Live Oak Bancshares, Inc. (LOB) Q3 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Quarter 3 2020 Live Oak Bancshares, Inc. Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Greg Seward, General Counsel. Thank you. Please go ahead.

Thank you, and good morning, everyone. Welcome to Live Oak's Third Quarter 2020 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, 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 a reconciliation of those measures to GAAP measures, can also be found in our SEC filings and in the presentation materials and commentary. I will now turn the call over to Chip Mahan, our Chairman and Chief Executive Officer.

Thanks, Greg. Good morning, all. Slide 3. We are extremely excited about talking about the best quarter in our company's history. We acknowledge, as Chris Donat from Sandler Piper noted in his report this morning, that Live Oak is a complicated story. And we're going to attempt to unpack that for you now. Headlines. We're hitting on all cylinders. Margins up, originations all-time high, loan sale prices at or near all-time highs, fintech investments raising money at frothy valuations, even got a break on the servicing asset [indiscernible] and with all this production, Huntley was able to keep expenses in check. What could possibly go wrong? Everyone knows that small business in America, the 28 million small businesses in America, create 66% of the new jobs, and they're struggling. Many of you that hold bank stocks are worried about the small business portfolio. The object of this exercise today is we want to create the most transparent bank in the United States relative to showing you the quality of our loan portfolio and the capital that stands behind it. So let's get going. Next slide. You've seen this one before. Capital at the end of the quarter, $532 million, fair mark and loan loss reserve allowance for credit losses, it is these days of $62 million gets you to about a 26% capital ratio adjusted compared to $2.3 billion of unguaranteed paper. I'm happy to report that our guaranteed loan portfolio grew from about $1.1 billion to about $1.7 billion. And with this frothy secondary market, that is worth about $155 million pretax, to put another arrow in our quiver. I guess the third thing I'd like to show you on this slide is the past dues, like, they're not any. This had to do with the SBA subsidy in the spring, where the federal government said they were going to make P&I payments for 6 months to every SBA borrower. And then they also said that if you borrow money on or before September 25, we're going to help you out for 6 months P&I as well, which is, in some part, the reason for our frothy increase in loan originations. Lastly, I would like to point out what we call the examiner's ratio. In the last crisis, federal banking examiners look very closely at classified assets to capital and reserves. And today, that number for us is a little over 9%. They get a wee bit fussy around 30%. So you see we have a very long runway there. So moving on to the next slide. As you know, we have 45, 22 to 30-year old [indiscernible] collect financial statements. Attempt to collect financial statements every quarter. That number as of today is 65% interim and 86% for annual financial statements. Most banks don't that, but we do. And Steve Smith, who will probably help out later in this call, asked every one of our folks that are in touch with these customers literally every day, to call every one of them and put them in one of these categories, high, medium and low, in terms of stress. So what you see on the left is a 5.5 stress level on the whole portfolio. And then we created what we affectionately call the COVID-6, that would be the pie chart on the right. That would be our more stressful verticals, hotels, early education, family entertainment, wine and craft beverage, fitness centers and quick service restaurants. And again, the point is here, we know our customer. Moving on to the next slide, Loan Portfolio Characteristics. So what we try to do here is break out for you in an open fashion, a transparent fashion, our top 5 or big 5 verticals, that would be mainly chickens, health care is mainly dentist, veterinarian, self-storage and our general lending group, more to come on them in a minute. So compare that to the COVID-6. And I would say, effectively, the COVID-5, quick service restaurants, are doing quite well these days. And really, this is kind of case by case, right? So if you're running anything, whether it's a fitness center or a quick service restaurant in Los Angeles, trouble, New York, trouble, Michigan, trouble. It's almost state-by-state, governor by governor, mayor by mayor. So moving on to the next slide. We wanted to give you more transparency relative to our credit reserves and fair value mark on big 5 and COVID-6. And there's also data here on deferrals and those that receive the SBA subsidy. The point here is that this type of data will be published each quarter. And we just don't know what we don't know, is the short of this. So for small business America, will we get more federal funding? How fast will the federal government give us the ability to forgive the $45 million in earnings we have hung up in the PPP product. Will the SBA come back and make P&I payments for our borrowers? Will the SBA do what they did in the last crisis and potentially increase the 7(a) product from $5 million into $10 million accompanied with a 90% guarantee? We just don't know. But we are going to manage this bank as if nothing happens. As always, we're going to take care of our customers. We understand if they have the eye of the tiger and they want to fight. And then some unfortunate situations, we're going to have to have tough conversations. There will be more losses. So continuing on with the credit analysis, let's look at our hotel portfolio: 39 properties, about $130 million of exposure to date, 59% occupancy. The average daily room rate in our portfolio is $116 with revenue per available room of about $74. In the minutia on the right, you can see our top 10 exposures as of today and more importantly, see the products, the SBA 504 is prominent here along with some USDA paper. And importantly, the loan-to-value ratios you see on the right. Now let me walk you through what we did in the quarter. We had about $190 million in exposure. We put $81 million of these loans up for sale. We actually sold $55 million face amount of the note at a $5.2 million loss. We kept 5 that we didn't want to sell at those prices, and we wrote them down to the prices that we received. So the $5.2 million and the $4.7 million gets you to what Brett told you last night's right of a $9.8 million charge off. And again, the theme here is we're going to give you this much data quarter-to-quarter on this portfolio, and anything else that gets in trouble as we move forward through this crisis. Next slide. We've shown this in the past. We want to continue to highlight our geographic diversity and lack of concentration risk. And obviously, where the population is, is where we have the most exposure. You could probably take North Carolina out of that, California, Texas, Florida, New York, largest states in the United States and $212 million in exposure in our home state of North Carolina. Moving on to originations and soon profits. As you can see, take the PPP out of it, we typically do about $500 million in originations per quarter. And this time, we did almost $1 billion, and you see the granularity of that in the box up top, 7(a) was $639 million. And so the real question is, which we're not going to disclose, which is what is after this? And I will tell you that after the $1 billion in originations, our pipeline is at an all-time high. Next slide. Again, geographic diversification and lack of concentration in the $1 billion we put on the books this quarter, a little bit smaller loans this time, 46 states, $790,000 worth of exposure of unguaranteed paper. Moving on to the next slide, and this has been fun. So how did all of this happen, right? $966 million for the quarter. Clearly, the SBA subsidy had something to do with this. My guess is, Steve, 40% to 33% would probably be from the subsidy, and the rest would be from hard work and really kicking in this time where our general lenders and sponsor finance people. And certainly, the PPP basket had a lot to do with this. We did almost 12,000 PPP loans totaling $1.8 billion, and that gave us many more looks than we would have had. Moving on to the next slide. Here's a little more discussion of our general lenders and our sponsor group, right? So we built this bank until about three years ago on the theory of verticality, hire a domain expert, have that domain expert sit down with Steve and his credit guys, create a credit box, tell the sales guys go get that, because we rather think that our customers care about two things: Have I approved and when are you going to give me the money? So evidence and [indiscernible] and all that workflow that allows that to happen to treat every customer like the only customer in the bank. And then we stepped outside of that and said, well, the former #1 SBA lender in the country had a lot of folks that were unhappy. And as you can see from the map on the right, we have hired a total of 19 lenders from Los Angeles to Austin, Texas, Miami, Florida to Boston, and you see these folks all over the country, making loans this quarter in 17 separate industries, totaling some $228 million. And if you go to the next slide, we are continually proud of maintaining our number one position as the top SBA lender in the country. And you can make a case that we're pulling away from the pack this year. And if, in fact, our general lenders and sponsor group, again, outside the theory of verticality, were on their own, they would be top 10 in and of themselves. Worthy of note is the tiny little note at the bottom about 7(a) program gross loan approvals per quarter, jumping to almost $8 billion. Maybe, just maybe, this will get the attention of the folks in Washington. And maybe, just maybe, we'll get a little more help as we get through this crisis from them. So my last slide is on profits and Huntley's going to really jump into before I turn it over to Neil to talk about our finance fintech investments. But we're finally here. Take this second quarter out, had a lot of noise there. We're bopping along at $17 million of pretax pre-provision in earnings, and now we're at $24 million. So finally, all those investments are kicking in. Those investments in the general lenders that I just discussed because it's just not those folks, the architect of the deal behind them, there are underwriters, closers, servicers. So all of the investments that we've made, all the money that we spent to get to this point are finally beginning to translate to the profit line. So let your mind wander on post COVID. What is the provision going to be with all the arrows we have in our quiver? What is the tax rate going to be when we manage that in the past with our leasing income to somewhere in the mid-teens? And I think you're going to see that we're going to get to some of the things that Huntley puts in every slide at the end of the day of what is the ultimate object of the exercise. So Neil, why don't you jump in and talk about investments, and let Huntley take us home?

