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EX-32 - EXHIBIT 32 - Live Oak Bancshares, Inc.exhibit322016q2.htm
EX-31.2 - EXHIBIT 31.2 - Live Oak Bancshares, Inc.exhibit3122016q2.htm
EX-31.1 - EXHIBIT 31.1 - Live Oak Bancshares, Inc.exhibit3112016q2.htm
EX-10.4 - EXHIBIT 10.4 - Live Oak Bancshares, Inc.exhibit104esppmay242016.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 June 30, 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 August 5, 2016, there were 29,483,160 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 June 30, 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 June 30, 2016 (unaudited) and December 31, 2015*
(Dollars in thousands)
 
June 30,
2016
 
December 31,
2015*
Assets
 
 
 
Cash and due from banks
$
175,506

 
$
102,607

Certificates of deposit with other banks
8,500

 
10,250

Investment securities available-for-sale
66,804

 
53,762

Loans held for sale
329,206

 
480,619

Loans held for investment
690,517

 
279,969

Allowance for loan losses
(12,309
)
 
(7,415
)
Net loans
678,208

 
272,554

Premises and equipment, net
61,064

 
62,653

Foreclosed assets
2,971

 
2,666

Servicing assets
48,454

 
44,230

Other assets
24,591

 
23,281

Total assets
$
1,395,304

 
$
1,052,622

Liabilities and Shareholders’ Equity
 
 
 
Liabilities
 
 
 
Deposits:
 
 
 
Noninterest-bearing
$
22,942

 
$
21,502

Interest-bearing
1,117,855

 
783,286

Total deposits
1,140,797

 
804,788

Long term borrowings
28,173

 
28,375

Other liabilities
18,984

 
19,971

Total liabilities
1,187,954

 
853,134

Shareholders’ equity
 
 
 
Preferred stock, no par value, 1,000,000 authorized, none issued or outstanding at June 30, 2016 and December 31, 2015

 

Class A common stock, no par value, 100,000,000 shares authorized, 29,468,852 and 29,449,369 shares issued and outstanding at June 30, 2016 and December 31, 2015, respectively
141,181

 
137,492

Class B common stock, no par value, 10,000,000 shares authorized, 4,723,530 shares issued and outstanding at June 30, 2016 and December 31, 2015
50,015

 
50,015

Retained earnings
15,928

 
12,140

Accumulated other comprehensive income (loss)
201

 
(192
)
Total shareholders’ equity attributed to Live Oak Bancshares, Inc.
207,325

 
199,455

Noncontrolling interest
25

 
33

Total equity
207,350

 
199,488

Total liabilities and shareholders’ equity
$
1,395,304

 
$
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 and six months ended June 30, 2016 and 2015 (unaudited)
(Dollars in thousands, except per share data)
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
Interest income
 
 
 
 
 
 
 
Loans and fees on loans
$
12,902

 
$
7,408

 
$
23,907

 
$
14,138

Investment securities, taxable
252

 
200

 
503

 
376

Other interest earning assets
248

 
70

 
386

 
136

Total interest income
13,402

 
7,678

 
24,796

 
14,650

Interest expense
 
 
 
 
 
 
 
Deposits
3,243

 
1,801

 
5,687

 
3,277

Borrowings
242

 
444

 
483

 
885

Total interest expense
3,485

 
2,245

 
6,170

 
4,162

Net interest income
9,917

 
5,433

 
18,626

 
10,488

Provision for loan losses
3,453

 
50

 
4,886

 
1,127

Net interest income after provision for loan losses
6,464

 
5,383

 
13,740

 
9,361

Noninterest income
 
 
 
 
 
 
 
Loan servicing revenue
5,081

 
3,870

 
9,865

 
7,463

Loan servicing asset revaluation
(1,604
)
 
(2,098
)
 
(1,630
)
 
(1,585
)
Net gains on sales of loans
14,555

 
15,719

 
30,980

 
31,180

Equity in loss of non-consolidated affiliates

 

 

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

 

 

