Live Oak Bancshares, Inc.
Q1 2017 Earnings Call Transcript

Published: 13 May 2017

[Operator:]

Good day ladies and gentleman and welcome to the Live Oak Bancshares Investor Call. At this time, all participants are in a listen-only mode. Later we will conduct the question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference may be recorded. I would now like to turn the conference over to our host for today's call, Mr. Brett Caines, Chief Financial Officer. You may begin.

[Brett Caines:]

Thank you, and good morning, everyone. Welcome to Live Oak's conference call to discuss the transaction agreement with First Data Corporation that we recently announced. We're webcasting live over the Internet and this call is being recorded. To access the call over the Internet, please visit our website at investor.liveoakbank.com and follow the links from there. 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 press release announcing this conference 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. I will now turn the call over to Chip Mahan, our Chairman and Chief Executive Officer.

[Chip Mahan:]

Thanks, Brett. We're incredibly excited about announcing this partnership with First Data today. As we plan to offer fully digital products and services on both sides of the balance sheet to the 28 million small businesses in this country. So, this is the really interesting transaction to require some explanation. Let me give you the history of what -- how this came about. So, about a year ago Neil and I met some folks at First Data and that count articulated up the organization became close friends with Frank Bisignano who runs the business and we learned of their Clover Connect investment on the West Coast. So, again in my words, not First Data words, their attempt to go direct to their 6 million small business customers. We at the same time, as Neil has told you in the past, have been working on our Acorn project. So elegantly delivering on the liability side of the balance sheet, merchant services, online banking, bill pay, remote deposit capture and financial forecasting. So, is there a way that we could offer those products and services, the Acorn project to the 6 million small businesses that First Data does business with and the 63 billion transactions that they do a year; so we've been working on that for about a year. Along the way we found out that First Data had purchased 10 years ago-ish FundsXpress, a company that could use to compete with Neil and I at S1 corporation in the 90s. FundsXpress was basically online banking and bill pay delivering those products and services to about 550 banks, 138 employees and a data center in Austin, Texas. So, we said what if we put these businesses together, what if we took our Acorn project, our 40 engineers and combine that with First Data's business with 60 million of revenues, $80 million worth of free cash flow, and all for our online banking and someday through our sister software company, nCino Online Lending. We certainly recognized that the product of online banking and bill pay is a bit of a yawn, kind of rip and replace. But if we could deliver to those 550 banks, a next generation platform with both the lending and the deposit side that would be quite interesting. So, we reached an agreement which we're announcing today. So, then the accountants basically come in and say you have to value the consolidated entity. So the value of an independent third party in this case, KPMG value the consolidated entity at about a $145 million. That translates into a $63 million pretax gain or $38 million after tax gain for this 50-50 owned sub of Live Oak banking company, a sub of Live Oak Bancshares. Along the way we know we did not have to have an application, this transaction did not require an application from the FDIC. We are currently working with FDIC and answering their questions relative to what is that relatively complex transaction. And also, we decided in order to do this, we would give first data an, what we call an earnings placement. So for the first two to two and a half years, those earnings with this business flow directly to first data, so when you are modeling in the future there will be no accretive EPS attributed to this transaction for a couple of years to Live Oak Bancshares. Neil, you might want to talk a little about where you stand on the Acorn project, and the white-label initiative refers data. And Brett will certainly be available to answer any financial questions.

[Neil Underwood:]

Sure. So continuing to make progress on Acorn, this week we launched the savings application, so now you can actually go online and enroll with a savings product. So we are excited about that. As we continue to rollout new products in the platform, you will see us rollout business checking and bill pay is really the next piece of that puzzle. Well, that’s exciting for Live Oak Bank. First Data saw value in that and said, hey why don’t we partner together with brand name Clover Connect and go to market direct and electronically. So we are excited about that aspect of the partnership as well. And we should see new deposits come on board to that channel by yearend. And then connected with two this opportunity what we are announcing today. We are taking those aspects and putting them into the Joint Venture. And Live Oak will benefit as a result of that as well. Because it will allow us to accelerate the digital banking platform, leveraging the both aspects from First Data as well as RIT and bring digital products to the market quicker. So that’s all I have to add there, Chip.

