Live Oak Bancshares Inc

NYSE:LOB

Earnings Call Analysis

Live Oak Bank Q3 Earnings Highlights

Live Oak Bank reported a notably strong third quarter characterized by vital metrics that met their guidance such as margin performance, loan growth, stable credit quality, and controlled expenses. The bank capitalized on the economic forecast by aligning with the Federal Reserve's rate cycle, expanding net interest margin to 3.37%, and increasing net interest income by 9%. Loan production surged nearly $1.1 billion from $860 million in the prior quarter, underscoring the bank's continuing revenue and customer growth momentum. Deposits from business customers grew by 12%, totalling a 36% increase since March without paying higher rates. While the expense ratio has moderated, with salary and employee benefits relatively stable, the bank emphasizes growth investments. Looking ahead, no further Fed rate hikes are expected through the first half of 2024, and the effective tax rate is projected to be around 20-22%. Live Oak Bank continues to maintain robust credit quality, leveraging industry expertise and government programs to attract strong loan applicants among small businesses, particularly in burgeoning sectors like solar energy.

Stable Credit Quality and Future Aggressiveness in Hiring

The company takes pride in the robustness of its loan book and maintains a strong credit quality profile. Past due loans over 30 days and nonaccrual loans have shown downward trends, along with a slight uptick in classified assets relative to Tier 1 capital plus the lower loss reserve; this is a stable indicator reminiscent of the Texas ratio used during recessions. The firm stands firm on its credit standards amidst industry apprehensions, positioning itself to aggressively hire top talent even as competition retreats.

Meticulous Provisioning and Charge-offs Strategy

Q3 experienced a major charge-off due to a previously discussed fraud-influenced loan, but normal charge-offs stood at a modest level. The company's loan loss reserve is solid, countering assumptions that the company's small business clientele would face more hardship in a recession. The data supports the company's resilience.

The Secret Weapon: A Proactive Approach to Asset Quality

The company's 'secret weapon' is its rigorous business analyst group, which continually assesses customer financial statements. By intimately understanding the health of their customers' businesses, the company is better equipped to support them through potential downturns with advice and data-driven, definitive plans for success.

Adapting to a Dynamic Banking Environment

Interest rates have risen significantly, consequently noninterest-bearing deposits have decreased within the industry while interest costs have escalated. However, the company has managed to preserve a stronger net interest margin compared to larger traditional banks. By paying market rates for deposits, the company achieves a net interest margin of 3.37%, significantly higher than the industry's 2.67% average.

Investments in Next-Gen Technology and Talent

The company has bolstered its technological capabilities, growing its tech staff by 60 high-quality engineers over the past two years. These investments, supported by strong pretax gains from ventures, are laying the foundation for a future-focused, cloud-based, industry-specific banking experience.

Financial Performance: Operating Leverage and Recurring Revenue

Expenses have plateaued while recurring revenue streams are gaining momentum. The business is evolving towards a model that emphasizes stable earnings, with insightful management of the cost structure to secure operating leverage and profitability.

Positive Trends in Customer Deposits and Net Interest Margin

Business customer deposits achieved a 12% increase linked quarter and a 36% growth since March, all without climbing the rates paid on business savings. Net interest margin and net interest income also ascended, reflecting the company's disciplined pricing strategy amid a vigorous loan growth. Considering these factors, the company anticipates continued net interest margin expansion and net interest income improvement in coming quarters.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the Live Oak Bancshares Q3 Earnings Conference Call. [Operator Instructions] This call is being recorded on Thursday, October 26, 2023. I would now like to turn the conference over to Greg Seward, General Counsel and Chief Risk Officer. Please go ahead.

[Gregory Seward, executive]

Thank you, and good morning, everyone. Welcome to Live Oak's Third Quarter 2023 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 go to the Events and Presentations to have 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. Confirmation about any non-GAAP financial measures referenced, including reconciliation of those measures to GAAP measures, can also be found in our SEC filings and in the presentation materials. I will now turn the call over to James Mahan, our Chairman and Chief Executive Officer.

