Live Oak Bancshares, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016; unaudited. Live Oak is a nationwide small-business lender focused on selected industry verticals, with a significant portion of originations supported by SBA 7(a) guarantees. Figures below are in U.S. dollars; financial-statement amounts are generally in millions unless noted.
Financial performance
- Q2 revenue and earnings: Net interest income was $9.9 million, up 82.5% year over year; noninterest income was $19.3 million, up 6.7%. Net income attributable to Live Oak was $123,000, versus $3.9 million a year earlier; diluted EPS was reported as $0.00.
- First-half performance: Net interest income was $18.6 million, up 77.6%; noninterest income was $41.8 million, down 1.0%. Net income attributable to Live Oak was $4.8 million versus $12.0 million, and diluted EPS was $0.14 versus $0.41.
- Interest margin: Net interest margin rose to 3.26% in Q2 from 2.95% a year earlier, and to 3.38% for the first half from 2.95%. First-half average earning-asset yield was 4.49%; cost of interest-bearing liabilities was 1.24%.
- Credit costs and asset quality: Q2 provision for loan losses was $3.5 million versus $50,000; first-half provision was $4.9 million versus $1.1 million. The allowance was $12.3 million, or 1.8% of held-for-investment loans. Nonperforming loans were $12.9 million, 1.87% of held-for-investment loans; $10.7 million was SBA-guaranteed. Nonperforming assets and troubled debt restructurings totaled $18.1 million.
- Expenses and tax: Noninterest expense rose 49.4% in Q2 to $25.1 million and 48.6% for the first half to $46.8 million. Salaries and benefits were $15.4 million in Q2, including $2.2 million of restricted-stock compensation. Q2 effective tax rate was 81.9%, which management attributed primarily to nondeductible expenses against low pretax income.
- Cash flow: First-half operating cash use was $170.4 million, reflecting the loan-origination and sale cycle; investing cash use was $91.2 million. Financing provided $334.5 million, principally from a $336.0 million increase in deposits. Cash ended at $175.5 million, up $72.9 million from year-end.
Financial position and material changes
- Total assets were $1.40 billion at June 30, up 32.6% from December 31, 2015. Deposits increased 41.8% to $1.14 billion. Shareholders’ equity was $207.4 million; book value per share was $6.06.
- Held-for-investment loans rose to $690.5 million from $280.0 million; loans held for sale fell to $329.2 million from $480.6 million. The principal driver was a Q2 transfer of $318.8 million in unguaranteed loans from held for sale to held for investment, reflecting a decision to retain more loans.
- Servicing assets were $48.5 million, up from $44.2 million at year-end; the company serviced $2.12 billion of loans for others. Q2 servicing-asset revaluation reduced income by $1.6 million.
- Long-term borrowings were $28.2 million, broadly unchanged. Immediate liquidity from cash, federal funds sold, unpledged securities and credit availability was $399.8 million, or 28.7% of assets. The company reported no outstanding balances on its federal funds lines or discount-window capacity.
- Regulatory capital remained above stated minimums. The Bank’s June 30 ratios included 11.12% Common Equity Tier 1 and 12.34% total capital, compared with “well-capitalized” thresholds of 6.50% and 10.00%, respectively.
Outlook, commentary and risks
- Management expected 2016 loan originations of approximately $1.50 billion, guaranteed-loan sales of $620–$640 million, and year-end on-balance-sheet loans of $1.35–$1.45 billion. Beginning in Q3, it planned to retain up to approximately 25% of newly originated guaranteed loans otherwise eligible for sale, alongside the Q2 reclassification, to build recurring net interest income.
- Management expected $6.7 million of additional stock-based compensation expense in the second half of 2016 for key-employee retention awards, followed by approximately $350,000 per quarter through Q3 2020. Award vesting is subject to a 2016 total-revenue threshold of at least $100 million.
- Management cited investment in staff, infrastructure, and a new small-loan and deposit platform as drivers of higher expenses. The company also noted sensitivity of servicing-asset values to prepayment assumptions and interest rates, and a liability-sensitive balance-sheet position that can pressure net interest income if rates rise.
- Key risks include borrower deterioration and reserve-estimation uncertainty, SBA program or preferred-lender changes, interest-rate and secondary-market conditions, loan and industry concentrations, technology or security disruption, competition, and regulatory requirements. Commitments to extend credit were $1.19 billion; these are not necessarily expected to be fully drawn. Management said routine legal proceedings were not expected to have a material effect and reported no material change to previously disclosed risk factors.
- After quarter-end, effective July 29, 2016, the company elected financial holding company status, which is subject to ongoing capital, management, and CRA criteria.
Most important facts for investors to verify
- Whether planned loan retention and the $1.35–$1.45 billion year-end loan target are achieved, and how this affects net interest income, funding needs, and loan-sale revenue.
- Credit performance of the newly retained unguaranteed loans, including the adequacy of the $12.3 million allowance and trends in criticized, past-due, and nonperforming loans.
- Whether deposit growth and liquidity remain sufficient as loan commitments and on-balance-sheet lending expand; review the $1.19 billion in commitments and deposit mix and maturities.
- Servicing-asset valuation sensitivity, secondary-market gain-on-sale pricing, and the impact of interest-rate changes on both servicing values and net interest income.
- Future operating costs and dilution from stock awards, including the stated retention-award vesting conditions and expected expense schedule.