B O U N D L E S S O P P O R T U N I T Y
2 0 1 9 A N N U A L R E P O R T
L I V E O A K B A N C S H A R E S
A special note:
March 27, 2020
To our shareholders,
While we were assembling our 2019 Annual Report, working with our finance, accounting and marketing
teams, recapping a solid year for Live Oak Bank the world threw us a curveball, COVID-19.
While our vision for Live Oak certainly has not changed, and our commitment to our customers and our
employees has not changed, how we forge our way to our goals through this unprecedented global event
will certainly change.
We believe our technology infrastructure and the investments we have made to transform banking will
certainly help us. We believe that the team we have in place is the best in the world, and we believe we
can be a force for good for small businesses as our economy emerges from the storm.
One of our founding principles is, “soundness, profitability, and growth in that order.” As we navigate our
new shared reality, this principle will continue to be at the forefront of our business as we seek to serve
our small business customers in these unprecedented times.
James S. "Chip" Mahan III
Chairman and Chief Executive Officer
F R O M T H E C H A I R M A N A N D C E O
T O O U R
S H A R E H O L D E R S
For the first time in decades, it is clear to
me that the banking industry has reached a
pivotal point. The foundational systems we
need to operate in the modern world are
successfully being built and Live Oak Bank is
eagerly in the process of adopting them. In
short, there is light at the end of the tunnel.
It’s been a complex path, and one that
required dedication and patience to forge a
new way. Community banks are traditionally
not the pioneering kind, but then again, Live
Oak is not your traditional bank. What we
have built is complicated, takes investment
and we strongly believe it is the only way.
To dissect what this means to you, Huntley
Garriott, the president of Live Oak Bank,
and Neil Underwood, president of Live Oak
Bancshares, and I are going to address you
separately. We will break down the impact
of what we have built to show you how Live
Oak has been preparing for this moment,
and what it means for the future.
L E T ’ S G E T T O I T .
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In 1994 when Mosaic and Netscape were launching, it was an exciting time for business and struck me
as a great time to put a bank on the internet. My brother-in-law and I set out to do just that in 1995
with Security First Network Bank. Over the course of the next two decades, engineers and developers
across the globe created incredible opportunities for all banks to shift from brick-and-mortar to apps
at our fingertips.
Since then, we have seen digital advances bring banking to our computers, phones, watches and the
voice-controlled devices on our kitchen countertops.
In 2020, we are now able to build next generation products for America’s small business owners.
Live Oak Bank has been preparing our systems to build an entirely cloud-native, open, API-first bank.
With these massive milestones in place, we will be able to do what no other bank in the country is
doing – bank on a real-time core.
The new infrastructure is in the process of being in place and we expect to soon be ready to give
America’s small business owners a better way to bank.
Live Oak believes in fundamentally doing things differently. We always have. Customers today want
better products, quick action and fair pricing. Community banks have struggled to devise ways to do
this in a modern way. The challenge is having ancient software systems as your central infrastructure.
Up until now, we have not been able to fundamentally change those systems and the definition of a
community bank remains archaic.
How archaic? Simply look at a standard community bank investor presentation and you will see
amazing similarities:
• Dots on a map noting branch locations
• Break outs of the deposit franchise by product and pricing of checking, savings, CDs, etc.
• Break out of the loan book
Fundamentally this is all a consolidated geographic real estate play.
Live Oak is dedicated to changing community banking from the ground up. We think things are
changing rapidly and native mobile applications will rule the future, not branch networks.
For 12 years, we have built a loan origination engine that spans 33 industries in all 50 states. Our team
of lenders generated exceptionally strong production in 2019, keeping the drumbeat of our business
at a steady rhythm.
Layer the growth of our deposit platform on top of that and the bank is right where we need to be.
Poised for the future.
We are now three months into live testing of a new deposits core built by Finxact. Finxact’s platform,
paired with the cloud-native services of our other ecosystem partners, creates the next generation
infrastructure Live Oak must have to compete.
W E A R E P R E P A R E D F O R T H E N E X T C H A P T E R O F B A N K I N G .
So, what happens when you put the power of
this new digital banking infrastructure on top
of the nation’s #1 SBA1, #1 USDA1, branchless,
small business bank – Live Oak Bank?
B O U N D L E S S
B O U N D L
O P P O R T
O P P O R U U N I T Y
Envision a day in the not so distant future where banking services (lending and deposits) are
seamlessly integrated with small business accounting providers, payroll, or tax software. The
businesses we serve typically have less than $5 million in revenues. They are orphaned by the rest of
our industry, but they could be served by these highly sophisticated, next-generation cloud platforms.
The community bank of the future is one that is able to, for instance, embed the bank inside practice
management software. That’s important because practice management software is the real engine
connecting small businesses with their customers. When you are fully integrated and have the ability
to help business owners with better financial insight into their business, you will have changed the
nature of the banking relationship from utility to necessity.
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The SBA allows us to lend to approximately 1,000 industries2. There are approximately 1.2 million small
business firms3 (<100 employees) in the industries we currently serve. As we expand beyond the 33
verticals that we currently serve, all will need next generation banking services.
Over the past year we have also made more conventional, non-government guaranteed loans. It only
makes sense! SBA and USDA represent a small portion of total loans in a particular vertical, therefore
we expect to see meaningful growth.
As excited as we are about our bank, our future growth and possibilities, the threats to our industry
are real and are directly in front of us.
Consider a Harris Poll survey4 that found 64% of consumers would consider buying or applying for
financial products from a tech company instead of traditional banks. Or, 81% of American consumers
ages 18-34 would prefer tech companies over legacy banks. That same poll also shows:
•
•
72% of Americans think tech companies entering the financial services sector would pose a
significant threat to smaller banks
64% of Americans think tech companies entering the financial industry would encourage
traditional financial firms to improve their financial products
1Source: The data supplied by the SBA reflects 7(a) gross loan approvals during FY 2019; USDA.gov
2Source: Number of NAICS codes with SBA loan approvals between 2018-2019 from the 2010-Current SBA 7(a)
Loan Data located at https://www.sba.gov/about-sba/open-government/foia
3Source: United States Census Bureau 2016 SUSB Annual Data Tables by Establishment Industry
4Source: Harris Poll survey commissioned Ondot Systems https://www.ondotsystems.com/press/20200303
This shows nearly all Americans would bank with tech giants, but at the same time there is distrust
of them. The poll also found:
•
•
75% think tech companies are not transparent about how they use consumers’
personal data5
74% of Americans think tech companies are more likely to sell consumers’ personal
financial information than traditional banks and credit unions
Having a banking charter and regulatory oversight gives customers confidence. It is clear to me
that sophisticated adoption of fintech advancements coupled with the underpinning of regulatory
protection is the only way to prevail. Live Oak is leading an industry pivot, and we are frankly far
ahead of the curve.
Let me close by reflecting on an article my friend Bill Harris contributed to American Banker. You can
read it at www.liveoakbank.com/billharris. It outlines how next generation systems hold the key to
meeting the needs of consumers and small businesses alike.
He says, “The future is owned by companies agile enough to combine real-time apps and a
bank charter.”
F O L K S , W E H A V E T H A T I N S P A D E S .
I F T H E R A C E G O E S T O T H E S W I F T A S H A R R I S P R E D I C T S ,
T H E N W E A R E P O S I T I O N E D T O W I N .
James S. "Chip" Mahan III
Chairman and Chief Executive Officer
5Source: https://www.americanbanker.com/news/consumers-of-nearly-all-ages-say-theyd-bank-with-tech-giants
F R O M T H E P R E S I D E N T O F L I V E O A K B A N K
B Y A L L A C C O U N T S ,
2 0 1 9 W A S A T E R R I F I C
Y E A R F O R L I V E O A K
We came into the year with an ambitious
plan to continue to expand our lending
franchise, to dramatically grow our balance
sheet, and to invest in our people and our
technology. We not only delivered on those
objectives, but we spent the year building in
order to succeed a rapidly evolving future.
2019 also marked my first calendar year
as president of Live Oak Bank and my first
contribution to the annual letter, and I
couldn’t be more proud about being part of
this company.
Chip discussed our technology initiatives,
where we are rebuilding the infrastructure
of the banking industry from the core up.
Doing that as a regulated bank involves
much more than just writing code. It
requires seamless integration across
finance, IT, operations, risk and more. It has
taken a concerted effort from our entire
bank along with our ecosystem partners to
position ourselves as an early adopter of a
next-gen core platform.
Despite our maniacal focus on our technology initiatives, we didn’t slow down building out the heart and
soul of Live Oak, our small business lending franchise. We added multiple industry verticals over the
course of the year to bring our total to 33, built out our team of general SBA lenders across the country,
and expanded our capabilities in non-government guaranteed, commercial and industrial (C&I) lending.
T H I S I N V E S T M E N T N O T O N LY L E D T O A R E C O R D Y E A R F O R
L O A N A N D L E A S E P R O D U C T I O N A T L I V E O A K I N 2 0 1 9 , A S W E
M A D E $ 2 B I L L I O N O F L O A N S A N D L E A S E S A C R O S S 1 , 0 7 0
S M A L L B U S I N E S S E S, B U T I T H A S P O S I T I O N E D U S W E L L F O R
F U T U R E G R O W T H .
To support this growth, we built our team to over 600 colleagues. Investing in our people has always
been the hallmark of Live Oak, and that mission has only gotten more important as we have continued
to grow. Our expanded training and development programs, wellness benefits, and facilities on campus
are all commitments to the importance of our people – the only true differentiator in banking. We also
took the opportunity to articulate our purpose, something all of us at the bank know to be truly special.
Succinctly put, our purpose is to seek, serve and invest in the doers impacting the world. We fulfill that
purpose through five core values: dedication, ownership, respect, innovation and teamwork. As anyone
that has visited our campus can attest to, we have created a strong culture here at Live Oak and formally
recognizing it has been an impactful exercise as we continue to build on our foundation.
As many of you are aware, in late 2018 we shifted our strategy and decided to hold more loans on our
balance sheet. We made that decision knowing it would reduce our near-term earnings as gain-on-sale
declined, but by replacing those earnings with less volatile, recurring net interest income we would
emerge a stronger company. Over the course of the year we held over $625 million in government
guaranteed loans that we historically would have sold, bringing the held for sale portfolio to almost
$1 billion, providing not only a valuable source of earnings but also a source of contingent liquidity
and capital.
To grow the loan and lease portfolio $1 billion over the course of the year, you also have to grow funding
in-line. Our deposit platform was designed to do just that, by providing a great customer experience, a
market rate of interest, and doing so extremely efficiently. We ended the year with over 48,000 deposit
customers and $3 billion of retail deposits, all with just 12 bps of operating expenses. As market rates
have continued to decline, the relative value of our deposit franchise becomes even more apparent, as
we don’t have to absorb the cost of a branch infrastructure the way most banks do.
As part of that strategic balance sheet shift, we set out a series of profitability targets that we expect to
achieve as our balance sheet reaches scale. We made progress on those targets over the course of the
year, but we realize in order to hit those we must be extremely mindful of our expenses. Year over year
we held expense growth to 8%, despite growing our balance sheet by more than 30%.
A T T H E H E A R T O F E V E R Y L O A N W E M A K E I S
S A F E T Y A N D S O U N D N E S S .
As we continue to grow our lending franchise, we stay true to our core beliefs and refuse to cut corners
on credit quality. With each loan, we continue to fully underwrite, perform site visits, and maintain pricing
discipline. Our credit metrics continue to display the strength of our portfolio.
C R E D I T S T A T S
provision for loan and lease losses
$19,573
$13,058
$9,536
$12,536
$3,806
2019
2018
2017
2016
2015
net charge-offs to average loans
and leases held for investment
allowance for loan and lease losses to
loans and leases held for investment
unguaranteed nonperforming loans,
leases and foreclosures
unguaranteed nonperforming loans,
leases and foreclosures to total assets
unguaranteed criticized and classified loans
and leases to held for investment unguaranteed
loans and leases
0.17%
0.31%
0.32%
0.29%
0.37%
1.82%
1.76%
1.80%
2.01%
2.65%
$19,028
$14,636
$3,700
$5,030
$2,410
0.40%
0.40%
0.13%
0.29%
0.23%
6.77%
5.12%
3.39%
4.03%
9.05%
We are fortunate to have about 500 of our 600 employees work on our Wilmington campus. So, it should
come as no surprise that we are deeply committed to our community. We are proud of Live Oak’s charitable
giving last year that totaled $1.3 million, with 90 percent directed to local organizations.
Last year also marked the launch of the Cape Fear Collective (CFC) with the support of Live Oak and many
other community partners. CFC is a collective impact and data science nonprofit backbone organization
based in Wilmington. CFC’s mission is to scale big data, fundraising, social innovation, and large-scale
initiative management to a six-county region in Southeastern North Carolina.
CFC employs data scientists, strategists, journalists, and process improvement experts who partner with
anchor institutions from across the region. Together, they create sustainable impact programs that address
social progress across a variety of sectors including economic development, health and human services,
climate change, and housing. While we are in the early innings, it is exciting work that strives to make real
change in the community where we live and work. We also remain committed to our sustainability efforts.
Last year, we originated $181.7 million of renewable energy loans across solar and bio-energy. And, we
installed our own panels as well on our campus, generating 15-20% of our energy needs.
The banking landscape continues to change quickly, with technology as a core driver of that change. I increasingly ascribe to the theory that to be successful you need to be really big or really specialized. Live Oak has, since inception, had a laser focus on small businesses. We have built technology solutions designed to support our customers, recruited world class talent and fostered a culture that is adaptable to change. With relentless focus on every aspect of the customer journey and guiding principles rooted in safety and soundness, we deliver what small business owners need — capital. That’s how we became the nation’s top SBA lender in 2018 and extended our lead in 2019. We’ve taken a similar approach to USDA lending, a complicated process that requires expertise and efficient workflow, and became the top USDA lender last year as well. As we evaluate what the future holds for us, we believe that our domain expertise within our industry verticals will allow us to migrate up-market to incremental C&I lending opportunities. And the technology that we are building will provide us with additional deposit, payment, and lending products to offer to small businesses.M. Huntley Garriott, Jr.President - Live Oak BankWE ARE DRIVEN TO SERVE OUR CUSTOMERS AND TO PROVIDE THEM WITH THE TOOLS, ADVICE AND CAPITAL THEY NEED TO SUCCEED. F R O M T H E P R E S I D E N T O F L I V E O A K B A N C S H A R E S
A S C H I P A L L U D E D T O E A R L I E R , T H E F I N A N C I A L S E R V I C E S
I N D U S T R Y I S A T A M A J O R I N F L E C T I O N P O I N T .
Cloud computing has ushered in a whole new class of competition. What used to cost $5 million now
costs $5,000. What used to take 12 months now takes 12 hours. The evolution of the costly “data center”
is now replaced with a superior alternative. Efficiencies, measured in orders of magnitude, allow fintechs
to innovate at such an accelerated rate, setting a new standard for the customer journey, and banks,
saddled with massive technology debt, are looking for answers.
In 2019, global fintech funding topped $24.6 billion through Q36, already surpassing 2017’s total.
This represents new R&D capital fueling fintechs, which in many cases, compete with the standard
banking model. Adding to the pressure, the world’s largest banks have the scale to invest. To put that in
perspective, in 2019 JP Morgan invested $11 billion in technology7.
T H E T I M E I S N O W .
We have been diligently preparing. From nCino, to the joint venture Apiture, to Live Oak Ventures’
strategic investments in Finxact, Payrailz, DefenseStorm, Greenlight and local Wilmington company
Kwipped, we have been paving the way for Live Oak Bank to be at the forefront of digital transformation.
Last year marked the launch of Canapi Ventures, a set of fintech funds focused on fueling innovation
around digital transformation in financial services. Canapi Ventures’ goal is to find high potential fintech
companies with disruptive technologies which, in addition to anticipated financial benefit, will allow Live
Oak and other investors in the funds a first look at the much-needed innovation in our space. The funds’
structure is as follows:
T A R G E T I N G $ 6 0 0 M A C R O S S T W O
F I N T E C H - F O C U S E D V E N T U R E C A P I T A L F U N D S
S B I C F U N D ( $ 5 0 0 M )
S I B L I N G F U N D ( $ 1 0 0 M )
BANKS WITH +/- $10B ASSETS
NON-BANK STRATEGICS, TRADITIONAL LPS
& BANKS WITH LESS THAN $10B ASSETS
the funds plan to make eligible investments in parallel on a pro rated basis
US INVESTMENTS
SCOPE - FINTECH
VOLCKER COMPLIANT
CRA ELIGIBLE
US INVESTMENTS
GLOBAL OPPORTUNISTIC
SCOPE - FINTECH
6Source: CBI Insights Global Fintech Report, Q3 2019
7Source: https://www.jpmorganchase.com/corporate/news/stories/tech-investment-could-disrupt-banking.htm
In the first quarter of 2020, we have raised just over $550 million, with a significant share of
the invested capital coming from banks and bank holding companies. These banks, known as
the Canapi Alliance, are expected to be involved in the Funds’ portfolios, not just as investors
but as potential partners and customers to the companies in the Funds’ portfolios. These
banks represent the innovative, progressive companies who recognize the need for digital
transformation at its core.
We anticipate that the Funds’ initial equity investments will generally range from $10-15
million per company for earlier stage deals, and from $20-40 million for growth and later stage
deals. The Funds may also occasionally consider seed-stage investments in companies led by
experienced founders.
Canapi Ventures expects to invest the $600 million in aggregate across 15-25 portfolio
companies. This projects to an average of four new investments per year during the five-year
investment period (although the pace of deployment may vary), with the potential for follow-on
investments extending beyond the investment period.
I N V E S T M E N T S T R A T E G Y
position
Lead, co-lead or co-invest
invested per company
$10M - $40M
stage
Series A to Series C
geography
US focus, globally opportunistic
governance
Board representation on led or co-led deals
portfolio
15-25 companies
A key differentiating point of Canapi Ventures as compared
to other venture capital funds will be the Canapi Alliance,
a group of diverse banks who will invest only in the SBIC
Fund (with a few exceptions). Canapi Alliance members, in
addition to providing capital, are also ready and willing to be
actively involved with the portfolio companies of the Funds
for educational and market intelligence purposes via events,
and hopefully also as potential customers or partners of the
portfolio companies.
In this way, the Canapi Alliance will help to accelerate portfolio
companies’ growth and potentially de-risk early investment.
This is a unique value proposition that few, if any, other venture
capital funds can offer, and we believe this differentiator will
lead to superior deal flow for Canapi Ventures.
I N T E R M S O F C O R E I N V E S T M E N T F O C U S , T H E C A N A P I
V E N T U R E S T E A M W I L L F O C U S O N F O U R M A I N T H E M E S :
UNDERSTANDING AND REACHING
THE CUSTOMER
SUPPORTING DIGITAL MIGRATION
THROUGH NEW PRODUCTS
• Data Analytics & AI
• Consumer Fintech
• Digital Marketing Tech
• Payments
•
InsurTech
• WealthTech
• Real Estate Tech
PROMOTING A COMPETITIVE AND
STABLE INFRASTRUCTURE
RUNNING AN EFFICIENT AND SECURE
COMPLIANCE RISK OPERATION
• Core Banking Tech
• Capital Markets Tech
•
Enterprise Blockchain & DLT
• RegTech
• Cybersecurity
•
ID Management &
Fraud Detection
CANAPI VENTURES FACILITATES A TRUE WIN, WIN, WIN WITH ALL OUR STAKEHOLDERS:Neil L. Underwood President - Live Oak BancsharesThe convergence of banking and fintech is upon us. Investing into innovative companies will allow Live Oak to stay on the forefront of digital transformation. We’ll be able to deliver on our maniacal quest of treating every customer like the only customer, and delighting them in every interaction along the way—both personal and digital. We bring top tier fintech companies, so BANKS WINWe bring the customers, so FINTECHS WINWe bring the best deals, so INVESTORS WIN UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
☒
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2019
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
(State or other jurisdiction of incorporation or organization)
1741 Tiburon Drive, Wilmington, NC
(Address of principal executive offices)
26-4596286
(I.R.S. Employer Identification No.)
28403
(Zip Code)
Registrant’s telephone number, including area code: (910) 790-5867
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Voting Common Stock, no par value per share
Trading Symbol(s)
LOB
Name of each exchange on which registered
The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ☐ NO ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ☐ NO ☒
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 ☒ NO ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such
files). YES ☒ NO ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or
an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth
company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
Non-accelerated Filer
☒
☐
Accelerated Filer
Smaller Reporting Company
Emerging growth company
☐
☐
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any
new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO ☒
The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant as of June 30, 2019, was approximately
$518,033,826. Shares of common stock held by each officer and director have been excluded in that such persons may be deemed to be affiliates.
There is no public market for the registrant's non-voting common stock. For purposes of this calculation, the registrant has assumed that the market
value of each share of non-voting common stock is equal to a share of voting common stock.
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of February 26, 2020, there were 37,616,203 shares of the registrant’s voting common stock outstanding and 2,715,531 shares of the registrant’s
non-voting common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for the 2020 Annual Meeting of Shareholders, which the registrant plans to file subsequent to the
date hereof, are incorporated by reference into Part III. Portions of the registrant's annual report to shareholders for the year ended December 31, 2019,
which will be posted on the registrant's website subsequent to the date hereof, are incorporated by reference into Part II.
Live Oak Bancshares, Inc.
Annual Report on Form 10-K
December 31, 2019
TABLE OF CONTENTS
PART I
Item 1.
Business
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Item 3.
Item 4.
PART II
Properties
Legal Proceedings
Mine Safety Disclosures
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Item 6.
Item 7.
Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
Item 8.
Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2019 and 2018
Consolidated Statements of Income for the Years Ended December 31, 2019, 2018 and 2017
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2019, 2018
and 2017
Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2019,
2018 and 2017
Consolidated Statements of Cash Flows for the Years Ended December 31, 2019, 2018 and 2017
Notes to Consolidated Financial Statements
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
Controls and Procedures
Item 9B.
Other Information
PART III
Item 10.
Directors, Executive Officers and Corporate Governance
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Item 14.
Principal Accounting Fees and Services
PART IV
Item 15.
Exhibits, Financial Statement Schedules
Item 16
Form 10-K Summary
Signatures
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Important Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K (this “Report”) contains statements that management believes are forward-looking statements,
within the meaning of the Private Securities Litigation Reform Act of 1995. These statements generally relate to the financial
condition, results of operations, plans, objectives, future performance or business of Live Oak Bancshares, Inc. (the "Company").
They usually can be identified by the use of forward-looking terminology, such as “believes,” “expects,” or “are expected to,”
“plans,” “projects,” “goals,” “estimates,” “will,” “may,” “should,” “could,” “would,” “continues,” “intends to,” “outlook” or
“anticipates,” or variations of these and similar words, or by discussions of strategies that involve risks and uncertainties. You
should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to,
those described in this Report. When considering these forward-looking statements, you should keep in mind these risks and
uncertainties, as well as any cautionary statements management may make. Moreover, you should treat these statements as
speaking only as of the date they are made and based only on information actually known to the Company at the time.
Management undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information,
future events or otherwise. Forward-looking statements contained in this Report are based on current expectations, estimates and
projections about the Company’s business, management’s beliefs and assumptions made by management. These statements are
not guarantees of the Company’s future performance and involve certain risks, uncertainties and assumptions, which are difficult
to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in the forward-
looking statements. These risks, uncertainties and assumptions include, without limitation:
• deterioration in the financial condition of borrowers resulting in significant increases in the Company’s loan and lease
losses and provisions for those losses and other adverse impacts to results of operations and financial condition;
•
•
•
changes in Small Business Administration ("SBA") rules, regulations and loan products, including specifically the
Section 7(a) program, changes in SBA standard operating procedures or changes to the status of Live Oak Banking
Company (the "Bank") as an SBA Preferred Lender;
changes in rules, regulations or procedures for other government loan programs, including those of the United States
Department of Agriculture (“USDA”);
changes in interest rates that affect the level and composition of deposits, loan demand and the values of loan collateral,
securities, and interest sensitive assets and liabilities;
•
the failure of assumptions underlying the establishment of reserves for possible loan and lease losses;
•
•
•
changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination
conclusions, or regulatory developments;
a reduction in or the termination of the Company’s ability to use the technology-based platform that is critical to the
success of the Company’s business model or to develop a next-generation banking platform, including a failure in or a
breach of the Company’s operational or security systems or those of its third party service providers;
changes in financial market conditions, either internationally, nationally or locally in areas in which the Company
conducts operations, including reductions in rates of business formation and growth, demand for the Company’s products
and services, commercial and residential real estate development and prices, premiums paid in the secondary market for
the sale of loans, and valuation of servicing rights;
•
changes in accounting principles, policies, and guidelines applicable to bank holding companies and banking;
•
•
fluctuations in markets for equity, fixed-income, commercial paper and other securities, which could affect availability,
market liquidity levels, and pricing;
the effects of competition from other commercial banks, non-bank lenders, consumer finance companies, credit unions,
securities brokerage firms, insurance companies, money market and mutual funds, and other financial institutions
operating in the Company’s market area and elsewhere, including institutions operating regionally, nationally and
internationally, together with such competitors offering banking products and services by mail, telephone and the
Internet;
•
the Company's ability to attract and retain key personnel;
•
changes in governmental monetary and fiscal policies as well as other legislative and regulatory changes, including with
respect to SBA or USDA lending programs and investment tax credits;
•
changes in political and economic conditions;
•
•
the impact of heightened regulatory scrutiny of financial products and services, primarily led by the Consumer Financial
Protection Bureau and various state agencies;
the Company's ability to comply with any requirements imposed on it by regulators, and the potential negative
consequences that may result;
• operational, compliance and other factors, including conditions in local areas in which the Company conducts business
such as inclement weather or a reduction in the availability of services or products for which loan proceeds will be used,
that could prevent or delay closing and funding loans before they can be sold in the secondary market;
•
the effect of any mergers, acquisitions or other transactions, to which the Company or the Bank may from time to time
be a party, including management’s ability to successfully integrate any businesses acquired;
• other risk factors listed from time to time in reports that the Company files with the SEC, including those described
under “Risk Factors” in this Report; and
•
the success at managing the risks involved in the foregoing.
Except as otherwise disclosed, forward-looking statements do not reflect: (i) the effect of any acquisitions, divestitures or similar
transactions that have not been previously disclosed; (ii) any changes in laws, regulations or regulatory interpretations; or (iii) any
change in current dividend or repurchase strategies, in each case after the date as of which such statements are made. All forward-
looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to
update any statement, to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence
of unanticipated events.
Item 1. BUSINESS
General
PART I
Live Oak Bancshares, Inc. (“LOB” and, collectively with its subsidiaries including Live Oak Banking Company, the “Company,”
also referred to as "our" and "we"), headquartered in Wilmington, North Carolina, is the bank holding company for Live Oak
Banking Company (the “Bank” or "Live Oak Bank"). The Bank was incorporated in February 2008 as a North Carolina-chartered
commercial bank and operates an established national online platform for small business lending and deposit gathering. LOB
was incorporated under the laws of the state of North Carolina on December 18, 2008, for the purpose of serving as the bank
holding company of Live Oak Bank. LOB completed its initial public offering (“IPO”) in July 2015.
The Company
The Company predominantly originates loans partially guaranteed by the U.S. Small Business Administration (the "SBA") and
to a lesser extent by the USDA Rural Energy for America Program ("REAP"), Water and Environmental Program (“WEP”),
Business & Industry ("B&I") and Community Facilities loan programs. These loans are to small businesses and professionals
with what the Company believes are lower risk characteristics. Industries, or “verticals,” on which the Company focuses its
lending efforts are carefully selected. Within these verticals the Company typically retains individuals who possess extensive
industry-specific experience.
In addition to focusing on industry verticals, the Company emphasizes developing detailed knowledge of its customers’
businesses. This knowledge is developed, in part, through regular visits to customers’ operations, wherever they are located.
These regular visits are designed to foster both for the Company and for the customer a deep and personalized experience
throughout the lending relationship. The Company has developed and continues to refine a technology-based platform to facilitate
providing financial services to the small business community on a national scale and has leveraged this technology to optimize
the Company's loan origination process, customer experience, reporting metrics, and servicing activity. The Company services
customers efficiently throughout the loan process and monitors their performance by means of the technology-based platform
without maintaining traditional branch locations.
For additional information on the Company's business, financial performance and results of operations, see “Overview” and
“Executive Summary” in Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
of this Report. For information on the Company’s financial information about geographic areas, see Part II, Item 8 of this Report.
LOB's voting common stock trades on the NASDAQ Global Select Market (“NASDAQ”) under the symbol “LOB.” As of
January 31, 2020, there were 341 holders of record of LOB's voting common stock. The Company's principal executive office is
located at 1741 Tiburon Drive, Wilmington, North Carolina 28403, telephone number (910) 790-5867. The Company maintains
a website at www.liveoakbank.com. Documents available on the website include: (i) the Company's Code of Ethics and Conflict
of Interest Policy; and (ii) charters for the Audit and Risk, Compensation, and Nominating and Corporate Governance Committees
of the Board of Directors. These documents also are available in print to any shareholder who requests a copy.
In addition, available free of charge through the Company's website is the Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q, Current Reports on Form 8-K and amendments to those reports as soon as reasonably practicable after electronically
filing or furnishing such material to the U.S. Securities and Exchange Commission (“SEC”). These filings are also accessible on
the SEC’s website at www.sec.gov.
The Company also will provide without charge a copy of this Report, as well as any documents available on the Company's
website, to any shareholder by mail. Requests should be sent to Live Oak Bancshares, Inc., Attention: Corporate Secretary, 1741
Tiburon Drive, Wilmington, NC 28403.
1
Competition
Commercial banking in the United States is extremely competitive. The Company competes with national banking organizations,
including the largest commercial banks headquartered in the country, all of which have small business lending divisions. The
Company also competes with other federally and state chartered financial institutions such as community banks and credit unions,
finance and business development companies, peer-to-peer and marketplace lenders and other non-bank lenders. Many of the
Company's competitors have higher legal lending limits and are also able to provide a wider array of services and make greater
use of media advertising given their size and resources.
Despite the intense level of competition among small business lenders, the Company believes that it occupies a lending category
distinct from its competitors. One of the Company's principal advantages is the technology-based platform it uses, which
management believes has accelerated the Company's ability to issue proposals, complete credit due diligence, finalize
commitments and improve the overall customer experience. The Company believes that its personnel also provide a competitive
advantage because they include industry participants with relevant experience in the Company's identified verticals.
Employees
As of December 31, 2019, the Company had 603 full-time employees and 32 part-time employees. None of these employees are
covered by a collective bargaining agreement, and management considers relations with employees to be good.
Subsidiaries
In addition to the Bank, the Company directly or indirectly held the following wholly owned subsidiaries as of December 31,
2019:
• Canapi Advisors, LLC, formed in September 2018 for the purpose of providing investment advisory services to a series
of new funds focused on providing venture capital to new and emerging financial technology companies.
• Live Oak Ventures, Inc., formed in August 2016 for the purpose of investing in businesses that align with the Company's
strategic initiative to be a leader in financial technology;
• Live Oak Grove, LLC, formed in February 2015 for the purpose of providing Company employees and business visitors
an on-site restaurant location; and
• 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.
504 Fund Advisors, LLC (“504FA”), was formed in June 2013 to serve as the investment advisor to The 504 Fund, a closed-end
mutual fund organized to invest in SBA section 504 loans. During 2019, 504FA completed the transfer of its advisory agreement
and was dissolved in December 2019. In 2019, Live Oak Clean Energy Financing LLC, which was formed in November 2016
for the purpose of providing financing to entities for renewable energy applications, became a subsidiary of the Bank. In 2018,
the Bank formed Live Oak Private Wealth, LLC, a registered investment advisor that provides high-net-worth individuals and
families with strategic wealth and investment management services. In 2010, the Bank formed Live Oak Number One, Inc., a
wholly owned subsidiary, to hold properties foreclosed on by the Bank.
SUPERVISION AND REGULATION
Federal Bank Holding Company Regulation and Structure
As a registered bank holding company, LOB is subject to regulation under the Bank Holding Company Act, or BHCA, and to the
supervision, examination and reporting requirements of the Board of Governors of the Federal Reserve System (the “Federal
Reserve”). The Bank is a North Carolina-chartered commercial bank and is subject to regulation, supervision and examination
by the Federal Deposit Insurance Corporation, or the FDIC, and the North Carolina Commissioner of Banks, or NCCOB.
2
The BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve before:
•
it may acquire direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank
holding company will directly or indirectly own or control more than 5% of the voting shares of the bank;
•
it or any of its subsidiaries, other than a bank, may acquire all or substantially all of the assets of any bank; or
•
it may merge or consolidate with any other bank holding company.
The BHCA further provides that the Federal Reserve may not approve any transaction that would result in a monopoly or that
would substantially lessen competition in the banking business, unless the public interest in meeting the needs of the communities
to be served outweighs the anti-competitive effects. The Federal Reserve is also required to consider the financial and managerial
resources and future prospects of the bank holding companies and banks involved and the convenience and needs of the
communities to be served. Consideration of financial resources generally focuses on capital adequacy, and consideration of
convenience and needs issues focuses, in part, on the performance under the Community Reinvestment Act of 1977, both of
which are discussed elsewhere in more detail.
Subject to various exceptions, the BHCA and the Change in Bank Control Act, together with related regulations, require Federal
Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively
presumed to exist if a person or company acquires 25% or more of any class of voting securities of a bank holding company.
Control is also presumed to exist, although rebuttable, if a person or company acquires 10% or more, but less than 25%, of any
class of voting securities and either:
•
the bank holding company has securities registered under Section 12 of the Securities Exchange Act of 1934, as
amended, or the Exchange Act; or
• no other person owns a greater percentage of that class of voting securities immediately after the transaction.
LOB's voting common stock is registered under Section 12 of the Exchange Act. The regulations provide a procedure for
challenging rebuttable presumptions of control.
On January 30, 2020, the Federal Reserve adopted a final rule revising the “controlling influence” prong of its “control” rules
promulgated under the BHCA. The final rule largely reaffirms the Federal Reserve’s existing framework for analyzing
“controlling influence” but with some new rules for presumptions of control for investments in and by banking organizations that
represent more than 4.9% and less than 24.9% of control over any class of voting securities. The final rule becomes effective on
April 1, 2020 and we are currently assessing its potential impact on our operations.
The BHCA generally prohibits a bank holding company from retaining direct or indirect ownership or control of any voting shares
of any company which is not a bank or bank holding company or engaging in activities other than banking, managing or
controlling banks or other permissible subsidiaries and acquiring or retaining direct or indirect control of any company engaged
in any activities other than activities closely related to banking or managing or controlling banks. In determining whether a
particular activity is permissible, the Federal Reserve considers whether performing the activity can be expected to produce
benefits to the public that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair
competition, conflicts of interest or unsound banking practices. The Federal Reserve has the power to order a bank holding
company or its subsidiaries to terminate any activity or control of any subsidiary when the continuation of the activity or control
constitutes a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company.
Under the BHCA, a bank holding company may file an election with the Federal Reserve to be treated as a financial holding
company and engage in an expanded list of financial activities. The election must be accompanied by a certification that all of
the company’s insured depository institution subsidiaries are “well capitalized” and “well managed.” Additionally, the
Community Reinvestment Act of 1977 rating of each subsidiary bank must be satisfactory or better. If, after becoming a financial
holding company and undertaking activities not permissible for a bank holding company, the company fails to continue to meet
any of the prerequisites for financial holding company status, the company must enter into an agreement with the Federal Reserve
to comply with all applicable capital and management requirements. If the company does not return to compliance within 180
days, the Federal Reserve may order the company to divest its subsidiary banks or the company may discontinue or divest
investments in companies engaged in activities permissible only for a bank holding company that has elected to be treated as a
financial holding company. LOB filed an election and became a financial holding company in 2016.
3
Under Federal Reserve policy and as codified by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or
the Dodd-Frank Act, the Company is expected to act as a source of financial strength for Live Oak Bank and to commit resources
to support Live Oak Bank. This support may be required at times when LOB might not be inclined to provide it or it might not
be in LOB's best interests or the best interests of its shareholders. In addition, any capital loans made by the Company to Live
Oak Bank will be repaid only after Live Oak Bank’s deposits and various other obligations are repaid in full.
Live Oak Bank is also subject to numerous state and federal statutes and regulations that affect its business, activities and
operations and is supervised and examined by state and federal bank regulatory agencies. The FDIC and the NCCOB regularly
examine the operations of Live Oak Bank and are given the authority to approve or disapprove mergers, consolidations, the
establishment of branches and similar corporate actions. These agencies also have the power to prevent the continuance or
development of unsafe or unsound banking practices or other violations of law.
Bank Merger Act
Section 18(c) of the Federal Deposit Insurance Act, popularly known as the “Bank Merger Act,” requires the prior written
approval of appropriate federal bank regulatory agencies before any bank may (i) merge or consolidate with, (ii) purchase or
otherwise acquire the assets of, or (iii) assume the deposit liabilities of, another bank if the resulting institution is to be a state
nonmember bank.
The Bank Merger Act prohibits the applicable federal bank regulatory agency from approving any proposed merger transaction
that would result in a monopoly, or would further a combination or conspiracy to monopolize or to attempt to monopolize the
business of banking in any part of the United States. Similarly, the Bank Merger Act prohibits the applicable federal bank
regulatory agency from approving a proposed merger transaction whose effect in any section of the country may be substantially
to lessen competition, or to tend to create a monopoly, or which in any other manner would be in restraint of trade. An exception
may be made in the case of a merger transaction whose effect would be to substantially lessen competition, tend to create a
monopoly, or otherwise restrain trade, if the applicable federal bank regulatory agency finds that the anticompetitive effects of
the proposed transaction are clearly outweighed in the public interest by the probable effect of the transaction in meeting the
convenience and needs of the community to be served.
In every proposed merger transaction, the applicable federal bank regulatory agency must also consider the financial and
managerial resources and future prospects of the existing and proposed institutions, the convenience and needs of the community
to be served, and the effectiveness of each insured depository institution involved in the proposed merger transaction in combating
money-laundering activities, including in overseas branches.
State Law
Live Oak Bank is subject to extensive supervision and regulation by the NCCOB. The NCCOB oversees state laws that set
specific requirements for bank capital and that regulate deposits in, and loans and investments by, banks, including the amounts,
types, and in some cases, rates. The NCCOB supervises and performs periodic examinations of North Carolina-chartered banks
to assure compliance with state banking statutes and regulations, and banks are required to make regular reports to the NCCOB
describing in detail their resources, assets, liabilities, and financial condition. Among other things, the NCCOB regulates mergers
and consolidations of North Carolina state-chartered banks, capital requirements for banks, loans to officers and directors,
payment of dividends, record keeping, types and amounts of loans and investments, and the establishment of branches.
The NCCOB has extensive enforcement authority over North Carolina banks. Such authority includes the ability to issue cease
and desist orders and to seek civil money penalties. The NCCOB may also take possession of a North Carolina bank in various
circumstances, including for a violation of its charter or of applicable laws, operating in an unsafe and unsound manner, or as a
result of an impairment of its capital, and may appoint a receiver.
The Company is also required to maintain registration as a bank holding company with the NCCOB. Subject to certain exceptions,
the Company may not acquire control over another bank or bank holding company or consummate a merger or other combination
transaction with another company without the prior approval of the NCCOB. The NCCOB also has authority to assert civil money
penalties against a holding company if the NCCOB determines such holding company to be in violation of any banking laws and
the holding company fails to comply with an NCCOB order to cease and desist from such violations of law.
The primary state banking laws to which the Company and the Bank are subject are set forth in Chapters 53C and 53 of the North
Carolina General Statutes. The North Carolina Business Corporation Act is also applicable to the Company as a North Carolina
business corporation and to the Bank as a North Carolina banking corporation.
4
Payment of Dividends and Other Restrictions
The Company is a legal entity separate and distinct from the Bank. While there are various legal and regulatory limitations under
federal and state law on the extent to which banks can pay dividends or otherwise supply funds to holding companies, the principal
source of cash revenues for the Company is dividends from the Bank. The relevant federal and state regulatory agencies have
authority to prohibit a state bank or bank holding company, which would include the Bank and the Company, from engaging in
what, in the opinion of such regulatory body, constitutes an unsafe or unsound practice in conducting its business. The payment
of dividends could, depending upon the financial condition of a bank, be deemed to constitute an unsafe or unsound practice in
conducting its business.
North Carolina commercial banks, such as Live Oak Bank, are subject to legal limitations on the amounts of dividends they are
permitted to pay. Specifically, an insured depository institution, such as Live Oak Bank, is prohibited from making capital
distributions, including the payment of dividends, if, after making such distribution, the institution would become
“undercapitalized” (as such term is defined in the applicable law and regulations).
The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses
the Federal Reserve’s view that a bank holding company should pay cash dividends only to the extent that the holding company’s
net income for the past four quarters is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent
with the holding company’s capital needs, asset quality and overall financial condition. The Federal Reserve has also indicated
that it would be inappropriate for a holding company experiencing serious financial problems to borrow funds to pay dividends.
Furthermore, under the prompt corrective action regulations adopted by the Federal Reserve, the Federal Reserve may prohibit a
bank holding company from paying any dividends if any of the holding company’s bank subsidiaries are classified as
undercapitalized.
A bank holding company is required to give the Federal Reserve prior written notice of any purchase or redemption of its
outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration
paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of its consolidated net worth.
The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe
or unsound practice or would violate any law, regulation, Federal Reserve order or any condition imposed by, or written agreement
with, the Federal Reserve.
Capital Adequacy
General. The Company must comply with the Federal Reserve’s established capital adequacy standards, and Live Oak Bank is
required to comply with the capital adequacy standards established by the FDIC. The Federal Reserve has promulgated two basic
measures of capital adequacy for bank holding companies: a risk-based measure and a leverage measure. A bank holding company
must satisfy all applicable capital standards to be considered in compliance.