 
3,782

Construction supervision fee income
667

 
317

 
1,297

 
533

Other noninterest income
649

 
327

 
1,268

 
843

Total noninterest income
19,348

 
18,135

 
41,780

 
42,190

Noninterest expense
 
 
 
 
 
 
 
Salaries and employee benefits
15,411

 
9,319

 
28,404

 
17,674

Travel expense
2,330

 
2,238

 
4,176

 
3,714

Professional services expense
910

 
548

 
1,438

 
1,398

Advertising and marketing expense
1,365

 
1,118

 
2,328

 
2,126

Occupancy expense
1,055

 
736

 
2,248

 
1,217

Data processing expense
1,404

 
722

 
2,612

 
1,615

Equipment expense
534

 
388

 
1,085

 
831

Other loan origination and maintenance expense
621

 
234

 
1,195

 
711

Other expense
1,502

 
1,514

 
3,357

 
2,233

Total noninterest expense
25,132

 
16,817

 
46,843

 
31,519

Income before taxes
680

 
6,701

 
8,677

 
20,032

Income tax expense
557

 
2,766

 
3,871

 
8,044

Net income
123

 
3,935

 
4,806

 
11,988

Net loss attributable to noncontrolling interest

 

 
8

 
20

Net income attributable to Live Oak Bancshares, Inc.
$
123

 
$
3,935

 
$
4,814

 
$
12,008

Basic earnings per share
$
0.00

 
$
0.14

 
$
0.14

 
$
0.42

Diluted earnings per share
$
0.00

 
$
0.13

 
$
0.14

 
$
0.41

See Notes to Unaudited Consolidated Financial Statements

2


Live Oak Bancshares, Inc.
Consolidated Statements of Comprehensive Income
For the three and six months ended June 30, 2016 and 2015 (unaudited)
(Dollars in thousands)
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
123

 
$
3,935

 
$
4,806

 
$
11,988

Other comprehensive income (loss) before tax:
 
 
 
 
 
 
 
Net unrealized gain (loss) on investment securities arising during the period
251

 
(339
)
 
640

 
(136
)
Reclassification adjustment for (gain) loss on sale of securities available-for-sale included in net income

 

 

 

Other comprehensive income (loss) before tax
251

 
(339
)
 
640

 
(136
)
Income tax (expense) benefit
(97
)
 
131

 
(247
)
 
52

Other comprehensive income (loss), net of tax
154

 
(208
)
 
393

 
(84
)
Total comprehensive income
$
277

 
$
3,727

 
$
5,199

 
$
11,904

See Notes to Unaudited Consolidated Financial Statements

3


Live Oak Bancshares, Inc.
Consolidated Statements of Changes in Shareholders’ Equity
For the six months ended June 30, 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)

 

 

 
12,008

 

 
(20
)
 
11,988

Other comprehensive loss

 

 

 

 
(84
)
 

 
(84
)
Consolidation of investment with non-controlling interest

 

 

 

 

 
35

 
35

Stock option exercises
34,930

 

 
154

 

 

 

 
154

Stock option based compensation expense

 

 
295

 

 

 

 
295

Restricted stock expense

 

 
16

 

 

 

 
16

Capital contribution from non-controlling interest

 

 

 

 

 
22

 
22

Dividends (distributions to shareholders)

 

 

 
(859
)
 

 

 
(859
)
Balance at June 30, 2015
23,931,330

 
4,723,530

 
$
99,137

 
$
4,206

 
$
1

 
$
37

 
$
103,381

Balance at December 31, 2015
29,449,369

 
4,723,530

 
$
187,507

 
$
12,140

 
$
(192
)
 
$
33

 
$
199,488

Net income (loss)

 

 

 
4,814

 

 
(8
)
 
4,806

Other comprehensive income

 

 

 

 
393

 

 
393

Issuance of restricted stock
2,776

 

 

 

 

 

 

Stock option exercises
16,707

 

 
107

 

 

 

 
107

Stock option based compensation expense

 

 
1,173

 

 

 

 
1,173

Restricted stock expense

 

 
2,409

 

 

 

 
2,409

Dividends (distributions to shareholders)

 

 

 
(1,026
)
 

 

