Live Oak Bancshares (NYSE:LOB) reported third-quarter financial results on Thursday. The transcript from the company’s third-quarter earnings call has been provided below.
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Summary
Live Oak Bancshares reported third-quarter EPS of $0.52, which was impacted by a $17 million provision related to its exited distillery portfolio. Excluding this, adjusted EPS was $0.76.
The company demonstrated strong operating leverage with a record adjusted PPNR of $88 million, up 33% year over year, and adjusted revenue growth of 15% year over year.
Live Oak Bancshares emphasized strategic initiatives such as expanding Live Oak Express and growing business checking accounts, both of which showed significant growth.
The company continues to leverage AI for operational improvements, with 100% employee access to AI-native tools to enhance credit data management and portfolio monitoring.
Management expressed confidence in the company’s small business banking model, highlighting its position as the top SBA lender by dollar amount and the resilience of its loan portfolio.
The future outlook remains positive, with expected continued growth in loan originations and a stable net interest margin despite competitive deposit markets.
Management addressed the distillery portfolio’s challenges proactively, emphasizing its commitment to resolving such issues swiftly and maintaining transparency.
The company is working toward reducing its provision expenses over time, focusing on maintaining strong pre-provision earnings to absorb any future credit challenges.
Full Transcript
OPERATOR
After today’s prepared remarks, we will host a question-and-answer session. If you would like to ask a question, please press star one to raise your hand. To withdraw your question, press star one again. I will now hand the conference over to Greg Seward, General Counsel. Greg, please go ahead.
Greg Seward (General Counsel)
Thank you. Good morning everyone. Welcome to Live Oak’s third quarter 2026 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 Live Oak Bancshares and go to the Events and Presentations tab for supporting materials. Our 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 and in the presentation materials. Here in the room we have Chip Mahan, our Chairman and CEO, and Michael Cairns, our Chief Credit Officer, who will be available for Q&A after our President, William C. (BJ) Losch III, and CFO, Walt Phifer, finish their prepared remarks. I’ll now turn the call over to BJ.
William C. (BJ) Losch III (President)
Great. Thanks, Greg. Good morning everybody. Let me start where you’d expect me to start. We reported EPS at $0.52. That is obviously not the number we wanted to print and not the number you expected from us. The driver was 17 million of additional provision on our exited distillery portfolio, about $0.27 of EPS. Excluding that action, adjusted EPS was $0.76. Later on, Walt will walk you through that bridge on slide 15. So I’ll spend time right up front on that this morning, but then I’m going to spend quality time on what is at risk of getting lost this quarter, which is our operating performance and momentum. Underneath these results, which is simply outstanding, one of the strongest operating quarters in our company history.
Let’s get started on slide 4. Five themes in the quarter. 1. The decisive action on the distillery portfolio. 2. Outstanding operating leverage momentum with record adjusted PPNR of $88 million, up 33% year over year. 3. The main Live Oak engine, our small business banking model, is humming. 4. Live Oak Express and Business Checking are now generating meaningful profit and have a long runway ahead. And 5. Deploying AI is front and center for us, and our adoption continues to accelerate.
We’ve only scratched the surface of what’s possible. First of those five is about actively dealing with a challenge head on, which is who we are. And the others are about continuing to build a company with strong, sustainable operating earnings and growth. Overall provision this quarter was 55 million, four pieces, and they shouldn’t be looked at the same way. And you can see that on slide 5. First, 17 million, or 31%, on the exited distillery portfolio. More on that in a moment. Second, 16 million, or 30% of the total, from loan growth. We added more than 700 million of loan balance growth this quarter, a record. As I’ve said before, CECL is not kind to growing companies like ours. That 16 million is a reserve against loans we haven’t had a chance to earn a penny on yet.
I’ll take that trade over low growth and lower provision all day, every day. The third, 13 million, or 24% of the provisioning, was in commercial banking from six relationships across three verticals, not concentrated. Since these are larger loans, we will see more of a mix of impairments, charge-offs and recoveries in any given quarter, making results more lumpy. Fourth, 9 million, or 16% of provisioning, was in small business where it was diversified, with no single industry driving it and consistent with the history of our book.