The risk-based capital standards are designed to make regulatory capital requirements sensitive to differences in risk profile
among banks and bank holding companies, account for off-balance-sheet exposure and minimize disincentives for holding liquid
assets.
5
Assets and off-balance-sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital
ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items. Under applicable capital
standards, the minimum risk-based capital ratios are a common equity Tier 1 capital to risk-weighted assets ratio of 4.5%, a Tier
1 capital to risk-weighted assets ratio of 6%, and a total capital to risk-weighted assets ratio of 8%. In addition, to avoid restrictions
on capital distributions and discretionary bonus payments, the Company and the Bank are required to meet a capital conservation
buffer of common equity Tier 1 capital in addition to the minimum common equity Tier 1 capital ratio. The capital conservation
buffer is set at a ratio of 2.5% common equity Tier 1 capital to risk-weighted assets, which sits “on top” of the 4.5% minimum
common equity Tier 1 to risk-weighted assets ratio. Common equity Tier 1 capital is predominantly composed of retained earnings
and common stock instruments (that meet strict delineated criteria), net of treasury stock, and after making necessary capital
deductions and adjustments. Tier 1 capital is composed of common equity Tier 1 capital plus Additional Tier 1 capital, which
consists of noncumulative perpetual preferred stock and similar instruments meeting specified eligibility criteria and “TARP”
preferred stock and other instruments issued under the Emergency Economic Stabilization Act of 2008. Total capital is composed
of Tier 1 capital plus Tier 2 capital, which consists of subordinated debt with a minimum original maturity of at least five years
and a limited amount of loan loss reserves.
At December 31, 2019, the Company's risk-based capital ratios, as calculated under applicable capital standards were 14.85%
common equity Tier 1 capital to risk weighted assets, 14.85% Tier 1 capital to risk weighted assets, and 16.10% total capital to
risk weighted assets.
In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines
provide for a minimum ratio of Tier 1 capital to average total on-balance sheet assets, less goodwill and certain other intangible
assets, of 4% for bank holding companies. The Company’s ratio at December 31, 2019 was 10.65% compared to 13.40% at
December 31, 2018. The guidelines also provide that bank holding companies experiencing internal growth or making
acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without
significant reliance on intangible assets. Furthermore, the Federal Reserve has indicated that it will consider a “tangible Tier 1
Capital leverage ratio” and other indications of capital strength in evaluating proposals for expansion or new activities.
Failure to meet capital guidelines could subject a bank to a variety of enforcement remedies, including issuance of a capital
directive, the termination of deposit insurance by the FDIC, a prohibition on taking brokered deposits and certain other restrictions
on its business. As described below, the FDIC can impose substantial additional restrictions upon FDIC-insured depository
institutions that fail to meet applicable capital requirements.
Prompt Corrective Action. The Federal Deposit Insurance Act, or FDI Act, requires the federal bank regulatory agencies to take
“prompt corrective action” if a depository institution does not meet minimum capital requirements. The FDI Act establishes five
capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically
undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare to various relevant
capital measures and certain other factors, as established by regulation.
An institution may be downgraded to, or deemed to be in, a capital category that is lower than is indicated by its capital ratios if
it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to
certain matters. As of December 31, 2019, Live Oak Bank had capital levels that qualify as “well capitalized” under the applicable
regulations.
The FDI Act generally prohibits an FDIC-insured bank from making a capital distribution (including payment of a dividend) or
paying any management fee to its holding company if the bank is or would thereafter be “undercapitalized.” “Undercapitalized”
banks are subject to growth limitations and are required to submit a capital restoration plan. The federal regulators may not accept
a capital restoration plan without determining, among other things, that the plan is based on realistic assumptions and is likely to
succeed in restoring the bank’s capital. In addition, for a capital restoration plan to be acceptable, the bank’s parent holding
company must guarantee that the institution will comply with such capital restoration plan until the institution has been adequately
capitalized on average during each of four consecutive calendar quarters. The aggregate liability of the parent holding company
under such guaranty is limited to the lesser of: (i) an amount equal to 5% of the bank’s total assets at the time it became
“undercapitalized”; and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance
with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a bank fails
to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.”
6
“Significantly undercapitalized” insured banks may be subject to a number of requirements and restrictions, including orders to
sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets, cease receipt of deposits from
correspondent banks, or dismiss directors or officers, and restrictions on interest rates paid on deposits, compensation of executive
officers, and capital distributions by the parent holding company. “Critically undercapitalized” institutions are subject to the
appointment of a receiver or conservator, may not make any payment of principal or interest on certain subordinated debt, extend
credit for a highly leveraged transaction, or enter into any material transaction outside the ordinary course of business.
A bank that is not “well capitalized” is also subject to certain limitations relating to brokered deposits. If a bank is not well-
capitalized, it cannot accept brokered deposits without prior FDIC approval. Even if approved, rate restrictions will govern the
rate the institution may pay on the brokered deposits. In addition, a bank that is less than well-capitalized generally cannot offer
an effective yield in excess of 75 basis points over the “national rate” (as defined below) paid on deposits (including brokered
deposits, if approval is granted for the bank to accept them) of comparable size and maturity. The “national rate” is defined as a
simple average of rates paid by insured depository institutions and branches for which data are available and is published weekly
by the FDIC. Institutions subject to the restrictions that believe they are operating in an area where the rates paid on deposits are
higher than the “national rate” can use the local market to determine the prevailing rate if they seek and receive a determination
from the FDIC that it is operating in a high rate area. Regardless of the determination, institutions must use the national rate to
determine conformance for all deposits outside their market area.
Basel III. The regulatory capital framework under which the Company and Live Oak Bank operate changed in significant respects
as a result of the Dodd-Frank Act, which was enacted in July 2010, and other regulations, including the separate regulatory capital
requirements put forth by the Basel Committee on Banking Supervision, commonly known “Basel III.”
In July 2013, the Federal Reserve, FDIC and Office of the Comptroller of the Currency approved final rules that established an
integrated regulatory capital framework that addressed shortcomings in certain capital requirements. The rules implemented in
the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes
required by the Dodd-Frank Act. These rules began to apply to the Company effective January 1, 2015. Compliance by LOB and
the Bank with these capital requirements affects their respective operations by increasing the amount of capital required to conduct
operations.
Community Bank Leverage Ratio. As discussed below, in May 2018, the Economic Growth, Regulatory Relief, and Consumer
Protection Act (“EGRRCPA”) became law, which directs the federal banking agencies to develop a community bank leverage
ratio (“CBLR”) of not less than 8 percent and not more than 10 percent for qualifying community banking organizations.
EGRRCPA defines a qualifying community banking organization as a depository institution or depository institution holding
company with total consolidated assets of less than $10 billion, which would include the Company and the Bank. A qualifying
community banking organization that exceeds the CBLR level established by the agencies is considered to have met: (i) the
generally applicable leverage and risk-based capital requirements under the agencies’ capital rule; (ii) the capital ratio
requirements in order to be considered well capitalized under the agencies’ prompt corrective action framework (in the case of
insured depository institutions); and (iii) any other applicable capital or leverage requirements. Section 201 of EGRRCPA defines
the CBLR as the ratio of a banking organization’s CBLR tangible equity to its average total consolidated assets, both as reported
on the banking organization’s applicable regulatory filing.
On September 17, 2019, the FDIC passed a final rule on the CBLR, setting the minimum required CBLR at 9 percent. The rule
went into effect on January 1, 2020. Under the final rule, a qualifying community banking organization may elect to use the
CBLR framework if its CBLR is greater than 9 percent. A qualifying community banking organization that has chosen the
proposed framework is not required to calculate the existing risk-based and leverage capital requirements. A bank is also
considered to have met the capital ratio requirements to be well capitalized for the agencies’ prompt corrective action rules
provided it has a CBLR greater than 9 percent. The Company has not elected to implement the CBLR framework at this time.
7
Acquisitions
The Company must comply with numerous laws related to any potential acquisition activity. Under the BHCA, a bank holding
company may not directly or indirectly acquire ownership or control of more than 5% of the voting shares or substantially all of
the assets of any bank or merge or consolidate with another bank holding company without the prior approval of the Federal
Reserve. The acquisition of non-banking companies is also regulated by the Federal Reserve. Current federal law authorizes
interstate acquisitions of banks and bank holding companies without geographic limitation. Furthermore, a bank headquartered
in one state is authorized to merge with a bank headquartered in another state, as long as neither of the states has opted out of
such interstate merger authority prior to such date, and subject to any state requirement that the target bank shall have been in
existence and operating for a minimum period of time, not to exceed five years, and to certain deposit market-share limitations.
After a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire
additional branches at any location in the state where a bank headquartered in that state could have established or acquired
branches under applicable federal or state law. Additionally, since passage of the Dodd-Frank Act, banks are now permitted to
open a de novo branch in any state if that state would permit a bank organized in that state to open a branch.
Restrictions on Affiliate Transactions
Sections 23A and 23B of the Federal Reserve Act establish parameters for a bank to conduct “covered transactions” with its
affiliates, with the objective of limiting risk to the insured bank. Generally, Sections 23A and 23B (i) limit the extent to which the
bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such bank’s
capital stock and surplus, and limit the aggregate of all such transactions with all affiliates to an amount equal to 20% of such
capital stock and surplus and (ii) require that all such transactions be on terms substantially the same, or at least as favorable, to
the bank or subsidiary as those that would be provided to a non-affiliate. The term “covered transaction” includes the making of
loans to the affiliate, purchase of assets from the affiliate, issuance of a guaranty on behalf of the affiliate and several other types
of transactions.
The Dodd-Frank Act imposed additional restrictions on transactions between affiliates by amending these two sections of the
Federal Reserve Act. Under the Dodd-Frank Act, restrictions on transactions with affiliates are enhanced by (i) including among
“covered transactions” transactions between bank and affiliate-advised investment funds; (ii) including among “covered
transactions” transactions between a bank and an affiliate with respect to securities repurchase agreements and derivatives
transactions; (iii) adopting stricter collateral rules; and (iv) imposing tighter restrictions on transactions between banks and their
financial subsidiaries.
FDIC Insurance Assessments
The Bank’s deposits are insured by the FDIC. The standard FDIC insurance coverage amount is $250,000 per depositor. The
FDIC maintains its Deposit Insurance Fund, or DIF, for the purposes of (1) insuring the deposits and protecting the depositors of
insured banks and (2) resolving failed banks. The DIF is funded mainly through quarterly assessments on insured banks, but also
receives interest income on securities. The DIF is reduced by loss provisions associated with failed banks and by FDIC operating
expenses.
The FDIC imposes a risk-based deposit insurance premium assessment on member institutions in order to maintain the DIF. The
assessment rates for an insured depository institution vary according to the level of risk incurred in its activities, which for
established small institutions like the Bank (i.e., those institutions with less than $10 billion in assets and insured for five years
or more), is generally determined by reference to the institution’s supervisory ratings. The assessment rate schedule can change
from time to time, at the discretion of the FDIC, subject to certain limits. Live Oak Bank’s insurance assessments during 2019
and 2018 were $3.4 million and $3.2 million, respectively. The FDIC may terminate insurance of deposits upon a finding that an
institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has
violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
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The Dodd-Frank Act expanded the base for FDIC insurance assessments, requiring that assessments be based on the average
consolidated total assets less tangible equity capital of a financial institution. In 2011, the FDIC approved a final rule to implement
the foregoing provision of the Dodd-Frank Act. Among other things, the final rule revised the assessment rate schedule to provide
initial base assessment rates ranging from 5 to 35 basis points, subject to adjustments which could increase or decrease the total
base assessment rates. The FDIC has three possible adjustments to an institution’s initial base assessment rate: (1) a decrease of
up to five basis points (or 50% of the initial base assessment rate) for long-term unsecured debt, including senior unsecured debt
(other than debt guaranteed under the Temporary Liquidity Guarantee Program) and subordinated debt; (2) an increase for holding
long-term unsecured or subordinated debt issued by other insured depository institutions known as the Depository Institution
Debt Adjustment; and (3) for institutions not well rated and well capitalized, an increase not to exceed 10 basis points for brokered
deposits in excess of 10 percent of domestic deposits.
The law also gives the FDIC enhanced discretion to set assessment rate levels. A significant increase in insurance premiums
would likely have an adverse effect on the operating expenses and results of operations of the Company and the Bank.
Management cannot predict what insurance assessment rates will be in the future.
The FDIC also collects a deposit-based assessment from insured financial institutions on behalf of the Financing Corporation, or
the FICO. The funds from these assessments are used to service debt issued by FICO in its capacity as a financial vehicle for the
Federal Savings & Loan Insurance Corporation. The FICO assessment rate is set quarterly. These assessments continued until the
FICO bonds matured, which was in 2019.
Privacy
Financial institutions are required by the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 to disclose their
policies for collecting and protecting confidential customer information. Customers generally may prevent financial institutions
from sharing personal financial information with nonaffiliated third parties except for third parties that market the institutions’
own products and services. Additionally, financial institutions generally may not disclose consumer account numbers to any
nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing through electronic mail to consumers.
The Bank has established a privacy policy that it believes promotes compliance with these federal requirements.
Federal Home Loan Bank System
The Federal Home Loan Bank, or FHLB, System consists of 12 district FHLBs subject to supervision and regulation by the
Federal Housing Finance Agency, or FHFA. The FHLBs provide a central credit facility primarily for member institutions. As a
member of the FHLB of Atlanta, the Bank is required to acquire and hold shares of capital stock in the FHLB of Atlanta. The
Bank was in compliance with this requirement with investment in FHLB of Atlanta stock of $3.3 million at December 31, 2019.
The FHLB of Atlanta serves as a reserve or central bank for its member institutions within its assigned district. It is funded
primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It offers advances to members in
accordance with policies and procedures established by the FHFA and the Board of Directors of the FHLB of Atlanta. Long-term
advances may only be made for the purpose of providing funds for residential housing finance, small businesses, small farms and
small agribusinesses.
Community Reinvestment Act
The Community Reinvestment Act requires federal bank regulatory agencies to encourage financial institutions to meet the credit
needs of low and moderate-income borrowers in their local communities. An institution’s size and business strategy determines
the type of examination that it will receive. Large, retail-oriented institutions are examined using a performance-based lending,
investment and service test. Small institutions are examined using a streamlined approach. All institutions may opt to be evaluated
under a strategic plan formulated with community input and pre-approved by the bank regulatory agency.
The Community Reinvestment Act regulations provide for certain disclosure obligations. Each institution must post a notice
advising the public of its right to comment to the institution and its regulator on the institution’s Community Reinvestment Act
performance and to review the institution’s Community Reinvestment Act public file. Each lending institution must maintain for
public inspection a file that includes a listing of branch locations and services, a summary of lending activity, a map of its
communities and any written comments from the public on its performance in meeting community credit needs. The Community
Reinvestment Act requires public disclosure of the regulators’ written Community Reinvestment Act evaluations of financial
institutions. This promotes enforcement of Community Reinvestment Act requirements by providing the public with the status of
a particular institution’s community reinvestment record.
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The Community Reinvestment Act agreements with private parties must be disclosed and annual Community Reinvestment Act
reports relating to such agreements must be made available to a bank’s primary federal regulator. A bank holding company will
not be permitted to become a financial holding company and no new activities authorized under the Gramm-Leach-Bliley Act
may be commenced by a holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a
satisfactory Community Reinvestment Act rating in its latest Community Reinvestment Act examination.
The Office of the Comptroller of the Currency and the FDIC have proposed changes to the regulations under the Community
Reinvestment Act. The Company will monitor the proposed changes as they make their way through the agency rulemaking
process.
The Volcker Rule
Under provisions of the Dodd-Frank Act referred to as the “Volcker Rule,” certain limitations are placed on the ability of insured
depository institutions and their affiliates to engage in sponsoring, investing in and transacting with certain investment funds,
including hedge funds and private equity funds. The Volcker Rule also places restrictions on proprietary trading, which could
impact certain hedging activities. The Volcker Rule became fully effective in July 2015, and banking entities had until July 21,
2017, to divest certain legacy investments in covered funds. The Federal Reserve, Office of the Comptroller of Currency, FDIC,
SEC, and Commodity Futures Trading Commission finalized amendments to the Volcker Rule in 2019, which relate primarily to
the Volcker Rule’s proprietary trading and compliance program requirements. These amendments to the Volcker Rule became
effective January 1, 2020, with compliance required by January 1, 2021. The amendments do not change the Volcker Rule’s
general prohibitions, but they offer certain clarifications and a simplified approach to compliance. On January 30, 2020, the
agencies proposed further amendments to the Volcker Rule's funds provisions, which would, if adopted, clarify key definitions
and add new, and modify certain existing, exclusions from the definition of covered fund. The proposal is currently open for
comment, and the timeline for finalization remains uncertain. Further, pursuant to EGRRCPA enacted in May 2018 and discussed
below, community banks are excluded from the restrictions of the Volcker Rule if (i) the community bank, and every entity that
controls it, has total consolidated assets equal to or less than $10 billion and (ii) trading assets and liabilities of the community
bank, and every entity that controls it, are equal to or less than five percent of its total consolidated assets. The Company and
Live Oak Bank are currently below these thresholds and thus exempt from the Volcker Rule.
USA PATRIOT Act
The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of
2001, or the USA PATRIOT Act, required each financial institution: (i) to establish an anti-money laundering program; (ii) to
establish due diligence policies, procedures and controls with respect to its private banking accounts involving foreign individuals
and certain foreign banks; and (iii) to avoid establishing, maintaining, administering or managing correspondent accounts in the
United States for, or on behalf of, foreign banks that do not have a physical presence in any country. The USA PATRIOT Act also
required the Secretary of the Treasury to prescribe by regulation minimum standards that financial institutions must follow to
verify the identity of customers, both foreign and domestic, when a customer opens an account. In addition, the USA PATRIOT
Act encouraged cooperation among financial institutions, regulatory authorities and law enforcement authorities with respect to
individuals, entities and organizations engaged in, or reasonably suspected of engaging in, terrorist acts or money laundering
activities.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, mandated for public companies, such as the Company, a variety of reforms
intended to address corporate and accounting fraud and provided for the establishment of the PCAOB, which enforces auditing,
quality control and independence standards for firms that audit SEC-reporting companies. Sarbanes-Oxley imposed higher
standards for auditor independence and restricted the provision of consulting services by auditing firms to companies they audit
and requires that certain audit partners be rotated periodically. It also requires chief executive officers and chief financial officers,
or their equivalents, to certify the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they
knowingly or willfully violate this certification requirement, and increases the oversight and authority of audit committees of
publicly traded companies.
10
Fiscal and Monetary Policy
Banking is a business which depends on interest rate differentials for success. In general, the difference between the interest paid
by a bank on its deposits and its other borrowings, and the interest received by a bank on its loans and securities holdings,
constitutes a significant portion of a bank’s earnings. Thus, the Company's earnings and growth will be subject to the influence
of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States
and its agencies, particularly the Federal Reserve. The Federal Reserve regulates the supply of money through various means,
including open market dealings in United States government securities, the discount rate at which banks may borrow from the
Federal Reserve and the reserve requirements on deposits. The nature and timing of any changes in such policies and their effect
on the Company's business and results of operations cannot be predicted.
Current and future legislation and the policies established by federal and state regulatory authorities will affect the Company's
future operations. Banking legislation and regulations may limit the Company's growth and the return to its investors by restricting
certain of its activities.
In addition, capital requirements could be changed and have the effect of restricting the activities of the Company or requiring
additional capital to be maintained. The Company cannot predict with certainty what changes, if any, will be made to existing
federal and state legislation and regulations or the effect that such changes may have on the Company's business and results of
operations.
Real Estate Lending Evaluations
The federal regulators have adopted uniform standards for evaluations of loans secured by real estate or made to finance
improvements to real estate. Banks are required to establish and maintain written internal real estate lending policies consistent
with safe and sound banking practices and appropriate to the size of the institution and the nature and scope of its operations. The
regulations establish loan to value ratio limitations on real estate loans. Live Oak Bank’s respective loan policies establish limits
on loan to value ratios that are equal to or less than those established in such regulations.
Commercial Real Estate Concentrations
Lending operations of commercial banks may be subject to enhanced scrutiny by federal banking regulators based on a bank’s
concentration of commercial real estate, or CRE, loans. The federal banking regulators have issued guidance to remind financial
institutions of the risk posed by commercial real estate, or CRE, lending concentrations. CRE loans generally include land
development, construction loans, and loans secured by multifamily property, and nonfarm, nonresidential real property where the
primary source of repayment is derived from rental income associated with the property. The guidance prescribes the following
guidelines for bank examiners to help identify institutions that are potentially exposed to significant CRE risk and may warrant
greater supervisory scrutiny:
•
•
total reported loans for construction, land development and other land, or C&D, represent 100% or more of the
institution’s total capital; or
total CRE loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s
CRE loan portfolio has increased over 50% or more during the prior 36 months.
As of December 31, 2019, the Bank's C&D concentration as a percentage of bank capital totaled 147.1% and the Bank's CRE
concentration, net of owner-occupied loans, as a percentage of capital totaled 146.9%.
Limitations on Incentive Compensation
In October 2009, the Federal Reserve issued proposed guidance designed to help ensure that incentive compensation policies at
banking organizations do not encourage excessive risk-taking or undermine the safety and soundness of the organization. In
connection with the proposed guidance, the Federal Reserve announced that it would review incentive compensation
arrangements of bank holding companies such as the Company as part of the regular, risk-focused supervisory process.
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In June 2010, the Federal Reserve issued the incentive compensation guidance in final form and was joined by the FDIC, and the
Office of the Comptroller of the Currency. The final guidance, which covers all employees that have the ability to materially
affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking
organization’s incentive compensation arrangements should (i) provide employees incentives that appropriately balance risk and
reward and, thus, do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be
compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including
active and effective oversight by the organization’s board of directors. Any deficiencies in compensation practices that are
identified may be incorporated into the organization’s supervisory ratings, which can affect its ability to make acquisitions or
perform other actions. The guidance provides that enforcement actions may be taken against a banking organization if its incentive
compensation arrangements or related risk-management control or governance processes pose a risk to the organization’s safety
and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
While the Dodd-Frank Act contemplated additional regulatory action to be taken related to incentive compensation, the
administrative agencies have not yet adopted the contemplated regulations.
Registered Investment Adviser Regulation
Live Oak Private Wealth is a registered investment adviser under the Investment Advisers Act of 1940 and the SEC’s regulations
promulgated thereunder. The Investment Advisers Act imposes numerous obligations on registered investment advisers, including
fiduciary, recordkeeping, operational, and disclosure obligations. Supervisory agencies have the power to limit or restrict Live
Oak Private Wealth from conducting its business in the event that it fails to comply with such laws and regulations. Possible
sanctions that may be imposed in the event of such noncompliance include the suspension of individual employees, limitations
on the business activities for specified periods of time, revocation of registration as an investment adviser and/or other
registrations, and other censures and fines. Changes in these laws or regulations could have a material adverse impact on the
profitability and mode of operations of Live Oak Private Wealth.
Economic Environment
The policies of regulatory authorities, including the monetary policy of the Federal Reserve, have a significant effect on the
operating results of bank holding companies and their subsidiaries. Among the means available to the Federal Reserve to affect
the money supply are open market operations in U.S. government securities, changes in the discount rate on member bank
borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations
to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged
on loans or paid on deposits. The Federal Reserve’s monetary policies have materially affected the operating results of commercial
banks in the past and are expected to continue to do so in the future. The nature of future monetary policies and the effect of these
policies on the Company's business and earnings cannot be predicted.
Dodd-Frank Act
The Dodd-Frank Act was signed into law in 2010 and implemented many new changes in the way financial and banking
operations are regulated in the United States, including through the creation of a new resolution authority, mandating higher
capital and liquidity requirements, requiring banks to pay increased fees to regulatory agencies and numerous other provisions
intended to strengthen the financial services sector. Pursuant to the Dodd-Frank Act, the Financial Stability Oversight Council,
or the FSOC, was created and is charged with overseeing and coordinating the efforts of the primary U.S. financial regulatory
agencies (including the Federal Reserve, the FDIC and the SEC) in establishing regulations to address systemic financial stability
concerns. Under the Dodd-Frank Act, the Consumer Financial Protection Bureau, or the CFPB, was also created as a new
consumer financial services regulator. The CFPB is authorized to prevent unfair, deceptive and abusive practices and ensure that
consumers have access to markets for consumer financial products and services and that such markets are fair, transparent and
competitive.
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Federal and State Taxation
The Company and its subsidiaries file a consolidated federal income tax return and separate state income tax returns in North
Carolina. All the returns are filed on a calendar year basis. Consolidated income tax returns have the effect of eliminating
intercompany income and expense, including dividends, from the computation of consolidated taxable income for the taxable
year in which the items occur. In accordance with an income tax sharing agreement, income tax charges or credits are allocated
among Live Oak and its subsidiaries on the basis of their respective taxable income or taxable loss that is included in the
consolidated income tax return.
Banks and bank holding companies are subject to federal and state income taxes in essentially the same manner as other
corporations. Taxable income is generally calculated under applicable sections of the Internal Revenue Code of 1986, as amended
(the “Code”), with some modifications required by state law and the December 2017 tax legislation commonly referred to as the
Tax Cut and Jobs Act (the "Tax Act"). Although Live Oak’s federal income tax liability is determined under provisions of the
Code, which is applicable to all taxpayers, Sections 581 through 597 of the Code apply specifically to financial institutions.
Among other things, the new Tax Act (i) establishes a new, flat corporate federal statutory income tax rate of 21%, (ii) eliminates
the corporate alternative minimum tax and allows the use of any such carryforwards to offset regular tax liability for any taxable
year, (iii) limits the deduction for net interest expense incurred by U.S. corporations, (iv) allows businesses to immediately
expense, for tax purposes, the cost of new investments in certain qualified depreciable assets, (v) eliminates or reduces certain
deductions related to meals and entertainment expenses, (vi) modifies the limitation on excessive employee remuneration to
eliminate the exception for performance-based compensation and clarifies the definition of a covered employee and (vii) limits
the deductibility of deposit insurance premiums. The Tax Cuts and Jobs Act also significantly changes U.S. tax law related to
foreign operations, however, such changes do not currently impact the Company. Based upon current 2020 projections, the
effective tax rate for 2020 is anticipated to be approximately 25%; however, management continues to explore investments which
generate investment tax credits and as a result there can be no assurance as to the actual effective rate because it will be dependent
upon the nature and amount of future income and expenses as well as actual investments generating investment tax credits and
transactions with discrete tax effects.
Economic Growth, Regulatory Relief, and Consumer Protection Act
On May 24, 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”) was signed into law,
which amended provisions of the Dodd-Frank Act and was intended to ease, and better tailor, regulation, particularly with respect
to smaller-sized institutions such as the Company. EGRRCPA’s highlights include, among other things: (i) exempts banks with
less than $10 billion in assets from the ability-to-repay requirements for certain qualified residential mortgage loans held in
portfolio; (ii) not requiring appraisals for certain transactions valued at less than $400,000 in rural areas; (iii) clarifies that, subject
to various conditions, reciprocal deposits of another depository institution obtained using a deposit broker through a deposit
placement network for purposes of obtaining maximum deposit insurance would not be considered brokered deposits subject to
the FDIC’s brokered-deposit regulations; (iv) raises eligibility for the 18-month exam cycle from $1 billion to banks with $3
billion in assets; and (v) simplifies capital calculations by requiring regulators to establish for institutions under $10 billion in
assets a community bank leverage ratio (tangible equity to average consolidated assets) at a percentage not less than 8% and not
greater than 10% that such institutions may elect to replace the general applicable risk-based capital requirements for determining
well capitalized status. On September 17, 2019, the FDIC passed a final rule on the community bank leverage ratio, setting the
minimum required community bank leverage ratio at 9 percent. The rule went into effect on January 1, 2020. In addition, the
Federal Reserve was required to raise the asset threshold under its Small Bank Holding Company Policy Statement from $1
billion to $3 billion for bank or savings and loan holding companies that are exempt from consolidated capital requirements,
provided that such companies meet certain other conditions such as not engaging in significant nonbanking activities and not
having a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with
the SEC. Consistent with EGRRCPA, the Federal Reserve passed an interim final rule that became effective on August 30, 2018,
to increase the asset threshold to $3 billion for qualifying for such policy statement.
Evolving Legislation and Regulatory Action
New laws or regulations or changes to existing laws and regulations, including changes in interpretation or enforcement, could
materially adversely affect the Company's financial condition or results of operations. Many aspects of the Dodd-Frank Act are
subject to further rulemaking and will take effect over several years. As a result, the overall financial impact on the Company and
Live Oak Bank cannot be anticipated at this time.
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Item 1A. RISK FACTORS
An investment in LOB common stock involves certain risks. The following discussion highlights the risks that management
believes are material for the Company, but do not necessarily include all the risks that we may face. Additional risks and
uncertainties that are not currently known or that management does not currently deem material could also have a material
adverse impact on our business, results of our operations and financial condition. You should carefully consider the risk factors
and uncertainties described below and elsewhere in this Report in evaluating an investment in LOB’s common stock.
Risks Related to Our Business
We may experience increased delinquencies and credit losses, which could have a material adverse effect on our capital,
financial condition, and results of operations.
Like other lenders, we face the risk that our customers will not repay their loans. A customer’s failure to repay us is usually
preceded by missed monthly payments. In some instances, however, a customer may declare bankruptcy prior to missing
payments, and, following a borrower filing bankruptcy, a lender’s recovery of the credit extended is often limited. Since many of
our loans are secured by collateral, we may attempt to seize the collateral if and when a customer defaults on a loan. However,
the value of the collateral might not equal the amount of the unpaid loan, and we may be unsuccessful in recovering the remaining
balance from our customer. The resolution of nonperforming assets, including the initiation of foreclosure proceedings, requires
significant commitments of time from management, which can be detrimental to the performance of their other responsibilities,
and which expose us to additional legal costs. Elevated levels of loan delinquencies and bankruptcies in our market areas,
generally, and among our customers specifically, can be precursors of future charge-offs and may require us to increase our
allowance for loan and lease losses, or ALLL. Higher charge-off rates, delays in the foreclosure process or in obtaining judgments
against defaulting borrowers or an increase in our ALLL may negatively impact our overall financial performance, may increase
our cost of funds, and could materially adversely affect our business, results of operations and financial condition.
SBA lending and other government guaranteed lending is an important part of our business. These lending programs are
dependent upon the federal government, and we face specific risks associated with originating SBA and other government
guaranteed loans.
Our SBA lending program is dependent upon the federal government. As an SBA Preferred Lender, we enable our clients to
obtain SBA loans without being subject to the potentially lengthy SBA approval process necessary for lenders that are not SBA
Preferred Lenders. The SBA periodically reviews the lending operations of participating lenders to assess, among other things,
whether the lender exhibits prudent risk management. When weaknesses are identified, the SBA may request corrective actions
or impose enforcement actions, including revocation of the lender’s Preferred Lender status. If we lose our status as a Preferred
Lender, we may lose some or all of our customers to lenders who are SBA Preferred Lenders, and as a result we could experience
a material adverse effect to our financial results. Any changes to the SBA program, including changes to the level of guarantee
provided by the federal government on SBA loans, may also have a material adverse effect on our business.
During the fourth quarter of 2018, we began implementing a strategic decision to retain a larger portion of our loans eligible for
sale on our balance sheet. Notwithstanding this decision, we anticipate that gains on the sale of loans will comprise a significant
component of our revenue in 2020. We sell the guaranteed portion of some of our SBA 7(a) loans in the secondary market. These
sales have resulted in premium income for us at the time of sale and created a stream of future servicing income. We may not be
able to continue originating these loans or selling them in the secondary market. Furthermore, even if we are able to continue
originating and selling SBA 7(a) loans in the secondary market, we might not continue to realize premiums upon the sale of the
guaranteed portion of these loans. When we sell the guaranteed portion of our SBA 7(a) loans, we incur credit risk on the non-
guaranteed portion of the loans, and if a customer defaults on the non-guaranteed portion of a loan, we share any loss and recovery
related to the loan pro-rata with the SBA. If the SBA establishes that a loss on an SBA guaranteed loan is attributable to significant
technical deficiencies in the manner in which the loan was originated, funded or serviced by us, the SBA may seek recovery of
the principal loss related to the deficiency from us, which could materially adversely affect our business, results of operations and
financial condition.
In addition, we make loans through the Rural Energy for America Program of the United States Department of Agriculture, or the
USDA, which provides guaranteed loan financing and grant funding to agricultural producers and rural small businesses for
renewable energy systems or to make energy-efficient improvements, and through other USDA guaranteed lending programs. A
typical SBA 7(a) loan carries a 75% guarantee while USDA guarantees range from 60% to 80% depending on loan size and type.
We expect to continue to sell a large proportion of the USDA loans that we originate in the secondary market as they become
eligible for sale. The origination and sale of these loans are subject to similar risks associated with the origination and sale of
SBA 7(a) loans as described above.
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The laws, regulations and standard operating procedures that are applicable to SBA loan products may change at any time. For
example, effective January 1, 2018, the SBA changed its procedures relating to equity levels required to qualify for an SBA loan.
These changes had an adverse impact on originations, particularly in our Agriculture vertical and other verticals where the
borrowers historically have faced challenges meeting equity requirements for eligibility. In March 2018, the Office of Inspector
General (the “OIG”) for the SBA issued its Evaluation of SBA 7(a) Loans Made to Poultry Farmers. The report summarized the
OIG’s review of SBA 7(a) loans made to poultry farmers along with its findings and recommendations. Among other things, the
OIG report concluded that the loans to poultry farmers it had reviewed did not meet regulatory and SBA requirements for
eligibility. In response to the March 2018 OIG’s report, the SBA issued a proposed rule in September of 2018. In February 2020,
the SBA issued a final interim rule on affiliation standards, including a process for the SBA to review poultry and agriculture
contracts for an eligibility determination on affiliation. We are still assessing the potential impact of these final interim rules,
including potential impacts on verticals outside of poultry lending. We cannot predict the effects of future changes on our business
and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and
bank holding companies and especially our organization, changes in the laws, regulations and procedures applicable to SBA and
USDA loans could adversely affect our ability to operate profitably.
A prolonged U.S. government shutdown or default by the U.S. on government obligations would harm our results of
operations.
Our results of operations, including revenue, non-interest income, expenses and net interest income, would be adversely affected
in the event of widespread financial and business disruption on account of a default by the United States on U.S. government
obligations or a prolonged failure to maintain significant U.S. government operations, particularly those pertaining to the SBA,
the USDA or the FDIC. Any such failure to maintain such U.S. government operations would impede our ability to originate SBA
loans and our ability to sell such loans in the secondary market, which would materially adversely affect our business, results of
operations and financial condition.
We are dependent upon the use of intellectual property owned by third parties, and any change in our ability to use, or the
terms upon which we may use, this intellectual property could have a material adverse effect on our business.
The technology-based lending platform that is pivotal to our success is dependent on the use of the nCino Bank Operating System
and Salesforce.com, Inc.’s Force.com cloud computing infrastructure platform. We rely on a non-exclusive license to use nCino’s
platform. Because our license is non-exclusive, the nCino Bank Operating System is available to other lenders and nothing would
prevent our competitors from developing, licensing or using similar technology. Our license currently expires on November 14,
2021. Notwithstanding the term of our agreement, our license may be terminated if we are in material breach of the license and
do not cure the breach within 30 days. In addition, nCino relies on a license to use the Salesforce.com platform, and if nCino
were unable to maintain its rights under that license, our ability to rely on the nCino license could be adversely affected. We can
offer no assurance that we will be able to renew or maintain our license to use the nCino Bank Operating System on terms that
are acceptable. Termination of either of these licenses or the reduction or elimination of our licensed rights may result in our
having to negotiate new licenses with less favorable terms, or the inability to obtain access to such licensed technology at all.
Similarly, Apiture LLC (“Apiture”) has provided the Bank significant engineering, development, professional and other services.
We are currently negotiating with Apiture for an agreement to deliver the products and services that will comprise the next-
generation banking platform that we believe will be important for our future strategy and success. There can be no assurance that
Apiture will agree to, or be able to, develop and support the implementation of our new banking platform in a timely and cost-
effective manner or that Apiture will continue to provide any services on which we rely at appropriate service levels or at prices
that would be market competitive. See “Risks Related to Our Investment in Apiture” below for additional risks that Apiture faces,
some or all of which could have a material adverse impact on our Bank as a customer of Apiture. In addition, we are an investor
in Finxact, Inc., an early-stage fintech company developing an enterprise class, cloud-native Core-as-a-Service platform that we
also believe will be important for our future strategy and success. We also rely on numerous other vendors and third parties to
provide software and solutions comprising the new banking platform that we are developing. If this technology is not successfully
developed and implemented at our Bank, if we were to lose access to any of this technology, or if we were only able to access the
technology on less favorable terms, we would not be able to offer our customers the next-generation banking platform services
that we intend to offer, and our business, financial condition, results of operations and prospects could be materially and adversely
affected.
15
A failure in or breach of our operational or security systems, or those of our third party service providers, including as a result
of cyber-attacks, could disrupt our business, result in unintentional disclosure or misuse of confidential or proprietary
information, damage our reputation, increase our costs and cause losses.
As a financial institution, our operations rely heavily on the secure data processing, storage and transmission of confidential and
other information on our computer systems and networks. Any failure, interruption or breach in security or operational integrity
of these systems could result in failures or disruptions in our online banking system, customer relationship management, general
ledger, deposit and loan servicing and other systems. The security and integrity of our systems and the technology we use could
be threatened by a variety of interruptions or information security breaches, including those caused by computer hacking, cyber-
attacks, electronic fraudulent activity or attempted theft of financial assets. We may fail to promptly identify or adequately address
any such failures, interruptions or security breaches if they do occur. While we have certain protective policies and procedures in
place, the nature and sophistication of the threats continue to evolve. We may be required to expend significant additional
resources in the future to modify and enhance our protective measures.
The nature of our business may make it an attractive target and potentially vulnerable to cyber-attacks, computer viruses, physical
or electronic break-ins or similar disruptions. The technology-based platform we use processes sensitive data from our borrowers,
depositors and other customers. While we have taken steps to protect confidential information that we have access to, our security
measures and the security measures employed by the owners of the technology in the platform that we use could be breached.
Any accidental or willful security breaches or other unauthorized access to our systems could cause confidential customer,
borrower, employee, vendor, partner or investor information to be stolen and used for criminal purposes. Security breaches or
unauthorized access to confidential information could also expose us to liability related to the loss of the information, time-
consuming and expensive litigation, and negative publicity. If security measures are breached because of third-party action,
employee error, malfeasance or otherwise, or if design flaws in the technology-based platform that we use are exposed and
exploited, our relationships with customers, borrowers, employees, vendors, partners and investors could be severely damaged,
and we could incur significant liability.
Because techniques used to sabotage or obtain unauthorized access to systems change frequently and generally are not recognized
until they are launched against a target, we and our collaborators may be unable to anticipate these techniques or to implement
adequate preventative measures. In addition, federal regulators and many federal and state laws and regulations require companies
to notify individuals of data security breaches involving their personal data. These mandatory disclosures regarding a security
breach are costly to implement and often lead to widespread negative publicity, which may cause customers, borrowers,
employees, vendors, partners or investors to lose confidence in the effectiveness of our data security measures. Any security
breach, whether actual or perceived, would harm our reputation, we could lose customers, borrowers, employees, vendors,
partners, or investors, and our business and operations could be adversely affected.
Additionally, we face the risk of operational disruption, failure, termination or capacity constraints of any of the third parties that
facilitate our business activities, including exchanges, clearing agents, clearing houses or other financial intermediaries. Such
parties could also be the source of an attack on, or breach of, our operational systems. Any failures, interruptions or security
breaches in our information systems could damage our reputation, result in a loss of customer business, result in a violation of
privacy or other laws, or expose us to civil litigation, regulatory fines or losses not covered by insurance.
Our business is dependent on the successful and uninterrupted functioning of our information technology and telecommunications
systems and third-party providers. The failure of these systems, or the termination of a third-party software license or service
agreement on which any of these systems is based, could interrupt our operations. Because our information technology and
telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand
for such services exceeds capacity or such third-party systems fail or experience interruptions. If significant, sustained or repeated,
a system failure or service denial could compromise our ability to operate effectively, damage our reputation, result in a loss of
customer business, and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could
materially adversely affect our business, financial condition, results of operations and prospects, as well as the value of our
common stock.
A return of recessionary conditions could result in increases in our level of nonperforming loans and/or reduce demand for
our products and services, which could have a material adverse effect on our results of operations.
Like many financial institutions, we are subject to certain risks resulting from a weakened economy, such as increased charge-
offs and levels of past-due loans and nonperforming assets. A period of deteriorating economic conditions could adversely affect
the ability of our customers to repay their loans, the value of our investments, and our ongoing operations, including our
equipment leasing and title insurance businesses, costs and profitability. These events may cause us to incur losses and may
materially adversely affect our business, results of operations and financial condition.
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Our loan portfolio mix, which includes owner-occupied commercial real estate loans, could result in increased credit risk in
a challenging economy.
Our loan portfolio is concentrated in owner-occupied commercial real estate and owner-occupied commercial business loans.
These types of loans generally are viewed as carrying more risk of default than residential real estate loans or certain other types
of loans or investments. In fact, the FDIC has issued pronouncements alerting banks of its concern about heavy loan
concentrations in certain types of commercial real estate loans, including acquisition, construction and development loans, and
heavy loan concentrations in certain geographic segments. Because a portion of our loan portfolio is composed of these types of
higher-risk loans, we face an increased risk of nonperforming loans that could result in a loss of earnings from these loans, an
increase in the provision for loan and lease losses, or an increase in loan charge-offs, any of which could have a material adverse
impact on our business, results of operations and financial condition.