 
(1,026
)
Balance at June 30, 2016
29,468,852

 
4,723,530

 
$
191,196

 
$
15,928

 
$
201

 
$
25

 
$
207,350

See Notes to Unaudited Consolidated Financial Statements

4


Live Oak Bancshares, Inc.
Consolidated Statements of Cash Flows
For the six months ended June 30, 2016 and 2015 (unaudited)
(Dollars in thousands)
 
Six Months Ended
June 30,
 
2016
 
2015
Cash flows from operating activities
 
 
 
Net income
$
4,806

 
$
11,988

Adjustments to reconcile net income to net cash used by operating activities:
 
 
 
Depreciation and amortization
2,109

 
1,021

Provision for loan losses
4,886

 
1,127

Amortization of premium on securities, net of accretion
79

 
24

Amortization (accretion) of discount on unguaranteed loans, net
156

 
1,313

Deferred tax (benefit) expense
(1,457
)
 
847

Originations of loans held for sale
(471,295
)
 
(472,413
)
Proceeds from sales of loans held for sale
322,748

 
318,125

Net gains on sale of loans held for sale
(30,980
)
 
(31,180
)
Net loss on sale of foreclosed assets
1

 
7

Net increase in servicing assets
(4,224
)
 
(4,984
)
Gain on sale of investment in non-consolidated affiliate

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

 
16

Stock option based compensation expense
1,173

 
295

Restricted stock expense
2,409

 
16

Equity in loss of non-consolidated affiliates

 
26

Changes in assets and liabilities:
 
 
 
Other assets
(1,301
)
 
(3,192
)
Other liabilities
478

 
2,402

Net cash used by operating activities
(170,412
)
 
(178,344
)
Cash flows from investing activities
 
 
 
Purchases of securities available-for-sale
(14,799
)
 
(5,925
)
Proceeds from sales, maturities, calls, and principal paydowns of securities available-for-sale
2,318

 
4,364

Proceeds from sale/collection of foreclosed assets
91

 
330

Maturities of certificates of deposit with other banks
1,750

 

Proceeds from sale of investment in non-consolidated affiliate

 
9,896

Net cash acquired in consolidation of equity method investment

 
319

Capital contribution from non-controlling interest

 
22

Loan originations and principal collections, net
(80,162
)
 
84,252

Purchases of premises and equipment, net
(433
)
 
(23,068
)
Net cash (used in) provided by investing activities
(91,235
)
 
70,190

See Notes to Unaudited Consolidated Financial Statements

5


Live Oak Bancshares, Inc.
Consolidated Statements of Cash Flows (Continued)
For the six months ended June 30, 2016 and 2015 (unaudited)
(Dollars in thousands)
 
Six Months Ended
June 30,
 
2016
 
2015
Cash flows from financing activities
 
 
 
Net increase in deposits
336,009

 
205,266

Proceeds from long term borrowings

 
21,322

Repayment of long term borrowings
(202
)
 
(8,681
)
Repayment of short term borrowings

 
(6,100
)
Stock option exercises
107

 
154

Shareholder dividend distributions
(1,368
)
 
(2,222
)
Net cash provided by financing activities
334,546

 
209,739

Net increase in cash and cash equivalents
72,899

 
101,585

Cash and cash equivalents, beginning
102,607

 
29,902

Cash and cash equivalents, ending
$
175,506

 
$
131,487

 
 
 
 
Supplemental disclosure of cash flow information
 
 
 
Interest paid
$
6,180

 
$
4,152

Income tax
2,776

 
9,174

 
 
 
 
Supplemental disclosures of noncash operating, investing, and financing activities
 
 
 
Unrealized holding gains (losses) on available-for-sale securities, net of taxes
$
393

 
$
(84
)
Transfers from loans to foreclosed real estate and other repossessions
406

 

Transfers from foreclosed real estate to SBA receivable
9

 

