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EX-32 - EXHIBIT 32 - Live Oak Bancshares, Inc.exhibit322016q1.htm
EX-31.1 - EXHIBIT 31.1 - Live Oak Bancshares, Inc.exhibit3112016q1.htm
EX-31.2 - EXHIBIT 31.2 - Live Oak Bancshares, Inc.exhibit3122016q1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2016
or
¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from              to             .
Commission file number: 001-37497
LIVE OAK BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
North Carolina
26-4596286
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
1741 Tiburon Drive
Wilmington, North Carolina
28403
(Address of principal executive offices)
(Zip Code)
(910) 790-5867
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ý    NO  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  ý    NO  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
 
¨
 
Accelerated Filer
 
¨
 
 
 
 
Non-accelerated Filer
 
x  (Do not check if smaller reporting company)
 
Smaller Reporting Company
 
¨
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  ý
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of May 11, 2016, there were 29,467,643 shares of the registrant’s voting common stock outstanding and 4,723,530 shares of the registrant’s non-voting common stock outstanding.




Live Oak Bancshares, Inc. and Subsidiaries
Form 10-Q
For the Quarterly Period Ended March 31, 2016
TABLE OF CONTENTS

 
 
Page
PART I. FINANCIAL INFORMATION
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
PART II. OTHER INFORMATION
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 




PART I. FINANCIAL INFORMATION
Item 1.        Financial Statements
Live Oak Bancshares, Inc.
Consolidated Balance Sheets
As of March 31, 2016 (unaudited) and December 31, 2015*
(Dollars in thousands)
 
March 31,
2016
 
December 31,
2015*
Assets
 
 
 
Cash and due from banks
$
226,556

 
$
102,607

Certificates of deposit with other banks
9,000

 
10,250

Investment securities available-for-sale
55,674

 
53,762

Loans held for sale
537,293

 
480,619

Loans held for investment
313,633

 
279,969

Allowance for loan losses
(8,616
)
 
(7,415
)
Net loans
305,017

 
272,554

Premises and equipment, net
61,839

 
62,653

Foreclosed assets
3,020

 
2,666

Servicing assets
47,377

 
44,230

Other assets
22,765

 
23,281

Total assets
$
1,268,541

 
$
1,052,622

Liabilities and Shareholders’ Equity
 
 
 
Liabilities
 
 
 
Deposits:
 
 
 
Noninterest-bearing
$
21,125

 
$
21,502

Interest-bearing
994,340

 
783,286

Total deposits
1,015,465

 
804,788

Long term borrowings
28,271

 
28,375

Other liabilities
20,372

 
19,971

Total liabilities
1,064,108

 
853,134

Shareholders’ equity
 
 
 
Preferred stock, no par value, 1,000,000 authorized, none issued or outstanding at March 31, 2016 and December 31, 2015

 

Class A common stock, no par value, 100,000,000 shares authorized, 29,460,348 and 29,449,369 shares issued and outstanding at March 31, 2016 and December 31, 2015, respectively
138,199

 
137,492

Class B common stock, no par value, 10,000,000 shares authorized, 4,723,530 shares issued and outstanding at March 31, 2016 and December 31, 2015
50,015

 
50,015

Retained earnings
16,147

 
12,140

Accumulated other comprehensive income (loss)
47

 
(192
)
Total shareholders’ equity attributed to Live Oak Bancshares, Inc.
204,408

 
199,455

Noncontrolling interest
25

 
33

Total equity
204,433

 
199,488

Total liabilities and shareholders’ equity
$
1,268,541

 
$
1,052,622

*    Derived from audited consolidated financial statements.
See Notes to Unaudited Consolidated Financial Statements

1


Live Oak Bancshares, Inc.
Consolidated Statements of Income
For the three months ended March 31, 2016 and 2015 (unaudited)
(Dollars in thousands, except per share data)
 
Three Months Ended
March 31,
 
2016
 
2015
Interest income
 
 
 
Loans and fees on loans
$
11,005

 
$
6,730

Investment securities, taxable
251

 
176

Other interest earning assets
138

 
66

Total interest income
11,394

 
6,972

Interest expense
 
 
 
Deposits
2,444

 
1,476

Borrowings
241

 
441

Total interest expense
2,685

 
1,917

Net interest income
8,709

 
5,055

Provision for loan losses
1,433

 
1,077

Net interest income after provision for loan losses
7,276

 
3,978

Noninterest income
 
 
 
Loan servicing revenue and revaluation
4,758

 
4,106

Net gains on sales of loans
16,425

 
15,461

Equity in loss of non-consolidated affiliates

 
(26
)
Gain on sale of investment in non-consolidated affiliate

 
3,782

Construction supervision fee income
630

 
216

Other noninterest income
619

 
516

Total noninterest income
22,432

 
24,055

Noninterest expense
 
 
 