The current economic environment and any deterioration or downturn in the economies or real estate values in the markets we
serve could have a material adverse effect on both borrowers’ ability to repay their loans and the value of the real property securing
those loans. Our ability to recover on defaulted loans would then be diminished, and we would be more likely to suffer losses on
defaulted loans. Any of these developments could materially adversely affect our business, financial condition, results of
operations and prospects.
The fair value of our investment securities can fluctuate due to factors outside of our control.
As of December 31, 2019, the fair value of our investment securities portfolio was approximately $540.0 million. Factors beyond
our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the
fair value of these securities. These factors include, but are not limited to, rating agency actions in respect of the securities,
defaults by the issuer or with respect to the underlying securities, monetary tapering actions by the Federal Reserve, and changes
in market interest rates and potential instability in the capital markets. Any of these factors, among others, could cause other-than-
temporary impairments and realized or unrealized losses in future periods and declines in other comprehensive income, which
could materially and adversely affect our business, results of operations, financial condition and prospects, as well as the value
of our common stock. The process for determining whether impairment of a security is other-than-temporary usually requires
complex, subjective judgments about the future financial performance and liquidity of the issuer and any collateral underlying
the security in order to assess the probability of receiving all contractual principal and interest payments on the security. Our
inability to accurately predict the future performance of an issuer or to efficiently respond to changing market conditions could
result in a decline in the value of our investment securities portfolio, which could have a material and adverse effect on our
business, results of operations and financial condition.
Our allowance for loan and lease losses may prove to be insufficient to cover actual loan and lease losses, which could have
a material adverse effect on our financial condition and results of operations.
Our future success depends to a significant extent upon the quality of our assets, particularly loans. In originating loans, there is
a substantial likelihood that we will experience credit losses. The risk of loss will vary with, among other things, general economic
conditions, including the current economic environment and real estate market, the type of loan, the creditworthiness of the
borrower over the term of the loan, and, in the case of a collateralized loan, the quality of the collateral for the loan.
Our loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of
these loans may be insufficient to assure repayment. As a result, we may experience significant loan losses, which could have a
material adverse effect on our operating results. Our management makes various assumptions and judgments about the
collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets
serving as collateral for the repayment of many of our loans. We maintain an allowance for loan and lease losses in an attempt
to cover any loan and lease losses that may occur. In determining the size of the allowance, we rely on an analysis of our loan
and lease portfolio based on historical loss experience, volume and types of loans and leases, trends in classification, volume and
trends in delinquencies and non-accruals, national and local economic conditions, and other pertinent information.
If our assumptions are wrong, our current allowance may not be sufficient to cover future loan and lease losses, and we may need
to make adjustments to allow for different economic conditions or adverse developments in our loan and lease portfolio. Material
additions to our allowance in the form of provisions for loan and lease losses would materially decrease our net income. We
expect our allowance to continue to fluctuate; however, given current and future market conditions, our allowance may not be
adequate to cover future loan and lease losses.
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Federal and state regulators periodically review our allowance for loan and lease losses and may require us to increase our
provision for loan and lease losses or recognize further loan charge-offs, based on judgments different than those of our
management. Any increase in our allowance for loan and lease losses or loan charge-offs as required by these regulators could
have a negative effect on our operating results and could materially adversely affect our business, results of operations and
financial condition.
In addition, the adoption of Accounting Standards Update (“ASU”) 2016-13, “Financial Instruments - Credit Losses (Topic 326):
Measurement of Credit Losses on Financial Instruments,” as amended, on January 1, 2020 will impact our methodology for
estimating the allowance for loan and lease losses. See Note 1. Organization and Summary of Significant Accounting Policies
under the subheading entitled “Recent Accounting Pronouncements” further discussion of this new standard.
The valuation of our servicing rights is based on estimates and subject to fluctuation based on market conditions and other
factors that are beyond our control.
The fair value of our servicing rights is estimated based upon projections of expected future cash flows generated by the loans
we service, historical prepayment rates, future prepayment estimates, portfolio characteristics, interest rates based on interest rate
yield curves, volatility, market demand for servicing rights and other factors. While this evaluation process uses historical and
other objective information, the valuation of our servicing rights is ultimately an estimate based on our experience, judgment and
expectations regarding our servicing portfolio and the broader market. This is an inherently uncertain process and the value of
our servicing rights may be adversely impacted by factors that are beyond our control, which may in turn have a material adverse
effect on our business, results of operations and financial condition.
The recognition of gains on the sale of loans reflects certain assumptions.
During the fourth quarter of 2018, we began implementing a strategic decision to retain a larger portion of our loans eligible for
sale on our balance sheet. Notwithstanding this decision, we anticipate that gains on the sale of loans will comprise a significant
component of our revenue in 2020. The determination of noncash gains is based on assumptions regarding the value of
unguaranteed loans retained, servicing rights retained and deferred fees and costs. The value of retained unguaranteed loans and
servicing rights are determined by our wholly owned subsidiary, GLS, which applies market derived factors such as prepayment
rates, current market conditions and recent loan sales to arrive at valuations. Deferred fees and costs are determined using internal
analysis of the cost to originate loans. Significant errors in assumptions used to compute gains on sale of loans could result in
material revenue misstatements, which may have a material adverse effect on our business, results of operations and profitability.
In addition, while we believe that the valuations provided by GLS are at arm’s length, reflect fair value and are reperformed for
indications of bias by an independent third party on a biannual basis, if such valuations are not reflective of fair market value then
our business, results of operations and financial condition may be materially and adversely affected.
We anticipate that going forward we will experience increasing growth in our held-for-sale and held-for-investment loan
portfolios due to our strategic business decisions and increasing construction portfolio.
Our revenue model has historically been driven by selling loans that we originate, or a portion of those loans, in the secondary
market when fully funded. The growth of our construction portfolio that typically funds in stages will result in a decrease in the
volume of loans sold relative to production in any period, which, in turn, decreases our revenue relative to production in any
period. In addition, we anticipate growth in our loans held for investment due to our origination of loans that we choose not to
sell or for which there is no secondary market or due to other strategic choices, including the pursuit of potential opportunities in
conventional lending outside of SBA or other government guarantee programs. During the fourth quarter of 2018, we began
implementing a strategic decision to retain a larger portion of our loans eligible for sale on our balance sheet. Growth in our held-
for-sale and our held-for-investment loan portfolios exposes us to increased interest rate and credit risks.
Our rental equipment is subject to residual value risk upon disposition, and may not sell at the prices or in the quantities we
expect.
The market value of any given piece of rental equipment could be less than its depreciated value at the time it is sold. The market
value of used rental equipment depends on several factors, including:
•
the market price for new equipment of a like kind;
•
the age of the equipment at the time it is sold, as well as wear and tear on the equipment relative to its age;
18
•
the supply of used equipment on the market;
•
technological advances relating to the equipment;
• demand for the used equipment; and
• general economic conditions.
We include in income from operations the difference between the sales price and the depreciated value of an item of equipment
sold. Changes in our assumptions regarding depreciation could change our depreciation expense, as well as the gain or loss
realized upon disposal of equipment. Sales of our used rental equipment at prices that fall significantly below our projections or
in lesser quantities than we anticipate will have a negative impact on our results of operations and cash flows.
We are subject to liquidity risk in our operations.
Liquidity risk is the possibility of being unable, at a reasonable cost and within acceptable risk tolerances, to pay obligations as
they come due, to capitalize on growth opportunities as they arise, or to pay regular dividends because of an inability to liquidate
assets or obtain adequate funding on a timely basis. Liquidity is required to fund various obligations, including credit obligations
to borrowers, loan originations, withdrawals by depositors, repayment of debt, dividends to shareholders, operating expenses,
and capital expenditures. Our liquidity is derived primarily from retail deposit growth and retention, the sale of loans in the
secondary market, principal and interest payments on loans and investment securities, net cash provided from operations, and
access to other funding sources. A significant portion of our deposit base is gathered through our nationwide direct deposit
platform, and we have historically also relied on brokered deposits. If our Bank were to become less than well capitalized, we
could not offer an effective yield on our deposits in excess of 75 basis points over the “national rate” as defined in applicable
FDIC rules. We also could not accept brokered deposits without FDIC approval. See “Capital Adequacy” under the heading
“Supervision and Regulation” above for more details on these restrictions. If we became subject to these restrictions, they could
have a material adverse effect on our liquidity, results of operations and financial condition.
Our access to funding sources in amounts adequate to finance our activities or at a reasonable cost could be impaired by factors
that affect us specifically or the financial services industry in general. Factors that could adversely affect our access to liquidity
sources include a decrease in the level of our business activity due to a market downturn, failures of or interruptions to the next-
generation banking platform we are developing, our lack of access to a traditional branch banking network designed to generate
core deposits, and adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific
to us, such as a severe disruption in the financial markets or negative views and expectations about the prospects for the financial
services industry as a whole. Our access to borrowed funds could become limited in the future, and we may be required to pay
above market rates for additional borrowed funds, if we are able to obtain them at all, which may adversely affect our business,
results of operations and financial condition.
Changes in the interest rate environment could reduce our net interest income, which could reduce our profitability.
As a financial institution, our earnings depend in part on our net interest income, which is the difference between the interest
income that we earn on interest-earning assets, such as investment securities and loans, and the interest expense that we pay on
interest-bearing liabilities, such as deposits and borrowings. Additionally, changes in interest rates affect the premiums we may
receive in connection with the sale of SBA 7(a) and USDA loans in the secondary market, pre-payment speeds of loans for which
we own servicing rights, our ability to fund our operations with customer deposits, and the fair value of securities in our
investment portfolio. Therefore, any change in general market interest rates, including changes in federal fiscal and monetary
policies, affects us more than non-financial companies and can have a significant effect on our net interest income and results of
operations. Our assets and liabilities may react differently to changes in overall market rates or conditions because there may be
mismatches between the repricing or maturity characteristics of the assets and liabilities. As a result, an increase or decrease in
market interest rates could have material adverse effects on our net interest margin, noninterest income and results of operations.
In a rising interest rate environment, potential borrowers could seek to defer loans as they wait for interest rates to settle, and
borrowers of variable rate loans may be subject to increased interest rates, which could result in a greater rate of prepayment or
default. Changes in interest rates may also present additional challenges to our business that we have not anticipated.
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The amount of other real estate owned, or OREO, may increase significantly, resulting in additional losses, and costs and
expenses that will negatively affect our operations.
In connection with our banking business, we take title to real estate collateral from time to time through foreclosure or otherwise
in connection with efforts to collect debts previously contracted. Such real estate is referred to as other real estate owned, or
OREO. As the amount of OREO increases, our losses, and the costs and expenses to maintain the real estate, likewise increase.
The amount of OREO we hold may increase due to various economic conditions or other factors. Any additional increase in
losses and maintenance costs and other expenses due to OREO may have a material adverse effect on our business, results of
operations and financial condition. Such effects may be particularly pronounced in a market of reduced real estate values and
excess inventory, which may make the disposition of OREO properties more difficult, increase maintenance costs and other
expenses, and reduce our ultimate realization from any OREO sales. In addition, at the time of acquisition of the OREO we are
required to reflect its fair market value in our financial statements. If the OREO declines in value subsequent to its acquisition,
we are required to recognize a loss. As a result, declines in the value of our OREO will have a negative effect on our business,
results of operations and financial condition. As of December 31, 2019, we had six OREO properties with an aggregate carrying
value of $5.6 million.
We are subject to environmental liability risk associated with our lending activities.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose
on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found
on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal
injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the
affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent
interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. The
remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect
on our business, results of operations and financial condition.
Our use of appraisals in deciding whether to make a loan secured by real property or how to value the loan in the future may
not accurately reflect the net value of the collateral that we can realize.
In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an
appraisal is only an estimate of the value of the property at the time the appraisal is made, and, as real estate values may experience
changes in value in relatively short periods of time, especially during periods of heightened economic uncertainty, this estimate
might not accurately describe the net value of the real property collateral after the loan has been closed. If the appraisal does not
reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to the
indebtedness secured by the property. In addition, we rely on appraisals and other valuation techniques to establish the value of
our OREO and to determine certain loan impairments. If any of these valuations are inaccurate, our consolidated financial
statements may not reflect the correct value of OREO, and our Allowance for loan and lease losses may not reflect accurate loan
impairments. The valuation of the properties securing the loans in our portfolio may negatively impact the continuing value of
those loans and could materially adversely affect our business, results of operations and financial condition.
We could be subject to losses, regulatory action or reputational harm due to fraudulent and negligent acts on the part of loan
applicants, our borrowers, our employees and vendors.
In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on
information furnished by or on behalf of customers and other third parties, including financial statements, property appraisals,
title information, employment and income documentation, account information and other financial information which may
include information furnished by sellers to our borrowers in connection with business acquisitions that we finance. We may also
rely on representations of clients and other third parties as to the accuracy and completeness of such information and, with respect
to financial statements, on reports of independent auditors. Any such misrepresentation or incorrect or incomplete information
may not be detected prior to funding a loan or during our ongoing monitoring of outstanding loans. In addition, one or more of
our employees or vendors could cause a significant operational breakdown or failure, either as a result of human error or where
an individual purposefully sabotages or fraudulently manipulates our loan documentation, operations or systems. Any of these
developments could have a material adverse effect on our business, results of operations and financial condition.
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We may fail to realize all of the anticipated benefits, including estimated cost savings, of potential future acquisitions.
In the future, we may encounter difficulties in obtaining required regulatory approvals for, or face unexpected contingent liabilities
from, businesses we may acquire. Integration of an acquired business can be complex and costly, sometimes including combining
relevant accounting and data processing systems and management controls, as well as managing relevant relationships with
employees, customers, suppliers and other business partners. Integration efforts could divert management attention and resources,
which could adversely affect our business, results of operations and financial condition. Additionally, during periods of market
volatility and uncertainty, we may also experience increased credit costs or need to take additional markdowns and allowances
for loan losses on assets and loans we may acquire. These increased credit costs, markdowns and allowances could materially
adversely affect our financial condition and results of operations, as well as the value of our common stock.
Implementation of our growth strategy depends, in part, on our ability to successfully identify acquisition opportunities and
strategic partners that will complement our operating philosophy, and also on the successful integration of their operations with
our own. To successfully acquire target companies or establish complementary lines of business, we must be able to correctly
identify profitable or growing markets, as well as attract the necessary relationships and high caliber personnel to make these new
business lines profitable. In addition, we may not be able to identify suitable opportunities for further growth and expansion. As
consolidation of the financial services industry continues, the competition for suitable acquisition candidates may increase. We
will compete with other financial services companies for acquisition opportunities, and many of these competitors have greater
financial resources than we do and may be able to pay more for an acquisition than we are able or willing to pay. If we are unable
to effectively implement our growth strategies, our business, results of operations and financial condition may be materially and
adversely affected.
Acquisitions may be delayed, impeded, or prohibited due to regulatory issues.
Acquisitions by the Company or the Bank, particularly those of financial institutions, are subject to approval by a variety of
federal and state regulatory agencies. Regulatory approvals could be delayed, impeded, restrictively conditioned or denied due to
regulatory issues we have, or may have, with regulatory agencies, including, without limitation, issues related to the CRA; fair
lending laws; fair housing laws; consumer protection laws; unfair, deceptive, or abusive acts or practices regulations; and other
similar laws and regulations. We may fail to pursue, evaluate or complete strategic and competitively significant acquisition
opportunities as a result of our inability, or perceived or anticipated inability, to obtain regulatory approvals in a timely manner,
under reasonable conditions or at all. Difficulties associated with potential acquisitions that may result from these factors could
have a material adverse impact on our business, and, in turn, our financial condition and results of operations.
The value of our goodwill and other intangible assets may decline in the future.
In connection with our acquisitions, we have generally recognized intangible assets, including goodwill, in our consolidated
balance sheet. We may not realize the value of these assets. Management performs an annual review of the carrying values of any
goodwill and indefinite-lived intangible assets and periodic reviews of the carrying values of all other intangible assets to
determine whether events and circumstances indicate that an impairment in value may have occurred. A variety of factors could
cause the carrying value of an asset to become impaired. Should a review indicate impairment, a write-down of the carrying value
of the asset would occur, resulting in a non-cash charge which would adversely affect our results of operations for the period. All
goodwill and intangibles recorded in 2017 were related to the acquisition of Reltco. On August 1, 2018, the Company financed
the sale of its entire interest in Reltco for $3.0 million. The Company’s divestiture was driven by expectations of future
profitability under current market conditions impacting the mortgage industry. See Note 2. Title Insurance Business for further
information on this transaction and related financial impacts. Although we did not have any goodwill or other intangible assets
on our balance sheet as of December 31, 2019, we may recognize intangible assets in connection with future acquisitions.
21
New lines of business or new products and services may subject us to additional risks.
We are focused on our long-term growth and have undertaken various new business initiatives, many of which involve activities
that are new to us, or in some cases, are in the early stages of development. From time to time, we may develop, grow and/or
acquire new lines of business or offer new products and services within existing lines of business. There are substantial risks and
uncertainties associated with these efforts, particularly in instances where the markets for these products and services are not fully
developed. For example, we have expanded our services in the government contracting industry to provide consulting and merger
and acquisition advisory services. We have also launched a Venture Banking vertical where we provide credit and other financial
services to venture-backed businesses that often have limited operating histories and are incurring significant losses. During
2019, our subsidiary Canapi Advisors began providing investment advisory services to a series of new funds focused on providing
venture capital to new and emerging financial technology companies. Given our evolving business and product diversification,
these new initiatives may subject us to, among other risks, increased business, reputational and operational risk, as well as more
complex legal, regulatory and compliance costs and risks.
In developing and marketing new lines of business and/or new products and services, we may invest significant time and
resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may
not be achieved, and price and profitability targets may not prove feasible. External factors, such as compliance with regulations,
competitive alternatives and shifting market preferences, may also impact the successful implementation of a new line of business
or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact
on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and
implementation of new lines of business or new products or services could have a material adverse effect on our business, results
of operations and financial condition. All service offerings, including current offerings and those which may be provided in the
future, may become more risky due to changes in economic, competitive and market conditions beyond our control.
We are subject to risk in connection with our strategic activities, including acquisitions, joint ventures, partnerships, and
investments.
We are engaged, and may in the future engage, in strategic activities, including acquisitions, joint ventures, partnerships,
investments or other business growth initiatives or undertakings. There can be no assurance that we will successfully identify
appropriate opportunities, that we will be able to negotiate or finance such activities or that such activities, if undertaken, will be
successful.
Our ability to execute strategic activities and new business initiatives successfully will depend on a variety of factors. These
factors likely will vary based on the nature of the activity but may include our success in integrating an acquired company or a
new internally-developed growth initiative into our business, operations, services, products, personnel and systems, operating
effectively with any partner with whom we elect to do business, meeting applicable regulatory requirements and obtaining
applicable regulatory licenses or other approvals, hiring or retaining key employees, achieving anticipated synergies, meeting
management's expectations, actually realizing the anticipated benefits of the activities, and overall general market conditions.
Our ability to address these matters successfully cannot be assured. In addition, our strategic efforts may divert resources or
management's attention from ongoing business operations and may subject us to additional regulatory scrutiny and potential
liability. If we do not successfully execute a strategic undertaking, it could adversely affect our business, financial condition,
results of operations, reputation or growth prospects. In addition, if we were to conclude that the value of an acquired business
had decreased and that the related goodwill had been impaired, that conclusion would result in an impairment of goodwill charge
to us, which would adversely affect our results of operations.
In addition, in order to finance future strategic undertakings, we might require additional financing, which might not be available
on terms favorable to us, or at all. If obtained, equity financing could be dilutive and the incurrence of debt and contingent
liabilities could have a material adverse effect on our business, results of operations or financial condition.
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Our investments in financial technology companies and initiatives, including the activities of our subsidiary Canapi Advisors,
subject us to material financial, reputational and strategic risks.
Our investments in various financial technology companies have had a significant impact on our results of operations, and we
anticipate they will continue to have a significant impact on our results of operations in the future. Investments where we have
the ability to exercise significant influence but not control over the operating and financial policies of the investee are accounted
for using the equity method of accounting. For investments accounted for under the equity method, we increase or decrease our
investment by our proportionate share of the investee’s net income or loss. Those investments where we are not able to exercise
significant influence over the investee are accounted for under ASU 2016-01, where changes in fair value resulting from
observable price changes arising from orderly transactions are recognized in net income. We also periodically evaluate our
investments for impairment. See Note 1. Organization and Summary of Significant Accounting Policies under the subheading
entitled “Investments” for more information.
Any earnings from our financial technology investments can be volatile and difficult to predict. Furthermore, we invest in many
of these financial technology companies for strategic purposes. Where we are a minority shareholder, we may be unable to
influence the activities of these organizations which could have an adverse impact on our ability to execute our strategic initiatives
and successfully develop and implement the banking platform we are developing with these and other partners.
Our subsidiary Canapi Advisors is an investment advisor to Canapi Ventures, a series of new funds focused on providing venture
capital to new and emerging financial technology companies. Canapi Ventures plans to invest in early to growth-stage companies
that may include companies that utilize advanced science, technology, engineering and/or mathematics to innovate in the financial
technology market. Investments in these companies involve a high degree of business and financial risk that can result in
substantial losses. These companies may be unseasoned, unprofitable or have no established operating histories or earnings and
may lack technical, marketing, financial and other resources. These companies often have the need for substantial additional
capital to support expansion or to achieve or maintain a competitive position. Less established companies tend to have lower
capitalization and fewer resources and, therefore, are often more vulnerable to financial failure. These companies may be
dependent upon the success of one product or service, a unique distribution channel, or the effectiveness of its manager or
management team. The failure of this one product, service or distribution channel, or the loss or ineffectiveness of a key executive
or executives within the management team may have a materially adverse impact on such companies. Such companies may face
intense competition, including competition from companies with greater financial resources, more extensive development,
manufacturing, marketing and service capabilities and a larger number of qualified managerial and technical personnel. If Canapi
Advisors is unable to successfully identify investment opportunities, it will likely lose the capital that it invests on behalf of the
fund’s investors, including the capital that we will invest, and will not generate any carried interest for the benefit of Live Oak
Bancshares, which would have a materially adverse effect on our results of operations, our reputation and our ability to raise
successive funds for similar purposes.
Many of the financial technology companies in which we invest present risks similar to those in which Canapi Ventures will
invest. The possibility that the companies in which we and Canapi Ventures invest will not be able to commercialize their
technology or product concept presents significant risk to our business operations and financial results. These companies tend to
lack management depth, to have limited or no history of operations and to not have attained profitability. Additionally, although
some of these companies may already have a commercially successful product or product line at the time of investment,
technology products and services often have a more limited market or life span than products in other industries. Thus, the ultimate
success of these companies may depend on their ability to continually innovate in increasingly competitive markets. Most of the
companies in which we and Canapi Ventures invest will require substantial additional equity financing to satisfy their continuing
growth and working capital requirements. Each round of venture financing is typically intended to provide a company with
enough capital to reach the next stage of development. The circumstances or market conditions under which such companies will
seek additional capital is unpredictable. It is possible that one or more of such companies will not be able to raise additional
financing or may be able to do so only at a price or on terms which are unfavorable.
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Our investments in other companies may be illiquid.
The equity securities of the companies in which we and Canapi Ventures invest are at the time of acquisition unmarketable and
illiquid, and there can be no assurance that a ready market for these securities will ever exist. Such securities generally cannot
be sold publicly without prior agreement with the issuer to register the securities under the Securities Act or by selling such
securities under Rule 144 or other provisions of the Securities Act which permit only limited sales under specified conditions.
We generally will realize the value of such securities only if the issuer is able to make an initial public offering of its shares or
enters into a business combination with another company which purchases our equity securities or exchanges them for publicly
traded securities of the acquirer. The feasibility of such transactions depends upon the company's financial results as well as
general economic and equity market conditions. Furthermore, even if the equity securities owned become publicly traded, our
ability to sell such securities may be limited by the lack of or limited nature of a trading market for such securities. There can be
no assurance that the value at which we carry these assets will necessarily reflect the amount which could be realized upon a sale
or other liquidity event.
We may be adversely impacted by the transition from LIBOR as a reference rate.
In 2017, the United Kingdom’s Financial Conduct Authority announced that after 2021 it would no longer compel banks to submit
the rates required to calculate the London Interbank Offered Rate (“LIBOR”). This announcement indicates that the continuation
of LIBOR on the current basis cannot and will not be guaranteed after 2021. Consequently, at this time, it is not possible to predict
whether and to what extent banks will continue to provide submissions for the calculation of LIBOR. Similarly, it is not possible
to predict whether LIBOR will continue to be viewed as an acceptable market benchmark, what rate or rates may become accepted
alternatives to LIBOR, or what the effect of any such changes in views or alternatives may be on the markets for LIBOR-indexed
financial instruments.
We have loans and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. The
transition from LIBOR could create considerable costs and additional risk. Since proposed alternative rates are calculated
differently, payments under contracts referencing new rates will differ from those referencing LIBOR. The transition will change
our market risk profiles, requiring changes to risk and pricing models, valuation tools, product design and hedging strategies.
Furthermore, failure to adequately manage this transition process with our customers could adversely impact our reputation.
Although we are currently unable to assess what the ultimate impact of the transition from LIBOR will be, failure to adequately
manage the transition could have a material adverse effect on our business, financial condition and results of operations.
We face strong competition from a diverse group of competitors.
The banking business is highly competitive, and we experience strong competition from many other financial institutions,
including some of the largest commercial banks headquartered in the country, as well as other federally and state chartered
financial institutions such as community banks and credit unions, finance and business development companies, consumer finance
companies, peer-to-peer and marketplace lenders, securities brokerage firms, insurance companies, money market and mutual
funds and other non-bank lenders.
We compete with these institutions both in attracting deposits and in making loans, primarily on the basis of the interest rates we
pay and yield on these products. We also compete with these institutions in our other business lines, including equipment leasing
and title insurance. Many of our competitors are well-established, much larger financial institutions. While we believe we can
successfully compete with these other lenders in our industry verticals, we may face a competitive disadvantage as a result of our
smaller size. Furthermore, nothing would prevent our competitors from developing or licensing a technology-based platform
similar to the technology-based platform we currently use in our business. In addition, many of our non-bank competitors have
fewer regulatory constraints and may have lower cost structures. We expect competition to continue to intensify due to financial
institution consolidation, legislative, regulatory and technological changes, and the emergence of alternative banking sources.
Our ability to compete successfully will depend on a number of factors, including, among other things:
• our ability to build and maintain long-term customer relationships while ensuring high ethical standards and safe and
sound banking practices;
•
the scope, relevance and pricing of products and services that we offer;
•
customer satisfaction with our products and services;
•
industry and general economic trends; and
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• our ability to keep pace with technological advances and to invest in new technology.
Increased competition could require us to increase the rates we pay on deposits or lower the rates we offer on loans, which could
reduce our profitability. Our failure to compete effectively in our primary markets could cause us to lose market share and could
have a material adverse effect our business, results of operations and financial condition.
Our investments and/or financings in certain tax-advantaged projects may not generate returns as anticipated and may have
an adverse impact on our financial results.
We invest in and/or finance certain tax-advantaged projects promoting renewable energy sources. Our investments in these
projects are designed to generate a return primarily through the realization of federal and state income tax credits, and other tax
benefits, over specified time periods. We utilize an investment tax credit for the installation of certain solar power facilities. We
are subject to the risk that previously recorded tax credits, which remain subject to recapture by taxing authorities based on
compliance features required to be met at the project level, will fail to meet certain government compliance requirements and will
not be able to be fully realized. The possible inability to realize these tax credits and other tax benefits can have a negative impact
on our financial results. The risk of not being able to realize the tax credits and other tax benefits depends on many factors outside
of our control, including changes in the applicable provisions of the tax code and the ability of the projects to be completed and
properly managed. In addition, we make loans through the USDA’s Rural Energy for America Program, which provides
guaranteed loan financing and grant funding to agricultural producers and rural small businesses for renewable energy systems
or to make energy-efficient improvements. Any changes to applicable provisions of the tax code or other developments could
adversely impact demand for these loans even where we are not utilizing an investment tax credit.
Our loan portfolio may be affected by deterioration in real estate markets, including declines in the performance of loans.
Deterioration in real estate markets could result in declining prices and excess inventories. As a result, developers may experience
financial deterioration and banking institutions may experience declines in the performance of construction, development and
commercial loans. We make credit and reserve decisions based on the current conditions of borrowers or projects combined with
our expectations for the future. If conditions are worse than forecast, we could experience higher charge-offs and delinquencies
than is provided in the allowance for loan and lease losses, which could materially adversely affect our business, results of
operations and financial condition.
Deterioration in the fiscal position of the U.S. federal government and downgrades in U.S. Treasury and federal agency
securities could adversely affect us and our subsidiary’s banking operations.
The long-term outlook for the fiscal position of the U.S. federal government is uncertain, as illustrated by the 2011 downgrade
by certain rating agencies of the credit rating of the U.S. government and federal agencies. In addition to causing economic and
financial market disruptions, any future downgrade, failure to raise the U.S. statutory debt limit, or deterioration in the fiscal
outlook of the U.S. federal government, could, among other things, materially adversely affect the market value of the U.S.
government and federal agency securities that we hold, the availability of those securities as collateral for borrowing, and our
ability to access capital markets on favorable terms. In particular, it could increase interest rates and disrupt payment systems,
money markets, and long-term or short-term fixed income markets, adversely affecting the cost and availability of funding, which
could negatively affect our profitability. Also, the adverse consequences could extend to those to whom we extend credit and
could adversely affect their ability to repay their loans. Any of these developments could materially adversely affect our business,
results of operations and financial condition.
Deterioration in the commercial soundness of our counterparties could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of
other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other
relationships, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even
rumors or questions about, one or more financial services institutions, or the financial services industry generally, could create
another market-wide liquidity crisis similar to that experienced in late 2008 and early 2009 and could lead to losses or defaults
by us or by other institutions. The deterioration or failure of our counterparties would have a material adverse effect on our
business, results of operations and financial condition.
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We have different lending risks than larger, more diversified banks.
Our ability to diversify our economic risks is limited. We lend primarily to small businesses in selected industries, which may
expose us to greater lending risks than those of banks lending to larger, better-capitalized businesses with longer operating
histories. Small businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities
and may have limited operating histories. If economic conditions negatively impact the verticals in which we operate, our
business, results of operations and financial condition may be adversely affected.
We attempt to manage our credit exposure through careful monitoring of loan applicants and through loan approval and review
procedures. We have established an evaluation process designed to determine the adequacy of our allowance for loan and lease
losses. While this evaluation process uses historical and other objective information, the classification of loans and the
establishment of loan losses is an estimate based on experience, judgment and expectations regarding our borrowers, and the
economies in which we and our borrowers operate, as well as the judgment of our regulators. This is an inherently uncertain
process, and our loan loss reserves may not be sufficient to absorb future loan losses or prevent a material adverse effect on our
business, results of operations and financial condition.
We rely heavily on our management team, and the unexpected loss of any of those personnel could adversely affect our
operations; we depend on our ability to attract and retain key personnel.
We are a customer-focused and relationship-driven organization. We expect our future growth to be driven in a large part by the
relationships maintained with our customers and partners by our chief executive officer, president, and other senior officers. The
unexpected loss of any of our key employees could have an adverse effect on our business, results of operations and financial
condition. The implementation of our business strategy will also require us to continue to attract, hire, motivate and retain skilled
personnel to develop new customer relationships as well as new financial products and services. We are not party to non-compete
or non-solicitation agreements with any of our officers or employees. The market for qualified employees in the businesses in
which we operate is competitive, and we may not be successful in attracting, hiring or retaining key personnel. Our inability to
attract, hire or retain key personnel could have a material adverse effect on our business, results of operations and financial
condition.
Our risk management framework may not be effective in mitigating risks and/or losses to us.
We have implemented a risk management framework to manage our risk exposure. This framework is comprised of various
processes, systems and strategies, and is designed to manage the types of risk to which we are subject, including, among others,
credit, market, liquidity, interest rate and compliance risks. Our framework also includes financial and other modeling
methodologies which involve management assumptions and judgment. Our risk management framework may not be effective
under all circumstances and it may fail to adequately identify or mitigate risk or loss to us. If our framework is not effective, we
could suffer unexpected losses and be subject to potentially adverse regulatory consequences, and our business, results of
operations and financial condition could be materially and adversely affected.
Hurricanes or other adverse weather events could disrupt our operations, which could have an adverse effect on our business
or results of operations.
North Carolina’s coastal region is affected, from time to time, by adverse weather events, particularly hurricanes. We cannot
predict whether, or to what extent, damage caused by future hurricanes or other weather events will affect our operations. Weather
events could cause a disruption in our day-to-day business activities and could have a material adverse effect on our business,
results of operations and financial condition.
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Outbreaks of disease or other pandemic events, such as the coronavirus or avian influenza, or the perception that outbreaks
may occur, could have a material adverse effect on our business.
Pandemic events beyond our control could have a material adverse effect on our business, financial condition, results of operations
and prospects. For example, there are broad and continuing concerns related to the potential effects of coronavirus on
international trade (including supply chains and export levels), travel, employee productivity and other economic activities that
may have a destabilizing effect on financial markets and economic activity. In addition, an outbreak of avian disease, or “bird
flu,” could have a material adverse effect on the performance of our portfolio of loans in our Agriculture vertical and on the
demand for new loans in this vertical. An outbreak of disease could result in governmental restrictions on the import and export
of fresh and frozen chicken or other poultry products to or from our customers. This could result in the cancellation of orders and
the curtailment of farming operations by our customers and could create adverse publicity that may have a material adverse effect
on the performance of our existing loans and future business prospects in our Agriculture vertical. In addition, consumer fears
about avian disease have, in the past, depressed demand for fresh poultry, which may adversely impact the demand for future
loans and the performance of existing loans in our Agriculture vertical.
If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report
our financial results. As a result, current and potential shareholders could lose confidence in our financial reporting which
would harm our business and the trading price of our securities.
If we identify material weaknesses in our internal control over financial reporting or are otherwise required to restate our financial
statements, we could be required to implement expensive and time-consuming remedial measures and could lose investor
confidence in the accuracy and completeness of our financial reports. We may also face regulatory enforcement or other actions,
including the potential delisting of our securities from NASDAQ. This could have a material adverse effect on our business,
financial condition and results of operations, and could subject us to litigation.
Changes in accounting standards and management’s selection of accounting methods, including assumptions and estimates,
could materially impact our financial statements.
From time to time the SEC and the Financial Accounting Standards Board, or FASB, update accounting principles generally
accepted in the United States ("GAAP") that govern the preparation of our financial statements. These changes can be hard to
predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we
could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results,
or a cumulative charge to retained earnings. In addition, management is required to use certain assumptions and estimates in
preparing our financial statements, including determining the fair value of certain assets and liabilities, among other items. If the
assumptions or estimates are incorrect, we may experience unexpected material adverse consequences that could negatively affect
our business, results of operations and financial condition.
Our business reputation is important and any damage to it could have a material adverse effect on our business.
Our reputation is very important to sustain our business, as we rely on our relationships with our current, former and potential
customers, our technology and other strategic partners, our shareholders, and the industries that we serve. Any damage to our
reputation, whether arising from legal, regulatory, supervisory or enforcement actions, matters affecting our financial reporting
or compliance with SEC and exchange listing requirements, negative publicity, the conduct of our business or otherwise could
have a material adverse effect on our business, results of operations and financial condition.
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Insiders have substantial control over us, and this control may limit our shareholders’ ability to influence corporate matters
and may delay or prevent a third party from acquiring control over us.
As of January 31, 2020, our directors and executive officers and their related entities currently beneficially own, in the aggregate,
approximately 25.1% of our outstanding common stock. The significant concentration of stock ownership may adversely affect
the trading price of our common stock due to investors’ perception that conflicts of interest may exist or arise. In addition, these
shareholders will be able to exercise influence over all matters requiring shareholder approval, including the election of directors
and approval of corporate transactions, such as a merger or other sale of our company or its assets. This concentration of ownership
could limit your ability to influence corporate matters and may have the effect of delaying or preventing a change in control,
including a merger, consolidation or other business combination involving us, or discouraging a potential acquirer from making
a tender offer or otherwise attempting to obtain control, even if that change in control would benefit our other shareholders. For
information regarding the ownership of our outstanding stock by our executive officers and directors and related entities, see
“Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters” in this Report.
Risks Related to Our Investment in Apiture
If the market for Apiture’s digital banking solutions develops more slowly than we expect or changes in ways that we fail to
anticipate, our operating results would be adversely affected.
Use of and reliance on digital banking solutions is at an early stage, and we do not know whether the market will develop more
slowly than we anticipate. Many financial institutions have invested substantial resources in legacy software, and these institutions
may be reluctant or unwilling to convert from their existing systems to Apiture’s digital banking solutions. Furthermore, for most
financial institutions, transitioning from an existing software provider (or from an internally developed legacy system) to a new
provider is a significant and expensive undertaking. Potential customers of Apiture’s digital banking solutions may conclude that
switching providers involves too many potential disadvantages such as disruption of business operations, loss of accustomed
functionality and increased costs (including conversion and transition costs). Furthermore, some financial institutions may be
reluctant or unwilling to use a cloud-based solution over concerns such as the security of their data and reliability of the delivery
model. These concerns or other considerations may cause potential customers to choose not to adopt cloud-based solutions such
as those being developed by Apiture or to adopt alternative solutions, either of which could have a material adverse impact on
our business, results of operations and financial condition.
Apiture's future success will depend on its ability to develop, sell and deliver new or enhanced solutions to financial institution
clients; however, these solutions and related services may not be attractive to existing or prospective clients. In addition,
promoting, selling and delivering these new and enhanced solutions may require increasingly costly sales, marketing and
implementation efforts, and if existing or prospective clients choose not to adopt these solutions, our business, results of
operations and financial condition could be materially and adversely affected.
Apiture may experience development delays or software defects, which could adversely impact its potential profitability and
our results of operations.
Apiture’s digital banking solution will require sophisticated software and computing systems that may encounter development
delays or software defects. Defects in Apiture’s software offerings or delays in the development of such software could result in
unforeseen costs, diversion of technical and other resources, loss of credibility with existing and potential clients or reputational
harm, any of which could materially adversely affect our business, results of operations and financial condition. Furthermore,
to the extent that the Bank is involved in beta testing or early adoption of Apiture’s digital banking solutions, the Bank’s personnel
and resources may be diverted from the day-to-day operation of the Bank, and the Bank’s operations may be adversely impacted.
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Apiture’s ability to anticipate and respond to changing industry trends and the needs and preferences of financial institution
clients may affect its competitiveness or demand for its digital banking solutions, which may adversely affect our operating
results.
The financial services, payments, and technology industries are subject to rapid technological advancements, new products and
services, an evolving competitive landscape, developing industry standards and changing client and consumer needs and
preferences. We expect that new services and technologies applicable to the financial services, payments and technology
industries will continue to emerge and evolve. These changes in technology may limit the competitiveness of and demand for
products or services offered by Apiture. Also, Apiture’s existing and prospective financial institution clients and their respective
customers continue to adopt new technology for business and personal uses. Apiture must anticipate and respond to these changes
in order to compete in its market.
Apiture’s failure to develop products and services that meet the needs and preferences of its clients could have an adverse effect
on its ability to compete effectively. Furthermore, potential negative reaction to Apiture’s products and services can spread
quickly through social media and damage its reputation before it has the opportunity to respond. If Apiture is unable to anticipate
or respond to technological changes or evolving industry demands on a timely basis, our business, results of operations and
financial condition could be materially adversely affected.
If Apiture is unable to effectively integrate its digital banking solutions with other systems used by financial institutions, its
solutions will not operate effectively and our results of operations could be adversely affected.
The functionality of Apiture’s digital banking solutions will depend on its ability to integrate with other third-party systems used
by potential clients, including well-established core processing systems. Certain providers of these third-party systems also offer
solutions that are competitive to the solutions being developed by Apiture and may have an advantage with clients already using
their software by having better ability to integrate with their software and by being able to bundle their competitive products with
other applications used by Apiture’s existing and prospective financial institution clients at favorable pricing.
Security breaches or attacks on Apiture’s systems may have a significant effect on our business.
In order to offer its products and services, Apiture must process, store, and transmit sensitive business information and personal
consumer information, including, but not limited to, names, bankcard numbers, home or business addresses, social security
numbers, driver's license numbers and bank account numbers. Under various federal, state and international laws, Apiture is
responsible for information provided to it by financial institutions, merchants, third-party service providers, and others.
Maintaining the confidentiality of such sensitive business information and personal consumer information will be critical to
Apiture’s business; however, Apiture cannot be certain that the security measures and procedures it puts in place to protect this
sensitive data will be successful or sufficient to counter all current and emerging technology threats designed to breach network
security in order to gain access to confidential information. The increasing sophistication of cyber criminals and their continuous
attempts to breach networks presents risk of a security breach of Apiture’s systems. A breach of Apiture’s systems processing or
storing sensitive business information or personal consumer information could lead to claims against it, reputational damage, lost
clients and lost revenue, substantial additional costs (including costs of notification of consumers, credit monitoring, card
reissuance, contact centers and forensics), loss of clients' and their customers’ confidence, as well as imposition of fines and
damages, all of which could materially adversely affect our business, results of operations and financial condition. In addition,
as security threats continue to evolve, Apiture will be required to invest additional resources to modify and update the security of
its systems. The level of required investment could materially adversely affect our business, results of operations and financial
condition.
Apiture may experience breakdowns in its processing systems that could damage client relations and expose it to liability.