[James Mahan, executive]

Good morning to all on the call, and thanks, Greg. We're going to start on Slide 4. In an effort to support BJ's reporting of a very fine quarter, I'm going to cover 5 views of the future at Live Oak Bank. First, as always, we lead with the quality of our loan book, revealing more data than usual and reintroducing you to our unique secret weapon. Secondly, I like the hand we've dealt ourselves as the historic banking business has challenges with infrastructure fixed costs. Third, we shall be aggressive in hiring high-quality revenue producers. Fourth, the building out of our Community Bank of the future has predictably taken longer and been more costly than we thought. We want to remind this audience how we're going to pay for it. Lastly, a quick slide describing the true operating earnings of our business and the corresponding achievements in operating leverage. Moving to Slide 5, beginning with credit quality. Moving from left to right at the top, nothing doing on past dues over 30 days less than it was 8 quarters ago. On the nonaccrual slide, top right, over the last 4 quarters, nonaccrual loans deducting those borrowers that were paying as agreed were 25 basis points, 47 basis points, 77 basis points and declined to 64 basis points at the end of this quarter. On the bottom left, classified loans or risk grade 6 loans divided by total unguaranteed loans was less than 8 quarters ago. Bottom right, the section is what we call our regulator slide, classified assets to Tier 1 capital plus the lower loss reserve is up slightly, but virtually unchanged over the last 2 years. Some will remember this as the closely watched Texas ratio during the recession. Moving to Slide 6. Let's take a look at the Q3 provision and charge-offs. We charged off our total exposure or $8 million on the shared national credit fraud influence loan that we discussed last quarter when we itemized a specific $6 million reserve. Normal charge-offs for the quarter would have been $2 million or about 1/5 of our provision. The combination of our conservative CECL calculations, along with consistent growth in our loan book, has built a loan loss reserve of $121 million or 1.56% of loans held for investment. More importantly, our unguaranteed reserve to unguaranteed loans to leases is 2.32% or 76 basis points higher. Many analysts on this call have told us we have never been through a recession. And because we lend to small businesses, the investment community expects our customers to be at the tip of the spear. Well, now you have the data to draw your own conclusion. Moving to Slide 7. Let me remind you of our secret weapon. Managing asset quality begins with caring about each customer and providing the resources to do so every day. There are 49 of 62 folks on this slide that comprise our business analyst group. These folks are responsible for analyzing our customers' financial statement every 90 days. So back to a potential recession. Workouts are an art, not a science, knowledge and data are paramount. We have more data and understanding of what's going on with our customers' business than any bank in the country. Our theory of verticality combines with our early warning system to provide a solution, whether it's M&A advice or using industry benchmarks to provide them a definitive plan for success. So moving to Slide 8. So what's happened to the banking business recently. Rates are up 550 bps and noninterest-bearing deposits are fleeing our industry. Here is a brief deep dive on comparing our business model to larger banks with a more traditional model of gathering deposits through retail branches. On the left side of the slide, the large banks have lost 5% of their noninterest-bearing checking accounts from 30% to 25% in the last 12 months. In total, $429 billion of noninterest-bearing deposits have left or shifted into interest-bearing deposits at JPM, the Bank of America, Wells, Citi, Truist, P&C and U.S. Bank again since Q3 of '22. Their average interest-bearing cost of funds has risen almost 2% over the last year. On the other hand, we strive to pay our deposit customers a market rate while maintaining a net interest margin that it's almost 100 bps higher at 3.37% compared to $2.67. Moving deposit accounts digitally has become exponentially easier for all banks. Evidence the $43 billion that exited SVB during March Madness. We choose not to estimate the cost of their branch system to collect those deposits. Most folks think it's about 2%. For those interested in what our customers think of our branchless business model, Claire Parker would be delighted to shoot the link to an online video interview conducted recently by a third party. Moving to Slide 9. All on this call have seen these reports of layoffs, asset sales in an effort to shrink the balance sheet in anticipation of more stringent capital requirements as well as declining loan portfolio balances. Many times, the fear of recession leads to tightening credit standards, which leads to unhappy lending officers, many of which will suffer incentive compensation declines. Our model, our credit quality standards and our excess capital allow us to be incredibly active for the best of the best when others are pulling in their horse. Slide 10. While our sales team has not grown headcount over the last several quarters, they've done an amazing job in continuing to grow our loan book over $2 billion over the last 2 years in a very difficult banking environment. Again, we will seek to extend our feet on the street as the competition retrenches. Slide 11. As further confirmation of our efforts in growing our business through innovation, I thought I would show you our investment in building our cloud-based API first next-gen technologies. Over the past 2 years, we have grown our tech staff by 60 high-quality engineers. Our vision of building out a bespoke bank by industry has played a large part in attracting this level of talent. Outstanding engineers must believe in the dream. They completely understand our customer base and that the largest banks in the land tend to focus on everything but the small business owner that operates an under $5 million revenue business. In addition, many have firsthand information of the sizable technical debt that those banks must overcome. On the left-hand side of the slide, I wanted to remind you of how we're supporting and maintaining these 119 folks. Our venture pretax gains over the past several years has amounted to over $0.25 billion after providing $20 million in bonuses to our folks and to our community Slide 12. Before I turn it over to BJ for more color on this slide, it's working. Ours is the business model of the future. We are trying to show you the true operating earnings of our business by taking out the noise here. Expenses have flattened and recurring revenue is on the rise. BJ, overview.