Salaries and employee benefits
12,993

 
8,355

Travel expense
1,846

 
1,476

Professional services expense
528

 
850

Advertising and marketing expense
963

 
1,008

Occupancy expense
1,193

 
481

Data processing expense
1,208

 
893

Equipment expense
551

 
443

Other loan origination and maintenance expense
574

 
477

Other expense
1,855

 
719

Total noninterest expense
21,711

 
14,702

Income before taxes
7,997

 
13,331

Income tax expense
3,314

 
5,278

Net income
4,683

 
8,053

Net loss attributable to noncontrolling interest
8

 
20

Net income attributable to Live Oak Bancshares, Inc.
$
4,691

 
$
8,073

Basic earnings per share
$
0.14

 
$
0.28

Diluted earnings per share
$
0.13

 
$
0.27

See Notes to Unaudited Consolidated Financial Statements

2


Live Oak Bancshares, Inc.
Consolidated Statements of Comprehensive Income
For the three months ended March 31, 2016 and 2015 (unaudited)
(Dollars in thousands)
 
Three Months Ended
March 31,
 
2016
 
2015
Net income
$
4,683

 
$
8,053

Other comprehensive income before tax:
 
 
 
Net unrealized gain on investment securities arising during the period
389

 
203

Reclassification adjustment for (gain) loss on sale of securities available-for-sale included in net income

 

Other comprehensive income before tax
389

 
203

Income tax expense
(150
)
 
(79
)
Other comprehensive income, net of tax
239

 
124

Total comprehensive income
$
4,922

 
$
8,177

See Notes to Unaudited Consolidated Financial Statements

3


Live Oak Bancshares, Inc.
Consolidated Statements of Changes in Shareholders’ Equity
For the three months ended March 31, 2016 and 2015 (unaudited)
(Dollars in thousands)
 
Common stock
 
Retained
earnings
(accumulated
deficit)
 
Accumulated
other
comprehensive
income (loss)
 
Non-
controlling
interest
 
Total
equity
Shares
 
 
 
Class A
 
Class B
 
Amount
 
Balance at December 31, 2014
23,896,400

 
4,723,530

 
$
98,672

 
$
(6,943
)
 
$
85

 
$

 
$
91,814

Net income (loss)

 

 

 
8,073

 

 
(20
)
 
8,053

Other comprehensive income

 

 

 

 
124

 

 
124

Consolidation of investment with non-controlling interest

 

 

 

 

 
35

 
35

Stock option exercises
3,679

 

 
16

 

 

 

 
16

Stock option based compensation expense

 

 
118

 

 

 

 
118

Restricted stock expense

 

 
8

 

 

 

 
8

Balance at March 31, 2015
23,900,079

 
4,723,530

 
$
98,814

 
$
1,130

 
$
209

 
$
15

 
$
100,168

Balance at December 31, 2015
29,449,369

 
4,723,530

 
$
187,507

 
$
12,140

 
$
(192
)
 
$
33

 
$
199,488

Net income (loss)

 

 

 
4,691

 

 
(8
)
 
4,683

Other comprehensive income

 

 

 

 
239

 

 
239

Issuance of restricted stock
2,776

 

 

 

 

 

 

Stock option exercises
8,203

 

 
48

 

 

 

 
48

Stock option based compensation expense

 

 
592

 

 

 

 
592

Restricted stock expense

 

 
67

 

 

 

 
67

Dividends (distributions to shareholders)

 

 

 
(684
)
 

 

 
(684
)
Balance at March 31, 2016
29,460,348

 
4,723,530

 
$
188,214

 
$
16,147

 
$
47

 
$
25

 
$
204,433

See Notes to Unaudited Consolidated Financial Statements

4


Live Oak Bancshares, Inc.
Consolidated Statements of Cash Flows
For the three months ended March 31, 2016 and 2015 (unaudited)
(Dollars in thousands)
 
Three Months Ended
March 31,
 
2016
 
2015
Cash flows from operating activities
 
 
 
Net income
$
4,683

 
$
8,053

Adjustments to reconcile net income to net cash used by operating activities:
 
 
 
Depreciation and amortization
1,065

 
433

Provision for loan losses
1,433

 
1,077

Amortization of premium on securities, net of accretion
30

 
15

Amortization (accretion) of discount on unguaranteed loans, net
146

 
319

Deferred tax expense
739

 
226

Originations of loans held for sale
(256,077
)
 
(223,905
)
Proceeds from sales of loans held for sale
172,638

 
180,991

Net gains on sale of loans held for sale
(16,425
)
 
(15,461
)
Net loss on sale of foreclosed assets

 
7

Net increase in servicing assets
(3,147
)
 
(3,458
)
Gain on sale of investment in non-consolidated affiliate

 
(3,782
)
Net loss on disposal of premises and equipment

 
3

Stock option based compensation expense
592

 
118

Restricted stock expense
67

 
8

Equity in loss of non-consolidated affiliates

 
26

Changes in assets and liabilities:
 
 
 
Other assets
516

 
92

Other liabilities
(146
)
 
5,265

Net cash used by operating activities
(93,886
)
 
(49,973
)
Cash flows from investing activities
 
 
 