Turning to slide 6 on distillery, as we talked about last quarter, we exited this vertical in 2024, over two years ago, and we’re at workout only. And while eight of the 13 loans are still accruing, we have 98% of the portfolio classified and have dedicated workout resources for all of them, with every remaining loan under enhanced monitoring. What happened industry-wide is pretty straightforward if you read the news: second straight year of declining U.S. spirits demand, resulting in further excess barrel inventory across the industry, which is driving a sharp decline in collateral values.
We’ve now recognized 29 million of provision year to date on this portfolio through specific reserves and net charge-offs. That portfolio is about 1/2 of 1% of our total loan book. So of course this hurts, but it’s manageable given our PPNR strength. We have a saying at Live Oak that when you have to eat something unpleasant, you don’t take small bites. And that’s exactly what we’ve done here. Every quarter we’ve taken every charge and every impairment we could reasonably support, as soon as we could support it.
We have not spread this out to smooth the quarter, and we’re not going to with this or any challenge we have from here. What we watch is collateral realization versus our current estimates, ongoing performance of those businesses, and active cooperation from our borrowers. We’ve been proactive with each relationship and exposure and will continue to be. And we’ve made significant progress working the book in the last six months. We’ll continue to be transparent as we work through the rest of the exposures.
Now turning to slide 7, let’s move beyond the distillery noise and look at the fantastic operating earnings which are outstanding. Adjusted revenue grew 15% year over year to 172 million, while adjusted expenses grew only 1%. Fifteen and one, 15x operating leverage. That produced record adjusted PPNR of 88 million, up 33% from a year ago and 16% from just last quarter, with our adjusted efficiency ratio improving 7 points year over year from 56% to 49%.
We’ve built an operating model that produces 88 million of pre-provision earnings a quarter and growing. That’s the number that matters most to me because it is the number that allows us to absorb actions like we did this quarter. And on that last point, slide 8 demonstrates just how much we have improved the business over the last two years. So go back two years to the third quarter of 2024. Adjusted PPNR was 53 million. Today it’s 88 million, up 64%. Adjusted revenue is up 31% over that stretch while expenses are up 9—over 3x operating leverage—and total assets are up 35%. Now look at the provision. Q3 2024, we took 35 million in provision and delivered 19 million of adjusted pre-tax income.
This quarter we took 55 million—$20 million more—and still delivered 33 million of pre-tax income. That is 74% more pre-tax income in just two years while absorbing substantially more provision, and excluding distillery was 50 million, 163% above where we were just two years ago. That’s excellent operating leverage and it earns us the flexibility to deal with a problem and keep momentum moving forward. Flexibility we did not have two years ago. It is the reason we can take the big bite and still earn money, still grow 16%, and still fund every initiative that matters to us.
Turning to slide 9, the biggest driver of that performance continues to be our small business franchise, the engine of this company. We are the number one SBA lender in the country by dollar amount again, and it’s not even close. Our deep expertise across 30 verticals, along with an unmatched speed and quality of execution, is why. The business is clearly demonstrating soundness and profitability along with that growth, and our default performance continues to significantly outperform the broader SBA industry.
This is a portfolio we have underwritten through multiple cycles and is doing exactly what we expect it to do. A key initiative to extend our SBA scope is on slide 10. Live Oak Express, our small 7(a) business, posted another record with 107 million of originations, up 173% from a year ago and up from 82 million last quarter. This is a fee-generating, capital-efficient engine for us. We sell more than 75% of the guaranteed portion at strong gain-on-sale premiums, which recycles liquidity. We earn servicing fees, and we retain the roughly 25% unguaranteed portion on the balance sheet, which earns recurring net interest income.
Gain on sale from Express was 7 million this quarter, up 250% year over year, and we’ve now generated 18 million over the last five quarters—about 30 cents of earnings accretion and growing. This is just fantastic work by our Live Oak Express team and everyone involved. Our target at cruise altitude remains over $750 million annually in this business, and again, do the math on that kind of volume. At those premiums, the earnings impact still in front of us is substantial.