[BJ Losch, executive]

Excellent. Thank you, Chief, and good morning to everybody. Let's start on Slide 14 with a high-level earnings summary of the quarter, and it was quite a good one for us here at Live Oak. The key commitments we made about what we would do in Q3, such as margin performance, continued loan growth, stable credit quality and moderating expenses were all delivered. And while we cannot predict what the economic outlook might bring, the actions we took in the first quarter, our performance in both the last 2 quarters and the ongoing strength of our business model have set us on a strong path towards continued earnings and customer growth over the next several quarters. Put some numbers to it. In Q3, we earned $0.88 while aided by a positive change in estimate related to our servicing asset and fair value loans, PPNR, excluding that $15 million impact, grew nicely again this quarter, driven by strong net interest income growth and good expense management. In addition, our credit quality remains strong. Loan production was up almost $1.1 billion from $860 million in the second quarter as closing activity was spicier than it had been in the first half of the year, and pipelines continue to be very healthy. Deposit growth was intentionally moderate this quarter as we soaked up some of the excess liquidity we had built coming out of March. Very importantly, however, our business customer deposits, our primary focus, were up 12% linked quarter. Since March, we have grown business deposits 36% or $1 billion and have done so without increasing our rates paid on business savings, and we continue to see strong inflows, great performance by our teams and a testament to our brand. As discussed in April, we believe that Q2 would mark the bottom for net interest margin, and we're pleased to see that our margin was 3.37% in Q3, up from 3.29% in the second quarter. Even more importantly, net interest income at $89 million is up almost $7 million or 9% from last quarter, owing to strong loan growth and disciplined loan and deposit pricing by our teams. I'll get into a bit more detail on the reasons for our NIM resiliency in the positive net interest income growth in a few minutes. But in short, it's due to the excellent efforts by our lenders, along with our deposit and treasury teams to remain both competitive with our customer offerings and disciplined with our pricing. Fee income was improved linked quarter on a core basis with relatively steady gain on sale premiums. Expenses declined again quarter-over-quarter. And while we expect continued discipline here, as Chief said, we're a growing company, which will continue to invest in good costs, which are those that support continued revenue growth. Provision declined modestly with the vast majority of net charge-offs, like Chief said, from a credit previously impaired and largely reserved for, and the majority of the provision build came from net new loan growth, which I believe is good provision. Let's turn to our net interest income and margin trends on Slide 16. As we've discussed in prior calls, we expected to see downward pressure on the NIM in the first half of the year because of the accelerated deposit repricing from the Fed's rate increase cycle, and that would be more rapid than the loan repricing. But in the back half of the year, as our loan repricing flowed through the balance sheet and the Fed neared the end of its rate increase cycle, we would expect NIM expansion. All of those things are still true. We've been able to both grow deposits and hold savings rates very steady since March due to our already strong rate offering. Loan repricing tailwinds continue as our lenders remain disciplined with new production yields. We expect loan pricing discipline to remain strong, but deposit competition to continue increasing. Overall, however, while the trajectory may not be linear quarter-to-quarter, we do expect steady NIM expansion and net interest income improvement over the next several quarters. A few highlights to point out. First, on the deposit side. You see that we again provided information on both Live Oak and the top digital competitors as it relates to pricing in betas. Even though the Fed's move 50 bps since mid-March, we were already in a highly competitive position to attract customer deposits, particularly on the business side, such that we continue to see healthy deposit growth while holding very steady on savings rates and our through-the-cycle beta of 70% is exactly what we've communicated all along as our expectation. It is modestly better than that on the business side. Now let's take a look at the loan side. Our loan yields have been moving up nicely as you can see in the table, but hadn't been moving nearly as rapidly as deposit betas. That dynamic [Audio Gap] shifting. 2 points we've made on loan yields in the last 2 quarters continue to hold true. Number one, loan production yields are currently being booked at rates much higher than the portfolio rates, see the $8.93 on new loan production yields in the upper right of the slide versus the 7.52% on portfolio loan yields in the upper right of the table. And number two, the majority of our variable rate loans are quarterly, not monthly adjusting. This means that unlike deposit rate changes, which happened intra-quarter, we don't see intra-quarter increases in loan yields. They move up the full change in the prime rate over the prior quarter on the first day of the following quarter. So as of October 1, our quarterly adjusting loans saw another 25 basis point increase in rate, owing to the 25 basis point July Fed move. And about 47% of our total loan portfolio is variable rate, and almost 90% of our current production is variable rate, that will certainly help. Therefore, as our newer loan yields replace older loans over time, our portfolio yields will continue to rise, supporting continued stabilization, then improvement in our net spread. On the deposit side, we've been able to see continuing strong customer deposit growth however, while we have fully expected upward pricing pressure for traditional banks, we have been a bit surprised by the aggressive consumer savings pricing we've seen from top digital competitors. Time will tell if this continues, and it's a trend we are monitoring closely. So what does all this mean for the NIM? Same as what we believe the last 2 quarters, have seen a large change in direction from the Fed or an economic shock, both