Purchases of securities available-for-sale
(2,443
)
 
(1,900
)
Proceeds from sales, maturities, calls, and principal paydowns of securities available-for-sale
890

 
629

Proceeds from sale/collection of foreclosed assets
52

 
330

Maturities of certificates of deposit with other banks
1,250

 

Proceeds from sale of investment in non-consolidated affiliate

 
9,896

Net cash acquired in consolidation of equity method investment

 
319

Loan originations and principal collections, net
8,742

 
26,725

Purchases of premises and equipment, net
(251
)
 
(3,281
)
Net cash provided by investing activities
8,240

 
32,718

See Notes to Unaudited Consolidated Financial Statements

5


Live Oak Bancshares, Inc.
Consolidated Statements of Cash Flows (Continued)
For the three months ended March 31, 2016 and 2015 (unaudited)
(Dollars in thousands)
 
Three Months Ended
March 31,
 
2016
 
2015
Cash flows from financing activities
 
 
 
Net increase in deposits
210,677

 
34,003

Proceeds from long term borrowings

 
8,468

Repayment of long term borrowings
(104
)
 
(107
)
Repayment of short term borrowings

 
(6,100
)
Stock option exercises
48

 
16

Shareholder dividend distributions
(1,026
)
 
(1,363
)
Net cash provided by financing activities
209,595

 
34,917

Net increase in cash and cash equivalents
123,949

 
17,662

Cash and cash equivalents, beginning
102,607

 
29,902

Cash and cash equivalents, ending
$
226,556

 
$
47,564

 
 
 
 
Supplemental disclosure of cash flow information
 
 
 
Interest paid
$
2,690

 
$
1,915

Income tax
2,181

 
1,974

 
 
 
 
Supplemental disclosures of noncash operating, investing, and financing activities
 
 
 
Unrealized holding gains on available-for-sale securities, net of taxes
$
239

 
$
124

Transfers from loans to foreclosed real estate and other repossessions
406

 

Transfers of loans accounted for as secured borrowing collateral to other assets

 
4,674

Dividends declared but not paid

 
169

Transfer of loans held for sale to loans held for investment
13,763

 
2,294

Transfer of loans held for investment to loans held for sale
752

 
1,370

Contingent consideration in acquisition of controlling interest in equity method of investment

 
170

See Notes to Unaudited Consolidated Financial Statements

6


Live Oak Bancshares, Inc.
Notes to Unaudited Consolidated Financial Statements
Note 1. Basis of Presentation
Nature of Operations
Live Oak Bancshares, Inc. (the “Company” or “LOB”) is a bank holding company headquartered in Wilmington, North Carolina incorporated under the laws of North Carolina in December 2008. The Company conducts business operations primarily through its commercial bank subsidiary, Live Oak Banking Company (the “Bank”). The Bank was established in May 2008 as a North Carolina-chartered commercial bank. The Bank specializes in providing lending services to small businesses nationwide in targeted industries. The Bank identifies and grows within credit-worthy industries through expertise within those industries. A significant portion of the loans originated by the Bank are guaranteed by the Small Business Administration (“SBA”) under the 7(a) program. On July 23, 2015 the Company closed on its initial public offering. In 2010, the Bank formed Live Oak Number One, Inc., a wholly-owned subsidiary, to hold properties foreclosed on by the Bank.
During 2011, the Company formed Independence Aviation, LLC, a wholly-owned subsidiary, for the purpose of purchasing and operating aircraft used for business purposes of the Company. The net assets of Independence Aviation, LLC were transferred to the Company and the Bank effective December 31, 2015 resulting in its dissolution.
In addition to the Bank, the Company owns Live Oak Grove, LLC, opened in September 2015 for the purpose of providing Company employees and business visitors an on-site restaurant location, Government Loan Solutions, Inc. (“GLS”), a management and technology consulting firm that specializes in the settlement, accounting, and securitization processes for government guaranteed loans, including loans originated under the SBA 7(a) loan program and USDA-guaranteed loans, and 504 Fund Advisors, LLC (“504FA”), formed to serve as the investment adviser to the 504 Fund, a closed-end mutual fund organized to invest in SBA section 504 loans.
The Company acquired control over 504FA, previously carried as an equity method investment, on February 2, 2015 by increasing its ownership from 50.0% to 91.3%. The acquisition of an additional 41.3% of ownership occurred in exchange for contingent consideration estimated to total $170 thousand. Transactions in the third quarter of 2015 and first quarter of 2016 increased the Company’s ownership to 92.9%. With 7.1% of ownership remaining with a third party investor, amounts of earnings and equity in 504FA attributable to the third party investor are now disclosed in the Company’s consolidated financial statements as related to a noncontrolling interest.
The Company earns revenue primarily from the sale of SBA-guaranteed loans. This income is comprised of net gains on the sale of loans, revenues on the servicing of sold loans and valuation of loan servicing rights. Net interest income is another contributor to earnings. Offsetting these revenues are the cost of funding sources, provision for loan losses, any costs related to foreclosed assets and other operating costs such as salaries and employee benefits, travel, professional services, advertising and marketing and tax expense.
General
In the opinion of management, all adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included, and all intercompany transactions have been eliminated in consolidation. Results of operations for the three months ended March 31, 2016 are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2016. The consolidated balance sheet as of December 31, 2015 has been derived from the audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015, filed with the Securities Exchange Commission on March 14, 2016 (SEC File No. 001-37497) (the "2015 Annual Report"). A summary description of the significant accounting policies followed by the Company is set forth in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2015 Annual Report. These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes in the Company's 2015 Annual Report.
The preparation of financial statements in conformity with United States generally accepted accounting principles, or GAAP, requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates.
Amounts in all tables in the Notes to Unaudited Consolidated Financial Statements have been presented in thousands, except percentage, time period, stock option, share and per share data or where otherwise indicated.


