Motley Fool Money - Are Banking Relationships Sticky?

Episode Date: June 11, 2023

When Silicon Valley Bank collapsed, $43 billion left its doors in one afternoon, or $1 million every second. How has the banking landscape changed since then? Motley Fool Senior Analyst Bill Mann caught up with Chip Mahan, CEO of Live Oak Bank. They discuss: - The breakdown of communication between regulators and Silicon Valley Bank - How Live Oak Bank is differentiating itself from larger institutions - Why traditional banks may face margin issues in the “not too distant future”  Companies discussed: LOB, JPM Host: Bill Mann Guest: Chip Mahan Producer: Ricky Mulvey Engineers: Rick Engdahl, Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

Hi everyone, I'm Charlie Cox. Join us on Disney Plus as we talk with the cast and crew of Marvel Television's Daredevil Born Again. What haven't you gotten to do as Daredevil? Being the Avengers. Charlie and Vincent came to play. I get emotional when I think about it. One of the great finale of any episode we've ever done. We are going to play Truth or Daredevil.

What? Oh, boy. Fantastic. You guys go hard, man. Daredevil Born Again, official podcast Tuesdays, and stream season two of Marvel Television's Daredevil Born Again on Disney Plus. But you've got an industry here that has spent since 1950 building branches, heat light utility taxes, tellers, CSRs to gather what they consider to be low-cost deposits that'll never be moved and sticky, and then make loans to the butcher, the baker, the candlestick maker. I think those days are over.

I'm Mary Long, and that's Chip Mayhan, CEO of Live Oak Bank, a digital bank that focuses on small, businesses and niche industries. Bill Mann caught up with Mayhan to discuss how the banking landscape has changed over the past few months and decades, the golden rule of taking market share, and why Mayhan believes were in a seminal moment for the banking industry. I thought we would just start at the top because I think it will be the thing that people will be most interested in. What is the lending environment for you all right now? I know there was a point in time in which borrowers kind of have the upper hand in terms of of in terms of their relationship with lenders.

But have you seen a really dramatic shift in risk appetites that's gone along with the rate changes? So I think we're seeing this daily. And so what is this? I think gradually, but ever so predictably, the credit guys are beginning to run these banks. They're worried about recession. We had March the,

the ninth. They're worried about liquidity. They're worried about regulatory actions and increased capital ratios. They're worried about too big to fail and all those guys got all these cheap deposits. So I think what that happens, then the credit guys end up running the bank. We absolutely, absolutely love it. We're going to do the same thing that we've always done. As you know, we're a different bank. You can argue that our capital account is roughly three times what is necessary because of the weird bank that we run at the government guaranteed paper. So we are in the market all day every day. I just returned from Florida just a minute ago looking at a recreational vehicle park, which most banks wouldn't touch, but we seem to really like that space. So we're all

a headfold, brother. So you've perhaps already started to answer. answer this question, but just in terms of setting the table, going back to what happened in early March with the meltdown at Silicon Valley Bank, what is your take on how your fellow bankers have been reacting to the headlines and to the changes of realities and, you know, from a customer basis as well as from a capital basis? You know, it's unfortunate because we know those people. These are banks that were were extremely well respected that had NPS ratios that were off the charts that had a long track record of growing earnings organically. And it was Jimmy Stewart and a wonderful life driven by social

media, right? So that said, let's drop back and analyze the facts, right? So the average bank bill in this country has 44% of its deposits uninsured. If you go back, to when the FDIC was created in 1933, that average from 1933 until today is 60%. Now, FDIC insurance in 1933 was like $1,000. And you and I remember when they bumped it from $100,000 to $250. So how does that relate to Live Oak Bank, right? So our average uninsured depositors were 18%. And in the abundance of caution, we,

immediately went out and had four times, $4 for every dollar of uninsured deposits sitting in a checking account at Live Oak Bank if any of our customers wanted to money. So I think we've been kind of through that. And now the question is, what are we going to do about that in the future? Are we going to ask every human being to analyze every financial statement of every bank to see how safe and sound you are at Live Oak Bank? when their accountant says, you need to move your money to J.P. Morgan Chase. I'm so glad to hear you say this because it was an argument that I was making in terms of making sure that the depositors were held harmless. It's not something that a healthy banking system should expect of depositors, I wouldn't think. Well, and, you know, there are a number of companies out there that make it rather easy.