Turning to slide 11, our second key initiative, growing checking to deepen relationships and lower our funding costs. Checking balances crossed a half a billion dollars this quarter, up 39% year over year, with total relationship deposits at now 1.3 billion. Why it matters is cost and stickiness. Our relationship deposit base only costs us 184 basis points compared with our overall deposit cost of 347. And the relationship depth keeps building. Twenty-five percent of our customers now have both a loan and deposit account, up from 20% a year ago, and four years ago that number was only 3%.
We’re at roughly 5% of checking and DBA to total deposits, with our target at 10% and above on a deposit base of about 15 and a half billion, growing 16% a year. That is an enormous amount of funding improvement still ahead of us—phenomenal work by our lenders and our treasury management teams. And there’s a lot more to come. Moving to slide 12, our AI efforts continue to accelerate. One hundred percent of our employees have access to AI-native tools, and we now have 200 Claude super users across the company, with a bank-wide rollout of Claude for Enterprise kicking off this fall, which will unlock even more capabilities. Our people are building real things, as you can see on the bottom left. But we have been smart about it—building common skills and prompts and requiring training while also encouraging innovation.
And I’d point you to the credit side of that list on purpose. Better portfolio management, better aggregated credit data and faster credit work are exactly what help us see things earlier. What I like to say about AI is today is not tomorrow. The technology is advancing rapidly, so we’re dreaming big about how to use it to accelerate our strategy. Thank you to all Live Oakers. I could not be more proud of how our people are taking care of customers, making our operations better and profitably growing this company. With that, Walt, why don’t you take us through a few more financial details.
Walt Phifer (Chief Financial Officer)
Thanks, BJ. Good morning, everyone. BJ hit the highlights. I’ll go straight to the numbers behind them: the EPS bridge, growth and funding, our margin performance, credit trends across our two lending business units, and capital. Turning to Slide 15. As BJ noted, reporting figures are on the left, with reported EPS of $0.52 driven by reported PPNR of $90 million, up 26% linked quarter and 53% year over year, and offset by an elevated provision that supported record loan growth, distillery actions, and the portfolio changes across the two lending business units. The right-hand side of the page walks you from the reported to adjusted EPS. Adjusted EPS was $0.49 in the quarter, and the bottom right shows that excluding the $0.27 drag from the distillery actions, adjusted EPS would have been the $0.76 BJ referred to.
Slide 16 and 17 highlight our consistent outstanding growth trends. Q3 originations were well diversified across 34 different industries and totaled $2.1 billion, up 38% linked quarter and 29% year over year, and a record quarter of production for the bank. That production drove period-end loans to $13.9 billion, up 6% linked quarter and 16% year over year, while we funded that growth with approximately $920 million in new deposits, with our customer deposit channels contributing about 75% of that growth in a highly competitive market.
Moving to Slide 18. Net interest income grew to $133 million, up 6% linked quarter and 15% year over year, in line with our balance sheet growth. Net interest margin of 3.30% remained in line with the last five quarters. Loan volume and mix added about 14 basis points, offset by higher funding costs, reflecting both our need to fund our strong loan growth as well as that very competitive deposit market. We will take that trade every day: a relatively stable margin and substantially more net interest income dollars.
Looking ahead, we still view a flat to rising rate environment as a favorable backdrop for our balance sheet, with volume growth remaining the primary driver of net interest income and funding competition and growth needs the key variables for the margin performance. Highlighted on Slide 19, the annual sale of guaranteed loans was $19 million for the quarter, up 12% both linked quarter and year over year, while premiums held steady. Overall, Live Oak Express contributed a record $7 million, nearly 40% of Q3’s total gain on sale. The success of Live Oak Express in the third quarter also provided us with the opportunity to sell more seasoned, larger SBA loans while still growing the gain-on-sale line and maintaining an average premium of 7% on total sales for the quarter.
Earlier, BJ gave you the adjusted view of operating leverage, while Slide 20 shows our operating leverage on a reported basis. Reported revenue grew 23% year over year while expenses grew 3%, and the reported efficiency ratio improved to 49%, approximately 1,000 basis points better than a year ago and 500 basis points better than just linked quarter. Credit trends are detailed on Slide 21, with further granularity provided this quarter by splitting out trends across our two lending business units. Small business banking credit performance remains stable. Past dues remain low at 9 basis points, and non-accruals of 1.10% and net charge-offs of 1.07% were consistent with recent quarters. In commercial banking, past dues are essentially zero; non-accruals of 1.17% and net charge-offs of 86 basis points reflect the distillery actions, which the majority of this portfolio sits within this business unit, as well as the six credits BJ referenced.