Sounds good. We have a couple of slides on some of the fintech investments, both in the context of Live Oak Ventures and Canopy. Chip, you've mentioned the right place, right time, right model, I'd probably add right tech to that. We are finally live with the deposits platform after 5 years in the shop. And this is really exciting because it's the new tech stack aperture of the next-gen onboarding system, Finxact, as a next-gen core, all validated, API first. Huntley is going to talk more about this, but a shout out to [indiscernible] as you've been more than patient on this particular topic. Relative to Live Oak Ventures, look, we've been really excited to get some write-ups based upon some of the recent valuations. This should be seen as precious non-dilutive Tier 1 capital to the bank. When Live Oak Bank decides to upstream into the holding company and then downstream into the bank, there are some significant advantages there. The most notable this quarter, obviously, is Greenlight, where we took a $13.7 million mark to the good. If you recall, we invested $3 million in 2018 in the Series A and $2 million in 2019 in the B. And Greenlight continues to perform at record levels. As you know, these are debit cards for kids, but it's a mission-based theme, where it's really helping families with financial literacy. On to Canapi, as you guys know, Canapi is the successor of Live Oak Ventures, and it really allows us to invest at scale. I mean, given it's a $600 million fintech fund powered by banks as limited partners. We've been super busy in quarter 3 as well. And as you all know, it's a highly competitive market and evaluations are frothy. Even still, we won 3 deals against the best names in Silicon Valley. We led or co-led Alloy, Blend and Greenlight. And we go further into these at later part, just go to our website to understand these technologies. But suffice to say, these are led by the industry's best, all bringing next-gen fintech capability to banks. And as important as the financial upside, a lot of those bank can now use these assets and be first up with the latest in fintech technology. Moving on to the next slide. This shows 6 Live Oak Ventures' companies. And as you can see, on the $18.6 million invested, the current carrying value on our books is $90 million. We feel this is conservative given the accountants and their view of how this has to sit on our books. If you actually just did the math and looked at the valuations of these companies, the most recent valuations in our ownership, I believe it's closer to about $150 million in value. We feel this is good progress, but given the growth rates of each of these companies, we do expect these numbers to grow over time. And again, just provide a precious Tier 1 non-dilutive capital to the bank, while giving us access to the latest in fintech advancements. So Huntley, over to you.