7



Live Oak Bancshares, Inc.
Notes to Unaudited Consolidated Financial Statements

Business Segments
Management has determined that the Company has one significant operating segment, which is providing a lending platform for small businesses nationwide. In determining the appropriateness of segment definition, the Company considers the materiality of a potential segment, the components of the business about which financial information is available, and components for which management regularly evaluates relative to resource allocation and performance assessment.
Reclassifications
Certain reclassifications have been made to the prior period’s consolidated financial statements to place them on a comparable basis with the current year. Net income and shareholders’ equity previously reported were not affected by these reclassifications.
Note 2. Recent Accounting Pronouncements
In March 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” (“ASU 2016-08”). This guidance amends the previously issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU 2016-08 clarifies the implementation guidance on principal versus agent considerations in order to determine if revenue will be recognized on a gross or net basis. This guidance is effective for the Company on January 1, 2018 and is not expected to have a material impact on the consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-09, “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 simplifies the accounting for share-based payment transactions for items including income tax consequences, classification of awards as equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 will be effective for the Company on January 1, 2017 and the Company is currently assessing the impact the adoption of this standard will have on the consolidated financial statements.
Note 3. Earnings Per Share
Basic and diluted earnings per share are computed based on the weighted average number of shares outstanding during each period. Diluted earnings per share reflects the potential dilution that could occur, upon the exercise of stock options or upon the vesting of restricted stock grants, any of which would result in the issuance of common stock that would then be shared in the net income of the Company.
 
Three Months Ended
March 31,
 
2016
 
2015
Basic earnings per share:
 
 
 
Net income available to common shareholders
$
4,691

 
$
8,073

Weighted-average basic shares outstanding
34,176,753

 
28,620,120

Basic earnings per share
$
0.14

 
$
0.28

Diluted earnings per share:
 
 
 
Net income available to common shareholders, for diluted earnings per share
$
4,691

 
$
8,073

Total weighted-average basic shares outstanding
34,176,753

 
28,620,120

Add effect of dilutive stock options and restricted stock grants
777,839

 
741,721

Total weighted-average diluted shares outstanding
34,954,592

 
29,361,841

Diluted earnings per share
$
0.13

 
$
0.27

Anti-dilutive shares
2,369,813

 
720,447



8



Live Oak Bancshares, Inc.
Notes to Unaudited Consolidated Financial Statements

Note 4. Securities
The carrying amount of securities and their approximate fair values are reflected in the following table:
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
March 31, 2016
 
 
 
 
 
 
 
US government agencies
$
22,005

 
$
129

 
$

 
$
22,134

Residential mortgage-backed securities
31,627

 
22

 
96

 
31,553

Mutual fund
1,966

 
21

 

 
1,987

Total
$
55,598

 
$
172

 
$
96

 
$
55,674

 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
 
US government agencies
$
21,992

 
$
81

 
$
5

 
$
22,068

Residential mortgage-backed securities
30,131

 
1

 
374

 
29,758

Mutual fund
1,951

 

 
15

 
1,936

Total
$
54,074

 
$
82

 
$
394

 
$
53,762

During the three months ended March 31, 2016, the Company purchased one mortgage-backed security for $2.4 million for the purpose of complying with the Community Reinvestment Act. During the three months ended March 31, 2016, there was $15 thousand of dividend reinvestment in the 504 Fund mutual fund. There were no calls, sales or maturities of securities during the three months ended March 31, 2016.
There were no calls, sales or maturities of securities during the three months ended March 31, 2015. On March 31, 2015, the Company invested $1.9 million in the 504 Fund mutual fund. The investment in this mutual fund was purchased at current market value (190,380.762 shares at $9.98 per share).
The following tables show gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.
 