The commercial banking ratios have been and will continue to be lumpy given the size of these loans and the timing of impairments and recoveries. Our unguaranteed reserve coverage increased 5 basis points to 2.06% in the third quarter, reflecting growth, portfolio changes, and a more uncertain macroeconomic backdrop. Lastly, capital levels are detailed on Slide 22. Roughly 37% of our assets are cash or government guaranteed, with a guaranteed loan mix about nine times the industry. Given our uniquely large guaranteed loan portfolio, we focus on two metrics that measure capital against our true credit risk: the unguaranteed loan book. First, our Mahan ratio—Tier 1 capital plus reserves and fair value mark as a percent of unguaranteed loans—was a strong 15.4%.
And second, the tangible common equity version of that ratio, shown on the bottom right of the page, was 14%. We believe that our capital position relative to the true risk on our balance sheet remains healthy. And with that, thank you for your time. I’ll turn it back over to BJ for his final remarks before Q&A.
William C. (BJ) Losch III (President)
Thanks, Walt. Just quickly, let me close where I started. This quarter had, you know, we realized something unfortunate—$17 million on distillery. We took it head on, and that’s how we’ll always operate on any challenge. You can count on us for that. And at the same time, record originations of $2.1 billion across 34 industries, record adjusted PPNR, loans and deposits each up 16%, a sub-50% efficiency ratio and improving, and record quarters in both of our key initiatives.
So the franchise we have and are building is stronger than the quarter we just reported. And the quarter we just reported is the proof, because it took a $17 million hit and kept moving. We understand that the best way out is through on things like this, and we’ll continue to build our momentum while we do it. So again, with a big thank you to all Live Oakers and our customers, let’s take some questions.
OPERATOR
We will now begin the question-and-answer session. If you would like to ask a question, please press star one to raise your hand. To withdraw your question, press star one again. We ask that you pick up your handset when asking a question to allow for optimum sound quality. If you are muted locally, please remember to unmute your device. Please stand by while we compile the Q&A roster. Your first question comes from the line of David Feaster with Raymond James.
Your line is open. Please go ahead.
David Feaster (Analyst)
Hey, good morning, everybody.
William C. (BJ) Losch III (President)
Hey, David.
David Feaster (Analyst)
Let’s maybe just dig in a little bit more on the credit front. Obviously some pretty aggressive actions here. I was hoping you could touch on—we’ve talked about the distillery book for a while, I guess. Could you maybe just elaborate on what led to the change that you saw this quarter and what lessons you’ve learned as you’ve gone through this process? Since we exited the book, we’ve had some lagging credit issues. Touch on that a bit. And then the other migration that you saw—any color on those loans and just how you think about credit here as rates are rising and what you see on the horizon as you stress the book from higher rates.
Michael Cairns (Chief Credit Officer)
Hey, good morning, it’s Michael. I’ll take all of that. So, as BJ and Walt highlighted on the call, distillery is obviously the biggest mover for our book during the quarter. And whenever you would classify an entire loan portfolio, you’re going to see that in the metrics, and we’ve done that. We’ve also reserved heavily in anticipation of exiting every single one of these credits. We have about $60 million in exposure remaining to work out of. And as BJ mentioned, some of these customers continue to pay us, so we’re working with the customers hand in hand.
The $60 million is backed by conservative collateral estimates, and we’re going to work towards exiting that as safely and quickly as possible. When you look at the bigger picture, our SBA portfolio actually performed pretty well this quarter. It was a really quiet quarter from that book. We didn’t see a lot of risk-rate migration. Our borrowers are really resilient. I think we’re doing a good job underwriting. I think that’s a sign of that. Where my focus is on the SBA book, particularly because of the fact that these are small businesses, is I’m thinking a lot about interest rates and where interest rates are headed.
At underwriting, we are being pretty conservative with our shocking of interest rates at origination and assuming that these borrowers are going to be operating at some point over the life of their loan in an elevated interest-rate environment, and so we’re making sure we have that cushion on the front end. And as we highlighted in the deck, our existing portfolio is well prepared for elevated rates as long as we see them coming in and anticipating them.
