Live Oak Bancshares, Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; unaudited. Dollar amounts are in millions unless otherwise noted. Live Oak is a Wilmington, North Carolina-based bank holding company focused on nationwide small-business lending in selected industries, with significant SBA 7(a)-guaranteed loan activity. Revenue depends substantially on loan sales, servicing fees and servicing-asset valuations.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net interest income | $5.4 | $3.6 | $10.5 | $6.5 |
| Noninterest income | $18.1 | $15.1 | $42.2 | $27.3 |
| Noninterest expense | $16.8 | $11.5 | $31.5 | $26.0 |
| Net income | $3.9 | $6.7 | $12.0 | $7.0 |
| Diluted EPS | $0.13 | $0.31 | $0.41 | $0.33 |
| Net interest margin | 2.94% | 3.13% | 2.94% | 3.03% |
- At June 30, total assets were $899.4, up 33.6% from year-end 2014. Loans held for sale were $356.5 and loans held for investment were $237.6; deposits were $727.3.
- Cash and due from banks totaled $131.5. Management reported $311.2 of immediately available liquidity, 34.6% of assets, including cash, federal funds sold, unpledged securities and available credit lines.
- Long-term borrowings were $54.5, up from $41.8 at year-end; short-term borrowings were zero. Total shareholders’ equity was $103.4. Consolidated Tier 1 leverage was 10.96%; the Bank’s was 8.50%. Both exceeded the filing’s stated well-capitalized thresholds.
- Six-month operating cash flow was negative $178.3, reflecting the loan-origination and sale cycle, including $472.4 of originations of loans held for sale and $318.1 of sale proceeds. Investing cash flow was positive $70.2 and financing cash flow positive $209.7; cash increased $101.6 to $131.5.
- The allowance for loan losses was $5.2, or 2.2% of loans held for investment. Six-month net charge-offs were $0.35; provision expense was $1.13.
Changes versus comparable periods
- Q2 net income fell to $3.9 from $6.7, despite higher net interest income and loan-sale gains. Management attributed the decline principally to higher personnel and travel costs, a $2.8 tax provision versus none in 2014, and a $1.8 downward servicing-asset valuation adjustment.
- Six-month net income increased to $12.0 from $7.0. Net interest income rose 60.2% and noninterest income rose 54.5%, chiefly from loan growth and higher loan-sale gains. Growth in expenses and $8.0 of income-tax expense partly offset the increases.
- Net interest margin declined year over year in both the quarter and half-year, to 2.94%, as asset yields softened and funding costs and balances changed.
- Noninterest expense rose 45.6% in Q2 and 21.2% year to date. Staffing and travel were prominent increases, reflecting investment in loan production and servicing capacity.
- Loans held for investment increased 16.5% from year-end. Nonperforming loans were $19.7, compared with $18.7 at year-end; $16.6 was SBA-guaranteed, leaving $3.1 of unguaranteed exposure. Nonperforming loans were 8.27% of held-for-investment loans, down from 9.17% at year-end.
Outlook, commentary, risks and unusual items
- The filing provides no quantified earnings or growth guidance. Management cautions that first-half results are not necessarily indicative of full-year results.
- Management described loan-sale and servicing income as primary earnings drivers, and net interest income as a secondary contributor. Servicing-asset fair value is sensitive to prepayment speeds, market rates and other assumptions.
- Credit risks include borrower deterioration, loan concentrations in industries such as veterinary and independent pharmacy, changes to SBA programs or procedures, and the uncertainty inherent in loss-reserve estimates. At June 30, unfunded commitments to extend credit were $696.4; commitments do not necessarily represent future cash needs because many may expire undrawn.
- Interest-rate risk is material. Management characterized the balance sheet as liability-sensitive: rising rates could generally reduce net interest income. The filing also identifies SBA/regulatory changes, competition, economic conditions and dependence on the technology-based platform as risks.
- Unusual items include a $3.8 gain from the first-quarter sale of the company’s nCino investment and consolidation of 504 Fund Advisors after increasing ownership from 50.0% to 91.3%. The company’s conversion from S corporation to C corporation in August 2014 means 2015 tax expense is not directly comparable with reported 2014 results.
- After quarter-end, the July 2015 IPO issued 5.5 million voting shares at $17 per share, generating approximately $87.2 net proceeds. By August, $12.2 of borrowings had been repaid; remaining proceeds were intended for deposit into the Bank, further debt repayment and strategic growth. The company later declared a $0.01-per-share dividend payable September 11, 2015.
- Management said ordinary-course legal proceedings were not expected to materially affect the company. No material risk-factor changes were reported. Disclosure controls were assessed as effective; management did not evaluate changes in internal control over financial reporting during the quarter under the transition provisions for newly public companies.
Investor facts to verify
- Whether loan-sale volumes and premiums can sustain growth in noninterest income, and how much earnings depend on servicing-asset valuation assumptions.
- Credit quality and reserve adequacy, particularly the composition of criticized/impaired loans, the $3.1 unguaranteed nonperforming exposure, and industry concentrations.
- Funding economics: deposit growth and pricing, the liability-sensitive rate position, borrowing costs and the effect of post-IPO debt repayments.
- How IPO proceeds are ultimately deployed and the effects of new share and option issuance on dilution, per-share results and capital.
- The scale and conversion rate of the $696.4 in unfunded credit commitments, alongside liquidity and capital requirements.