of which are entirely possible given the geopolitical environment. We have hopefully seen the bottom for our NIM, and we should continue to see steady margin expansion over the next several quarters. It may not be linear improvement quarter-to-quarter, but should be generally up and to the right over time. This remains an uncertain environment. So let me be very clear and transparent with our current assumptions here. First, we are assuming no further Fed rate increases and remain on hold through at least the first half of 2024. Second, deposit pricing will remain highly competitive from both traditional banks and digital competitors. And if it gets more competitive, we will respond accordingly to support continued growth. Third, healthy loan growth continues on pace with current pricing. And fourth, no further major industry disruption related to deposits or liquidity. So to recap, we saw expected NIM expansion in Q3, and we're particularly pleased with the net interest income improvement we've seen. Turning to Slide 17. Our loan production in the quarter was again diverse across multiple areas, with particular strength in our specialty health care and middle market sponsor solar, senior care, educational services, self-storage and general lending verticals. As Chip talked about, others are pulling back on lending, but we expect to see good opportunities for new business going forward. We're open for business and focused on growing our revenue-generating capabilities. We've already talked enough about deposit growth and pricing dynamics. So let's move on to Slide 19, take a look at noninterest income trends. Our SBA sales activity and gain on sale premiums were pretty steady in Q3, not much new to report. The gain on sale at roughly 8% to 12% of quarterly total revenue feels like the right range for us. Over the last 2 years, we have intentionally reduced our reliance on gain on sale income to both improve the consistency of our revenue by shifting to more net interest income and to provide more flexibility. In addition, the USDA secondary market has been nonexistent for 6 quarters now. Eventually, that will change, and that will provide us with technique used to estimate the fair value of our servicing asset and the mark on our held-for-sale loan portfolio. And so as a result, we made a onetime adjustment to both the servicing asset and the fair value portfolio. Going forward, there will be continued variability as these assets are revalued quarterly, but we believe that these revisions are more representative of the value of the portfolios. Turning to expenses on Slide 20. We're doing just as we said we would do. We're moderating our expense growth while continuing to grow revenues. And going forward, we will always be opportunistic with hiring revenue producers, but we are smartly managing our expense growth. We're confident in our ability to consistently grow our PPNR and improve our efficiency ratio over the next several quarters. Our expenses were down linked quarter. And as you can see, we have held salary and employee levels steady for the past several quarters, even while continuing to invest in next-generation technology. One item I will mention as I wrap up expenses, which also relates to the variability in the tax rate. As you have seen over the last few years, we will, from time to time, invest in investment tax credits related to solar projects. These tax credit impairments show up as a noninterest expense in a given quarter, but they're more than offset in the tax expense line over the course of the year, resulting in an overall net benefit after tax earnings. That is why you will see much variability in our effective tax rate from quarter-to-quarter, and you saw it again this quarter with only a 7% tax rate. In Q4, we expect one of those investment tax credit investments to hit noninterest expense for about $16 million, but it will ultimately lead to an effective tax rate for the full year 2023 of about 10%, so a net positive to us overall. Turning to credit trends on Slide 21. As Chip discussed earlier, credit metrics remain strong. We continue to actively monitor the existing portfolio and don't currently see any significant weak spots. Past dues are low, nonaccruals remain quite manageable as well. And as you can see, the credit quality trends across all our 3 major business segments are healthy. As expected in the current environment, we moved some more loans to nonaccrual status during the quarter. But on the bottom left of the slide, you'll see a 5-quarter trend of our nonaccruals and see that they're still at very manageable levels. Provisioning again, was healthy, largely driven by what I call good provision for new loan growth. Our reserves on guaranteed loans, as Chip said, remain almost twice as high as the industry average and 40% of our total loan portfolio is government guaranteed. Slide 22 shows our overall capital strength, which continues to give us great ability to continue providing growth capital to our small business customers and comfort that we are well positioned to thrive in whatever environment lies ahead. So to wrap up on Slide 23, I really like our position at Live Oak over the long term. Our revenue growth has a strong upward bias, our loan production engine and reduced reliance on secondary market sales is producing solid double-digit loan growth. That loan growth, coupled with strong new loan nation yields and deposit rates that are already at market is leading to growing net interest income and expanding margins, and we are in the very early innings of attracting checking accounts, which will be a tailwind to building longer-term customer relationships and lowering funding costs for years to come. We've already made smart investments in lender support and technology over the last few years. So while our expenses will grow commensurate with a growing company, that is adding what I call good costs, such as new lenders, and they should increase as we grow over the next several years. Credit quality is strong, and we expect it to hold up very well on a relative basis in whatever credit environment we might face. And again, having 40% of our portfolio government guaranteed when the industry is about 1/10 of that provides great comfort and confidence. Finally, and most importantly, we have got the best mission inspired people and culture in the industry serving America's small businesses. With that, we're happy to take questions.