So we’re thinking about all of that. On the commercial book, there’s a handful of loans that migrated during the quarter. Again, reminder that our commercial book carries larger exposures than our SBA book. But what comes with those larger exposures is a more sophisticated borrower that has significant capital invested into these businesses. And in almost every case, those sponsors are contributing additional equity toward the turnaround plan at the business level, and so there’s a potential pathway for recovery at virtually all of those loans.
But when a few of them move, you’re going to see them in the numbers. And as I look at everything that we’ve just talked about—industry-specific to distillery—but within our commercial and SBA book, we’re not seeing broad signs of credit deterioration, just some risks playing out that we underwrite to that we’re going to have to navigate through on an individual loan level. And like I said, our customers are working with us through that.
David Feaster (Analyst)
Okay, that’s helpful. And then maybe switching gears to loan growth. I mean, loan growth has been tremendous. We saw a pretty sharp increase in production, especially on the commercial front. I guess curious what drove that, how demand’s trending as rates are rising, both in the SBA book and in the commercial book, and, you know, just kind of the health of the client from your perspective and, you know, just again as rates are rising and where you’re seeing demand today.
William C. (BJ) Losch III (President)
Yeah. Hey, David, BJ. I’ll take that one. Starting on the small business side, I really think it’s two factors. Number one, I said it before, is, you know, we are the well-known engine, particularly in SBA on the small business side. And so, you know, that halo of who we are and what our lenders do is very important, and so that engine continues to deliver excellent production. But on the other side as well is there’s been a lot of change in SBA world the last couple years—SOP changes and going back to the beginning of this administration—and a lot of uncertainty.
And so what you’ve actually seen, what we’ve seen, is a lot of lenders exit SBA. And so you have to know how to do this business really well. You have to. And that’s who we are, that’s what we do. And so we’ve seen market share come to us in addition to our lenders continuing to do what they do every day. So that has generated further production. Not to mention, like we said, introducing a relatively new small-dollar loan option for our customers that is driving even more growth.
And on the commercial side, we’ve seen different dynamics because there are different businesses, whether it’s on our project finance side like seniors housing or solar, or on the sponsor finance side which is more private equity based. You know, so there’s different dynamics going on over there. Project finance, collateral-based lending has probably been a little bit stronger over the last year, and that’s where we’ve seen growth and strength on the commercial side.
But it’s been pretty balanced and broad based as well. So we feel really good about the growth, and we monitor it very closely. At the same time we’re celebrating growth, we’re also asking the question about soundness and making sure that that stays front and center. So we think we have a pretty good balance.
David Feaster (Analyst)
That’s helpful. And maybe just last one for me, just wanted to touch on the outlook for the margin here. Obviously there’s a lot of moving parts. Right. You’re highly asset-sensitive. There are some timing differences as loans reset versus funding costs. We’ve got increasing competition. I suspect you’re seeing that on the commercial front, and then funding competition’s intensifying. Could you just help us think through the margin trajectory, taking all these factors together and where you see things headed?
Walt Phifer (Chief Financial Officer)
Yeah, Dave, that’s a great question. This is Walt. I think you hit on a lot of the variables there. The 3.30 margin that we had here in third quarter was right in line with our expectations and what we talked about in the past couple quarters. Really no changes to the expectations moving forward. As I mentioned earlier, net interest income is where I tend to focus a lot on. The dollars that we earn is really driven by growth. The margin will be influenced by that growth as well as our deposit market competition. You mentioned our asset sensitivity. Look, if the Fed continues to raise rates, there’s potential for upside to the margin. But the two things I keep focusing on are the growth, which BJ just discussed, as well as the point that you just made on the deposit market competition and what you’re seeing there in stated rates, but also what you’re seeing in exception-based pricing and market promotions.
And I don’t think any of those things, whether growth or deposit market competition, are going to change here greatly in the near term. So where I sit, my overall assumption is that the margin remains relatively stable and our net interest income will continue to grow at the same pace as our balance sheet.
David Feaster (Analyst)
Perfect. That’s helpful. Thank you.
