Live Oak Bancshares, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017; unaudited. Live Oak operates primarily through its bank, specializing in nationwide small-business lending in selected industries, with significant SBA-guaranteed loan activity. It also earns income from loan sales and servicing and, following its February 2017 acquisition, title insurance.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Net interest income | $18.4 million | $9.9 million | $34.0 million | $18.6 million |
| Noninterest income | $26.7 million | $19.3 million | $52.4 million | $41.8 million |
| Net income attributable to Live Oak | $9.8 million | $0.1 million | $15.9 million | $4.8 million |
| Diluted EPS | $0.27 | $0.00 | $0.44 | $0.14 |
| Net interest margin | 3.92% | 3.26% | 3.84% | 3.38% |
Net interest income plus noninterest income was $45.1 million for Q2 and $86.5 million for the first half, versus $29.3 million and $60.4 million, respectively, in 2016. Noninterest expense rose 32.5% in Q2 to $33.3 million and 41.5% in the first half to $66.3 million, reflecting business growth and the title business acquisition, among other costs.
- Growth and earnings drivers: Management cited higher loan balances and yields, increased loan-sale volume and servicing revenue, and title insurance income. Q2 net gains on loan sales were $18.2 million; loan servicing revenue was $6.2 million. Title insurance contributed $2.4 million of Q2 income.
- Balance sheet at June 30: Total assets were $2.20 billion, up 25.2% from year-end 2016. Loans held for sale were $609.1 million; loans and leases held for investment were $1.085 billion, net of a $19.6 million allowance. Deposits were $1.872 billion. Shareholders’ equity was $237.6 million.
- Funding and liquidity: Short- and long-term borrowings totaled $62.2 million. Cash and due from banks was $207.4 million. Management reported $485.1 million of immediately available liquidity sources, or 22.1% of assets, including cash, unpledged securities and available credit arrangements.
- Cash flows, first half: Operating activities used $182.5 million and investing activities used $263.6 million; financing activities provided $415.5 million, principally from deposit growth. Cash declined $30.6 million to $207.4 million. Loan originations held for sale were $632.4 million, while related sale proceeds were $466.3 million.
- Credit quality: Nonperforming loans were $21.9 million, including $18.3 million covered by U.S. government guarantees; nonperforming loans not SBA-guaranteed were $3.6 million. Nonperforming assets and troubled debt restructurings totaled $26.4 million, down from $27.6 million at December 31, 2016. The allowance was 1.8% of loans held for investment, compared with 2.0% at year-end.
- Capital: At June 30, the Bank’s common equity Tier 1 ratio was 9.54%, total capital ratio 10.76%, and leverage ratio 7.85%; each exceeded the stated well-capitalized thresholds.
Material changes and unusual items
- Q2 and first-half earnings improved substantially year over year, but comparisons are affected by a one-time 2016 increase in provision following the transfer of $318.8 million of unguaranteed loans from held for sale to held for investment. The 2017 provision was $1.6 million for Q2 and $3.1 million for the first half.
- Reltco was acquired on February 1, 2017. The transaction recorded $7.3 million of goodwill and a $4.7 million contingent-consideration liability at June 30; the company also recognized $766,000 of merger expenses during the first half.
- Premises and equipment rose $60.3 million in the first half, driven by an aircraft hangar, aircraft replacements, and solar panels for leasing initiatives. A revised estimate shortening aircraft useful life reduced first-half net income by $490,000, or $0.01 per basic and diluted share.
- Servicing asset revaluation was a negative $1.2 million in Q2 and negative $3.2 million in the first half. Management noted that servicing values are sensitive to market premiums, prepayment speeds and other assumptions.
- The effective tax rate was 4.0% for Q2 and 7.0% for the first half, principally reflecting investment tax credits from renewable-energy leasing. Adoption of share-based compensation guidance increased first-half basic EPS by $0.03 and diluted EPS by $0.02.
Outlook, risks and contingencies
Management expected full-year 2017 loan and lease originations of approximately $1.80–$1.90 billion and an effective tax rate below 10%. These are forward-looking expectations, not guarantees.
Key risks include deterioration in borrower credit, changes to SBA or other government lending programs, interest-rate and secondary-market changes, deposit funding costs, servicing-right valuations, and operational or technology disruptions. Lending and commitments are concentrated in sectors including agriculture, healthcare and veterinary businesses. The filing reports $1.425 billion in commitments to extend credit and $89.6 million in solar purchase commitments; amounts committed may not be drawn. Management said ordinary-course legal proceedings were not expected to materially affect the company. The filing also added a risk that rental equipment may sell below its depreciated value or in lower quantities than anticipated.
Important facts for investors to verify
- Whether loan origination and sale growth can continue without weakening underwriting, and how credit quality, charge-offs and reserve adequacy evolve.
- How much earnings depend on SBA-related loan sales, secondary-market premiums, servicing revenue and the assumptions used to value servicing assets.
- Whether deposit growth and funding costs support loan growth, and the availability and terms of liquidity and borrowing sources.
- Whether Reltco meets earn-out performance targets and integrates as expected, and whether renewable-energy investments generate the anticipated tax credits and returns.
- How the aircraft useful-life change, rental-equipment residual values and other growth-related expenses affect future earnings and cash flows.