[Operator]

[Operator Instruction]. Your first question comes from Brandon King from Truist Securities.

[Brandon King, analyst]

So I wanted to start on expenses. They were down quarter-over-quarter and FTEs were down as well. But how are you thinking about growth next year, excluding the tax credit impairments. I know in 2023, as mentioned mid-teens was kind of the target. But kind of how are you thinking about expense growth next year, any details around that?

[BJ Losch, executive]

Yes. Sure, Brandon. It's BJ. Like I said, like Chip said at the front, we're a growing company, and we're always going to be in the market for what I call good costs, costs that are going to help us generate revenue in the future, whether that's hiring new lenders or creating additional technologies that are going to be better for our customers and building relationships. So we did have the bubbles of expense growth, I would say, in 2021 and 2022 related to lender support, in particular, and technology. That obviously has moderated this year. So mid-teens to actually in the 20%, 25% range, we're kind of the norm in 2021 and '22. I would see it as much lower than that going forward, but still at a pretty healthy clip as we continue to support revenue growth.

[Brandon King, analyst]

So I would say high single digits and lower is kind of a better gauge. Is that fair to say?

[James Mahan, executive]

It's certainly less than mid-teens. How about that.

[Brandon King, analyst]

There you go. Okay. Got it. Okay. And then on the net interest margin, I appreciate the commentary around that and expertise for expansion going forward. I know the 350 has been mentioned before, do you think you can get there in the fourth quarter, just given what you're seeing as far as deposit competition in rates in loan repricing?

[James Mahan, executive]

So I kind of, if you read between the lines and some of my comments, I basically said I'm highly confident that our margin is up and to the right over the next several quarters, but it won't necessarily be linear. So said a different way, in the fourth quarter, given what we've been seeing in deposit competition, particularly from top digital competitors, it's been quite surprising. We would have thought that, that would have moderated, but it hasn't. So we still have an upward bias, we believe, to the margin and net interest income, but it will depend in the fourth quarter on how proactive we need to be repricing the deposit portfolio, giving competition to support our loan growth. So I'm still very confident in our abilities to expand the margin. But again, it will be based on what near-term deposit competition looks like.

[Brandon King, analyst]

Okay. And just a follow-up to that. Any thoughts to maybe leaning more into that business customer deposits since that's seen for strong growth as opposed to maybe not competing as much for those consumer deposits?

[BJ Losch, executive]

Yes, great question. If you go back in time, I think around 2018, the vast majority, well over 90% of our deposits were consumer, very, very little were business. And over the last 5 years, we intentionally have shifted that such that I think it actually was last quarter that we tipped over 50% business savings deposits versus consumer savings. So it's been a very intentional shift towards small businesses and providing them very competitive rates in building that book. So with that said, we continue to emphasize our business savings product offerings and operating accounts to build business account relationships. We will use consumer more as an opportunistic funding toggle, if you will. It's a bit more competitive than the small business deposit industry might be. And so we'll continue to try to optimize both those portfolios as we grow.

[James Mahan, executive]

And BJ, I think on that point, [Audio Gap] 18 months or so, does not a trend make, but it certainly seems that it's less volatile, like consumers are a little more rate sensitive and a little more flighty and the stability of our business savings book seems to be much more predictable.

[BJ Losch, executive]

Yes. That is certainly true. So whenever we can build a loan and deposit relationship, that certainly helps, I think, our Live Oak brand as a small business certainly helps. And our rates for business savings are literally at the top of the industry. And there's quite a bit more competition from a variety of other competitors, traditional and digital on the consumer side. So yes, that's why we focus on small business side a bit more.