Walt Phifer (Chief Financial Officer)
Thank you.
OPERATOR
Your next question comes from the line of Crispin Love with Piper Sandler. Your line is open. Please go ahead.
Ben Graham (Analyst)
Hey, good morning, this is Ben Graham in for Crispin Love, thanks so much for taking my question. As you mentioned, you’re very close to your small businesses, and just wondering if you could discuss what you’re seeing now related to health of the small business owner today, given the monthly financials you get, survey work you do, etc. Just wondering if it’s improving, stable, or—yeah, just curious on what you’re seeing there. Thank you.
William C. (BJ) Losch III (President)
Yeah, Ben, it’s BJ. You know, again, I’ll use the word resiliency. When we see problems with customers, it’s not always, but the majority of the time it’s some kind of life event or business event that causes deterioration in the business as opposed to a small business owner not being able to manage their business through higher gas prices or higher energy prices. Small business owners, that is who they are, that’s their livelihood. And so we tend to see that they will do everything in their power to make sure that they can keep their businesses active and healthy.
So we’re not really seeing a ton of change like Michael talked about in the portfolio itself or in the financials that we’re seeing right now. Obviously we’re constantly monitoring that and requesting financials every 90 days for all those small business customers. So we are on top of that. So we feel good right now. But to Michael’s point, moving forward, we are underwriting new production at higher rates than where we are today, anticipating potential stress in debt service coverage going forward.
And we want to make sure that we and customers are prepared for that. We never want to put a customer in a position to not be able to have a prosperous business or pay us back. So that’s what we’ll continue to do.
Ben Graham (Analyst)
Awesome. Thank you so much. That’s it for me. I’ll step back.
William C. (BJ) Losch III (President)
Thanks, Ben.
OPERATOR
Your next question comes from the line of Dave Rochester with Cantor Fitzgerald. Your line is open. Please go ahead.
Dave Rochester (Analyst)
Hey, good morning, guys.
Walt Phifer (Chief Financial Officer)
Hey, Dave.
Dave Rochester (Analyst)
I know you’ve done a lot of work on the distillery book. This hasn’t been the only quarter you’ve taken other reserves. Was just wondering what the total mark is now that you have on that 60 million that you’ve kept at this point. And then, given your outlook on small business credit, which sounds positive, and the larger commercial credit overall, how are you thinking about the provision trend in 4Q and next year and the likelihood that you can return to that 20 to 25 million normal provision range?
Michael Cairns (Chief Credit Officer)
Yeah, this is Mike. I’ll start on the distillery question. So to answer your question, $60 million is our outstanding unreserved balance against that portfolio. What we do is we charge off the excess of what we don’t think will be collectible. And so what we’re talking about there is $60 million that is secured with collateral. And we take, in my view, a very conservative estimate of what that collateral value is.
Walt Phifer (Chief Financial Officer)
And then, Dave, this is Walt. I’ll jump in on the provision expense. Yeah. So, you know, really to take that $55 million that we have, we’ll break it down into kind of two halves. We had the distillery of the $17 million. And then that leaves essentially $38 million across three different pieces. BJ kind of walked through $16 million of that $38 million is growth-related. Under CECL on record production, we reserve the day the loan goes on the books before we even earn a penny.
That piece is always going to move with our volume. And we have no intention to stop growing. So you see some variability there. $9 million or so on small business. That’s normal. Portfolio changes, diversified. That book’s really performing in line with its history, kind of our expectations. And then commercial is the other piece. So that’s $13 million, and that’s really where a lot of our variability lives. So for perspective, let’s just talk about the last three quarters. The first quarter we had three new impairments across two verticals, otherwise pretty stable migration.
Second quarter we had zero new impairments, positive migration across the rest of the portfolio. And then this quarter we had six impairments with positive migration elsewhere. So same book, really, three different outcomes across three different quarters. And then it kind of runs both directions as well. So if you think about, you know, that was the focus on impairments, but then you also have recoveries, and they can be very lumpy as well. So net charge-offs in commercial were actually negative in the first quarter because recoveries ran ahead of our charge-off. We had net recoveries in Q2 as well, but then we had zero in Q3. So really, the point here is that resolutions can swing a quarter just as much as an individual impairment.
