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EX-32 - EXHIBIT 32 - Live Oak Bancshares, Inc.exhibit322016q3.htm
EX-31.2 - EXHIBIT 31.2 - Live Oak Bancshares, Inc.exhibit3122016q3.htm
EX-31.1 - EXHIBIT 31.1 - Live Oak Bancshares, Inc.exhibit3112016q3.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 September 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
liveoakbancshareslogo.jpg
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
 
x
 
 
 
 
Non-accelerated Filer
 
¨ (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 November 7, 2016, there were 29,509,945 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 September 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 September 30, 2016 (unaudited) and December 31, 2015*
(Dollars in thousands)
 
September 30,
2016
 
December 31,
2015*
Assets
 
 
 
Cash and due from banks
$
355,485

 
$
102,607

Certificates of deposit with other banks
7,500

 
10,250

Investment securities available-for-sale
70,334

 
53,762

Loans held for sale
345,277

 
480,619

Loans held for investment
766,977

 
279,969

Allowance for loan losses
(15,178
)
 
(7,415
)
Net loans
751,799

 
272,554

Premises and equipment, net
60,646

 
62,653

Foreclosed assets
2,235

 
2,666

Servicing assets
49,729

 
44,230

Other assets
26,735

 
23,281

Total assets
$
1,669,740

 
$
1,052,622

Liabilities and Shareholders’ Equity
 
 
 
Liabilities
 
 
 
Deposits:
 
 
 
Noninterest-bearing
$
28,461

 
$
21,502

Interest-bearing
1,374,556

 
783,286

Total deposits
1,403,017

 
804,788

Long term borrowings
28,074

 
28,375

Other liabilities
24,497

 
19,971

Total liabilities
1,455,588

 
853,134

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

 

Class A common stock, no par value, 100,000,000 shares authorized, 29,491,520 and 29,449,369 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively
145,284

 
137,492

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

 
50,015

Retained earnings
18,723

 
12,140

Accumulated other comprehensive income (loss)
130

 
(192
)
Total shareholders’ equity attributed to Live Oak Bancshares, Inc.
214,152

 
199,455

Noncontrolling interest

 
33

Total equity
214,152

 
199,488

Total liabilities and shareholders’ equity
$
1,669,740

 
$
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 nine months ended September 30, 2016 and 2015 (unaudited)
(Dollars in thousands, except per share data)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Interest income
 
 
 
 
 
 
 
Loans and fees on loans
$
14,961

 
$
8,728

 
$
38,868

 
$
22,866

Investment securities, taxable
337

 
211

 
840

 
587

Other interest earning assets
264

 
84

 
650

 
220

Total interest income
15,562

 
9,023

 
40,358

 
23,673

Interest expense
 
 
 
 
 
 
 
Deposits
3,689

 
1,997

 
9,376

 
5,274

Borrowings
242

 
395

 
725

 
1,280

Total interest expense
3,931

 
2,392

 
10,101

 
6,554

Net interest income
11,631

 
6,631

 
30,257

 
17,119

Provision for loan losses
3,806

 
1,212

 
8,692

 
2,339

Net interest income after provision for loan losses
7,825

 
5,419

 
21,565

 
14,780

Noninterest income
 
 
 
 
 
 
 
Loan servicing revenue
5,860

 
4,216

 
15,725

 
11,678

Loan servicing asset revaluation
(3,421
)
 
(2,650
)
 
(5,051
)
 
(4,234
)
Net gains on sales of loans
21,833

 
15,424

 
52,813

 
46,604

Equity in loss of non-consolidated affiliates

 

 

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

 

 

 
3,782

Gain on sale of investment securities available-for-sale
1

 
12

 
1

 
12

Construction supervision fee income
502

 
344

 
1,799

 
877

Other noninterest income
657

 
424

 
1,925

 
1,267

Total noninterest income
25,432

 
17,770

 
67,212

 
59,960

Noninterest expense
 
 
 
 
 
 
 