Apiture’s business will rely heavily on the reliability of its processing systems. A system outage could have a material adverse
effect on Apiture’s business, financial condition, and results of operations. Not only would it suffer damage to its reputation in
the event of a system outage, but Apiture may also be liable to third parties. To successfully operate its business, Apiture must be
able to protect its processing and other systems from interruption, including from events that may be beyond its reasonable
control. Events that could cause system interruptions include, but are not limited to, fire, natural disaster, unauthorized entry,
power loss, telecommunications failure, computer viruses, terrorist acts, cyber attacks and war. To the extent Apiture outsources
its disaster recovery functions, it is at risk of the vendor’s unresponsiveness or other failures in the event of system breakdowns.
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Risks Related to Our Regulatory Environment
We are subject to extensive regulation that could limit or restrict our activities.
We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various
federal and state regulatory agencies. Our compliance with these regulations is costly and restricts certain of our activities,
including the declaration and payment of cash dividends to shareholders, mergers and acquisitions, investments, loans and interest
rates charged, interest rates paid on deposits, and locations of offices. We are also subject to capitalization guidelines established
by our regulators, which require us to maintain adequate capital to support our growth and operations. See “Supervision and
Regulation” above for more information on the federal and state laws, rules and regulations that apply to our business activities.
Should we fail to comply with these regulatory requirements, federal and state regulators could impose additional restrictions on
the activities of the Company and the Bank, which could materially and adversely affect our business, results of operations and
financial condition.
The laws and regulations applicable to the banking industry have changed in recent years and may continue to change, and we
cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the
business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect
our business, results of operations and financial condition.
Congress may consider proposals to change substantially the financial institution regulatory system and to expand or contract the
powers of banking institutions and bank holding companies. Such legislation may change existing banking statutes and
regulations, as well as our current operating environment significantly. If enacted, such legislation could increase or decrease the
cost of doing business, limit or expand our permissible activities, or affect the competitive balance among banks, savings
associations, credit unions, other financial institutions and non-bank lenders. We cannot predict whether new legislation will be
enacted and, if enacted, the effect that it, or any regulations, would have on our business, results of operations or financial
condition.
Our financial condition and results of operations are affected by credit policies of monetary authorities, particularly the Federal
Reserve. Actions by monetary and fiscal authorities, including the Federal Reserve, could have an adverse effect on our deposit
levels, loan demand, or business and earnings, as well as the value of our common stock.
We may be required to raise additional capital in the future, including to comply with increased minimum capital thresholds
established by our regulators as part of their implementation of Basel III, but that capital may not be available when it is
needed and could be dilutive to our existing shareholders, which could adversely affect our financial condition and results of
operations.
In July 2013, the Federal Reserve, FDIC and Office of the Comptroller of the Currency approved final rules that establish an
integrated regulatory capital framework that addresses perceived shortcomings in certain capital requirements. The rules
implement in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and
certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act.
The major provisions of the rule applicable to the Company are:
• The rule implemented higher minimum capital requirements, including a new common equity Tier1 capital requirement,
and established criteria that instruments must meet in order to be considered Common Equity Tier 1 capital, additional
Tier 1 capital, or Tier 2 capital. The minimum capital to risk-weighted assets (“RWA”) requirements under the rule are
a common equity Tier 1 capital ratio of 4.5% and a Tier 1 capital ratio of 6.0%, which is an increase from 4.0%, and a
total capital ratio that remains at 8.0%. The minimum leverage ratio (Tier 1 capital to total assets) is 4.0%. The rule
maintains the general structure of the current prompt corrective action, or PCA, framework while incorporating these
increased minimum requirements.
• The rule implemented changes to the definition of capital, including stricter eligibility criteria for regulatory capital
instruments that disallow the inclusion of instruments such as trust preferred securities in Tier 1 capital going forward,
and new constraints on the inclusion of minority interests, mortgage-servicing assets (“MSAs”), deferred tax assets
(“DTAs”), and certain investments in the capital of unconsolidated financial institutions.
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• Under the rule, in order to avoid limitations on capital distributions, including dividend payments and certain
discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer
composed of common equity Tier 1 capital above its minimum risk-based capital requirements. The buffer is measured
relative to RWA. A three-year phase-in of the capital conservation buffer requirements began on January 1, 2016 and
was completed on January 1, 2019. A banking organization with a buffer greater than 2.5% is not subject to limits on
capital distributions or discretionary bonus payments; however, a banking organization with a buffer of less than 2.5%
is subject to increasingly stringent limitations as the buffer approaches zero. The rule also prohibits a banking
organization from making distributions or discretionary bonus payments during any quarter if its eligible retained income
is negative in that quarter and its capital conservation buffer ratio was less than 2.5% at the beginning of the quarter.
Now that the rule is fully phased in, the minimum capital requirements plus the capital conservation buffer exceed the
PCA well-capitalized thresholds.
• The rule also increased the risk weights for past-due loans, certain commercial real estate loans, and some equity
exposures, and made selected other changes in risk weights and credit conversion factors.
Compliance by LOB and the Bank with these capital requirements affects their respective operations by increasing the amount
of capital required to conduct operations. In order to support the operations at the Bank, we may need to raise capital in the
future. Our ability to raise capital will depend in part on conditions in the capital markets at that time, which are outside our
control. Accordingly, we may be unable to raise capital on terms acceptable to us if at all. If we cannot raise capital when needed,
our ability to operate or further expand our operations could be materially impaired. In addition, if we decide to raise equity
capital under such conditions, the interests of our shareholders could be diluted.
Our deposit operations are subject to extensive regulation, and we expect additional regulatory requirements to be
implemented in the future.
We are subject to significant anti-money laundering, “know your customer” and other regulations under applicable law, including
the Bank Secrecy Act and the USA PATRIOT Act, and we could become subject in the future to additional regulatory requirements
beyond those that are currently adopted, proposed or contemplated. We expect that federal and state bank regulators will increase
their oversight, inspection and investigatory role over our deposit operations and the financial services industry generally.
Furthermore, we intend to increase our deposit product offerings and grow our customer deposit portfolio in the future and, as a
result, we are, and will continue to be, subject to heightened compliance and operating costs that could adversely affect our
business, results of operations and financial condition. In addition, legal and regulatory proceedings and other contingencies will
arise from time to time that may have an adverse effect on our business practices and results of operations.
The FDIC Deposit Insurance assessments that we are required to pay may continue to materially increase in the future, which
would have an adverse effect on our earnings.
As a member institution of the FDIC, our Bank is assessed a quarterly deposit insurance premium. During 2009 to 2012, the large
number of bank failures across the nation significantly depleted the deposit insurance fund, or DIF, and reduced the ratio of
reserves to insured deposits. On October 19, 2010, the FDIC adopted a DIF Restoration Plan, which requires the DIF to attain a
1.35% reserve ratio by September 30, 2020. The Dodd-Frank Act directs the FDIC to “offset the effect” of the increased reserve
ratio for insured depository institutions with total consolidated assets of less than $10 billion. In addition, the FDIC modified the
method by which assessments are determined and, effective April 1, 2011, adjusted assessment rates, which currently range from
2.5 to 45 basis points (annualized), subject to adjustments for unsecured debt and, in the case of small institutions outside the
lowest risk category and certain large and highly complex institutions, brokered deposits. As a result, we may be required to pay
significantly higher premiums or additional special assessments that could adversely affect our business, results of operations and
financial condition. Increased FDIC assessment premiums, due to our risk classification, emergency assessments, or
implementation of the modified DIF reserve ratio, could have a material adverse effect on our business, results of operations and
financial condition.
31
Risks Related to our Common Stock
The low trading volume in our common stock may adversely affect your ability to resell shares at prices that you find attractive
or at all.
Our common stock is listed for quotation on the NASDAQ Global Select Market under the ticker symbol “LOB”. The average
daily trading volume for our common stock is less than that of larger financial institutions. Due to its relatively low trading
volume, sales of our common stock may place significant downward pressure on the market price of our common stock.
Furthermore, it may be difficult for holders to resell their shares at prices they find attractive, or at all.
Securities analysts may not initiate or continue coverage on our common stock.
The trading market for our common stock depends in part on the research and reports that securities analysts publish about us
and our business. We do not have any control over these securities analysts, and they may not cover our common stock. If
securities analysts do not cover our common stock, the lack of research coverage may adversely affect its market price. If we are
covered by securities analysts, and our common stock is the subject of an unfavorable report, the price of our common stock may
decline. If one or more of these analysts cease to cover us or fail to publish regular reports on us, we could lose visibility in the
financial markets, which could cause the price or trading volume of our common stock to decline.
We are incurring increased costs and obligations as a result of being a public company.
As a relatively new public company, we are required to comply with certain additional corporate governance and financial
reporting practices and policies required of a publicly traded company. As a result, we have and will continue to incur significant
legal, accounting and other expenses that we were not required to incur as a privately held company, due to compliance
requirements of the Exchange Act, Sarbanes-Oxley, the Dodd-Frank Act, the listing requirements of NASDAQ, and other
applicable securities rules and regulations. The Exchange Act requires, among other things, that we file annual, quarterly, and
current reports with respect to our business and operating results with the SEC. We are also required to ensure that we have the
ability to prepare financial statements that are fully compliant with all SEC reporting requirements on a timely basis. Compliance
with these rules and regulations will increase our legal and financial compliance costs, and might make some activities more
difficult, time-consuming or costly and increase demand on our systems and resources.
Future sales of shares of our common stock by existing shareholders could depress the market price of our common stock.
LOB had 40,318,407 shares of common stock outstanding at January 31, 2020. In addition, as of January 31, 2020, there were
outstanding options to purchase 2,513,862 shares of our common stock that, if exercised, will result in these additional shares
becoming available for sale. Also, as of January 31, 2020, there were 457,152 outstanding restricted stock units that vest over
time and 3,154,324 outstanding restricted stock units that vest based on revenue and stock price performance criteria, that when
vested will result in additional shares becoming available for sale. A large portion of these shares, options and restricted stock
units are held by a small number of persons. Sales by these shareholders or option and restricted stock unit holders of a substantial
number of shares could significantly reduce the market price of our common stock.
Our ability to pay cash dividends on our securities is limited and we may be unable to pay future dividends.
We may not declare or pay dividends on our securities, including our common stock, in the future. Any future determination
relating to dividend policy will be made at the discretion of our board of directors and will depend on a number of factors,
including our future earnings, capital requirements, financial condition, future prospects, regulatory restrictions, and other factors
that our board of directors may deem relevant. The holders of our capital stock are entitled to receive dividends when, and if,
declared by our board of directors out of funds legally available for that purpose. As part of our consideration to pay cash
dividends, we intend to retain adequate funds from future earnings to support the development and growth of our business. In
addition, our ability to pay dividends is restricted by federal policies and regulations. It is the current policy of the Federal Reserve
that bank holding companies should pay cash dividends on capital stock only out of net income available over the past year and
only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. Further,
our principal source of funds to pay dividends is cash dividends that we receive from the Bank, which, in turn, will be highly
dependent upon the Bank’s historical and projected results of operations, liquidity, cash flows and financial condition, as well as
various legal and regulatory prohibitions and other restrictions on the ability of the Bank to pay dividends, extend credit or
otherwise transfer funds to LOB.
32
Additional issuances of common stock or securities convertible into common stock may dilute holders of our common stock.
LOB may, in the future, determine that it is advisable, or LOB may encounter circumstances where it is determined that it is
necessary, to issue additional shares of common stock, securities convertible into, exchangeable for or that represent an interest
in common stock, or common stock-equivalent securities to fund strategic initiatives or other business needs or to build additional
capital. Our board of directors is authorized to cause us to issue additional shares of common stock from time to time for adequate
consideration without any additional action on the part of our shareholders. The market price of our common stock could decline
as a result of other offerings, as well as other sales of a large block of common stock or the perception that such sales could occur.
LOB is subject to extensive regulation, and ownership of its common stock may have regulatory implications for holders
thereof.
LOB is subject to extensive federal and state banking laws, including the Bank Holding Company Act of 1956, as amended, or
BHCA, and federal and state banking regulations, that impact the rights and obligations of owners of its common stock, including,
for example, its ability to declare and pay dividends on its common stock.
Shares of LOB’s common stock are voting securities for purposes of the BHCA and any bank holding company or foreign bank
that is subject to the BHCA may need approval to acquire or retain more than 5% of the then outstanding shares of LOB’s common
stock, and any holder (or group of holders deemed to be acting in concert) may need regulatory approval to acquire or retain 10%
or more of the shares of LOB’s common stock. Furthermore, the BHCA generally requires regulatory approval before any
individual or company may acquire 25% or more of any class of LOB’s common stock, and such regulatory approval may be
required under certain circumstances if a person, company or group acting in concert acquires 10% or more, but less than 25%
of LOB’s common stock. Under certain limited circumstances, a holder or group of holders acting in concert may exceed the
25% percent threshold and not be deemed to control us until they own 33% percent or more of our total equity. The amount of
total equity owned by a holder or group of holders acting in concert is calculated by aggregating all shares held by the holder or
group, whether as a combination of voting or non-voting shares or through other positions treated as equity for regulatory or
accounting purposes and meeting certain other conditions. Holders of LOB common stock should consult their own counsel with
regard to regulatory implications.
Holders should not expect us to redeem or repurchase outstanding shares of LOB common stock.
LOB’s common stock is a perpetual equity security. This means that it has no maturity or mandatory redemption date and will
not be redeemable at the option of the holders. Any decision LOB may make at any time to propose the repurchase or redemption
of shares of its common stock will depend upon, among other things, our evaluation of the Company’s capital position, the
composition of our shareholders’ equity, general market conditions at that time and other factors we deem relevant. LOB’s ability
to redeem shares of its common stock is subject to regulatory restrictions and limitations, including those of the Federal Reserve
Board.
Offerings of debt, which would rank senior to LOB’s common stock upon liquidation, may adversely affect the market price
of LOB common stock.
The Company may attempt to increase its capital resources or, if regulatory capital ratios fall below the required minimums, The
Company could be forced to raise additional capital by making additional offerings of debt or equity securities, senior or
subordinated notes, preferred stock and common stock. Upon liquidation, holders of the Company’s debt securities and lenders
with respect to other borrowings will receive distributions of available assets prior to the holders of LOB common stock.
Anti-takeover provisions could adversely affect LOB shareholders.
In some cases, shareholders would receive a premium for their shares if LOB were acquired by another company. However, state
and federal law and LOB’s articles of incorporation and bylaws make it difficult for anyone to acquire the Company without
approval of the LOB board of directors. For example, LOB’s articles of incorporation require a supermajority vote of two-thirds
of our outstanding common stock in order to effect a sale or merger of the Company in certain circumstances. Consequently, a
takeover attempt may prove difficult, and shareholders may not realize the highest possible price for their securities.
Shares of LOB common stock are not insured deposits and may lose value.
Shares of LOB common stock are not savings accounts, deposits or other obligations of any depository institution and are not
insured or guaranteed by the FDIC or any other governmental agency or instrumentality, any other deposit insurance fund or by
33
any other public or private entity. An investment in our common stock is inherently risky for the reasons described in this “Risk
Factors” section. As a result, if you acquire shares of our common stock, you may lose some or all of your investment.
Item 1B. UNRESOLVED STAFF COMMENTS
There were no unresolved comments received from the SEC regarding LOB’s periodic or current reports.
Item 2. PROPERTIES
The following table sets forth the location of the Company’s main offices, as well as additional administrative offices and certain
information relating to the facilities.
Office
Main Offices
Atlanta, GA Office
Santa Rosa, CA Office
Roseville, CA Office
Wilmington Flight
Operations
Washington, DC Office
New York, NY Office
Raleigh, NC Office
Address
1741 Tiburon Dr
1757 Tiburon Dr
1805 Tiburon Dr
1811 Tiburon Dr
3060 Peachtree Rd
Ste. 1220
100 B Street
Ste. 100
1223 Pleasant Grove Blvd
Ste. 120
1890 Trask Drive
2099 Pennsylvania Ave,
NW
212 West 91st St,
Apt 635
1017 Main Campus Dr.,
Ste. 3200
Year Opened
2013
2015
2019
2019
2010
2015
2016
2017
2017
2018
2019
Approximate
Square Footage Owned or Leased
36,000
55,000
80,972
24,329
4,455
2,386
1,186
Owned
Leased
Leased
Leased
25,500
Owned
3,698
400
3,889
Leased
Leased
Leased
The Company believes that its properties are maintained in good operating condition and are suitable and adequate for its
operational needs.
Item 3. LEGAL PROCEEDINGS
In the ordinary course of operations, the Company is at times involved in legal proceedings. In the opinion of management, as of
December 31, 2019, there are no material pending legal proceedings to which LOB or any of its subsidiaries is a party or of which
any of their property is the subject.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
34
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
The Company's voting common stock is traded on the NASDAQ Global Select Market under the symbol “LOB.” Quotations of
the sales volume and the closing sales prices of the voting common stock of the Company are listed daily in the NASDAQ Global
Select Market’s listings. As of January 31, 2020, there were 40,318,407 shares outstanding (comprised of 37,602,876 voting
common shares and 2,715,531 non-voting common shares) and 344 holders of record (comprised of 341 holders of record for
voting common shares and 3 holders of record for non-voting common shares) for the Company's common stock. The Company's
non-voting common stock is not listed for trading on any exchange.
Dividend Policy
The timing and amount of cash dividends paid depends on the Company’s earnings, capital requirements, financial condition and
other relevant factors. Although the Company has paid quarterly cash dividends to its shareholders are not entitled to receive
dividends. Downturns in domestic and global economies and other factors could cause the Company’s board of directors to
consider, among other things, the elimination of or reduction in the amount and/or frequency of cash dividends paid on the
Company’s common stock. See “Supervision and Regulation” under Item 1 of this Report for more information on restrictions
on the Company’s ability to declare and pay dividends. The Company can offer no assurance that the board of directors will
continue to declare or pay cash dividends in any future period.
Recent Sales of Unregistered Securities
None.
Securities Authorized for Issuance under Equity Compensation Plans
See Item 12 of this report for disclosure regarding securities authorized for issuance and equity compensation plans required by
Item 201(d) of Regulation S-K.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
Stock Performance Graph
The stock performance graph required by Item 201(e) of Regulation S-K is incorporated into this Report by reference from the
Company’s annual report to shareholders for the year ended December 31, 2019, which will be posted on the Company’s website
subsequent to the date of this Report. The stock performance graph shall not be deemed to be “filed” for purposes of Section 18
of the Exchange Act, nor shall it be deemed to be “soliciting material” subject to Regulation 14A or incorporated by reference in
any filing under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.
35
Item 6. SELECTED FINANCIAL DATA
The tables below set forth selected consolidated financial data as of the dates or for the periods indicated. This data should be
read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and
the Consolidated Financial Statements and Notes in Item 8 of this Report.
(dollars in thousands, except per share data)
Income Statement Data
Net interest income
Provision for loan and lease loss
Noninterest income
Noninterest expense
Income, before income taxes
Income tax (benefit) expense
Net income
Net income attributable to noncontrolling interest
Net income to common shareholders
Period End Balances
Assets
Loans held for sale
Loans and leases held for investment
Allowance for loan and lease losses
Deposits
Borrowings
Shareholders' equity
Per Common Share Data
Net income per share - basic
Net income per share - diluted
Operating net income per share
(Non-GAAP) - basic (1)
Operating net income per share
(Non-GAAP) - diluted (1)
Dividends declared
Book value
Tangible book value (1)
2019
As of and for the Year Ended December 31,
2017
2018
2016
78,034 $
$ 140,082 $ 108,043 $
19,573
9,536
13,058
67,880 103,765 172,921
42,649 $
12,536
93,539
164,924 152,704 143,165 106,445
17,207
3,443
13,764
9
13,773
98,254
46,046
(5,402 )
(2,245 )
51,448 100,499
—
51,448 100,499
23,465
5,431
18,034
—
18,034
—
2015
25,589
3,806
84,328
71,715
34,396
13,795
20,601
24
20,625
4,814,970 3,670,449 2,758,474 1,755,261 1,052,622
966,447 687,393 680,454 394,278 480,619
2,647,299 1,843,419 1,343,973 907,566 279,969
7,415
4,229,122 3,149,583 2,260,263 1,485,076 804,788
28,375
532,386 493,560 436,933 222,847 199,488
32,434
26,564
24,190
48,247
27,843
18,209
1,457
14
0.45
0.44
1.28
1.24
2.75
2.65
0.40
0.39
0.66
0.65
0.48
1.36
1.29
0.59
0.54
0.47
0.12
13.20
13.20
1.32
0.12
12.29
12.29
1.25
0.10
10.95
10.85
0.57
0.07
6.51
6.51
0.53
0.10
5.84
5.84
36
Performance Ratios
Return on average assets
Return on average equity
Net interest margin
Efficiency ratio (1)
Noninterest income to total revenue
Average equity to average assets
Dividend payout ratio (inclusive of tax distributions)
Selected Loan Metrics
Loans and leases originated
Guaranteed loans sold
Average net gain on sale of guaranteed loans
Adjusted average net gain on sale of guaranteed
loans (1)
Outstanding balance of sold loans serviced:
Guaranteed
Unguaranteed
Total
2019
As of and for the Year Ended December 31,
2017
2016
2018
0.42 %
3.46
3.65
79.54
32.44
12.15
26.67
1.52 %
11.00
3.62
72.10
48.99
13.83
9.38
4.55 %
33.80
3.92
57.05
68.91
13.46
3.64
0.96 %
6.55
3.28
78.16
68.68
14.63
17.50
2015
2.26 %
14.52
3.26
65.25
76.72
15.53
15.15
$ 2,001,886 $ 1,765,680 $ 1,934,238 $ 1,537,010 $ 1,158,640
340,374 945,178 787,926 761,933 640,886
105.14
100.38
84.79
98.86
80.91
93.58
80.98
100.53
-
-
2,746,480 3,045,460 2,680,641 2,278,618 1,779,989
224,127 174,066 169,355 145,099 178,036
2,970,607 3,219,526 2,849,996 2,423,717 1,958,025
$
$
Asset Quality Ratios
Allowance for loan and lease losses to loans and
leases held for investment
Net charge-offs
Net charge-offs to average loans and leases held for
investment
Nonperforming loans
Foreclosed assets
Nonperforming loans (unguaranteed exposure)
Foreclosed assets (unguaranteed exposure)
Nonperforming loans not guaranteed by the U.S.
government and foreclosed assets
Nonperforming loans not guaranteed by the U.S.
government and foreclosed assets to total assets
Capital and Liquidity Ratios
Common equity tier 1 capital (to risk-weighted assets)
Total capital (to risk-weighted assets)
Tier 1 risk-based capital (to risk-weighted assets)
Tier 1 leverage capital (to average assets)
1.82 %
3,760 $
1.76 %
4,814 $
1.80 %
3,555 $
2.01 %
1,742 $
0.17 %
76,307 $
5,612
17,908
1,120
0.31 %
57,690 $
1,094
14,488
148
0.32 %
23,480 $
1,281
3,610
90
0.29 %
23,781 $
1,648
4,784
246
2.65 %
798
0.37 %
12,367
2,666
2,037
373
19,028
14,636
3,700
5,030
2,410
0.40 %
0.40 %
0.13 %
0.29 %
0.23 %
14.85 %
16.10
14.85
10.65
17.10 %
18.28
17.10
13.40
17.81 %
18.91
17.81
15.50
15.31 %
16.56
15.31
12.00
23.22 %
24.12
23.22
18.36
(1) See "Non-GAAP Measures" in Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations of this Report for more information and a reconciliation to the most closely related GAAP measure.
37
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Overview
The following presents management’s discussion and analysis of the more significant factors that affected the Company's
financial condition as of December 31, 2019 and 2018 and results of operations for each of the years in the three-year period
ended December 31, 2019. This discussion should be read in conjunction with the financial statements and related notes included
elsewhere in this Annual Report on Form 10-K. Results of operations for the periods included in this review are not necessarily
indicative of results to be obtained during any future period.
Dollar amounts in tables are stated in thousands, except for per share amounts.
Nature of Operations
Live Oak Bancshares, Inc. is a financial holding company and 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 was incorporated in February 2008 as a North
Carolina-chartered commercial bank. The Bank specializes in providing lending to small businesses nationwide in targeted
industries and deposit-related services to small businesses, consumers and other customers nationwide. The Bank identifies and
seeks to grow within selected industry sectors, or verticals, by leveraging expertise within those industries. A significant portion
of the loans originated by the Bank are guaranteed by the Small Business Administration under the 7(a) Loan program and the
U.S. Department of Agriculture (“USDA”) Rural Energy for America Program (“REAP”), Water and Environmental Program
(“WEP”) and Business & Industry (“B&I”) loan programs.
During the fourth quarter of 2018, the Company began implementing a strategic decision to retain a larger portion of its loans
eligible for sale on its balance sheet. Management believes this decision will reduce future earnings volatility and maximize
long-term profitability. This strategic change had an immediate impact through the reclassification of $80.3 million in guaranteed
loans from held-for-sale to held-for-investment status. Other effects of this change began to be reflected in the financial statements
in the fourth quarter of 2018 with significantly fewer loans sold during the quarter and the initial consequence of increased net
interest income.
In 2018, the Company formed Canapi Advisors, LLC for the purpose of providing investment advisory services to a series of new
funds focused on providing venture capital to new and emerging financial technology companies. In 2019, Live Oak Clean
Energy Financing LLC (“LOCEF”) became a wholly owned subsidiary of the Bank. LOCEF was formed in November 2016 as
a subsidiary of the Company for the purpose of providing financing to entities for renewable energy applications. In 2018, the
Bank formed Live Oak Private Wealth, LLC, a registered investment advisor that provides high-net-worth individuals and families
with strategic wealth and investment management services. In 2017, the Bank entered into a joint venture, Apiture LLC
(“Apiture”), with First Data Corporation for the purpose of creating next generation technology for financial institutions. In
August 2018, the Company exited the title insurance business by financing the sale of its entire ownership interest in Reltco, Inc.
and National Assurance Title, Inc. for $3.0 million. This divestiture was driven by lower expectations of future profitability for
this business. The title insurance business was acquired in 2017. In addition to the Bank, the Company owns; Live Oak Ventures,
Inc. (formerly known as "Canapi, Inc."), formed in August 2016 for the purpose of investing in businesses that align with the
Company's strategic initiative to be a leader in financial technology; Live Oak Grove, LLC, formed in February 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 advisor to The 504 Fund, a closed-end mutual
fund organized to invest in SBA section 504 loans. In 2019, 504FA exited as advisor for the 504 Fund and the Company
subsequently dissolved this legal entity.
The Company generates revenue primarily from net interest income and secondarily through origination and sale of government
guaranteed loans. Income from the retention of loans is comprised of interest income. Income from the sale of loans is comprised
of loan servicing revenue and revaluation of related servicing assets along with net gains on sales of loans. Offsetting these
revenues are the cost of funding sources, provision for loan and lease 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.
38
Executive Summary
Following is a summary of the Company's financial highlights and events for 2019:
• Loans and leases held for sale and investment increased by $1.08 billion, or 42.8%, to $3.61 billion at the end of 2019
as a result of over $2.00 billion in loan originations in combination with executing the strategic decision to retain higher
levels of loans.
• Guaranteed loans eligible for sale increased by $564.0 million, or 157.9%, as a result of robust government guaranteed
loan origination volume and the aforementioned loan retention strategy.
• Concurrent with the intentional lowering of guaranteed loan sale volumes in 2019, the average gain per million on sold
loans increased from $80.9 thousand in 2018 to $84.8 thousand in 2019. This increase in premium values during 2019
was influenced by the mix of loans sold by the Company along with the improving strength of market conditions for the
purchase of guaranteed loans. Compared to 2018, guaranteed loan sale volume decreased $604.8 million, or 64.0%,
while net gains on sales of loans declined $46.2 million, or 61.4%.
•
Investment securities available-for-sale increased $159.6 million, or 41.9%, to enhance liquidity options while also
improving asset-liability repricing mix and duration.
• Combined net interest income and loan servicing revenue increased by $31.0 million, or 22.6%, to $168.1 million in
2019.
• Total nonperforming unguaranteed loans and leases as a percentage of total loans and leases held for investment
decreased from 0.79% at the end of 2018 to 0.68% at the end of 2019.
• Net charge-offs as a percentage of average held for investment loans and leases, for the years ended December 31, 2019
and 2018, were 0.17% and 0.31%, respectively.
• Total deposits rose by 34.3% to $4.23 billion at the end of 2019 following successful deposit gathering campaigns to
support higher loan retention.
•
Income tax expense increased $10.8 million, This increase was largely the result of planned reductions in the solar panel
leasing activity for 2019 which negatively impacted the annual effective tax rate.
• Reported net income decreased by 64.9% from 2018 to $18.0 million as discussed in the opening to the section titled
Results of Operations.
•
Investment in growth continued with the hiring of 11 seasoned SBA generalists along with ongoing diversification of
lending activities, such as the entry into venture banking by providing financing and banking solutions to early and
expansion stage venture-backed companies.
Business Outlook
Below is a discussion of management’s current expectations regarding company performance over the near-term based on market
conditions, the regulatory environment and business strategies as of the time the Company filed this Report. Actual outcomes and
results may differ materially from what is expressed or forecasted in these forward-looking statements. See “Important Note
Regarding Forward-Looking Statements” in this Report for more information on forward-looking statements.
The Company's results for 2019 demonstrated a continuation of strong underlying financial performance and solid growth
momentum. Management continues to focus on building recurring revenue streams, promoting change within the financial
technology industry, and building out selected existing verticals while adding new verticals to the Company's business model.
Management anticipates that the Company's held-for-sale and held-for-investment loan portfolios will continue to grow as a result
of healthy origination volumes and higher levels of loan retention that are intended to promote long-term recurring revenue and
profitability, including the continued pursuit of potential opportunities in conventional lending outside of SBA or other
government guarantee programs.
39
Non-GAAP Financial Measures
Statements included in this management's discussion and analysis include non-GAAP financial measures and should be read
along with the accompanying tables, which provide a reconciliation of non-GAAP financial measures to GAAP financial
measures. The reconciliation of non-GAAP measures is presented at the conclusion of this Item 7 section.
Management believes that non-GAAP financial measures provide additional useful information that allows readers to evaluate
the ongoing performance of the Company without regard to certain transactional activities. Non-GAAP financial measures should
not be considered as an alternative to any measure of performance or financial condition as reported under GAAP, and investors
should consider the Company's performance and financial condition as reported under GAAP and all other relevant information
when assessing the performance or financial condition of the Company. Non-GAAP financial measures have limitations as
analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company's results or
financial condition as reported under GAAP.
Results of Operations
Years ended December 31, 2019 vs. 2018
The Company reported net income available to common shareholders totaling $18.0 million, or $0.44 per diluted share, for 2019
compared to $51.4 million, or $1.24 per diluted share, for 2018.
This decrease in net income was primarily attributable to the following items:
• The strategic shift in the latter part of 2018 to hold substantially more of its eligible-for-sale production on balance sheet
resulted in lower net income in the near-term by significantly decreasing net gains on sales of loans by $46.2 million, or
61.4%. The volume of guaranteed loan sales in 2019 declined to $340.4 million compared to $945.2 million in 2018;
• The provision for loan and lease losses increased $6.5 million primarily due to significant portfolio growth combined
with an increase in criticized and classified loans and leases;
•
Increased salaries and employee benefits of $13.2 million, or 17.1% largely due to a reversal of $4.5 million in accrued
incentive compensation in the latter part of 2018 combined with ongoing investment in workforce to support growth and
a variety of initiatives;
• The flow-through loss from investments accounted for under the equity method totaled $7.9 million, largely due to the
Company’s ownership in Apiture, LLC, compared to $386 thousand for 2018; and
•
Income tax expense increased $10.8 million. This increase was largely the result of planned reductions in the solar panel
leasing activity for 2019 which negatively impacted the annual effective tax rate.
Other key factors partially offsetting the year-over-year decline in net income were composed of the following:
•
Increased net interest income of $32.0 million, or 29.7%, predominately driven by significant growth in the combined
held for sale and held for investment loan and lease portfolios along with higher investment security holdings; and
• Negative loan servicing revaluation decreased by $14.0 million, or 74.4%, principally due to improving market
conditions, such as increased premiums, for sold loans.
Years ended December 31, 2018 vs. 2017
The Company reported net income available to common shareholders totaling $51.4 million, or $1.24 per diluted share, for 2018
compared to $100.5 million, or $2.65 per diluted share, for 2017.
This decrease in net income was primarily attributable to the following items:
• The decline in noninterest income due to the $68.0 million one-time pretax gain arising from the Company's equity
method investment in Apiture during the fourth quarter of 2017;
40
• Negative loan servicing revaluation increased by $5.6 million, or 42.5%, due to the increased amortization speed of the
serviced portfolio which was largely impacted by the rising rate environment and deterioration in premium markets for
government guaranteed loans compared to 2017; and
• Lower net gains on sales of loans of $3.4 million, or 4.4%, principally driven by current year market conditions that
reduced the average gain per million from $100.4 thousand in 2017 to $80.9 thousand in 2018. This decline in premium
values during 2018 influenced the Company’s strategic shift during the fourth quarter to hold substantially more
production on the balance sheet.
Other key factors partially offsetting the year-over-year decline in net income were composed of the following:
•
•
Increased net interest income of $30.0 million, or 38.5%, predominately driven by significant growth in the combined
held for sale and held for investment loan and lease portfolios along with higher investment security holdings, reflecting
the Company’s ongoing initiative to grow recurring revenue sources;
Increased loan servicing revenue of $4.5 million, or 18.4%, as a result of continued growth in the servicing portfolio due
to ongoing loan sales;
•
Increased lease income of $6.1 million, or 329.2%, due to business diversification and increased lease originations; and
• Decreased costs to retain and operate the title insurance business, net of income earned, that was exited in the third
quarter of 2018.
Net Interest Income and Margin
Net interest income represents the difference between the revenue that the Company earns on interest-earning assets and the cost
of interest-bearing liabilities. The Company’s net interest income depends upon the volume of interest-earning assets and interest-
bearing liabilities and the interest rates that the Company earns or pays on them, respectively. Net interest income is affected by
changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as “volume changes.” It is
also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed
funds, referred to as “rate changes.” As a bank without a branch network, the Bank gathers deposits over the Internet and in the
community in which it is headquartered. Due to the nature of a branchless bank and the relatively low overhead required for
deposit gathering, the rates the Bank offers are generally above the industry average.
Years ended December 31, 2019 vs. 2018
For 2019, net interest income increased $32.0 million, or 29.7%, to $140.1 million compared to $108.0 million in 2018. This
increase was principally due to the significant growth in the combined held for sale and held for investment loan and lease
portfolios along with higher investment security holdings reflecting the Company's ongoing initiative to grow recurring revenue
sources and fortify its liquidity profile. Average interest earning assets rose by $853.7 million, or 28.6%, to $3.83 billion for
2019 compared to $2.98 billion for 2018, while the yield on average interest earning assets rose by 49 basis points to 5.95% for
2019 versus 5.46% for 2018. A substantial portion of the Company's loan portfolio are variable rate loans that adjust regularly in
accordance with changes in designated benchmark indices. The cost of funds on interest bearing liabilities for 2019 increased 46
basis points to 2.38%, and the average balance in interest bearing liabilities increased by $843.1 million, or 29.7% during the
same period. As indicated in the rate/volume table below, the increase in interest bearing liabilities and corresponding cost of
funds was outpaced by the positive effects of the increased volume of interest earning assets, resulting in increased interest income
of $65.3 million versus increased interest expense of $33.4 million for 2019. For 2019 compared to 2018, net interest margin
increased from 3.62% to 3.65%. This increase in margin for the year was largely impacted by the cumulative impact of Federal
Reserve rate cuts in the latter part of 2019 that favorably impacted deposit rates combined with the delayed repricing timing of
the Company’s variable rate loans.
41
Years ended December 31, 2018 vs. 2017
For 2018, net interest income increased $30.0 million, or 38.5%, to $108.0 million compared to $78.0 million in 2017. This
increase was principally due to the significant growth in average interest earning assets and, to a lesser extent, by higher yields
on these assets which outpaced the growth and change in the cost of interest-bearing liabilities. Average interest earning assets
rose by $992.6 million, or 49.9%, to $2.98 billion for 2018 compared to $1.99 billion for 2017, while the yield on average interest
earning assets rose by 26 basis points to 5.46% for 2018 versus 5.20% for 2017. A substantial portion of the Company's loan
portfolio are variable rate loans that adjust regularly in accordance with changes in designated benchmark indices. The cost of
funds on interest bearing liabilities for 2018 increased 54 basis points to 1.92%, and the average balance in interest bearing
liabilities increased by $1.00 billion, or 54.3% during the same period. As indicated in the rate/volume table below, the increase
in interest bearing liabilities and corresponding cost of funds was outpaced by the positive effects of the increased volume of
interest earning assets along with higher yields, resulting in increased interest income of $59.2 million versus increased interest
expense of $29.2 million for 2018. For 2018 compared to 2017, net interest margin decreased from 3.92% to 3.62% due
principally to the narrowing of the interest rate spread during the year. This compression of the spread was largely the result of
strategic liquidity initiatives which were accomplished during 2018 which led to much higher levels of investment securities and
cash balances held with other banks which carry much lower yields.
Average Balances and Yields. The following table presents information regarding average balances for assets and liabilities, the
total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amount of interest
expense on average interest-bearing liabilities, and the resulting average yields and costs. The yields and costs for the periods
indicated are derived by dividing the income or expense by the average balances for assets or liabilities, respectively, for the
periods presented. Loan fees are included in interest income on loans.
Interest earning assets:
Interest earning balances in
other banks
Investment securities
Loans held for sale
Loans and leases held for
investment(1)
Total interest earning assets
Less: Allowance for loan and lease
losses
Non-interest earning assets
Total assets
Interest bearing liabilities:
Interest bearing checking
Savings
Money market accounts
Certificates of deposit
Total deposits
Other borrowings
Total interest bearing liabilities
Non-interest bearing deposits
Non-interest bearing liabilities
Shareholders' equity
Total liabilities and
shareholders' equity
Net interest income and interest
rate spread
Net interest margin
Ratio of average interest-earning
assets to average interest-bearing
liabilities
2019
2018
2017
Average
Balance
Interest
Average
Yield/Rate
Average
Balance
Interest
Average
Yield/Rate
Average
Balance
Interest
Average
Yield/Rate
$ 217,331 $ 4,799
533,364 15,345
864,470 58,018
2.21 % $ 373,104 $ 6,600
8,733
2.88 334,175
6.71 712,566 46,411
1.77 % $ 232,398 $ 2,407
1,432
76,250
2.61
6.51 582,245 34,567
1.04 %
1.88
5.94
2,219,541 149,818
3,834,706 227,980
(37,172 )
495,054
$ 4,292,588
86,175
$
0
42 $
1,013,177 20,598
561
2,585,367 66,738
3,684,761 87,897
1
3,685,956 87,898
1,195
51,699
33,481
521,452
$ 4,292,588
6.75 1,561,146 100,899
5.95 2,980,991 162,643
6.46 1,097,510 65,066
5.46 1,988,403 103,472
5.93
5.20
(27,071 )
427,221
$ 3,381,141
(19,230 )
239,797
$ 2,208,970
1.07 % $
342
32,792 $
2.03 911,757 15,357
0.65 131,495
1,452
2.58 1,761,948 37,318
2.39 2,837,992 54,469
0.08
131
2.38 2,842,861 54,600
50,580
20,132
467,568
4,869
256
1.04 % $
39,213 $
2,685
1.68 193,083
1.10 413,648
4,060
2.12 1,161,651 17,222
1.92 1,807,595 24,223
2.69
1,215
34,968
1.92 1,842,563 25,438
40,831
28,248
297,328
0.65 %
1.39
0.98
1.48
1.34
3.47
1.38
$ 3,381,141
$ 2,208,970
$ 140,082
3.57 %
3.65 %
$ 108,043
3.54 %
3.62 %
$ 78,034
3.82 %
3.92 %
104.04 %
104.86 %
107.92 %
(1) Average loan and lease balances include non-accruing loans and leases.
42
Rate/Volume Analysis. The following table sets forth the effects of changing rates and volumes on net interest income. The rate
column shows the effects attributable to changes in rate (changes in rate multiplied by current period volume). The volume column
shows the effects attributable to changes in volume (changes in volume multiplied by prior period rate). The total column
represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that
cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume.
2019 vs. 2018
Increase (Decrease) Due to
2018 vs. 2017
Increase (Decrease) Due to
Rate
Volume
Total
Rate
Volume
Total
Interest income:
Interest earning balances in other banks
Investment securities
Loans held for sale
Loans and leases held for investment
Total interest income
$ 1,297 $ (3,098 ) $ (1,801 ) $ 2,220 $ 1,973 $ 4,193
7,301
5,792
1,509
6,612
5,468
1,144
3,731
8,113 11,844
1,563 10,044 11,607
5,422 43,497 48,919
7,107 28,726 35,833
9,426 55,911 65,337 14,567 44,604 59,171
Interest expense:
Interest bearing checking
Savings
Money market accounts
Certificates of deposit
Other borrowings
Total interest expense
Net interest income
140
(347 )
1,885
(398 )
5
3,356
(493 )
(342 )
5,241
(891 )
10,072 19,348 29,420
(130 )
86
1,623 11,049 12,672
(2,608 )
(2,942 )
9,289 10,807 20,096
(1,084 )
(156 )
12,861 20,437 33,298 11,230 17,932 29,162
$ (3,435 ) $ 35,474 $ 32,039 $ 3,337 $ 26,672 $ 30,009
(928 )
334
(54 )
(79 )
(51 )
Provision for Loan and Lease Losses. The provision for loan and lease losses represents the amount necessary to be charged
against the current period’s earnings to maintain the allowance for loan and lease losses at a level that is appropriate in relation
to the estimated losses inherent in the loan and lease portfolio. A number of factors are considered in determining the required
level of loan and lease loss reserves and the provision required to achieve the appropriate reserve level, including loan growth,
credit risk rating trends, nonperforming loan levels, delinquencies, loan portfolio concentrations and economic and market trends.