Great. Thanks, Neil. We'll turn to Page 19. To say it's been a challenging year for everybody would be a massive understatement, and especially for small business owners. In the face of everything that was going on this year, Live Oaks, roughly 600 people accomplished some pretty amazing things in the third quarter, just like we did in the second quarter when the PPP program was live. Our focus throughout the year has been constant, that of our customers, our employees, the communities that we're in and then supporting small businesses with our personal service, our capital and our technology. While we've all been affected by events of this year, we're exceptionally proud of how the dedication of our people, the commitment to our industries and our brand have resonated across small businesses. Hopefully, we've all gotten a chance to review our earnings release. And Brett, CFO, highlights, and as Chip said, it's a really strong quarter financially across the board. On pages 20 and 21, we'll try to unpack some of the headline numbers and all of these are adjusted for PPP, both the loans and the excess liquidity to give a bit more view into the core. We'll run through these relatively quickly and then get into some more details on subsequent slides. So as Chip said, our loan portfolio grew $600 million in the quarter, driven by our origination as well as slower prepayment speeds across the portfolio. Total assets were relatively flat as we were able to redeploy a substantial amount of the excess liquidity we stockpiled earlier this year. We enjoyed a really strong capital build, driven by our core earnings plus the fintech activities and as the PPP earnings flow into capital as well with our capital ratios, as you can see there, increasing across the board. Page 21, on the earnings side, core earnings were driven by NII growth as we replace that excess liquidity with loans, and our deposit or pricing went down. Loan yields remained strong at just under 5.5% across the portfolio, and our margin recovered nicely after the Q2 impact of the rate cuts. Gain on sale benefited from a stronger market. Secondary market allowing us to sell less loans and still generate the higher gains. And we're back on track for our targeted 65% hold of the SBA loans become available despite increased sale activity at the beginning of the year. And as Chip mentioned, it's a great story on the expense side as well. With travel curtails, we found creative ways to engage with our customers and partners and dramatically increased our productivity. All that led to a core pretax, pre-provision profitability of $24 million, and we'll go through that in a little more detail here in a little bit. So let's spend a minute on the PPP, Page 22. As folks know, a little over $1.7 billion of origination. And you count that with the excess liquidity that we stockpiled, had a balance sheet impact at the end of the second quarter of $2.6 billion. Then that's come down a bit as we deployed the excess liquidity, but still over $2 billion of impact on our balance sheet. From an income perspective, we recognized $13.6 million of income from both the deferred fees and interest income, offset by a bit of negative carry on excess liquidity. So about $13 million of net impact in the income statement as well. As Chip mentioned, we booked a total of about $60 million of those deferred fees. They're still about $43 million remaining on the balance sheet as of September 30, that will come through with forgiveness. And as it relates to forgiveness, we're off to a solid start. We've got about 1,500 of those 11,000 loans that are in-flight, that are in the process of being forgiven. And our friends at Encino have been helpful building out the portal. And we've actually used that as an opportunity to advance the ball on some other customer-facing technology initiatives. We expect we'll start to see some forgiveness come through in the fourth quarter, but the bulk of it will still probably be the first half of next year. And as Chip mentioned, there's still significant funding available in that program that was unused over $130 billion. And so we think that we could see additional funds released in some form to the benefit of our customers, but predicting things in D.C. is pretty tricky right now. So we'll wait and see. Turning to Page 23, a lot to impact here. This is really all the adjustments that we've made to get to that core number of $24 million that we mentioned. So we'll just run through it. For starters, if you looked at the top 2 rows, the stated pretax earnings up considerably with a headline number of $45 million. You add the provision to that, which is $10 million, which was largely driven by our origination growth and the sale of the hotel loans that Chip mentioned, that gets you to about $56 million of pretax, pre-provision earnings. But there's still a lot of noise in there, so let's go through those. And most of them broke our way this quarter, right? So the beginning of the year, we faced some headwinds around valuations and mark-to-market. You can see those that effectively reversed or got some of those back. So we take those out. We had $1 million of an expense for the pending sale of an aircraft. Neil touched on the $13-plus million of fintech gains. And then you've got the $13 million of PPP activity that we mentioned as well. So all of that drops to about $23.7 million, $23.8 million of core pretax pre provision earnings, which is up 40% from this time last year. And that's the result of a ton of hard work, and the commitment we made a couple of years ago to strengthen our balance sheet and driving that sustainable profitability. And when you couple that with the growth that we still believe we have, we think, is pretty unique. So turn