Live Oak Bancshares, Inc. — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015. This annual summary includes fourth-quarter information where relevant. Live Oak is a North Carolina bank holding company whose bank uses a technology-based nationwide lending platform, focusing on selected small-business industries and originating primarily SBA 7(a)-guaranteed loans. The company completed its IPO in July 2015.
Financial results and position
| Metric | 2015 | 2014 |
|---|---|---|
| Net interest income | $25.6 million | $14.7 million |
| Provision for loan losses | $3.8 million | $2.8 million |
| Noninterest income | $84.3 million | $60.0 million |
| Noninterest expense | $71.7 million | $54.5 million |
| Net income attributable to Live Oak | $20.6 million | $10.0 million |
| Diluted earnings per share | $0.65 | $0.41 |
| Total assets, year-end | $1.053 billion | $673.3 million |
| Deposits, year-end | $804.8 million | $522.1 million |
| Loans held for sale, year-end | $480.6 million | $295.2 million |
| Loans held for investment, year-end | $280.0 million | $203.9 million |
| Shareholders’ equity, year-end | $199.5 million | $91.8 million |
| Borrowings, year-end | $28.4 million | $47.9 million |
- Net interest margin rose to 3.26% from 3.04%; the efficiency ratio improved to 65.25% from 72.87%.
- Loan originations grew 36.6% to $1.159 billion; guaranteed loan sales increased 47.7% to $640.9 million. The outstanding balance of guaranteed loans sold and serviced reached $1.78 billion.
- Cash and cash equivalents were $102.6 million at year-end. Reported operating cash flow was negative $334.7 million, reflecting substantial loan originations held for sale; investing cash flow was positive $59.6 million and financing cash flow was positive $347.8 million.
- Management reported $291.4 million of immediately available liquidity, or 27.7% of assets. Deposits were mainly money-market accounts ($375.5 million) and time deposits ($407.8 million); 61.7% of time deposits of at least $100,000 were scheduled to mature within one year.
- Consolidated capital ratios were 23.22% common equity Tier 1, 24.12% total risk-based capital and 18.36% Tier 1 leverage. The Bank’s corresponding ratios were 12.28%, 13.23% and 9.75%; regulators categorized the Bank as well capitalized.
- Nonperforming loans were $12.4 million, down from $18.7 million; nonperforming assets plus troubled debt restructurings totaled $17.2 million, down from $20.6 million. The allowance for loan losses increased to $7.4 million from $4.4 million, or 2.65% of loans held for investment.
Changes, unusual items and management commentary
- Reported net income more than doubled year over year. Growth reflected higher net interest income and loan-sale gains, partly offset by higher operating expenses, provisions and income taxes.
- 2015 noninterest income included a $3.8 million gain from selling the company’s remaining nCino investment. The company also recorded a negative $6.2 million servicing-rights revaluation, compared with a negative $2.2 million in 2014; reported loan servicing revenue and revaluation together were $9.9 million.
- Operating expenses rose 31.5%, particularly salaries and benefits, which increased 38.3% to $40.3 million, as the company invested in staffing, new lending verticals and its technology platform. The company added four verticals, bringing the year-end total to eleven, and launched an eLending pilot for smaller business loans.
- The July IPO issued 5.5 million voting shares at $17 per share and generated $87.2 million net of issuance costs. The company repaid its $6.8 million Small Business Lending Fund securities in December and had no short-term borrowings at year-end.
- Comparability with 2014 is affected by the conversion from S-corporation to C-corporation status in August 2014 and the related $3.3 million initial deferred-tax liability. 2014 also included $3.0 million of stock-grant expense and $1.7 million of costs related to capital-raising alternatives.
- Management forecast approximately $1.35 billion of loan originations in 2016, with about 40% fully funded at closing. It expected held-for-sale and held-for-investment portfolios to grow, including from construction lending and potential conventional lending, and anticipated higher expenses to support growth. These are forward-looking expectations, not guarantees.
Risks, contingencies and governance
- Results depend substantially on SBA programs, preferred-lender status, secondary-market demand and loan-sale premiums. SBA rule changes, technical deficiencies in loan origination or servicing, or reduced ability to sell guaranteed portions could adversely affect earnings.
- Credit and concentration risks include lending to small businesses in selected verticals, construction and development exposure, and reliance on collateral and SBA guarantees. Veterinary, healthcare and independent-pharmacy businesses are significant portfolio segments. New verticals have limited historical loss data.
- Loan-sale gains and servicing assets rely on estimates, including premiums, prepayment speeds and discount rates. Servicing assets are a significant valuation exposure; management identified the allowance for loan losses, servicing assets and foreclosed assets as critical estimates.
- Funding risks include reliance on Internet and brokered deposits and the potential for deposit outflows or higher funding costs. Interest-rate changes can affect net interest income, loan demand, prepayments, servicing values and securities valuations.
- Technology, cybersecurity and third-party service continuity are key risks. The platform depends on non-exclusive nCino and Salesforce technology licenses; the disclosed nCino license was due to expire in November 2018, subject to its terms.
- Commitments to extend credit totaled $737.6 million at year-end; total unfunded off-balance-sheet commitments, including investment commitments, were $739.5 million. Management stated that ordinary-course legal proceedings were not expected to materially affect the company; it reported no material pending legal proceedings.
- The company’s financial statements received an unqualified audit opinion. Disclosure controls were deemed effective, but the 10-K did not include management’s internal-control assessment or auditor attestation under the transition rules for newly public companies.
Important facts for investors to verify
- Whether loan originations, secondary-market sales and premiums can sustain growth while construction loans take longer to fund and sell.
- Whether the $7.4 million allowance remains adequate as the portfolio expands into newer industries, and how nonperforming loans, criticized credits and unguaranteed exposure develop.
- How servicing-asset assumptions and market premiums affect recurring earnings; separate the $3.8 million nCino gain and servicing revaluation from core operating trends.
- Deposit stability, large time-deposit maturities, available borrowing capacity and the significance of negative operating cash flow during rapid loan growth.
- Execution of the 2016 origination outlook, growth-related expenses, eLending rollout and any expansion into conventional lending.
- Future dividends are discretionary and subject to regulatory and capital restrictions. The company declared $0.10 per share in 2015; in February 2016 it declared a separate $0.02 per-share dividend.