Live Oak Bancshares, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Live Oak is a North Carolina bank holding company whose bank lends to small businesses nationwide, including through SBA- and USDA-guaranteed programs. Amounts below are in millions unless noted.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $37.5 | $27.7 | $102.1 | $79.2 |
| Provision for loan and lease losses | $7.2 | $(0.2) | $13.4 | $6.2 |
| Noninterest income | $18.6 | $24.3 | $46.4 | $85.7 |
| Noninterest expense | $42.7 | $41.2 | $120.5 | $120.1 |
| Net income | $3.9 | $14.3 | $11.2 | $41.0 |
| Diluted EPS | $0.09 | $0.34 | $0.27 | $0.98 |
| Net interest margin | 3.74% | 3.61% | 3.69% | 3.59% |
At September 30, total assets were $4.60 billion, up 25.4% from December 31, 2018. Loans held for sale were $903.1 million; loans and leases held for investment were $2.44 billion, up 32.5% since year-end. Deposits totaled $4.02 billion, up 27.6%. The allowance for loan and lease losses was $42.9 million, or 1.8% of held-for-investment loans and leases. Shareholders’ equity was $528.2 million; book value per share was $13.12.
For the first nine months, net cash used in operating activities was $352.8 million, compared with $144.0 million provided in 2018; net cash used in investing was $582.0 million, while financing provided $866.4 million. Cash and cash equivalents ended at $248.4 million, down from $316.8 million at year-end. Management reported available immediate liquidity of $1.26 billion, or 27.4% of assets. Borrowings were limited: $1.3 million short-term and $15,000 long-term; the company also reported substantial unused credit facilities.
Material changes and drivers
- Net income fell 72.7% in Q3 and 72.7% year to date. Management attributed the decline primarily to retaining more eligible loans rather than selling them: Q3 guaranteed loan sales fell to $100.5 million from $298.1 million, and year-to-date sales to $235.4 million from $840.5 million. Loan-sale gains declined by $14.6 million in Q3 and $51.8 million year to date.
- The retention strategy contributed to higher recurring net interest income and loan growth, but also increased the provision for credit losses. Q3 provision rose by $7.4 million year over year; criticized and classified loans increased alongside portfolio growth.
- Negative servicing-asset revaluation narrowed to $0.9 million in Q3 and $3.5 million year to date, versus $9.4 million and $18.1 million, respectively, in 2018, which partly offset lower loan-sale gains.
- Equity-method investment losses were $2.4 million in Q3 and $6.1 million year to date, compared with $0.4 million and $1.4 million in 2018. The company also recorded $3.3 million of Q3 gains on equity security investments.
- Total nonperforming assets and troubled debt restructurings were $114.1 million, up from $79.8 million at year-end. Criticized and classified loans and leases were $228.0 million, versus $148.0 million. Management cited emerging competitive pressure in Wine and Craft Beverage and Family Entertainment Center borrowers; a Government Contractors credit was criticized after a covenant violation.
Outlook, risks and unusual items
- Management expects loan and lease portfolios to continue growing, including through higher retention and potential conventional lending. It expects loan-sale gains to become a smaller revenue component in 2019 and forecast a 20%–25% effective tax rate for the year.
- The Q3 effective tax rate was 37.8%. Management attributed the increase versus 2018 largely to reduced anticipated solar-panel leasing activity and related investment tax credits.
- Credit risk remains a key concern: nonperforming loans and leases were $80.8 million, while $19.8 million represented unguaranteed exposure. The allowance is an estimate and management cautioned that future losses or deteriorating conditions could require additional provisions.
- Other disclosed risks include changes to SBA/USDA programs, interest-rate and funding conditions, loan-sale premiums and servicing-asset valuations, competition, technology or cybersecurity disruptions, and regulatory or economic changes. The company said its balance sheet was asset-sensitive, with a 1.7% cumulative gap; rate changes may affect net interest income and servicing valuations differently.
- The company adopted lease accounting guidance in January 2019, recording operating lease right-of-use assets and liabilities. It expects to adopt the current expected credit loss standard on January 1, 2020, but could not reasonably estimate its impact at filing.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. It reported no material change to previously disclosed risk factors and no material ordinary-course legal proceedings.
Investor facts to verify
- Whether retained-loan growth produces recurring interest income sufficient to offset lower loan-sale gains and higher deposit funding costs.
- Credit trends, particularly criticized/classified balances, nonaccrual loans, TDRs, vertical and borrower concentrations, and the adequacy of the allowance.
- Whether the forecast tax rate and anticipated renewable-energy investment tax credits are achieved.
- Cash-flow timing and liquidity, including deposit composition, loan-sale activity, and availability of disclosed borrowing facilities.
- The eventual transition effect of the expected-credit-loss standard and changes in servicing-asset valuation assumptions.