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Nearly 20 years ago, Chip Mahan's early Internet venture with Security First Network Bank led to the birth of S1 Corp., one of the boom times' most-hyped online-banking technology providers. Today, he's behind a startup small-business lender with another technology offshoot in mind: loan underwriting in the cloud.
June 1
When Chip Mahan went to banking regulators in 2007 with the idea of starting a bank in Wilmington, N.C., with no branches, no tellers and a national lending platform heavily concentrated in Small Business Administration loans, the response was less than enthusiastic.
"I was skeptical at first," says Joseph Smith Jr., North Carolina's banking commissioner at the time. "What Chip was proposing was very much out of the ordinary for the banking industry."
It took more than a year for authorities to get comfortable with the idea and grant a charter to Live Oak Bancshares, but Mahan didn't wait. Confident of approval, he started hiring lenders with contacts in his first targeted niche, veterinary medicine, and began originating.
"The SBA market had dried up, and he had these lenders on his staff. It was prime time for them to be lending," recalls Greg Gibson, then the CEO of Mountain 1st Bank & Trust in Hendersonville, N.C., which warehoused $100 million in Live Oak loans while Mahan waited for his charter. "I acted as their proxy and shared my balance sheet with them."
It didn't take long for Live Oak to explode onto the SBA lending scene. Though it has just $330 million in assets, it trails only Wells Fargo and U.S. Bank on the government's list of the most active SBA lenders. Its third-place ranking puts it ahead of JPMorgan Chase and large regionals such as SunTrust Banks and KeyBank.
Live Oak concentrates on just a handful of high-performing niches, such as veterinary medicine, dental care, funeral homes and small-town pharmacies. All show up near the top of the SBA's list of categories with the lowest default rates.
The philosophy underlying Live Oak's strategy is that industry expertise matters more than location. General manager Travis York, for instance, is the son of a veterinarian; senior loan officer Ed Webman is a third-generation pharmacist and once owned a small-town drug store himself. Another senior loan officer, Annemarie Murphy, was a vice president of healthcare finance at United Western Bank in Denver, and still lives in Colorado.
Live Oak targets business customers with $1 million to $3 million in annual revenue. They need some hand-holding, and are more concerned about getting a loan than a percentage point on their rates.
The well-connected lending team gets its leads mostly through word of mouth and at trade shows. The bank has lent to funeral home directors in Michigan and California, veterinarians in South Dakota and Tennessee, and dentists in Oregon and Missouri.
When underwriting, Live Oak focuses more on cash flow than on equity or experience. "We don't worry about collateral," Mahan says. "Most of these businesses generate plenty of cash flow for them to make a nice living and pay the loan back."
Growth has been strong. Live Oak's figures show that in 2012 it originated $415.2 million in loans, up from $161.8 million three years earlier. Almost all of that volume came from the SBA's 7(a) loan program, which slaps a government guarantee on 75 percent of each loan.
The company sold $276.7 million of its loans to investors on a resurgent secondary market, reaping a net gain-on-sale of $121,900 per $1 million in loans sold.
Most of the unguaranteed portions of those loans were sold as participations to loan-starved community banks, with Live Oak retaining about 10 percent of the typical loan on its books, as well as the servicing income. About 80 percent of bank's revenues come from noninterest sources, most of it gains-on-sale.
The returns have been impressive. Excluding nCino losses, net income at the holding company was $12.2 million last year, beating internal forecasts by more than 50 percent. Return on average assets was 4 percent; return on average equity was a tick over 40 percent.
"If every community bank in the country really understood the power of the 7(a) program ... they'd all be doing it," Mahan says. Done right, "it allows your returns on risk-weighted capital to go through the roof."
But the SBA's 7(a) lending program also introduces a confusing mass of paperwork into the underwriting process. The typical loan requires some 148 documents to complete, plus regular monitoring.
Mahan felt the frustration early on, and brought in some of his former crew from S1, the bank technology firm he led before starting Live Oak. (Former S1 general manager Neil Underwood is now Live Oak's COO.)
After a couple of failed stabs at creating in-house solutions, they stumbled on Salesforce.com and its scalable, cloud-based platform for hosting proprietary applications. The San Francisco-based firm helped pioneer the cloud-computing movement a decade ago, and today boasts hundreds of thousands of clients and a market cap of $24 billion.
Live Oak built an app that transfers the bulk of the paper-intensive lending process online, making it more efficient, more accessible to more people and easier to manage.
Cloud-based apps don't require users to buy additional hardware or software, because the platforms are housed on and accessed via the Internet. Salesforce.com's customers build their apps on the same platform, which also comes with what's considered a state-of-the-art customer relationship management function.