Losses inherent in loan relationships are mitigated by the portion of the loan that is guaranteed by U.S. government loan programs.
A typical SBA 7(a) loan carries a 75% guarantee while USDA guarantees range from 50% to 90% depending on loan size and
type, which reduces the risk profile of these loans. The Company believes that its focus on compliance with regulations and
guidance from U.S. government loan programs are key factors to managing this risk.
Years ended December 31, 2019 vs. 2018
For 2019, the provision for loan and lease losses was $19.6 million, an increase of $6.5 million, or 49.9%, compared to 2018.
The increase in the provision for loan and lease losses compared to the prior year was primarily the result of a materially growing
loan and lease portfolio through robust loan and lease originations and higher balance sheet retention rates combined with an
increase in criticized and classified loans and leases.
Loans and leases held for investment as of December 31, 2019 increased by $803.9 million, or 43.6%, compared to December
31, 2018. This growth was fueled by strong loan and lease origination volume of $2.00 billion for the year ended December 31,
2019.
Net charge-offs were $3.8 million, or 0.17% of average loans and leases held for investment, for 2019, compared to net charge-
offs of $4.8 million, or 0.31% of average loans and leases held for investment, for 2018. Net charge-offs are a key element of
historical experience in the Company's estimation of the allowance for loan and lease losses.
In addition, at December 31, 2019, nonperforming loans and leases not guaranteed by the SBA or USDA totaled $17.9 million,
which was 0.68% of the held-for-investment loan and lease portfolio compared to $14.5 million, or 0.79%, of loans and leases
held for investment at December 31, 2018.
43
Years ended December 31, 2018 vs. 2017
For 2018, the provision for loan and lease losses was $13.1 million, an increase of $3.5 million, or 36.9%, compared to 2017.
The increase in the provision for loan and lease losses was principally driven by additional reserves recorded to accommodate
robust loan and lease growth combined with increases in classified loans in 2018.
Loans and leases held for investment as of December 31, 2018 increased by $499.4 million, or 37.2%, compared to December
31, 2017. This growth was fueled by strong loan origination volume of $1.77 billion for the year ended December 31, 2018.
Net charge-offs were $4.8 million, or 0.31% of average loans and leases held for investment, for 2018, compared to net charge-
offs of $3.6 million, or 0.32% of average loans and leases held for investment, for 2017. Net charge-offs are a key element of
historical experience in the Company's estimation of the allowance for loan and lease losses.
In addition, at December 31, 2018, nonperforming loans and leases not guaranteed by the SBA or USDA totaled $14.5 million,
which was 0.79% of the held-for-investment loan and lease portfolio compared to $3.6 million, or 0.27%, of loans and leases
held for investment at December 31, 2017.
Noninterest Income
Noninterest income is principally comprised of net gains from the sale of SBA and USDA-guaranteed loans along with servicing
revenue and related revaluation. Revenue from the sale of loans depends upon volume and rates of underlying loans as well as
cost and availability of funds in the secondary markets prevailing in the period between completed loan funding and closing of
sale. In addition, the loan servicing revaluation is significantly impacted by changes in market rates and other underlying
assumptions such as prepayment speeds and default rates. Other less common elements of noninterest income include
nonrecurring gains and losses on investments.
The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.
Noninterest income
Loan servicing revenue
Loan servicing revaluation
Net gains on sales of loans
Equity method investments income
(loss)
Equity security investments gains
(losses), net
Gain on sale of investment securities
available-for-sale
Lease income
Gain on contribution to equity method
investment
Construction supervision fee income
Title insurance income
Other noninterest income
Total noninterest income
Years Ended December 31,
2018
2017
2019
2018/2019 Increase
(Decrease)
Amount Percent
2017/2018 Increase
(Decrease)
Amount Percent
$ 28,034 $ 29,121 $ 24,588 $ (1,087 )
(4,812 ) (18,765 ) (13,171 ) 13,953
29,002 75,170 78,590 (46,168 )
(3.73 )% $ 4,533 18.44 %
(5,594 ) (42.47 )
74.36
(4.35 )
(3,420 )
(61.42 )
(7,889 )
(386 )
(513 ) (7,503 ) 1,943.78
127 (24.76 )
3,532
213
89 3,319 1,558.22
124 139.33
620
9,655
—
7,966
—
1,856 1,689
620 100.00
21.20
— —
6,110 329.20
—
—
— 68,000
—
1,776
(22.49 )
(512 )
1,765
7,565 (2,775 ) (100.00 )
—
47.81
7,973
4,141 2,579
(34.58 )% $ (69,156 ) (39.99 )%
$ 67,880 $ 103,765 $ 172,921 $ (35,885 )
(68,000 ) (100.00 )
501 28.21
(4,790 ) (63.32 )
1,253 30.26
2,277
2,775
5,394
44
Years ended December 31, 2019 vs. 2018
For 2019, noninterest income decreased by $35.9 million, or 34.6%, compared to 2018. The decrease from the prior year is
primarily the result of the aforementioned strategic decision made in the latter part of 2018 to sell fewer loans, resulting in net
gains on sales of loans declining to $29.0 million for 2019, compared to $75.2 million for 2018, a reduction of $46.2 million,
or 61.4%. The flow-through loss from investments accounted for under the equity method increased $7.5 million for 2019,
compared to 2018. Also impacting the overall decrease in noninterest income was a decline in title insurance income of
$2.8 million during 2019, compared to 2018, due to the sale of the title insurance business in third quarter of 2018. Partially
offsetting the overall decrease in noninterest income was a $14.0 million, or 74.4%, decrease in the negative loan servicing
revaluation principally due to improving market conditions, such as increased premiums, combined with an increase in net gains
on equity security investments of $3.3 million and an increase in solar panel lease income of $1.7 million.
The tables below reflect loan and lease production, sales of guaranteed loans and the aggregate balance in guaranteed loans sold
that are being serviced. These components are key drivers of the Company's noninterest income.
Three months ended
December 31,
Three months ended
September 30,
2019
2018
2019
2018
Three months ended
June 30,
2019
2018
Three months ended
March 31,
2019
2018
Amount of loans and
leases originated
Guaranteed portions of
loans sold
Outstanding balance of
guaranteed loans sold (1)
$ 523,688 $ 498,987 $ 562,259 $ 377,337 $ 525,088 $ 491,797 $ 390,851 $ 397,559
105,002 104,646 100,498 298,073
71,934 295,216
62,940 247,243
2,746,480 3,045,460 2,802,073 3,102,820 2,870,108 2,951,379 2,952,774 2,812,108
Amount of loans and leases originated
Guaranteed portions of loans sold
Outstanding balance of guaranteed loans sold (1)
2018
2019
Years ended December 31,
2017
$ 2,001,886 $ 1,765,680 $ 1,934,238 $ 1,537,010 $ 1,158,640
340,374 945,178 787,926 761,933 640,886
2,746,480 3,045,460 2,680,641 2,278,618 1,779,989
2016
2015
(1) This represents the outstanding principal balance of guaranteed loans serviced, as of the last day of the applicable period,
which have been sold into the secondary market.
Changes in various components of noninterest income are discussed in more detail below.
Loan Servicing Revenue: While portions of the loans that the Bank originates are sold and generate gain on sale revenue, servicing
rights for those sold portions are retained by the Bank. In exchange for continuing to service sold loans, the Bank receives fee
income represented in loan servicing revenue equivalent to 1.0% of the outstanding balance of SBA loans sold and 0.40% of the
outstanding balance of USDA loans sold. In addition, the standard cost (adequate compensation) for servicing sold loans is
approximately 0.40% of the balance of the loans sold, which is included in the loan servicing revaluation computations.
Unrecognized servicing revenue above the standard cost to service is reflected in a servicing asset recorded on the balance sheet.
Revenues associated with the servicing of loans are recognized over the expected life of the loan through the income statement,
and the servicing asset is reduced as this revenue is recognized. For the year ended December 31, 2019, loan servicing revenue
decreased $1.1 million, or 3.7%, to $28.0 million as compared to the year ended December 31, 2018, as a result of the declining
balance of the serviced portfolio. At December 31, 2019, the outstanding balance of guaranteed loans sold in the secondary market
was $2.75 billion compared to $3.05 billion at December 31, 2018.
Loan Servicing Revaluation: The Company revalues its serviced loan portfolio at least quarterly. The revaluation considers the
amortization of the portfolio, current market conditions for loan sale premiums, and current prepayment speeds. For the years
ended December 31, 2019 and 2018, there was a negative loan servicing revaluation of $4.8 million and $18.8 million,
respectively. The lower negative service revaluation amount for 2019 was primarily a result of improving market conditions.
45
In consideration of the sensitivity of servicing rights as discussed above and in Note 7 to the accompanying audited financial
statements, the following table is provided as of December 31, 2019 reflecting the effect on fair value due to changes in yield
curve rates.
Change in Yield Curve Assumption
+300 basis point
+200 basis point
+100 basis point
- 100 basis point
Increase (Decrease) in Value
($4,542)
(3,178)
(1,672)
1,868
Net Gains on Sale of Loans: For the year ended December 31, 2019, net gains on sales of loans of $29.0 million, decreased $46.2
million, or 61.4%, compared to 2018. This decrease was primarily due to the lower volume of guaranteed loans sold in 2019,
decreasing $604.8 million, or 64.0%, from $945.2 million in 2018 to $340.4 million in 2019. The average net gain on sale for
2019 was higher at $84.8 thousand of revenue for each $1 million in loans sold, compared to $80.9 thousand of revenue for each
$1 million sold for 2018. The year over year increase in average gains was influenced by the mix of loans sold by the Company
and continued strength of market conditions for the purchase of guaranteed loans.
Years ended December 31, 2018 vs. 2017
For 2018, noninterest income decreased by $69.2 million, or 40.0%, compared to 2017. The decrease from the prior year was
largely driven by the $68.0 million one-time pretax gain recognized during the fourth quarter of 2017 as a result of the equity
method investment in Apiture. Other contributors to the net decrease in noninterest income were the $5.6 million increase to
negative loan servicing revaluation, a reduction in the net gains on sales of loans of $3.4 million, and a decline in title insurance
income of $4.8 million resulting from the exit of the title insurance business in 2018. Partially offsetting the decrease in
noninterest income were improved loan servicing revenue and improved lease income of $4.5 million and $6.1 million,
respectively.
Changes in various components of noninterest income are discussed in more detail below.
Loan Servicing Revenue: While portions of the loans that the Bank originates are sold and generate gain on sale revenue, servicing
rights for all loans that the Bank originates, including loans sold, are retained by the Bank. In exchange for continuing to service
loans that are sold, the Bank receives fee income represented in loan servicing revenue equivalent to 1.0% of the outstanding
balance of SBA loans sold and 0.40% of the outstanding balance of USDA loans sold. In addition, the standard cost (adequate
compensation) for servicing sold loans is approximately 0.40% of the balance of the loans sold, which is included in the loan
servicing revaluation computations. Unrecognized servicing revenue above the standard cost to service is reflected in a servicing
asset recorded on the balance sheet. Revenues associated with the servicing of loans are recognized over the expected life of the
loan through the income statement, and the servicing asset is reduced as this revenue is recognized. For the year ended
December 31, 2018, loan servicing revenue increased $4.5 million, or 18.4%, to $29.1 million as compared to the year ended
December 31, 2017, as a result of an increase in the average outstanding balance of guaranteed loans sold. At December 31, 2018,
the outstanding balance of guaranteed loans sold in the secondary market was $3.05 billion compared to $2.68 billion at
December 31, 2017.
Loan Servicing Revaluation: The Company revalues its serviced loan portfolio at least quarterly. The revaluation considers the
amortization of the portfolio, current market conditions for loan sale premiums, and current prepayment speeds. For the years
ended December 31, 2018 and 2017, there was a negative loan servicing revaluation of $18.8 million and $13.2 million,
respectively. The higher negative service revaluation amount for 2018 was principally driven by the increased amortization speed
of the serviced portfolio which was largely impacted by the rising rate environment and deterioration in premium markets for
government guaranteed loans.
46
In consideration of the sensitivity of servicing rights as discussed above and in Note 7 to the accompanying audited financial
statements, the following table is provided as of December 31, 2018 reflecting the effect on fair value due to changes in yield
curve rates.
Change in Yield Curve Assumption
+300 basis point
+200 basis point
+100 basis point
- 100 basis point
Increase (Decrease) in Value
($5,420)
(3,769)
(1,969)
2,164
Net Gains on Sale of Loans: For the year ended December 31, 2018, net gains on sales of loans of $75.2 million, decreased $3.4
million, or 4.4%, compared to 2017. This decrease was primarily due to a lower average net gain per loan sold which was partially
offset by a higher volume of guaranteed loans sold. For 2018, the volume of guaranteed loans sold increased $157.3 million, or
20.0%, from $787.9 million in 2017 to $945.2 million in 2018. The average net gain on sale for 2018 was lower at $80.9 thousand
of revenue for each $1 million in loans sold, compared to $100.4 thousand of revenue for each $1 million sold for 2017. The
decrease in average gains was influenced by the same deterioration in the premium markets discussed above.
Noninterest Expense
Noninterest expense comprises all operating costs of the Company, such as employee related costs, travel, professional services,
advertising and marketing expenses, exclusive of interest and income tax expense.
The following table shows the components of noninterest expense and the related dollar and percentage changes for the periods
presented.
Noninterest expense
Years Ended December 31,
2018
2019
2017
2018/2019 Increase
(Decrease)
Amount Percent
2017/2018 Increase
(Decrease)
Amount Percent
$ 90,634 $ 77,411 $ 74,669 $ 13,223 17.08 % $ 2,742
3.67 %
Salaries and employee benefits
Non-staff expenses:
Travel expense
Professional services expense
Advertising and marketing expense
Occupancy expense
Data processing expense
Equipment expense
Other loan origination and
maintenance expense
Renewable energy tax credit
investment impairment
FDIC insurance
Title insurance closing services
expense
Impairment expense on goodwill
and other intangibles
Other expense
Total non-staff expenses
Total noninterest expense
9,156
6,921
4,878
6,859
6,015
5,936
8,116
7,065
9,265 12,010
16,327 13,724
8,124 (2,235 ) (24.41 ) 1,032 12.70
(1.20 )
4,937 1,981 40.61
(59 )
(348 )
6,363
(5.47 )
(1.31 )
(79 )
6,195 1,051 14.88
870 14.04
8,449 (2,745 ) (22.86 ) 3,561 42.15
7,479 2,603 18.97 6,245 83.50
9,272
5,967
4,970 3,305 55.39
997 20.06
602
3,447
—
3,234
690
3,206
602 100.00
6.59
213
(690 ) (100.00 )
0.87
28
—
912
2,418
(912 ) (100.00 ) (1,506 ) (62.28 )
—
7,545
3,648 (2,680 ) (100.00 )
(968 ) (26.54 )
2,680
9,652 12,017 (2,107 ) (21.83 ) (2,365 ) (19.68 )
9.92
6.66 %
(1.33 ) 6,797
8.00 % $ 9,539
74,290 75,293 68,496 (1,003 )
$ 164,924 $ 152,704 $ 143,165 $ 12,220
47
Years ended December 31, 2019 vs. 2018
Total noninterest expense for 2019 increased $12.2 million, or 8.0%, compared to 2018. The increase in noninterest expense was
predominately driven by increased personnel cost, equipment, and other loan related expenses.
Changes in various components of noninterest expense are discussed below.
Salaries and employee benefits: Total personnel expense for 2019 increased by $13.2 million, or 17.1%, compared to 2018. This
increase is largely due to a reversal of $4.5 million in accrued incentive compensation in the latter part of 2018 due to not meeting
internal performance metrics for that year combined with ongoing investment in workforce to support growth and a variety of
initiatives. While personnel expense is carefully managed, the Company continues to invest in human capital to support a variety
of initiatives by the Company, including growing loan production and financial services technology. Total full-time equivalent
employees increased from 498 at December 31, 2018 to 612 at December 31, 2019. Salaries and employee benefits expense
included $11.7 million and $9.2 million of stock-based compensation expense in 2019 and 2018, respectively. Expenses related
to the employee stock purchase program, stock grants, stock option compensation and restricted stock expense are all considered
stock-based compensation.
Travel expense: Travel expense decreased $2.2 million, or 24.4%, compared to 2018. This decrease was principally due to a
reduction in repairs and maintenance costs associated with an older aircraft that was sold during the first quarter of 2019, higher
deferred travel costs as more loans were retained, and general improvements in operational efficiency.
Professional services expense: For 2019, total professional services expense increased $2.0 million, or 40.6%, compared to
2018. This increase was driven by legal, accounting, and consulting fees incurred to support various strategic initiatives, such as
the Company’s investments in Apiture and Canapi Advisors, LLC.
Data processing expense: Total data processing expense decreased $2.7 million, or 22.9%, compared to 2018. The decrease is
primarily the result of the expiration of software development services provided by Apiture directly to the Company at the end of
2018 combined with the capitalization of certain software development costs during 2019.
Equipment expense: Equipment expense increased $2.6 million, or 19.0%, compared to 2018. Primary factors contributing to
this increase were the depreciation of solar panels arising from operating lease activities and a new aircraft placed in service in
the third quarter of 2019.
Other loan origination and maintenance expense: Other loan origination and maintenance expense increased $3.3 million, or
55.4%, compared to 2018. This increase was due principally to expenses associated with the repurchase of certain guaranteed
loans in the portfolio during the third quarter of 2019 along with increases in the ongoing guarantee fees arising from holding a
higher volume of loans on balance sheet.
Title insurance closing services expense: Expenses associated with title insurance closing services decreased $912 thousand, or
100.0%, driven by the exit from the title insurance business during the third quarter of 2018.
Impairment expense on goodwill and other intangibles, net: During the third quarter of 2018, the Company incurred a one-time
impairment expense of $2.7 million on goodwill and other intangibles associated with the sale of Reltco, Inc.
Years ended December 31, 2018 vs. 2017
Total noninterest expense for 2018 increased $9.5 million, or 6.7%, compared to 2017. The increase in noninterest expense was
predominately driven by increased personnel, equipment, and data processing expenses. Partially mitigating the increase in
noninterest expense were reductions in expenses associated with the retention and operation of the title insurance business.
Changes in various components of noninterest expense are discussed below.
48
Salaries and employee benefits: Total personnel expense for 2018 increased by $2.7 million, or 3.7%, compared to 2017. The
growth in personnel expense was due to the continued investment in human capital to support the growing loan and lease
production from new and existing verticals, partially offset by transferring the recognition of costs associated with software
development to data processing expense with the formation of Apiture. The increase in personnel expense was also mitigated by
the Company’s exit from the title insurance business during the third quarter of 2018, which reduced the full-time equivalent
headcount by 33 for the last five months of the year. Full-time equivalent employees decreased from 515 at December 31, 2017 to
498 at December 31, 2018. Salaries and employee benefits expense included $9.2 million and $7.5 million of stock-based
compensation in 2018 and 2017, respectively. Expenses related to the employee stock purchase program, stock grants, stock
option compensation and restricted stock expense are all considered stock-based compensation.
Of the total stock-based compensation included in salaries and employee benefits, $1.4 million in both 2018 and 2017 was related
to restricted stock unit ("RSU") awards for key employee retention with an effective grant date of May 24, 2016. See Note 14.
Benefit Plans for more information.
Travel expense: Travel expense increased $1.0 million, or 12.7%, compared to 2017. The increase was the result of expanding
the business franchise and lending initiatives and the operation and maintenance of corporate aircraft.
Data processing expense: The total expenses associated with data processing and development increased $3.6 million, or 42.2%,
compared to 2017. Largely influencing this increase was the contribution of software development resources to Apiture in the
fourth quarter of 2017 which transferred the recognition of certain subsequent costs associated with the Company’s technology
development from salaries and employee benefits to data processing. Data processing expenses were additionally influenced by
higher levels of activity in the core system and related software and applications to operate and expand the Company’s digital
platform.
Equipment expense: Equipment expenses increased $6.2 million, or 83.5%, compared to 2017. This increase was primarily the
result of depreciation expense incurred on solar panels purchased for operating lease initiatives.
Title insurance closing services expense: Expenses associated with title insurance closing services decreased $1.5 million, or
62.3%, primarily driven by the exit from the title insurance business during the third quarter of 2018.
Impairment expense on goodwill and other intangibles, net: Impairment expense decreased $968 thousand, or 26.5%, compared
to 2017. The Company incurred $3.6 million due to the impairment of intangible assets associated with the acquisition of Reltco
during 2017 compared to $2.7 million in expense related to the seller financed exit of the title insurance business in the third
quarter of 2018. See Notes 1 and 2 for additional discussion around the impairment of goodwill and intangibles at Reltco.
Other expense: Other expense decreased $2.4 million, or 19.7%, compared to the prior year. Activity for the year ended
December 31, 2017 included acquisition and other costs associated with Reltco and Apiture, and losses incurred with the trade-
in of aircraft. These expenses were predominantly non-routine and largely absent from the year ended December 31, 2018.
Income Tax Expense
Years ended December 31, 2019 vs. 2018
For 2019 and 2018, there was an income tax expense of $5.4 million and benefit of $5.4 million, respectively, and the Company's
effective tax rates were 23.1% and (11.7)%, respectively. The negative effective rate for 2018 was largely a product of significant
investments in renewable energy assets which generate investment tax credits. For 2019, investment tax credits were less of a
driver for the Company’s effective tax rate.
The Company invested $5.9 million and $70.2 million in renewable energy assets that generated $1.7 million and $20.3 million
in investment tax credits in 2019 and 2018, respectively.
See Note 11. Income Taxes for more information.
49
Years ended December 31, 2018 vs. 2017
For 2018 and 2017, there was an income tax benefit of $5.4 million and $2.2 million, respectively, and the Company's effective
tax rates were (11.7)% and (2.3)%, respectively. The negative effective rate for 2018 and 2017 was largely a product of significant
investments in renewable energy assets which generate investment tax credits. The negative effective rate in 2017 was also
significantly impacted by positive tax effects arising from changes in enacted tax legislation.
The Company invested $70.2 million and $90.6 million in renewable energy assets that generated $20.3 million and $24.9 million
in investment tax credits in 2018 and 2017, respectively. Also, on December 22, 2017, the U.S. government enacted
comprehensive tax legislation commonly referred to as the Tax Cut and Jobs Act (the “Tax Act”). The Tax Act made broad
and complex changes to the U.S. tax code that affected 2018 and 2017, including, but not limited to, accelerated depreciation
that a llows for full expensing of qualified property. The Tax Act also enacted a reduction in the U.S. federal corporate
income tax rate from 35% to 21% effective in 2018. As a result of the reduction of the federal corporate income tax rate, the
Company revalued its net deferred tax liability, excluding after tax credits, as of December 31, 2017, and recorded a provisional
net tax benefit of $18.9 million to reduce the net deferred tax liability balance, which was recorded as a reduction in income
tax expense for the year ended December 31, 2017. During 2018, the Company completed its accounting for the effects of the
Tax Act which resulted in an increase to income tax expense of $244 thousand.
Discussion and Analysis of Financial Condition
Years ended December 31, 2019 vs. 2018
Total assets at December 31, 2019 were $4.81 billion, an increase of $1.14 billion, or 31.2%, compared to total assets of $3.67
billion at December 31, 2018. This increase was principally driven by the following:
•
Increased investment securities available-for-sale of $159.6 million which was driven by the Company’s strategic plan
to enhance liquidity and improve asset-liability repricing mix; and
• Growth in loan and leases held for sale and held for investment of $1.08 billion resulting from strong originations and
higher levels of balances being retained to support the Company's strategic plan to hold more loans.
Cash and cash equivalents were $223.5 million at December 31, 2019, a decrease of $93.3 million, or 29.4%, compared to $316.8
million at December 31, 2018. This decrease was primarily the result of increased levels of loans held on books combined with
the Company’s maximization of returns on liquid assets by redeployment of funds into higher-yielding available-for-sale
securities.
Total investment securities increased $159.6 million during 2019, from $380.5 million at December 31, 2018 to $540.0 million
at December 31, 2019, an increase of 41.9%. The Company began enhancing its investment securities position early in 2019 as
part of its strategy to improve the returns of an enhanced liquidity profile and improve asset-liability repricing mix. At December
31, 2019, the investment portfolio was comprised of US treasury and government agency securities, mortgage-backed securities
and municipal bonds.
Loans held for sale increased $279.1 million, or 40.6%, during 2019, from $687.4 million at December 31, 2018 to $966.4 million
at December 31, 2019. This increase reflected the impact of a significantly lower volume of loan sales combined with strong
origination activity during 2019.
Loans and leases held for investment increased $803.9 million, or 43.6%, during 2019, from $1.84 billion at December 31, 2018
to $2.65 billion at December 31, 2019. The increase was primarily the result of $2.00 billion in loan and lease origination
activities during 2019 combined with the late 2018 strategic shift to retain higher levels of loans on the balance sheet.
Premises and equipment increased $16.6 million, or 6.3%, during 2019, from $262.5 million at December 31, 2018 to $279.1
million at December 31, 2019. This increase was primarily driven by construction of new facilities and infrastructure to
accommodate Company growth.
Foreclosed assets increased $4.5 million, or 413.0%, during 2019 from $1.1 million at December 31, 2018 to $5.6 million at
December 31, 2019. The increase in foreclosed assets arose primarily from four relationships. The underlying loans were subject
to an SBA guarantee and the total current estimated exposure to the Company is considered negligible for these more recent
foreclosures.
50
Servicing assets decreased $12.3 million, or 25.8%, during 2019 from $47.6 million at December 31, 2018 to $35.4 million at
December 31, 2019 due to the reduced level of loan sales during the year combined with amortization of the outstanding balance
of guaranteed loans sold. At December 31, 2019, the outstanding balance of government guaranteed loans sold in the secondary
market was $2.75 billion compared to $3.05 billion at December 31, 2018. See the preceding Noninterest Income section under
the subheading “Loan Servicing Revaluation” for more information.
Operating leases right-of-use assets and operating lease liabilities were additions to the balance sheet pursuant to the adoption of
the new lease standard (ASU No. 2016-02) effective January 1, 2019. These balance sheet accounts reflect the Company’s rights
and obligations created by almost all leases in which it is a lessee with remaining terms of more than 12 months. See Note 1.
Organization and Summary of Significant Accounting Policies and Note 6. Leases for more information on the adoption of this
new standard.
Total deposits were $4.23 billion at December 31, 2019, an increase of $1.08 billion, or 34.3%, from $3.15 billion at December 31,
2018. The increase in deposits was driven by the combined success of deposit gathering campaigns to support the growth in loan
and lease originations and balance sheet management initiatives.
Other liabilities increased $25.0 million, or 96.6%, during 2019, from $25.8 million at December 31, 2018 to $50.8 million at
December 31, 2019. The increase in other liabilities was largely driven by a $16.3 million increase in unfunded investment
commitments to a series of new funds advised by Canapi Advisors, increased accruals for incentive compensation of $6.2 million
and an increased deferred tax liability of $5.7 million.
Shareholders’ equity at December 31, 2019 was $532.4 million as compared to $493.6 million at December 31, 2018. The book
value per share was $13.20 at December 31, 2019 and average equity to average assets was 12.1% for 2019, compared to a book
value per share of $12.29 at December 31, 2018 and average equity to average assets of 13.8% for the year ended December 31,
2018. The increase in shareholders’ equity is principally the result of net income to common shareholders of $18.0 million, other
comprehensive income of $13.4 million and stock-based compensation expense of $11.7 million, partially offset by $4.8 million
in dividends.
Years ended December 31, 2018 vs. 2017
Total assets at December 31, 2018 were $3.67 billion, an increase of $912.0 million, or 33.1%, compared to total assets of $2.76
billion at December 31, 2017. This increase was principally driven by the following:
• Growth in cash and investments was largely the result of successful deposit gathering campaigns generating $889.3
million in new deposits arising from strategic initiatives to strengthen the Company’s liquidity profile and sources of
contingent funding;
• Growth in loan and leases held for sale and held for investment resulting from strong originations and higher levels of
balances being retained, in alignment with the Company’s fourth quarter strategic decision to migrate to a more recurring
revenue model; and
• Growth in premises and equipment related primarily to the addition of solar panels to meet leasing commitments
combined with construction of new facilities to provide infrastructure to support Company expansion.
Cash and cash equivalents were $316.8 million at December 31, 2018, an increase of $21.6 million, or 7.3%, compared to $295.3
million at December 31, 2017. This increase was primarily the result of increases in the deposit portfolio and the sale of loans.
Total investment securities increased $287.1 million during 2018, from $93.4 million at December 31, 2017 to $380.5 million at
December 31, 2018, an increase of 307.6%. The Company increased its investment securities position during 2018 as part of the
aforementioned strategic liquidity initiative employed to enhance contingent funding sources. At December 31, 2018, the
investment portfolio was comprised of US treasury and government agency securities, residential mortgage-backed securities and
a municipal bond.
Loans held for sale increased $6.9 million, or 1.02%, during 2018, from $680.5 million at December 31, 2017 to $687.4 million
at December 31, 2018. The increase was primarily the result of loan origination activities throughout 2018 offset by loan sales
and the reclassification to loans held for investment as part of Company’s new focus on retaining larger volumes of its guaranteed
loan originations.
51
Loans and leases held for investment increased $499.4 million, or 37.2%, during 2018, from $1.34 billion at December 31, 2017
to $1.84 billion at December 31, 2018. The increase was the result of loan and lease growth from origination activities during
2018 and the reclassification of loans from held for sale status, as a part of the above referenced strategic decision to retain higher
levels of loans.
Premises and equipment increased $83.7 million, or 46.8%, during 2018, from $178.8 million at December 31, 2017 to $262.5
million at December 31, 2018. This increase was primarily driven by the addition of solar panels to meet leasing commitments
and the expansion of facilities at the Company’s headquarters.
Servicing assets decreased $4.7 million, or 8.9%, during 2018 from $52.3 million at December 31, 2017 to $47.6 million at
December 31, 2018. The decrease in servicing assets is due to the higher negative loan servicing revaluation amount in 2018
discussed more fully in the preceding Noninterest Income section under the subheading “Loan Servicing Revaluation.” This
decrease was partially offset by additions to the servicing asset from ongoing loan sales.
Other assets increased $22.0 million, or 16.4%, during 2018, from $134.2 million at December 31, 2017 to $156.2 million at
December 31, 2018, principally as a result of increases in accrued interest receivable on loans and leases of $5.7 million, $12.1
million in other investments which are generally comprised of non-marketable equity securities, and an aircraft reclassified as
held for sale with a carrying amount of $10.5 million.
Total deposits were $3.15 billion at December 31, 2018, an increase of $889.3 million, or 39.3%, from $2.26 billion at
December 31, 2017. The increase in deposits was driven by successful deposit initiatives to support the growth in loan and lease
originations and strengthen the Company’s liquidity profile.
Long term borrowings decreased $26.5 million, or 99.9%, during 2018, from $26.6 million at December 31, 2017 to $16 thousand
at December 31, 2018. The decrease was primarily the result of significant debt reductions during the first quarter of 2018, largely
funded by capital raised in the third quarter of 2017.
Other liabilities decreased $8.9 million, or 25.5%, during 2018, from $34.7 million at December 31, 2017 to $25.8 million at
December 31, 2018, primarily driven by a decrease in deferred tax liabilities of $5.9 million combined with the reversal of $1.9
million in contingent consideration related to the disposition of the title insurance business.
Shareholders’ equity at December 31, 2018 was $493.6 million as compared to $436.9 million at December 31, 2017. The book
value per share was $12.29 at December 31, 2018 and average equity to average assets was 13.8% for 2018, compared to a book
value per share of $10.95 at December 31, 2017 and average equity to average assets of 13.5% for the year ended December 31,
2017. The increase in shareholders’ equity is principally the result of net income to common shareholders of $51.4 million, stock-
based compensation expense of $9.2 million and $2.0 million arising from stock option exercises combined with employee stock
purchase programs, partially offset by $4.8 million in dividends.
Loans
As of December 31, 2019 and 2018, the cumulative total outstanding principal balance of guaranteed loans sold since May 2007
totaled $2.75 billion and $3.05 billion, respectively. The Company has historically sold a significant portion of loans it originates
in the secondary market while it continues to service the loans sold in full. As of December 31, 2019 and 2018, combined loans
and leases held for investment and held for sale totaled $3.61 billion and $2.53 billion, respectively. Any loan or portion of a loan
that the Company has the intent and ability to sell is classified as held for sale.
The average age of the held for sale portfolio as of December 31, 2019 was 11.9 months from origination date. Less than 25% of
the current held for sale portfolio is older than two years. The majority of held for sale loans over one year old are composed of
construction loans. Construction loans typically have extended build out periods that inherently result in longer lead times
between origination and the ultimate sale date. Approximately 33.0% of the held for sale portfolio is aged between one and two
years. All loans classified as special mention (risk grade 5) or worse are identified as impaired and excluded from the held for
sale loan portfolio.
52
As of December 31, 2019 and 2018, loans and leases held for investment totaled $2.64 billion and $1.84 billion, respectively. The
increase in loans and leases held for investment is the result of continued growth in loan and lease originations, combined with
the Company’s fourth quarter of 2018 strategic decision to shift to retain higher levels of loans. The following table presents the
balance and associated relative percentage of each category of loans and leases held for investment within the loan and lease
portfolio at the five most recently completed fiscal year ends. The following held for investment loan and lease tables do not
include net deferred costs and discounts on SBA 7(a) and USDA unguaranteed loans. The net impact on loans and leases held for
investment related to net deferred costs and discounts on SBA 7(a) unguaranteed loans and leases is $7.5 million, $(7.1) million,
$(2.9) million, $(926) thousand, and $23 thousand as of December 31, 2019, 2018, 2017, 2016 and 2015, respectively.
2019
2018
2017
2016
2015
Total
Loans
and
Leases
% of
Total
Loans
and
Leases
Total
Loans
and
Leases
% of
Total
Loans
and
Leases
Total
Loans
and
Leases
% of
Total
Loans
and
Leases
Total
Loans
and
Leases
% of
Total
Loans
and
Leases
Total
Loans
and
Leases
% of
Total
Loans
and
Leases
Commercial & Industrial
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment
Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment
Advisors
Veterinary Industry
Other Industries
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment
Advisors
Veterinary Industry
Other Industries
Total
Commercial Land
Agriculture
Total
Total Loans and Leases
$
9,344 0.35 % $
26,388
45,581
106,096
1.00
1.73
4.02
6,400 0.35 % $
17,378
51,082
108,783
0.94
2.76
5.88
3,274 0.24 % $ 1,714 0.19 % $
13,495
43,301
99,920
9,684
37,270
83,677
1.06
4.10
9.21
1.00
3.21
7.42
1.73
4,832
15,240
5.44
41,588 14.86
30 0.01 %
99,191
51,251
3.76
1.94
557,146 21.10
894,997 33.90
94,338
45,604
5.10
2.46
295,163 15.95
618,748 33.44
93,770
46,387
6.96
3.45
184,903 13.73
485,050 36.01
68,335
7.52
4.29
38,930
94,836 10.44
334,446 36.81
18,358
21,579
3,230
6.56
7.71
1.15
104,857 37.46
44,571
9,033
94,742
443
1.69
0.34
3.59
0.02
43,454
9,874
81,619
2,149
2.35
0.53
4.41
0.12
34,188
6,119
49,770
1,496
2.54
0.45
3.70
0.11
32,372
3,956
30,467
2,013
3.56
0.44
3.35
0.22
11,351
769
7,231
101
0.09
2,404
0.84
22,132
173,993
6.59
347,318 13.16
1,232
14,094
96,482
0.07
0.76
5.21
248,904 13.45
376
13,184
58,120
0.03
0.98
4.32
163,253 12.13
0.03
294
1.27
11,514
31,715
3.49
112,331 12.36
378
3,834
658
24,322
4.05
0.27
2.58
0.04
0.13
1.37
0.24
8.68
50,365
113,517
247,625
26,379
1.91
4.30
9.38
1.00
53,085
71,344
2.87
3.85
188,531 10.19
1.11
20,597
46,717
67,381
126,631
19,028
3.47
5.00
9.40
1.41
5,591
0.62
5.78
52,510
114,281 12.58
1.67
15,151
1,863
0.67
7.26
20,327
37,684 13.46
2.61
7,298
7,431
0.28
5.54
146,319
461,157 17.47
1,052,793 39.88
7,905
0.43
7.39
136,721
260,847 14.10
739,030 39.94
0.88
11,789
8.46
113,932
134,172
9.96
519,650 38.58
11,462
1.26
102,906 11.33
46,245
5.09
348,146 38.33
2,808
1.00
59,999 21.43
1.70
134,731 48.13
4,752
344,732 13.06
178,897 13.28
178,897 13.28
344,732 13.06
$ 2,639,840 100.00 % $ 1,850,480 100.00 % $ 1,346,850 100.00 % $ 908,492 100.00 % $ 279,946 100.00 %
243,798 13.17
243,798 13.17
113,569 12.50
113,569 12.50
16,036
16,036
5.73
5.73
Regardless of the classification reflected above and discussed in more detail below, the loans and leases the Bank originates are
generally to small businesses where operating cash flow is the primary source of repayment, but may also include collateralization
by real estate, inventory, accounts receivable, equipment and/or personal guarantees. When collateral includes real estate, it is
typically owner-occupied. These common attributes among most of the loans the Bank funds is a product of the Bank’s
specialization as a government guaranteed program lender.
53
Commercial & 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.
C&I loans and leases increased $276.2 million, or 44.6%, from December 31, 2018 to December 31, 2019. Increases occurred in
all verticals except the Healthcare and Independent Pharmacies, with most of the growth occurring in Funeral Home & Cemetery,
Veterinary, Registered Investment Advisors, and Other Industries verticals which increased $9.0 million, $5.6 million, $4.9
million and $262.0 million, respectively, due to the Bank’s marketing efforts and brand recognition in these industries. The
majority of the increase in the Other Industries category was attributable to Sponsor Finance, M & A Lending, ABL, Wine and
Craft Beverages, and Fitness Centers with respective increases of $53.2 million, $23.8 million, $23.4 million, $21.9 million and
$15.4 million. Real estate collateral on C&I loans and leases is often owner occupied. The premises for industries in C&I loans
and leases tend to have either a small real estate component or the business occupies a leasehold space. Terms for C&I loans and
leases are generally ten years.
Construction & Development
Construction and development (C&D) 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.
C&D loans increased $98.4 million, or 39.5%, from December 31, 2018 to December 31, 2019. The increase was also across
most verticals, with the majority of growth arising from increased industry emphasis on facility expansion principally in the
Healthcare and Other Industries verticals which increased $13.1 million and $77.5 million, respectively. The majority of the
increase in the Other Industries category was attributable to Early Education Services with an increase of $31.3 million. Terms
for C&D loans are generally 20 to 25 years.
Commercial Real Estate
Commercial real estate (CRE) 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.
CRE loans increased $313.8 million, or 42.5%, from December 31, 2018 to December 31, 2019. All CRE verticals experienced
growth in 2019 except Agriculture and Registered Investment Advisor, with the largest increases occurring in Healthcare, Funeral
Home & Cemetery and Other Industries with year to year growth of $59.1 million, $42.2 million and $200.3 million respectively.
The majority of the increase in the Other Industries category was attributable to Self Storage, Early Education Services, Hotels,
M & A Lending, and Senior Care with respective increases of $60.2 million, $47.3 million, $26.8 million, $24.0 million and $21.5
million. Growth in CRE lending was largely attributed to ongoing facility expansion and acquisition activity during 2019.
54
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 loans 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.
Commercial land loans increased $100.9 million, or 41.4%, from December 31, 2018 to December 31, 2019. Commercial land
loans are solely comprised of credits within the Agriculture vertical. The growth in commercial land lending was driven by the
Bank's continued expansion into the poultry segment of the Agriculture vertical.
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.
Loan and Lease Concentration
Loan and lease concentrations may exist when there are borrowers engaged in similar activities or types of loans and leases
extended to a diverse group of borrowers that could cause those borrowers or portfolios to be similarly impacted by economic or
other conditions. The breakdown of total held for sale loans by industry sector is presented in the following table. The following
table does not include net deferred costs and discount on SBA 7(a) unguaranteed loans. The net impact on loans held for sale
related to net deferred costs and discount on SBA 7(a) and USDA unguaranteed loans is $6.4 million, $3.8 million, $6.6 million,
$4.5 million, and $3.2 million as of December 31, 2019, 2018, 2017, 2016 and 2015, respectively.
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The addition of unguaranteed loans to the held for sale classification in 2018 was related to certain Renewable Energy credits.
These unguaranteed credits have been classified as held for sale due to the Company’s intent to manage exposure with certain
borrower relationships.
When a loan held for sale exhibits credit quality issues (i.e., the loan is on nonaccrual, downgraded to special mention, risk grade
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are classified as held for investment. For loans and leases transferred from held for sale to held for investment during the
twelve months ended December 31, 2019 and 2018 there have been charge offs of $646 thousand and $509 thousand, respectively.
For loans transferred from held for investment to held for sale during the twelve months ended December 31, 2019 and 2018
there have been no charge offs. As of December 31, 2019 and 2018, there were no loans or leases classified as held for sale which
were identified as being impaired or on nonaccrual status.
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Loans and leases held for investment generally consist of unguaranteed loan and lease balances, loans and leases classified as
special mention (Risk Grade 5) or worse and those identified as impaired. At December 31, 2019, total guaranteed loans and
leases held for investment classified as special mention or worse was $139.1 million with $58.4 million on a non-accrual basis.
Of total guaranteed loans and leases held for investment at December 31, 2018, $69.3 million was classified as special mention
or worse with $43.2 million on a non-accrual basis.