So that brings us back to the run rate we’ve talked about past. I’m not going to replace that range that we’ve discussed with a new one. And I’m not going to tell you that this steps down next quarter either. What I think is, looking forward, the commercial book is really going to be lumpy in both directions, and that’s for a lot of the reasons we’ve talked about. Loans are larger. It’s just the nature of that book. What’s not going to change is how we handle all that.
So every one of these credits is analyzed, reserved on its own facts, and as soon as we get to the point where we can reasonably support impairment, we impair it. And that’s what we did this quarter; it’s what we’ll do next quarter and so on. So, really our focus, and BJ hit on this earlier in terms of PPNR, our earnings power is going to help allow us to continue to move up and to the right. It’s just not always going to be in a linear line. And I think that’ll be the focus for us this year, it’ll be the focus for us next year, and so on.
I think we’ve done a pretty good job at it.
Dave Rochester (Analyst)
Yeah. All right. Appreciate the color there. And just back on the distillery book, you’re saying that any kind of reserve you’ve already taken has already been charged off, so that 60 is the outstanding balance you have left after the marks with no additional reserve applied to it, is that right?
Michael Cairns (Chief Credit Officer)
Yeah. We have charged off everything that we can. There is a small amount of reserve there, but the unreserved component of those loans is about $60 million.
Dave Rochester (Analyst)
Got it. Okay, great. And then switching to expenses. How are you thinking about the trajectory here as you head into the end of the year and then next year? You guys have done a great job in keeping a lid on growth there. And you’ve talked about seeing ways to use AI to keep expense growth more limited, especially, I think, going into next year. So how should we be thinking about that quarterly trajectory going forward?
Walt Phifer (Chief Financial Officer)
Yeah, Dave, this is Walt again. Thanks for the question. Look, I think our team’s done a really great job over the past years calling in efficiency, implementing automation, and now we’re starting to leverage AI. At the same time, we’re cognizant we’re a growth organization, and we still want to invest heavily into especially the strategic initiatives that BJ mentioned about Live Oak Express and checking, as well as new products. So it’s a balance.
We work at this pretty hard each and every day. From an expense outlook standpoint, I’d expect a modest expense growth rate as we continue to find ways to support those initiatives, with continued improvement in our efficiency ratio. Because we’re attacking both sides of that ratio: the expenses through finding inefficiencies and opportunities, like you mentioned, leveraging AI and things of the like; and then the more fun side of that is really attacking the revenue side. And that’s what we’re doing really well right now between our main engine as well as Live Oak Express.
So, modest growth in expenses with continued improvement in our efficiency ratio over time.
OPERATOR
Your next question comes from the line of Emily Lee with KBW. Your line is open. Please go ahead.
Emily Lee (Analyst)
Hey, everyone, it’s Emily. Thanks for taking my question.
William C. (BJ) Losch III (President)
Morning, Emily.
Emily Lee (Analyst)
Yeah, so just to touch on Live Oak’s business checking initiative, can you just expand a bit more on the progress made? You’ve been really successful in deepening the relationship, with the percentage of customers with both a loan and deposit account continuing to move up. So are there any incremental product capabilities or investments needed to deepen those relationships? And any update there?
William C. (BJ) Losch III (President)
Sure, Emily. This is BJ, so we’re incredibly pleased with the progress that we’ve seen in checking. For a lending organization for most of our life to, in two years, go from virtually no checking relationships to 5% of our deposit base, to me, is incredible work by our team, and we have a lot more to go. I think the first couple years it’s been more driven by commercial customers, which are used to, when they are accessing new credit, they know that a lot of times they’re going to have to move their operating accounts.
And so about 60% of that 500 million or so has come from commercial the first couple years, 40% from small business, which, as you might imagine, are much smaller balances, but there’s more customers there. And so one of the key priorities we have this year, certainly going into next year, is the introduction of merchant services, which we think will really be compelling for our small business customers to move over. And then, obviously, if they are running their merchant services transactions through our operating account, that’s incredibly sticky, that’s incredibly active. We are literally giving them more income based on the way that we are working with them on merchant services, and we’re getting higher, stickier balances over time.