to Page 2, the franchise fundamental, chip covered a lot of this ground already, so I won't repeat it, but a couple of things to note. And the first is operating leverage. If you look at those two lines on the top of the page, net interest income increasing by 25% in the quarter and noninterest expense decreasing by 11% in the quarter, obviously, massive operating leverage. Even if you adjust for the PPP impact and for the Q2 special bonus related to PPP, there's still a roughly 17% increase in NII and flat expenses. So continuing to drive that operating leverage. And the second thing to note, as Chip mentioned, the increase in our guaranteed loan portfolio to $1.7 billion from $1.1 billion last quarter and over doubled over the course of the year. That's a great driver of low-risk earnings, but also a really nice source of contingent capital. And you add that to the unrealized gains in the fintech portfolio that Neil talked about, then we like having those levers from a capital perspective in an uncertain time. So originations, I think Chip hit this pretty well. So I'll just add 1 or 2 comments. How did we accomplish this level of origination in the course of a quarter? And I think importantly, we did that without sacrificing any of our credit standards, any of our closing processes, any of the ways we do business. So we feel really good that we didn't cut any corners across the board. Then in some cases, we tightened our credit standards. You look across our credit scores, of our borrowers, the equity injection, debt service coverage ratios, they're consistent with or tracking above the balance of the portfolio. So we feel really good about the quality of the portfolio. You can see on the top of the page, the originations skewing towards these newer verticals. A lot of this, as Chip said, our business is coming online that we've invested in, whether that's generalists, whether that's some of the bioenergy community facilities, things that are coming online here over the last couple of years that are really hitting on all cylinders. And then the final comment is the at-risk verticals and the origination there. And as you can see, in the entertainment centers and hotels, we all but stopped origination there, put a little bit of capital back into some of our customers to help support them. But in these other verticals, we're actually seeing some pretty interesting opportunities as a lot of competition has fallen away. We're seeing stronger customers, some really interesting opportunities. So we'll continue to be selective in those spaces as well. Chip mentioned the SBA subsidy, which clearly supported our customers and drove some of the activity in the third quarter. And that applied to all the fully funded 7(a) loans that closed prior to September 25. It's worth noting that the SBA 7(a) program is really designed for times like these to support lending to small businesses during periods of uncertainty. And we've been working at it for over a decade to be the best SBA lender we can be, and I think it really paid off and then showed in this quarter. We're also fortunate we don't have some of the issues that other banks are dealing with, like income-producing CRE, retail or office spaces and energy. So I think that helps support that lack of competition that we've seen there as well. We just kept singularly focused on small businesses and avoided distractions. And if you flip to loan sales, we touched on this already as well. Flowing prepayments speeds, increased liquidity in the capital markets drove spreads significantly higher in the secondary market in both SBA and USDA products, we're seeing gains at or near all-time highs. And we really like the market dynamics, but we also really like the assets that we're originating. So we elected to sell incrementally less this quarter than we had earlier in the year, where we really were kind of stockpiling liquidity in the face of all the uncertainty at the beginning of the year. And so we were kind of back in line with our long-term targets in terms of hold. We've deployed a fair amount of that excess liquidity that we had, too. So we like where we are. I think we'll continue on track from a target perspective in terms of our hold versus sales that we've indicated. Turning to expenses. Chip mentioned a really, really solid story there. And that's pretty remarkable, given all the franchise growth that we've seen. Last quarter, there was a $7 million bonus accrual and a bit of additional deferred origination expenses. So when you net that out, core expenses are down a little bit quarter-over-quarter. Travel and entertainment expenses are obviously way down, and we had a bump up in FDIC assessment that sort of offset each other. So we recognize that the pace that we've been running this year is unsustainable. We've driven folks really, really hard. And in Q2, we tackled the once in a lifetime opportunity to serve our customers with PPP loans. And then right after that expired, we were looking at a record pipeline and a bunch of loan activity in the third quarter as well. So we've done this with flat headcount, and our folks just delivered, right? And so we're going to add a little bit to the team to help load balance a bit as we see continued opportunity and continued pipelines. And if travel starts to come back a little bit, we may see expenses creep back up a bit. But we're really excited about how efficiently we've been operating, and we'll stay disciplined on that front as well. So turning to deposits, and this might be the unsung hero of our model right now, which is our direct deposit platform. So 50,000 customers, $4 billion in retail deposits and the efficiency of this portfolio in a 0-interest-rate environment, it's pretty remarkable, right? We pay 