Lending in the Cloud: Man Behind First Web Bank Is Back

This story is featured in the June issue of American Banker Magazine.

Chip Mahan travels with an entourage. The 62-year-old community banker is leading them now—five men, all of them cheery, but exhausted—in a single-file procession across the tarmac and up the airstairs onto one of his company's two planes.

It's midafternoon on a typical work day for these atypical small-business lenders, who are returning to Wilmington, N.C., after an overnight visit to Boston. They met the day before with Fidelity to talk about the idea of a partnership that could give their $337 million-asset Live Oak Bancshares access to thousands of new borrowers, if a deal is struck.

Mahan plays steward as they board the Gulfstream G200, handing waters to everybody before sinking into one of the white leather seats himself. The plane is in use almost daily. On a recent three-day trip, this crew followed Mahan, Live Oak's chairman and CEO, to Minneapolis, Portland, San Francisco, San Diego, and finally to Las Vegas, before heading home.

The jet-setting is essential to Mahan's business, which combines a small bank and high-tech ambitions.

Instead of focusing on a specific geographic area, Live Oak lends nationwide to veterinarians and a handful of other niche customer segments. In the five years since its start, it has leapfrogged to number three on the Small Business Administration's list of the largest 7(a) lenders by dollar volume. The $90.8 million of loans it made in the SBA's fiscal 2013 first quarter trails only Wells Fargo's $197.9 million and U.S. Bank's $99.2 million.

Although the bank's thriving, it also serves another purpose. It's a showcase for cloud-computing technology that Mahan expects to revolutionize the lending process for the banking industry.

This is Mahan's second time starting a nontraditional bank. He is best known as the driving force behind the nation's first Internet-only bank nearly two decades ago, Security First Network Bank, and its profitable technology offshoot, S1 Corp. Though Security First never took off—remember 1995 was very early for online anything—it succeeded in what Mahan views as the primary goal: demonstrating what the Internet banking platform from S1 could do. He rapidly inked deals with major industry players like Citibank and not only built a technology juggernaut for a time, but an impressive network of loyalists who still buy into his entrepreneurial vision all these years later.

"What Chip does more than anyone else," says Anil Arora, the president and CEO of bank tech vendor Yodlee, where Mahan once served on the board, "he inspires."

Mahan believes his latest startup could be just as big, if not bigger, than all of his earlier efforts combined. It replicates the Security First strategy of pairing a branchless bank that uses new technology with a firm that offers this technology to others.

In addition to owning its namesake Live Oak Bank, Mahan's new company retains a 40 percent stake in a cloud-computing venture it created, called nCino. The technology—which Mahan sees as rivaling Internet banking in significance—puts the voluminous paperwork necessary for each loan into the cloud, allowing everyone involved easier access.

There is plenty of reason to be skeptical about Live Oak, from its concentration in small-business lending to its unusual gambit in a technology so new that the industry has yet to embrace it and so promising that bigger competitors are making their own plays. Daunting security concerns about the cloud have regulators and bankers leery. But it's déjà vu for Mahan, who faced down similar skepticism about Internet banking and is unfazed by the doubters.

The bankers spread out around him on the jet—laptops open, typing away-are just as confident as Mahan is in what the future holds. They don't just work for Live Oak; they are investors, each having put a percentage of their own liquid assets into the business, as is required for all senior executives.

Another believer is John Mack, the former Morgan Stanley chairman and CEO. An nCino investor, Mack makes clear that what he's really putting his money into is Mahan.

"The magic sauce is Chip," Mack says.

"There are a lot of products out there, but it's all about taking a great idea and executing on it."

—•—

Mahan was 11 years old when his father died in a plane crash in 1962. "It was devastating," says Mahan, who describes his father as having a "larger-than-life" personality to go with his 6-foot-7-inch frame. His mother was 32 at the time and "had never written a check," he says. (Though Mahan is named James after his father, Mahan's grandfather called him Chip. The nickname stuck.)

