SBA Loan Sales Drop at Live Oak Bancshares – Is the Stock Still a Buy?

Despite its relatively small size, the $9.1 billion asset bank Live Oak Bancshares (LOB 2.22%) is one of the largest US Small Business Administration (SBA) loan originators in the country. SBA loans are made to slightly riskier businesses than a bank normally would, but the loans are heavily backed by the SBA, which makes them much more attractive.

Lenders like Live Oak can write these loans on their balance sheet or sell the secured portion of the loan, which is typically about 75% SBA-backed, in the secondary market, which helps with liquidity. Live Oak has recently seen secondary SBA loan sales slow. Is the stock still a buy? We’ll take a look.

Difficult market conditions

In the second quarter, Live Oak only made a net gain on loan sales of about $6 million, which is significantly lower than what has been the norm over the past year. The bank only sold $50 million in SBA loans in the secondary market, down significantly from the $92 million the bank sold in the second quarter of 2021 and the $211 million it sold in the first quarter of the year.

Image source: Live Oak Bancshares.

In its second-quarter earnings release, the bank said the slowdown could be attributed to the dislocation of the secondary market, largely due to rapidly rising interest rates and tough market conditions. When rates rise, secondary market investors have a higher cost of capital, which increases the required returns they will need for the loans they purchase. Additionally, as the macroeconomic outlook becomes murkier, with the potential for a recession, investors are beginning to worry about loan performance.

The slowdown in loan sales in the second quarter was most apparent among the SBA fixed rate loans behind Live Oak. Very few of these loans were sold in the second quarter and the premiums paid by investors on these loans fell from 106% to 102%, probably because even though investors will have to pay a higher cost of capital, the returns on these loans do not adjust upwards. with interest rates almost as high as variable rate loans.

Live Oak also suffered an $8.7 million hit after having to reassess its loan servicing rights due to rising rates in the quarter.

Although the decline in loan sales in the second quarter and the difficulties in the secondary market may have surprised some investors, Live Oak chief financial officer BJ Losch warned investors to prepare for the impact of rising rates. on the bank’s first-quarter earnings call on April 28. .

“While premiums have remained relatively stable with recent trends over the first 45-60 days of the quarter, we have started to see significant shifts in demand and pricing, primarily due to shifts in market sentiment. on the Fed rate and the economic outlook,” Losch said. “So with the $120 million fintech gain recorded in the second quarter, we will take advantage of this to moderate our guaranteed sales in the second quarter and allow the markets to further digest the Fed’s rate movements.”

Is Live Oak stock a buy?

Right now, most banks or fintech companies that sell loans in some sort of secondary market face the same issues as Live Oak, so the problem isn’t bank-specific or a result of poor management.

And while revenue from those loan sales moderated, it was partially offset by higher revenue from loans held on Live Oak’s balance sheet, many of which saw their yields revalue with higher interest rates.

Live Oak also saw healthy origination volume in the quarter of $960 million, up from the first quarter of the year. Additionally, since 2013, the bank’s credit quality has significantly exceeded the broader SBA lending program and the bank has strong capital levels.

Live Oak also continues to execute on its strategic vision to become America’s bank for small businesses and to more holistically serve the small business community. Management adopted and implemented cutting-edge technology that enabled it to begin rolling out products that help small businesses manage their day-to-day operations and make Live Oak an attractive banking partner.

The market should eventually adjust to rising interest rates, and with the Federal Reserve recently stating that it may soon begin to slow the pace of rate hikes, problems in the secondary market could end up being a wind. opposite in the short term. I still think Live Oak shares are a good long-term buy.

Bram Berkowitz has no position in the stocks mentioned. The Motley Fool holds positions and recommends Live Oak Bancshares. The Motley Fool has a disclosure policy.

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