Good day, ladies and gentlemen, and welcome to the Live Oak Bancshares Fourth Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Greg Seward, General Counsel from Live Oak Bancshares. Please begin.

Thank you, and good morning, everyone. Welcome to Live Oak's fourth quarter 2017 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 that we will reference on the call, please visit our website at investor.liveoakbank.com, and follow the links from there. Our fourth quarter earnings release is also available on our website. Before we get started, 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.

Greg, thanks. And, good morning, all. We're obviously excited to talk about 2017 and to talk a little bit about what's going on in 2018. First, the noise. We reported on October 1 our joint venture with First Data that $68 million onetime accounting gain is now complete. Somewhat fortuitous, we have an $8 million charge relative to our title insurance agency Reltco write-down and some merger-related expenses. And just a word on Reltco, so we often say here that our customers care about two things: Am I approved; and when am I going to get the money? We bought this agency to get them the money faster. And in 2016, we tested that company with about 100 customers. That grew to 400 customers this year. At precisely the point in time interest rates went up, the retail business softened to the tune of about 20% resulting in this write-down. But we're very confident that they will continue to get our customers the money faster. And it looks like the retail pipeline is picking up, so healthy 2018 from our view. DTL reval $19 million, about $14 million of that will be cash, mostly at the bank, some at the holding company, but certainly able to downstream to the bank to grow the business. Bullet point number two on Slide 1, strong core operating business. We had a good year, loan originations up from about $1.5 billion to about $2 billion or 26%. And just a word to the wise here, during the crash the SBA decided to allow 100% financing. And recently, beginning 1/1 of this year, they decided to revert to where they used to be, which is requiring 10% down. This will hurt some of our verticals, particularly the chicken business, the vet business and the healthcare…

Yeah, thanks Chip. Good morning. I'm going to cover the next four slides. And I think the best way to capture. These four is the Live Oak business model at work. And my simple brain can do things in sets of three, and so I would capture Slide 8, 9, and 10 in three ways. One is the sustainability of the business model; two would be the leverage that exists in the business model; and three would be the growth characteristics that are inherent to the business model; and then fourthly, I'm going to touch on deposits. But first, Slide 8 does speak to the sustainability of Live Oak's model, and I would go to the middle column and that is Live Oak 2.0 and that is our verticals that have a - that are still relatively new but are catching their momentum. And you know the growth, once we get a vertical up and running, once it catches its momentum, you see the healthy growth characteristics that are there with a year-over-year growth from $441 million to $805 million. Live Oak 3.0 is the verticals that we're really just started in 2017, and you see the early returns there are exceptional and we believe look very good for 2018 based on current pipeline. So I think that slide, if nothing else shows that is verticals mature, we're able to add new verticals and the sustainability of the model is exceptional. The next slide speaks to what I said was the leverage that exist in each of the - in our verticals that as they mature and potentially growth slows, revenue is still is being generated and generated over a relatively fixed costs base. You see the leverage has already been built in 1.0, growing in 2.0, and we'll see…

Thank you, Scott. And, Chip, I don't know if I'd characterize my motivation as being bored. But I refer you to Slide 12. 2017, as Scott mentioned, was a banner year in collecting and gathering net new deposits. The number totaled to 719 through electronic channels with no branches. We did this with four products: personal and business, CDs and savings. 2018 is going to be even a busier year. We have to take our current assets and the Live Oak Bank platform, move that to Apiture and get on to Apiture 1.0 product. In addition to Apiture 1.0, we'll be rolling out this year Finxact, our digital core banking system that will enable massive scale. In addition to that, we'll also be rolling out Payrailz, which is our payment processing platform. So it's going to be a busy year. The ultimate result will be a digital banking platform being able to service, this picture that we're looking at on Slide 12. I'd like to term this my digital banking topography picture. On the left side, you're going to see something that's much more common place, access to consumers and small businesses through channels like web and mobile. The only complexity there are new Internet of things devices such Alexa, Apple TV, chatbots, wearables. So the industry has a problem reconciling just that. However, that's not the exciting thing to us. On the right side, there is an entire new opportunity to gather deposits. We're calling this digital partner banking. And it effectively is new customer acquisition through digital partners, such as practice management providers, online lenders, robo advisors and more. The ultimate benefactor to this will be Live Oak Bank accessing sticky low-cost core deposits and the most important thing is at scale. And the example that we're about…

