Live Oak Bancshares, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; balance-sheet comparisons are with December 31, 2015. Live Oak is a Wilmington, North Carolina-based bank holding company focused on small-business lending nationwide in selected industries. A significant portion of originations is guaranteed under the SBA 7(a) program; the company earns primarily from loan sales, servicing and net interest income. Amounts below are in U.S. dollars.
Financial performance and condition
- Income: Net income attributable to Live Oak Bancshares was $4.7 million, or $0.13 diluted EPS, versus $8.1 million, or $0.27, in Q1 2015. Net interest income rose to $8.7 million from $5.1 million; noninterest income was $22.4 million versus $24.1 million. Income before taxes was $8.0 million; income tax expense was $3.3 million.
- Margins and operating costs: Net interest margin increased to 3.52% from 2.97%. Total noninterest expense increased 47.7% to $21.7 million, including salaries and benefits of $13.0 million, up 55.5%. The efficiency burden of higher expenses contributed to lower earnings despite growth in core lending income.
- Lending and fee drivers: Q1 loan originations were $284.5 million versus $248.1 million. SBA-guaranteed portions sold were $155.6 million versus $137.0 million; net gains on loan sales were $16.4 million versus $15.5 million. Loan servicing revenue and revaluation totaled $4.8 million, including a $26,000 negative revaluation, compared with $4.1 million and a $513,000 positive revaluation a year earlier.
- Assets, funding and debt: Total assets were $1.27 billion, up 20.5% from year-end. Loans held for sale were $537.3 million and loans held for investment were $313.6 million. Deposits rose 26.2% to $1.02 billion. Long-term borrowings were $28.3 million, broadly unchanged; no balances were outstanding on the disclosed federal funds or repurchase lines.
- Liquidity and cash flow: Cash and due from banks was $226.6 million. Management reported $430.6 million of immediately available liquidity, or 33.9% of assets. Operating cash flow was negative $93.9 million, compared with negative $50.0 million in Q1 2015, reflecting the lending business’s loan-origination and sale cycle. Financing cash flow was positive $209.6 million, mainly from a $210.7 million increase in deposits.
- Credit and capital: The allowance for loan losses was $8.6 million, or 2.7% of held-for-investment loans; the Q1 provision was $1.4 million and net charge-offs were $232,000. Nonperforming loans were $14.8 million, 4.73% of held-for-investment loans, but $12.4 million was SBA-guaranteed; unguaranteed nonperforming-loan exposure was $2.4 million. Bank capital ratios remained above “well-capitalized” thresholds: common equity Tier 1 was 10.73% and total capital was 11.71%.
Material changes versus the prior comparable period
- Net income declined 42% year over year. Q1 2015 included a one-time $3.8 million gain from the sale of an investment in nCino; Q1 2016 also reflected higher staffing, travel, occupancy and infrastructure costs as the company expanded its lending platform.
- Net interest income increased 72.3%, supported by 44.0% growth in average interest-earning assets and a 50-basis-point increase in their yield. Net interest margin rose 55 basis points; the cost of funds increased 3 basis points.
- Total nonperforming assets and troubled debt restructurings were $20.5 million, up from $17.2 million at year-end. Criticized Risk Grade 5 loans increased to $22.3 million from $17.5 million.
- Period-end deposits increased $210.7 million and assets increased $215.9 million from December 31, 2015. Loans held for sale grew partly because multi-advance loans in newer verticals took longer to sell.
Outlook, commentary and risks
- Management expected to originate $1.35 billion to $1.40 billion of loans during 2016, with approximately 40% fully funded at closing. The filing provides no specific full-year earnings or margin guidance.
- Management cited investment in people, infrastructure and a new small-loan and deposit platform as drivers of expense growth. It attributed increased loan-loss provision partly to expansion into newer industries with limited loss history.
- Key disclosed risks include borrower deterioration and reserve-estimation uncertainty; SBA program, rules or preferred-lender changes; interest-rate, deposit and loan-sale-premium movements; servicing-right valuation sensitivity to prepayments; competition; technology, cybersecurity and third-party service-provider failures; and regulatory, operational and key-personnel risks. The balance sheet was described as liability-sensitive, so rising rates could reduce net interest income.
- Unfunded off-balance-sheet credit commitments totaled $955.5 million, primarily commitments to extend credit; the filing notes that many may expire undrawn. Management said routine legal proceedings were not expected to materially affect results. Disclosure controls were considered effective; management did not evaluate quarterly changes in internal control over financial reporting under the newly public company transition provision.
- Performance-based restricted stock unit awards covering 1,357,500 shares were approved subject to shareholder approval of plan amendments. Vesting conditions include at least $100 million of 2016 revenue, and some awards also require the stock to reach $34 per share for 20 consecutive trading days. The filing recognized no expense for these awards pending the required approval and grant date.
Important facts for investors to verify
- Whether loan production, loan-sale timing and secondary-market premiums support management’s 2016 origination outlook and sustain gains on loan sales.
- Whether expense growth moderates as new lending and deposit platforms develop, and how staffing and infrastructure costs affect profitability.
- Trends in nonperforming, criticized and past-due loans by industry, including the growth in nonperforming loans and the proportion covered by SBA guarantees.
- Whether the $8.6 million allowance remains adequate as the portfolio grows and expands into newer verticals; management cautions that actual losses may exceed estimates.
- Deposit growth, funding costs and available liquidity, as well as the effect of interest-rate changes on net interest income and servicing-asset valuations.
- Shareholder approval and eventual dilution or compensation expense from the contingent RSU awards, alongside the substantial unfunded credit commitments.