Live Oak Bancshares, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited. Live Oak is a Wilmington, North Carolina-based bank holding company whose bank subsidiary lends to small businesses nationwide, including through SBA- and USDA-guaranteed programs. Figures below are in U.S. dollars; financial statement amounts are generally in millions.
Financial performance and position
- Profit: Net income was $2.4 million, or $0.06 per diluted share, versus $12.5 million, or $0.30, in Q1 2018. Pretax income was $2.7 million versus $12.8 million.
- Interest income and margin: Net interest income increased 25% to $30.6 million. Net interest margin was 3.63%, down from 3.72%; the company attributed pressure to deposit costs rising faster than loan yields. Average earning assets rose 27.9% to $3.42 billion, while their average yield increased to 5.93% from 5.32%. Average cost of interest-bearing liabilities rose to 2.38% from 1.70%.
- Noninterest income: $13.0 million, down 57.6% from $30.8 million. Net gains on loan sales were $4.2 million versus $24.4 million; servicing revenue was $7.4 million, while servicing-asset revaluation reduced income by $2.2 million.
- Expenses and credit provision: Noninterest expense was essentially flat at $38.2 million. Salaries and benefits increased 8.1% to $21.9 million. Provision for loan and lease losses declined 37.6% to $2.7 million. Net charge-offs were $65,000, or 0.01% of average held-for-investment loans on an annualized basis.
- Balance sheet: Total assets were $4.06 billion, up 10.6% from year-end 2018. Held-for-investment loans and leases were $2.00 billion, up 8.6% from year-end; loans held for sale were $772.5 million. Deposits increased 12.0% to $3.53 billion. Shareholders’ equity was $500.4 million; book value per share was $12.45.
- Cash flow and liquidity: Cash and cash equivalents were $285.9 million at quarter-end, down from $316.8 million at year-end. Operating cash flow was negative $107.3 million and investing cash flow negative $301.4 million, partly reflecting loan production and securities purchases; financing cash flow was positive $377.8 million, mainly from $378.8 million of deposit growth. Management reported $1.22 billion of immediately available liquidity sources, including cash, federal funds sold, unpledged securities and credit availability.
- Debt and capital: Short-term borrowings were $1.4 million and long-term borrowings $17,000. The company reported substantial additional borrowing capacity. At March 31, the Bank’s common equity tier 1 ratio was 14.89%, total capital ratio 16.14%, and tier 1 leverage ratio 11.02%; each exceeded the stated “well capitalized” thresholds.
Material changes versus comparable periods
- Management’s late-2018 strategy shift to retain more eligible loans rather than sell them reduced Q1 2019 guaranteed loan sales to $62.9 million from $247.2 million a year earlier, contributing to the $20.2 million decline in loan-sale gains. Management said the shift is intended to build recurring revenue, reduce earnings volatility and improve long-term profitability.
- The lower loan-sale volume also coincided with higher net interest income as loan and securities balances grew. Management expects loan-sale gains to become a diminishing component of revenue in 2019.
- Title insurance income fell by $1.3 million following the 2018 sale of that business. Lease income increased 44.6% to $2.3 million, reflecting growth in renewable-energy equipment leasing.
- Nonperforming loans rose to $70.7 million from $57.7 million at December 31, 2018. Total nonperforming assets and troubled debt restructurings rose to $98.8 million from $79.8 million. Allowance for loan and lease losses increased to $35.1 million from $32.4 million.
Outlook, risks and unusual items
- Management expects held-for-sale and held-for-investment portfolios to continue growing through originations and greater loan retention, and is pursuing conventional lending beyond government-guaranteed programs. No numeric earnings or growth guidance was provided.
- Credit quality warrants monitoring: nonperforming loans were 3.53% of held-for-investment loans, compared with 3.13% at year-end. Management said the increase in criticized and impaired loans was concentrated among a relatively small number of borrowers in mature verticals, with no systemic issues identified. It also noted that 96.9% of Risk Grade 5 loans were performing without payments more than 30 days past due.
- Loan concentrations include healthcare, agriculture and veterinary businesses. Of $98.8 million in nonperforming assets and restructurings, $68.6 million carried an SBA guarantee; the remaining unguaranteed exposure was $30.2 million. The allowance is based on estimates that management says could require material revision if credit quality or economic conditions deteriorate.
- Unfunded commitments to extend credit totaled $1.43 billion; these amounts are not necessarily expected to be drawn. The filing also identifies $10.5 million of airplane purchase commitments and concentration in several large unguaranteed borrower relationships.
- Key operating risks include borrower deterioration, changes to SBA or USDA programs, interest-rate and deposit-cost movements, secondary-market loan premiums and servicing-asset valuations, technology and cybersecurity events, competition, and regulatory or economic changes. The servicing asset is sensitive to assumptions, particularly prepayment speeds.
- The company adopted lease accounting guidance in January 2019, recording operating lease right-of-use assets and liabilities and a $66,000 opening retained-earnings adjustment. The expected-credit-loss standard (CECL) was scheduled for adoption in 2020; the company had not yet estimated its impact.
- Management reported effective disclosure controls, no material change in internal control over financial reporting, and no material change to previously disclosed risk factors. Ordinary-course legal proceedings were described as not material.
Important facts for investors to verify
- Whether loan retention drives recurring interest income and portfolio growth sufficient to offset lower loan-sale gains, while preserving margins.
- Trends in nonperforming loans, unguaranteed credit exposure, criticized loans, delinquencies, charge-offs and allowance adequacy.
- Deposit growth, deposit pricing, liquidity sources and the sensitivity of net interest income to rate changes.
- Loan-sale premiums and servicing-asset valuation assumptions, including prepayment speeds.
- Concentrations by industry and borrower, the likelihood of credit commitments being drawn, and the eventual impact of CECL adoption.