Agriculture loans and leases represent the largest vertical at $449.0 million, or 17.0%, of the total held for investment balance at
December 31, 2019. From May 2007 through December 31, 2019, the Bank originated $1.27 billion in loans and leases to small
business professionals in the Agriculture vertical with $796.7 million in outstanding principal remaining in the servicing portfolio
and $491.1 million remaining on the consolidated balance sheet. Loans and leases to healthcare professionals represent the second
largest vertical at $387.9 million, or 14.7%, of the total held for investment balance. From inception in May 2007 through
December 31, 2019, the Company originated $1.70 billion of loans and leases to small business professionals in the Healthcare
vertical, with $940.6 million in outstanding principal remaining in the servicing portfolio and $573.5 million remaining on the
consolidated balance sheet. Veterinary loans and leases represent the third largest vertical at $219.7 million, or 8.3%, of the total
held for investment balance. The Veterinary vertical was the original industry specialization and formed the basis of the
Company’s existing vertical oriented model. From May 2007 through December 31, 2019, the Bank originated $1.68 billion
loans and leases to small business professionals in the Veterinary vertical with $681.3 million in outstanding principal remaining
in the servicing portfolio and $309.8 million remaining on the consolidated balance sheet.
The Company believes the risk associated with industry concentration is mitigated by the geographical diversity of the overall
loan and lease portfolio with loans and leases originated in each of the fifty U.S. states and certain U.S. territories. Additionally,
the Company has demonstrated the ability to expand lending activities into selected new verticals and intends to continue this
expansion in the future. To the extent that the Company is successful in expanding into new verticals, the Company believes any
risk related to concentration within any one industry will be further mitigated.
At December 31, 2019, no single SBA or USDA loan had an outstanding borrower principal balance greater than $5.0 million
and $25.0 million, respectively. The average loan size at origination for the Company’s entire portfolio in its chosen industries in
2019 was $1.3 million, and the average original lease receivable was $237 thousand. At December 31, 2019, the average
outstanding balance per loan was approximately $671 thousand, and the average outstanding balance per lease was $186 thousand.
The outstanding principal balance of the full loan and lease portfolio, including those serviced for others, totaled $6.57 billion of
which $2.65 billion was held for investment.
Loan and Lease Maturity
As of December 31, 2019, $5.53 billion, or 84.2%, of the total outstanding principal of loans and leases, including those serviced
for others, were variable rate loans that adjust at specified dates based on the prime lending rate or other variable indices. As of
December 31, 2019, $3.95 billion, or 60.1%, of total outstanding principal of loans and leases were variable rate loans that adjust
on either a calendar monthly or calendar quarterly basis using the prime lending rate or other variable indices. At December 31,
2019, 85.3%, or $3.1 billion, of the combined held for sale and held for investment loan and lease portfolio was composed of
variable rate loans. At December 31, 2019, $303.7 million, or 11.5%, of the held for investment balance matures in less than five
years. Loans and leases maturing in greater than five years total $2.34 billion of the total $2.64 billion. The variable rate portion
of the total held for investment loans and leases is 84.7%, which reflects the Company’s strategy to minimize interest rate risk
through the use of variable rate products.
59
Fixed rate loans and leases:
Commercial & Industrial
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Agriculture
Healthcare
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Land
Agriculture
Total
Total fixed rate loans and leases
Variable rate loans and leases:
Commercial & Industrial
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Land
Agriculture
Total
Total variable rate loans and leases
Total
At December 31, 2019
Remaining Contractual Maturity of Total Held for Investment Loans and
Leases (Excluding net deferred costs and discount on
SBA 7(a) and USDA unguaranteed loans)
One Year
or Less
After One
Year
and Through
Five Years
After Five
Years
Total
2,181 $
—
—
5
—
—
24,887
27,073
15,631
—
—
—
—
15,631
—
—
—
—
—
—
712
712
4,397
4,397
47,813
101
—
162
224
656
88
44,359
45,590
—
—
—
—
—
—
11,855
11,855
—
6
354
—
—
363
6,684
7,407
68 $
1,824
918
692
1,024
2,185
15,301
22,012
9,935
—
—
1,278
—
11,213
—
1,846
1,023
—
—
175
8,102
11,146
23,912
23,912
68,283
257
279
3,181
11,130
5,291
3,942
53,086
77,166
—
3,140
—
—
—
—
8,544
11,684
—
2,062
167
761
129
6,148
24,020
33,287
975 $
3,030
4,120
7,698
16,531
4,042
65,497
101,893
8,809
3,632
90
564
1,637
14,732
8,408
13,375
39,227
777
1,043
13,795
15,999
92,624
77,973
77,973
287,222
5,762
21,255
37,200
86,347
75,689
40,994
354,016
621,263
10,196
5,893
91,110
443
2,314
20,290
151,957
282,203
41,957
96,228
206,854
24,841
6,259
125,838
405,640
907,617
3,224
4,854
5,038
8,395
17,555
6,227
105,685
150,978
34,375
3,632
90
1,842
1,637
41,576
8,408
15,221
40,250
777
1,043
13,970
24,813
104,482
106,282
106,282
403,318
6,120
21,534
40,543
97,701
81,636
45,024
451,461
744,019
10,196
9,033
91,110
443
2,314
20,290
172,356
305,742
41,957
98,296
207,375
25,602
6,388
132,349
436,344
948,311
—
—
64,852
112,665 $
599
599
122,736
191,019 $
237,851
237,851
2,048,934
2,336,156 $
238,450
238,450
2,236,522
2,639,840
$
$
60
Asset Quality
Management considers asset quality to be of primary importance. A formal loan review function, independent of loan origination,
is used to identify and monitor problem loans. This function reports directly to the Audit & Risk Committee of the Board of
Directors.
Nonperforming Assets
The Bank places loans and leases on nonaccrual status when they become 90 days past due as to principal or interest payments,
or prior to that if management has determined based upon current information available to it that the timely collection of principal
or interest is not probable. When a loan or lease is placed on nonaccrual status, any interest previously accrued as income but not
actually collected is reversed and recorded as a reduction of loan or lease interest and fee income. Typically, collections of interest
and principal received on a nonaccrual loan or lease are applied to the outstanding principal as determined at the time of collection
of the loan or lease.
Troubled debt restructurings occur when, because of economic or legal reasons pertaining to the debtor’s financial difficulties,
debtors are granted concessions that would not otherwise be considered. Such concessions would include, but are not limited to,
a modification of terms such as a reduction of the interest rate below the current market rate for a loan or lease with similar risk
characteristics or the waiving of certain financial covenants without corresponding offsetting compensation or additional support.
The following table provides information with respect to nonperforming assets and troubled debt restructurings at the dates
indicated.
2019
2018
2017
2016
2015
Nonaccrual loans:
Total nonperforming loans (all on nonaccrual)
Total accruing loans past due 90 days or more
Foreclosed assets
Total troubled debt restructurings
Less nonaccrual troubled debt restructurings
Total performing troubled debt restructurings
Total nonperforming assets and troubled debt
restructurings
Total nonperforming loans to total loans and leases
held for investment
Total nonperforming loans to total assets
Total nonperforming assets and troubled debt
restructurings to total assets
$ 76,307 $ 57,690 $ 23,480 $ 23,781 $ 12,367
—
2,666
11,021
(8,814 )
2,207
—
5,612
43,801
(14,627 )
29,174
—
1,281
10,223
(8,129 )
2,094
—
1,094
27,495
(6,494 )
21,001
—
1,648
9,856
(7,688 )
2,168
$ 111,093 $ 79,785 $ 26,855 $ 27,597 $ 17,240
2.88 %
1.58 %
3.13 %
1.57 %
1.75 %
0.85 %
2.62 %
1.36 %
4.42 %
1.17 %
2.31 %
2.17 %
0.97 %
1.57 %
1.64 %
61
2019
2018
2017
2016
2015
31,022
—
946
—
4,492
—
1,402
—
1,191
$ 58,399 $ 43,202 $ 19,870 $ 18,997 $ 10,330
Nonaccrual loans guaranteed by U.S. government:
Total nonperforming loans guaranteed by the U.S.
government (all on nonaccrual)
Total accruing loans past due 90 days or more
guaranteed by the U.S. government
Foreclosed assets guaranteed by the U.S. government
Total troubled debt restructurings guaranteed by the
U.S. government
Less nonaccrual troubled debt restructurings
guaranteed by the U.S. government
Total performing troubled debt restructurings
guaranteed by U.S. government
Total nonperforming assets and troubled debt
restructurings guaranteed by the U.S. government $ 83,869 $ 58,244 $ 21,140 $ 20,520 $ 12,783
Total nonperforming loans not guaranteed by the
U.S. government to total held for investment loans
and leases
Total nonperforming loans not guaranteed by the U.S.
government to total assets
Total nonperforming assets and troubled debt
restructurings not guaranteed by the U.S. government
to total assets
—
2,293
(10,044 )
19,780
14,096
20,978
(7,099 )
(6,602 )
(5,684 )
7,178
6,723
0.21 %
0.13 %
0.27 %
0.40 %
0.39 %
0.27 %
0.59 %
0.79 %
0.53 %
0.57 %
0.37 %
0.68 %
121
79
7,710
160
(7,550 )
0.73 %
0.19 %
0.42 %
Total nonperforming assets and troubled debt restructurings at December 31, 2019 were $111.1 million, which represented a
$31.3 million, or 39.2%, increase from December 31, 2018. Total nonperforming assets at December 31, 2019 were composed of
$76.3 million in nonaccrual loans and $5.6 million of foreclosed assets. Of the $111.1 million of nonperforming assets, $83.9
million carried a government guarantee, leaving an unguaranteed exposure of $27.2 million in total nonperforming assets and
TDRs at December 31, 2019. This represents an increase of $5.7 million, or 26.4%, from unguaranteed exposure of $21.6 million
at December 31, 2018. The vast majority of this increase in nonperforming assets and TDRs arose from our mature verticals. See
the below discussion related to the change in potential problem and impaired loans for management’s overall observations
regarding growth in this area.
As a percentage of the Bank’s total capital, nonperforming loans represented 15.5% at December 31, 2019, compared to 14.8%
of the Bank’s total capital at December 31, 2018. Adjusting the ratio to include only the unguaranteed portion of nonperforming
loans to reflect management's belief that the greater magnitude of risk resides in this portion, the ratios at December 31, 2019 and
December 31, 2018 were 3.6% and 3.7%, respectively.
62
As of December 31, 2019 and 2018, potential problem (also referred to as criticized) and classified loans and leases totaled $270.3
million and $148.0 million, respectively. Risk Grades 5 through 8 represent the spectrum of criticized and classified loans and
leases. At December 31, 2019, the portion of criticized loans and leases guaranteed by the SBA or USDA totaled $139.1 million
resulting in unguaranteed exposure risk of $131.2 million, or 6.8% of total held for investment unguaranteed exposure. This
compares to total criticized and impaired loans and leases of $148.0 million at December 31, 2018, of which $69.3 million was
guaranteed by the SBA or USDA. As of December 31, 2019, loans and leases in the Other Industries, Healthcare, Agriculture,
Independent Pharmacies and Veterinary Industry comprise the largest portion of the total potential problem and impaired loans
and leases at 40.2%, 22.2%, 15.7%, 8.6% and 8.4%, respectively. Of the 40.2% of total potential problem and classified loans
and leases in the Other Industries, 9.3% was related to Wine & Craft Beverages, 8.9% was related to Hotels and 5.8% was related
to Self Storage. As of December 31, 2018, loans and leases in the Healthcare, Other Industries, Independent Pharmacies and
Veterinary Industry verticals comprise the largest portion of the total potential problem and impaired loans and leases at 28.0%,
18.6%, 15.5% and 15.0%, respectively. Of the 18.6% of total potential problem and impaired loans and leases in the Other
Industries, 8.7% was related to Government Contractors and 6.8% was related to Wine and Craft Beverage industries. The
majority of the increase in potential problem and classified loans and leases was comprised of a relatively small number of
borrowers largely concentrated in our more mature verticals. Furthermore, the Company believes that its underwriting and credit
quality standards have improved as the business has matured. However, systemic issues that emerged during the latter part of
2019 related to higher than expected levels of competition in the Wine and Craft Beverage and Family Entertainment Center
Verticals continue to contribute towards heightened levels of criticized loans. Some signs of stress have also been identified in a
small number of loans originated in the first two years of the Government Contracting vertical. In 2018, the Company tightened
underwriting standards for this vertical which resulted in refined product offerings. Additionally, the Company has subsequently
invested in the build out of a more robust servicing team specialized in government contract analysis. The Company feels that
the appropriate measures have been taken to yield positive outcomes and to mitigate future risk. The Company will continue to
closely monitor these verticals.
The Bank does not classify loans and leases that experience insignificant payment delays and payment shortfalls as impaired. The
Bank considers an “insignificant period of time” from payment delays to be a period of 90 days or less. The Bank would consider
a modification for a customer experiencing what is expected to be a short-term event that has temporarily impacted cash flow.
This could be due, among other reasons, to illness, weather, impact from a one-time expense, slower than expected start-up,
construction issues or other short-term issues. In all cases, credit will review the request to determine if the customer is stressed
and how the event has impacted the ability of the customer to repay the loan or lease over the long term. To date, the only types
of short-term modifications the Bank has given are payment deferral and interest only extensions. The Bank does not typically
alter the rate or lengthen the amortization of the note due to insignificant payment delays. Short term modifications are not
classified as troubled debt restructurings, or TDRs, because they do not meet the definition set by the applicable accounting
standards and the Federal Deposit Insurance Corporation.
Management endeavors to be proactive in its approach to identify and resolve problem loans and leases and is focused on working
with the borrowers and guarantors of these loans and leases to provide loan and lease modifications when warranted. Management
implements a proactive approach to identifying and classifying loans and leases as special mention (also referred to as criticized),
Risk Grade 5. For example, at December 31, 2019 and 2018, Risk Grade 5 loans and leases totaled $150.0 million and $65.5
million, respectively. The increase in Risk Grade 5 loans and leases from December 31, 2018 to 2019 was spread across eight
industries; Hotels ($18.2 million or 21.5%), Wine and Craft Beverage ($14.0 million or 16.5%), Self Storage ($10.5 million or
12.4%), Healthcare ($9.7 million or 11.5%), Early Education Services ($7.3 million or 8.7%), Family Entertainment ($5.1 million
or 6.1%), Insurance ($5.0 million or 5.9%) and Veterinary ($5.0 million or 5.9%). The increase in risk grade 5 loans in 2019 was
primarily due to the continued maturity of these verticals combined with the above mentioned issues that have begun to emerge
in certain verticals. At December 31, 2019, approximately 88.6% of loans classified as Risk Grade 5 are performing with no
current payments past due more than 30 days. While the level of nonperforming assets fluctuates in response to changing
economic and market conditions, in light of the relative size and composition of the loan and lease portfolio and management’s
degree of success in resolving problem assets, management believes that a proactive approach to early identification and
intervention is critical to successfully managing a small business loan portfolio.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses (“ALLL”), a material estimate which could change significantly in the near-term in the
event of rapidly deteriorating credit quality, is established through a provision for loan and lease losses charged to earnings to
account for losses that are inherent in the loan and lease portfolio and estimated to occur, and is maintained at a level that
management considers appropriate to absorb losses in the loan and lease portfolio. Loan and lease losses are charged against the
ALLL when management believes that the collectability of the principal loan or lease balance is unlikely. Subsequent recoveries,
if any, are credited to the ALLL when received.
63
Judgment in determining the adequacy of the ALLL is inherently subjective as it requires estimates that are susceptible to
significant revision as more information becomes available and as situations and information change.
The ALLL is evaluated on a quarterly basis by management and takes into consideration such factors as changes in the nature
and volume of the loan and lease portfolio, overall portfolio quality, review of specific problem loans and leases and current
economic conditions and trends that may affect borrowers' ability to repay.
Estimated credit losses should meet the criteria for accrual of a loss contingency, i.e., a provision to the ALLL, set forth in
accounting principles generally accepted in the United States of America (“GAAP”). Methodology for determining the ALLL is
generally based on GAAP, the Interagency Policy Statement on the Allowance for Loan and Lease Losses and other regulatory
and accounting pronouncements. The ALLL is determined by the sum of three separate components: (i) the impaired loan or lease
component, which addresses specific reserves for impaired loans and leases; (ii) the general reserve component, which addresses
reserves for pools of homogeneous loans and leases; and (iii) an unallocated reserve component (if any) based on management’s
judgment and experience. The loan and lease pools and impaired loans and leases are mutually exclusive; any loan or lease that
is impaired should be excluded from its homogenous pool for purposes of that pool’s reserve calculation, regardless of the level
of impairment.
The ALLL of $32.4 million at December 31, 2018 increased by $15.8 million, or 48.8%, to $48.2 million at December 31, 2019.
The ALLL, as a percentage of loans and leases held for investment, amounted to 1.8% at both December 31, 2019 and 2018. The
increase in the allowance for loan and lease losses was largely attributable to a rapidly growing loan and lease portfolio through
robust loan and lease originations and higher balance sheet retention rates combined with an increase in criticized and classified
loans and leases, as addressed in the Provision for Loan and Lease Losses section of Results of Operations. General reserves as
a percentage of non-impaired loans and leases amounted to 1.26% at December 31, 2019 as compared to 1.34% at December 31,
2018. See the aforementioned Provision for Loan and Lease Losses section of earlier Results of Operations section of this Report
for a discussion of the Company's charge-off experience.
Actual past due held for investment loans and leases have increased by $4.0 million since December 31, 2018. The primary driver
of this increase was growth in total loans past due less than 90 days of $5.8 million. Partially offsetting this increase was a $1.8
million decline in total loans past due 90 or more. At December 31, 2019 and 2018, total held for investment unguaranteed loans
and leases past due as a percentage of total held for investment unguaranteed loans and leases was 1.01% and 1.56%, respectively.
Management continues to actively monitor and work to improve asset quality. Management believes the ALLL of $48.2 million
at December 31, 2019 is appropriate in light of the risk inherent in the loan and lease portfolio. Management’s judgments are
based on numerous assumptions about current events that it believes to be reasonable, but which may or may not be valid. Thus,
there can be no assurance that loan and lease losses in future periods will not exceed the current ALLL or that future increases in
the ALLL (or allowance for credit losses also known as ACL under CECL, which was adopted effective January 1, 2020) will not
be required. No assurance can be given that management’s ongoing evaluation of the loan and lease portfolio in light of changing
economic conditions and other relevant circumstances will not require significant future additions to the ALLL, thus adversely
affecting the Company’s operating results. Additional information on the ALLL is presented in Note 5. Loans and Leases Held
for Investment and Credit Quality to the consolidated financial statements included with this Report.
64
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6
6
Analysis of Loan and Lease Loss Experience. The following table sets forth an analysis of the allowance for loan and lease losses
for the years indicated.
Allowance for Loan and Lease Losses:
Beginning Balance
Provision
Charge-offs:
Commercial & Industrial
Agriculture
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Real Estate
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Veterinary Industry
Other Industries
Total
Commercial Land
Agriculture
Total
Total charge-offs
Recoveries:
Commercial & Industrial
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Real Estate
Healthcare
Independent Pharmacies
Veterinary Industry
Total
Commercial Land
Agriculture
Total
Total recoveries
Ending Balance
2019
2018
2017
2016
2015
$
32,434 $
19,573
24,190 $
13,058
$
18,209
9,536
7,415 $
12,536
4,407
3,806
(18 )
(248 )
(1,177 )
(70 )
(124 )
(1,147 )
(2,784 )
(74 )
—
—
(2 )
(1,103 )
(1,179 )
—
(599 )
(2,296 )
(526 )
(50 )
(744 )
(4,215 )
—
(19 )
(403 )
(619 )
—
(1,041 )
—
(1,367 )
(882 )
(236 )
(132 )
—
(2,617 )
—
(14 )
(541 )
(622 )
—
(1,177 )
—
(1,137 )
(6 )
—
(321 )
—
(1,464 )
—
—
—
(707 )
—
(707 )
—
(44 )
(274 )
—
(660 )
—
(978 )
—
(29 )
—
(135 )
—
(164 )
(327 )
(327 )
(4,290 )
(241 )
(241 )
(5,497 )
(58 )
(58 )
(3,852 )
(63 )
(63 )
(2,234 )
—
—
(1,142 )
133
161
—
32
166
492
—
—
33
33
161
181
30
40
81
493
14
—
176
190
79
3
—
19
—
101
—
170
21
191
104
40
—
342
—
486
—
—
6
6
126
70
—
17
—
213
—
—
131
131
5
5
530
48,247 $
—
—
683
32,434 $
5
5
297
24,190 $
—
—
492
18,209 $
—
—
344
7,415
$
67
Investment Securities
Investment securities totaled $540.0 million at December 31, 2019, an increase of $159.5 million, or 41.9%, compared to $380.5
million at December 31, 2018. The large increase in the investment portfolio for 2019 was primarily related to a strategic initiative
to enhance the Company’s contingent funding sources and reduce the Company’s asset-sensitivity to interest rate risk by adding
longer duration assets to the balance sheet. This also included purchases of $17.3 million in mortgage-backed securities for
purposes of complying with the Community Reinvestment Act and purchases of $148.4 million in mortgage-backed securities
and $61.8 million in collateralized mortgage obligations to increase yield and duration. In addition, the Company purchased $17.2
million in US government agencies and $8.4 million in municipal bonds. There was also a $92 thousand loan to a municipality
classified and recorded under GAAP as a municipal bond investment during 2019.
The investment securities portfolio consists entirely of available-for-sale securities. The Company purchases securities for the
investment securities portfolio to manage interest rate risk, ensure a stable source of liquidity and to provide a steady source of
income in excess of cost of funds.
The following table sets forth the amortized cost and fair values of the securities portfolio at the dates indicated.
2019
2018
2017
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
US treasury securities
US government agencies
Mortgage-backed securities
Mutual fund
Municipal bonds
Total securities
$
4,988 $
22,444
4,969 $
31,121
5,015 $
22,779
4,966 $
30,944
488,694 503,297 345,606 343,581
—
999
$ 524,619 $ 540,045 $ 382,696 $ 380,490 $
—
8,954
—
1,000
—
8,493
— $
22,778
70,167
2,090
—
95,035 $
—
22,624
68,696
2,035
—
93,355
At December 31, 2019, the duration of the overall available-for-sale securities portfolio was approximately 5.18 years.
The following table sets forth the stated maturities and weighted average yields of investment securities at December 31, 2019.
Certain mortgage related securities have adjustable interest rates and will reprice annually within the various maturity ranges.
These repricing schedules are not reflected in the tables below.
US treasury securities
US government securities
Mortgage-backed securities
Municipal bonds
Total securities
Total
Amortized
Cost
Within One Year
After One
to Five Years
After Five
to Ten Years
After Ten Years
Average
Yield
Amortized
Cost
Amortized
Cost
Average
Yield
$ 4,988 $ 4,988 2.13 % $ — — % $
22,444 7,008 2.52 12,520 2.36
488,694
8,493
— — %
— —
— — 5,030 2.43 152,561 2.99 331,103 3.13
8,493 4.77
— —
— —
$ 524,619 $ 11,996 2.36 % $ 17,550 2.38 % $ 155,477 2.99 % $ 339,596 3.17 %
Average
Yield
— — % $
2,916 2.84
Amortized
Cost
Amortized
Cost
— —
Average
Yield
At December 31, 2019, the Company had 93.2% of its total investment securities portfolio in mortgage-backed securities,
compared with 90.3% at December 31, 2018. The Company has continued to purchase mortgage-backed securities in order to
obtain a favorable yield with low risk.
The Company did not have debt obligations of any issuer in excess of 10% of equity at year-end 2019, 2018 or 2017, excluding
U.S. government sponsored entities.
68
Deposits
The following table sets forth the composition of deposits.
Period end:
Noninterest-bearing demand deposits
Interest-bearing deposits:
Interest-bearing checking
Money market
Savings
Time deposits
Total
Total period end deposits
2019
2018
2017
Total
Percent
Total
Percent
Total
Percent
$
54,107
1.28 % $
53,993
1.71 % $
57,868
2.56 %
—
2.05
—
86,754
2,099
89,329
1.64
8.32
1,101,065 26.04 886,718 28.15 696,989 30.84
2,987,196 70.63 2,117,444 67.23 1,280,282 56.64
4,175,015 98.72 % 3,095,590 98.29 % 2,202,395 97.44 %
$ 4,229,122 100.00 % $ 3,149,583 100.00 % $ 2,260,263 100.00 %
0.07
36,978
2.84 188,146
Average:
Noninterest-bearing
demand deposits
Interest-bearing deposits:
Interest-bearing checking
Money market
Savings
Time deposits
Total average deposits
2019
2018
2017
Total
Percent
Average
Rate
Total
Percent
Average
Rate
Total
Percent
Average
Rate
$
51,699 1.38 % — % $
50,580 1.75 % — % $
40,831 2.21 % — %
42 0.00 1.07
32,792 1.14 1.04
39,213 2.12 0.65
86,175 2.31 0.65 131,495 4.55 1.10 413,648 22.38 0.98
1,013,177 27.12 2.03 911,757 31.56 1.68 193,083
10 1.39
2,585,367 69.19 2.58 1,761,948 61.00 2.12 1,161,651 62.84 1.48
$ 3,736,460 100.00 % 2.39 % $ 2,888,572 100.00 % 1.92 % $ 1,848,426 100.00 % 1.34 %
Deposits increased to $4.23 billion at December 31, 2019 from $3.15 billion at December 31, 2018, an increase of $1.08 billion,
or 34.3%. This increase was primarily due to the growth of the Company’s customer base in the savings and time deposit
products, enhanced by a nationwide marketing campaign with attractive rates and additional wholesale funding. The $2.1 million
decrease in interest-bearing checking was related to the remaining wind-down of the Company’s trust operations that primarily
occurred in 2018. Noninterest-bearing deposits increased $114 thousand, or 0.2%, during this period, and interest-bearing
deposits increased $1.08 billion, or 34.9%, during the same period. The growth in deposits during 2018 was primarily in savings
and time deposits, offset by a strategic initiative to reduce the Company’s wholesale money market funds. Long-term wholesale
funding contributed to the time deposit increases.
At December 31, 2019, the aggregate balance of time deposit accounts individually equal to or greater than $100 thousand totaled
$1.63 billion. At December 31, 2019, 80.9% of time deposit accounts in amounts equal to or greater than $100 thousand were
scheduled to mature within one year. The maturity profile of time deposits at December 31, 2019 is as follows:
Maturity Period
Time deposits, $100,000 and over
Other time deposits
Total time deposits
Three months
or less
597,935 $
213,600
811,535 $
$
$
More than
three months
to six months
More than
six months to
twelve months
More than
twelve
months
288,896 $
229,700
518,596 $
431,276 $
323,880
755,156 $
312,083
589,826
901,909
69
Borrowings
Total borrowings decreased $1.4 million at December 31, 2019 from December 31, 2018 as a result of the following:
In 2015, the Company transferred two related party loans to an unaffiliated commercial bank in exchange for $4.7 million. The
exchange price equated to the unpaid principal balance plus accrued but uncollected interest at the time of transfer. The terms of
the transfer agreement with the unaffiliated commercial bank identified the transaction as a secured borrowing for accounting
purposes. Interest accrued at prime plus 1% with monthly principal and interest payments over a term of 60 months. The maturity
date was October 5, 2019. The pledged collateral was classified in other assets with a fair value of $1.4 million at December 31,
2018. The remaining loan with an outstanding balance of $1.3 million was repurchased by the Company on November 7, 2019.
In 2018, the Company renewed a revolving line of credit issued in 2017. The line of credit is unsecured and accrues interest at
30-day LIBOR plus 1.15% for a term of 13 months. Payments are interest only with all principal and accrued interest due on
October 20, 2020. The terms of this loan require the Company to maintain minimum capital and debt service coverage ratios. No
advances have been made to this line of credit and there is $50.0 million of available credit remaining at December 31, 2019.
In 2017, the Company entered into a financing lease of $19 thousand with an unaffiliated equipment lease company, secured by
fitness equipment which is included in premises and equipment on the consolidated balance sheet. Payments are principal and
interest due monthly starting December 15, 2017 over a term of 60 months. At the end of the lease term there is a $1.00 bargain
purchase option. As of January 1, 2019, this borrowing was revised in accordance with ASU 2016-02.
Liquidity Management
Liquidity management refers to the ability to meet day-to-day cash flow requirements based primarily on activity in loan and
deposit accounts of the Company’s customers. Liquidity is immediately available from four major sources: (a) cash on hand and
on deposit at other banks; (b) the outstanding balance of federal funds sold; (c) the market value of unpledged investment
securities; and (d) availability under lines of credit. A primary tool in the Company’s liquidity management process is the
utilization of a Volatile Liability Coverage Ratio (“VLCR”) model to stress outflows in various scenarios with targeted days of
liquidity coverage. The VLCR model output is then used by management to ensure adequate liquidity sources are available
during those future periods. At December 31, 2019, the total amount of these four liquidity source items was $1.19 billion, or
24.8% of total assets, a decrease of 3.6% of total assets from $1.04 billion, or 28.4% of total assets, at December 31, 2018.
Loans and other assets are funded primarily by loan sales, wholesale deposits and core deposits. To date, an increasing retail
deposit base and a stable amount of brokered deposits have been adequate to meet loan obligations, while maintaining the desired
level of immediate liquidity. Additionally, an investment securities portfolio is available for both immediate and secondary
liquidity purposes.
At December 31, 2019, none of the investment securities portfolio was pledged to secure public deposits or pledged to retail
repurchase agreements, leaving $540.0 million available to be pledged as collateral.
Asset/Liability Management and Interest Rate Sensitivity
One of the primary objectives of asset/liability management is to maximize the net interest margin while minimizing the earnings
risk associated with changes in interest rates. One method used to manage interest rate sensitivity is to measure, over various time
periods, the interest rate sensitivity positions, or gaps. This method, however, addresses only the magnitude of timing differences
and does not address earnings or market value. Therefore, management uses an earnings simulation model to prepare, on a regular
basis, earnings projections based on a range of interest rate scenarios to more accurately measure interest rate risk. For more
information, see Item 7A of this Report.
70
The Company's balance sheet is asset-sensitive with a total cumulative gap position of 2.09% at December 31, 2019. During the
year ending December 31, 2019, the addition of a large volume of fixed rate investments along with the production of variable
rate loans and leases outpaced the growth of variable deposits. An asset-sensitive position means that net interest income will
generally move in the same direction as interest rates. For instance, if interest rates increase, net interest income can be expected
to increase, and if interest rates decrease, net interest income can be expected to decrease. The Company attempts to mitigate
interest rate risk with the majority of assets and liabilities being short-term, adjustable rate instruments. The quarterly revaluation
adjustment to the servicing asset, however, adjusts in an opposite direction to interest rate changes. Asset/liability sensitivity is
primarily derived from the prime-based loans that adjust as the prime interest rate changes in conjunction with the longer duration
of indeterminate term deposits.
Capital
The maintenance of appropriate levels of capital is a management priority and is monitored on a regular basis. The Company’s
principal goals related to the maintenance of capital are to provide adequate capital to support the Company’s risk profile
consistent with the risk appetite approved by the Board of Directors; provide financial flexibility to support future growth and
client needs; comply with relevant laws, regulations, and supervisory guidance; achieve optimal credit ratings for the Company
and its subsidiaries; and provide a competitive return to shareholders. Management regularly monitors the capital position of the
Company on both a consolidated and Bank level basis. In this regard, management’s goal is to maintain capital at levels that are
in excess of the regulatory “well capitalized” levels. Risk-based capital ratios, which include Tier 1 Capital, Total Capital and
Common Equity Tier 1 Capital, are calculated based on regulatory guidance related to the measurement of capital and risk-
weighted assets.
71
Capital amounts and ratios as of December 31, 2019, 2018 and 2017 are presented in the table below.
Actual
Minimum Capital
Requirement
Minimum To Be
Well Capitalized
Under Prompt
Corrective Action
Provisions (1)
Amount
Ratio
Amount
Ratio
Amount
Ratio
Consolidated - December 31, 2019
Common Equity Tier 1 (to Risk-Weighted Assets) $ 499,513
$ 541,635
Total Capital (to Risk-Weighted Assets)
$ 499,513
Tier 1 Capital (to Risk-Weighted Assets)
Tier 1 Capital (to Average Assets)
$ 499,513
Bank - December 31, 2019
Common Equity Tier 1 (to Risk-Weighted Assets) $ 451,807
$ 493,382
Total Capital (to Risk-Weighted Assets)
$ 451,807
Tier 1 Capital (to Risk-Weighted Assets)
Tier 1 Capital (to Average Assets)
$ 451,807
Consolidated - December 31, 2018
Common Equity Tier 1 (to Risk-Weighted Assets) $ 467,033
$ 499,467
Total Capital (to Risk-Weighted Assets)
$ 467,033
Tier 1 Capital (to Risk-Weighted Assets)
Tier 1 Capital (to Average Assets)
$ 467,033
Bank - December 31, 2018
Common Equity Tier 1 (to Risk-Weighted Assets) $ 385,030
$ 417,609
Total Capital (to Risk-Weighted Assets)
$ 385,030
Tier 1 Capital (to Risk-Weighted Assets)
Tier 1 Capital (to Average Assets)
$ 385,030
Consolidated - December 31, 2017
Common Equity Tier 1 (to Risk-Weighted Assets) $ 390,816
$ 415,006
Total Capital (to Risk-Weighted Assets)
$ 390,816
Tier 1 Capital (to Risk-Weighted Assets)
$ 390,816
Tier 1 Capital (to Average Assets)
Bank - December 31, 2017
Common Equity Tier 1 (to Risk-Weighted Assets) $ 277,943
$ 302,385
Total Capital (to Risk-Weighted Assets)
$ 277,943
Tier 1 Capital (to Risk-Weighted Assets)
$ 277,943
Tier 1 Capital (to Average Assets)
14.85 % $ 151,365
16.10 % $ 269,093
14.85 % $ 201,820
10.65 % $ 187,582
4.50 %
8.00 %
6.00 %
4.00 %
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
13.61 % $ 149,370
14.86 % $ 265,547
13.61 % $ 199,161
9.68 % $ 186,627
4.50 % $ 215,757
8.00 % $ 331,934
6.00 % $ 265,547
4.00 % $ 233,283
6.50 %
10.00 %
8.00 %
5.00 %
17.10 % $ 122,937
18.28 % $ 218,555
17.10 % $ 163,917
13.40 % $ 139,453
4.50 %
8.00 %
6.00 %
4.00 %
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
14.35 % $ 120,706
15.57 % $ 214,588
14.35 % $ 160,941
11.22 % $ 137,304
4.50 % $ 174,353
8.00 % $ 268,235
6.00 % $ 214,588
4.00 % $ 171,630
6.50 %
10.00 %
8.00 %
5.00 %
17.81 % $ 98,764
18.91 % $ 175,580
17.81 % $ 131,685
15.50 % $ 100,828
4.50 %
8.00 %
6.00 %
4.00 %
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
12.89 % $ 97,060
14.02 % $ 172,551
12.89 % $ 129,413
11.36 % $ 97,864
4.50 % $ 140,197
8.00 % $ 215,688
6.00 % $ 172,551
4.00 % $ 122,330
6.50 %
10.00 %
8.00 %
5.00 %
(1) Prompt corrective action provisions are not applicable at the bank holding company level.
72
Contractual Obligations
The following table presents the Company’s significant fixed and determinable contractual obligations by payment date as of
December 31, 2019. The payment amounts represent those amounts contractually due to the recipient. The table excludes
liabilities recorded where management cannot reasonably estimate the timing of any payments that may be required in connection
with these liabilities.
Less than
One Year
Payments Due by Period
One to
Three Years
Three to
Five Years
More Than
Five Years
Total
Contractual Obligations
Deposits without stated maturity
Time deposits
Borrowings
Operating lease obligations
Total
— $
$ 1,241,926 $ 1,241,926 $
2,987,196 2,085,287 653,461 193,435
—
500
$ 4,232,444 $ 3,327,888 $ 654,363 $ 193,935 $
14
3,308
9
893
5
670
— $
—
55,013
—
1,245
56,258
As of December 31, 2019 and 2018, the Company had commitments for on-balance sheet instruments in the amount of $16.9
million and $2.8 million, respectively.
Off-Balance Sheet Arrangements
In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with accounting
principles generally accepted in the United States of America, are not recorded in the consolidated financial statements. These
transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily
to manage customers’ requests for funding and take the form of loan or investment commitments, lines of credit and letters of
credit.
The contractual amounts of commitments to extend credit represent the amounts of potential accounting loss should the contract
be fully drawn upon, the customer defaults and any existing collateral has no value. The Company uses the same credit policies
in making commitments and conditional obligations as the Company does for on-balance sheet instruments. Financial instruments
whose contract amounts represent credit risk at December 31, 2019, 2018 and 2017 are as follows:
Commitments to extend credit (1)
Standby letters of credit
Solar purchase commitments
Airplane purchase agreement commitments
Total commitments
2019
1,834,449 $
25,532
—
—
1,859,981 $
2018
1,435,024 $
2,150
—
10,450
1,447,624 $
2017
1,701,137
2,298
106,921
25,450
1,835,806
$
$
(1) Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition
established in the contract. Commitments may require payment of a fee and generally have fixed expiration dates or other
termination clauses.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in accordance with GAAP requires the Company to make estimates and
judgments that affect reported amounts of assets, liabilities, income and expenses and related disclosure of contingent assets and
liabilities. The Company bases estimates on historical experience and on various other assumptions that are believed to be
reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain
assets and liabilities that are not readily available from other sources. Estimates are evaluated on an ongoing basis. Actual results
may differ from these estimates under different assumptions or conditions.
73
Accounting policies, as described in detail in the notes to the Company’s consolidated financial statements, are an integral part
of the Company’s consolidated financial statements. A thorough understanding of these accounting policies is essential when
reviewing the Company’s reported results of operations and financial position. Management believes that the critical accounting
policies and estimates listed below require the Company to make difficult, subjective or complex judgments about matters that
are inherently uncertain.
• Determination of the allowance for loan and lease losses;
• Valuation of servicing assets;
•
Income taxes;
• Restricted stock unit awards with market price conditions;
• Valuation of foreclosed assets;
• Business combinations and goodwill; and
• Unconsolidated joint ventures.
Changes in these estimates that are likely to occur from period to period, or the use of different estimates that the Company could
have reasonably used in the current period, would have a material impact on the Company’s financial position, results of
operations or liquidity.
Non-GAAP Measures
Some of the financial measures included in our selected historical consolidated financial data and elsewhere in this Annual Report
are not measures of financial performance recognized by GAAP. These non-GAAP financial measures are: “tangible
shareholders’ equity;” “tangible assets;” “tangible shareholders’ equity to tangible assets;” “tangible book value per share;”
“efficiency ratio;” “non-GAAP net income;” “noninterest income, as adjusted;” “provision for loan and lease losses, as adjusted;”
“noninterest expense, as adjusted;” “income before tax, as adjusted;” and “income tax expense, as adjusted.” Management uses
these non-GAAP financial measures in its analysis of the Company’s performance.
•
•
•
•
•
“Tangible shareholders’ equity” is total shareholders’ equity less goodwill and other intangible assets. Management has
not considered loan servicing rights as an intangible asset for purposes of this calculation.
“Tangible assets” is total assets less goodwill and other intangible assets. Management has not considered loan servicing
rights as an intangible asset for purposes of this calculation.
“Tangible shareholders’ equity to tangible assets” is defined as the ratio of shareholders’ equity less goodwill and other
intangible assets, divided by total assets less goodwill and other intangible assets. Management believes this measure is
important because it shows relative changes from period to period in equity and total assets, each exclusive of changes
in intangible assets. Management has not considered loan servicing rights as an intangible asset for purposes of this
calculation.
“Tangible book value per share” is defined as total equity reduced by goodwill and other intangible assets divided by
total common shares outstanding. Management believes this measure is important because it shows changes from period
to period in book value per share exclusive of changes in intangible assets. Management has not considered loan
servicing rights as an intangible asset for purposes of this calculation.
“Efficiency ratio” is defined as total noninterest expense divided by the sum of net interest income and noninterest
income less gain (loss) on sale of securities. Management believes this measure is important as an indicator of
productivity because it shows the amount of noninterest expense that was required to generate a dollar of revenue. While
the efficiency ratio is a measure of productivity, its value reflects the unique attributes of the “high-touch business model”
the Company employs.
74
•
•
•
•
•
“Non-GAAP net income” is defined as net income adjusted to exclude significant non-routine sources of income and
uses of expenses and an estimated corporate income tax expense across all periods being compared. Management
believes these measures are important as they allow for an evaluation of the core profitability of the Company's business.
“Noninterest income, as adjusted” is defined as noninterest income adjusted to exclude significant non-routine sources
of income, including gain on sale of aircraft and the gain on contribution to equity method investment. Management
believes these measures are important as they allow for an evaluation of the core profitability of the Company's business.
“Noninterest expense, as adjusted” is defined as noninterest expense adjusted to exclude significant non-routine sources
of expenses, including stock-based compensation expense of restricted stock awards for key employee retention with an
effective date of May 24, 2016, merger costs associated with the Reltco acquisition and Apiture investment, trade-in loss
on an aircraft, impairment expense on goodwill and other intangibles, a contract modification for Reltco, and
impairments of renewable energy tax credit investment. Management believes these measures are important as they
allow for an evaluation of the core profitability of the Company's business.
“Income before taxes, as adjusted” is defined as income before taxes adjusted to exclude significant non-routine sources
of income and uses of expenses as discussed above. Management believes these measures are important as they allow
for an evaluation of the core profitability of the Company's business.