Less Than 12 Months
 
12 Months or More
 
Total
March 31, 2016
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Residential mortgage-backed securities
$
16,254

 
$
73

 
$
2,978

 
$
23

 
$
19,232

 
$
96

Total
$
16,254

 
$
73

 
$
2,978

 
$
23

 
$
19,232

 
$
96

 
Less Than 12 Months
 
12 Months or More
 
Total
December 31, 2015
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
US government agencies
$
7,990

 
$
5

 
$

 
$

 
$
7,990

 
$
5

Residential mortgage-backed securities
26,015

 
333

 
3,019

 
41

 
29,034

 
374

Mutual fund
1,936

 
15

 

 

 
1,936

 
15

Total
$
35,941

 
$
353

 
$
3,019

 
$
41

 
$
38,960

 
$
394

At March 31, 2016, there were three mortgage-backed securities in unrealized loss positions for greater than 12 months and six mortgage-backed securities in unrealized loss positions for less than 12 months. Unrealized losses at December 31, 2015 were comprised of three mortgage-backed securities in unrealized loss positions for greater than 12 months and one US government agency security, twelve mortgage-backed securities and the 504 Fund mutual fund investment in an unrealized loss position for less than 12 months.
These unrealized losses are primarily the result of volatility in the market and are related to market interest rates. Since none of the unrealized losses relate to marketability of the securities or the issuer’s ability to honor redemption obligations, none of the securities are deemed to be other than temporarily impaired.
All residential mortgage-backed securities in the Company’s portfolio at March 31, 2016 and December 31, 2015 were backed by US government sponsored enterprises (“GSEs”).

9



Live Oak Bancshares, Inc.
Notes to Unaudited Consolidated Financial Statements

The following is a summary of investment securities by maturity:
 
March 31, 2016
 
Available-for-Sale
 
Amortized
cost
 
Fair
value
US government agencies
 
 
 
Within one year
$
9,212

 
$
9,229

One to five years
12,793

 
12,905

Total
22,005

 
22,134

 
 
 
 
Residential mortgage-backed securities
 
 
 
Five to ten years
9,095

 
9,101

After 10 years
22,532

 
22,452

Total
31,627

 
31,553

 
 
 
 
Total
$
53,632

 
$
53,687

The table above reflects contractual maturities. Actual results will differ as the loans underlying the mortgage-backed securities may repay sooner than scheduled. This table excludes the 504 Fund mutual fund investment.
At March 31, 2016 and December 31, 2015, an investment security with a fair market value of $1.2 million and $1.3 million, respectively, was pledged to secure a line of credit with the Company’s correspondent bank.


10



Live Oak Bancshares, Inc.
Notes to Unaudited Consolidated Financial Statements

Note 5. Loans Held for Investment and Allowance for Loan Losses
Loan Portfolio Segments
The following describes the risk characteristics relevant to each of the portfolio segments. Each loan category is assigned a risk grade during the origination and closing process based on criteria described later in this section.
Commercial and Industrial
Commercial and industrial loans (C&I) receive similar underwriting treatment as commercial real estate loans in that the repayment source is analyzed to determine its ability to meet cash flow coverage requirements as set forth by Bank policies. Repayment of the Bank’s C&I loans generally comes from the generation of cash flow as the result of the borrower’s business operations. This business cycle itself brings a certain level of risk to the portfolio. In some instances, these loans may carry a higher degree of risk due to a variety of reasons – illiquid collateral, specialized equipment, highly depreciable assets, uncollectable accounts receivable, revolving balances, or simply being unsecured. As a result of these characteristics, the SBA guarantee on these loans is an important factor in mitigating risk.
Construction and Development
Construction and development loans are for the purpose of acquisition and development of land to be improved through the construction of commercial buildings. Such loans are usually paid off through the conversion to permanent financing for the long-term benefit of the borrower’s ongoing operations. At the completion of the project, if the loan is converted to permanent financing or if scheduled loan amortization begins, it is then reclassified to the “Owner Occupied Commercial Real Estate” segment. Underwriting of construction and development loans typically includes analysis of not only the borrower’s financial condition and ability to meet the required debt obligations, but also the general market conditions associated with the area and type of project being funded.
Owner Occupied Commercial Real Estate
Owner occupied commercial real estate loans are extensions of credit secured by owner occupied collateral. Underwriting generally involves intensive analysis of the financial strength of the borrower and guarantor, liquidation value of the subject collateral, the associated unguaranteed exposure, and any available secondary sources of repayment, with the greatest emphasis given to a borrower’s capacity to meet cash flow coverage requirements as set forth by Bank policies. Such repayment of owner-occupied loans is commonly derived from the successful ongoing operations of the business occupying the property. These typically include small businesses and professional practices.
Commercial Land
Commercial land loans are extensions of credit secured by farmland. Such loans are often for land improvements related to agricultural endeavors that may include construction of new specialized facilities. These loans are usually repaid through the conversion to permanent financing, or if scheduled loan amortization begins, for the long-term benefit of the borrower’s ongoing operations. Underwriting generally involves intensive analysis of the financial strength of the borrower and guarantor, liquidation value of the subject collateral, the associated unguaranteed exposure, and any available secondary sources of repayment, with the greatest emphasis given to a borrower’s capacity to meet cash flow coverage requirements as set forth by Bank policies.
Each of the loan types referenced in the sections above is further segmented into verticals in which the Bank chooses to operate. The Bank chooses to finance businesses operating in specific industries because of certain similarities. The similarities range from historical default and loss characteristics to business operations. However, there are differences that create the necessity to underwrite these loans according to varying criteria and guidelines. When underwriting a loan, the Bank considers numerous factors such as cash flow coverage, the credit scores of the guarantors, revenue growth, practice ownership experience and debt service capacity. Minimum guidelines have been set with regard to these various factors and deviations from those guidelines require compensating strengths when considering a proposed loan.