Mahan took on responsibility at an early age. He recalls tough work at his grandfather's farm, in Mahan's hometown of Frankfort, Ky. In summer, he would toss bales of hay onto a trailer for up to 12 hours straight. The aching in his arms was terrible.

Sitting in a silo covered in molasses was worse, though. He had to mix the sticky substance with hay to make a type of feed called silage. The powerful odor—similar to soy sauce, Mahan says—was unbearable.

"We put 50 gallons of molasses in that somebitch," he says with a deep twang that gives away his Kentucky roots. "Totally a shit job. I only lasted a day."

It was perhaps an aha moment for Mahan. Working on a farm wasn't going to be a lifetime occupation.

After graduating from Washington and Lee University with a degree in finance, he worked his way through an executive trainee program at a Wachovia office in Winston-Salem, N.C., not far from where Live Oak's headquarters is today.

Going into banking wasn't a life goal. He just happened to have connections to the former Wachovia (since absorbed by Wells Fargo), through his college fraternity, Delta Tau Delta. "So here is how that worked: I was president of my fraternity and the past two presidents went to work at the Wachovia training program," Mahan says.

A year in, he says, he started getting serious about a banking career. But he also felt his mindset shifting, permanently as it turns out, into a more entrepreneurial mode.

"I just came to the conclusion that you are either going to be an employee or an owner," says Mahan, who was making $9,000 a year at the time.

Hugh Durden, one of Mahan's mentors and bosses at the former Wachovia, describes Mahan's rise there as steep.

He had a knack for signing up many of Kentucky's distilleries, including "really local ones that no one ever heard of," Durden recalls, "and they were becoming successful." Mahan's clients also included Louisville Slugger, the baseball bat maker.

"No one did it better than him in the corporate banking field—he was a star," says Durden, who is now the chairman of the Alfred I. duPont Trust, a $5 billion organization that funds children's healthcare.

"Back before people talked about your emotional IQ, he had it. He could relate to all sorts of people."

—•—

Mahan left Wachovia to become an owner in 1983. He formed a group of investors—including friends of his stepfather, a veterinarian known for his orthopedic surgery on racehorses—to buy Citizens Union National Bank & Trust Co.

Among those investors were Mickey and Karen Taylor, part-owners of Seattle Slew, which is one of only 11 racehorses to ever win the Triple Crown.

Mahan recalls flying to the Sun Valley, Idaho, airport in the winter of 1984 and being picked up by actor and racehorse investor Albert Finney, who famously played Daddy Warbucks in the screen and stage versions of "Annie"—apropos, Mahan reflects, given the multimillion-dollar mission he was on. "I was 31 years old, and I was raising money to buy what was a $300 million bank in Lexington, Kentucky," he says, almost in disbelief at his younger self.

The outside investors put up $3.5 million in all, leaving Mahan and his business partners to mortgage their homes to raise the final $1 million they needed. The deal closed in 1985, and Mahan moved with his wife and two children from North Carolina back to Kentucky. He was the bank's chairman, president and CEO for about a year, before selling it at a healthy profit to Bank One (now part of JPMorgan Chase).

—•—

The country's first Internet bank started around a dinner table in Lexington, Ky. It was 1993, and Mahan was at a party in his father-in-law's home. He was chatting with Michael McChesney, his brother-in-law at the time.

Mahan by then was chairman and CEO of Cardinal Bancshares in Lexington. He had raised $16 million to start the company two years after selling Citizens Union.

McChesney was running a 50-person software firm in Atlanta called SecureWare. "He did very technical security work for the government, the Department of Defense ... launch codes, very complex stuff," Mahan says.

The two men were trying to find some middle ground between business and technology, for what was such inconsequential small talk that Mahan struggles unsuccessfully to recount any of it.

That is, except for one remark by McChesney that proved very consequential indeed. "He said: 'Let's just put a bank on the Internet,'" Mahan says. "'Let's advertise CDs and money market accounts.'"