60 basis points on new CD, 70 basis points on customer savings. And those numbers are down, deposit costs down 25 basis points in the quarter, savings rate down 100 basis this year, CD rate down 150 basis points this year and all of that being operated with 6 basis points of allocated expenses. So from an earnings perspective, we've got the CD portfolio that's continued to run off, and that will reprice -- we'll talk about it in a second, but close to $3 billion in the next 12 months. But a really, really impressive operation, funding in this environment. I think it's hard to see even a branch-based checking account portfolio with a lower fully loaded cost than that. We still remain really committed to our technical strategy. We're really excited about all the things we're doing there. We'll drive deeper customer relationships, we'll capture transaction flows, we'll be able to better provide liquidity to our customers. But this funding model right now in this environment is incredibly efficient and incredibly attractive. Let's turn and stay on deposits for a minute. So almost $3 billion of retail CDs and broker CDs that will reprice in the next 12 months, that will, at today's rates of savings and CDs, drop another $30 million of net interest expense to the bottom line, apologies. So $30 million of pretax earnings on an annualized basis, that's 40 to 50 basis points of NIM just on the runoff of that stuff. So again, really excited about the deposit portfolio we have and how we're managing that over the course of the next 12 months. That will be a nice tailwind. So looking at NIM, obviously, a big drop in the second quarter with interest rates dropping 100 basis points and our floating rate loan book. So we were down on a core basis, close to 50 basis points. And then you have the PPP and the excess liquidity, but core margin down close to 50 basis points. We've got almost half of that back in one quarter. And with the deposit savings that we talked about, you should continue to see solid tailwinds on that. On the right-hand side, you can see liquidity, which obviously elevated in the course of the second quarter. From an average basis, it's still up, but we've done a really good job of redeploying that liquidity. We took 10 percentage points down on a spot basis over the course of the quarter, and we'll continue to redeploy that as we go forward. So turning to capital and liquidity. In an uncertain time, it feels pretty good to have over half your balance sheet guaranteed by the U.S. government and in cash. You add to that the 13% CET1 ratio, excess liquidity, continued capital sources, and we feel really, really solid about where our balance sheet is, which also gives us confidence to continue to provide capital to small businesses, which is sort of our mission every day. So feel really good about where the balance sheet is positioned as we sit here right now. And again, Chip mentioned this, but our portfolio is really diversified, not just across government and government programs, across all of these industries as well. It's granular. A lot of small loans. We're working really hard to stay in touch with all of them and know where they all stand. But we like the diversification across that. And then finally, on capital. Tier 1 leverage, which obviously took a big step down in the second quarter with PPP and the excess liquidity. We got a lot of that PPP back if all those loans pledged to the PPPLF, and so that was a big jump act. We still are sitting on a bunch of excess liquidity, but over 50 basis points recovery on that Tier 1 leverage. So we're around that 8.50 number that we feel pretty good about. So all right, let's go and look at the slide we show every quarter, these high-performing bank metrics and sort of what we see as these targets. And yes, as Chip mentioned, there is some onetime stuff in there, PPP and fintech, et cetera. But on a core basis, we're a $6 billion asset bank and moving up pretty quickly in that regard. Core NIM is over 3.25 and making its way North. Fee income side feels really good. Efficiency expenses feel really good, and the capital is kind of right in line. So all these things with our continued growth, we feel really good that we're going to track to deliver all of this. A final note before we open up for questions, on the new deposit platform, Neil touched on this. We went live at the end of September with business savings and CDs on the new stack, the new core in production. We got almost 200 customers and over $10 million in account balances already. That's with no marketing, basically. And that provides us the ability to seamlessly open a business account online, which is actually pretty rare. And it's got a great mobile app and all these features, but that's really just a start. With our partners at Apiture and Finxact and others, our road map has new product design, enhanced customer experience, integrations with software companies. And that's what we're really playing for and what we believe will truly improve the lives of the small business owners that we serve. And then on the checking account front, we are currently live with our first debit card. They're in production. They're working, and we'll be expanding that pilot group over the next few weeks. Given the strength of our existing deposits and our liquidity base, we can afford to take our time with the rollout to make sure we get it right. And I think you'll see a broad market launch to small businesses as well as the conversion of our existing consumer deposit schedule for early in the new year. And we just remain incredibly excited about everything that we can accomplish in addition to what we're currently delivering with the core business. So with that, why don't we turn it over to questions?