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

 
4,575

Dividends declared but not paid

 
169

Transfer of loans held for sale to loans held for investment
336,263

 
7,400

Transfer of loans held for investment to loans held for sale
1,848

 
4,514

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 28, 2015 the Company completed 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 six months ended June 30, 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.
Loans Reclassified to Held for Investment
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are classified as held for investment ("HFI") and reported at their outstanding principal amount adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premium or discount on purchased loans. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. Loans originated and intended for sale are classified as held for sale ("HFS") and carried at the lower of cost or estimated fair value.
During the second quarter of 2016, the Bank transferred $318.8 million in unguaranteed loans from the HFS category to the HFI category to better reflect intentions of the Company.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the un-collectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
Upon transfer from held for sale classification, loans held for investment become subject to the allowance for loan loss review process. As a result of this process, the above mentioned $318.8 million loan reclassification resulted in a $4.0 million increase in the provision for loan losses during the second quarter of 2016.
During the second quarter of 2016, the Company also implemented enhancements to the methodology for estimating the allowance for loan losses, including refinements to the measurement of qualitative factors in the estimation process. Management believes these enhancements will improve the precision of the process for estimating the allowance, but did not fundamentally change the Company's approach. These revisions resulted in a $390 thousand reduction in the provision for loan losses during the second quarter of 2016.
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.

8



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

In April 2016, the FASB issued ASU No. 2016-10, "Identifying Performance Obligations and Licensing" ("ASU 2016-10"). This guidance amends the previously issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606)" ("ASU 2014-09"). ASU 2016-10 clarifies the guidance related to identifying performance obligations and accounting for licenses of intellectual property. The amendments will be effective for the Company on January 1, 2018. The Company does not expect these amendments to have a material effect on its consolidated financial statements.
In May 2016, the FASB issued ASU 2016-12, "Narrow-Scope Improvements and Practical Expedients" ("ASU 2016-12"). This guidance also amends the previously issued ASU No. 2014-09 to clarify guidance related to collectibility, noncash consideration, presentation of sales tax and transition. The amendments will be effective for the Company on January 1, 2018. The Company does not expect these amendments to have a material effect on its consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, "Measurement of Credit Losses on Financial Instruments" ("ASU 2016-13"). This new guidance replaces the incurred loss impairment methodology in current standards with an expected credit loss methodology and requires consideration of a broader range of information to determine credit loss estimates. ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 will be effective for the Company on January 1, 2020. The Company is currently evaluating the effect the implementation of the new standard will have on its 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
June 30,
 
Six Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
Basic earnings per share:
 
 
 
 
 
 
 
Net income available to common shareholders
$
123

 
$
3,935

 
$
4,814

 
$
12,008

Weighted-average basic shares outstanding
34,189,217

 
28,636,182

 
34,183,004

 
28,628,177

Basic earnings per share
$
0.00

 
$
0.14

 
$
0.14

 
$
0.42

Diluted earnings per share:
 
 
 
 
 
 
 
Net income available to common shareholders, for diluted earnings per share
$
123

 
$
3,935

 
$
4,814

 
$
12,008

Total weighted-average basic shares outstanding
34,189,217

 
28,636,182

 
34,183,004

 
28,628,177

Add effect of dilutive stock options and restricted stock grants
1,016,908

 
862,217

 
896,656

 
811,645

Total weighted-average diluted shares outstanding
35,206,125

 
29,498,399

 
35,079,660

 
29,439,822

Diluted earnings per share
$
0.00

 
$
0.13

 
$
0.14

 
$
0.41

Anti-dilutive shares
1,807,823

 
916,199

 
1,807,823

 
956,199



9



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
June 30, 2016
 
 
 
 
 
 
 
US government agencies
$
22,018

 
$
165

 
$

 
$
22,183

Residential mortgage-backed securities
42,478

 
161

 
36

 
42,603

Mutual fund
1,981

 
37

 

 
2,018

Total
$
66,477

 
$
363

 
$
36

 
$
66,804

 
 
 
 
 
 
 
 