I wouldn't say really easy, but rather easy. For you, Bill Mann, if you have $5 million and you want to put it in Live Oak Bank, that we can get you insured deposits through a network of other banks. There's several companies that do that. But I think that the hill is going to make any changes to that and get together between the right and the left. I just don't think they're going to change that deposit insurance right now. As an outsider, I've described some of what happened at Silicon Valley Bank as being a breakdown

of communication from their state banking regulators. From my own past in being in an asset management business, we had constant conversations with our regulators that never saw the light of day, but just in terms of our own capital adequacy in terms of our own risk appetite. What is your view about what happened there? How a bank that was a white shoe bank like Silicon Valley ended up where it did so quickly? What broke down? Well, everything happened quickly. In a matter of two years, they went from a $100 billion bank to a $200 billion bank to a $300 billion bank. And yes, it is true that TikTok and other

folks overseas had, you know, a billion dollars of uninsured deposits, non-interest bearing at the bank. But, you know, what is the management team going to do? You know, this was not a credit crisis. All those, they put it in, albeit, you know, longer-term securities, but who could have predicted interest rates to rise five and a half percent in the last 12 to 15 months? And, you know, then they basically said, we're going to sell that at a loss, we're going to raise capital, and then all of a sudden, social media took over, and $43 billion went out of that bank that afternoon. As Greg Baker said, when he testified before Congress, it was, you know, a million

a second. No one could have predicted that. Yeah, I mean, it is on some levels, you know, on some levels, a banker's job is to, is to bend your headlights around corners. and make sure that a lot of your risks are not aligned in ways that may have been in anticipated when, you know, in a steady state in times of crisis, sometimes correlations go to one. But I do wonder where the California banking regulators were, you know, late 2022, saying, perhaps this might be a good time for you to raise a little capital. Well, that in the Fed, too.

Yeah, the Fed is a bank that size is going to have to deal with a Fed on almost a daily basis. Yeah, yeah. Well, let's talk about Live Oak for a little bit. So you had mentioned in the past there were certain franchises where Live Oak has a knowledge advantage regarding lending. One that we talked about before was veterinary clinics. Is this a good time to continue your lift-out? or is this more of a devil-you-know environment in terms of your borrowers? So I would say that we are all ahead offensively on three fronts.

As we probably talked last time, the SBA allows you to lend to 1,100 industries. We're in 35. So someone like you said. So you've got some more left is what you're saying. Well, you can look at me and say, why are you? you in only 35 industries after 15 years, Mayhand. Come on. Just one a month, pal. Come on. Well, I think that's it. I think, you know, our theory there is to understand that those

industries deeply. Usually we hire a domain expert to advise our credit team that have actually run one of those businesses. And then what is a natural progression is, now that we're not just a startup bank, but we're a $10 billion bank, if you know, and understand how those industries operate, why don't you make a non-SBA loan? So we are going upmarket with larger loans in those industries. And then about five years ago, we started hiring people from other banks in other towns. So that now totals about 33 separate towns where we have lenders that have relationships with business brokers and acquisitions, and those are all SBA lenders. So would I like to be in a hundred of the top cities in the United States?

Absolutely, right? So we're seeing growth both across other industries. So 35 should go to whatever, more conventional loans in those industries that we understand, and more SBA lenders in the top 100 cities. So are we reasonably confident we can continue what we've done here for 15 years, which is grow this business organically in good times and bad in excess of 15% per year? The answer is yes. How do you go about, I mean, perhaps this is as naive a question as I can come up with, but how did you go about assessing the 35 that you are in? Is it a matter of making sure that you've got subject level expertise on the lending side first?

or was it a matter of targeting ones that have a certain credit profile that you think you can do business with? Well, I mean, it's almost like don't be a dumbass. If the SBA has the data, then go get the data from the SBA over the past 35 years of how every bank in the country did in lending to veterinarians, funeral homes, independent pharmacies, and go cherry pick to the best of the best, then find your expert to advise the credit department. as to what the rules are, and then wrap that in a bunch of technology, because we have learned one thing over 15 years, relative to our customers. Two things. They want to know two things. Am I approved? And when are you going to give me the money? So if we can go faster in an industry that is hung up with excuses and not necessarily taken care of the customer and treating every customer like the only customer, then we can distinguish ourselves.

And I think that's what we've done. So how would you go about assessing a new industry to move into? It'll be the same process. You start with SBA and you begin to make some assumptions based on the lending profile and the credit profiles from what has happened in the past? Well, you know, again, we get the data, right? So it charge off defaults, all of that, or when we're in the field, we find something interesting. So we were in the self-storage lending business for the longest time.

Then we learned a little bit about recreational vehicle parks and the fact that they're always full. And it's really a zoning issue. So if we can get in there at a modest loan to value ratio and drive, break even at, you know, 50% occupancy, then now you have project financing with a government guarantee. So we like that. One of Live Oaks primary taglines is that you are or want to be America's best small business bank. Is it you're claiming to be, I believe, or that you would like to be? Here's the way I look at that.