Salaries and employee benefits
17,471

 
9,949

 
45,875

 
27,623

Travel expense
2,218

 
2,200

 
6,394

 
5,914

Professional services expense
907

 
493

 
2,345

 
1,891

Advertising and marketing expense
1,097

 
1,051

 
3,425

 
3,177

Occupancy expense
1,058

 
703

 
3,306

 
1,920

Data processing expense
1,252

 
773

 
3,864

 
2,388

Equipment expense
611

 
642

 
1,696

 
1,473

Other loan origination and maintenance expense
806

 
673

 
2,001

 
1,384

Other expense
1,798

 
1,579

 
5,155

 
3,811

Total noninterest expense
27,218

 
18,063

 
74,061

 
49,581

Income before taxes
6,039

 
5,126

 
14,716

 
25,159

Income tax expense
2,561

 
2,228

 
6,432

 
10,272

Net income
3,478

 
2,898

 
8,284

 
14,887

Net loss attributable to noncontrolling interest
1

 
3

 
9

 
23

Net income attributable to Live Oak Bancshares, Inc.
$
3,479

 
$
2,901

 
$
8,293

 
$
14,910

Basic earnings per share
$
0.10

 
$
0.09

 
$
0.24

 
$
0.50

Diluted earnings per share
$
0.10

 
$
0.09

 
$
0.24

 
$
0.48

See Notes to Unaudited Consolidated Financial Statements

2


Live Oak Bancshares, Inc.
Consolidated Statements of Comprehensive Income
For the three and nine months ended September 30, 2016 and 2015 (unaudited)
(Dollars in thousands)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
3,478

 
$
2,898

 
$
8,284

 
$
14,887

Other comprehensive (loss) income before tax:
 
 
 
 
 
 
 
Net unrealized (loss) gain on investment securities arising during the period
(115
)
 
151

 
525

 
15

Reclassification adjustment for (gain) loss on sale of securities available-for-sale included in net income
(1
)
 
(12
)
 
(1
)
 
(12
)
Other comprehensive (loss) income before tax
(116
)
 
139

 
524

 
3

Income tax benefit (expense)
45

 
(53
)
 
(202
)
 
(1
)
Other comprehensive (loss) income, net of tax
(71
)
 
86

 
322

 
2

Total comprehensive income
$
3,407

 
$
2,984

 
$
8,606

 
$
14,889

See Notes to Unaudited Consolidated Financial Statements

3


Live Oak Bancshares, Inc.
Consolidated Statements of Changes in Shareholders’ Equity
For the nine months ended September 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)

 

 

 
14,910

 

 
(23
)
 
14,887

Other comprehensive income

 

 

 

 
2

 

 
2

Consolidation of investment with non-controlling interest

 

 

 

 

 
35

 
35

Stock option exercises
47,570

 

 
215

 

 

 

 
215

Stock option based compensation expense

 

 
726

 

 

 

 
726

Restricted stock expense

 

 
83

 

 

 

 
83

Capital contribution from non-controlling interest

 

 

 

 

 
22

 
22

Issuance of common stock in connection with initial public offering, net of issue costs
5,500,000

 

 
87,171

 

 

 

 
87,171

Dividends (distributions to shareholders)

 

 

 
(859
)
 

 

 
(859
)
Balance at September 30, 2015
29,443,970

 
4,723,530

 
$
186,867

 
$
7,108

 
$
87

 
$
34

 
$
194,096

Balance at December 31, 2015
29,449,369

 
4,723,530

 
$
187,507

 
$
12,140

 
$
(192
)
 
$
33

 
$
199,488

Net income (loss)

 

 

 
8,293

 

 
(9
)
 
8,284

Other comprehensive income

 

 

 

 
322

 

 
322

Issuance of restricted stock
16,745

 

 

 

 

 

 

Stock option exercises
25,406

 

 
147

 

 

 

 
147

Stock option based compensation expense

 

 
1,752

 

 

 

 
1,752

Restricted stock expense

 

 
5,893

 

 

 

 
5,893

Acquisition of non-controlling interest

 

 

 

 

 
(24
)
 
(24
)
Dividends (distributions to shareholders)

 

 

 
(1,710
)
 

 

 
(1,710
)
Balance at September 30, 2016
29,491,520

 
4,723,530

 
$
195,299

 
$
18,723

 
$
130

 
$

 
$
214,152

See Notes to Unaudited Consolidated Financial Statements

4


Live Oak Bancshares, Inc.
Consolidated Statements of Cash Flows
For the nine months ended September 30, 2016 and 2015 (unaudited)
(Dollars in thousands)
 
Nine Months Ended
September 30,
 
2016
 
2015
Cash flows from operating activities
 
 
 
Net income
$
8,284

 
$
14,887

Adjustments to reconcile net income to net cash used by operating activities:
 
 
 
Depreciation and amortization
3,201

 
1,917

Provision for loan losses
8,692

 
2,339

Amortization of premium on securities, net of accretion
135

 
36

Amortization (accretion) of discount on unguaranteed loans, net
773

 
1,650

Deferred tax (benefit) expense
(510
)
 
936

Originations of loans held for sale
(701,415
)
 