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 June 30, 2016, the Company purchased four mortgage-backed securities for $12.3 million for the purpose of complying with the Community Reinvestment Act ("CRA"). In addition, during the first quarter of 2016, the Company purchased one mortgage-backed security for $2.4 million for the purchase of complying with the CRA. During the six months ended June 30, 2016, there was $30 thousand of dividend reinvestment in the 504 Fund mutual fund. There were no calls, sales or maturities of securities during the three and six months ended June 30, 2016.
There were no calls or maturities of securities during the three and six months ended June 30, 2015. During the three months ended June 30, 2015, the Company sold six mortgage-backed securities at their carrying amount for $3.4 million in an odd-lot consolidation and purchased two mortgage-backed securities totaling $4.0 million for the purpose of complying with the Community Reinvestment Act. In addition, during the first quarter of 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
June 30, 2016
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Residential mortgage-backed securities
$
2,401

 
$
16

 
$
5,494

 
$
20

 
$
7,895

 
$
36

Total
$
2,401

 
$
16

 
$
5,494

 
$
20

 
$
7,895

 
$
36

 
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 June 30, 2016, there were four mortgage-backed securities in unrealized loss positions for greater than 12 months and one mortgage-backed security in an unrealized loss position 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.

10



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

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 June 30, 2016 and December 31, 2015 were backed by US government sponsored enterprises (“GSEs”).
The following is a summary of investment securities by maturity:
 
June 30, 2016
 
Available-for-Sale
 
Amortized
cost
 
Fair
value
US government agencies
 
 
 
Within one year
$
9,210

 
$
9,227

One to five years
12,808

 
12,956

Total
22,018

 
22,183

 
 
 
 
Residential mortgage-backed securities
 
 
 
Five to ten years
8,324

 
8,402

After 10 years
34,154

 
34,201

Total
42,478

 
42,603

 
 
 
 
Total
$
64,496

 
$
64,786

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 June 30, 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. At June 30, 2016, an investment security with a fair market value of $101 thousand was also pledged to the Ohio State Treasurer for the Company's trust department to conduct business in the state of Ohio.


11



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 “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.
Commercial Real Estate
Commercial real estate loans are extensions of credit secured by owner occupied and non-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 commercial real estate 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.

12



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

Loans consist of the following:
 
June 30,
2016
 
December 31,
2015
Commercial & Industrial
 
 
 
Agriculture
$
463

 
$
30

Death Care Management
9,753

 
4,832

Healthcare
32,959

 
15,240

Independent Pharmacies
77,818

 
41,588

Registered Investment Advisors
54,091

 
18,358

Veterinary Industry
37,584

 
21,579

Other Industries
32,010

 
3,230

Total
244,678

 
104,857

Construction & Development
 
 
 
Agriculture
35,041

 
11,351

Death Care Management
2,455

 
769

Healthcare
23,561

 
7,231

Independent Pharmacies
2,081

 
101

Registered Investment Advisors
703

 
378

Veterinary Industry
10,534

 
3,834

Other Industries
11,477

 
658

Total
85,852

 
24,322

Commercial Real Estate
 
 
 
Agriculture
5,672

 
1,863

Death Care Management
45,162

 
20,327

Healthcare
95,146

 
37,684

Independent Pharmacies
13,650

 
7,298

Registered Investment Advisors
6,787

 
2,808

Veterinary Industry
96,162

 
59,999

Other Industries
23,739

 
4,752

Total
286,318

 
134,731

Commercial Land
 
 
 
Agriculture
72,643

 
16,036

Total
72,643

 
16,036

Total Loans1
689,491

 
279,946

Net Deferred Costs
6,902

 
3,056

Discount on SBA 7(a) Unguaranteed2
(5,876
)
 
(3,033
)
Loans, Net of Unearned
$
690,517

 
$
279,969

1
Total loans include $28.5 million and $17.2 million of U.S. government guaranteed loans as of June 30, 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.

13



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.