11



Live Oak Bancshares, Inc.
Notes to Unaudited Consolidated Financial Statements

Loans consist of the following:
 
March 31,
2016
 
December 31,
2015
Commercial & Industrial
 
 
 
Agriculture
$
23

 
$
30

Death Care Management
5,084

 
4,832

Healthcare
17,365

 
15,240

Independent Pharmacies
43,185

 
41,588

Registered Investment Advisors
21,649

 
18,358

Veterinary Industry
22,385

 
21,579

Other Industries
7,251

 
3,230

Total
116,942

 
104,857

Construction & Development
 
 
 
Agriculture
12,420

 
11,351

Death Care Management
726

 
769

Healthcare
8,051

 
7,231

Independent Pharmacies
279

 
101

Registered Investment Advisors
286

 
378

Veterinary Industry
3,646

 
3,834

Other Industries
1,966

 
658

Total
27,374

 
24,322

Owner Occupied Commercial Real Estate
 
 
 
Agriculture
1,929

 
1,863

Death Care Management
22,318

 
20,327

Healthcare
44,286

 
37,684

Independent Pharmacies
7,285

 
7,298

Registered Investment Advisors
3,035

 
2,808

Veterinary Industry
61,744

 
59,999

Other Industries
5,338

 
4,752

Total
145,935

 
134,731

Commercial Land
 
 
 
Agriculture
23,081

 
16,036

Total
23,081

 
16,036

Total Loans1
313,332

 
279,946

Net Deferred Costs
3,330

 
3,056

Discount on SBA 7(a) Unguaranteed2
(3,029
)
 
(3,033
)
Loans, Net of Unearned
$
313,633

 
$
279,969

1
Total loans include $24.6 million and $17.2 million of U.S. government guaranteed loans as of March 31, 2016 and December 31, 2015, respectively.
2
The Company measures the carrying value of the retained portion of loans sold at fair value under ASC Subtopic 825-10. The value of these retained loan balances is discounted based on the estimates derived from comparable unguaranteed loan sales.

12



Live Oak Bancshares, Inc.
Notes to Unaudited Consolidated Financial Statements

Credit Risk Profile
The Bank uses internal loan reviews to assess the performance of individual loans by industry segment. An independent review of the loan portfolio is performed annually by an external firm. The goal of the Bank’s annual review of select borrowers' financial performance is to validate the adequacy of the risk grade assigned.
The Bank uses a grading system to rank the quality of each loan. The grade is periodically evaluated and adjusted as performance dictates. Loan grades 1 through 4 are passing grades and grade 5 is special mention. Collectively, grades 6 through 8 represent classified loans in the Bank’s portfolio. The following guidelines govern the assignment of these risk grades:
Exceptional Loans (1 Rated): These loans are of the highest quality, with strong, well-documented sources of repayment. Debt service coverage (“DSC”) is over 1.75X based on historical results. Secondary source of repayment is strong, with a loan to value (“LTV”) of 65% or less if secured solely by commercial real estate (“CRE”). Discounted collateral coverage from all sources should exceed 125%. Guarantors have credit scores above 740.
Quality Loans (2 Rated): These loans are of good quality, with good, well-documented sources of repayment. DSC is over 1.25X based on historical or pro-forma results. Secondary source of repayment is good, with a LTV of 75% or less if secured solely by CRE. Discounted collateral coverage should exceed 100%. Guarantors have credit scores above 700.
Acceptable Loans (3 rated): These loans are of acceptable quality, with acceptable sources of repayment. DSC of over 1.00X based on historical or pro-forma results. Companies that do not meet these credit metrics must be evaluated to determine if they should be graded below this level.
Acceptable Loans (4 rated): These loans are considered very weak pass. These loans are riskier than a 3-rated credit, but due to various mitigating factors are not considered a Special Mention or worse. The mitigating factors must clearly be identified to offset further downgrade. Examples of loans that may be put in this category include start-up loans and loans with less than 1:1 cash flow coverage with other sources of repayment.
Special mention (5 rated): These loans are considered as emerging problems, with potentially unsatisfactory characteristics. These loans require greater management attention. A loan may be put into this category if the Bank is unable to obtain financial reporting from a company to fully evaluate its position.
Substandard (6 rated): Loans graded Substandard are inadequately protected by current sound net worth, paying capacity of the borrower, or pledged collateral. They typically have unsatisfactory characteristics causing more than acceptable levels of risk, and have one or more well-defined weaknesses that could jeopardize the repayment of the debt.
Doubtful (7 rated): Loans graded Doubtful have inherent weaknesses that make collection or liquidation in full questionable. Loans graded Doubtful must be placed on non-accrual status.
Loss (8 rated): Loss rated loans are considered uncollectible and of such little value that their continuance as an active Bank asset is not warranted. The asset should be charged off, even though partial recovery may be possible in the future.