[Operator Instructions]. First question comes from the line of Jennifer Demba.

Congratulations on a good quarter and congrats on the deposit platform. You gave a lot of good information in those slides and in your commentary. I want to start with the hotel loan sale, what brought you to do that? And will there be more sales in future periods?

Yes. Steve Smits, our Chief Credit Officer is here, and I think you can describe it best, Steve. Give that a shot.

Yes. So Jennifer, this is Steve Smits. I'll start, and certainly, Chip, you can add some additional thoughts from your perspective. To start with, clearly one of our most impacted industries. Chip talked about the COVID-6. And for us, really, it's the COVID-5. If we look at our portfolio, hotels being at the top. And really, we had to look at it as not necessarily that we were expecting to take an immediate loss. However, the administrative burden to work these loans through to the other side is a consideration that we thought about. There were certainly many of them very highly likely to go to nonaccrual before they got better. That would be an impact. And the need for us to hire additional special assets personnel to focus on this portfolio was a reality, possible dealing with litigations and bankruptcies and other things. So it was a multiyear administrative burden that we had to pair that against just taking some risk off the table so that we could focus on the rest of the portfolio. And that really was a driver in the decision, is really looking at the long-term burden to get them through to the other side and the cost to do that. And we were in a fortunate position where it made sense that we could take that off so we could focus on the rest of the portfolio.