Thanks, Neil. We're very excited with Q4 earnings of $1.74 per share and $2.65 for the year. With several onetime events occurring in Q4 like Chip mentioned, I will at times refer to operating results compared to reported results. Operating results are reflection of our financials, excluding these onetime or non-routine transactions. A full schedule of these items is available in the GAAP to non-GAAP reconciliations at the end of our earnings release that we filed yesterday. Adjusted for onetime events, we consider our operating EPS to be $0.41 bringing the full-year to $1.25, well above the prior year was $0.57. Likewise, we view our steadily raising after-tax operating ROA as 2.6% for the quarter. Reported results benefited from both one-time gain and the effect of the new tax bill signed in late December. The exceptional gain of $68 million resulted from the formation of Apiture JV with First Data. We also reported a reduction to income tax expense of $18.9 million from the revaluation of our net deferred tax liability arising out of the recently enacted tax legislation, which resulted in a negative effective tax rate for the full year of 2017. This Q4 event also served to bolster our capital levels. There were also some offsetting one-time expenses that I'll discuss shortly. Looking to our balance sheet. The total loan portfolio grew 56% over the past four quarters to just over $2 billion. This is the product of our very successful strategy to build longer term revenue streams and reduced earnings volatility by retaining more of our lower risk guaranteed loans. We will continue the strategy in the coming year and does expect to sustain exceptional portfolio growth. Loan originations rose to $483 million in Q4 bringing the 2017 total to over $1.9 billion, nearly a 26% increase…

Brett, thanks. I think it's obvious that we're beginning to hit on all cylinders. That said, we're going to report back to you on growth of originations, because this is less of an origination story and more of a profit story. So as we reflect on 2017, we made right at $40 million pre-tax. Analyst estimates for 2018 are for us to make about $50 million pre-tax. That's a 25% increase. We're comfortable with that. Michael, we will open the floor for questions.

Thank you. [Operator Instructions] The first question is from Nick Grant of KBW. Your line is open.

Hey, good morning, guys.

Hey, Nick.

So I really appreciate the color on the tax rate that you're anticipating in 2018. But as you're avoiding kind of building too large DTA, you got to speak to, I guess, what kind of limitations you had and how large that can be? And any feel for, I don't know, capacity of what you can add in terms of tax credits?

Yeah, I think the way that we look at DTA and those types of credits internally we can manage or control that through the volume of leases that we originate. Internally, and I think we - I think we said externally in prior calls that we do not intend to build a DTA that we would foresee taking more than five years to work through that DTA, so maximum buildup of five years' worth. And just a reminder, tax credits generated from the leasing activity is that, those can be carried forward for 20 years. But we would manage that number to something less than five.

Okay, great. Thanks. And then, obviously, I mean, you guys are building a lot of capital right now. I know you guys have always kind of run with a little bit more, just kind of offensive and some additional flexibility from that. But I mean, with the TCE, where it's at now, do you guys think about capitals returned any differently. Is it an opportunity to increase venture investments or how should we be thinking about that?

Well, that's a good question. I mean, I'm looking at Underwood and he knows that we have another $15 million of cash coming back from taxes that he would be excited about investing in other members of this ecosystem. I mean, the way I look at that, Nick, is multi-dimensional. So if you think about the theory of verticality in 19 verticals, and you think about the domain experts that advise the credit guys in each of those verticals. And then you think about, of all the loans in America that are made to those industries, how much are SBA 7(a) loans? And yeah, little bit of a curve ball from the agency on what the black and white and the grey to qualify as a eligible loan for 7(a). But let's be smart about this, right? Now, that we have as you pointed out, large amounts of excess capital, can we make really smart conventional loans inside those verticals? And I don't mean like competing with Wells Fargo to make a 4.25% 25-year fixed rate loan to veterinary. No, not that at all. But I think Scott will tell you that there are multiple opportunities out there to diversify the product mix.

Sure, yeah, there are. And whether it's leveraging - and the great thing about it is we do have some subject matter experts that are not just subject matter experts in SBA, they're just subject matter experts in credit, finding ways to structure credit. And I think there are niches in conventional lending that we will be able to explore, probably more to come on subsequent calls as we go through the year in 2018.

Okay. And then, maybe like I guess a quick follow up on that, as I think of the strategy how you do that. But in terms of your process, do you think layering in conventional products, would that be going back to SBA borrowers that have kind of migrated to more bankable or would you be bringing in kind of new vertical sales teams and layering in a new product with new customers or - is there a way to think about that yet?