[Operator]

Your next question comes from Michael Perito from ABW.

[Michael Perito, analyst]

I wanted to just dissect the margin question a bit further. And BJ, I think I pretty much have a good handle on it. I was just curious if maybe you could give us an indication, I think you mentioned in October the loan yields kind of readjusted higher. And I was wondering if you could maybe just give us an indication of where the margin was in October, just as we kind of think about the starting point moving forward with those -- with the loan yield adjustment.

[BJ Losch, executive]

I'd say the margin in October was largely the same as where we were in September, maybe a modest step-up because of that repricing of the loan yields. So if you think about it, Mike, 47% of our loan book is variable rate, not all of that is the quarterly adjusting. We do have some sulfur-based loans in there. But generally speaking, you can kind of look at our loan yields in the third quarter and then adjusted for 40% of the portfolio being variable rates. So that's helpful. But we also moved late in the quarter, consumer savings up from $4 to $4.15, and so that has somewhat of an offset as well. So largely the same, but we'll have to see how, again, deposit competition heats up or not in the fourth and beyond.

[Michael Perito, analyst]

Yes. No, that's helpful and makes sense. And so on that last point, obviously, switching, I think in the slides, I saw 80% of production in the last few quarters has been variable. Now obviously, that's been very advantageous. And particularly on the loan sales, right? I mean the fixed rate SBA loan sales were pretty nonexistent for a while there. But curious how you guys are thinking about that dynamic as we approach theoretically, the top of the cycle here and rates aren't quite as volatile. I would think that the market for fixed loan rate sales might come back a bit stronger, if that's the case. And just wondering how you guys are thinking about the mix of loan production going forward where we're -- given where we're at today?

[BJ Losch, executive]

Yes. I think there's obviously much less appetite right now for fixed rate product, where we and a customer think it's the best for them. We'll certainly put them there. But variable rate is kind of the flavor of the day right now. When rates do start to come down, obviously, our portfolio loan yields will come down on the variable rate side commensurate with that. But we also think prepayments would slow because rates are coming down on those loans and making a cash flow a little bit more palatable for existing clients. So that will continue to help us expand our balance sheet growth and our net interest income growth. So we feel good about that. And then our ability to move the deposit portfolio rates down with market at the betas that we usually do. We feel like in a higher for longer, but even in a probably more importantly, in a declining rate environment, our margin will have tailwinds. That will be very helpful.

[James Mahan, executive]

Michael, let me add to that in another way, right? I have said for the 50 years I've been in this business that historically loyalty in the bank and this ought to be somewhere between 1/4 and 8.25%. I really don't feel that way right now relative to our small business borrowers, I tell you why. So the theory of verticality exists. When you've been in the -- for us in the vet lending space for 15 years and your reputation is out there when times get tough, people need capital. I think that matters. So our folks in the field every day, understanding the businesses that we lend to, I think, makes a difference in terms of everything, including that bid on that last rate on the loan.

[Michael Perito, analyst]

Just 2 more quick ones, if I can. And I'll just ask them together even though they're really not related. But BJ, I was wondering if -- just as we think about the model, wondered if you'd be willing to provide a little guidance or some guardrails around charge-offs and the tax rate for 2024. I realize both are probably incredibly difficult. But obviously, the charge-offs starting there have been kind of up and down, and I imagine that will just continue to be the case given the environment. But it's like a 30, 40 basis point number annually, you think pretty fair given the type of portfolio you have and where we're at? And then secondly, on the tax rate, just any initial thoughts about what you're budgeting there for next year, just given the pipeline of tax credit activity?

[James Mahan, executive]

Michael, this is Chip. That way to take a shot, buddy. We're not going to predict charge-offs in 2024. So I'll take that one and leave the other one to BJ.

[BJ Losch, executive]

Okay. On the tax rate, Mike, we currently don't have any investment tax credit activity in the pipeline for 2024. If that changes, we'll certainly let you know. But in the absence of any ITCs, you should expect our effective tax rate more in the 20% to 22% range next year.

[Michael Perito, analyst]

Got it. That's helpful. I understand on the chart off, maybe I'll ask the credit question just a little differently, Chip, and take the numbers out of it. I think this quarter, over the last 2 weeks, we saw some data points from others, particularly about my credit card data and like Discover and stuff like that, that wasn't great. Obviously, that's not directly correlated to you guys. But just curious, as you think about the reserve levels, the $232 million you guys mentioned, could you maybe go a layer deeper in terms of why you think that's kind of the right level just given where we're at. Obviously, a unique portfolio, and it's kind of a unique metric. So some -- maybe just some context around it, additional context would be helpful.