I mean, that's a great question. I think we're gaining on becoming the best small business lending bank. And we've waited 15 years to be a complete bank on the deposit side. You're familiar with our investment and creation of FNZACT? Yes. We started that company in 2016 and fundamentally sold it to FISA for close to a billion dollars. Well, we're the first bank to use that next generation core in the marketplace. So can we take that technology and fundamentally create a bespeer?

bank for every industry that we're in. That's called embedded banking. You can't do that on an old core, 40-year-old technology. You can only do it on a situation like this. So can we tightly integrate banking, payments, loans, deposits, to practice management software, to financial forecasting, to payroll, to whatever you make your mind water, on whatever other next-general code that small business is operating. And the really good news about this is we have 6,000 loan customers. There are 2.2 million customers out there with revenues between $2 and $5 million, which is our target said. If you ask any other banker about what is a small business to them, it is highly likely that 80 plus percent are going to say anybody with revenues over $10 million. So we believe

that that subset, particularly with the larger banks, larger banks being defined as the top 50, so the top 50 banks in this country have 80% market share, 8-0. I don't think they do a very good job with a $1 million revenue business. So if we can wrap the deposit side of the business, which, by the way, their deposits in this sub-segment are five times their loans. So if we can continue to be the best of the best on the lending side, and now, Now, some say, well, we've been an overnight success. Well, it took us 15 years to be an overnight success of the deposit business, right?

I think if we can do that, we can achieve our dream. Chip, some of the fear in the marketplace has pushed, or at least has made it a reasonable outcome for a lot of business customers to move their lending, to move their borrowing, I should say, to the bigger banks, though. I mean, that has been, I think that that is a reasonable presumption for customers to make. How are you getting past that trend that's happened over the last two months? You know, I really don't care. I mean, when I think about our folks and I think about, you know, whatever service they're going to, I'll give you an example, right? I'll give you a quick example.

My wife works out every morning. And this guy trains a bunch of these old ladies. And he said, I saw that Live Oak is paying 4% on a savings account. So I called him. Somebody answered the phone. Then I called him a second day. And in 12 seconds, somebody answered the phone again. And then I called him again on something else the third day.

So three days in a row. Now, you can pick whatever one of those big banks that you're thinking of. Call them and see who you talk to and how long it takes. I mean, it's real simple. Like, treat folks the way you want to be treated. So I think with that advantage and how we operate this business, we can take market share from those big guys. So I'm not worried a bit about them.

It's a target-rich friggin' environment bill. Chip, I'm going to, as my last question to you, I'm going to give you the opportunity to speak on behalf of Live Oak Bank. And then also for small banks in general, as a lot of people, a lot of investors who we talk with, following the recent turmoil, have said maybe the best move for them is just to swear off banks as an investment to put them into the too hard pile. So what would you say to these people? And then furthermore, we all know anyone who's ever known a banker has heard a banker describe a competitor as being a well-run bank or, you know, the opposite. So how would you go about describing to the average investor how to find well-run banks to invest in?

You know, this may sound uncharacterously self-serving, but I do believe this is a seminal moment, right, in the banking business. So we went through a situation, you know, the Jimmy Stewart situation, right? Silicon Valley Bank goes down at precisely the point in time interest rates have risen at the highest rate in 45 years. and we as an industry applaud low deposit betas, and you're familiar with a deposit beta. How can I think about as a normal bank not to pay market rates on deposits? So if you look at the average money market of savings account rate of the larger banks in the United States today and maybe 50 basis points, we're paying. It's the amount they're paying. Yeah. That's their paying. You know, on a one-off basis, maybe they'll, you know, have a conversation with you if you have more money with them. But you've got an industry here that has spent since 1950 building branches, heat light utility taxes, tellers, CSRs to gather what they consider to be low-cost deposits that'll never be moved and sticky and then make loans to the butcher, the baker, the candlestick maker. I think those days are over.

I think when you can pick up your cell phone before you sign off on this call and close your account at J.P. Morgan Chase, I'll just pick on the most famous bank in the United States. Sure, you're not going to cause a run at J.P. Morgan. It's okay. That's probably a good target. It's highly unlikely that Jamie Diamond's going to call and fussing me. Man, what are you doing? But, you know, it's like even if all... All you had in the world was $10,000, and you could pick up 4% or $400. If that person found $400 in the couch, they're going to do it. We are all now about ones and zeros.

So when we have the technology and you treat every customer like the only customer and pay them a market rate, and then you can lend that out and achieve a spread, I think that the normal and customary bank with branch infrastructure is going to have margin problems in the not too much. distant future. Now, if you're a community bank to your point, and you've had done business with that person forever and other in a smaller town, those deposits may be a bit stickier. But I like where we are because we've been operating this business without branches, without that overhead, paying a fair rate, both on the deposit side and a fair rate to our customers and achieving a 4% spread. If we can continue to do that with everything else we talked about, we can grow this

business 15% year over year. And that's what we're going to do. As always, people on the program may have interests in the stocks they talk about. And the Motley Fool may have formal recommendations for or against. So, don't buy stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow.