Live Oak Bancshares Inc

NYSE:LOB

Earnings Call Transcript 2017-Q4

[Operator]

Good day, ladies and gentlemen, and welcome to the Live Oak Bancshares Fourth Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Greg Seward, General Counsel from Live Oak Bancshares. Please begin.

[Greg Seward, General Counsel]

Thank you, and good morning, everyone. Welcome to Live Oak's fourth quarter 2017 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 follow the links from there. Our fourth 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 reconciliation of those measures to GAAP measures, can also be found in our SEC filings.

I will now turn the call over to Chip Mahan, our Chairman and Chief Executive Officer.

[James Mahan, Chairman and Chief Executive Officer]

Greg, thanks. And, good morning, all. We're obviously excited to talk about 2017 and to talk a little bit about what's going on in 2018.

First, the noise. We reported on October 1 our joint venture with First Data that $68 million onetime accounting gain is now complete. Somewhat fortuitous, we have an $8 million charge relative to our title insurance agency Reltco write-down and some merger-related expenses.

And just a word on Reltco, so we often say here that our customers care about two things: Am I approved; and when am I going to get the money? We bought this agency to get them the money faster. And in 2016, we tested that company with about 100 customers. That grew to 400 customers this year. At precisely the point in time interest rates went up, the retail business softened to the tune of about 20% resulting in this write-down. But we're very confident that they will continue to get our customers the money faster. And it looks like the retail pipeline is picking up, so healthy 2018 from our view.

DTL reval $19 million, about $14 million of that will be cash, mostly at the bank, some at the holding company, but certainly able to downstream to the bank to grow the business.

Bullet point number two on Slide 1, strong core operating business. We had a good year, loan originations up from about $1.5 billion to about $2 billion or 26%. And just a word to the wise here, during the crash the SBA decided to allow 100% financing. And recently, beginning 1/1 of this year, they decided to revert to where they used to be, which is requiring 10% down. This will hurt some of our verticals, particularly the chicken business, the vet business and the healthcare business.

That said, we are extremely excited about the work done by Seal Team 6 and Seal Team 7. You'll remember that Seal Team 6 is the theory of verticality. I think we can continue to grow that business four verticals a year-ish. And there are 4,800 SBA lenders out there that do not work here. And Kay Anderson is doing a wonderful job, attracting certain key individuals that we think fit our culture.

So moving on to our march to increasing recurring revenue, while surgically enhancing return on equity through strategic loan sales. When we took this company public in 2015, many of you were reflecting on us as being a gain on sale junky. We had tried to make the case that, that loan sales in the SBA business were predictable. Many thought that when rates went up, that premiums would go down. And it was certainly in these recent rate increases we have seen that that is not the case.

Credit quality is excellent. And, I got a slide, my favorite slide, to talk about capital generation and how we think that we can grow this business substantially and not dilute you our existing shareholder.

Moving on to Neil Underwood and software development 2.0, many of you know that in February of 2012, we spun off our sister software company and friends across town, nCino. We had to solve the problem. We had to, in order to treat every customer like the only customer of the bank we had to have an elegant handoff from the lending officer to the underwriter, to the closer, to the servicer.

This back in commercial loan origination software company, nCino now does business with 10 of the top 30 banks in the United States of America and a 100 community banks. Recently, opening an office in London and taking that software global. We're very proud of what they have done there.

That said, Neil was bored and decided to attack the right side of the balance sheet, and began writing code with soon to be 50 software developers to develop next generation deposit technology. That deposit technology will be offered to over 500 Apiture banks. He will talk about that more in a minute.

Moving on, Greg and Mike, at the Slide 2, growing recurring revenue. It's shocking and exciting that just three years ago today we generated $27 million of recurring revenue that being defined as net interest income plus loan servicing revenue. And we have quadrupled that this year to over $100 million. So our recurring revenue as a percent of total revenue has increased from 37% to 56%, because the loan portfolio quadrupled as well from $499 million to over $2 billion.

So for you credit guys out there, hang on, I got another slide to make you feel better, coming in a minute. Before we do, let's look a bit more granularly.

In Slide 3, over the last five quarters. So again, excited about recurring revenue growing from $18 million to almost $30 million, and as a percent, from 47% to 58%. And the portfolio grew from $1.3 billion to over $2 billion. And Scott's going to talk about some more of this in just a second.

So the credit guy and he loves to talk about this on Slide 4, proactive approach to credit decisions. For the quarter, charge-offs 28 bps, for the year 20 bps of losses, about $3.6 billion on an average loans or whatever the reverse of that calculation is.

ALLL, almost 2%, amazingly total non-performing loans plus other real estate owned is $3.7 million on a portfolio of $1.250 billion. And unguaranteed nonperforming loans as a percentage of total assets only 13 bps.

So now my favorite slide moving onto Slide 5, I kind of view this is the safety and soundness non-dilution slide. So at the end of the year, we had $437 million of equity at the holding company of $24 million loan loss reserve, and in the past 12 months we grew our treasure chest which as you know is our guaranteed loan portfolio from $112 million to a little over $300 million.

So back to the market for loan sales and premiums, so if you apply a 10% premium to that, pre-tax, after-tax just assume pre-tax is after-tax as another $30 million. So $437 million plus $24 million plus $30 million gets you to almost $500 million of capital and unguaranteed paper of $1,250 million on a $2.7 billion bank. The point is we can grow this business substantially and not dilute you, our existing shareholders.

Scott, talk a little bit about the bank.

[Scott Custer, President, Live Oak Bank]

Yeah, thanks Chip. Good morning. I'm going to cover the next four slides. And I think the best way to capture. These four is the Live Oak business model at work. And my simple brain can do things in sets of three, and so I would capture Slide 8, 9, and 10 in three ways. One is the sustainability of the business model; two would be the leverage that exists in the business model; and three would be the growth characteristics that are inherent to the business model; and then fourthly, I'm going to touch on deposits.

But first, Slide 8 does speak to the sustainability of Live Oak's model, and I would go to the middle column and that is Live Oak 2.0 and that is our verticals that have a - that are still relatively new but are catching their momentum. And you know the growth, once we get a vertical up and running, once it catches its momentum, you see the healthy growth characteristics that are there with a year-over-year growth from $441 million to $805 million.

Live Oak 3.0 is the verticals that we're really just started in 2017, and you see the early returns there are exceptional and we believe look very good for 2018 based on current pipeline. So I think that slide, if nothing else shows that is verticals mature, we're able to add new verticals and the sustainability of the model is exceptional.

The next slide speaks to what I said was the leverage that exist in each of the - in our verticals that as they mature and potentially growth slows, revenue is still is being generated and generated over a relatively fixed costs base. You see the leverage has already been built in 1.0, growing in 2.0, and we'll see the same thing in 3.0. That leverage not only exists in the verticals but it translates to the operating leverage that's inherent in the business and we'll see that continue as we move forward.

And finally with respect to the loan part of the business model, I don't know that there is a bank that has this type of asset generation characteristic. And Chip touched on some of the challenges that we may faces, we move into 2018 with changes to the SBA policy with other just external macro factors that are out there. However, we are hard at work, identifying new lending opportunities, new business moving us away from just sevenists [ph] being reliant on 7(a) lending, you'll see by the percent of 7(a) lending as a total continue to decline as we move into 2018 generating a more diversified asset mix and a more diversified revenue stream.

And whether 40% compounded annual growth rate can be continued, but I'm not going to speak to that, I think though that this is a company that's always found a way to grow, and we'll continue to do so.

Just a quick word, because as we have that kind of growth on the left hand side of the balance sheet, we need to be sure we're doing the right work on the right hand side, and I keep tell you how much work is being done on deposits, funding in general. But this is just a great snapshot of one area where huge progress was made in 2017 and that's in our new online savings product. You'll see just in the last quarter $577 million generated - generated the deposit portfolios $2.3 billion. Now, in just some of the growth statistics, in this account alone, we're averaging almost 40 new accounts a day, $3 million in new deposit inflows a day. Nice sizeable account balances, almost little over 17,000 new accounts for the year.

And you'll see the cost of funds there at 1.43% and therein is our challenge going forward. We're proving that we can grow deposits in a branchless online way. Now, we got to work on how we lower our cost. To do that and my partner Neil Underwood is going to tell us how he is hard at work making that happen.

[Neil Underwood, President, Live Oak Bancshares]

Thank you, Scott. And, Chip, I don't know if I'd characterize my motivation as being bored. But I refer you to Slide 12. 2017, as Scott mentioned, was a banner year in collecting and gathering net new deposits. The number totaled to 719 through electronic channels with no branches.

We did this with four products: personal and business, CDs and savings. 2018 is going to be even a busier year. We have to take our current assets and the Live Oak Bank platform, move that to Apiture and get on to Apiture 1.0 product.

In addition to Apiture 1.0, we'll be rolling out this year Finxact, our digital core banking system that will enable massive scale. In addition to that, we'll also be rolling out Payrailz, which is our payment processing platform. So it's going to be a busy year. The ultimate result will be a digital banking platform being able to service, this picture that we're looking at on Slide 12.

I'd like to term this my digital banking topography picture. On the left side, you're going to see something that's much more common place, access to consumers and small businesses through channels like web and mobile. The only complexity there are new Internet of things devices such Alexa, Apple TV, chatbots, wearables. So the industry has a problem reconciling just that.

However, that's not the exciting thing to us. On the right side, there is an entire new opportunity to gather deposits. We're calling this digital partner banking. And it effectively is new customer acquisition through digital partners, such as practice management providers, online lenders, robo advisors and more. The ultimate benefactor to this will be Live Oak Bank accessing sticky low-cost core deposits and the most important thing is at scale.

And the example that we're about to show you is a great one, because with just one digital partnership you have access to tens of thousands worth of customers. So moving on to the next slide, we're actually going to show just kind of an example. I happen to be a veterinarian at Loving Paws and Tails Clinic. And I'm now enrolling in my new veterinarian system. It's a cloud based practice management system.

Veterinarian happens to be a great place for us to start, because we got massive brand recognition there. And just in line as you see with that setup, there is a Live Oak Bank icon and you could double-click that and open up a new account. Slide 14 actually demonstrates that. Some of the same field required in a practice management software, going to be the same field you need to open up a new account. So we do an API call from that system.

And what's beneficial about that is the customer never had to leave the system. They never enter data twice. And we call this, kind of this notion of friction-less onboarding. They're going to get an e-mail in their inbox saying, Welcome to Live Oak Bank Business Checking. But they never had to leave and go to our site. All this happens in a KYC BSA compliant manner. And the benefit is with this one relationship we have access to about 10,000 veterinarians that are signing up.

The last slide, the team, really talks about the total addressable market and it's not a onesie-twosie type of the same practice management systems. And there are two or three of those in every industry and there were thousand industry robo advisors, tax prep companies, e-commerce store fronts. You could read a list. The whole point being, we feel that if we can roll out this digital banking platform as we're discussing, Apiture 1.0, Finxact and Payrailz will be uniquely equipped to go after that market.

So the goal, along with the rollout of those technology platforms will be to have three partner customers live, partners this year. And the benefactor, of course, will be Live Oak Bank, driving new low-cost deposits with low deposit betas.

We'll keep you informed of this over the quarters to come. So that's all I got. Caines, over to you.

[Brett Caines, Chief Financial Officer]

Thanks, Neil. We're very excited with Q4 earnings of $1.74 per share and $2.65 for the year. With several onetime events occurring in Q4 like Chip mentioned, I will at times refer to operating results compared to reported results.

Operating results are reflection of our financials, excluding these onetime or non-routine transactions. A full schedule of these items is available in the GAAP to non-GAAP reconciliations at the end of our earnings release that we filed yesterday.

Adjusted for onetime events, we consider our operating EPS to be $0.41 bringing the full-year to $1.25, well above the prior year was $0.57. Likewise, we view our steadily raising after-tax operating ROA as 2.6% for the quarter. Reported results benefited from both one-time gain and the effect of the new tax bill signed in late December.

The exceptional gain of $68 million resulted from the formation of Apiture JV with First Data. We also reported a reduction to income tax expense of $18.9 million from the revaluation of our net deferred tax liability arising out of the recently enacted tax legislation, which resulted in a negative effective tax rate for the full year of 2017. This Q4 event also served to bolster our capital levels. There were also some offsetting one-time expenses that I'll discuss shortly.

Looking to our balance sheet. The total loan portfolio grew 56% over the past four quarters to just over $2 billion. This is the product of our very successful strategy to build longer term revenue streams and reduced earnings volatility by retaining more of our lower risk guaranteed loans.

We will continue the strategy in the coming year and does expect to sustain exceptional portfolio growth. Loan originations rose to $483 million in Q4 bringing the 2017 total to over $1.9 billion, nearly a 26% increase over 2016. We expect year-over-year loan originations to continue to grow in 2018, but at a lesser magnitude in that experience in 2017 with an increase in the lower double digits range over 2017. Given our much larger base, this continued year-over-year growth remains very healthy relative to production volume.

Our recurring revenue of net interest income and servicing revenue sources increased to $29 million in Q4, a 60% increase over Q4 2016 and a direct result of our retention strategy. The net interest income component grew 85% over the prior year's fourth quarter to $23 million, driven by loan growth combined with the raising net interest margin that grew 16 basis points from Q3 to just under 4.1%, illustrating the quarterly repricing nature of much of our loan portfolio.

The servicing revenue component totaled $6 million in Q4 with servicing portfolio of $2.68 billion. The resulting servicing asset value was approximately $52 million after revaluation loss of $6.3 million in Q4, which had more to do with loan amortization and prepayments than with changing market conditions. While don't foresee valuation losses moving back down in the coming quarters, we fully expect servicing revenue to exceed such amount. The secondary market for SBA loans was very stable in 2017 through several rate changes and we don't anticipate any threats to this stability in 2018.

Guaranteed loan sales totaled $212 million in Q4. Overall premiums were steady compared to Q3 and significantly higher than those prevailing in late 2016 and early 2017. The net gain on sale of loans was $23.3 million or approximately $110,000 of revenue for each million sold similar to last quarter's average premium.

Reported non-interest expense in Q4 totaled $41 million, which included an aggregate of $8 million in onetime costs as mentioned earlier. The majority was $5.2 million related to Reltco including goodwill and other intangible impairments and the recognition of the contingent liability for the modification of certain original agreement.

As mentioned last quarter, the financial performance of Reltco has been lower than originally projected due to the overall slowdown of refinancing activity for the mortgage industry. We also incurred $1.7 million in M&A related expenses in Q4 related to the formation of the Apiture joint venture. Excluding these non-routine items, operating non-interest expenses in Q4 was $33 million, a decrease from the Q3 level. We do expect expenses to resume growing throughout 2018, as we build out new verticals, add products and pursue growth opportunities.

However, we possess excellent operating leverage as evidenced by the 60% growth in recurring revenues in 2017, well above that of operating expenses. Our deposit base continued its upward trajectory in Q4 reaching nearly $2.3 billion. With the increased emphasis on liquidity in the industry, we will be ramping up our deposit campaigns in the early part of 2018 to increase liquidity. This will put some downward pressure on our interest margins, which will be somewhat mitigated by higher loan yields arising out of the fed rate increases.

Turning to credit quality, net charge-offs declined to $892,000 with a 28 basis point loss rate in Q4, and we continued our improving NPA trend for the fifth straight quarter. As a percent of total assets, non-guaranteed non-performing loans and foreclosures were 13 basis points, down from 29 basis points in the year ago.

Provision expense totaled $4.1 million in the fourth quarter, well above net charge offs and consistent with our rapidly growing loan portfolio. Our renewable energy leasing business exceeded expectation for 2017, generating approximately $25 million in growth investment tax credits.

Looking to 2018, we expect good, but intentionally slower renewable energy lease originations and related ITC generation in order to manage the buildup of any DTA balances. When combined with the lower corporate tax rate, we believe our effective tax rate for the full year of 2018 will be in the low to mid-single digits, keeping in mind that this can vary from quarter to quarter. These tax benefit sources will allow us to retain more of our earnings, further augment capital and continue to grow our brand.

Our capital position is very strong exiting 2017 with a total capital ratio of 18.9%. We are well positioned for a strong 2018 as revenue continues to grow, primarily in the form of predictable, recurring stream, and as our loan and deposit platforms continue to diversify.

This concludes my comments. I will turn the call back to Chip for final comments before Q&A.

[James Mahan, Chairman and Chief Executive Officer]

Brett, thanks. I think it's obvious that we're beginning to hit on all cylinders. That said, we're going to report back to you on growth of originations, because this is less of an origination story and more of a profit story. So as we reflect on 2017, we made right at $40 million pre-tax. Analyst estimates for 2018 are for us to make about $50 million pre-tax. That's a 25% increase. We're comfortable with that.

Michael, we will open the floor for questions.

[Operator]

Thank you. [Operator Instructions] The first question is from Nick Grant of KBW. Your line is open.

[Nick Grant, KBW]

Hey, good morning, guys.

[James Mahan, Chairman and Chief Executive Officer]

Hey, Nick.

[Nick Grant, KBW]

So I really appreciate the color on the tax rate that you're anticipating in 2018. But as you're avoiding kind of building too large DTA, you got to speak to, I guess, what kind of limitations you had and how large that can be? And any feel for, I don't know, capacity of what you can add in terms of tax credits?

[Brett Caines, Chief Financial Officer]

Yeah, I think the way that we look at DTA and those types of credits internally we can manage or control that through the volume of leases that we originate. Internally, and I think we - I think we said externally in prior calls that we do not intend to build a DTA that we would foresee taking more than five years to work through that DTA, so maximum buildup of five years' worth.

And just a reminder, tax credits generated from the leasing activity is that, those can be carried forward for 20 years. But we would manage that number to something less than five.

[Nick Grant, KBW]

Okay, great. Thanks. And then, obviously, I mean, you guys are building a lot of capital right now. I know you guys have always kind of run with a little bit more, just kind of offensive and some additional flexibility from that. But I mean, with the TCE, where it's at now, do you guys think about capitals returned any differently. Is it an opportunity to increase venture investments or how should we be thinking about that?

[James Mahan, Chairman and Chief Executive Officer]

Well, that's a good question. I mean, I'm looking at Underwood and he knows that we have another $15 million of cash coming back from taxes that he would be excited about investing in other members of this ecosystem.

I mean, the way I look at that, Nick, is multi-dimensional. So if you think about the theory of verticality in 19 verticals, and you think about the domain experts that advise the credit guys in each of those verticals. And then you think about, of all the loans in America that are made to those industries, how much are SBA 7(a) loans?

And yeah, little bit of a curve ball from the agency on what the black and white and the grey to qualify as a eligible loan for 7(a). But let's be smart about this, right? Now, that we have as you pointed out, large amounts of excess capital, can we make really smart conventional loans inside those verticals?

And I don't mean like competing with Wells Fargo to make a 4.25% 25-year fixed rate loan to veterinary. No, not that at all. But I think Scott will tell you that there are multiple opportunities out there to diversify the product mix.

[Scott Custer, President, Live Oak Bank]

Sure, yeah, there are. And whether it's leveraging - and the great thing about it is we do have some subject matter experts that are not just subject matter experts in SBA, they're just subject matter experts in credit, finding ways to structure credit. And I think there are niches in conventional lending that we will be able to explore, probably more to come on subsequent calls as we go through the year in 2018.

[Nick Grant, KBW]

Okay. And then, maybe like I guess a quick follow up on that, as I think of the strategy how you do that. But in terms of your process, do you think layering in conventional products, would that be going back to SBA borrowers that have kind of migrated to more bankable or would you be bringing in kind of new vertical sales teams and layering in a new product with new customers or - is there a way to think about that yet?

[James Mahan, Chairman and Chief Executive Officer]

Yeah, so our Chief Credit Officer and former head of the Office of Capital Access of the SBA is with us today. And, Steve, I know that we've been working hard, particularly in the gov-con area on asset-based lending and doing some more conventional sort of things and other vertical. You may want to comment on those other products and how you look at that from a credit quality standpoint.

[Steve Smits, Chief Credit Officer]

Thank you, Chip. Yes, so to Scott's point, asset-based lending is one example of subject matter expertise in a specific type of lending opportunity. So we can look at that both as opportunities within our existing verticals. Accounts receivable, financing is a good example of that. But we can also look at that as outside of our existing verticals, where we leverage the expertise and we build the expertise to provide very specific specialty financing opportunities.

And then, yes, as well as we have a robust portfolio of growing businesses, that as they continue to grow we would like to continue to provide solutions for them that may be outside of SBA. So there is that opportunity as well, so I would say both in tandem.

[James Mahan, Chairman and Chief Executive Officer]

Thanks, Steve.

[Nick Grant, KBW]

Okay. And then, maybe - yeah, maybe one last follow-up and then I'll hop back on the queue. Can you speak to the amount of, I guess, your new originations are coming on now. They're non-government guaranteed and also maybe just the regular ABL loan. Is there any of that right now or to - anyway you can speak about size it would be really helpful?

[James Mahan, Chairman and Chief Executive Officer]

There is, so gov-con or government contracting is an example of a division or a team that focuses on providing asset based lending solutions to government contractors. These are non-SBA, true monitored accounts receivable financing solutions. So that's a good example. We're seeing a good growth within that space as well.

[Nick Grant, KBW]

All right, excellent. Thanks, guys.

[Operator]

Thank you. The next question is from Jennifer Demba of SunTrust. Your line is open.

[Jennifer Demba, SunTrust Robinson Humphrey]

Thank you. Good morning.

[James Mahan, Chairman and Chief Executive Officer]

Good morning, Jennifer. First question, if you look at your Slide 8, your three buckets of vertical groups, could you just talk about the growth or declines in each of those buckets and what was driving each? So, which verticals were relatively more successful or not in 2017?

[Scott Custer, President, Live Oak Bank]

Sure, Jennifer. This is Scott. Let me just take them. I'll go left to right as you're looking at your slide. So you got Live Oak 1.0. I'll pick out a couple there, because you know originations went from a little over $1 billion to just a little under a $1 billion, so a little decline. Our vet business, which is the business we've been in the longest, yeah, that business is just - it's stable, but it's not growing and probably had a slight step-back, just because you reached a point in a market and in a specific industry where you've sort of reached your - not reached your saturation point, but you've reached an optimal level of origination there.

I would say, if you just go down the healthcare businesses, the way we do it, we don't compromise credit standards and we have our own pricing and it's exceptionally competitive. And so, we see some challenge just really from a competitive standpoint there.

And the checking business, which Chip referenced at the bottom, while still strong, you're really relying on how the integrators build new complexes and that ebbs and flows from year-to-year, 2017 was a little bit slower year, we believe that as we go into 2018 and 2019 there will be more of those larger complex is being brought online and that will drive more volume.

So I'd say those are the three areas there that probably drove a relatively flat year. As you move across to the next column, our self-storage business is exceptionally strong. Steve commented on our government contracting business, which is new but gaining really good momentum. Strong originations in our hotel business and renewable energy, it's an interesting vertical in that it gives us an opportunity to do a little different type lending, often still government guaranteed, but guaranteed with USDA product. And the individual loan sizes they are tend to be larger, so we get good volume there.

And then finally, in our newest verticals, our early education was brand-new, it's a vertical that we've gotten established in there are four or five key players in that market. We've got great recognition and traction with those key players and we think that's a growing an important vertical. We hired - our really first step at hiring team lift-outs is in our merger acquisition business. And we were able to hire a really qualified team of two individuals that are going to drive that business in the pipeline there is good.

And then really the start - what is that - I'm adding up seven verticals in a year and do a - over $150 million out of the gate, I think, represents how these things can get going and gain momentum.

[Jennifer Demba, SunTrust Robinson Humphrey]

Okay. You said, you're looking for low-double-digit growth in originations in 2018?

[James Mahan, Chairman and Chief Executive Officer]

Yeah. So let us get back to you on that. Brett said that, this is kind of the law of large numbers. We are going to digest this SBA rule change. So I don't want you to plug in a number on that one, Jennifer.

[Scott Custer, President, Live Oak Bank]

I would just add that, Chip. It's still early days, I mean, the SBA changes - this is January 24, 25, wherever, and the changes went into effect January 1. So we need to see how that's going to play across the broad. We also have, as Steve and you pointed out, we have new products that are coming online. And as you begin to bring new lending products, we know that there are - there is market demand, we know there are niches we can play in. But we are just beginning to scratch the surface in some of those areas. So it's a long way from here to the finish line of 2018, and much work to be done into try to put a specific number here in January is a difficult thing to do.

[Jennifer Demba, SunTrust Robinson Humphrey]

So my hearing that your biases, you think that your low-double-digit guidance is conservative?

[James Mahan, Chairman and Chief Executive Officer]

No. We are not going to talk about any predictions, Jennifer.

[Jennifer Demba, SunTrust Robinson Humphrey]

Okay. What do you think it could be - if you think low-double-digit is not conservative, what is your worst case scenario?

[James Mahan, Chairman and Chief Executive Officer]

We never think - again, Jennifer, I think we need to be talking more about pre-tax income and recurring revenue as opposed to historical year-over-year originations. That's where we wanted to focus in the future.

[Jennifer Demba, SunTrust Robinson Humphrey]

On that, expenses, Brett, you said, you're running at core run rate at about $33 million in the fourth quarter. What kind of non-interest expense growth, are we looking at this year and what are the drivers there and are there any unusual components, we should be watching for?

[Brett Caines, Chief Financial Officer]

Yeah, I would say on non-interest expense growth, I think $33 million is core and Q4 was probably a little bit of an anomaly, I think looking back to Q3 of 2017 and Q4 of 2017 together probably would establish of better base to work from going forward.

But we continue and we have plans to add new verticals in 2017. So any infrastructure we add to support that, excuse me, in 2018. So any infrastructure that we add to support that growth would certainly add to non-interest expense. And I would just point you back to looking at our metric of non-interest expense to production. And seeing how that trends, along with our historical efficiency ratios quarter-to-quarter as you trend forward.

[Jennifer Demba, SunTrust Robinson Humphrey]

And can you give us some more detail on your non-interest margin outlook? For the year, you said you expect some pressure.

[Brett Caines, Chief Financial Officer]

Yeah, so you probably noticed in our earnings release, our loan to deposit ratio was 95%. We are looking to work that down a touch. We - I guess, from that, holding that extra liquidity, we do think that will put downward pressure on our net interest margin. However, as we talked about in the past, roughly two-thirds or little more than two-thirds of our own book, loan portfolio, does re-price on a quarterly basis.

So as the fed makes its moves in 2018, the bulk of that loan portfolio will be re-pricing upward, so that will mitigate any NIM that has dampened by the excess liquidity that we're bringing on. And, I guess, the point in that comment was you won't necessarily see the big jumps in NIM that we've experienced over the last couple of quarters.

[Jennifer Demba, SunTrust Robinson Humphrey]

Okay. Thank you.

[Operator]

Thank you. The next question is from Aaron Deer of Sandler O'neill & Partners. Your line is open.

[Aaron Deer, Sandler O'neill & Partners LP]

Hey, good morning, everyone.

[James Mahan, Chairman and Chief Executive Officer]

Good morning, Aaron.

[Aaron Deer, Sandler O'neill & Partners LP]

I'm just curious with the - have you guys given any thought to the tariff that was announced on solar tax panels, and what impact that might have on your renewable energy and solar panel leasing businesses?

[James Mahan, Chairman and Chief Executive Officer]

Steve, help us out there.

[Scott Custer, President, Live Oak Bank]

Absolutely, Chip. So, yeah, so, as we think about a couple of points, first of all in the projects in our solar area, we're not providing the construction financing, and so there is a quite a bit of lead-time. So as we look at our pipe, all the projects that are currently in the pipe have already procured their panels. So it's really not an issue for what we have in the pipe going forward.

But as we look beyond that, the panels represent about 40%, typically about 40% of the total project costs of the projects that we're financing. So if you kind of think about 40%, 30% of 40% that kind of equates to 12% increase in the project scope, which the projects that we're financing can certainly tolerate that.

So it will be a little less to the developer, but certainly manageable. So we don't see it as being a big issue. Where also keep in mind that the tariffs supply to 2.5 gigawatts or above, so many of the projects fall below that as well. And then, they also just start to step down over the years of 5% increment. So again, we don't see that as impacting our forecasts going forward.

[James Mahan, Chairman and Chief Executive Officer]

Well said, Steve.

[Aaron Deer, Sandler O'neill & Partners LP]

Okay. And then, relateably, Brett can you talk a little bit about the amortization on the lease equipment tied to that and how that plays into kind of your expense guidance here?

[Brett Caines, Chief Financial Officer]

Yeah, I think when you're thinking about expenses and income associated with those solar panel leases, the lease income that we receive will roughly offset the depreciation expense that we take. So as you're modeling that, I would say the depreciation expense that you're putting in, should be offset by any lease income that you're modeling in your other non-interest income for us.

[Aaron Deer, Sandler O'neill & Partners LP]

Okay. And then another one for you, Brett, on the - given, I guess, some of the mix changes and doing more of the loans that are backed by the USDA, which I believe typically have the lower gain on sale margin. The gain on sale premiums or margins recently have just been exceptionally strong. As that mix changes, even assuming no change in kind of the secondary market, where do you see the average premium or margin on your gain on sale going through 2018?

[Brett Caines, Chief Financial Officer]

Yeah, I think so, with the backdrop of - overall, we think that secondhand market's going to be pretty stable. As you said, it is heavily impacted by the mix of loans that we sell within any quarter. In Q4, for example, we sold very little USDA production. And the USDA that we did sell was actually originated from our hotel vertical mostly, which I think received a higher gain on sale than the structure - through renewable energy loans.

But you're correct, as we layer in more renewable energy loans for sale in 2018 that will put downward pressure on the gain on sale that we're forecasting out. I would say to look at Q4 as the top-end of what you model with 2018 being less than what we experienced in Q4, as we sell more renewable energy USDA.

[Aaron Deer, Sandler O'neill & Partners LP]

Okay. Good stuff. Thank you for taking my questions.

[James Mahan, Chairman and Chief Executive Officer]

Thanks.

[Operator]

Thank you. And at this time, there are no further questions in the queue. I'd like to turn the call back over to Chip Mahan for closing remarks.

[James Mahan, Chairman and Chief Executive Officer]

Thanks, everyone, for attending and we'll see you next quarter.

[Operator]

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day, everyone.