Salesforce.com hosts proprietary apps from some 5,000 financial services companies, including such big names as Wells Fargo and Huntington National Bank, but had nothing along the lines of a "purpose-built application for mid-market banking," says Ron Huddleston, a Salesforce.com senior vice president.
With his background in financial technology, it didn't take long for Mahan to conclude there could be a market for a standalone firm to sell his solution to other banks. Live Oak named the software business nCino, a play on the Spanish term for the live oak tree, and made it a separate enterprise.
Live Oak uses nCino for managing its SBA loans, but most bank clients employ it on commercial or construction loans. Versions are being readied to tackle the retail- and mortgage-lending markets as well.
Pierre Naude, a former S1 divisional president and now head of nCino, says that on the cloud, offerings can be adapted and customized quickly. In contrast, S1's solution involved 15 million bug-filled lines of code, with network interfaces and database designs that required constant attention.
With Salesforce.com, "you get all your hardware, all your software layers, on a highly secure platform," Naude says. "I can focus all my energy on my industry domain expertise and business problems, as opposed to worrying about the core technology."
nCino's app doesn't replace a bank's core system, but complements the core, Naude says.
At the beginning of the lending process, a complete file is scanned into a template and uploaded to the app. The file is accessible to underwriters, closers, executives and anyone else with a valid interest in seeing what's needed next, be it appraisals, tax returns or closing documents. Everything to do with the process, except for a signature page, is digital.
Naude says the app makes a cumbersome process more manageable and cuts the average time to approve a loan from 60 days to 45. "Instead of a serial, step-by-step process, you can stroll up and down and see exactly where you are at, what documentation is outstanding," he says. "The loan moves faster."
Bankers report being pleased. "They literally take data dumps from my core every day," says Jarrod Beck, CEO of $200 million-asset United Texas Bank in Dallas, which uses the app to manage residential construction loans. "It puts all this disparate data at my fingertips, where I can print reports and do stuff with it."
Some clients expect the offering to get bigger and deeper with time. "With what I'm creating through them, it would make a lot of sense for nCino to eventually be my core," Beck says.
Emmanuel Viale, director of Accenture Technology Labs in France, doesn't know of nCino specifically, but argues that the design agility, scalability and sheer firepower of the cloud make it too attractive to ignore.
He notes that big banks such as Spain's BBVA are making cloud-based technology more central to their operations, while large tech firms, including Amazon.com, HP and Google, are expanding their cloud offerings.
"Cloud computing can fuel new ways of doing thingsnew segmentation models, new ways of sharing data, new ways of connecting with social media," Viale adds. "With time, it's natural to think the cloud will become a primary way of doing things for banks."
It's possible that nCino could prove to be a bigger jackpot for Mahan than the bank itself. Or it could become a black hole that gets lost in the shadows of larger competitors and security concerns.
The nCino app, housed on the platform of Salesforce.com, is accessible only via the Interneta tough sell for many bankers at a time of increased fears over data security and privacy, and the heightened scrutiny those fears can bring.
"The Internet component doesn't feel as secure as a point-to-point communication with your servicer," says Gibson, Live Oak's early champion, who is now chief financial officer of the $2.3 billion-asset Northwest Federal Credit Union, an nCino customer in Herndon, Va. "But if you put in the time to understand the layers of technology that exist, you can get comfortable with it."
Regulators have cast a wary eye at the concept, cautioning banks in a July 2012 bulletin to perform "thorough due diligence and risk assessments" on prospective cloud-computing providers, while also talking about firming up regulations on the use of their solutions.
Mahan heard similar concerns during the early days of Internet banking, when he ran Security First Network Bank, the online play he founded in 1995. (The bank's software efforts formed the basis of S1, which, like nCino, was spun off as a separate firm.)
Each of Mahan's endeavors seems to push the envelope on innovation at a time when profit pressures demand new thinking. Each also has had to confront skepticism from regulators and bankers alike.
Even today some critics argue that Live Oak shouldn't have deposit insurance because it isn't a "traditional community lending institution," says Smith, who stepped down as North Carolina's banking commissioner in 2012 and is now an attorney with the law firm Poyner Spruill in Raleigh, N.C.
"We wouldn't want every bank in North Carolina doing what Chip is doing, but I thought it was important to allow some experimentation to see if there were different ways to use the small-bank charter," Smith says, explaining the decision to approve Live Oak's charter. "Having one bank that focused on a different kind of lending ... would give our banks some insights into how to be more successful small-business lenders."John Engen
