Live Oak Bancshares, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Live Oak is a Wilmington, North Carolina-based bank holding company focused on small-business lending nationwide, including SBA- and USDA-guaranteed loans. Results reflect the COVID-19 disruption and the launch of the Paycheck Protection Program (PPP).
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net interest income | $40.9m | $33.9m | $81.1m | $64.5m |
| Net interest margin | 2.56% | 3.71% | 2.97% | 3.68% |
| Provision for credit losses | $10.0m | $3.4m | $21.8m | $6.4m |
| Noninterest income | $22.4m | $14.7m | $28.2m | $28.0m |
| Noninterest expense | $48.1m | $39.6m | $97.6m | $77.8m |
| Net income (loss) | $3.8m | $4.9m | $(3.8)m | $7.3m |
| Diluted earnings (loss) per share | $0.09 | $0.12 | $(0.10) | $0.18 |
Q2 net interest income and loan-sale gains increased, but higher credit provisioning, fair-value losses on loans, and operating costs weighed on earnings. Q2 loan-sale gains were $10.7m, up 77.8%; the six-month amount was $21.8m, up 113.5%. Six-month results also included an estimated $3.7m tax benefit related to the CARES Act carryback rules.
Financial position, cash flow and liquidity
- Total assets were $8.21bn at June 30, up 70.6% from year-end 2019. Loans held for investment were $4.65bn, including $1.74bn of PPP loans; available-for-sale securities were $779.8m.
- Deposits totaled $5.87bn, up $1.65bn since year-end. Borrowings were $1.72bn, principally advances under the Federal Reserve’s Paycheck Protection Program Liquidity Facility (PPPLF), secured by PPP loans and bearing 0.35% interest. Shareholders’ equity was $548.4m.
- Cash and cash equivalents ended the period at $1.35bn. Management reported $3.28bn of immediately available liquidity, or 40.0% of assets; the securities portfolio was unpledged and available as lendable collateral.
- For the first half, operating cash flow was $(79.3)m, investing cash flow $(2.16)bn, and financing cash flow $3.37bn, producing a $1.13bn net increase in cash and cash equivalents.
- At June 30, consolidated capital ratios included 12.84% common equity Tier 1 and 13.99% total capital to risk-weighted assets. The Bank’s ratios exceeded applicable well-capitalized thresholds.
Material changes and credit developments
- Credit-loss provision for the first half rose to $21.8m, and the allowance for credit losses (ACL) was $44.1m at June 30. The ACL was 1.2% of loans at historical cost, or 2.0% excluding PPP loans. Management attributed increased reserves primarily to COVID-19 uncertainty and forecast unemployment.
- Six-month net charge-offs were $4.6m, versus $34,000 in the prior-year period. Criticized and classified loans and leases totaled $146.9m, compared with $129.1m at year-end.
- Nonperforming assets and troubled debt restructurings (TDRs), including loans measured at fair value, totaled $134.3m; $100.9m carried an SBA guarantee. Excluding fair-value-option loans, the filing reports $65.2m, up 55.7% from year-end.
- PPP drove a sharp increase in loan originations and balance-sheet size: the Bank originated $1.74bn across 10,847 PPP loans by June 30. PPP loans carry a 100% SBA guarantee subject to program requirements; the Company funded them in part with PPPLF advances.
- Operating expenses increased, especially salaries and benefits, which included a $7.2m employee performance bonus pool. Full-time-equivalent employees rose to 640 from 531 a year earlier. FDIC insurance expense also increased.
- The Company adopted CECL on January 1, 2020, recording an $822,000 net increase to retained earnings, including a $1.3m decrease in loan ACL and a $499,000 increase in reserves for unfunded commitments.
- On April 1, the Company acquired Jolley Asset Management, LLC for wealth-management expansion; management said the acquisition did not materially affect results or financial position. A $20m share-repurchase authorization was approved through year-end; no shares had been repurchased by June 30.
Outlook, risks and contingencies
- Management provided no earnings or revenue guidance. It estimated an effective tax rate of approximately 26%–28% for the remainder of 2020, subject to future income, expenses, credits, and discrete tax items.
- COVID-19 effects remained highly uncertain. Management warned that worsening conditions could require further credit reserves or fair-value losses, reduce future loan-sale gains and interest income, and weaken asset quality. At June 30, 60% of non-PPP loans at amortized cost were receiving six months of SBA payments, and 9% had a payment deferral.
- Management identified hotels, wine and craft beverage, educational services, entertainment centers, fitness centers, and quick-service restaurants as pandemic-at-risk lending verticals. Delinquency measures may be obscured by SBA payment support.
- PPP risks include changing or unclear program guidance, forgiveness and eligibility issues, possible SBA denial or recovery of guarantees for origination or servicing deficiencies, and potential litigation. Funding costs, deposit withdrawals, interest-rate changes, and the ability to maintain capital and liquidity are additional risks.
- The Company reported $1.60bn of unfunded off-balance-sheet credit commitments and standby letters of credit. Management stated that ordinary-course litigation was not expected to materially affect the Company.
Key facts for investors to verify
- Whether COVID-19 forecasts, SBA payment relief, and PPP guarantees are adequately reflected in the ACL and fair-value marks.
- Changes in criticized loans, nonperforming assets, TDRs, charge-offs, and exposures in pandemic-sensitive business verticals.
- Whether PPP-related growth, PPPLF funding, deposit trends, and available liquidity remain sustainable as PPP loans are forgiven or repaid.
- Drivers of margin compression and the sensitivity of loan-sale gains and servicing-asset values to market rates and prepayment assumptions.
- Whether rising personnel and other operating costs are supported by recurring revenue, and how the stated tax-rate outlook develops.