The idea was not of the lightning-strike variety. It didn't spark any feverish excitement or immediate action. But it stuck in Mahan's mind for an entire year afterward.

Ultimately, he decided to repurpose one of Cardinal's banks to give the idea a try and brought McChesney in to help. The First Federal Savings and Loan of Pineville, Ky., turned into Security First, and the two men set up operations in Atlanta with an eye toward creating a branchless bank.

Security First attracted investments of $2 million each from Huntington Bancshares and Wachovia in its initial public offering. Connections Mahan made earlier in his career helped in securing support. Durden, who was still at Wachovia, talked with the operations executive there, after having dinner with Mahan and hearing what he was up to. "I said, 'I don't understand the technology, but if they are right, this thing could be very important.' Then I stepped out of it," Durden says.

Developers were a priority. But by then, SecureWare, McChesney's old firm, had sold its software to Hewlett-Packard, and just like that a team was in place.

McChesney initially created a separate company to house the technology development business. (It later would be part of the bank, and later still, spun off.)

This tech startup would evolve into S1. It had wild ups and downs over the years, but it was more successful than the bank, which never made a profit.

Security First opened before the Internet gained mainstream traction—a full two years before Bank One orchestrated the high-profile launch of its online-only Wingspan Bank. Though heavily advertised, even Wingspan didn't make it.

Security First attracted only a few thousand depositors. They had to mail in checks to get money into the bank.

In 1998, Mahan sold Security First's banking operations for $20 million to Royal Bank of Canada, which would later contract with S1 for its online banking platform.

As Internet banking grew, so did S1. Thousands of banks, big and small, used its technology, including 35 of the top 100 banks in the world, Morgan Stanley and JPMorgan Chase among them. Mahan became a practiced pitchman in the process.

But the company, which had a market capitalization of $4 billion at its peak, would go on an ill-fated acquisition spree to expand into enterprise software and payments processing. S1 struggled mightily after Mahan, its chairman and CEO at the time, gave up the CEO title in 2000 to care for his wife, Peggy, who had breast cancer. Mahan's family moved to Wilmington to be closer to the research hospital treating his wife.

"He never left her side," recalls Jeff Lunsford, a former S1 corporate development executive and now an nCino investor. "He just said: 'We have to go to Duke every week; we have to go and treat this thing.'"

Mahan returned as CEO again in 2005—partly because Peggy had gone into remission, partly because the company was floundering. But contentious activist investors left him so frustrated that he quit a year later. "Heartbroken is the word," he says.

Mahan says he learned a lot through the experience, though. He says the insight he gained is valuable for keeping nCino from making similar missteps.

And S1 did ok in the end. It was acquired last year by ACI Worldwide in a deal worth $516 million.

—•—

Restless after leaving S1 the second time, Mahan soon began laying the groundwork for Live Oak. The inspiration came from former banking acquaintances who shared their experiences with SBA lending.

"I can't not work," Mahan says. He had to get up and do something every day. He just had to figure out what.

He got some help from David G. Lucht, a former chief credit officer at Cardinal.

Lucht wrote the charter application for Live Oak sitting on a wicker chair in the anteroom between a wine cellar and a walk-in closet full of guns and hunting attire at Mahan's house on South Live Oak Parkway. (Mahan is a big-time duck hunter.)

It took three months. "I came in every day with a muffin for breakfast," says Lucht. "And every day Chip's golden retriever would come in and eat the wrapper."

Lucht says he had no hesitation leaving his chief credit officer gig at FirstMerit Bank in Akron, Ohio, when Mahan called to pitch another startup.

It was Lucht who had the idea of requiring all senior employees to invest a percentage of their liquid assets in Live Oak. He put in $200,000 himself and now owns $600,000 of stock.