Yeah, so our Chief Credit Officer and former head of the Office of Capital Access of the SBA is with us today. And, Steve, I know that we've been working hard, particularly in the gov-con area on asset-based lending and doing some more conventional sort of things and other vertical. You may want to comment on those other products and how you look at that from a credit quality standpoint.

Thank you, Chip. Yes, so to Scott's point, asset-based lending is one example of subject matter expertise in a specific type of lending opportunity. So we can look at that both as opportunities within our existing verticals. Accounts receivable, financing is a good example of that. But we can also look at that as outside of our existing verticals, where we leverage the expertise and we build the expertise to provide very specific specialty financing opportunities. And then, yes, as well as we have a robust portfolio of growing businesses, that as they continue to grow we would like to continue to provide solutions for them that may be outside of SBA. So there is that opportunity as well, so I would say both in tandem.

Thanks, Steve.

Okay. And then, maybe - yeah, maybe one last follow-up and then I'll hop back on the queue. Can you speak to the amount of, I guess, your new originations are coming on now. They're non-government guaranteed and also maybe just the regular ABL loan. Is there any of that right now or to - anyway you can speak about size it would be really helpful?

There is, so gov-con or government contracting is an example of a division or a team that focuses on providing asset based lending solutions to government contractors. These are non-SBA, true monitored accounts receivable financing solutions. So that's a good example. We're seeing a good growth within that space as well.

All right, excellent. Thanks, guys.

Thank you. The next question is from Jennifer Demba of SunTrust. Your line is open.

Thank you. Good morning.

Good morning, Jennifer. First question, if you look at your Slide 8, your three buckets of vertical groups, could you just talk about the growth or declines in each of those buckets and what was driving each? So, which verticals were relatively more successful or not in 2017?

Sure, Jennifer. This is Scott. Let me just take them. I'll go left to right as you're looking at your slide. So you got Live Oak 1.0. I'll pick out a couple there, because you know originations went from a little over $1 billion to just a little under a $1 billion, so a little decline. Our vet business, which is the business we've been in the longest, yeah, that business is just - it's stable, but it's not growing and probably had a slight step-back, just because you reached a point in a market and in a specific industry where you've sort of reached your - not reached your saturation point, but you've reached an optimal level of origination there. I would say, if you just go down the healthcare businesses, the way we do it, we don't compromise credit standards and we have our own pricing and it's exceptionally competitive. And so, we see some challenge just really from a competitive standpoint there. And the checking business, which Chip referenced at the bottom, while still strong, you're really relying on how the integrators build new complexes and that ebbs and flows from year-to-year, 2017 was a little bit slower year, we believe that as we go into 2018 and 2019 there will be more of those larger complex is being brought online and that will drive more volume. So I'd say those are the three areas there that probably drove a relatively flat year. As you move across to the next column, our self-storage business is exceptionally strong. Steve commented on our government contracting business, which is new but gaining really good momentum. Strong originations in our hotel business and renewable energy, it's an interesting vertical in that it gives us an opportunity to do a little different type lending, often still government guaranteed, but guaranteed with USDA product. And the individual loan sizes they are tend to be larger, so we get good volume there. And then finally, in our newest verticals, our early education was brand-new, it's a vertical that we've gotten established in there are four or five key players in that market. We've got great recognition and traction with those key players and we think that's a growing an important vertical. We hired - our really first step at hiring team lift-outs is in our merger acquisition business. And we were able to hire a really qualified team of two individuals that are going to drive that business in the pipeline there is good. And then really the start - what is that - I'm adding up seven verticals in a year and do a - over $150 million out of the gate, I think, represents how these things can get going and gain momentum.

Okay. You said, you're looking for low-double-digit growth in originations in 2018?

Yeah. So let us get back to you on that. Brett said that, this is kind of the law of large numbers. We are going to digest this SBA rule change. So I don't want you to plug in a number on that one, Jennifer.

I would just add that, Chip. It's still early days, I mean, the SBA changes - this is January 24, 25, wherever, and the changes went into effect January 1. So we need to see how that's going to play across the broad. We also have, as Steve and you pointed out, we have new products that are coming online. And as you begin to bring new lending products, we know that there are - there is market demand, we know there are niches we can play in. But we are just beginning to scratch the surface in some of those areas. So it's a long way from here to the finish line of 2018, and much work to be done into try to put a specific number here in January is a difficult thing to do.

So my hearing that your biases, you think that your low-double-digit guidance is conservative?

No. We are not going to talk about any predictions, Jennifer.

Okay. What do you think it could be - if you think low-double-digit is not conservative, what is your worst case scenario?

