Live Oak Bancshares, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015; balance-sheet comparisons are to December 31, 2014. Dollar figures are in millions unless otherwise noted. Live Oak is a nationwide small-business lender focused on selected industry verticals; a significant portion of its lending is supported by SBA 7(a) guarantees. It generates substantial fee income by selling guaranteed loan portions and retaining servicing rights.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Net interest income | $6.6 | $3.9 | $17.1 | $10.4 |
| Provision for loan losses | $1.2 | $0.5 | $2.3 | $1.4 |
| Noninterest income | $17.8 | $16.5 | $60.0 | $43.8 |
| Noninterest expense | $18.0 | $13.3 | $49.5 | $39.3 |
| Net income attributable to Live Oak | $2.9 | $0.6 | $14.9 | $7.6 |
| Diluted EPS | $0.09 | $0.02 | $0.48 | $0.33 |
| Net interest margin | 3.11% | 3.13% | 3.02% | 3.08% |
- Growth and earnings drivers: Q3 loan originations were $303.0 million; nine-month originations were $827.8 million, up 41.8% year over year. Net gains on loan sales were $15.4 million in Q3 and $46.6 million year to date. Growth in average interest-earning assets drove higher net interest income, while margin declined slightly.
- Costs and credit: Noninterest expense rose 36.0% in Q3 and 26.2% year to date, primarily from staffing and travel to support loan production and business expansion. The loan-loss provision increased as the company expanded into newer verticals with limited loss experience; Q3 also included charge-offs related to one veterinary-industry relationship.
- Balance sheet at September 30: Assets were $1,012.8, up 50.4% from year-end. Loans held for sale were $443.9 and loans held for investment were $259.6; the latter was net of a $6.2 allowance. Deposits were $762.6, up 46.1%. Cash was $129.9. Long-term borrowings were $42.1 and short-term borrowings were zero. Equity was $194.1, versus $91.8 at year-end.
- Cash flow, nine months: Operating cash flow was negative $265.7, reflecting the timing and scale of loans originated for sale. Investing cash flow was positive $45.8; financing cash flow was positive $319.8, including deposit growth and IPO proceeds. Cash increased $100.0 to $129.9.
- Liquidity and capital: Management reported $313.4 of immediately available liquidity sources, or 30.9% of assets. Bank capital ratios included a 12.95% Common Equity Tier 1 ratio and 9.92% Tier 1 leverage ratio; both exceeded the stated “well-capitalized” thresholds.
Material changes versus comparable periods
- Q3 attributable net income increased to $2.9 million from $0.6 million. The prior-year quarter included a one-time $3.3 million deferred tax liability charge following the change from S-corporation to C-corporation status, so the comparison is affected by tax treatment.
- Nine-month attributable net income rose to $14.9 million from $7.6 million. Higher loan-sale gains and net interest income were partly offset by increased expenses and negative servicing-asset revaluations. The 2015 period also included a $3.8 million gain on sale of the company’s nCino investment; 2014 included $2.4 million of equity-method investment losses.
- Loan servicing revenue and revaluation were $1.6 million in Q3 and $7.4 million year to date, down from $3.2 million and $9.5 million, respectively. Servicing-asset valuation adjustments were negative $3.0 million in Q3 and negative $4.7 million year to date.
- Loans held for sale increased 50.4% from year-end, as multi-advance loans and newer verticals extended the time between origination and sale. The company completed its IPO in July, raising approximately $87.2 million net; $12.2 million was used to reduce corporate borrowings.
Outlook, risks and unusual items
- Management expected approximately $1.1 billion of loan originations for full-year 2015 and planned to develop existing and new lending verticals. It expected expenses to increase with the company’s growth stage.
- Management anticipated multi-advance loans would continue to increase, extending the period before gain-on-sale and servicing income is realized, while supporting net interest income. It also expected loans sold as a proportion of originations to decline over the next several quarters.
- Management said average loan-sale gains had fallen in Q3, primarily due to market conditions, but had shown some stabilization after quarter-end. A return to prior premium levels, and its timing, remained uncertain.
- Credit risk includes concentration in veterinary and independent-pharmacy lending, growth in newer verticals without extensive loss history, and reliance on SBA program rules and guarantees. At September 30, nonperforming loans were $18.4 million, largely SBA-guaranteed; unguaranteed exposure was $2.6 million. Criticized and impaired loans totaled $42.5 million, with veterinary-industry loans representing 52.8%.
- The allowance was $6.2 million, or 2.4% of held-for-investment loans. Management considered it appropriate but cautioned that estimates could change and future additions may adversely affect results.
- Other material risks include interest-rate exposure—the balance sheet was slightly liability-sensitive—servicing-asset valuation sensitivity to prepayment assumptions, competition, regulatory or SBA changes, and operational or cybersecurity disruption to the technology-based lending platform. Commitments to extend credit were $747.9 million; these are contractual amounts and do not necessarily represent future cash needs.
- The filing reported only routine, nonmaterial legal proceedings and no material changes to previously disclosed risk factors. Management stated disclosure controls were effective; it did not evaluate changes in internal control over financial reporting during the quarter under the newly public company transition provisions.
Important facts for investors to verify
- Whether originations, loan-sale volumes, and sale premiums support the approximately $1.1 billion full-year production expectation, especially as multi-advance lending grows.
- Credit trends by vertical, including the veterinary portfolio, unguaranteed exposure, delinquencies, criticized loans, charge-offs, and adequacy of the allowance.
- How servicing-asset values respond to prepayment speeds, interest rates, and market premiums, and whether negative revaluations persist.
- Deposit growth and funding costs relative to asset growth, available liquidity, debt repayment, and the company’s liability-sensitive interest-rate position.
- The sustainability of earnings excluding the nCino sale gain and the prior-year tax charge, alongside rising compensation and operating costs and potential dilution from stock awards.