At the moment, the most important factor in achieving this is in the refinancing of CDs.
Live Oak Bancshares, Inc. (LOB) Q2 2024 Earnings Call
The latter have been the main headwind in recent years, as their cost has reached very high levels. Suffice it to say that the average rate at the moment is 4.18%, but it is continuing to increase. In fact, the average CD renewal rate has increased by 5 basis points from the previous quarter.
CDs represent about 49% of total deposits, so they are critical to LOB. While they have been headwinds for the net interest margin in the past, starting in Q4 2024 it could become a tailwind:
So you’ll roughly be somewhere between 15% to 20% of our customers’ CD portfolio will reprice in Q3. Q4 is a large quarter as well as Q1. I think that the rate that it’s rolling off on right now would be – our current offering is about 5%, rolling off 5.20% to 5.25%, so you see a slight pick-up there. Again, that all depends on our growth and our funding needs, especially short-term CDs are one of the primary tactics that we use given the Fed uncertainty going into the second half.
CFO Walt Phifer, conference call Q2 2024.
In other words, in Q3 2024 CDs worth between $754 million and $1 billion could come due; in Q4 2024 the figure could be around $716 million. If there is probably no refinancing at lower rates in the next quarter, as early as Q4, this situation could occur if the Fed cut rates at least once. From a medium-term perspective, about 76% of total deposits will mature in 12 months, so the potential to reprice them at a lower rate is by no means negligible in terms of profitability.
Conclusion
LOB is a solid bank that has performed excellently over the past few quarters. Management is so convinced of its expectations for future growth that it increased its borrowing in the last quarter in order to have the capital needed to meet demand for loans. Specifically, in Q2 2024, LOB took out a $100 million unsecured loan, fixed rate 5.95% and a 60-month term. This is an aggressive move, but one that makes sense if management’s expectations are correct. After all, new loans originated can exceed a 9% yield.
Despite these good premises, I still do not rate LOB as a buy since the Price/ TBV per share ratio is too high as far as I am concerned.
TIKR
Comparing it with historical levels, the current level is actually not that high. However, for about two years this ratio has been way too high, and those bubble levels affect its historical average. As of today, a value of 2.08x for such a bank I find fair, so I am not willing to pay more.
Therefore, after this incredible rally, I still consider LOB a hold.
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