We never think - again, Jennifer, I think we need to be talking more about pre-tax income and recurring revenue as opposed to historical year-over-year originations. That's where we wanted to focus in the future.

On that, expenses, Brett, you said, you're running at core run rate at about $33 million in the fourth quarter. What kind of non-interest expense growth, are we looking at this year and what are the drivers there and are there any unusual components, we should be watching for?

Yeah, I would say on non-interest expense growth, I think $33 million is core and Q4 was probably a little bit of an anomaly, I think looking back to Q3 of 2017 and Q4 of 2017 together probably would establish of better base to work from going forward. But we continue and we have plans to add new verticals in 2017. So any infrastructure we add to support that, excuse me, in 2018. So any infrastructure that we add to support that growth would certainly add to non-interest expense. And I would just point you back to looking at our metric of non-interest expense to production. And seeing how that trends, along with our historical efficiency ratios quarter-to-quarter as you trend forward.

And can you give us some more detail on your non-interest margin outlook? For the year, you said you expect some pressure.

Yeah, so you probably noticed in our earnings release, our loan to deposit ratio was 95%. We are looking to work that down a touch. We - I guess, from that, holding that extra liquidity, we do think that will put downward pressure on our net interest margin. However, as we talked about in the past, roughly two-thirds or little more than two-thirds of our own book, loan portfolio, does re-price on a quarterly basis. So as the fed makes its moves in 2018, the bulk of that loan portfolio will be re-pricing upward, so that will mitigate any NIM that has dampened by the excess liquidity that we're bringing on. And, I guess, the point in that comment was you won't necessarily see the big jumps in NIM that we've experienced over the last couple of quarters.

Okay. Thank you.

Thank you. The next question is from Aaron Deer of Sandler O'neill & Partners. Your line is open.

Hey, good morning, everyone.

Good morning, Aaron.

I'm just curious with the - have you guys given any thought to the tariff that was announced on solar tax panels, and what impact that might have on your renewable energy and solar panel leasing businesses?

Steve, help us out there.

Absolutely, Chip. So, yeah, so, as we think about a couple of points, first of all in the projects in our solar area, we're not providing the construction financing, and so there is a quite a bit of lead-time. So as we look at our pipe, all the projects that are currently in the pipe have already procured their panels. So it's really not an issue for what we have in the pipe going forward. But as we look beyond that, the panels represent about 40%, typically about 40% of the total project costs of the projects that we're financing. So if you kind of think about 40%, 30% of 40% that kind of equates to 12% increase in the project scope, which the projects that we're financing can certainly tolerate that. So it will be a little less to the developer, but certainly manageable. So we don't see it as being a big issue. Where also keep in mind that the tariffs supply to 2.5 gigawatts or above, so many of the projects fall below that as well. And then, they also just start to step down over the years of 5% increment. So again, we don't see that as impacting our forecasts going forward.

Well said, Steve.

Okay. And then, relateably, Brett can you talk a little bit about the amortization on the lease equipment tied to that and how that plays into kind of your expense guidance here?

Yeah, I think when you're thinking about expenses and income associated with those solar panel leases, the lease income that we receive will roughly offset the depreciation expense that we take. So as you're modeling that, I would say the depreciation expense that you're putting in, should be offset by any lease income that you're modeling in your other non-interest income for us.

Okay. And then another one for you, Brett, on the - given, I guess, some of the mix changes and doing more of the loans that are backed by the USDA, which I believe typically have the lower gain on sale margin. The gain on sale premiums or margins recently have just been exceptionally strong. As that mix changes, even assuming no change in kind of the secondary market, where do you see the average premium or margin on your gain on sale going through 2018?

Yeah, I think so, with the backdrop of - overall, we think that secondhand market's going to be pretty stable. As you said, it is heavily impacted by the mix of loans that we sell within any quarter. In Q4, for example, we sold very little USDA production. And the USDA that we did sell was actually originated from our hotel vertical mostly, which I think received a higher gain on sale than the structure - through renewable energy loans. But you're correct, as we layer in more renewable energy loans for sale in 2018 that will put downward pressure on the gain on sale that we're forecasting out. I would say to look at Q4 as the top-end of what you model with 2018 being less than what we experienced in Q4, as we sell more renewable energy USDA.

Okay. Good stuff. Thank you for taking my questions.

Thanks.

Thank you. And at this time, there are no further questions in the queue. I'd like to turn the call back over to Chip Mahan for closing remarks.

Thanks, everyone, for attending and we'll see you next quarter.