[James Mahan, executive]

So I'm going to Steve up, but let me just say this before I do, right? So in anticipation of this call earlier this week, I spent -- Steve and I spent a considerable amount of time with that business advisory group, our 62 young people that are in the market every day with all 6,000 customers. And then they went industry by industry, all 35 industries engaged Steve and I a complete write-up of what their view is currently of those industries at this time. So Steve, you can take it from there.

[Steven Smits, executive]

So I'll provide my thoughts around our portfolio today and then maybe from that, you can answer that question for yourself. So I am cautious, first of all, I feel the portfolio today is stable. I am cautiously optimistic that the portfolio will continue to be stable, if not improving over the next few periods. My confidence stems from a couple of points. First and foremost, what Chip articulated very well is we continue to double down in our servicing as we always have. I feel we have a very good pulse on the health of our borrowers. And I think we will continue to do that. That provides me confidence that I've identified where there is areas of stress, and we've wrapped that in support. Secondly, we made adjustments to our underwriting criteria, I believe, at the right times, and they appear to be proving out to be such. If we look at our performance by cohort year, we will see that 2020 cohort originations is significantly stronger than 2019. So we made adjustments with the anticipation that we will be entering into more rocky economic environment for a prolonged period of time, higher interest rate environment for a prolonged period of time. And I feel like that loans were underwritten to account for that. So I believe that those businesses will do quite well. I do believe that the government programs at the right time, provided meaningful support that has translated into stronger balance sheets, and we went to very strong operators that have done the right things, taking advantage of that additional balance sheet strength, and I believe they can navigate. We don't have the CRE challenges that many of our other banks have. Our CRE portfolio, I'll remind you, again, is not multi-tenant office. And then finally, I think we've been very strategic and smart about when others have -- there's a disruption in the lending environment. Our government-sponsored programs bode very, very well to attract higher profile applicants, and we're seeing that. So I again, feel really strong about what we're putting on the books today. So I think you put that all together, I would call it, confidence and stability knowing that we'll have pockets of challenges that we always will.

[Operator]

Your next question comes from Eric Specter from Raymond James.

[Eric Specter, analyst]

This is Eric Dialing in for David Feaster. Congrats on a good quarter. Just wanted to touch on the loan growth side, like loan growth accelerated in the quarter, pretty nice uptick in origination. Just curious how demand is trending from your perspective on what segments you're seeing the most growth? And it seems like solar is especially strong. Just curious what you're seeing across the board and especially in solar.

[BJ Losch, executive]

Yes. If you look at Slide 17, Eric, this is one that I like looking at every quarter and we put in every quarter to just kind of give you an idea of where you're seeing it. So solar had a really, really big year. Jen Williams, who is kind of our primary lender out there has just done a wonderful job, Taylor King and others. So we've seen huge opportunity, the inflation Reduction Act and all of the government incentives, combined with the network that we've got has just continued to create great opportunities. So that's certainly one. But if you look in lots of our other areas, like I talked about earlier, specialty health care and seniors housing have been quite strong in our conventional lending businesses, senior care, educational services, self-storage in our SBA verticals are up year-over-year versus where they were last year. So those are very strong. So we've got a very diverse set of verticals that complement each other quite well. And so we're very pleased with the performance of all of our verticals.

[Eric Specter, analyst]

I appreciate all the color earlier on credit. Just kind of ask it another way. More anecdotally, you have a pretty diverse production engine and tend to have a good pulse on markets. Just curious, as you talk to borrowers and see new loans come across your desk, are there any segments that you're starting to see weakness in? And have you noticed any shift in tone in your conversations with your small business customers?

[James Mahan, executive]

Steve and I will address that together, I think. I think the #1 thing that they say to us is people I'm having a hard time finding people that will actually work. I do not see trouble with price increases, Steve. I mean most of our borrowers seem to think that inflation is here, but they can pass that cost along. Those would be my 2 headline comments there.

