Live Oak Bancshares, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Live Oak is a Wilmington, North Carolina-based bank holding company whose bank lends to small businesses nationwide, including through SBA- and USDA-guaranteed programs. Amounts below are in U.S. dollars; financial statement amounts are generally in millions.
Financial performance and position
- Q2 earnings: Net income was $17.5 million, or $0.39 diluted EPS, versus $97.0 million, or $2.16, in Q2 2022. For the first half, net income was $17.9 million, or $0.40 diluted EPS, versus $131.5 million, or $2.92.
- Interest income and margin: Q2 net interest income increased 5.5% to $84.3 million; first-half net interest income increased 5.5% to $166.3 million. Net interest margin declined to 3.29% from 3.89% in Q2 and to 3.36% from 3.95% for the first half, as funding costs rose faster than asset yields.
- Noninterest income and expenses: Q2 noninterest income was $24.2 million, down 81.2%; first-half income was $43.7 million, down 72.9%. Q2 noninterest expense fell 5.5% to $76.5 million, while first-half expense rose 6.0% to $155.4 million.
- Credit costs: Provision for loan and lease losses was $13.0 million in Q2 and $32.0 million in the first half, compared with $5.3 million and $7.1 million, respectively, in 2022. The allowance for credit losses was $120.1 million, or 1.62% of loans held for investment at historical cost, versus $96.6 million, or 1.41%, at year-end 2022.
- Balance sheet and funding: Total assets were $10.82 billion, up 9.8% from year-end; loans held for investment were $7.84 billion, up 6.7%; and deposits were $9.88 billion, up 11.2%. Borrowings declined to $28.3 million from $83.2 million. Uninsured deposits were approximately $1.4 billion, or 14.3% of deposits.
- Cash flow: First-half operating cash flow was $294.9 million, investing cash outflow was $837.8 million, and financing cash inflow was $934.3 million. Cash and cash equivalents ended the period at $808.1 million, up $391.5 million from year-end.
- Capital and liquidity: Consolidated common equity tier 1 ratio was 11.55%; the Bank’s was 10.14%, above its 6.50% well-capitalized threshold. Management reported $4.59 billion of immediately available liquidity sources, equal to 42.4% of assets, and $3.77 billion of unused borrowing capacity.
Material changes and notable items
- The major reason earnings were far below 2022 was the absence of the prior-year $120.5 million gain from the sale of the Finxact investment. The Fintech segment reported a $0.7 million Q2 loss versus $94.7 million of income a year earlier; Banking reported $19.6 million of Q2 income.
- Higher interest rates lifted interest income, but deposit costs increased sharply. Q2 deposit interest expense was $85.0 million versus $18.8 million a year earlier; the average cost of interest-bearing liabilities rose to 3.59% from 0.99%.
- Loan and lease originations totaled $1.89 billion in the first half. Net gains on loan sales were $21.0 million, down 21.2% year over year for the first half, reflecting weaker sale premiums despite higher guaranteed-loan sale volume.
- Nonperforming loans and leases excluding fair-value-option loans increased to $111.2 million from $73.4 million at year-end; unguaranteed exposure rose to $44.9 million from $18.8 million. Criticized and classified loans excluding fair-value-option loans increased to $556.6 million from $424.7 million. Management said much of the deterioration was concentrated in a limited number of relationships; 97.5% of Risk Grade 5 loans were performing.
- Available-for-sale securities had $128.5 million of gross unrealized losses at June 30, primarily attributed to market interest-rate movements. The filing says these losses were not recognized in earnings because management intended and was able to hold the securities for potential recovery.
- The Company and Bank each exceeded $10 billion in assets during Q1 2023. The filing describes additional regulatory requirements that may apply after specified consecutive quarters above the threshold, including CFPB supervision and changes to FDIC assessment methodology.
Outlook, risks, and contingencies
- Guidance: The filing provides no specific earnings, loan-growth, or margin guidance. Management cautions that interim results are not necessarily indicative of full-year results.
- Management attributed increased credit provisions to loan growth, portfolio trends, and the macroeconomic outlook, and stated that further allowance additions could adversely affect results. The allowance methodology and reserve for unfunded commitments were refined in Q1, increasing them by $1.5 million and $2.4 million, respectively.
- Interest-rate risk is mixed: the Company described its near-term profile as slightly asset-sensitive, but projected net interest income sensitivity turns slightly liability-sensitive in year two under certain scenarios. A +100 basis-point shock was estimated to change NII by +0.3% over 12 months ending June 2024 and -0.9% over the following 12 months; estimated economic value of equity fell 7.1%. These are model estimates, not forecasts.
- Commitments included $3.12 billion to extend credit, $24.5 million of standby letters of credit, and $18.0 million of airplane purchase commitments. The allowance for off-balance-sheet credit exposures was $4.8 million. The Company also had $31.0 million of unfunded capital commitments for on-balance-sheet investments and was constructing a campus facility with an estimated total cost of $33.6 million.
- Management reported no material pending legal proceedings and no material changes to previously disclosed risk factors other than an additional factor disclosed in the Q1 2023 10-Q. Principal risks include credit deterioration, deposit and liquidity pressures, interest-rate changes, SBA/USDA program changes, technology and cybersecurity, and regulatory developments.
Important facts for investors to verify
- Whether rising deposit costs continue to pressure net interest margin and whether asset yields keep pace.
- Whether nonperforming, criticized, and unguaranteed loans continue to rise, particularly in the relationships and lending verticals identified by management, and whether the allowance remains adequate.
- Deposit stability and funding mix, including uninsured deposits, and the availability and practical usability of reported liquidity and borrowing capacity.
- Loan-sale volumes and premiums, servicing-asset valuations, and the extent to which earnings depend on investment gains or other volatile noninterest items.
- The timing and financial effect of regulatory requirements associated with exceeding $10 billion in assets, as well as the Company’s modeled interest-rate sensitivity under changing conditions.