Live Oak Bancshares, Inc. — 2019 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2019; quarterly results are also provided. Live Oak is a digital, nationwide small-business lender focused on selected industry “verticals.” A significant portion of its loans are guaranteed by the SBA or USDA, and the company also gathers deposits and retains servicing rights on loans sold.
Financial performance and condition
| Metric | 2019 | 2018 |
|---|---|---|
| Net interest income | $140.1 million | $108.0 million |
| Noninterest income | $67.9 million | $103.8 million |
| Net income | $18.0 million | $51.4 million |
| Diluted earnings per share | $0.44 | $1.24 |
| Net interest margin | 3.65% | 3.62% |
| Efficiency ratio | 79.54% | 72.10% |
| Total assets, year-end | $4.81 billion | $3.67 billion |
| Loans held for sale and investment, year-end | $3.61 billion | $2.53 billion |
| Deposits, year-end | $4.23 billion | $3.15 billion |
| Shareholders’ equity, year-end | $532.4 million | $493.6 million |
- Profit and revenue mix: Net income fell 64.9%. Net gains on loan sales dropped 61.4% to $29.0 million as the company retained more eligible loans. Total noninterest income declined 34.6%; improved servicing revaluation and higher interest income partly offset lower loan-sale gains.
- Costs and credit provision: Noninterest expense increased 8.0% to $164.9 million, including salaries and benefits of $90.6 million. Provision for loan and lease losses rose 49.9% to $19.6 million, primarily reflecting portfolio growth and higher criticized/classified balances.
- Cash flow: Operating cash flow was negative $493.9 million; investing cash flow was negative $673.2 million; financing provided $1.074 billion, primarily from $1.080 billion of deposit growth. Cash and cash equivalents decreased $93.3 million to $223.5 million. The operating outflow occurred amid loan originations and increased loans retained or held for sale.
- Credit quality: Allowance for loan and lease losses was $48.2 million, or 1.82% of held-for-investment loans. Net charge-offs were $3.8 million, 0.17% of average held-for-investment loans, versus $4.8 million and 0.31% in 2018. Nonperforming loans were $76.3 million, including $58.4 million covered by government guarantees; unguaranteed nonperforming loans were $17.9 million. Criticized and classified loans increased to $270.3 million from $148.0 million.
- Debt and liquidity: Year-end borrowings were $14,000. Management reported $1.19 billion of immediate liquidity sources, 24.8% of assets, including cash, federal funds sold, unpledged securities and credit availability. Deposits were heavily weighted toward time deposits: $2.99 billion, or 70.6% of deposits; $2.09 billion of time deposits were scheduled to mature in 2020.
- Capital: Consolidated common equity Tier 1 and total capital ratios were 14.85% and 16.10%; the Tier 1 leverage ratio was 10.65%, down from 13.40% in 2018. The Bank was reported well capitalized.
Material changes versus prior periods
- The late-2018 strategy to retain a larger share of eligible loans continued in 2019. Loans held for investment grew 43.6%, and loans held for sale grew 40.6%; guaranteed loan sales fell 64.0% to $340.4 million.
- Net interest income rose 29.7%, supported by loan growth and higher securities holdings. Average asset yield increased to 5.95%, while the cost of interest-bearing liabilities rose to 2.38%.
- Personnel expense increased 17.1%, reflecting workforce investment and comparison with a 2018 reversal of accrued incentive compensation. Full-time equivalent employees rose from 498 to 612.
- The company recorded a $7.9 million loss from equity-method investments, largely associated with Apiture, compared with a $386,000 loss in 2018. A $68.0 million one-time gain on contribution to Apiture had boosted 2017 results and makes that year less comparable.
- Income tax expense was $5.4 million in 2019, versus a $5.4 million benefit in 2018, when renewable-energy investment tax credits were substantially higher. Renewable-energy investments generating credits were $5.9 million in 2019 versus $70.2 million in 2018.
Outlook, risks and unusual items
- Management expected loan portfolios to continue growing, supported by healthy originations and higher retention, and planned to build recurring revenue and pursue conventional lending beyond government-guaranteed programs. It anticipated loan-sale gains would remain a significant revenue component in 2020, but provided no numerical earnings or growth guidance.
- Management characterized 2019 as showing growth momentum and continued investment in lending verticals, personnel and financial technology. It said the retention strategy is intended to reduce earnings volatility and support long-term recurring revenue, while acknowledging near-term pressure on loan-sale income.
- Credit risks include the increase in criticized/classified loans, concentrations in small businesses and selected industries, and exposure to real estate and construction lending. Management identified heightened competition or stress in Wine and Craft Beverage and Family Entertainment Center lending, and stress in some early Government Contracting loans.
- Other material risks include dependence on SBA/USDA programs and secondary-market loan sales, deposit funding and time-deposit maturities, interest-rate and servicing-rights valuation sensitivity, cyber and technology-provider risks, Apiture development and investment risk, and the possible effects of recession or pandemic events. The filing specifically discusses coronavirus as a potential risk based on information available at filing.
- CECL became effective for the company January 1, 2020. Management estimated an immaterial decrease of $0.8–$1.4 million in loan and lease credit-loss reserves and an immaterial $0.4–$0.8 million increase in off-balance-sheet reserves upon adoption.
- The auditor issued an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective. Servicing-asset valuation and the allowance for loan and lease losses were identified as critical audit matters. Management reported no material pending legal proceedings.
Important facts for investors to verify
- Whether loan retention produces the intended recurring income without further deterioration in loan-sale gains or materially higher credit costs.
- Trends in criticized/classified loans, unguaranteed nonperforming exposure, charge-offs, and allowance adequacy as the portfolio expands.
- Deposit stability, pricing, concentration in time deposits, 2020 maturities, and the company’s actual liquidity sources and borrowing availability.
- Assumptions and sensitivity behind the $35.4 million servicing asset and gains on loan sales, including prepayment and market-premium assumptions.
- Apiture’s performance, future funding needs and effect on results; equity-method investment losses totaled $7.9 million in 2019.
- The actual effect of CECL adoption and whether the reported estimated reserve changes proved accurate.