Live Oak Bancshares, Inc. — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Live Oak is a Wilmington, North Carolina-based bank holding company focused on nationwide small-business lending and deposits, including SBA- and USDA-guaranteed lending. It reports Banking and Fintech segments. Unaudited results are not necessarily indicative of full-year results.
Financial performance
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Net interest income | $83.9 million | $77.7 million | $241.6 million | $219.1 million |
| Provision for credit losses | $14.2 million | $4.3 million | $21.3 million | $11.3 million |
| Noninterest income | $57.7 million | $25.3 million | $218.9 million | $126.4 million |
| Noninterest expense | $83.0 million | $55.5 million | $229.6 million | $171.3 million |
| Net income | $42.9 million | $33.8 million | $174.4 million | $136.8 million |
| Diluted EPS | $0.96 | $0.76 | $3.88 | $3.05 |
| Net interest margin | 3.84% | 3.99% | 3.91% | 3.81% |
- Balance sheet: Total assets were $9.31 billion at September 30, up 13.4% from year-end 2021. Loans held for investment were $6.85 billion, versus $5.52 billion; loans held for sale were $537.6 million, versus $1.12 billion.
- Funding and liquidity: Deposits totaled $8.40 billion, up 18.2% from year-end. Borrowings fell to $35.6 million from $318.3 million, principally as Paycheck Protection Program Liquidity Facility borrowings were repaid. Cash and cash equivalents were $403.4 million. Management reported $4.06 billion of immediately available liquidity sources, or 43.6% of assets.
- Cash flow: For the first nine months, operating activities provided $98.3 million, compared with $134.2 million used in 2021. Investing activities used $903.2 million, while financing activities provided $1.00 billion. Cash and cash equivalents increased $199.6 million to $403.4 million.
- Credit and capital: The allowance for credit losses was $78.3 million, or 1.2% of historical-cost held-for-investment loans. Nonperforming loans and leases excluding fair-value loans were $60.1 million; nonperforming assets and troubled debt restructurings were $108.0 million. The Bank’s CET1 ratio was 11.08%, and total capital ratio was 12.33%.
- Other comprehensive loss: Nine-month net unrealized losses on available-for-sale securities were $97.2 million after tax; accumulated other comprehensive loss was $95.2 million at quarter-end.
Material changes and notable items
- Q3 net income increased 26.7% year over year. The quarter included a $28.4 million pretax gain from the sale of Payrailz. The first nine months included that gain and a $120.5 million pretax gain from the Finxact sale. These investment gains materially boosted reported earnings.
- Q3 net interest income rose 7.9%, but net interest margin declined from 3.99% to 3.84% as deposit funding costs rose faster than asset yields. For the nine-month period, margin increased from 3.81% to 3.91%.
- Loan growth and a change in loan-sale strategy were significant: the company transferred $754.7 million of loans from held for sale to held for investment in Q3, citing rising rates and market conditions. This contributed to higher provision expense and a shift toward retaining loans.
- Loan-sale gains fell 50.8% in Q3 and 23.7% year to date, reflecting lower sales volume and weaker market conditions. Year-to-date equity-security gains also declined substantially against a 2021 gain related to Greenlight.
- Noninterest expense rose 49.7% in Q3 and 34.1% year to date. Drivers included higher compensation and staffing, technology and marketing investment, and $7.7 million of Q3 impairment on a renewable-energy tax-credit investment. The Q3 effective tax rate was 3.4%, largely due to renewable-energy tax credits.
Outlook, risks and contingencies
- The filing provides no company-specific numerical earnings or growth guidance. Management described an asset-sensitive interest-rate position, while warning that changing deposit pricing, competition, customer behavior and nonparallel rate movements could alter the outcome. Under its modeled parallel-rate scenarios, a 100-basis-point increase was estimated to raise net interest income 2.4% over the following 12 months; the corresponding modeled EVE change was negative 5.6%.
- Management cited loan growth, charge-off experience, the held-for-investment transfer and macroeconomic assumptions as factors behind the higher credit-loss provision. It considers the allowance appropriate but cautions that changed conditions could require significant future additions.
- Key risks include borrower deterioration, interest-rate and market changes, SBA/USDA program or regulatory changes, loan-sale premiums and servicing-asset valuations, technology and cybersecurity disruptions, competition, and the ability to retain key personnel. The company had $2.98 billion in unfunded off-balance-sheet credit commitments and airplane purchase commitments, including a $30.0 million airplane commitment.
- The company reported no material pending legal proceedings at September 30. A previously disclosed employee antitrust class action settlement for $3.9 million became effective in June 2022. A $50 million share repurchase program was authorized through December 31, 2023; no shares had been repurchased through quarter-end.
Most important facts for investors to verify
- How much of earnings growth is recurring banking income versus the Payrailz and Finxact gains, and how investment gains may vary in future periods.
- Whether deposit costs continue to rise faster than loan yields, and how that affects net interest margin and funding mix.
- Performance and credit quality of the rapidly growing held-for-investment portfolio, including criticized loans, nonperformers, charge-offs and allowance adequacy.
- Whether retaining more loans improves risk-adjusted returns despite weaker loan-sale premiums, servicing-asset volatility and higher funding needs.
- Potential effect of unrealized securities losses, interest-rate sensitivity, renewable-energy investment impairment and tax-credit assumptions on earnings and capital.