Yes, I think that's right. I think it's offense and defense, Jennifer. I mean, we have so many arrows in our capital quiver that just to sit here and slug it out for three years with those $55 million worth of loan. There's no doubt we would have gotten that money back, but better focus on offense and defense and having we -- just because we could, we had the ability to do so. And we will do that again in the future, if necessary.

I also think that the secondary market was incredibly strong. And I think we were pleasantly surprised with the levels that we were seeing on these properties and that factored into it as well. But I think we're not actively out marketing a bunch of other assets in the portfolio, but we'll be opportunistic to manage risk, as Steve said.

Very helpful. Chip, I know we -- no one here really knows what's going to happen. But do you have any guess as what your net charge-off levels could look like over the next 2 to 4 quarters based on the level of economic activity we see today?

So I'll turn that on you Jennifer. If you can tell me exactly what's going to happen in Washington, D.C. relative to what they're talking about now to help small business then we can probably tell you that. But the answer is we just don't know. I mean, I would say that are we reasonably confident that something is around the corner for Small Business America, particularly those that have been affected, have 0 revenues in some cases. I mean, I think there's probably more help on the way there. But as I said in one slide earlier, we're going to operate this bank as if there's going to be nothing else, and they will make those decisions at the time. But I just don't have a clue.

Okay. One more question, expenses. Huntley, you said probably need more staff. So what kind of expense trends should we see over the next 2 or 3 quarters? Are there full expenses coming up in terms of accruals or whatever?

Yes. And I can turn this over to Brett for some details. But on the people front, it's really -- we're seeing more loan activity than I think we ever could have anticipated at this time. And so you think about loan closures and underwriters, things like that, that's really where we're seeing the need for some additional people. So that will have a modest impact on the total number. But I don't think there's anything major accruals up or down that we're expecting on the expense side. And so I think it will creep up modestly over the next couple of quarters, but we're going to fight hard to keep it pretty flat if we can. Brett, anything you want to add to that?

Maybe the only thing I would add is, I think you've seen us -- and we've communicated or shown in actuals in the past when we take on various initiatives such as SBA general lending and nonuser expenses that have a future payoff. And this quarter, specifically, using that same example, I can see through the loan originations by the FDA generalists, how that initial investment paid off. So maybe to Huntley's point on adding NIE for staffing, et cetera. As we see opportunity, I think one great thing we've done is invested in those, and it does have future returns. So there could be modest increases there, quarterly.

The next question comes from the line of Chris Donat from Piper Sandler.

I had nothing to say, but I really do. Anyway, looking at Slide 10 and the originations, as we think going forward, and I realize it's kind of like the net charge-off question of if we can tell you what's going on in Washington, then maybe you could tell us what's going on with originations. But if I think about scenarios where nothing happens, should we expect originations to be sort of like what they were pre pandemic? Or do you now have with the deposit platform and the liquidity on your balance sheet and the -- assuming the secondary markets where it is, an opportunity to really be meaningfully above where you were with originations pre pandemic?

Yes. As I said a minute earlier, Chris, our pipeline is at an all-time high, right? Trying to be somewhat conservative. Do we have the players on the field today that could originate on an ongoing basis, $2.5 billion plus, maybe as much as $3 billion on an annual basis? I would say the answer to that is probably yes. I'd be loathed to predict anything higher than that.

We are seeing opportunities right now that six months ago, we weren't seeing, right, very clearly where competition has pulled back in places. And so we continue to see that. I think how long that lasts is an open question as well. We will run hard as long as we see it and continue to have some of these businesses mature, that will help support that. But feels good right now, and we'll continue. But to chip's point, I think those numbers are good in terms of what we can visibly see.

Okay. And then just with the 6-month P&I program with the SBA, assuming we don't see anything like that again. I mean, I thought I heard a comment from chip that, that was like 1/3 of originations was sort of to take advantage of that deadline? Or did I mishear that one?