(740,378
)
Proceeds from sales of loans held for sale
555,192

 
508,322

Net gains on sale of loans held for sale
(52,813
)
 
(46,604
)
Net loss on sale of foreclosed assets
61

 
12

Net increase in servicing assets
(5,499
)
 
(5,591
)
Gain on sale of securities available-for-sale
(1
)
 
(12
)
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
1,752

 
726

Restricted stock expense
5,893

 
83

Equity in loss of non-consolidated affiliates

 
26

Changes in assets and liabilities:
 
 
 
Other assets
(858
)
 
(2,431
)
Other liabilities
2,652

 
2,025

Net cash used by operating activities
(174,461
)
 
(265,823
)
Cash flows from investing activities
 
 
 
Purchases of securities available-for-sale
(24,946
)
 
(15,437
)
Proceeds from sales, maturities, calls, and principal paydowns of securities available-for-sale
8,764

 
13,106

Proceeds from sale/collection of foreclosed assets
680

 
514

Maturities of certificates of deposit with other banks
2,750

 

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
(154,738
)
 
66,835

Purchases of premises and equipment, net
(1,194
)
 
(29,295
)
Net cash (used in) provided by investing activities
(168,684
)
 
45,960

See Notes to Unaudited Consolidated Financial Statements

5


Live Oak Bancshares, Inc.
Consolidated Statements of Cash Flows (Continued)
For the nine months ended September 30, 2016 and 2015 (unaudited)
(Dollars in thousands)
 
Nine Months Ended
September 30,
 
2016
 
2015
Cash flows from financing activities
 
 
 
Net increase in deposits
598,229

 
240,548

Proceeds from long term borrowings

 
12,960

Repayment of long term borrowings
(301
)
 
(12,730
)
Repayment of short term borrowings

 
(6,100
)
Stock option exercises
147

 
215

Sale of common stock, net

 
87,171

Shareholder dividend distributions
(2,052
)
 
(2,222
)
Net cash provided by financing activities
596,023

 
319,842

Net increase in cash and cash equivalents
252,878

 
99,979

Cash and cash equivalents, beginning
102,607

 
29,902

Cash and cash equivalents, ending
$
355,485

 
$
129,881

 
 
 
 
Supplemental disclosure of cash flow information
 
 
 
Interest paid
$
10,120

 
$
6,501

Income tax
5,739

 
11,312

 
 
 
 
Supplemental disclosures of noncash operating, investing, and financing activities
 
 
 
Unrealized holding gains on available-for-sale securities, net of taxes
$
322

 
$
2

Transfers from loans to foreclosed real estate and other repossessions
406

 
700

Transfers from foreclosed real estate to SBA receivable
96

 

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

 
4,575

Transfer of loans held for sale to loans held for investment
339,322

 
7,410

Transfer of loans held for investment to loans held for sale
2,296

 
2,129

Contingent consideration in acquisition of controlling interest in equity method investment
24

 
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%. On September 1, 2016, the Company acquired the remaining 7.1% ownership from a third party investor in exchange for contingent consideration estimated to total $24 thousand.
In August 2016, the Company formed Live Oak Ventures, Inc. for the purpose of investing in businesses that align with the Company's strategic initiative to be a leader in online banking for small businesses.
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 nine months ended September 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 current 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 uncollectibility 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. Early adoption is permitted.

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 No. 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.
In August 2016, the FASB issued ASU No. 2016-15, "Classification of Certain Cash Receipts and Cash Payments" ("ASU 2016-15"). This guidance amends the Accounting Standards Codification 230, "Statement of Cash Flows," to clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The ASU addresses cash flow issues including: (i) debt prepayment or debt extinguishment costs, (ii) zero-coupon bonds, (iii) settlement of a contingent consideration liability, (iv) proceeds from the settlement of insurance claims, (v) proceeds from corporate-owned life insurance, (vi) distributions received from equity method investees, (vii) beneficial interests in securitization transactions, and (viii) the "predominance principle." ASU 2016-15 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.
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
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Basic earnings per share:
 
 
 
 
 
 
 
Net income available to common shareholders
$
3,479

 
$
2,901

 
$
8,293

 
$
14,910

Weighted-average basic shares outstanding
34,206,943

 
32,824,587

 
34,191,014

 
30,037,436

Basic earnings per share
$
0.10

 
$
0.09

 
$
0.24

 
$
0.50

Diluted earnings per share:
 
 
 
 
 
 
 
Net income available to common shareholders, for diluted earnings per share
$
3,479

