Live Oak Bancshares, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Live Oak is a nationwide small-business lender, with significant SBA- and USDA-guaranteed lending, and also earns income from loan sales, servicing, leasing, wealth management, and financial-technology investments. Unaudited results; dollars below are U.S. dollars.
Key financial results
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $51.4 million | $37.5 million | $132.4 million | $102.1 million |
| Noninterest income | $47.0 million | $15.4 million | $75.2 million | $43.4 million |
| Provision for credit losses | $10.3 million | $4.0 million | $32.0 million | $10.4 million |
| Net income | $33.8 million | $3.9 million | $30.0 million | $11.2 million |
| Diluted EPS | $0.81 | $0.09 | $0.73 | $0.27 |
| Net interest margin | 2.77% | 3.75% | 2.89% | 3.71% |
Q3 pre-tax income was $45.5 million. Nine-month results include losses in the first half: Q3 net income exceeded the nine-month total. Q3 earnings benefited from higher net interest income, loan-sale gains, improved servicing-asset valuation, and investment gains. A $13.7 million noncash gain tied to the observable valuation of the Greenlight investment was a significant contributor.
Balance sheet, funding, liquidity, and cash flow
- At September 30, total assets were $8.09 billion, up 68% from year-end 2019. Loans held for investment were $5.04 billion; loans held for sale were $1.19 billion. The portfolio included $1.76 billion of PPP loans.
- Deposits were $5.71 billion, up 35% from December 31, 2019. Borrowings were $1.75 billion, almost entirely $1.74 billion of Federal Reserve PPPLF advances secured by PPP loans. The advances bear 0.35% interest.
- Cash and cash equivalents were $634.8 million, compared with $221.4 million at year-end. Management reported immediately available liquidity of $2.96 billion, or 36.6% of assets. Available borrowing capacity included $2.05 billion under FHLB arrangements and $1.43 billion at the Federal Reserve discount window; neither facility had advances outstanding.
- Shareholders’ equity was $584.2 million, versus $532.4 million at year-end. Consolidated CET1 and total capital ratios were 13.09% and 14.19%; the Bank’s were 12.06% and 13.19%, respectively. The filing states capital ratios exceeded regulatory requirements.
- For the first nine months, operating cash flow was negative $292.1 million and investing cash flow was negative $2.52 billion, largely reflecting loan origination and investment activity. Financing cash flow was positive $3.22 billion, principally from deposit growth and borrowings; cash increased $413.4 million.
Changes, credit quality, and unusual items
- Net interest income increased 36.9% in Q3 and 29.7% year to date, primarily on loan growth and PPP activity. Margin declined year over year as asset yields repriced down faster than funding costs; management said deposit repricing and use of excess liquidity to fund loans began to help in Q3.
- Credit-loss provision rose to $32.0 million for the nine months, and net charge-offs were $14.7 million versus $0.9 million a year earlier. The allowance for credit losses was $44.2 million at September 30. Management cited COVID-19-related economic forecasts, portfolio growth, and charge-offs; the Q3 provision included $6.4 million to replenish reserves following hotel-loan charge-offs.
- Fifteen hotel loans with $81.2 million of net investment were reclassified to held for sale and written down by $9.8 million. Ten had been sold by quarter-end; five remained held for sale at an aggregate $25.7 million net investment, written down to an agreed price.
- Nonperforming assets and troubled debt restructurings, including fair-value loans, totaled $145.0 million, up 30.5% from year-end; $46.4 million was unguaranteed exposure. Separately, the filing’s table excluding fair-value loans reports $74.4 million of nonperforming assets and TDRs. Management cautions that SBA payment support and deferrals may obscure borrowers’ repayment capacity.
- COVID-19-sensitive verticals identified by management include hotels, wine and craft beverage, education, entertainment, fitness, and quick-service restaurants. Criticized and classified loans excluding fair-value loans increased to $217.1 million from $129.1 million at year-end.
- Other notable items: the company adopted CECL on January 1, increasing opening retained earnings by $822,000; acquired Jolley Asset Management on April 1, with no material reported financial impact; and recorded a $1.0 million impairment on an aircraft classified as held for sale.
Outlook, risks, and contingencies
No quantitative earnings or growth guidance is provided. Management estimated a 26%–28% effective tax rate for the remainder of 2020, subject to the amount and nature of future income, expenses, tax-credit investments, and discrete tax effects. Management described improving economic forecasts and secondary-market conditions in Q3, but warned that a worsening or prolonged pandemic could increase credit provisions and fair-value losses, weaken loan-sale premiums and interest income, and pressure liquidity, capital, and funding costs.
As of September 30, 63% of loans and leases at amortized cost excluding PPP loans were receiving six months of SBA payments, and 2% had a payment deferral. By November 3, the company had submitted $77.5 million, or 4% of PPP loans by dollar amount, for forgiveness. PPP rules and forgiveness procedures remained subject to evolving guidance; the filing identifies operational, compliance, litigation, and SBA-guarantee risks. The company also reported $1.84 billion of unfunded commitments and $27.2 million of standby letters of credit. Management said ordinary-course litigation was not expected to materially affect results.
Important facts for investors to verify
- Whether reported earnings are sustainable without the $13.7 million Greenlight valuation gain and other market-sensitive loan-sale and fair-value items.
- How PPP forgiveness, SBA reimbursement, and evolving program requirements affect loan balances, fees, and the PPPLF borrowing balance.
- Whether pandemic-related borrower stress, especially in hotel and entertainment exposures, leads to further charge-offs, criticized loans, or allowance increases.
- How deposit pricing, excess liquidity deployment, and funding costs affect net interest margin and liquidity.
- Whether nonperforming-asset measures are comparable across disclosures, given the filing presents totals both including and excluding loans measured at fair value.