Yes. I think that's probably right. I mean, if you didn't have that, I mean, we would not have done $1 billion. But we probably would have done $600 million or $700 million in the quarter [indiscernible].

Yes, I think that's fair. Look, the majority of our origination benefited from that, right, which is great because it will support the borrower. But how many loans would have not happened without that subsidy, I think, is probably closer to 1/3 or less. Most or all of the customers had the opportunity to expand business acquisition, et cetera, and it was a nice to have, not a have to have. So that's the right way to think about it.

Well, and we took some business away from conventional lenders because when the borrower did the math, on an SBA loan at a higher rate, then he came with us because of the P&I payments. And that would be a onetime situation as well.

Okay. And what I just want to ask one more on compensation. I think you've been pretty clear on the creeping up part, but is there any benefit you have from say, the investments you had made in launching the deposit program, do you have some expenses that drop-off in that regard? Or should I think about you is you've got to like you're in the early stages here with the deposit platform. And now you have a lot of other things you want to add to it so there will be continued expenses with that?

No, that's a great question. The benefits that we'll see happen at deposit conversion, let's call that first part of next year. And then ultimately, loan conversion, which will take a little more time. And those will be relatively modest actually, just given we don't have the scale of units, right, that some really big banks do, but it will be meaningful. But really, to your point, is about growth, it's about new product development. So we'll likely reinvest that of savings in continued products. So I don't think you'll see a big move either way as it relates to technology spend over the next 12 to 18 months.

Well, they would be [indiscernible]. In other words, we have a number of people that were doing a lot of things to get us at this point, and that job will be done. Then on the other hand, if you think about 100-and-whatever we have on the lending side, right, we may have not that, but a whole lot of folks on the deposit side, calling on practice management software companies generate new relationships that we have been talking about now for years. And now it's around the corner.

Next question comes from the line of Ammar Samma from Raymond James.

Congrats on a very good quarter. So maybe starting on the all-in reserve coverage. It was down to about 2.66 from the 3.09 last quarter. Can you talk a little bit about the underlying unemployment and GDP forecast in your model and then maybe just your overall comfort with the reserve at these levels moving forward?

So this is Steve Smits, Chief Credit Officer. So I'll start. First of all, my confidence in our strategy, very confident. And talk a little bit about unemployment. You hit on a metric that's very important to our model for our general reserves and a reminder, that we heavily reserved in the early half of this year. We've seen some improvements in the forecast for unemployment. That impacts our model. Also, I'll point out, if you reflect on the slide that chip discussed on our stress measures, that is important because we used that strategy to put a mark on the level of that -- flows right into our model for what we're preserving against. So we are taking a micro loan level. So we're very fortunate in that we have a very robust servicing platform. It bodes very well in environments like today with uncertainties. So we reach out to every single borrower on a loan level. We place the mark based on their level of stress based and some very specific challenges that they may be finding. And that rolls into a qualitative factor that we plug into our provisioning model. And that correlates very closely to what we're seeing in unemployment. So that gives me confidence that it's doing what we expected to do.

Okay. Great. And then maybe a bigger picture, follow-up question. Has the pandemic opened up any opportunities to maybe lend in new verticals? Maybe remind us of the process behind entering a new vertical? And are there any plans in the pipeline right now?

So a great question. Look, in terms of new verticals, we do analysis, we research around the market, the credit characteristics, and then importantly, the market structure. So are there referral sources, influencers, experts, et cetera, how can we have somebody either in-house or that we're very close to with that expertise in that industry to help us drive success? And we really, I think, hit the pause button on that for the last several quarters as we've had a lot of them that were maturing, and we wanted to sort of see that through. I think that the -- what has COVID done and has it opened up anything, we look at our verticals, and I think some of them have more opportunity, either because of less competition or because of the market they're in. So I think we sort of like the breadth of what we have our generalists and our sponsors are seeing some transactions in certain sub industries that may be taking place as a result as well, see a little more technology, a little more services stuff. But overall, I think we really like the footprint that we have and some are growing. The diversification of that allows some to thrive a little more than others in this time.

There are no further questions at this time. Mr. Chip Mahan, please continue.

Yes. We thank everyone for joining us today, and look forward to seeing you 90 days from today.