Live Oak Bancshares, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Live Oak is a nationwide small-business lender focused on selected industry verticals; a significant portion of its originations carry SBA or USDA guarantees. Amounts below are in U.S. dollars; financial statement amounts are rounded to millions unless noted.
Financial performance
- Third quarter: Net interest income was $21.0 million, up 80.8% from $11.6 million. Noninterest income was $25.1 million versus $25.4 million, bringing combined net interest and noninterest income to $46.1 million. Pretax income was $7.8 million; net income was $12.9 million, or $0.33 per diluted share, versus $3.5 million, or $0.10 per diluted share.
- First nine months: Net interest income was $55.1 million, up 82.0%; noninterest income was $77.5 million, up 15.3%. Combined net interest and noninterest income was $132.5 million. Pretax income was $24.9 million and net income was $28.8 million, or $0.78 per diluted share, versus $8.3 million, or $0.24 per diluted share.
- Margins and costs: Net interest margin increased to 3.91% from 3.32% in Q3 and to 3.87% from 3.36% year to date. Provision for loan and lease losses was $2.4 million in Q3 and $5.5 million year to date, down from $3.8 million and $8.7 million, respectively. Noninterest expense rose 31.7% in Q3 to $35.9 million and 37.9% year to date to $102.1 million.
- Balance sheet and funding: Total assets were $2.43 billion at September 30, up 38.6% from year-end 2016. Loans held for sale were $692.6 million and loans held for investment were $1.17 billion. Deposits were $2.01 billion, up 35.5%; long-term borrowings were $26.9 million, down from $27.8 million. Shareholders’ equity was $364.6 million, including $113.1 million of net proceeds from an August secondary offering.
- Cash flow and liquidity: Cash and cash equivalents were $260.9 million, up $22.9 million from year-end. Nine-month operating cash flow was negative $256.2 million, primarily reflecting loan originations held for sale; investing cash flow was negative $354.4 million, including $71.4 million of net premises-and-equipment purchases. Financing cash flow was positive $633.5 million, mainly from deposit growth and the share offering. Management reported $589.1 million of immediately available liquidity, or 25.1% of assets.
Changes versus prior periods
- Growth in average interest-earning assets and higher asset yields drove most of the increase in net interest income; the cost of funds also rose. Q3 average interest-earning assets increased 53.8% year over year.
- Q3 net gains on loan sales fell 16.9% to $18.1 million as guaranteed-loan sale volume declined; year-to-date gains increased 4.7% to $55.3 million on higher cumulative sale volume. Negative servicing-asset revaluation was $3.7 million in Q3 and $6.9 million year to date.
- Expenses increased with business growth, added staff, the Reltco title-agency acquisition, technology and deposit-platform investment, and equipment depreciation. The company had 530 full-time-equivalent employees versus 400 a year earlier.
- The allowance for loan and lease losses rose to $21.0 million from $18.2 million at year-end 2016, while declining as a share of held-for-investment loans to 1.8% from 2.0%. Nonperforming loans were $22.4 million; $19.1 million were SBA-guaranteed. Nonperforming loans as a share of held-for-investment loans declined to 1.92% from 2.62% at year-end.
Outlook, commentary, and risks
- Guidance: Management expected full-year 2017 originations of approximately $1.90–$2.00 billion and an effective tax rate below 10%, excluding the anticipated one-time gain related to the First Data joint venture.
- The reported effective tax rates were negative 64.8% for Q3 and negative 15.5% year to date, principally reflecting expected investment tax credits from renewable-energy investments; adoption of stock-compensation accounting guidance also benefited the year-to-date tax result.
- Apiture subsequent event: On October 1, 2017, the Bank and First Data formed digital-banking joint venture Apiture. Management’s preliminary estimate assigned Live Oak a 45.3% economic interest valued at $68.0 million and indicated a corresponding preliminary one-time pretax gain of $68.0 million. First Data has a cash-earnings preference for 2017 and 2018. The valuation and initial accounting were still under review at filing, so the estimated gain was not a finalized result for the reported quarter.
- Reltco was acquired in February 2017. The acquisition generated $7.3 million of goodwill and a $4.7 million contingent-consideration liability at September 30; the company recorded $766,000 of merger expense year to date.
- The company shortened the estimated useful life of aircraft transportation from 20 years to 10 years. This change reduced 2017 net income by $692,000 year to date, including $202,000 in Q3.
- Management described the balance sheet as asset-sensitive, meaning net interest income would generally move in the same direction as interest rates, while servicing-asset revaluation may move oppositely. Key risks include credit deterioration, changes to SBA/USDA programs, loan-sale premiums and servicing valuations, funding and interest-rate conditions, operational or cybersecurity failures, and execution of growth and acquisitions.
- Commitments to extend credit were $1.56 billion; solar purchase commitments were $182.6 million. The filing notes that credit commitments may expire undrawn and do not necessarily represent future cash requirements. Hurricanes and wildfires affected areas where about 350 borrowers operated; the company reported limited short-term payment deferrals and no resulting impairments identified at the time.
Important facts for investors to verify
- Whether loan-sale volumes, gain premiums, and servicing-asset valuation assumptions support the earnings outlook, given the Q3 decline in loan-sale gains and sensitivity of servicing values to prepayments and rates.
- Credit quality and reserve adequacy, including trends in criticized, impaired, delinquent, and nonperforming loans and the extent to which SBA guarantees mitigate losses.
- Whether deposit growth and funding costs remain adequate to finance rapid loan growth while preserving liquidity and net interest margin.
- The final fair value, accounting treatment, cash preference, and realized earnings impact of Apiture; the $68.0 million gain estimate was preliminary and subject to review.
- The scale and recurring nature of investment tax credits, as the unusually low reported tax burden materially contributed to earnings.
- Execution and cost implications of Reltco integration, renewable-energy leasing commitments, aircraft and facilities investment, and the planned deposit-platform development.