Live Oak Bancshares, Inc. — 2018 Q3 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. All dollar amounts below are in millions unless noted. The company operates primarily through Live Oak Banking Company, a nationwide small-business lender, with significant SBA- and USDA-guaranteed lending and loan-sale activity.
Financial performance and position
| Metric | Q3 / September 30, 2018 | Comparable period / prior date |
|---|---|---|
| Net income | $14.3; diluted EPS $0.34 | Q3 2017: $12.9; diluted EPS $0.33 |
| Net interest income | Q3: $27.7; nine months: $79.2 | Q3 2017: $21.0; nine months 2017: $55.1 |
| Net interest margin | Q3: 3.61%; nine months: 3.59% | Q3 2017: 3.91%; nine months 2017: 3.87% |
| Net gains on loan sales | Q3: $22.0; nine months: $69.5 | Q3 2017: $18.1; nine months 2017: $55.3 |
| Noninterest income / expense | Q3: $24.3 / $41.2; nine months: $85.7 / $120.1 | Q3 2017: $25.1 / $35.9; nine months 2017: $77.5 / $102.1 |
| Assets / deposits | $3,444.8 / $2,924.3 | December 31, 2017: $2,758.5 / $2,260.3 |
| Loans held for investment, net of allowance | $1,604.5 | December 31, 2017: $1,319.8 |
| Cash and due from banks / available-for-sale securities | $368.6 / $374.3 | December 31, 2017: $295.3 / $93.4 |
| Long-term borrowings / shareholders’ equity | $1.5 / $477.2 | December 31, 2017: $26.6 / $436.9 |
| Cash flows, nine months | Operating +$144.0; investing −$707.3; financing +$636.6 | 2017: operating −$256.2; investing −$354.4; financing +$633.5 |
Changes versus comparable periods
- Q3 net income rose about 11%; nine-month net income increased to $41.0 from $28.8, and diluted EPS rose to $0.98 from $0.78.
- Net interest income increased 31.9% in Q3 and 43.9% year to date, driven mainly by growth in loans, leases and securities. However, net interest margin compressed year over year as funding costs rose and the company held more lower-yielding cash and securities for liquidity.
- Nine-month noninterest income grew 10.6%, supported by higher loan-sale gains, servicing revenue and lease income. The Q3 total declined 2.9%, largely because servicing-asset revaluation losses increased.
- Noninterest expense increased 15.0% in Q3 and 17.6% year to date, reflecting growth-related staffing and infrastructure costs, data processing and equipment expense, plus the title-business disposition charge.
- From year-end 2017, assets grew 24.9%, deposits 29.4%, and net loans held for investment 21.6%. Available-for-sale securities rose by $280.9 million as part of a liquidity initiative; borrowings fell by $25.1 million.
Outlook, commentary, risks and unusual items
- Outlook: Management expected full-year 2018 originations of approximately $1.70–$1.80 billion. For Q4, it expected to retain more loans on the balance sheet and sell less into the secondary market than historically. No earnings or margin guidance was provided.
- Credit quality: Nonperforming loans were $52.7 million, or 3.23% of loans held for investment, versus $23.5 million and 1.75% at year-end 2017. Nonperforming assets plus troubled debt restructurings totaled $67.9 million, up from $26.9 million. Management said the increase was concentrated in a relatively small number of borrowers, largely in mature verticals, and identified no systemic issue. The allowance was $26.8 million, 1.6% of held-for-investment loans, versus 1.8% at year-end.
- Management attributed the Q3 negative loan-loss provision of $0.2 million partly to a $2.9 million reduction from moving the family entertainment portfolio to mature-vertical loss factors and a $0.4 million reduction from transferring renewable-energy loans to held for sale. Nine-month provision expense was $6.2 million, versus $5.5 million.
- Liquidity and capital: Management reported $1.07 billion of immediately available liquidity, or 31.2% of assets. The securities portfolio had $371.7 million available as lendable collateral. At September 30, the bank’s CET1 ratio was 13.97% and total capital ratio 15.05%; both exceeded applicable “well capitalized” thresholds.
- Unusual items: The company sold its Reltco title-insurance businesses on August 1, 2018, financing the $3.0 million sale price and recording a $3.0 million reserve. The transaction resulted in a $2.7 million net impairment expense. The sale also reduced title-insurance income. Servicing-asset revaluation losses were $9.4 million in Q3 and $18.1 million year to date, which management linked to rising rates, a flattening yield curve, prepayment assumptions and fewer active loan purchasers.
- The reported tax benefit reflected anticipated investment tax credits from renewable-energy activities; management noted the actual 2018 effective tax rate could vary with future income, expenses and qualifying investments.
- Principal disclosed risks include borrower deterioration, changes to SBA/USDA programs, interest-rate and loan-sale market movements, servicing-right valuation, technology or cybersecurity disruptions, competition, regulatory requirements and execution of growth initiatives. Management reported no material change to previously disclosed risk factors, no material litigation, and effective disclosure controls.
Important facts for investors to verify
- Whether elevated nonperforming loans, past-due balances and criticized credits stabilize, and how much exposure is protected by government guarantees.
- Whether the $26.8 million allowance remains adequate as the portfolio grows and credit performance develops.
- Whether loan-sale volumes, premiums and servicing-asset valuations recover or continue to pressure noninterest income and margins.
- Whether deposit growth and the stated liquidity position can support planned originations without further margin compression or higher funding costs.
- Whether management achieves the $1.70–$1.80 billion full-year origination outlook and the planned Q4 shift toward retaining more loans.
- The realized economics of the Reltco sale and renewable-energy leasing activity, including investment tax credits, capital needs and operating costs.