13



Live Oak Bancshares, Inc.
Notes to Unaudited Consolidated Financial Statements

The following tables summarize the risk grades of each category:
 
Risk Grades
1 - 4
 
Risk Grade
5
 
Risk Grades
6 - 8
 
Total
March 31, 2016
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
Agriculture
$
23

 
$

 
$

 
$
23

Death Care Management
4,971

 
104

 
9

 
5,084

Healthcare
8,187

 
3,480

 
5,698

 
17,365

Independent Pharmacies
38,239

 
3,328

 
1,618

 
43,185

Registered Investment Advisors
20,545

 
721

 
383

 
21,649

Veterinary Industry
17,839

 
2,066

 
2,480

 
22,385

Other Industries
7,251

 

 

 
7,251

Total
97,055

 
9,699

 
10,188

 
116,942

Construction & Development
 
 
 
 
 
 
 
Agriculture
11,515

 
905

 

 
12,420

Death Care Management
726

 

 

 
726

Healthcare
8,051

 

 

 
8,051

Independent Pharmacies
279

 

 

 
279

Registered Investment Advisors
286

 

 

 
286

Veterinary Industry
2,453

 
1,193

 

 
3,646

Other Industries
1,966

 

 

 
1,966

Total
25,276

 
2,098

 

 
27,374

Owner Occupied Commercial Real Estate
 
 
 
 
 
 
 
Agriculture
1,929

 

 

 
1,929

Death Care Management
18,639

 
2,094

 
1,585

 
22,318

Healthcare
40,527

 
3,032

 
727

 
44,286

Independent Pharmacies
6,206

 
1,079

 

 
7,285

Registered Investment Advisors
3,035

 

 

 
3,035

Veterinary Industry
46,570

 
4,304

 
10,870

 
61,744

Other Industries
5,338

 

 

 
5,338

Total
122,244

 
10,509

 
13,182

 
145,935

Commercial Land
 
 
 
 
 
 
 
Agriculture
22,362

 

 
719

 
23,081

Total
22,362

 

 
719

 
23,081

Total1
$
266,937

 
$
22,306

 
$
24,089

 
$
313,332


14



Live Oak Bancshares, Inc.
Notes to Unaudited Consolidated Financial Statements

 
Risk Grades
1 - 4
 
Risk Grade
5
 
Risk Grades
6 - 8
 
Total
December 31, 2015
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
Agriculture
$
30

 
$

 
$

 
$
30

Death Care Management
4,728

 
104

 

 
4,832

Healthcare
8,334

 
2,160

 
4,746

 
15,240

Independent Pharmacies
36,704

 
3,430

 
1,454

 
41,588

Registered Investment Advisors
17,508

 
850

 

 
18,358

Veterinary Industry
16,800

 
1,817

 
2,962

 
21,579

Other Industries
3,089

 
141

 

 
3,230

Total
87,193

 
8,502

 
9,162

 
104,857

Construction & Development
 
 
 
 
 
 
 
Agriculture
11,194

 
157

 

 
11,351

Death Care Management
769

 

 

 
769

Healthcare
7,231

 

 

 
7,231

Independent Pharmacies
101

 

 

 
101

Registered Investment Advisors
378

 

 

 
378

Veterinary Industry
2,581

 
1,253

 

 
3,834

Other Industries
658

 

 

 
658

Total
22,912

 
1,410

 

 
24,322

Owner Occupied Commercial Real Estate
 
 
 
 
 
 
 
Agriculture
1,863

 

 

 
1,863

Death Care Management
18,223

 
425

 
1,679

 
20,327

Healthcare
33,529

 
2,930

 
1,225

 
37,684

Independent Pharmacies
6,210

 
1,088

 

 
7,298

Registered Investment Advisors
2,808

 

 

 
2,808

Veterinary Industry
45,453

 
3,171

 
11,375

 
59,999

Other Industries
4,752

 

 

 
4,752

Total
112,838

 
7,614

 
14,279

 
134,731

Commercial Land
 
 
 
 
 
 
 
Agriculture
16,036

 

 

 
16,036

Total
16,036

 

 

 
16,036

Total1
$
238,979

 
$
17,526

 
$
23,441

 
$
279,946

1
Total loans include $24.6 million of U.S. government guaranteed loans as of March 31, 2016, segregated by risk grade as follows: Risk Grades 1 – 4 = $5.9 million, Risk Grade 5 = $3.7 million, Risk Grades 6 – 8 = $15.0 million. As of December 31, 2015, total loans include $17.2 million of U.S. government guaranteed loans, segregated by risk grade as follows: Risk Grades 1 – 4 = $0, Risk Grade 5 = $2.6 million, Risk Grades 6 – 8 = $14.6 million.

