Live Oak Bancshares, Inc. annual report, FY2017

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Business context and reporting period

Live Oak Bancshares, Inc. filed this Form 10-K for the fiscal year ended December 31, 2017. The Wilmington, North Carolina-based bank holding company operates a nationwide, technology-enabled small-business lending platform, focusing on selected industry verticals. It primarily originates SBA-guaranteed loans, retains servicing rights, and also originates USDA-guaranteed loans. The financial statements were audited; the auditor issued an unqualified opinion.

Financial performance and condition

  • Revenue: Net interest income was $78.0 million, up 83.0% from $42.6 million. Noninterest income was $172.9 million, up 84.9%; it included a $68.0 million one-time gain on the Apiture joint venture contribution. Total revenue, defined as net interest income plus noninterest income, was $251.0 million. Management’s non-GAAP core revenues—net interest income, servicing revenue and loan-sale gains—were $181.2 million, up 30.0%.
  • Profit: Net income attributable to the company was $100.5 million, or $2.65 diluted EPS, versus $13.8 million, or $0.39, in 2016. The 2017 result included the Apiture gain and a provisional $18.9 million tax benefit from revaluing deferred taxes under the Tax Cuts and Jobs Act. Non-GAAP net income, excluding specified non-routine items, was $47.2 million, or $1.25 diluted EPS, versus $20.1 million, or $0.57, in 2016.
  • Margins and costs: Net interest margin rose to 3.92% from 3.28%; average earning-asset yield increased to 5.20% from 4.40%, while funding cost rose to 1.38% from 1.24%. The efficiency ratio improved to 57.05% from 78.16%, though noninterest expense increased 34.5% to $143.2 million. Loan servicing revaluation was a negative $13.2 million, compared with a negative $8.4 million in 2016.
  • Cash flow: Operating cash flow was negative $287.5 million and investing cash flow was negative $535.0 million, largely reflecting loan originations and purchases of property and equipment. Financing cash flow was positive $879.8 million, including $775.2 million of deposit growth and $113.1 million net proceeds from the secondary share offering. Cash and cash equivalents ended the year at $295.3 million, up $57.3 million.
  • Balance sheet and funding: Total assets increased 57.2% to $2.76 billion. Loans held for sale were $680.5 million; loans and leases held for investment were $1.34 billion, up 48.1%. Deposits rose 52.2% to $2.26 billion. Year-end borrowings were $26.6 million; the company reported $20 million and $25 million available under two revolving lines, plus approximately $189.1 million of Federal Reserve borrowing capacity. Immediate liquidity sources totaled $674.2 million, or 24.4% of assets, versus $495.8 million, or 28.2%, in 2016.
  • Capital and credit: Consolidated CET1 and total risk-based capital ratios were 17.81% and 18.91%; the Bank’s were 12.89% and 14.02%, respectively. The Bank was categorized as well capitalized. The allowance for loan and lease losses was $24.2 million, or 1.80% of held-for-investment loans, versus $18.2 million, or 2.01%, in 2016. Net charge-offs were $3.6 million, or 0.32% of average held-for-investment loans, versus $1.7 million, or 0.29%. Nonperforming loans totaled $23.5 million; $19.9 million was SBA-guaranteed, leaving $3.6 million of unguaranteed exposure.

Material changes versus 2016

  • Loan originations increased 25.8% to $1.93 billion, while guaranteed loan sales rose 3.4% to $787.9 million. Management said it emphasized loan retention to build recurring revenue.
  • Deposits increased by $775.2 million; the deposit mix shifted materially, including a new savings product and increased time deposits. A substantial share of large time deposits was scheduled to mature within one year.
  • The company issued 5.175 million voting shares in an August secondary offering, receiving $113.1 million net. Shareholders’ equity rose to $436.9 million from $222.8 million.
  • The company formed Apiture with First Data in October, with equal voting control; accounting recognized a $68.0 million one-time contribution gain. The company also acquired title agencies Reltco, whose weaker-than-expected results led to $3.6 million of impairment expense and a revised contingent earn-out.
  • Renewable-energy investment reached $90.6 million and generated $24.9 million of investment tax credits. Premises and equipment increased to $178.8 million, including solar assets, aircraft and hangar-related investment.

Outlook, commentary and risks

Management described 2017 as a year of strong underlying performance and growth. It expects continued growth in held-for-sale and held-for-investment loans, supported by healthy originations, loan retention, construction lending and potential conventional lending outside government-guaranteed programs. It also plans to develop existing verticals, add new ones, and pursue recurring revenue and financial-technology initiatives. Management projected a low-to-mid single-digit effective tax rate for 2018, subject to income mix, tax-credit investments and final Tax Act accounting; the provisional tax accounting was expected to be completed in the fourth quarter of 2018.

  • Management warned that SBA rule changes effective January 1, 2018, including equity eligibility requirements, could reduce originations, particularly in Agriculture. The filing also discusses an SBA Inspector General report on poultry-farmer loans and says the potential implications and any SBA response were still being assessed.
  • Key risks include credit deterioration in small-business and concentrated industry portfolios; reliance on SBA programs and secondary-market loan sales; deposit funding and liquidity dependence, including wholesale and online deposits; interest-rate and servicing-asset valuation sensitivity; and execution risks in new businesses and acquisitions.
  • The nCino platform license was due to expire in November 2018, and the Bank relies on Apiture for significant services. Technology outages, cybersecurity incidents or loss of third-party services could disrupt operations.
  • Other notable exposures include $1.70 billion of commitments to extend credit, $106.9 million of solar purchase commitments and $25.5 million of aircraft purchase commitments. Management reported no material pending legal proceedings. It identified no material weaknesses in internal control over financial reporting.
  • Subsequent events: the company repaid its $23.0 million construction-line balance in January 2018, including a $229,000 prepayment penalty; in February 2018 it bought $170.3 million of mortgage-backed securities to enhance contingent funding.

Most important facts for investors to verify

  1. Reconcile reported 2017 earnings with the $68.0 million Apiture gain, $18.9 million provisional deferred-tax benefit and the $47.2 million non-GAAP net-income figure; assess the assumptions underlying the Apiture valuation and gain.
  2. Review the quality, seasoning and concentration of the rapidly expanding loan portfolio, including Agriculture and construction lending, nonperforming and criticized loans, charge-offs, and allowance adequacy.
  3. Assess deposit composition, pricing and renewal risk, including large time-deposit maturities, brokered or wholesale funding, and liquidity after the February 2018 securities purchase.
  4. Track SBA eligibility and program developments, the poultry-loan review, and the effect of guarantee levels and secondary-market premiums on originations and earnings.
  5. Evaluate execution and economics of Apiture, Reltco and renewable-energy investments, as well as technology-license continuity and related-party investment exposures.