Live Oak Bancshares, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. Live Oak is a Wilmington, North Carolina-based bank holding company operating a national, technology-enabled small-business lending and deposit platform. Lending focuses primarily on SBA-guaranteed loans and, to a lesser extent, USDA-guaranteed loans.
Key financial metrics
| Metric | 2018 | 2017 |
|---|---|---|
| Total assets, year-end | $3.67 billion | $2.76 billion |
| Net interest income | $108.0 million | $78.0 million |
| Net interest margin | 3.62% | 3.92% |
| Noninterest income | $103.8 million | $172.9 million |
| Noninterest expense | $152.7 million | $143.2 million |
| Provision for loan and lease losses | $13.1 million | $9.5 million |
| Net income / diluted EPS | $51.4 million / $1.24 | $100.5 million / $2.65 |
| Non-GAAP net income / diluted EPS | $54.6 million / $1.32 | $47.2 million / $1.25 |
| Deposits, year-end | $3.15 billion | $2.26 billion |
| Loans held for investment, year-end | $1.84 billion | $1.34 billion |
| Cash and investment securities, year-end | $697.3 million | $388.6 million |
| Shareholders’ equity, year-end | $493.6 million | $436.9 million |
| Borrowings, year-end | $1.5 million | $26.6 million |
Consolidated cash flows were $11.5 million provided by operating activities, $850.6 million used in investing activities, and $860.6 million provided by financing activities. Cash and cash equivalents ended the year at $316.8 million. Management reported total immediate liquidity sources of $1.04 billion, or 28.4% of assets.
Other measures: return on average assets was 1.52% (4.55% in 2017); return on average equity was 11.00% (33.80%); and the efficiency ratio was 72.10% (57.05%). The company declared $0.12 per share in dividends for 2018.
Material changes versus 2017
- Reported net income fell 48.8%, principally because 2017 included a one-time $68.0 million pretax gain from the Apiture joint venture contribution. 2018 also had higher negative servicing-rights revaluation and lower loan-sale gains. Non-GAAP net income increased 15.6% to $54.6 million.
- Net interest income grew 38.5%, supported by growth in earning assets; net interest margin declined 30 basis points as higher cash and securities balances from liquidity initiatives carried lower yields and funding costs rose.
- Loan originations declined 8.7% to $1.77 billion, while guaranteed loan sales rose 20.0% to $945.2 million. Average gains per $1 million sold declined to $80.9 thousand from $100.4 thousand.
- In the fourth quarter, the company began retaining a larger share of loans previously eligible for sale, including reclassifying $80.3 million of guaranteed loans to held-for-investment. Management said the shift is intended to build recurring revenue and reduce earnings volatility.
- Deposits grew 39.3%; available-for-sale securities increased to $380.5 million from $93.4 million, strengthening liquidity. Long-term borrowings were substantially repaid.
- Credit indicators weakened: nonperforming loans rose to $57.7 million from $23.5 million, while nonperforming loans not guaranteed by the U.S. government increased to $14.5 million from $3.6 million. Net charge-offs were 0.31% of average held-for-investment loans, compared with 0.32%.
Outlook, risks and unusual items
- Management expects held-for-sale and held-for-investment portfolios to grow through originations and higher retention. It expects loan-sale gains to remain a significant revenue component in 2019, while pursuing recurring revenue and possible conventional lending opportunities. No quantified earnings or growth guidance was provided.
- Management expected the 2019 effective tax rate to be in the low double digits, subject to income, expenses, investment tax credits and other discrete items.
- The company invested $70.2 million in renewable-energy assets in 2018, generating approximately $20.3 million in investment tax credits. The reported tax benefit was $5.4 million; the effective tax rate was negative 11.7%.
- The 35-day federal government shutdown ending January 25, 2019 hampered SBA loan origination and secondary-market sales, though management said its 2018 liquidity and loan-retention measures softened the effect.
- Key exposures include borrower credit deterioration and concentrations in small-business sectors; SBA/USDA program or guarantee changes; loan-sale premiums and servicing-asset valuation; interest-rate, deposit-cost and liquidity risk; technology and cybersecurity, including reliance on third-party platforms; and execution of the loan-retention strategy.
- CECL is scheduled to take effect for the company on January 1, 2020. Management was evaluating the impact and could not estimate the required allowance adjustment or effects on regulatory capital.
- The company exited its title-insurance business in August 2018, financing the $3.0 million sale of its Reltco interest. It recorded $2.7 million of 2018 impairment expense related to the exit. The 2017 Apiture gain and 2018 renewable-energy tax credits materially affect period comparisons.
- Capital remained above regulatory minimums: consolidated common equity Tier 1 was 17.10%, total capital 18.28%, and Tier 1 leverage 13.40%. Live Oak Bank was reported well-capitalized. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether loan retention produces durable net interest income and recurring profitability, and how it affects credit, liquidity and interest-rate exposure.
- Whether the deterioration in nonperforming, criticized, past-due and restructured loans continues; assess government-guaranteed versus unguaranteed exposure and adequacy of the $32.4 million allowance.
- Loan-sale premiums, servicing-rights assumptions and valuation sensitivity, given lower average gains and increased negative servicing revaluation.
- Deposit composition, funding costs and maturities: time deposits were $2.12 billion, with $1.44 billion scheduled to mature in 2019.
- The realized effects of the federal shutdown and any SBA/USDA program changes, including the SBA review of poultry-farmer loans and revised equity eligibility procedures.
- The eventual CECL allowance and capital impact, alongside progress and costs for the company’s planned technology platforms.