15



Live Oak Bancshares, Inc.
Notes to Unaudited Consolidated Financial Statements

Past Due Loans
Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans less than 30 days past due and accruing are included within current loans shown below. The following tables show an age analysis of past due loans as of the dates presented.
 
Less Than 30
Days Past
Due & Not
Accruing
 
30-89 Days
Past Due
& Accruing
 
30-89 Days
Past Due &
Not Accruing
 
Greater
Than 90
Days Past
Due
 
Total Not
Accruing
& Past Due
Loans
 
Current
Loans
 
Total Loans
 
Loans 90
Days or More
Past Due &
Still Accruing
March 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture
$

 
$

 
$

 
$

 
$

 
$
23

 
$
23

 
$

Death Care Management

 

 

 

 

 
5,084

 
5,084

 

Healthcare
78

 
188

 
911

 
3,222

 
4,399

 
12,966

 
17,365

 

Independent Pharmacies
302

 
589

 
270

 

 
1,161

 
42,024

 
43,185

 

Registered Investment Advisors

 

 

 

 

 
21,649

 
21,649

 

Veterinary Industry
201

 

 
607

 
885

 
1,693

 
20,692

 
22,385

 

Other Industries

 

 

 

 

 
7,251

 
7,251

 

Total
581

 
777

 
1,788

 
4,107

 
7,253

 
109,689

 
116,942

 

Construction & Development
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture

 

 

 

 

 
12,420

 
12,420

 

Death Care Management

 

 

 

 

 
726

 
726

 

Healthcare

 

 

 

 

 
8,051

 
8,051

 

Independent Pharmacies

 

 

 

 

 
279

 
279

 

Registered Investment Advisors

 

 

 

 

 
286

 
286

 

Veterinary Industry

 

 

 

 

 
3,646

 
3,646

 

Other Industries

 

 

 

 

 
1,966

 
1,966

 

Total

 

 

 

 

 
27,374

 
27,374

 

Owner Occupied Commercial Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture

 

 

 

 

 
1,929

 
1,929

 

Death Care Management
1,423

 
222

 

 

 
1,645

 
20,673

 
22,318

 

Healthcare
357

 
258

 
133

 
93

 
841

 
43,445

 
44,286

 

Independent Pharmacies

 

 

 

 

 
7,285

 
7,285

 

Registered Investment Advisors

 

 

 

 

 
3,035

 
3,035

 

Veterinary Industry
1,363

 
5,038

 
908

 
3,357

 
10,666

 
51,078

 
61,744

 

Other Industries

 

 

 

 

 
5,338

 
5,338

 

Total
3,143

 
5,518

 
1,041

 
3,450

 
13,152

 
132,783

 
145,935

 

Commercial Land
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture
719

 

 

 

 
719

 
22,362

 
23,081

 

Total
719

 

 

 

 
719

 
22,362

 
23,081

 

Total1
$
4,443

 
$
6,295

 
$
2,829

 
$
7,557

 
$
21,124

 
$
292,208

 
$
313,332

 
$


16



Live Oak Bancshares, Inc.
Notes to Unaudited Consolidated Financial Statements

 
Less Than 30
Days Past
Due & Not
Accruing
 
30-89 Days
Past Due
& Accruing
 
30-89 Days
Past Due &
Not Accruing
 
Greater
Than 90
Days
Past Due
 
Total Not
Accruing
& Past Due
Loans
 
Current
Loans
 
Total Loans
 
Loans 90
Days or More
Past Due &
Still Accruing
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture
$

 
$

 
$

 
$

 
$

 
$
30

 
$
30

 
$

Death Care Management

 

 

 

 

 
4,832

 
4,832

 

Healthcare

 
1,854

 
30

 
2,337

 
4,221

 
11,019

 
15,240

 

Independent Pharmacies
314

 
603

 

 

 
917

 
40,671

 
41,588

 

Registered Investment Advisors

 

 

 

 

 
18,358

 
18,358

 

Veterinary Industry
208

 
466

 
1,131

 
394

 
2,199

 
19,380

 
21,579

 

Other Industries

 

 

 

 

 
3,230

 
3,230

 

Total
522

 
2,923

 
1,161

 
2,731

 
7,337

 
97,520

 
104,857

 

Construction & Development
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture

 

 

 

 

 
11,351

 
11,351

 

Death Care Management

 

 

 

 

 
769

 
769

 

Healthcare

 

 

 

 

 
7,231

 
7,231

 

Independent Pharmacies

 

 

 

 

 
101

 
101

 

Registered Investment Advisors

 

 

 

 

 
378

 
378

 

Veterinary Industry

 

 

 

 

 
3,834

 
3,834

 

Other Industries

 

 

 

 

 
658

 
658

 

Total

 

 

 

 

 
24,322

 
24,322

 

Owner Occupied Commercial Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture

 

 

 

 

 
1,863

 
1,863

 

Death Care Management
1,456

 
223

 

 

 
1,679

 
18,648

 
20,327

 

Healthcare

 
240