Live Oak Bancshares, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019; unaudited. Live Oak operates primarily through its bank subsidiary, lending to small businesses nationwide, including substantial SBA- and USDA-guaranteed lending.
Financial results and position
| Metric | Q2 2019 | Q2 2018 | H1 2019 | H1 2018 |
|---|---|---|---|---|
| Net interest income | $33.9M | $27.0M | $64.5M | $51.5M |
| Noninterest income | $14.7M | $30.6M | $27.7M | $61.4M |
| Provision for loan and lease losses | $3.5M | $2.1M | $6.2M | $6.5M |
| Income before taxes | $5.6M | $14.7M | $8.3M | $27.5M |
| Net income | $4.9M | $14.3M | $7.3M | $26.7M |
| Diluted EPS | $0.12 | $0.34 | $0.18 | $0.64 |
| Net interest margin | 3.70% | 3.46% | 3.67% | 3.58% |
At June 30, 2019, total assets were $4.27B, up 16.5% from year-end 2018. Loans held for sale were $857.8M and loans held for investment were $2.23B; deposits totaled $3.72B. Shareholders’ equity was $519.0M and book value per share was $12.90.
For the first half, operating cash flow was negative $251.7M, investing cash flow negative $451.4M, and financing cash flow positive $569.8M. Cash and cash equivalents ended at $183.4M, down $133.4M from year-end. Management reported $1.10B of immediately available liquidity, including cash, federal funds sold, unpledged securities, and credit availability.
Borrowings were low: $1.345M short-term and $16K long-term at quarter-end. The company also reported $20M available under an unsecured revolving line, $72.5M in federal funds lines, approximately $1.01B of FHLB borrowing capacity, and approximately $234.9M of Federal Reserve discount-window capacity; no balances were outstanding under those facilities.
Credit measures: the allowance for loan and lease losses was $38.0M, or 1.7% of held-for-investment loans. Q2 net charge-offs were $526K, or 0.10% of average loans on an annualized basis. Nonperforming loans were $65.5M; nonperforming assets and troubled debt restructurings totaled $98.6M. Nonperforming loans not guaranteed by the SBA were 0.82% of held-for-investment loans.
Bank capital ratios exceeded the reported well-capitalized thresholds: common equity Tier 1 was 14.43%, total capital 15.68%, and Tier 1 leverage 10.58% at June 30.
Material changes versus comparable periods
- Net income fell 65% year over year in Q2 and 73% for H1, despite higher net interest income. The principal driver was the shift toward retaining more eligible loans rather than selling them: Q2 guaranteed loan sales fell to $71.9M from $295.2M, while H1 sales fell to $134.9M from $542.5M. Net gains on loan sales declined 73.9% in Q2 and 78.5% for H1.
- Loan and lease originations reached $525.1M in Q2 and $915.9M for H1. Held-for-investment loans grew 20.7% from year-end, while deposits grew 18.2%.
- Higher net interest income reflected portfolio growth and higher investment-security holdings. Q2 net interest margin rose 24 basis points year over year; H1 margin rose 9 basis points.
- Noninterest income also reflected larger equity-method investment losses and the absence of title-insurance income following the 2018 business sale. Lower negative servicing-asset revaluation partly offset these items.
- Noninterest expense declined 3.1% in Q2 and 1.4% for H1. For H1, professional services and equipment costs increased, while travel, data processing, and other expenses declined.
Outlook, commentary, and risks
- Management expects loan portfolios to continue growing as originations remain strong and the company retains more loans. It expects gains on loan sales to make up a diminishing portion of 2019 revenue, with the strategy intended to support recurring revenue, reduce earnings volatility, and improve long-term profitability. No quantitative earnings or growth guidance was provided.
- Management described asset quality as actively monitored and reported no systemic credit issues identified in H1. However, potential problem and impaired loans increased to $178.8M from $148.0M at year-end; management said the increase was concentrated in a relatively small number of borrowers and mature industry verticals.
- Foreclosed assets rose to $6.0M from $1.1M, primarily from two SBA-guaranteed relationships; management characterized the company’s estimated exposure as negligible.
- Key risks include borrower deterioration and higher credit losses, changes to SBA or USDA programs, interest-rate and deposit-cost changes, loan-sale market conditions and servicing-asset valuations, and operational, technology, cybersecurity, regulatory, and competition risks. The allowance estimate and servicing-asset valuation depend on assumptions that may change.
- The company adopted lease accounting guidance in January 2019, recording operating lease right-of-use assets and liabilities and a $66K opening retained-earnings adjustment. It is preparing for the expected January 1, 2020 adoption of the current expected credit loss standard; the impact could not yet be reasonably estimated.
- Management said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter. It reported no material changes to previously disclosed risk factors and no material pending legal proceedings.
Important facts for investors to verify
- Whether retained-loan growth and recurring interest income offset lower loan-sale gains sufficiently to improve earnings over time.
- Trends in criticized, impaired, nonperforming, and restructured credits—especially unguaranteed exposures and concentrations in hotels, healthcare, agriculture, and other industries.
- Whether deposit growth and funding costs support margins as the balance sheet expands; the cost of interest-bearing liabilities rose year over year.
- Allowance adequacy and the eventual effect of CECL adoption, alongside the quality of management’s credit-loss assumptions.
- Sensitivity of servicing-asset valuations and secondary-market loan premiums to interest rates, prepayments, and loan-sale activity.
- Execution of the stated loan-retention strategy, liquidity plans, and investment in renewable-energy leasing and other strategic ventures.