“Income tax (benefit) expense, as adjusted” is defined as income tax expense adjusted to exclude significant non-routine
sources of expense or income, as discussed above, the impact of revaluing the Company's net deferred tax liability as a
result of reduced federal tax rates arising from the December 22, 2017 Tax Act legislation, other renewable energy tax
expense and renewable energy tax credits arising from the 2016 investment. Management believes these measures are
important as they allow for an evaluation of the core profitability of the Company's business.
75
The Company believes these non-GAAP financial measures provide useful information to management and investors that is
supplementary to the financial condition, results of operations and cash flows computed in accordance with GAAP; however, the
Company acknowledges that non-GAAP financial measures have a number of limitations. As such, you should not view these
measures as a substitute for results determined in accordance with GAAP, and they are not necessarily comparable to non-GAAP
financial measures that other companies use. The following table provides a reconciliation of these non-GAAP financial measures
to the most closely related GAAP measure.
Total shareholders' equity
Less:
Goodwill
Other intangible assets
Tangible shareholders' equity (a)
Shares outstanding (c)
Total assets
Less:
Goodwill
Other intangible assets
Tangible assets (b)
Tangible shareholders' equity to tangible assets (a/b)
Tangible book value per share (a/c)
Efficiency ratio:
Noninterest expense (d)
Net interest income
Noninterest income
Less: gain on sale of securities
Adjusted operating revenue (e)
2019
532,386 $
Years Ended December 31,
2018
493,560 $
2017
436,933
—
—
532,386 $
—
—
493,560 $
—
4,264
432,669
$
$
40,316,974 40,155,792 39,895,583
$
4,814,970 $
3,670,449 $
2,758,474
—
—
4,814,970 $
—
—
3,670,449 $
—
4,264
2,754,210
11.06 %
13.20 $
13.45 %
12.29 $
15.71 %
10.85
164,924 $
140,082
67,880
620
207,342 $
152,704 $
108,043
103,765
—
211,808 $
143,165
78,034
172,921
—
250,955
$
$
$
$
Efficiency ratio (d/e)
79.54 %
72.10 %
57.05 %
76
Reconciliation of net income to non-GAAP net income adjusted for
non-routine income and expenses:
Net income attributable to Live Oak Bancshares, Inc.
Gain on sale of aircraft
Gain on contribution to equity method investment
Stock based compensation expense for restricted stock awards with an effective
date of May 24, 2016, as discussed in Note 10 of the Notes to Unaudited
Consolidated Financial Statements included in our March 31, 2016 Form 10-Q
Merger costs associated with Reltco acquisition and Apiture investment
Trade-in loss on aircraft
Impairment expense on goodwill and other intangibles
Contract modification of Reltco
Renewable energy tax credit investment income, impairment and loss
Income tax effects and adjustments for non-GAAP items*
Deferred tax liability revaluation
Other renewable energy tax expense
Non-GAAP net income
* Estimated at 24.0% for 2019 and 2018 and 40.0% for 2017
Earnings per share:
Basic
Diluted
Weighted-average shares outstanding:
Basic
Diluted
Reconciliation of financial statement line items as reported to adjusted
for non-routine income and expenses:
Noninterest income, as reported
Gain on contribution to equity method investment
Gain on sale of aircraft
Noninterest income, as adjusted
$
$
$
$
$
Noninterest expense, as reported
Stock based compensation expense
Merger costs associated with Reltco acquisition and Apiture investment
Trade-in loss on aircraft
Impairment expense on goodwill and other intangibles
Contract modification of Reltco
Renewable energy tax credit investment impairment and loss
Noninterest expense, as adjusted
Income before taxes, as reported
Gain on contribution to equity method investment
Gain on sale of aircraft
Stock based compensation expense
Merger costs associated with Reltco acquisition and Apiture investment
Trade-in loss on aircraft
Impairment expense on goodwill and other intangibles, net
Contract modification of Reltco
Renewable energy tax credit investment impairment and loss
Income before taxes, as adjusted
Income tax expense (benefit), as reported
Income tax effects and adjustment for non-routine income and expenses
Deferred tax liability revaluation
Other renewable energy tax expense
Income tax expense (benefit), as adjusted
$
2019
Years Ended December 31,
2018
2017
18,034 $
(357 )
—
1,429
—
—
—
—
602
(402 )
—
—
19,306 $
51,448 $
—
—
1,429
—
—
2,680
—
—
(986 )
—
—
54,571 $
100,499
—
(68,000 )
1,370
2,874
206
3,648
1,600
690
23,045
(18,921 )
176
47,187
0.48 $
0.47 $
1.36 $
1.32 $
1.29
1.25
40,222,758
41,053,514
40,056,230
41,446,750
36,592,893
37,859,535
67,880 $
—
(357 )
67,523
164,924
(1,429 )
—
—
—
—
(602 )
162,893
23,465
—
(357 )
1,429
—
—
—
—
602
25,139
5,431
402
—
—
5,833 $
103,765 $
—
—
103,765
152,704
(1,429 )
—
—
(2,680 )
—
—
148,595
46,046
—
—
1,429
—
—
2,680
—
—
50,155
(5,402 )
986
—
—
(4,416 ) $
172,921
(68,000 )
—
104,921
143,165
(1,370 )
(2,874 )
(206 )
(3,648 )
(1,600 )
(690 )
132,777
98,254
(68,000 )
—
1,370
2,874
206
3,648
1,600
690
40,642
(2,245 )
(23,045 )
18,921
(176 )
(6,545 )
77
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate risk is a significant market risk and can result from timing and volume differences in the repricing of rate-sensitive
assets and liabilities, widening or tightening of credit spreads, changes in the general level of market interest rates and changes
in the shape and level of market yield curves. The Company manages the interest rate sensitivity of interest-bearing liabilities and
interest-earning assets in an effort to minimize the adverse effects of changes in the interest rate environment. Management of
interest rate risk is carried out primarily through strategies involving available-for-sale securities, loan and lease portfolio, and
available funding sources.
The Company has a total cumulative gap in interest-earning assets and interest-bearing liabilities of 2.09% as of December 31,
2019, indicating that, overall, assets will reprice before liabilities. The majority of both the Company’s loans and leases and
deposits have short-term repricing capabilities. The Company has a funding model which differs from that of traditional banks.
A significant portion of the Company’s revenue is attributable to non-interest income so the Company is less dependent on net
interest income when compared to a traditional bank model. With the strategic decision to hold more loans, net interest income
continues to grow. The Company does not have the traditional bank branch network and can operate with lower overhead costs
to offset the higher cost of funds used to attract deposits.
The Company has an Asset/Liability Committee to communicate, coordinate and control all aspects involving interest rate risk
management. The Asset/Liability Committee, which includes three members of our board of directors, establishes and monitors
the volume, maturities, pricing and mix of assets and funding sources with the objective of managing assets and funding sources
to provide results that are consistent with liquidity, growth, risk limits and profitability goals. Adherence to relevant policies is
monitored on an ongoing basis by the Asset/Liability Committee.
The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest
rate sensitive.” An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice
within that time period. The Company analyzes interest rate sensitivity position to manage the risk associated with interest rate
movements through the use of two simulation models: economic value of equity, or EVE, and net interest income, or NII,
simulations. The EVE simulation provides a long-term view of interest rate risk because it analyzes all of the Bank’s future cash
flows. EVE is defined as the present value of the Bank’s assets, less the present value of its liabilities, adjusted for any off-balance
sheet items. The results show a theoretical change in the economic value of shareholders’ equity as interest rates change.
EVE and NII simulations are completed quarterly and presented to the Asset/Liability Committee. The simulations provide an
estimate of the impact of changes in interest rates on equity and net interest income under a range of assumptions. The numerous
assumptions used in the simulation process are reviewed by the Asset/Liability Committee on a quarterly basis. Changes to these
assumptions can significantly affect the results of the simulation. The simulation incorporates assumptions regarding the potential
timing in the repricing of certain assets and liabilities when market rates change and the changes in spreads between different
market rates. The simulation analysis incorporates management’s current assessment of the risk that pricing margins will change
adversely over time due to competition or other factors.
Simulation analysis is only an estimate of interest rate risk exposure at a particular point in time. The Company continually
reviews the potential effect changes in interest rates could have on the repayment of rate sensitive assets and funding requirements
of rate sensitive liabilities.
78
The table below sets forth an approximation of the Company’s NII sensitivity exposure for the 12-month periods ending
December 31, 2020 and 2021 and the Company’s EVE sensitivity at December 31, 2019. The simulation uses projected repricing
of assets and liabilities at December 31, 2019 on the basis of contractual maturities, anticipated repayments and scheduled rate
adjustments. Prepayment rates can have a significant impact on interest income simulation. Because of the large percentage of
variable rate loans and mortgage-backed securities the Company holds, rising or falling interest rates have a significant impact
on the prepayment speeds of earning assets that in turn affect the rate sensitivity position. The Company’s loan and lease portfolio
consists of 85.3% variable rate loans adjustable with the prime rate or 3-month LIBOR. The Company’s prepayment speeds react
differently in a rising rate environment. Generally, when interest rates rise, the Company’s prepayments tend to increase which
is the opposite reaction from typical bank loan and lease portfolios. In a rising rate environment, the Company’s quarterly
adjustable borrowers seek to fix their payments so the loans prepay faster as borrowers refinance into fixed rate products with
another lender. When interest rates fall, prepayments tend to slow down. The Company’s sensitivity would be reduced if
prepayments slow and vice versa. While management believes such assumptions to be reasonable, approximate actual future
activity may differ from the assumed prepayment rates presented below
Basis Point ("bp") Change in
Interest Rates
+400
+300
+200
+100
-100
Estimated Increase/Decrease
in Net Interest Income
12 Months Ending
December 31, 2020
17.1%
12.9
8.6
4.3
(4.3)
12 Months Ending
December 31, 2021
3.5%
2.6
1.7
0.9
(0.9)
Estimated
Percentage Change in EVE
As of
December 31, 2019
(23.9)%
(18.5)
(12.5)
(6.2)
6.6
Rates are increased instantaneously at the beginning of the projection. The Company is overall slightly asset sensitive, therefore,
the large percentage of variable rate loans produce positive net interest income results as rates rise. Generally, banks will
experience a decrease in net interest income as rates rise and an increase as rates decline. Sensitivity will decrease in the second
year of the projection due to interest rates increasing or decreasing for the full year and also due to the other assumptions used in
the analysis as noted previously but still have a positive impact in a rising rate environment. Interest rates do not normally move
all at once or evenly over time, but management believes that the analysis is useful to understanding the potential direction and
magnitude of net interest income changes due to changing interest rates.
The EVE analysis shows that the Company would theoretically lose market value in a rising rate environment. The increased
fixed rate longer-term wholesale deposits have contributed a higher percentage than the assets to the portfolio mix, resulting in a
negative change in market value in a rising rate environment. The favorable EVE change resulting from the loan and lease
portfolio in a rising rate analysis is more than offset by the devaluation of the interest-bearing liabilities.
79
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
QUARTERLY FINANCIAL INFORMATION
The following table sets forth, for the periods indicated, certain consolidated quarterly financial information. This information is
derived from the Company’s unaudited financial statements, which include, in the opinion of management, all normal recurring
adjustments which management considers necessary for a fair presentation of the results for such periods. This information should
be read in conjunction with the consolidated financial statements included elsewhere in this report. The results for any quarter are
not necessarily indicative of results for any future period.
Quarterly Financials
(dollars in thousands, except per share data)
2019
Interest income
Interest expense
Net interest income
Provision for loan and lease losses
Net interest income after provision for loan and lease losses
Noninterest income
Noninterest expense
Income before income taxes
Income tax expense
Net income to common shareholders
Net income per share:
Basic
Diluted
Interest income
Interest expense
Net interest income
Provision for loan and lease losses
Net interest income after provision for loan and lease losses
Noninterest income
Noninterest expense
Income before income taxes
Income tax (benefit) expense
Net income to common shareholders
Net income per share:
Basic
Diluted
4th Qtr
3rd Qtr
2nd Qtr
1st Qtr
61,813 $
23,802
38,011
6,208
31,803
21,524
44,410
8,917
2,085
6,832 $
61,107 $
23,576
37,531
7,160
30,371
18,628
42,737
6,262
2,367
3,895 $
55,138 $
21,203
33,935
3,463
30,472
14,701
39,576
5,597
662
4,935 $
49,922
19,317
30,605
2,742
27,863
13,027
38,201
2,689
317
2,372
0.17 $
0.17 $
0.10 $
0.09 $
0.12 $
0.12 $
0.06
0.06
4th Qtr
3rd Qtr
2nd Qtr
1st Qtr
2018
44,754 $
15,959
28,795
6,822
21,973
18,065
32,558
7,480
(3,010 )
10,490 $
41,890 $
14,166
27,724
(243 )
27,967
24,331
41,244
11,054
(3,198 )
14,252 $
40,976 $
13,928
27,048
2,087
24,961
30,613
40,830
14,744
491
14,253 $
35,023
10,547
24,476
4,392
20,084
30,756
38,072
12,768
315
12,453
0.26 $
0.26 $
0.36 $
0.34 $
0.36 $
0.34 $
0.31
0.30
$
$
$
$
$
$
$
$
80
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of Live Oak Bancshares, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Live Oak Bancshares, Inc. and Subsidiaries (the “Company”)
as of December 31, 2019 and 2018, and the related consolidated statements of income, comprehensive income, changes in
shareholders’ equity and cash flows for each of the years in the three year period ended December 31, 2019, and the related notes
(collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects,
the financial position of the Company at December 31, 2019 and 2018, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
(“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in
Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 27, 2020, expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on
these financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting
Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with
the U.S. federal laws and applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to
error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due
to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis,
evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting
principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial
statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial
statements that were communicated or required to be communicated to the audit and risk committee and that: (1) relate to accounts
or disclosures that are material to the consolidated financial statements and (2) involved especially challenging, subjective, or
complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated
financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate
opinions on the critical audit matters or on the accounts or disclosures to which they relate.
81
Servicing Assets
As described within Notes 1 and 7 to the consolidated financial statements, the Company recognizes servicing assets which
represent the portion of the servicing spread that exceeds adequate compensation for the servicing function of the sold portion of
loans originated by the Company. Servicing assets of $35.4 million as of December 31, 2019 are carried at fair value with changes
in the fair value recorded in income as loan servicing asset revaluation. The determination of fair value of the servicing asset is
based on a valuation model that incorporates assumptions that market participants would use in estimating future net servicing
income, such as adequate compensation for servicing, the discount rate, the custodial earnings rate, an inflation rate, ancillary
income, prepayment speeds and default rates and losses. The fair value of servicing rights is highly sensitive to changes in
underlying assumptions. Changes in prepayment speed assumptions have the most significant impact on the fair value of servicing
rights.
We identified the Company’s valuation of the servicing asset as a critical audit matter. The principal considerations for our
determination include the high degree of auditor judgment required to assess the reasonableness of the assumptions used in the
valuation model. For instance, certain model assumptions, such as the discount rate and inflation rate, are inputs that we are able
to assess using observable market data, while others, including prepayment speeds and default rates, are developed using
proprietary information from management’s internal valuation specialists’ database. As such, these inputs are unobservable and
required significant audit effort to address, including engaging our internal valuation specialists to assist us in evaluating the
methodologies and assumptions used by management.
The primary audit procedures we performed to address this critical audit matter included the following:
(cid:120) We evaluated the design and operating effectiveness of controls relating to the valuation of servicing assets, including
controls over management’s valuation model which are designed to ensure the completeness and accuracy of data used
in the model and controls over the determination of significant inputs and assumptions, including unobservable inputs,
used in the model.
(cid:120) We involved the firm’s internal valuation specialists to assist in evaluating the methodologies and assumptions used by
management, including assessing the reasonableness of significant observable and unobservable inputs and assumptions
of the valuation model such as discount rates and prepayment speed and independently calculating the discounted cash
flows at the individual loan level for a sample of loans and comparing to management’s estimate.
(cid:120) We assessed the overall trends for the discount rate, prepayment speed, and servicing asset to compare the quarterly
change and how the Company’s discount rate assumptions compared to observable market interest rate trends.
Allowance for Loan and Lease Losses (ALLL)
As described in Notes 1 and 5 to the consolidated financial statements, the Company’s allowance for loan and lease losses (ALLL)
was $48.2 million as of December 31, 2019 and is evaluated on a regular basis by management and is based upon management’s
periodic review of the collectibility of loans or leases in light of historical experience, the nature and volume of the loan and lease
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. The ALLL is determined by the sum of three separate components: (i) the
impaired loan and lease component, which addresses specific reserves for impaired loans and leases; (ii) the general reserve
component, which addresses reserves for pools of homogeneous loans and leases; and (iii) an unallocated reserve component (if
any) based on management’s judgment and experience.
A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be
unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease
agreement. Factors considered by management in determining impairment include payment status and other circumstances
impacting the probability of collecting scheduled principal and interest payments when due. The Company utilizes the fair market
value of collateral method or the present value of future cash flow method to analyze impaired loans and leases. For the general
reserve component, quantitative allowances are calculated based on the loss experience of specific types of loans and leases.
Internal and external indicators, such as business type concentrations, vertical maturity, unemployment rates, experience of the
bank’s servicing staff, and changes in asset quality are considered when calculating the qualitative allowances.
82
We identified the Company’s estimate of the ALLL as a critical audit matter. The principal considerations for our determination
of the allowance for loan and lease losses as a critical audit matter include the degree of judgment and subjectivity used by
management to identify and value impaired loans and leases, assess and evaluate the probability of collection, and determine the
fair value of collateral, less selling cost, or present value of future cash flows to calculate the reserve. Additionally, management
applied significant judgment in determining the nature and impact of the adjustments applied when calculating the qualitative
allowance for pooled loans and leases. As such, auditing management’s judgments regarding the identification and valuation of
impaired loans and leases and qualitative factors applied in the ALLL calculation involved a high degree of subjectivity and
required a higher degree of auditor judgment to address.
The primary procedures we performed to address this critical audit matter included the following:
(cid:120) We evaluated the design and operating effectiveness of controls relating to management’s determination of the allowance
for loan and lease losses, including controls over management’s credit administration function to ensure the timely and
complete identification of impaired loans and leases, management’s review of portfolio trends that might impact the
calculation of the ALLL, and management’s review of the ALLL, including the review of adjustments applied when
determining the qualitative allowance to ensure they are applied properly.
(cid:120) We tested the calculation of losses on identified impaired loans and leases, including assessing the reasonableness of the
significant assumptions including adjustments made to appraisals for discounts, selling costs and other unobservable
adjustments, if applicable.
(cid:120) We tested the completeness of the impaired loan and lease population, including testing the modifications for potential
troubled debt restructurings, substandard or worse rated loans and leases, non-accrual loans and leases, and past due
loans and leases.
(cid:120) We evaluated management’s application of qualitative factor adjustments to the ALLL, which includes the comparison
of factors considered by management to third party or internal sources, as applicable, and evaluating management’s
rationale behind the application of qualitative factors and consistency in that application.
(cid:120) Assessed the overall trends in credit quality, including the review of the year-over-year changes in qualitative factors, at
the Company and in the industry and how the Company’s ALLL compared to those trends.
/s/ Dixon Hughes Goodman LLP
We have served as the Company’s auditor since 2010.
Raleigh, North Carolina
February 27, 2020
83
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of Live Oak Bancshares, Inc.
We have audited Live Oak Bancshares, Inc.’s (the “Company”) internal control over financial reporting as of December 31, 2019,
based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring
Organizations of the Treadway Commission. In our opinion, Live Oak Bancshares, Inc. maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2019, based on the criteria established in Internal Control –
Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
(“PCAOB”), the consolidated financial statements of Live Oak Bancshares, Inc. as of December 31, 2019 and 2018 and for each
of the three years in the period ended December 31, 2019, and our report dated February 27, 2020, expressed an unqualified
opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report
on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over
financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be
independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and
regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all
material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk and performing such other procedures as we considered necessary in
the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that
(1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions
of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation
of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Dixon Hughes Goodman LLP
Raleigh, North Carolina
February 27, 2020
84
$
$
$
December 31,
2019
December 31,
2018
126,752 $
96,787
7,250
540,045
966,447
2,647,299
(48,247 )
2,599,052
279,099
5,612
35,365
2,427
156,134
4,814,970 $
316,823
—
7,250
380,490
687,393
1,843,419
(32,434 )
1,810,985
262,524
1,094
47,641
—
156,249
3,670,449
54,107 $
4,175,015
4,229,122
14
2,619
50,829
4,282,584
53,993
3,095,590
3,149,583
1,457
—
25,849
3,176,889
—
—
309,526
278,945
30,871
180,265
11,724
532,386
4,814,970 $
49,168
167,124
(1,677 )
493,560
3,670,449
$
Live Oak Bancshares, Inc.
Consolidated Balance Sheets
(Dollars in thousands)
Assets
Cash and due from banks
Federal funds sold
Certificates of deposit with other banks
Investment securities available-for-sale
Loans held for sale
Loans and leases held for investment
Allowance for loan and lease losses
Net loans and leases
Premises and equipment, net
Foreclosed assets
Servicing assets
Operating lease right-of-use assets
Other assets
Total assets
Liabilities and Shareholders’ Equity
Liabilities
Deposits:
Noninterest-bearing
Interest-bearing
Total deposits
Borrowings
Operating lease liabilities
Other liabilities
Total liabilities
Shareholders’ equity
Preferred stock, no par value, 1,000,000 authorized, none issued or outstanding
at December 31, 2019 and December 31, 2018
Class A common stock, no par value, 100,000,000 shares authorized, 37,401,443
and 35,512,262, shares issued and outstanding at December 31, 2019 and
December 31, 2018, respectively
Class B common stock, no par value, 10,000,000 shares authorized,
2,915,531 and 4,643,530 shares issued and outstanding at December 31, 2019
and December 31, 2018, respectively
Retained earnings
Accumulated other comprehensive income (loss)
Total shareholders’ equity
Total liabilities and shareholders’ equity
See Notes to Consolidated Financial Statements
85
$
Live Oak Bancshares, Inc.
Consolidated Statements of Income
(Dollars in thousands, except per share data)
Interest income
Loans and fees on loans
Investment securities, taxable
Other interest earning assets
Total interest income
Interest expense
Deposits
Borrowings
Total interest expense
Net interest income
Provision for loan and lease losses
Net interest income after provision for loan and lease losses
Noninterest income
Loan servicing revenue
Loan servicing asset revaluation
Net gains on sales of loans
Equity method investments income (loss)
Equity security investments gains (losses), net
Gain on sale of investment securities available-for-sale
Lease income
Gain on contribution to equity method investment
Construction supervision fee income
Title insurance income
Other noninterest income
Total noninterest income
Noninterest expense
Salaries and employee benefits
Travel expense
Professional services expense
Advertising and marketing expense
Occupancy expense
Data processing expense
Equipment expense
Other loan origination and maintenance expense
Renewable energy tax credit investment impairment
FDIC insurance
Title insurance closing services expense
Impairment expense on goodwill and other intangibles
Other expense
Total noninterest expense
Income before taxes
Income tax expense (benefit)
Net income
Basic earnings per share
Diluted earnings per share
See Notes to Consolidated Financial Statements
$
$
86
2019
Years Ended December 31,
2018
2017
207,836 $
15,345
4,799
227,980
87,897
1
87,898
140,082
19,573
120,509
28,034
(4,812 )
29,002
(7,889 )
3,532
620
9,655
—
1,765
—
7,973
67,880
90,634
6,921
6,859
5,936
8,116
9,265
16,327
9,272
602
3,447
—
—
7,545
164,924
23,465
5,431
18,034
0.45 $
0.44 $
147,310 $
8,733
6,600
162,643
99,633
1,432
2,407
103,472
54,469
131
54,600
108,043
13,058
94,985
29,121
(18,765 )
75,170
(386 )
213
—
7,966
—
2,277
2,775
5,394
103,765
77,411
9,156
4,878
6,015
7,065
12,010
13,724
5,967
—
3,234
912
2,680
9,652
152,704
46,046
(5,402 )
51,448
1.28 $
1.24 $
24,223
1,215
25,438
78,034
9,536
68,498
24,588
(13,171 )
78,590
(513 )
89
—
1,856
68,000
1,776
7,565
4,141
172,921
74,669
8,124
4,937
6,363
6,195
8,449
7,479
4,970
690
3,206
2,418
3,648
12,017
143,165
98,254
(2,245 )
100,499
2.75
2.65
Live Oak Bancshares, Inc.
Consolidated Statements of Comprehensive Income
(Dollars in thousands)
Net income
Other comprehensive income (loss) before tax:
Net unrealized gain (loss) on investment securities arising during the
period
Reclassification adjustment for gain on sale of securities available-
for-sale included in net income
Other comprehensive income (loss) before tax
Income tax (expense) benefit
Other comprehensive income (loss), net of tax
Total comprehensive income
See Notes to Consolidated Financial Statements
2019
Years Ended December 31,
2018
2017
$
18,034 $
51,448 $
100,499
18,252
(526 )
(619 )
(620 )
17,632
(4,231 )
13,401
31,435 $
—
(526 )
126
(400 )
51,048 $
—
(619 )
238
(381 )
100,118
$
87
Live Oak Bancshares, Inc.
Consolidated Statements of Changes in Shareholders’ Equity
(Dollars in thousands, except per share data)
Common stock
Shares
Balance at December 31, 2016
Net income
Other comprehensive loss
Issuance of restricted stock
Withholding cash issued in lieu of
restricted stock issuance
Employee stock purchase program
Stock option exercises
Stock option based compensation expense
Restricted stock expense
Stock issued in acquisition of Reltco, Inc.
Non-voting common stock converted to
voting common stock in private sale
Issuance of common stock in connection
with secondary offering, net of issue costs
Cash dividends ($0.10 per share)
Balance at December 31, 2017
Net income
Other comprehensive loss
Issuance of restricted stock
Withholding cash issued in lieu of
restricted stock issuance
Employee stock purchase program
Stock option exercises
Stock option based compensation expense
Restricted stock expense
Reclassification of accumulated other
comprehensive income due to tax
rate change
Cash dividends ($0.12 per share)
Balance at December 31, 2018
Net income
Other comprehensive income
Issuance of restricted stock
Withholding cash issued in lieu of
restricted stock issuance
Employee stock purchase program
Non-voting common stock converted to
voting common stock in private sale
Stock option exercises
Stock option based compensation expense
Restricted stock expense
Cumulative effect of accounting change
for Accounting Standards Update 2016-02
Cash dividends ($0.12 per share)
Balance at December 31, 2019
See Notes to Consolidated Financial Statements
Accumulated
other
comprehensive
income (loss)
Retained
earnings
Total
equity
Class B
Amount
Class A
29,530,072 4,723,530 $ 199,981 $ 23,518 $
— 100,499
—
—
—
—
—
—
—
—
—
307,613
—
22,634
109,010
—
—
27,724
—
—
—
—
—
—
(4,891 )
445
1,026
1,786
5,717
565
—
—
—
—
—
—
(652 ) $ 222,847
— 100,499
(381 )
—
(381 )
—
—
—
—
—
—
—
(4,891 )
445
1,026
1,786
5,717
565
80,000
(80,000 )
—
—
—
—
5,175,000
—
—
— 113,096
(3,776 )
—
—
35,252,053 4,643,530 $ 317,725 $ 120,241 $
— 51,448
—
—
—
—
—
—
—
—
—
64,308
—
14,339
181,562
—
—
—
—
—
—
—
(756 )
342
1,626
1,713
7,463
—
—
—
—
—
— 113,096
(3,776 )
—
(1,033 ) $ 436,933
— 51,448
(400 )
—
(400 )
—
—
—
—
—
—
(756 )
342
1,626
1,713
7,463
—
—
—
—
244
—
(4,809 )
—
35,512,262 4,643,530 $ 328,113 $ 167,124 $
— 18,034
—
—
—
—
—
—
—
—
—
61,121
—
29,493
—
—
(409 )
437
1,727,999 (1,727,999 )
—
—
508
1,723
—
— 10,025
70,568
—
—
—
—
—
—
—
—
(66 )
—
(4,827 )
—
37,401,443 2,915,531 $ 340,397 $ 180,265 $
—
—
—
—
(244 )
—
—
(4,809 )
(1,677 ) $ 493,560
— 18,034
13,401 13,401
—
—
—
—
(409 )
437
—
—
—
508
1,723
—
— 10,025
—
—
(66 )
(4,827 )
11,724 $ 532,386
88
Live Oak Bancshares, Inc.
Consolidated Statements of Cash Flows
(Dollars in thousands)
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash provided (used) by
operating activities:
Depreciation and amortization
Provision for loan and lease losses
Amortization of premium on securities, net of accretion
Change in discount on unguaranteed loans
Impairment expense on goodwill and other intangibles, net
Deferred tax expense (benefit)
Originations of loans held for sale
Proceeds from sales of loans held for sale
Net gains on sale of loans held for sale
Net loss on sale of foreclosed assets
Gain on contribution to equity method investment
Net decrease (increase) in servicing assets
Gain on sale of securities available-for-sale
Net gain on sale or disposal of long lived asset
Net loss on disposal of premises and equipment
Equity method investments (income) loss
Equity security investments (gains) losses, net
Renewable energy tax credit investment impairment
Stock option based compensation expense
Restricted stock expense
Stock based compensation expense excess tax (shortfall) benefit
Business combination contingent consideration fair value
adjustment
Changes in assets and liabilities:
Lease right-of-use assets, net
Other assets
Other liabilities
Net cash provided (used) by operating activities
Cash flows from investing activities
Purchases of securities available-for-sale
Proceeds from sales, maturities, calls, and principal paydowns of
securities available-for-sale
Proceeds from sale/collection of foreclosed assets, net
Business combination, net of cash acquired
Sale of title insurance business, net of cash sold
Investment in certificates of deposit with other banks
Maturities of certificates of deposit with other banks
Loan and lease originations and principal collections, net
Proceeds from sale of long lived asset
Proceeds from sale of premises and equipment
Purchases of premises and equipment, net
Net cash used by investing activities
See Notes to Consolidated Financial Statements
89
2019
Years Ended December 31,
2018
2017
$
18,034 $
51,448 $
100,499
19,967
19,573
507
(9,270 )
—
1,467
(1,005,165 )
457,533
(29,002 )
25
—
12,276
(620 )
(357 )
109
7,889
(3,532 )
602
1,723
10,025
(125 )
16,386
13,058
802
2,768
2,680
(5,936 )
(1,079,472 )
1,086,614
(75,170 )
38
—
4,657
—
—
37
386
(213 )
—
1,713
7,463
101
10,279
9,536
460
2,848
3,648
12,017
(1,149,617 )
883,366
(78,590 )
59
(68,000 )
(304 )
—
—
215
513
(89 )
690
1,786
5,717
1,002
—
(260 )
1,950
126
394
3,896
(493,925 )
—
(14,040 )
(1,539 )
11,521
—
(25,671 )
157
(287,529 )
(253,100 )
(347,184 )
(43,071 )
111,290
796
—
—
—
—
(505,848 )
10,895
—
(37,197 )
(673,164 )
56,631
527
—
(209 )
(6,750 )
2,500
(445,643 )
—
865
(111,322 )
(850,585 )
19,693
1,498
(7,696 )
—
—
4,250
(385,551 )
—
—
(124,139 )
(535,016 )
Live Oak Bancshares, Inc.
Consolidated Statements of Cash Flows (Continued)
(Dollars in thousands)
Cash flows from financing activities
Net increase in deposits
Proceeds from borrowings
Repayment of borrowings
Stock option exercises
Employee stock purchase program
Withholding cash issued in lieu of restricted stock
Sale of common stock, net of issuance costs
Shareholder dividend distributions
Net cash provided by financing activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents, beginning
Cash and cash equivalents, ending
Supplemental disclosure of cash flow information
Interest paid
Income tax (received) paid, net
2019
Years Ended December 31,
2018
2017
1,079,539 $
—
(1,443 )
508
437
(409 )
—
(4,827 )
1,073,805
(93,284 )
316,823
223,539 $
889,320 $
18
(25,125 )
1,626
342
(756 )
—
(4,809 )
860,616
21,552
295,271
316,823 $
775,187
40,000
(41,279 )
1,026
445
(4,891 )
113,096
(3,776 )
879,808
57,263
238,008
295,271
87,280 $
(12,293 )
54,106 $
1,750
25,390
7,084
$
$
$
Supplemental disclosures of noncash operating, investing, and
financing activities
$
Unrealized holding gains (losses) on available-for-sale securities,
net of taxes
Transfers from loans and leases to foreclosed real estate and other
repossessions
Net transfers (to) from foreclosed real estate to SBA receivable
Transfer from fixed assets to other assets held for sale
Transfer of loans held for sale to loans and leases held for investment
Transfer of loans and leases held for investment to loans held for sale
Accrued premises and equipment additions
Loans to finance sale of other assets
Right-of-use assets obtained in exchange for lessee operating lease
liabilities
Equity method investment commitments
Business combination:
Assets acquired (excluding goodwill)
Liabilities assumed
Purchase price
Goodwill recorded
See Notes to Consolidated Financial Statements
13,401 $
(400 ) $
(381 )
5,058
(281 )
—
277,964
39,067
88
—
2,241
16,282
—
—
—
—
346
(32 )
10,467
131,266
94,154
534
3,642
—
—
—
—
—
—
1,406
216
—
63,643
19,534
—
—
—
—
5,766
4,681
8,363
7,278
90
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Note 1. Organization and Summary of Significant Accounting Policies
Organization
Live Oak Banking Company (the “Bank”) was organized and incorporated under the laws of the State of North Carolina on
February 25, 2008 and commenced operations on May 12, 2008. In December 2008, Live Oak Bancshares, Inc. (the “Company”)
was formed and in the first quarter of 2009 acquired all the outstanding shares of Live Oak Banking Company. The Bank is
headquartered in the city of Wilmington, North Carolina and has six satellite sales offices across the United States. The Bank
specializes in providing lending and deposit related services to small businesses nationwide. The Bank identifies and extends
lending to credit-worthy borrowers both within specific industries, also called verticals, through expertise within those industries,
and more broadly to select borrowers outside of those industries. A significant portion of the loans originated by the Bank are
guaranteed by the Small Business Administration (“SBA”) under the 7(a) Loan Program and the U.S. Department of Agriculture
("USDA") Rural Energy for America Program ("REAP"), Water and Environmental Program (“WEP”) and Business & Industry
("B&I") loan programs. The guaranteed portion of select loans are generally available for sale in the secondary market. From
time to time the Bank may also engage in the sale of participating interests in the unguaranteed portion. As a state-chartered bank,
the Bank is subject to regulation by the North Carolina Commissioner of Banks and the Federal Deposit Insurance Corporation.
The Bank’s wholly owned subsidiaries are Live Oak Number One, Inc., Live Oak Clean Energy Financing LLC (“LOCEF”), and
Live Oak Private Wealth, LLC.
The Company’s wholly owned subsidiaries are the Bank, Government Loan Solutions (“GLS”), Live Oak Grove, LLC (“Grove”),
Live Oak Ventures, Inc. (“Live Oak Ventures”), and Canapi Advisors, LLC (“Canapi”).
Live Oak Number One, Inc. holds properties foreclosed on by the Bank. GLS is a management and technology consulting firm
that advises and offers solutions and services to participants in the government guaranteed lending sector. GLS primarily provides
services in connection with the settlement, accounting, and securitization processes for government guaranteed loans, including
loans originated under the SBA 7(a) loan programs and USDA guaranteed loans. The Grove provides Company employees and
business visitors an on-site restaurant location. Live Oak Ventures’ purpose is investing in businesses that align with the
Company's strategic initiative to be a leader in financial technology. LOCEF provides financing to entities for renewable energy
applications and became a wholly owned subsidiary of the Bank during the first quarter of 2019. Live Oak Private Wealth, LLC
was formed in June 2018 for the purpose of providing high-net-worth individuals and families with strategic wealth and
investment management services. Canapi was formed in September 2018 for the purpose of providing investment advisory
services to a series of new funds focused on providing venture capital to new and emerging financial technology companies.
The Company jointly formed 504 Fund Advisors, LLC (“504FA”) to serve as the investment adviser for the 504 Fund, a closed-
end mutual fund organized to invest in SBA section 504 loans. 504FA exited as advisor for the 504 Fund in May 2019 and the
Company subsequently dissolved this legal entity.
On February 1, 2017, the Company completed its acquisition of Reltco Inc. and National Assurance Title, Inc. (collectively
referred to as “Reltco”), two nationwide title agencies under common control based in Tampa, Florida. Effective August 1, 2018,
Reltco was sold. See Note 2. Title Insurance Business for more information.
Basis of Presentation
Dollar amounts in all tables in the Notes to Consolidated Financial Statements have been presented in thousands, except
percentage, time period, stock option, share and per share data. The accounting and reporting policies of the Company and the
Bank follow United States generally accepted accounting principles and general practices within the financial services industry.
The following is a description of the significant accounting and reporting policies the Company follows in preparing and
presenting its consolidated financial statements.
The Company has evaluated subsequent events for potential recognition and/or disclosure through the date these consolidated
financial statements were issued.
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Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Consolidation Policy
The consolidated financial statements include the financial statements of the Company and wholly owned subsidiaries of Live
Oak Banking Company, Live Oak Number One, Inc., GLS, 504FA, Grove, Live Oak Ventures, LOCEF, Reltco, Live Oak Private
Wealth, LLC and Canapi. All significant intercompany balances and transactions have been eliminated in consolidation. In
addition, the Company evaluates its relationships with other entities to identify whether they are variable interest entities and to
assess whether it is the primary beneficiary of such entities. If the determination is made that the Company is the primary
beneficiary, then that entity is included in the consolidated financial statements. If an entity is not a variable interest entity, the
Company also evaluates arrangements in which there is a general partner or managing member to determine whether
consolidation is appropriate.
Unconsolidated investments where we have the ability to exercise significant influence over the operating and financial policies
of the respective investee are accounted for using the equity method of accounting; those that are not consolidated or accounted
for using the equity method of accounting are accounted for under equity security or fair value accounting. For these investments
accounted for under the equity method, the Company records its investment in non-consolidated affiliates and the portion of
income or loss in equity in income of non-consolidated affiliates. The Company periodically evaluates these investments for
impairment.
Variable Interest Entities
Variable interests are defined as contractual ownership or other interests in an entity that change with fluctuations in an entity's
net asset value. The primary beneficiary consolidates the variable interest entity ("VIE"). The primary beneficiary is defined as
the enterprise that has both the power to direct the activities of the VIE that most significantly impact the entity's economic
performance and the obligation to absorb losses or the right to receive benefits that could be significant to the VIE.
The Company has a limited interest in a partnership that owns and operates a solar renewable energy project which is accounted
for as an equity method investment. Over the course of the investment, the Company will receive federal and state tax credits,
tax-related benefits, and excess cash available for distribution, if any. The Company may be called to sell its interest in the limited
partnerships through a call option once all investment tax credits have been recognized.
This entity meets the criteria of a VIE; however, the Company is not the primary beneficiary of this entity, as the general partner
has both the power to direct the activities that most significantly impact the economic performance of the entities and the
obligation to absorb losses or the right to receive benefits that could be significant to the entity. While the partnership agreement
allows the Company to remove the general partner, this right is not deemed to be substantive as the general partner can only be
removed for cause.
The Company’s investments in the unconsolidated VIE is carried in other assets on the consolidated balance sheet and the
Company’s unfunded capital and other commitments related to the unconsolidated VIE is carried in other liabilities on the
consolidated balance sheet.
The Company’s maximum exposure to loss from this unconsolidated VIE includes the investment recorded on the Company’s
consolidated balance sheet, net of unfunded capital commitments and any impairment recognized, and previously recorded tax
credits which remain subject to recapture by taxing authorities based on compliance features required to be met at the project
level. While the Company believes the potential for losses from this investment is remote, the maximum exposure was determined
by assuming a scenario where related tax credits were recaptured.
The following table provides a summary of the tax advantaged VIE that the Company has not consolidated as of December 31,
2019 and 2018:
Investment carrying amount
Maximum exposure to loss
$
2019
2018
— $
1,758
602
3,240
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Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Business Combinations
Business combinations are accounted for by applying the acquisition method in accordance with Accounting Standards
Codification (ASC) 805, Business Combinations. Under the acquisition method, identifiable assets acquired and liabilities
assumed, and any non-controlling interest in the acquiree at the acquisition date are measured at their fair values as of that date,
and are recognized separately from goodwill. Results of operations of the acquired entities are included in the consolidated
statements of comprehensive income from the date of acquisition. Any measurement-period adjustments are recorded in the
period the adjustment is identified.
Business Segments
Operating segments are components of an enterprise about which separate financial information is available that is evaluated
regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. 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.
Initial and Secondary Public Offerings
In April 2015, the Company filed a Registration Statement on Form S-1 with the U.S. Securities and Exchange Commission
(SEC). This Registration Statement was declared effective by the SEC on July 22, 2015. In reliance on that Registration
Statement, the Company issued 5,500,000 shares of voting common stock, no par value, at $17.00 per share, in exchange for total
proceeds of $87.2 million, net of issue costs.
In August 2017, the Company completed a secondary offering by issuing 5,175,000 shares of voting common stock, no par value,
at $23.00 per share, in exchange for total proceeds of $113.1 million, net of issuance costs. The secondary offering was made
pursuant to a prospectus supplement dated August 8, 2017 and an accompanying prospectus dated July 28, 2017, pursuant to the
Company’s shelf registration statement on Form S-3 that was filed with the Securities and Exchange Commission and became
effective on July 28, 2017.
Use of Estimates
In preparing financial statements in conformity with accounting principles generally accepted in the United States of America
(“GAAP”), management is required to make estimates and assumptions that affect reported amounts of assets and liabilities as of
the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could
differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan and lease losses, valuations of servicing assets, restricted stock unit awards with market
price conditions and income taxes. In addition, the 2017 gain on contribution to equity method investment of $68.0 million was
based on management's estimates, including projected cash flows of the entity, and was inherently subjective by its nature.
