Live Oak Bancshares, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited consolidated results. Live Oak operates primarily through its bank subsidiary, lending to small businesses nationwide in selected industries; a significant portion of its originations are SBA 7(a)-guaranteed. Revenue is driven mainly by loan sales, servicing and net interest income.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $11.6 million | $6.6 million | $30.3 million | $17.1 million |
| Net interest margin | 3.32% | 3.12% | 3.36% | 3.03% |
| Net gains on loan sales | $21.8 million | $15.4 million | $52.8 million | $46.6 million |
| Net income attributable to Live Oak | $3.5 million | $2.9 million | $8.3 million | $14.9 million |
| Diluted earnings per share | $0.10 | $0.09 | $0.24 | $0.48 |
| Provision for loan losses | $3.8 million | $1.2 million | $8.7 million | $2.3 million |
| Noninterest expense | $27.2 million | $18.1 million | $74.1 million | $49.6 million |
For Q3, net income rose year over year as higher net interest income, loan servicing revenue and loan-sale gains outweighed increased provisions and operating expenses. Nine-month net income declined, reflecting higher credit provisions and expenses, a more negative servicing-asset revaluation, and the absence of the $3.8 million nCino investment-sale gain recorded in 2015. 2016 personnel expense also included substantial stock-based compensation tied to employee retention awards.
Balance sheet, cash flow and credit
- Scale and funding: Total assets were $1.67 billion at September 30, up 58.6% from year-end 2015. Deposits increased 74.3% to $1.40 billion; cash and due from banks was $355.5 million. Loans held for investment were $767.0 million and loans held for sale were $345.3 million.
- Portfolio reclassification: In Q2, $318.8 million of unguaranteed loans was transferred from held for sale to held for investment as the company chose to retain those credits. The transfer increased the provision for loan losses by $4.0 million.
- Credit quality: The allowance for loan losses was $15.2 million, or 2.0% of held-for-investment loans, versus $7.4 million, or 2.6%, at year-end 2015. Nonperforming loans were $14.0 million; nonperforming assets and troubled debt restructurings totaled $18.4 million. Criticized and impaired loans totaled $54.5 million, up from $41.0 million at year-end. Management said approximately 97% of special-mention loans were performing and current.
- Cash flow: Operating activities used $174.5 million and investing activities used $168.7 million in the first nine months; financing activities provided $596.0 million, mainly from a $598.2 million increase in deposits. Cash and cash equivalents ended at $355.5 million.
- Debt and liquidity: Long-term borrowings were $28.1 million. Management reported $603.6 million of immediately available liquidity sources, 36.1% of assets. The bank had no outstanding federal funds or Federal Reserve discount-window borrowings; reported available discount-window capacity was approximately $133.5 million.
- Capital: At September 30, the bank’s Common Equity Tier 1 ratio was 10.26% and total capital ratio was 11.52%, above the disclosed “well-capitalized” thresholds of 6.50% and 10.00%, respectively.
Outlook, commentary and risks
- Management expected to originate approximately $1.50 billion of loans in 2016. Nine-month originations were $1.02 billion.
- Management expected $3.4 million of additional stock-based compensation expense in Q4 2016 related to retention awards, followed by approximately $350,000 per quarter through Q3 2020.
- The company became a financial holding company in July 2016 and formed Live Oak Ventures in August to invest in businesses aligned with its online small-business banking strategy. Maintaining financial holding company status depends on meeting capital, management and CRA requirements.
- Key disclosed risks include borrower deterioration and reserve estimation, SBA program or Preferred Lender status changes, interest-rate and loan-sale market movements, servicing-asset valuation sensitivity, technology and cybersecurity failures, competition, regulatory changes, and the ability to attract and retain personnel. The balance sheet was liability-sensitive; management cautioned that rising rates could generally reduce net interest income.
- Unfunded off-balance-sheet commitments totaled $1.45 billion, primarily commitments to extend credit; these amounts do not necessarily represent future cash requirements because some commitments may expire unused. Management said ordinary-course legal proceedings were not expected to materially affect results.
Important facts for investors to verify
- Whether the $1.50 billion full-year origination outlook was achieved and how loan-sale premiums and volumes evolved.
- Credit performance of the expanded held-for-investment portfolio, including special-mention, criticized, nonperforming and unguaranteed exposures, and whether further reserve increases are needed.
- Whether deposit growth and the reported liquidity position remain sufficient to fund originations and commitments, including the cost and mix of deposits.
- How stock-based compensation and growth-related operating expenses affect earnings, and whether servicing-asset valuation changes or lower secondary-market premiums pressure revenue.
- Interest-rate sensitivity, SBA program and regulatory developments, and continued compliance with financial holding company requirements.