Live Oak Bancshares, Inc. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. This is an annual report, not a standalone fourth-quarter filing; selected Q4 results are noted below. Live Oak operates a nationwide, technology-enabled small-business lending bank, with significant SBA-guaranteed originations and revenue from loan sales, servicing and net interest income.
Financial performance and condition
| Metric | 2016 | 2015 |
|---|---|---|
| Total assets, year-end | $1.755 billion | $1.053 billion |
| Net interest income | $42.6 million | $25.6 million |
| Noninterest income | $93.5 million | $84.3 million |
| Net income attributable to Live Oak | $13.8 million | $20.6 million |
| Diluted earnings per share | $0.39 | $0.65 |
| Net interest margin | 3.28% | 3.26% |
| Efficiency ratio | 78.16% | 65.25% |
| Deposits, year-end | $1.485 billion | $804.8 million |
| Borrowings, year-end | $27.8 million | $28.4 million |
- Loan originations rose 32.7% to $1.537 billion; guaranteed loan sales rose 18.9% to $761.9 million. Management reported core revenue of $139.4 million, up 27.8%, comprising net interest income, servicing revenue and loan-sale gains.
- Net interest income grew 66.7%, reflecting larger average earning assets; net interest margin increased slightly. Net gains on loan sales were $75.3 million, while servicing revaluation was a negative $8.4 million.
- Noninterest expense rose 48.4% to $106.4 million, led by 56.2% growth in salaries and benefits. The allowance provision increased to $12.5 million from $3.8 million.
- Operating cash flow was negative $222.0 million, investing cash flow negative $320.1 million and financing cash flow positive $677.4 million, principally reflecting loan growth and deposit inflows. Cash and due from banks ended at $238.0 million. Management reported $495.8 million of immediate liquidity, or 28.2% of assets.
- Loans held for investment increased 224.2% to $907.6 million; loans held for sale were $394.3 million. A second-quarter transfer of $318.8 million of unguaranteed loans from held-for-sale to held-for-investment contributed to the portfolio and allowance increase.
- Allowance for loan losses was $18.2 million, or 2.01% of held-for-investment loans, versus $7.4 million, or 2.65%, in 2015. Nonperforming loans increased to $23.8 million from $12.4 million; $19.0 million was SBA-guaranteed, leaving $4.8 million of unguaranteed nonperforming-loan exposure. Nonperforming assets and troubled debt restructurings totaled $27.6 million.
- Consolidated regulatory capital ratios were 15.31% CET1, 16.56% total risk-based capital and 12.00% Tier 1 leverage. The Bank was categorized as well capitalized, with CET1 of 10.68%, total capital of 11.94% and leverage of 8.41%.
Q4 snapshot: Net income attributable to common shareholders was $5.48 million, or $0.16 diluted EPS; the quarter included a $2.99 million income tax benefit.
Changes versus 2015
- Reported net income declined 33.2% despite strong loan and deposit growth. Management attributed the decline principally to higher loan-loss provision, sharply higher operating costs, a $3.8 million investment-sale gain in 2015 that did not recur, and larger negative servicing-rights revaluation.
- Management’s non-GAAP net income, which excludes specified non-routine items and adjusts taxes, was $20.1 million versus $18.4 million in 2015. This is a company-defined measure and is not a substitute for GAAP results.
- Deposits increased 84.5%. Time deposits were $939.7 million, and 72.6% of time-deposit accounts of at least $100,000 were scheduled to mature within one year.
- Nonperforming loans rose in dollars, while unguaranteed nonperforming loans declined as a share of held-for-investment loans, from 0.73% to 0.53%. The allowance ratio also declined, partly reflecting the transfer of a large pool of loans into that portfolio.
Outlook, risks and unusual items
- Management forecast 2017 loan originations of $1.80–$1.90 billion and expects continued growth in held-for-sale and held-for-investment loans, including possible conventional lending outside government-guaranteed programs.
- Management intends to expand existing lending verticals and add new ones. It also expects renewable-energy tax credits may continue to benefit the tax rate in 2017; future tax benefits and investment returns are not assured.
- Unusual 2016 items included a $9.0 million retention-related restricted-stock compensation charge, a $3.2 million impairment of a renewable-energy tax-credit investment, and a $1.4 million aircraft impairment. The tax-credit investment generated $5.5 million of 2016 tax savings; the company reported a 20.0% effective tax rate.
- Interest-rate exposure is mixed: management described the balance sheet as liability-sensitive, while its simulations projected higher net interest income in rising-rate scenarios; the economic-value-of-equity analysis showed potential value declines as rates rise. Servicing-rights values are sensitive to prepayments and market premiums.
- Key risks include borrower credit deterioration and loan concentrations in selected small-business industries; dependence on SBA programs, Preferred Lender status and secondary-market loan sales; funding reliance on internet, brokered and other deposits; interest-rate and servicing-valuation volatility; and dependence on licensed technology and third-party systems, including cybersecurity and operational risks. The filing also identifies regulatory, competition, key-personnel and economic risks.
- After year-end, on February 1, 2017, the company acquired two title agencies for an estimated $15.8 million, including cash, shares and potential earn-out consideration.
- The company reported no material pending legal proceedings. The independent auditor issued an unqualified opinion; management reported effective disclosure controls and internal control over financial reporting.
Investor verification priorities
- Assess credit trends behind the increases in nonperforming loans, criticized loans and provisions, including the unguaranteed exposure and sector concentrations.
- Review the economics and accounting effects of retaining more loans, including future allowance needs, realized loan-sale premiums and servicing-rights assumptions.
- Evaluate deposit quality, concentration and repricing or maturity exposure, particularly large time deposits and reliance on wholesale funding.
- Reconcile GAAP earnings with management’s adjusted earnings and examine the recurring costs and dilution associated with stock-based compensation.
- Track delivery against the 2017 origination outlook, the integration and earn-out terms of the title-agency acquisition, and the future realization of renewable-energy tax benefits.