 
$
2,901

 
$
8,293

 
$
14,910

Total weighted-average basic shares outstanding
34,206,943

 
32,824,587

 
34,191,014

 
30,037,436

Add effect of dilutive stock options and restricted stock grants
794,874

 
1,092,695

 
812,408

 
892,794

Total weighted-average diluted shares outstanding
35,001,817

 
33,917,282

 
35,003,422

 
30,930,230

Diluted earnings per share
$
0.10

 
$
0.09

 
$
0.24

 
$
0.48

Anti-dilutive shares
1,778,995

 
1,391,828

 
1,778,995

 
1,562,168


9



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

Note 4. Investment Securities
The carrying amount of investment securities and their approximate fair values are reflected in the following table:
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
September 30, 2016
 
 
 
 
 
 
 
US government agencies
$
20,770

 
$
98

 
$
7

 
$
20,861

Residential mortgage-backed securities
47,356

 
184

 
89

 
47,451

Mutual fund
1,997

 
25

 

 
2,022

Total
$
70,123

 
$
307

 
$
96

 
$
70,334

 
 
 
 
 
 
 
 
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 and nine months ended September 30, 2016, the Company sold one mortgage-backed security for $1.9 million at a gain of $1 thousand.
During the three months ended September 30, 2015, the Company sold three US government agency securities for $8.3 million at a gain of $12 thousand. In addition, during the first and second quarters of 2015, the Company sold six mortgage-backed securities at their carrying amount for $3.4 million in an odd-lot consolidation.
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
September 30, 2016
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
US government agencies
$
1,515

 
$
7

 
$

 
$

 
$
1,515

 
$
7

Residential mortgage-backed securities
20,696

 
76

 
1,676

 
13

 
22,372

 
89

Total
$
22,211

 
$
83

 
$
1,676

 
$
13

 
$
23,887

 
$
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 September 30, 2016, there were two mortgage-backed securities in unrealized loss positions for greater than 12 months and seven mortgage-backed securities and one US government agency 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.
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 September 30, 2016 and December 31, 2015 were backed by US government sponsored enterprises (“GSEs”).

10



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

The following is a summary of investment securities by maturity:
 
September 30, 2016
 
Available-for-Sale
 
Amortized
cost
 
Fair
value
US government agencies
 
 
 
Within one year
$
7,998

 
$
8,007

One to five years
12,772

 
12,854

Total
20,770

 
20,861

 
 
 
 
Residential mortgage-backed securities
 
 
 
Five to ten years
7,817

 
7,872

After 10 years
39,539

 
39,579

Total
47,356

 
47,451

 
 
 
 
Total
$
68,126

 
$
68,312

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 September 30, 2016 and December 31, 2015, an investment security with a fair market value of $1.5 million and $1.3 million, respectively, was pledged to secure a line of credit with the Company’s correspondent bank. At September 30, 2016, an investment security with a fair market value of $101 thousand was pledged to the Ohio State Treasurer to allow the Company's trust department to conduct business in the state of Ohio and an investment security with a fair market value of $1.2 million was pledged to the Company's trust department for uninsured trust assets held by the trust department.


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:
 
September 30,
2016
 
December 31,
2015
Commercial & Industrial
 
 
 
Agriculture
$
1,503

 
$
30

Death Care Management
9,584

 
4,832

Healthcare
33,822

 
15,240

Independent Pharmacies
80,317

 
41,588

Registered Investment Advisors
61,521

 
18,358

Veterinary Industry
34,922

 
21,579

Other Industries
41,660

 
3,230

Total
263,329

 
104,857

Construction & Development
 
 
 
Agriculture
34,867

 
11,351

Death Care Management
2,500

 
769

Healthcare
28,454

 
7,231

Independent Pharmacies
2,387

 
101

Registered Investment Advisors
900

 
378

Veterinary Industry
11,662

 
3,834

Other Industries
20,080

 
658

Total
100,850

 
24,322

Commercial Real Estate
 
 
 
Agriculture
5,637

 
1,863

Death Care Management
50,611

 
20,327

Healthcare
99,519

 
37,684

Independent Pharmacies
14,697

 
7,298

Registered Investment Advisors
8,388

 
2,808

Veterinary Industry
98,003

 
59,999

Other Industries
30,713

 
4,752

Total
307,568

 
134,731

Commercial Land
 
 
 
Agriculture
94,111

 
16,036

Total
94,111

 
16,036

Total Loans1
765,858

 
279,946

Net Deferred Costs
7,613

 
3,056

Discount on SBA 7(a) Unguaranteed2
(6,494
)
 