[Chip Mahan:]

Well I think than we'll just open it up for questions and we will entertain those now.

[Operator:]

[Operator Instruction] And our first question comes from Aaron Deer of Sandler O'Neill & Par. Your line is open.

[Aaron Deer:]

I guess a little -- to start a little high level, can you talk a little about how -- what's you are building as differentiated from say the investments that you are making on the Finxact platform?

[Neil Underwood:]

Basically, this venture deals was effectively to the online banking, what you know and what the market and industry knows is this is online banking. So ironically, it's not far afield from what Chip and I were doing 20 years ago, just on the technologies and new platforms benefits of that are much lower total cost of ownership and the ability to interact digitally with other things other than mobile phones like apps as well. Finxact is a core processing system, what Frank Sanchez is the owner and CEO of that company what we would call a headless API, a headless core. And we use the term headless in the world of technology to imply elegant access to the core by third parties and we're kind of branding that kind of the app store; so ironically this joint venture ultimately will connect to Finxact, the core as the back-end system.

[Aaron Deer:]

And then a few kind of accounting related questions, on the purchase accounting related to the deal, is the -- I guess [indiscernible] $1.10 in book value, is that goodwill or is that -- will that be recognized as common equity?

[Brett Caines:]

It is recognized as common equity and it is not goodwill. This will be an equity method investment. So that amount will be sitting on balance sheet as an investment in the subsidiary and thus the entity, and have a resulting equity impact through the gain that we're booking.

[Aaron Deer:]

And any anticipated additional capital commitment that would be required on your part or ongoing investment cost related to the JV?

[Brett Caines:]

Not that we see at this time.

[Aaron Deer:]

And then you mentioned to the deposit opportunity with Clover, where do you see those deposits coming on balance sheet by say year-end '17 and year-end '18 and what kind of costs for those deposits have associated with them?

[Neil Underwood:]

We're rolling out both saver accounts as well as business checking. We truly have no idea as to the adoption which is why I'd rather not kind of commit any numbers now. I would say there's a ton of brand equity behind Clover and Clover Connect, and I was partnering side-by-side with them. We would hope would yield significant access to low yield deposits -- low cost of deposits.

[Operator:]

[Operator Instructions] Our next question comes from Jennifer Demba of SunTrust. And your line is open Jennifer.

[Jennifer Demba:]

How much do you think that's accelerates your own internal efforts on digital banking and deposit gathering?

[Chip Mahan:]

Neil, you can comment, I mean I think you basically just did comment on the deposit gathering effort for Live Oak Bank. What this does in terms of the overall strategy of fixing the problem? And Neil alluded to our partnership with the Sanchez Brothers is nCino in our opinion has "fixed" the lending side of the business to deliver those products and services digitally to small businesses in this country. This is our effort to solve the other side of the balance sheet and bring them together on one platform. Fundamentally using Live Oak Bank as a guinea pig and then the 550 customers that do business today with FundsXpress, they wholly own sub of First Data. So, we're taking our engineers and what Neil has built and -- over golly Neil, it's going to be a couple years offering that to those customers along with online lending.

[Neil Underwood:]

Yes, built by nCino. So I would say, Jennifer, I think this also, to Chip's point adds, accelerated pretty significantly. We are going to continue to add engineers instead of having a pool of engineers, developing a product for one, now engineering for many and the R&D budget can go up significantly and the investment can go up significantly. The first customer of First Data on some of these new platforms of Live Oak Bank, so that will make the first customer on the new platform real happy in, and then kind of go from there. But I think it's a generally a lot of thing, not just financially but from a product perspective for Live Oak Bank.

[Operator:]

And I am showing no further questions at this time. Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.