Live Oak Bancshares, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. The company is a bank holding company whose bank subsidiary lends to small businesses nationwide, including through SBA- and USDA-guaranteed programs. Unless noted, amounts below are in millions; year-over-year comparisons are with 2017.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net interest income | $27.0 | $18.4 | $51.5 | $34.0 |
| Noninterest income | $30.6 | $26.7 | $61.4 | $52.4 |
| Noninterest expense | $40.8 | $33.3 | $78.9 | $66.3 |
| Net income | $14.3 | $9.8 | $26.7 | $15.9 |
| Diluted EPS | $0.34 | $0.27 | $0.64 | $0.44 |
| Net interest margin | 3.46% | 3.92% | 3.58% | 3.84% |
Loan-sale gains were $23.1 million in Q2 and $47.5 million in the first half, up 26.9% and 27.9%, respectively. Higher sale volumes and loan growth supported results, partly offset by lower average sale premiums. Servicing-asset revaluation losses increased to $3.7 million in Q2 and $8.8 million in the first half. The effective tax rate was 3.3% for Q2 and 2.9% for the first half, principally reflecting renewable-energy investment tax credits.
Financial condition, liquidity and cash flow
- Balance-sheet growth: Total assets were $3.47 billion at June 30, up 25.9% from December 31, 2017. Loans held for investment were $1.53 billion, loans held for sale $757.5 million, and available-for-sale securities $384.9 million.
- Funding and debt: Deposits reached $2.97 billion, up $709.0 million from year-end. Long-term borrowings fell to $3.4 million from $26.6 million; there were no short-term borrowings outstanding.
- Liquidity: Management reported $1.10 billion of immediately available liquidity, or 31.8% of assets, including cash, securities and credit availability. $382.3 million of securities were available as lendable collateral. Cash and due from banks was $392.9 million.
- Capital: Shareholders’ equity was $463.0 million. The bank’s Common Equity Tier 1 ratio was 13.71% and total capital ratio was 14.92%; both exceeded the reported “well-capitalized” thresholds.
- Cash flow, first half: Operating cash flow was negative $11.8 million, investing cash flow negative $574.9 million, and financing cash flow positive $684.3 million. Deposit growth was the primary financing source; investing outflows included securities purchases and loan growth.
Changes, outlook and material matters
- Net interest income rose with substantial growth in earning assets, but margin contracted: management attributed Q2 pressure partly to liquidity initiatives that increased cash and securities balances, as well as higher funding costs.
- Operating expenses rose 19.0% in the first half, notably personnel, data processing, occupancy and equipment costs, reflecting investment in growth and renewable-energy leasing activity.
- Credit indicators weakened: nonperforming loans were $46.1 million, or 3.00% of held-for-investment loans, versus $23.5 million and 1.75% at year-end. The allowance for loan and lease losses was $29.4 million, 1.9% of held-for-investment loans. Criticized and impaired loans and leases totaled $122.4 million, compared with $76.8 million at year-end. Management said the increase was concentrated in a relatively small number of borrowers in mature verticals and reported no systemic issue identified.
- Management expected the loan and lease portfolio to continue growing and forecast a very low single-digit effective tax rate for full-year 2018. Results for the interim period were not presented as necessarily indicative of full-year results.
- On August 1, 2018, the company sold its entire interest in Reltco and National Assurance Title for $3.0 million. Accounting was still in process; initial estimates indicated a net cost of approximately $2.5 million.
- Key risks identified include borrower deterioration and credit-loss estimates, SBA/USDA program or regulatory changes, interest-rate and funding-cost changes, loan-sale premiums and servicing-asset valuations, competition, and operational or cybersecurity risks affecting its technology platform. Unfunded commitments included $1.35 billion to extend credit, $49.8 million in solar purchases and $19.5 million in airplane purchases.
Important facts for investors to verify
- Whether nonperforming and criticized credit trends continue to worsen, and how much exposure is unguaranteed by government programs.
- Whether loan growth and loan-sale volumes can sustain earnings as net interest margin and average sale premiums face pressure.
- The sensitivity of servicing-asset valuations to prepayments and market assumptions, given the larger revaluation losses.
- Deposit pricing, funding costs and liquidity after the deposit-gathering initiatives; confirm the availability and terms of contingent borrowing facilities.
- The final accounting and realized financial impact of the Reltco divestiture, and the full-year effect of renewable-energy tax credits and leasing activity.