14



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
June 30, 2016
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
Agriculture
$
406

 
$
57

 
$

 
$
463

Death Care Management
9,518

 
226

 
9

 
9,753

Healthcare
25,201

 
3,362

 
4,396

 
32,959

Independent Pharmacies
72,619

 
3,620

 
1,579

 
77,818

Registered Investment Advisors
52,617

 
1,101

 
373

 
54,091

Veterinary Industry
33,504

 
1,883

 
2,197

 
37,584

Other Industries
32,010

 

 

 
32,010

Total
225,875

 
10,249

 
8,554

 
244,678

Construction & Development
 
 
 
 
 
 
 
Agriculture
35,041

 

 

 
35,041

Death Care Management
2,049

 
406

 

 
2,455

Healthcare
21,340

 
2,221

 

 
23,561

Independent Pharmacies
2,081

 

 

 
2,081

Registered Investment Advisors
703

 

 

 
703

Veterinary Industry
9,341

 
1,193

 

 
10,534

Other Industries
11,477

 

 

 
11,477

Total
82,032

 
3,820

 

 
85,852

Commercial Real Estate
 
 
 
 
 
 
 
Agriculture
5,672

 

 

 
5,672

Death Care Management
41,173

 
2,405

 
1,584

 
45,162

Healthcare
88,389

 
5,724

 
1,033

 
95,146

Independent Pharmacies
12,053

 
1,597

 

 
13,650

Registered Investment Advisors
6,787

 

 

 
6,787

Veterinary Industry
81,384

 
4,096

 
10,682

 
96,162

Other Industries
23,739

 

 

 
23,739

Total
259,197

 
13,822

 
13,299

 
286,318

Commercial Land
 
 
 
 
 
 
 
Agriculture
70,636

 
1,890

 
117

 
72,643

Total
70,636

 
1,890

 
117

 
72,643

Total1
$
637,740

 
$
29,781

 
$
21,970

 
$
689,491


15



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

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 $28.5 million of U.S. government guaranteed loans as of June 30, 2016, segregated by risk grade as follows: Risk Grades 1 – 4 = $7.7 million, Risk Grade 5 = $7.6 million, Risk Grades 6 – 8 = $13.2 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.

16



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
June 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture
$

 
$

 
$

 
$

 
$

 
$
463

 
$
463

 
$

Death Care Management

 

 

 

 

 
9,753

 
9,753

 

Healthcare

 
576

 
487

 
2,219

 
3,282

 
29,677

 
32,959

 

Independent Pharmacies
294

 
415

 
156

 
270

 
1,135

 
76,683

 
77,818

 

Registered Investment Advisors

 

 

 

 

 
54,091

 
54,091

 

Veterinary Industry
90

 

 
690

 
1,054

 
1,834

 
35,750

 
37,584

 

Other Industries

 

 

 

 

 
32,010

 
32,010

 

Total
384

 
991

 
1,333

 
3,543

 
6,251

 
238,427

 
244,678

 

Construction & Development
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture

 

 

 

 

 
35,041

 
35,041

 

Death Care Management

 

 

 

 

 
2,455

 
2,455

 

Healthcare

 

 

 

 

 
23,561

 
23,561

 

Independent Pharmacies

 

 

 

 

 
2,081

 
2,081

 

Registered Investment Advisors

 

 

 

 

 
703

 
703

 

Veterinary Industry

 

 

 

 

 
10,534

 
10,534

 

Other Industries

 

 

 

 

 
11,477

 
11,477

 

Total

 

 

 

 

 
85,852

 
85,852

 

Commercial Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture

 

 

 

 

 
5,672

 
5,672

 

Death Care Management

 
221

 

 
1,423

 
1,644

 
43,518

 
45,162

 

Healthcare
350

 
258

 

 
209

 
817

 
94,329

 
95,146

 

Independent Pharmacies

 

 

 

 

 
13,650

 
13,650

 

Registered Investment Advisors

 

 

 

 

 
6,787

 
6,787

 

Veterinary Industry
2,224

 
4,284

 

 
3,319

 
9,827

 
86,335

 
96,162

 

Other Industries

 

 

 

 

 
23,739

 
23,739

 

Total
2,574

 
4,763

 

 
4,951

 
12,288

 
274,030

 
286,318

 

Commercial Land
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture
117

 

 

 

 
117

 
72,526

 
72,643

 

Total
117

 

 

 

 
117

 
72,526

 
72,643

 

Total1
$
3,075

 
$
5,754

 
$
1,333

 
$
8,494

 
$
18,656

 
$
670,835

 
$
689,491

 
$


17



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