(3,033
)
Loans, Net of Unearned
$
766,977

 
$
279,969

1
Total loans include $29.6 million and $17.2 million of U.S. government guaranteed loans as of September 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
September 30, 2016
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
Agriculture
$
1,445

 
$
58

 
$

 
$
1,503

Death Care Management
9,351

 
225

 
8

 
9,584

Healthcare
26,658

 
1,497

 
5,667

 
33,822

Independent Pharmacies
73,847

 
4,790

 
1,680

 
80,317

Registered Investment Advisors
58,427

 
2,730

 
364

 
61,521

Veterinary Industry
30,736

 
1,980

 
2,206

 
34,922

Other Industries
41,660

 

 

 
41,660

Total
242,124

 
11,280

 
9,925

 
263,329

Construction & Development
 
 
 
 
 
 
 
Agriculture
34,867

 

 

 
34,867

Death Care Management
2,500

 

 

 
2,500

Healthcare
26,042

 
2,412

 

 
28,454

Independent Pharmacies
2,387

 

 

 
2,387

Registered Investment Advisors
900

 

 

 
900

Veterinary Industry
10,177

 
1,485

 

 
11,662

Other Industries
20,080

 

 

 
20,080

Total
96,953

 
3,897

 

 
100,850

Commercial Real Estate
 
 
 
 
 
 
 
Agriculture
5,637

 

 

 
5,637

Death Care Management
45,801

 
3,228

 
1,582

 
50,611

Healthcare
93,248

 
5,270

 
1,001

 
99,519

Independent Pharmacies
12,613

 
2,084

 

 
14,697

Registered Investment Advisors
8,388

 

 

 
8,388

Veterinary Industry
83,540

 
3,787

 
10,676

 
98,003

Other Industries
30,713

 

 

 
30,713

Total
279,940

 
14,369

 
13,259

 
307,568

Commercial Land
 
 
 
 
 
 
 
Agriculture
92,379

 
1,582

 
150

 
94,111

Total
92,379

 
1,582

 
150

 
94,111

Total1
$
711,396

 
$
31,128

 
$
23,334

 
$
765,858


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 $29.6 million of U.S. government guaranteed loans as of September 30, 2016, segregated by risk grade as follows: Risk Grades 1 – 4 = $8.8 million, Risk Grade 5 = $7.0 million, Risk Grades 6 – 8 = $13.8 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
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture
$

 
$

 
$

 
$

 
$

 
$
1,503

 
$
1,503

 
$

Death Care Management

 

 

 

 

 
9,584

 
9,584

 

Healthcare
212

 
623

 
1,377

 
2,589

 
4,801

 
29,021

 
33,822

 

Independent Pharmacies

 
327

 
288

 
421

 
1,036

 
79,281

 
80,317

 

Registered Investment Advisors

 

 

 

 

 
61,521

 
61,521

 

Veterinary Industry
41

 
31

 
1,238

 
573

 
1,883

 
33,039

 
34,922

 

Other Industries

 

 

 

 

 
41,660

 
41,660

 

Total
253

 
981

 
2,903

 
3,583

 
7,720

 
255,609

 
263,329

 

Construction & Development
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture

 

 

 

 

 
34,867

 
34,867

 

Death Care Management

 

 

 

 

 
2,500

 
2,500

 

Healthcare

 

 

 

 

 
28,454

 
28,454

 

Independent Pharmacies

 

 

 

 

 
2,387

 
2,387

 

Registered Investment Advisors

 

 

 

 

 
900

 
900

 

Veterinary Industry

 

 

 

 

 
11,662

 
11,662

 

Other Industries

 

 

 

 

 
20,080

 
20,080

 

Total

 

 

 

 

 
100,850

 
100,850

 

Commercial Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture

 

 

 

 

 
5,637

 
5,637

 

Death Care Management

 

 
204

 
1,423

 
1,627

 
48,984

 
50,611

 

Healthcare

 
201

 
127

 
46

 
374

 
99,145

 
99,519

 

Independent Pharmacies

 
550

 

 

 
550

 
14,147

 
14,697

 

Registered Investment Advisors

 

 

 

 

 
8,388

 
8,388

 

Veterinary Industry
1,119

 
3,460

 
2,178

 
2,037

 
8,794

 
89,209

 
98,003

 

Other Industries

 

 

 

 

 
30,713

 
30,713

 

Total
1,119

 
4,211

 
2,509

 
3,506

 
11,345

 
296,223

 
307,568

 

Commercial Land
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture
150

 

 

 

 
150

 
93,961

 
94,111

 

Total
150

 

 

 

 
150

 
93,961

 
94,111

 

Total1
$
1,522