[Steven Smits, executive]

Yes. I would say that our borrowers for the most part, have done a very good job in adjusting their cost of their services or their products commensurate with increase in debt with the rate environment, coupled with any inflationary pressures depending on the industry. These are questions that we dig into quite deep with each one of them. I would say a pocket. We continue to watch our breweries and just to put that in context, we have about $20 million in total exposure in small breweries that were prior to the pandemic years, I think 2019 and before. So they've been on the books for 4-plus years. However, they continue to navigate challenges from the rate environment and just -- which is probably a common theme that we hear. Obviously, no one likes to see their payments going up because of the rate. So we do get a lot of questions there. But also, there is legitimate shift in the industry for smaller breweries. Customer behaviors have changed. They're -- you could argue, oversaturation in brands in many markets. And many of these small breweries, their plan was to distribute and distribution model really doesn't work real well. So they had to pivot and change to hyperlocal tap room, and then you have taprooms that were closed due to the pandemic. And they're just a mountain of challenges that they're navigating. One thing I can tell you is this $20 million have been on the books for 4-plus years. We feel very confident in they're fighters. They're very communitive working really hard. Some will navigate perfectly fine. Others will continue to have some challenges, and we'll watch it. But that is a space that I think that we're continuing to watch.

[Eric Specter, analyst]

Just one last question and then I'll step back maybe more longer term. Can you provide maybe an update on your embedded banking build-out [indiscernible]? I think you talked about the onboarding of the first client coming online pretty soon here. Just curious how that's progressing and if you have any color on your pipeline for additional clients.

[BJ Losch, executive]

Yes. Short answer, it's gone great. We wanted to really tune in on one partnership, make it a deep one, make it an excellent experience for our partner and the customers that would be onboarded via that platform. So that is still going quite well. We expect that to launch early next year. And then from there, we are building our capabilities and candidly learning a lot from each other in this partnership to then expand to further partnerships over the course of 2024 into 2025. So -- but we'll probably have a more fulsome update for you once we actually get to launch early next year. But it's gone quite well.

[Eric Specter, analyst]

And congrats again on a great quarter.

[Operator]

Your next question comes from Stephen Sokolov from JPMorgan.

[Alex Lau, analyst]

This is Alex Lau on for Steve. I want to start with the gain on sale income line. The premiums for the loan sales have been stable in the 5% range for the past few quarters. Are you expecting to remain in the 5% range in the next few quarters? And what would need to happen in your view for these premiums to expand and for USDA loan sales to return?

[BJ Losch, executive]

Alex, it's BJ. I would generally say that we expect them to be in this range. There's lots of factors that go into it, everything from demand from buyers and poolers to trade-offs of what the yields might be on those pools and securitizations for SBA relative to other alternative investments like treasuries or conventional mortgages backed by the government, et cetera. So there's a lot that goes into it. If you go 2 or 3 years ago, the enhanced premiums we saw were from some of the enhancements coming out of the pandemic as it related to higher guarantees and those types of things, which have burned off. So 105 is probably a good place to assume for the next several quarters. USDA, we do expect to eventually come back. But the way that those work is we're not able to sell the guaranteed portion of those loans until the project is actually operational. So when we book the loan, there's construction that builds up over 12 to 18 months, let's say. And then once the project is finished, we can then sell the guaranteed portion. But if you rewind 12 to 18 months, the rate environment was a lot different. So therefore, the rates on the guaranteed portion of what we originated in USDA is just not as attractive for sales right now. But what we're putting on now as rates have risen, will be very attractive going forward when the guarantee is ready to be sold. So that's why we're optimistic that at some point, hopefully, starting next year, we'll start to see more USDA sales volume, but it's been obviously nonexistent over the last 4 to 6 quarters.

[Alex Lau, analyst]

My next question is on checking accounts. Can you give us an update on the operating account initiative in terms of account growth, customer usage. When do you think the noninterest-bearing deposit mix will start increasing from the 2% today to, say, 5%? Will it be measured in quarters or years?

[BJ Losch, executive]

So I think right now, as of today, we're probably around $200 million new operating accounts. We were in pilot most of last year and as of September 1, we are asking, requiring that loans that we fund to be funded into a Live Oka checking account. I think that's going to be incredibly helpful to ramp. But that just was instituted in September 1. So we're still in the very, very early innings of growing our checking accounts. But if we're at 2% today, Alex, I can't -- it's not going to be measured in quarters, but I think if you measure it in years, we're going to continue to see steady improvement from the 2% range, hopefully up into the 10%, 15% plus range over the next several years, which will deepen customer relationships, make those stickier ability to keep lending customers longer in addition to deposit accounts and, of course, change fundamentally the mix of our funding, which will provide a tailwind to. So it's going to be a long-term effort, but one that's going to be a gift that keeps on giving for years to come.

[Operator]

And there are no further questions at this time. I will turn the call back over to Chip Mahan, Chairman and CEO, for final comments.

[Operator]

Final comments are thanks for joining today, and we shall be talking to you at the end of January.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for joining, and you may now disconnect your lines. Thank you.