Live Oak Bancshares, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are to December 31, 2016. Unaudited consolidated results. Unless noted, dollar amounts are in millions.
Business context and financial performance
Live Oak is a nationwide small-business lender focused on selected industry verticals. A significant share of originations is guaranteed by the SBA or USDA. Revenue is driven primarily by loan sales, servicing income, and net interest income. The company acquired title agencies Reltco and National Assurance Title on February 1, 2017.
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Net interest income | $15.6 | $8.7 |
| Noninterest income | $25.8 | $22.4 |
| Combined net interest and noninterest income | $41.4 | $31.1 |
| Provision for loan and lease losses | $1.5 | $1.4 |
| Noninterest expense | $33.0 | $21.7 |
| Income before taxes | $6.9 | $8.0 |
| Net income attributable to Live Oak | $6.1 | $4.7 |
| Diluted EPS | $0.17 | $0.13 |
| Net interest margin | 3.76% | 3.52% |
Net interest income rose 79.6%, reflecting substantial growth in average earning assets and a higher asset yield; average earning assets increased 69.9% to $1.69 billion. Net interest margin increased 24 basis points. Despite higher net income, pretax income declined as operating expenses rose sharply; the effective tax rate fell to 11.5% from 41.4%, principally reflecting investment tax credits from renewable-energy financing and the effect of a new share-based compensation accounting standard.
Financial position, cash flow, and credit
- Assets and lending: Total assets were $1.93 billion, up 10.1% from year-end. Loans held for sale were $512.5 million, up 30.0%; loans held for investment were $999.3 million, up 10.1%. Q1 loan and lease originations were $468.7 million, compared with $284.5 million a year earlier.
- Funding and liquidity: Deposits totaled $1.64 billion, up $154.1 million from year-end. Cash and due from banks fell to $158.9 million from $238.0 million. Management reported $426.8 million of immediate liquidity sources, or 22.1% of assets, and $66.0 million of investment securities available as lendable collateral.
- Debt and equity: Short-term borrowings were $13.1 million, versus none at year-end; long-term borrowings were $27.5 million. Shareholders’ equity was $226.2 million. The Bank’s March 31 capital ratios included 10.01% Common Equity Tier 1, 11.26% total capital, and 8.12% Tier 1 leverage; the Bank exceeded the stated “well-capitalized” thresholds.
- Cash flow: Operating cash use was $107.7 million and investing cash use was $133.1 million, including $37.7 million of premises and equipment purchases and $7.6 million net cash paid for the acquisition. Financing provided $161.7 million, mainly from deposit growth and $13.1 million of short-term borrowings. Cash declined by $79.1 million during the quarter.
- Credit quality: Nonperforming loans were $22.5 million, or 2.25% of held-for-investment loans, versus $23.8 million and 2.62% at year-end. Nonperforming assets plus troubled debt restructurings totaled $26.3 million, down from $27.6 million. The allowance for loan and lease losses was $18.2 million, approximately 1.8% of held-for-investment loans. Q1 net charge-offs were $1.5 million, or 0.63% of average loans held for investment on an annualized basis.
Material changes and unusual items
- Net gains on loan sales increased 15.4% to $19.0 million as guaranteed loan sales volume rose 34.1%; lower average sale premiums partly offset the volume growth. Loan servicing revenue rose 23.8% to $5.9 million.
- Loan servicing asset revaluation was a negative $2.0 million, compared with a negative $26,000 a year earlier, primarily due to higher prepayment assumptions and lower secondary-market premiums.
- Noninterest expense increased 51.9% to $33.0 million. Salaries and benefits rose 43.8%; management cited hiring to support growth and 59 employees added with the title-company acquisition. Other expense included $704,000 of charitable initiatives, $700,000 of title-company costs, and a $206,000 aircraft trade-in loss. Merger expenses were $766,000.
- The Reltco acquisition generated $1.4 million of title insurance income. The stated purchase price was $8.25 million, with contingent consideration recorded at fair value; the contingent consideration liability was $4.5 million at quarter-end and its revaluation added $200,000 of expense.
- The company shortened the estimated useful life of its aircraft from 20 to 10 years. The change reduced Q1 net income by $288,000, or $0.01 per basic and diluted share.
- Adoption of ASU 2016-09 placed $874,000 of excess share-based compensation tax benefits in income taxes; the company reported that adoption increased Q1 basic EPS by $0.03 and diluted EPS by $0.02.
Guidance, outlook, and risks
Management expects to originate approximately $1.80–$1.90 billion of loans and leases in 2017. No other specific earnings or margin guidance is provided. Management described continued investment in staff, loan production, deposits, technology, and infrastructure to support growth.
Key disclosed risks include borrower deterioration and higher credit losses; reliance on SBA and USDA programs and rules; interest-rate movements; loan-sale premiums and servicing-right valuations; deposit funding and liquidity; technology, cybersecurity, and third-party service disruptions; competition and regulatory change; and integration and performance of acquisitions. The balance sheet was liability-sensitive, with a cumulative gap of -5.47%; management said net interest income generally may fall when rates rise. Servicing asset values are sensitive to prepayment assumptions. The company reported $1.36 billion of commitments to extend credit and $39.9 million of solar purchase commitments; these are not necessarily expected cash outflows. Management said ordinary-course legal proceedings were not expected to materially affect the company.
Important facts for investors to verify
- Whether loan originations meet the $1.80–$1.90 billion 2017 outlook and whether loan-sale premiums and volumes sustain reported revenue.
- Whether expense growth, including staffing, acquisition costs, and infrastructure spending, moderates relative to revenue growth.
- Credit migration, net charge-offs, nonperforming loans, and reserve adequacy, particularly across healthcare, veterinary, and independent-pharmacy exposures.
- Deposit growth, funding costs, available liquidity, and sensitivity of earnings to interest-rate changes.
- Realization of renewable-energy tax credits and the assumptions used to value servicing assets and Reltco contingent consideration.