So I expect over time that 40/60 split to actually move more towards small business, and that will continue to accelerate our checking account growth. So very pleased with that. The other side of it that maybe we don’t talk about as much but that’s really important is other DBA. It’s things like control accounts or cash collateral accounts on some of our commercial-oriented or project finance businesses that are very low cost as well and very sticky through the life of the relationship that we have on those side. And so we’re actively pursuing those as well, which obviously is accretive to our cost of funds in addition to checking.
Emily Lee (Analyst)
That’s very helpful color. Thank you. And then, just moving back to the NIM, for each additional 25-basis-point rate hike, is there an expected incremental impact to NIM or quarterly NII that you guys have?
Walt Phifer (Chief Financial Officer)
Yeah. Hey, Emily. Well, that really depends broadly on some of the variables we talked about: growth and deposit competition. But look, I think our team’s done a really good job pricing on the asset side. I think we’re doing a good job finding the right positioning on the funding side. I’ll speak more to net interest income. Typically, 25 basis points can really kind of equate to anywhere from five to $10 million on an annual basis of accretion. So I think I’ll stop there.
I think that’s probably the key point for me. I think margin will kind of move up and down really depending on growth and deposit competition.
Emily Lee (Analyst)
Great. Well, thank you guys for taking my questions. Congrats on the quarter.
William C. (BJ) Losch III (President)
Thanks, Henry.
OPERATOR
Your next question comes from the line of Janet Lee with TD Cowen. Your line is open. Please go ahead.
Noah Kasten (Analyst)
Good morning, this is Noah Kasten. I’m in for Janet Lee.
William C. (BJ) Losch III (President)
Hey, Noah.
Noah Kasten (Analyst)
Noah, following up with the deposit conversation, can you provide us with an update on the competitive deposit environment and how you see deposit costs trending from here? And also, if you could provide the spot deposit cost today relative to the 3Q average.
Walt Phifer (Chief Financial Officer)
I know this is Walt. I’ll start there. Sorry. I guess with the overall deposit market, I think you probably heard BJ and I say the word “competitive” quite a bit here on the call, and I think that’s probably the best word to describe it. And it’s not just, like I mentioned, it’s not just competitive in stated rates. There’s a variety of ways banks right now are trying to raise funding. You obviously have to have a stated rate that’s competitive with the market, but you’re also trying to combat on cash-based promotions or exception-based pricing or relationship-based pricing and marketing campaigns.
So I guess the best way to describe it is there are a variety of channels that we continue to work and compete on. I think our team does a really good job at leveraging and really monitoring where the growth’s coming from. So we’ll switch between consumer and business savings or retail CDs, using brokered to help fund on a short-term basis some of the gaps that we need to support the strong loan growth. Stated rate: so right now where we averaged for the quarter was 3.47. Stated rates are trending a little bit higher than that, as you would expect given the September Fed hike. And that’s typically what happens, right? A Fed hike at the end of the quarter — our deposit pricing really reacts pretty quickly, and that’s what we assume in our modeling, typically elevated betas and whatnot. Like I said, a lot of that’s really just to support our growth.
Noah Kasten (Analyst)
Thank you for that. And then, just going back to the credit conversation, I know the inflection story has been discussed a lot. Is there any update on that timeline, and more specifically any timeline you can provide on the distillery portfolio and how long it will take to work this book completely off the balance sheet?
Michael Cairns (Chief Credit Officer)
This is Michael. Yeah, so we identified this vertical as having headwinds back in 2024, and at that time we stopped actively lending, and we have since that time been working through this book. Our goal is to exit as quickly as possible on every one of these credits. However, as I mentioned earlier, some of our borrowers continue to pay, so I’m not going to walk someone out of the bank if they’re paying on their loan. And so the timeline there depends significantly on a lot of different variables, but we’re taking active measures to exit as quickly as we can.
Noah Kasten (Analyst)
Great. Thank you.
OPERATOR
There are no further questions at this time. I will now turn the call back to Live Oak Bancshares Chairman and CEO Chip Mahan for closing remarks.
Chip Mahan (Chairman and CEO)
Thanks to everyone for dialing in today and we’ll see you in 90 days.
OPERATOR
This concludes today’s call. Thank you for attending. You may now disconnect.
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