Live Oak Bancshares, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Live Oak is a bank holding company whose bank specializes in small-business lending nationwide, including SBA- and USDA-guaranteed loans. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Financial performance and position
| Metric | Q1 2018 / March 31, 2018 | Comparable period / prior year-end |
|---|---|---|
| Net interest income | $24.5 million | $15.6 million in Q1 2017 |
| Net income | $12.5 million; diluted EPS $0.30 | $6.1 million; diluted EPS $0.17 in Q1 2017 |
| Net interest margin | 3.72% | 3.76% in Q1 2017 |
| Total assets | $3,460.9 million | $2,758.5 million at Dec. 31, 2017 |
| Loans held for sale | $720.5 million | $680.5 million at Dec. 31, 2017 |
| Loans and leases held for investment, net | $1,414.0 million after allowance | $1,319.8 million at Dec. 31, 2017 |
| Deposits | $2,973.3 million | $2,260.3 million at Dec. 31, 2017 |
| Long-term borrowings | $3.5 million | $26.6 million at Dec. 31, 2017 |
| Cash and due from banks | $528.0 million | $295.3 million at Dec. 31, 2017 |
| Shareholders’ equity | $448.8 million | $436.9 million at Dec. 31, 2017 |
- Total interest income rose to $35.0 million from $20.4 million; interest expense increased to $10.5 million from $4.8 million. Management attributed net interest income growth mainly to a 58.4% increase in average interest-earning assets, with higher asset yields also contributing.
- Noninterest income was $30.8 million, up 19.4%. Net loan-sale gains were $24.4 million, up 28.8%; loan servicing revenue was $6.9 million. A $5.1 million servicing-asset revaluation loss partially offset revenue growth. Lease income contributed $1.6 million.
- Noninterest expense increased 15.4% to $38.1 million, led by higher personnel, data-processing, occupancy, and equipment costs. Provision for loan and lease losses was $4.4 million versus $1.5 million. The effective tax rate was 2.5%, compared with 11.5% in Q1 2017.
- Net cash used in operating activities was $36.1 million; investing activities used $420.6 million, including $293.0 million of securities purchases and $41.7 million of premises and equipment purchases. Financing provided $689.3 million, largely from a $713.1 million net increase in deposits. Cash and cash equivalents increased $232.7 million.
- The allowance for loan and lease losses was $28.1 million, or 2.0% of held-for-investment loans and leases, versus $24.2 million and 1.8% at year-end. Net charge-offs were $0.5 million, or 0.15% annualized of average held-for-investment loans and leases.
- Regulatory capital ratios remained above stated minimum requirements. At the bank, Common Equity Tier 1 was 13.49%, total capital was 14.66%, and the leverage ratio was 11.14% at March 31, 2018.
Changes and asset quality
- Net income approximately doubled year over year, supported by stronger net interest income, loan-sale gains, and new leasing revenue. Higher credit provision, servicing-asset revaluation losses, and operating costs were offsets.
- Assets increased 25.5% from year-end. Deposits grew 31.5%; management said deposit-gathering initiatives supported lending growth and liquidity. Available-for-sale securities increased to $378.5 million from $93.4 million, primarily following purchases of mortgage-backed securities to strengthen contingent funding.
- Nonperforming loans rose to $36.8 million from $23.5 million at year-end; nonperforming loans were 2.55% of held-for-investment loans and leases, versus 1.75%. Nonperforming assets and troubled debt restructurings totaled $40.7 million, of which $31.3 million was government-guaranteed. Unguaranteed nonperforming-asset and restructuring exposure increased to $9.4 million from $5.7 million.
- Criticized loans and leases (risk grades 5–8) increased, including risk-grade-5 balances from $37.0 million to $57.3 million. Management attributed much of the government-contracting increase to the existing risk-grading model, which it said was not tailored to asset-based loans; it planned to formalize a revised methodology in Q2 2018. Management reported that about 90.9% of risk-grade-5 loans were current.
Outlook, risks, and contingencies
- Management expected the loan and lease portfolio to continue growing and projected a very low single-digit effective tax rate for full-year 2018, principally reflecting anticipated investment tax credits from renewable-energy financing. The filing provides no quantitative earnings or revenue guidance.
- Liquidity available from cash, federal funds, unpledged securities, and credit lines was reported at $1.22 billion, or 35.3% of assets. The company reported $375.9 million of securities available as lendable collateral and no outstanding balance on its reported lines of credit.
- Key risks include borrower deterioration and reserve-estimation uncertainty; changes to SBA/USDA programs; interest-rate and market movements affecting funding, loan-sale premiums, and servicing-asset values; operational, cybersecurity, and technology-provider risks; competition; regulatory changes; and concentration in lending verticals. The company also noted that servicing-asset valuation is sensitive to assumptions, particularly prepayment speeds.
- Unfunded off-balance-sheet commitments totaled $1.54 billion, including $1.45 billion of commitments to extend credit, $67.9 million of solar purchase commitments, and $25.5 million of airplane purchase commitments. Management said many credit commitments may expire undrawn. It reported ordinary-course legal proceedings and did not expect them to materially affect financial position, results, or cash flows.
- Management stated that disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Track whether loan growth is accompanied by stable credit quality, especially the rise in nonaccrual loans, criticized balances, and unguaranteed exposure; assess the revised government-contracting risk methodology and subsequent reserve levels.
- Assess sustainability of loan-sale gains and net interest income against deposit costs, the modest margin decline, loan-sale volumes, and servicing-asset valuation changes.
- Review execution and economics of renewable-energy leasing, including investment tax credits, equipment depreciation, and the effect on the unusually low effective tax rate.
- Monitor liquidity and funding mix, including deposit concentration and retention, security portfolio market values, and the use and availability of contingent funding.
- Reconcile apparent MD&A inconsistencies: the filing’s financial statements show a $28.1 million allowance at March 31, while one MD&A passage refers to $24.2 million at that date; another passage appears to misstate the reporting-year labels for loans held for sale. Confirm figures against the statements and notes.