Live Oak opened in May 2008 and has been going gangbusters ever since. The bank unit, which is an S corporation, earned a pretax $19.6 million last year, up 29 percent from 2011, according to Federal Deposit Insurance Corp. data. The earnings growth was driven primarily by a $10 million increase in noninterest income, to $42 million. (It generally sells the guaranteed portion of its SBA loans.)

Mahan says it has made roughly $1.5 billion in federally backed loans with a default rate of less than 1 percent since it opened.

Live Oak has no branches, no tellers and no customer service reps. But it does have four pilots on the payroll, because it likes to keep those planes busy. "Think mobile branch managers," Mahan enthuses. "New model, buddy!"

At first, Live Oak lent only to veterinarians. (FDIC chairman Sheila Bair nicknamed Live Oak "the doggy bank," Mahan says.)

But it later added dentists, pharmacists, funeral home owners and, most recently, independent investment advisers (hence the meeting at mutual-fund giant Fidelity).

The new types of borrowers help lower concentration risk and keep regulators happy, Live Oak President (and former S1 executive) Neil Underwood says, though he insists there's been no regulatory directive given to Live Oak to that effect.

Jon Winick, president of bank advisory firm Clark Street Capital, closely monitors SBA lenders. He says he doubts Live Oak, one of the last charters approved in North Carolina before the FDIC curtailed de novo banks, could have started up in the current regulatory climate.

"They looked at SBA lending from a strategic standpoint. They focused on a couple niches that they really understand, but you couldn't expect that charter to get approved today," Winick says. Now, "they would lock you up if you came to them with this business plan." Winick considers that all the more reason to admire Live Oak—and, by extension, Mahan.

"Of course, you could hang in the back of the room and say it's all going to blow up, that their growth is going to slow down," he says. "But you can't deny the tremendous success that they've had to date in a very difficult industry to navigate."

—•—

Though Mahan says he's strictly a banker, he runs his businesses with a formula that most bankers would find unfamiliar: separate the finance from the technology systems and sell both.

In 2010, Live Oak spawned nCino, which sells cloud-based software to other banks to help them underwrite loans and generate reports. The tech startup raised $7.5 million from the likes of Eugene Ludwig, the founder and CEO of Promontory Financial Group and former Comptroller of the Currency, and Mack, the former Morgan Stanley CEO, who says he became friends with Mahan when S1 was booming in the '90s. nCino is about to close on another $1.5 million of investments from employees.

But this Mahan enterprise might not fare any better than the ahead-of-its-time, online-only bank Security First.

Mack gets testy when asked about the fate of Security First. "That was 25 years ago," he says, sharply. "I mean, look, I don't know how old you are, but I'm 68 years old, and one of the things that I try to do is get more involved with technology companies."

Mahan says Live Oak and nCino are his last big endeavors. This is his working retirement before the real one—a way to hang out with smart 20-somethings and friends from his long banking career and get everyone paid in in the process.

Mahan says he is not in it to score a big payday from a sale. He expects what he is building here to last long after he is gone.

Live Oak, which hires 10 to 15 recent grads a year, is starting a training program that'll be run by Mahan's son, Jimmy IV, a former high school principal. Called Live Oak University, it's not unlike the Wachovia training program Mahan completed at the start of his career.

The bank completely covers its employees' healthcare and pays for them to work out with a personal trainer up to three days a week. There's also a profit-sharing program, which last year gave all Live Oak employees a 56 percent boost to their annual salaries.

Walking into the temporary offices (a larger $11 million space on a manmade pond is getting built on the other side of town) upon his return from Boston, Mahan gives a young nCino employee an exploding fist-bump. "There is nothing more fun than seeing these young folks walk into work happy and having all these fresh faces," Mahan says.

He mentions, not for the first time that day, that for him, working to make Live Oak a success is really more about securing their future than his.

He brings up the Boston trip as a way to underscore the point. "It was inspiring to go to Fidelity," Mahan says. "Ned Johnson's father started that company in 1945 and it's still here. That family had a vision."