Cash and Cash Equivalents
For the purpose of presentation in the statement of cash flows, cash and cash equivalents are defined as those amounts included
in the balance sheet caption “cash and due from banks” and “federal funds sold.” Cash and cash equivalents have initial maturity
of three months or less.
To comply with banking regulations, the Company is required to maintain certain average cash reserve balances. The daily
average cash reserve requirement was approximately $1.0 million and $1.7 million for the years ended December 31, 2019 and
2018, respectively.
Certificates of Deposit with other Banks
Certificates of deposit with other banks have maturities ranging from November 2020 through November 2023 and bear interest
at rates ranging from 0.20% to 3.55%. All investments in certificates of deposit are with FDIC insured financial institutions and
none exceed the maximum insurable amount of $250 thousand.
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Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Investments
Securities
Debt securities that management has the positive intent and ability to hold to maturity are classified as “held-to-maturity” and
recorded at amortized cost. Trading securities are recorded at fair value with changes in fair value included in earnings. Securities
not classified as held-to-maturity or trading, are classified as “available-for-sale” and recorded at fair value. Unrealized gains and
losses for available-for-sale investment securities are excluded from earnings and reported in other comprehensive income. The
Company’s entire portfolio for the periods presented is classified as available-for-sale.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.
Gains and losses on the sales of securities are typically recorded on the trade date and are determined using the specific
identification method.
Other
Other investments are generally non-marketable equity investments and are included in the other assets line on the consolidated
balance sheet while the impact is largely reflected in the equity method investments income (loss) and equity security investments
gains (losses), net line items on the consolidated statements of income. The Company generally accounts for other investments
either under the equity method or the provisions of Accounting Standards Update 2016-01 “Financial Instruments – Overall
(Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”), beginning in
2018. Investments through which there is significant influence but not control over the investee are accounted for under the equity
method. Investments through which the Company is not able to exercise significant influence over the investee are accounted for
under ASU 2016-01 whereby investments are measured at fair value with changes in fair value recognized in net income, unless
those investments have no readily determinable fair value. Investments without a readily determinable fair value are measured at
cost minus impairment, if any, plus or minus changes in value resulting from observable price changes arising from orderly
transactions. During the third quarter of 2019, the Company recorded a gain of $3.7 million resulting from an observable price
change arising from orderly transactions for one of its non-marketable equity investments. For periods ending prior to January 1,
2018, the Company recognized gains and losses in earnings only when equity securities were sold, based on the difference
between the sale proceeds and the cost of the securities, and for other than temporary impairment losses.
Impairment
At each reporting date, the Company evaluates each investment in a loss position for other than temporary impairment (“OTTI”).
The Company evaluates declines in market value below cost for debt securities by assessing the likelihood of selling the security
prior to recovering its cost basis. If the Company intends to sell the debt security or it is more-likely-than-not that the Company
will be required to sell the debt security prior to recovering its cost basis, the Company will write down the security to fair value
with the full charge recorded in earnings. If the Company does not intend to sell the debt security and it is not more-likely-than-
not that the Company will be required to sell the debt security prior to recovery, the security will not be considered other-than-
temporarily impaired unless there are credit losses associated with the security. In that case: (1) where credit losses exist, the
portion of the impairment related to those credit losses should be recognized in earnings; (2) any remaining difference between
the fair value and the cost basis should be recognized as part of other comprehensive income. For equity securities, any OTTI is
recognized with the full charge recorded in earnings. To determine whether an impairment of equity securities is OTTI, the
Company considers whether it has the ability and intent to hold the investment until there is a market price recovery and considers
whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary.
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Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
In determining whether OTTI exists, management considers many factors, including (1) the length of time and the extent to which
the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and
ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery
in fair value.
Federal Home Loan Bank Stock
Membership in the Federal Home Loan Bank of Atlanta (“FHLB”) requires ownership of FHLB stock. FHLB stock is restricted
because it may only be sold to the FHLB and all sales must be at par. FHLB stock is carried at cost minus impairment, if any, and
is recorded within other assets in the consolidated balance sheets. FHLB stock was $3.3 million and $3.1 million at December
31, 2019 and 2018, respectively.
Loans Held For Sale
Management designates loans as held for sale ("HFS") based on its intent to sell guaranteed portions in the SBA and USDA
Secondary Market and unguaranteed portions to participant banks and credit unions. Salability requirements of the guaranteed
portion include, but are not limited to, full disbursement of the loan commitment amount. Loans originated and intended for sale
are carried at the lower of cost or estimated fair value on a loan-by-loan basis. The cost basis of loans held for sale includes the
deferral of loan origination fees and costs. Deferred fees and costs are accreted and amortized for loans classified held for sale
until the sale occurs. At loan settlement, the pro-rata portion, based on the percent of the total loan sold, of the remaining deferred
fees and costs are recognized as an adjustment to the gain on sale.
As part of the Company’s management of the loans held in the portfolio, the Company will occasionally transfer loans from held
for investment to held for sale. Upon transfer, any associated allowance for loan and lease loss is released and the carrying value
of the loans is adjusted to the estimated fair value. The loans are subsequently accounted for at the lower of cost or fair value,
with valuation changes recorded in other noninterest income. Gains or losses on the sale of these loans are also recorded in
noninterest income. In certain circumstances, loans designated as held for sale may later be transferred back to the held for
investment loan and lease portfolio based upon the Company’s intent and ability to hold the loans for the foreseeable future. The
Company transfers these loans to loans and leases held for investment at the lower of cost or fair value and establishes a related
allowance for loan and lease loss.
In accordance with SBA and USDA regulation, the Bank is required to retain 10% and 5% of the principal balance of any SBA 7(a)
or USDA loan, respectively, comprised of unguaranteed dollars. With written consent from the SBA, the Bank may sell down to
a 5% exposure comprised of unguaranteed dollars.
The gain on sale recognized in income is the sum of the premium on the guaranteed loan and the fair value of the servicing assets
recognized, less the discount recorded on the unguaranteed portion of the loan retained, and any fair value fluctuations in
exchange-traded interest rate futures contracts, also defined as interest rate lock commitments.
The following summarizes the activity pertaining to loans held for sale for the years ended December 31, 2019 and 2018:
Balance at beginning of year
Originations
Proceeds from sale
Gain on sale of loans
Principal collections, net of deferred fees and costs
Non-cash transfers, net
Balance at end of period
$
$
2019
687,393 $
1,005,165
(457,533 )
29,002
(58,683 )
(238,897 )
966,447 $
2018
680,454
1,079,472
(1,086,614 )
75,170
(23,977 )
(37,112 )
687,393
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Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Loans and Leases Held for Investment
Loans and leases 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 and lease losses, and any deferred fees or costs on originated loans and leases 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. Discounts and premiums on any purchased loans are amortized to
income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Loans
and leases designated as held for investment include those identified as more beneficial to hold for the long term as well as the
required retention amount defined by the SBA and USDA. Loans and leases held for investment also consist of certain guaranteed
and unguaranteed credits including those designated as troubled debt restructurings, nonaccrual, non-marketable, and risk grade
5 or worse as defined by internal risk rating metrics.
Interest income on loans and leases is recognized as earned on a daily accrual basis. The accrual of interest on loans and leases is
discontinued when principal or interest is past due 90 days or the loan or lease is determined to be impaired. Impaired loans and
leases, or portions thereof, are charged off when deemed uncollectible.
Equipment Leasing
The Company purchases new equipment for the purpose of leasing such equipment to customers within its verticals. Equipment
purchased to fulfill commitments to commercial renewable energy projects is leased out under operating leases while leases of
equipment outside of the renewable energy vertical are generally direct financing leases. Accordingly, leased assets under
operating leases are included in premises and equipment while leased assets under direct financing leases are included in loans
and leases held for investment.
Direct Financing Leases
Interest income on direct financing leases is recognized when earned. Unearned interest is recognized over the lease term on a
basis which results in a constant rate of return on the unrecovered lease investment. The term of each lease is generally 3-7 years
which is consistent with the useful life of the equipment with no residual value.
Operating Leases
The term of each operating lease is generally 10 to 15 years. The Company retains ownership of the equipment and associated
tax benefits such as investment tax credits and accelerated depreciation. At the end of the lease term, the lessee has the option to
renew the lease for two additional terms or purchase the equipment at current fair market value.
Rental revenue from operating leases is recognized on a straight-line basis over the term of the lease. Rental equipment is
recorded at cost and depreciated to an estimated residual value on a straight-line basis over the estimated useful life. The useful
lives generally range from 20 to 25 years and residual values generally range from 20% to 50%, however, they are subject to
periodic evaluation. Changes in useful lives or residual values will impact depreciation expense and any gain or loss from the
sale of used equipment. The estimated useful lives and residual values of the Company's leasing equipment are based on industry
disposal experience and the Company's expectations for future sale prices.
If the Company decides to sell or otherwise dispose of rental equipment, it is carried at the lower of cost or fair value less costs
to sell or dispose. Repair and maintenance costs that do not extend the lives of the rental equipment are charged to direct
operating expenses at the time the costs are incurred.
Allowance for Loan and Lease Losses
The allowance for loan and lease losses is established as losses are estimated to have occurred through a provision for loan and
lease losses charged to earnings. Loan or lease losses are charged against the allowance when management believes the un-
collectibility of a loan or lease balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
96
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The allowance for loan and lease losses is evaluated on a regular basis by management and is based upon management’s periodic
review of the collectibility of loans or leases in light of historical experience, the nature and volume of the loan and lease 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.
A loan or lease is considered impaired when, based on current information and events, it is probable that the Company will be
unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease
agreement. Factors considered by management in determining impairment include payment status and other circumstances
impacting the probability of collecting scheduled principal and interest payments when due.
Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all circumstances surrounding the loan or lease and the borrower, including the length of the delay, the reasons for
the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a credit-by-credit basis by either the present value of expected future cash flows discounted at the
loan or lease's effective interest rate, the loan or lease’s obtainable market price, or the fair value of the collateral, if the loan or
lease is collateral dependent, except for large groups of smaller balance homogeneous loans or leases which may be collectively
evaluated for impairment. Prior to December 31, 2018, smaller balance loan or lease relationships collectively evaluated for
impairment are generally comprised of credits with unguaranteed exposure of less than $100,000 using a methodology based on
historical specific reserves on similar sized loans or leases. Loans or leases classified as troubled debt restructured (“TDR”) are
considered impaired. Loans or leases that experience insignificant payment delays and payment shortfalls generally are not
classified as impaired.
A loan or lease is accounted for as a TDR if the Company, for reasons related to the borrower’s financial difficulties, restructures
a loan or lease, and grants a concession to the borrower that it would not otherwise grant. A TDR typically involves a modification
of terms such as a reduction of the interest rate below the current market rate for a loan or lease with similar risk characteristics
or the waiving of certain financial covenants without corresponding offsetting compensation or additional support. The Company
measures the impairment loss of a TDR using the methodology for individually impaired loans or leases.
Interest is accrued and credited to income based on the principal amount outstanding. The accrual of interest on impaired loans
or leases is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due or
when the loan or lease becomes ninety days past due. Past due status of loans and leases is determined based on contractual terms.
When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized on the
cash-basis or cost-recovery method, as appropriate. Cash payments of interest on nonaccrual loans or leases will be applied to the
principal balance of the loan or lease. When facts and circumstances indicate the borrower has regained the ability to meet the
required payments, the loan or lease is returned to accrual status. Interest accruals are resumed on nonaccrual loans or leases only
when it is brought current with respect to interest and principal and when, in the judgment of management, the loans or leases are
estimated to be fully collectible as to all principal and interest. Management’s judgment is based on an assessment of the
borrower’s financial condition and a recent history of payment performance.
Foreclosed Assets
Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at the lower of
carrying amount or fair value less anticipated cost to sell at the date of foreclosure, establishing a new cost basis. Any write down
at the time of transfer to foreclosed assets is charged to the allowance for loan and lease losses. After foreclosure, valuations are
periodically performed by management, and the real estate is carried at the lower of the carrying amount or fair value, less cost
to sell. Subsequent write downs are charged to other loan origination and maintenance expense. Costs relating to improvement
of the property are capitalized while holding costs of the property are charged to other loan origination and maintenance expense
in the period incurred.
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Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Premises and Equipment
All premises and equipment, excluding land, are carried at cost, less accumulated depreciation. Land is carried at cost. Additions
and major replacements or improvements which extend useful lives of property or equipment are capitalized. Maintenance,
repairs, and minor improvements are expensed as incurred. Upon retirement or other disposition of the assets, the cost and related
depreciation are derecognized and any resulting gain or loss is reflected in income. Leasehold improvements are amortized over
the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Depreciation is
computed by the straight-line method over the following estimated useful lives:
Buildings
Transportation
Land improvements
Furniture and equipment
Computers and software
Solar panels
Servicing Assets
Years
39
5-10
10-15
5-10
3-5
20-25
All sales of loans are executed on a servicing retained basis. The standard SBA loan sale agreement is structured to provide the
Company with a “servicing spread” paid from a portion of the interest cash flow of the loan. SBA regulations require the Bank
to retain a portion of the cash flow from the interest payments received for a sold loan. The SBA retention requirement is at least
100 basis points in servicing spread while the Company's standard USDA loan sale agreement specifies a servicing spread of 40
basis points. The portion of the servicing spread that exceeds adequate compensation for the servicing function is recognized as
a servicing asset. Industry practice recognizes adequate compensation for servicing SBA and USDA loans as 40 basis points. The
fair value of the servicing asset is measured at the discounted present value of the excess servicing spread over the expected life
of the related loan using appropriate discount rates and assumptions based on industry statistics for prepayment speeds.
Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets
and are carried at fair value. Generally, purchased servicing rights are capitalized at the cost to acquire the rights. For sales of
loans, a portion of the cost of originating the loan is allocated to the servicing right based on fair value. Fair value is based on
market prices for comparable servicing contracts, when available, or alternatively, is based on a valuation model that calculates
the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants
would use in estimating future net servicing income, such as adequate compensation for servicing, the discount rate, the custodial
earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Capitalized servicing rights are
carried at fair value as of the reporting date. Changes to fair value are reported in loan servicing asset revaluation.
Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the
outstanding principal or a fixed amount per loan and are recorded as income when earned.
The Company’s investment in a loan is allocated between the retained portion of the loan, the servicing asset, and the sold portion
of the loan on the date the loan is sold. The carrying value of the retained portion of the loan is discounted based in part on the
estimates derived from the Company’s comparable nonguaranteed loan sales.
98
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Derivative Financial Instruments
Interest Rate Futures Contracts
The Company uses exchange-traded interest rate futures contracts to manage interest rate risk that may impact expected gains
arising from future secondary market loan sales. Upon entering into a futures contract, the Company is required to pledge to the
counterparty an amount of cash equal to a certain percentage of the contract amount, also known as an initial margin deposit.
Subsequent payments, known as variation margin, are made or received by the Company each day to settle the daily fluctuations
in the fair value of the underlying contract. As of December 31, 2019 and 2018, the cash margin balances were $2.7 million and
$1.0 million, respectively. Investments in these derivative contracts are subject to risks that can result in a loss of all or part of
an investment. Credit risk is considered low because the counterparties are futures exchanges. The Company has not designated
any derivative as a hedging instrument under applicable accounting guidance. Changes in fair value of the derivative contracts
is recorded as a component of "net gains on sales of loans" on the consolidated statement of income. The Company recognized a
loss of $3.0 million, a loss of $68 thousand and a gain of $117 thousand on the derivative contracts for the years ended December
31, 2019, 2018 and 2017, respectively. The total notional amount of derivative contracts outstanding was $20.4 million, $40.3
million and $29.9 million as of December 31, 2019, 2018 and 2017, respectively. The fair value of the derivative contracts on
the balance sheet date is zero due to the daily cash settlement of contracts.
Equity Warrant Assets
In connection with negotiated credit facilities and certain other services, the Company may obtain equity warrant assets giving
the Company the right to acquire stock in private companies in certain verticals. These assets are held for prospective investment
gains and are not used to hedge any economic risks. Further, the Company does not use other derivative instruments to hedge
economic risks stemming from equity warrant assets.
Equity warrant assets in certain private client companies are recorded as derivatives when they contain net settlement terms and
other qualifying criteria under Accounting Standards Codification 815. Equity warrant assets entitle the Company to purchase a
specific number of shares of stock at a specific price within a specific time period, generally 10 years. Certain equity warrant
assets contain contingent provisions, which adjust the underlying number of shares or purchase price upon the occurrence of
certain future events to prevent dilution of the Company’s implied ownership represented by the warrants. Certain warrant
agreements contain net share settlement provisions, which permit the receipt of, upon exercise, a share count equal to the intrinsic
value of the warrant divided by the share price (otherwise known as a “cashless” exercise). These equity warrant assets are
recorded at fair value and are classified as derivative assets, a component of other assets, on the consolidated balance sheet at the
time they are obtained.
The grant date fair values of equity warrant assets classified as derivatives received in connection with the issuance of a credit
facility are deemed to be loan fees and recognized as an adjustment of loan yield through loan interest income. Similar to other
loan fees, the yield adjustment related to grant date fair value of warrants is recognized over the life of that credit facility.
Any changes in fair value from the grant date fair value of equity warrant assets classified as derivatives will be recognized as
increases or decreases to other assets on the consolidated balance sheet and as net gains or losses on derivative instruments, in
other noninterest income, a component of consolidated net income. When a portfolio company is acquired, the Company may
exercise these equity warrant assets for shares or cash.
The fair value of equity warrant assets classified as derivatives is reviewed quarterly using a Black-Scholes option pricing model.
For those equity warrant assets that do not contain net share settlement provisions, the Company considers these to be equity
investments without readily determinable market values and records the asset at cost.
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Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Goodwill and Intangible Assets
Goodwill is the purchase premium after adjusting for the fair value of net assets acquired. Goodwill is not amortized but is
reviewed for potential impairment on an annual basis, or when events or circumstances indicate a potential impairment, at the
related reporting unit level. The goodwill impairment test involves comparing the fair value of the reporting unit with its carrying
value, including goodwill. If the fair value of the reporting unit exceeds its carrying value, goodwill of the reporting unit is
considered not impaired; however, if the carrying value of the reporting unit exceeds its fair value, an impairment charge must be
recorded. An impairment loss recognized cannot exceed the amount of goodwill assigned to a reporting unit. An impairment loss
establishes a new basis in the goodwill and subsequent reversals of goodwill impairment losses are not permitted under applicable
accounting guidance.
For intangible assets subject to amortization, the recoverability test is performed when a triggering event occurs and an
impairment loss is recognized if the carrying value of the intangible asset is not recoverable and exceeds fair value. The carrying
value of the intangible asset is considered not recoverable if it exceeds the sum of the undiscounted cash flows expected to result
from the use of the asset. Intangible assets deemed to have indefinite useful lives are not subject to amortization. An impairment
loss is recognized if the carrying value of the intangible asset with an indefinite life exceeds its fair value.
Intangibles subject to amortization related to the Reltco acquisition at December 31, 2017 included non-compete agreements with
former employees amortized over five years and customer relationships amortized over eight years. The Reltco trade name had
a carrying amount of $480 thousand as of December 31, 2017, and was the only indefinite-lived intangible asset.
On August 1, 2018, the Company financed the sale of its entire interest in Reltco, and as a result had no intangible assets as of
December 31, 2019 and 2018.
As of October 31, 2017, it was determined that impairment existed at the Reltco reporting unit and impairment charges of $3.6
million were recorded. There was no impairment charge for the year ended December 31, 2019. Impairment related charges for
the years ended December 31, 2018 and 2017 are reflected in a separate line in the income statement and are comprised of the
following components:
Intangible assets
Goodwill
Other net asset dispositions
Contingent consideration liability
Total impairment expense on goodwill and other intangibles, net
$
$
2018
2017
3,979 $
—
341
(1,640 )
2,680 $
720
7,278
—
(4,350 )
3,648
See Note 2. Title Insurance Business for further discussion related to impairment of Reltco.
Long-Lived Assets Impairment Evaluation
The Company evaluates the carrying value of rental equipment and identifiable definite lived intangible assets for impairment
whenever events or circumstances have occurred that would indicate the carrying amount may not be fully recoverable. A key
element in determining the recoverability of long-lived assets is the Company’s outlook as to the future market conditions for its
rental equipment. If the carrying amount is not fully recoverable, an impairment loss is recognized to reduce the carrying amount
to fair value. The Company determines fair value based upon the condition of the rental equipment and the projected net cash
flows from its rental and sale considering current market conditions. During the years ended December 31, 2019, 2018 and 2017,
there were no impairments of long-lived assets.
100
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Long -Lived Asset Reclassified to Held for Sale
During the fourth quarter of 2018, the Company determined that retention of one of its aircraft was ineffective in serving the
needs of an expanding nationwide customer base. As a result of this determination, the Company began marketing the aircraft
for sale. In December 2018, the Company received a non-binding letter of intent to purchase from a third party with expected
total proceeds, net of estimated expenses, of $10.9 million. The sale closed in the first quarter of 2019. The carrying amount of
the aircraft of $10.5 million is reflected in the 2018 consolidated balance sheet in the "Other assets" line item. A $357 thousand
gain associated with the sale of the aircraft was recorded upon consummation of the sale in the first quarter of 2019 and is reflected
in the 2019 consolidated statement of income in the “Other noninterest income” line item.
Change in Accounting Estimate
During 2017, the Company assessed its estimate of the useful lives of the Company’s aircraft transportation. The Company
revised its original useful life estimate of 20 years and currently estimates that its aircraft transportation will have a useful life of
10 years. The effects of reflecting this change in accounting estimate on the 2017 consolidated financial statements are as follows:
Decrease in:
Net income
Basic EPS
Diluted EPS
Common Stock
Year Ended
December 31, 2017
$
$
$
894
0.02
0.02
On June 11, 2014, the Company amended its Articles of Incorporation to create two classes of common stock. These two classes
are identified as Class A and Class B for Voting Common Stock and Non-Voting Common Stock, respectively, in the
accompanying consolidated balance sheet and statement of changes in shareholders’ equity. Voting and Non-Voting Common
Stock holders have identical rights and privileges, with the exception that Non-Voting Common shares have no voting power
unless circumstances arise where instances creating the Non-Voting Common Shares are modified in any way that negatively
impact rights of holder. Stock splits or dividends of Voting and Non-Voting Common Shares shall be in like stock (voting for
voting and non-voting for non-voting). Any number of Non-Voting Common Stock may be converted to an equal number of
Voting Common Stock at the option of the holder; provided that holder is not the initial transferee or an affiliate of initial
transferee.
During 2019, 1,727,999 shares of Class B common stock (non-voting) were converted to Class A common stock (voting) in
connection with private sales. This conversion decreased the value of Class B common stock (non-voting) and increased the value
of Class A common stock (voting) by $18.3 million.
Advertising Expense
Marketing costs are recognized in the month the event or advertisement takes place. These costs are included in advertising and
marketing expense as presented in the consolidated statements of income.
Income Taxes
Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities
(excluding deferred tax assets and liabilities related to business combinations or components of other comprehensive income).
Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts
and tax bases of assets and liabilities, computed using enacted tax rates. The effect of a change in tax rates on deferred assets and
liabilities is recognized in income taxes during the period that includes the enactment date. A valuation allowance, if needed,
reduces deferred tax assets to the expected amount more likely than not to be realized. Realization of deferred tax assets is
dependent upon the level of historical income, prudent and feasible tax planning strategies, reversals of deferred tax liabilities
and estimates of future taxable income.
101
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The Company uses the flow-through method of accounting on investments that generate investment tax credits. Under this
method, investment tax credits are recognized as a reduction to income tax expense immediately in the period that the credit is
generated, to the extent permitted by tax law. In accounting for any temporary difference that arise, the Company has elected the
income statement method whereby deferred taxes are adjusted through income tax expense.
The Company evaluates uncertain tax positions at the end of each reporting period. The Company may recognize the tax benefit
from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing
authorities, based on the technical merits of the position. The tax benefit recognized in the financial statements from any such
position is measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate
settlement. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. Any interest and/or penalties
related to income taxes are reported as a component of income tax expense.
Comprehensive Income
Annual comprehensive income reflects the change in the Company’s equity during the year arising from transactions and events
other than investment by and distributions to shareholders. The only components of other comprehensive income consist of
realized and unrealized gains and losses related to investment securities.
Stock Compensation Plans
The Company recognizes compensation cost based on the fair value of the equity or liability instruments issued. The expense
measures the cost of employee services received in exchange for stock options and restricted stock based on the grant-date fair
value of the award and recognizes the cost over the vesting period for all awards within an individual grant, including ones with
graded vesting features. The fair value of the restricted stock awards or units with a market price condition and implied service
period are calculated using the Monte Carlo Simulation method. The impact of forfeitures on stock-based compensation expense
is recognized as forfeitures occur. See Note 14. Benefit Plans for further discussion and detail.
Fair Value of Financial Instruments
GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in
the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the
measurement date. The Company determines the fair values of its financial instruments based on the fair value hierarchy
established per GAAP which requires an entity to maximize the use of observable inputs and minimize the use of unobservable
inputs when measuring fair value. See Note 12. Fair Value of Financial Instruments for further discussion and detail.
102
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
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.
Basic earnings per share:
Net income available to common shareholders
Weighted-average basic shares outstanding
Basic earnings per share
Diluted earnings per share:
Net income available to common shareholders, for diluted
earnings per share
Total weighted-average basic shares outstanding
Add effect of dilutive stock options and restricted stock grants
Total weighted-average diluted shares outstanding
Diluted earnings per share
Anti-dilutive shares
Reclassifications
2019
December 31,
2018
2017
$
$
18,034 $
40,222,758
0.45 $
51,448 $
40,056,230
1.28 $
100,499
36,592,893
2.75
$
$
18,034 $
40,222,758
830,756
41,053,514
0.44 $
1,071,467
51,448 $
40,056,230
1,390,520
41,446,750
1.24 $
1,111,236
100,499
36,592,893
1,266,642
37,859,535
2.65
253,338
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.
Revenue Recognition
In addition to lending and related activities the Company offers various services to customers that generate revenue. The
Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant
contract balances. Incremental costs of obtaining a contract are expensed when incurred when the amortization period is one year
or less. As of December 31, 2019 and 2018, remaining performance obligations consisted primarily of serviced based revenues
for contracts with an original expected length of one year or less.
Service based revenues are included in other noninterest income and consist of other recurring revenue streams from services
provided by GLS to its clients for settlement, accounting and valuation for government guaranteed loan sales and holdings, fund
investment advisory services performed by Canapi Advisors, investment management and financial planning services provided
by Live Oak Private Wealth, and administration of trust assets held by the Company's trust department.
Service Based Revenues
GLS provides services when requested by clients. Each requested service represents a specific performance obligation with a
transaction price outlined by GLS' fee schedule. Revenue is recognized as the requested services are completed and payment is
generally received the following month.
Canapi Advisors provides investment advisory services to two financial technology venture funds where its performance
obligations are satisfied over time. Fund management fees are based upon the contractual terms of the limited partnership
agreements and are recognized as earned over the specified contract period, which is generally equal to the life of the individual
fund. Fund management fees are calculated as a percentage of committed capital, are collected in advance and received quarterly.
Live Oak Private Wealth’s investment management and financial planning performance obligations are generally satisfied over
time. Fees are recognized quarterly based on the quarter-end market value of the managed assets as valued by the custodian of
the customer’s assets and the applicable fee rate. Payment is generally received in advance through a direct charge to customer’s
103
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
accounts. The Company does not earn performance-based incentives from investment management and financial planning
services. Contracts with customers may be terminated at any time by either party.
The Company’s trust department ceased operations in the first quarter of 2019. Trust account administration performance
obligations were generally satisfied over time and fees were recognized monthly, based on the month-end market value of assets
in fiduciary accounts and the applicable fee rate. Fees were generally received after month-end through a direct charge to
customers' accounts. The Company did not earn performance-based incentives from trust account administration services.
Accounting Change
On January 1, 2019, the Company adopted Accounting Standards Update ("ASU") No. 2016-02 “Leases (Topic 842),” (“ASU
2016-02”) and all subsequent ASUs that modified Topic 842. The Company elected to apply certain practical expedients provided
under ASU 2016-02 whereby the Company will not reassess (i) whether any expired or existing contracts are or contain leases,
(ii) the lease classification for any expired or existing leases and (iii) initial direct costs for any existing leases. The Company has
also applied the practical expedient to use hindsight in determining the lease term and in assessing impairment of the right-of-use
assets. The Company does not apply the recognition and measurement requirements to any short-term leases (as defined by ASU
2016-02). The Company accounts for lease and non-lease components separately because such amounts are readily determinable
under the lease contracts. The Company utilized the modified-retrospective transition approach prescribed by ASU 2018-11,
“Leases (Topic 842) Targeted Improvements” (“ASU 2018-11”). The implementation of the new standard resulted in the
Company recording $2.2 million of operating lease right-of-use ("ROU") assets, $2.4 million of operating lease liabilities and a
cumulative effect adjustment to opening retained earnings of $66 thousand. The Company also recorded $18 thousand of finance
ROU assets and finance lease liabilities.
The Company determines if an arrangement is or contains a lease at inception. If it is determined to be or contain a lease, then
the lease is classified as an operating or finance lease.
ROU assets represent the Company's right to use an underlying asset for the lease term. Lease liabilities represent the Company's
obligation to make lease payments arising from the lease. ROU assets and liabilities are measured on commencement date based
on the present value of the lease payments over the lease term, discounted using the discount rate for the lease at commencement.
The discount rate shall be the rate implicit in the lease, however, if that is not readily determinable, the Company will use its
incremental borrowing rate. The ROU asset also includes any lease payments made before the commencement date and initial
direct costs and excludes any lease incentives received. The lease terms may include options to extend or terminate the lease
when it is reasonably certain that the option will be exercised. Lease expense for lease payments is recognized on a straight-line
basis over the lease term.
Operating leases are included in operating lease right-of-use assets and operating lease liabilities in the consolidated balance
sheets. Finance leases are included in other assets and long term borrowings in the consolidated balance sheets. Lease expense
for operating leases and finance leases is included in occupancy expense in the consolidated statements of income and interest
expense for finance leases is included in other interest expense in the consolidated statements of income.
See Note 6. Leases for further discussion and detail.
In June 2018, the FASB issued ASU No. 2018-07, “Compensation - Stock Compensation (Topic 718) Improvements to
Nonemployee Share-Based Payment Accounting” (“ASU 2018-07”). ASU 2018-07 amends Accounting Standard Codification
718 to largely align accounting for share-based payment awards issued to employees and nonemployees. Under the new guidance,
existing employee guidance will generally apply to nonemployee share-based transactions, except for specific guidance on inputs
into option pricing models and the attribution of cost. The Company adopted the standard on January 1, 2019 with no material
effect on its consolidated financial statements.
Recent Accounting Pronouncements
The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure
of financial information by the Company.
104
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13,
“Financial Instruments – Credit Losses (Topic 326): 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 was effective for the Company on January 1, 2020. Through the date of
adoption, the Company’s cross-functional working group continued to meet in accordance with its implementation plan. During
the parallel run process qualitative factors and the reasonable and supportable forecast were refined to ensure the assumptions
were appropriate. Operational procedures and internal controls were designed and documented as parallel run results were
evaluated. Lastly, an assessment of our third-party vendor’s modeling tool was completed while the Company completed parallel
runs utilizing data from the third and fourth quarters of 2019.
Management plans to estimate credit losses over a one-year forecast horizon and revert to long term historical loss experience on
a straight-line basis over a one-year period. The duration of the forecast period, the method of reversion, and the duration of the
reversion period will all be reevaluated at each reporting period to ensure those judgements are appropriate. Management will
include forecasted levels of employment as the primary economic variable it believes to be most relevant based on the nature and
composition of the loan portfolio. Management also plans to leverage economic projections from a reputable and independent
third party to inform its reasonable and supportable forecasts over the forecast period. Based on the fourth quarter parallel run,
review of the portfolio, including composition characteristics and quality of the underlying loans, and the prevailing economic
conditions and forecasts as of the adoption date, the Company expects the adoption of ASU 2016-13 will result in an immaterial
decrease to its loan and lease credit loss reserves of approximately $800 thousand to $1.4 million as well as an immaterial increase
to reserves for off-balance sheet exposure of approximately $400 thousand to $800 thousand. The magnitude of this change is
consistent with management’s expectations considering the age of the Bank and its commercial lending specialization. The
adoption of ASU 2016-13 is not expected to have a significant impact on the allowance for expected credit losses for available-
for-sale debt securities or other purchased financial assets.
In March 2019, the FASB issued ASU 2019-01, “Leases (Topic 842): Codification Improvements” (“ASU 2019-01”). ASU 2019-
01 provides updates to Topic 842 including: (i) guidance on how to determine fair value of leased items for lessors who are not
dealers or manufacturers, (ii) cash flow presentation for lessors of sales-type and direct financing leases and (iii) clarifies that
certain transition disclosures. The amendments are effective for the Company on January 1, 2020. The Company does not expect
these amendments to have a material effect on its consolidated financial statements.
In April 2019, the FASB issued ASU No. 2019-04, “Codification Improvements to Topic 326, Financial Instruments-Credit
Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments” (“ASU 2019-04”). ASU 2019-04 provides
clarification and minor improvements related to ASU 2016-01 “Financial Instruments - Overall (Subtopic 825-10): Recognition
and Measurement of Financial Assets and Financial Liabilities,” ASU 2016-13 “Financial Instruments – Credit Losses (Topic
326): Measurement of Credit Losses on Financial Instruments” and ASU 2017-12 “Derivatives and Hedging (Topic 815) -
Targeted Improvements to Accounting for Hedging Activities.” The standard will be effective for the Company on January 1,
2020 with early adoption permitted. The Company does not expect this standard to have a material effect on its consolidated
financial statements.
In May 2019, the FASB issued ASU No. 2019-05, “Financial Instruments – Credit Losses (Topic 326): Targeted Transition Relief”
(“ASU 2019-05”). ASU 2019-05 allows entities an option to irrevocably elect the fair value option for eligible instruments upon
adoption of Topic 326. The amendments are effective for the Company on January 1, 2020. See discussion of ASU 2016-13
above for impact to the consolidated financial statements.
105
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
In November 2019, the FASB issued ASU No. 2019-11, “Codification Improvements to Topic 326, Financial Instruments-Credit
Losses” (“ASU 2019-11”). ASU 2019-11 addresses issues raised by stakeholders during the implementation of ASU 2016-13
including: (i) clarifying guidance on how to report expected recoveries for purchased financial assets with credit deterioration,
(ii) providing transition relief for troubled debt restructurings, (iii) extending disclosure relief related to accrued interest
receivables, (iv) clarifying practical expedients related to financial assets secured by collateral maintenance provisions and (v)
reinforcing existing guidance that prohibits organizations from recording negative allowances for available-for-sale debt
securities. The amendments are effective for the Company on January 1, 2020. See discussion of ASU 2016-13 above for impact
to the consolidated financial statements.
In December 2019, the FASB issued ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income
Taxes” (“ASU 2019-12”). ASU 2019-12 simplifies accounting for income taxes by removing specific technical exceptions in
ASC 740 related to the incremental approach for intra-period tax allocation, the methodology for calculating income taxes in an
interim period and the recognition for deferred tax liabilities for outside basis differences. ASU 2019-12 also simplifies aspects
of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that
result in a step-up in the tax basis of goodwill. The amendments are effective for the Company on January 1, 2021 with early
adoption permitted. The Company does not expect these amendments to have a material effect on its consolidated financial
statements.
Note 2. Title Insurance Business
Business Combination
On February 1, 2017, the Company completed its acquisition of Reltco, Inc. and National Assurance Title, Inc. (collectively
referred to as "Reltco"), two nationwide title agencies under common control based in Tampa, Florida. The acquisition was
expected to complement the Company's growth strategy, including vertically integrating with parallel services to deliver a high-
quality customer experience with speed.
On the acquisition date, the fair value of Reltco included $5.8 million in assets and $4.7 million in liabilities. The total acquisition
gross consideration at the time of the transaction, including earn-out contingent consideration was approximately $15.8 million.
The acquisition was valued at $12.7 million after consideration of the applicable fair value adjustments to the earn-out, resulting
in the Company paying $7.8 million in cash and issuing 27,724 shares of its common stock at closing in addition to an earn-out
of up to 184,012 shares of its stock and $3.8 million in cash, in exchange for all of the outstanding shares of Reltco. The earn-out
was recorded as a $4.3 million contingent liability on the acquisition date and is earned proportionally based on the ratio of the
new subsidiary's actual future aggregate net income after tax divided by a target net income after tax of approximately $6.0
million over the four year earn-out period. Fair value measurement of the earn-out was calculated using the Monte Carlo
Simulation. The Monte Carlo Simulation simulates 100,000 trials to assess the expected market price as of the earn-out
measurement date at the end of each of the next four years based on the Cox, Ross & Rubinstein option pricing methodology.
The Monte Carlo Simulation utilized various assumptions that include a risk free rate of return through the end of each
measurement period equivalent to that of a U.S. Treasury, expected volatility of 30.00% over four years and a dividend yield
of 0.40%.
The merger was accounted for in accordance with the acquisition method of accounting, and the identifiable assets acquired and
liabilities assumed were recorded at their estimated fair values as of the acquisition date separately from goodwill. The estimated
fair values of assets acquired and liabilities assumed are based on the information available at the date of the acquisition.
Management continues to evaluate these fair values, which are subject to revision as additional information becomes available.
Contingent consideration is recorded at fair value based on the terms of the purchase agreement with subsequent quarterly changes
in fair value recorded through earnings. The fair value of contingent consideration upon acquisition was $4.3 million and increased
by $350 thousand during the period leading up to the October 31, 2017 impairment assessment date discussed below. During this
pre-impairment assessment period fair value was estimated using the Monte Carlo Simulation. The assumptions utilized include
a risk-free rate of return through the end of each measurement period equivalent to that of a U.S. Treasury, expected volatility
of 30.00% over the remaining 3.25 years and a dividend yield of 0.51%.
106
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The following table summarizes the allocation of the purchase price on the date of acquisition to assets acquired and the liabilities
assumed based on their estimated fair values:
Fair value of assets acquired
Cash
Accounts receivable
Intangible assets
Total assets acquired
Fair value of liabilities assumed
Contingent consideration
Accounts payable and other liabilities
Total liabilities assumed
Net assets acquired
Purchase price
Common shares issued
Purchase price per share of the Company’s common stock
Company common stock issued
Cash
Total purchase price
Goodwill
$
$
$
$
$
102
159
5,505
5,766
4,300
381
4,681
1,085
27,724
20.38
565
7,798
8,363
7,268
Goodwill recorded represents future revenues and efficiencies gained through the Reltco acquisition. At the date of acquisition,
intangible assets consisted of trade names of $1.2 million, customer relationships of $3.9 million, and non-compete agreements
of $405 thousand.
The Company recorded no merger expenses for the years ended December 31, 2019 and 2018, and $766 thousand for the year
ended December 31, 2017 related to the Reltco acquisition.
Goodwill and Intangible Asset Impairment
Goodwill and intangible assets are evaluated for potential impairment annually or when circumstances indicate potential
impairment may have occurred. Impairment losses, if any, are determined based upon the excess of carrying value over the
estimated fair value of the asset.
As of October 31, 2017, the Company determined that its goodwill and certain intangible assets related to the Reltco business
combination had indications of impairment. Reltco’s financial performance was significantly lower during the first nine-months
of operations and expectations of future profitability for the reporting unit were also lower than originally expected due to a
slowing of refinance activity in the mortgage industry. The slowing of refinance activity in the mortgage industry was largely
driven by increased levels of market rates during 2017.
In performing the goodwill impairment testing and measurement process to identify possible impairment, the estimated fair value
of the Reltco reporting unit was developed using the income and market approaches to value Reltco. The income approach
consisted of discounting projected long-term future cash flows, which are derived from internal forecasts and economic
expectations for Reltco. The market valuation approach utilized revenue and EBITDA multiples from comparable market
transactions.
The results of the impairment test indicated that the estimated fair value of Reltco was less than book value which resulted in a
goodwill impairment charge of $7.3 million in accordance with accounting for Intangibles, Goodwill and other under ASC 360.
This non-cash goodwill impairment charge to earnings was recorded as a component of impairment expense on goodwill and
other intangibles in the consolidated statement of income.
107
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
While the intangibles subject to amortization were determined to be recoverable based on an undiscounted cash flow analysis,
impairment of $720 thousand was realized for indefinite life tradenames. This non-cash intangible impairment charge to earnings
was recorded as a component of impairment expense on goodwill and other intangibles in the consolidated statement of income.
As a result of Reltco’s 2017 results of operations and the direct contractual inclusion of impairment losses in the determination
of earn out consideration, the fair value of the contingent consideration decreased by $4.4 million, which is recorded as a
component of impairment expense on goodwill and other intangibles in the consolidated statement of income. The Company
subsequently modified the acquisition contract in 2017 to change the definition of net income related to the earn-out contingent
consideration which resulted in $1.6 million in salaries and employee benefit expense.
Fair value of contingent consideration was estimated using the Monte Carlo Simulation. The assumptions utilized in the
determining the impact of the impairment assessment and subsequent purchase contract modification include a risk-free rate of
return through the end of each measurement period equivalent to that of a U.S. Treasury, expected volatility of 25.00% over the
remaining 3.00 years and a dividend yield of 0.51%.
On August 1, 2018, the Company financed the sale of its entire interest in Reltco for $3.0 million. The Company's divestiture was
driven by expectations of future profitability under current market conditions impacting the mortgage industry.
Following is a summary of activity in contingent consideration for the Reltco reporting unit:
Balance, December 31, 2017
Fair value adjustments prior to August 1, 2018 sale
Impact of sale on August 1, 2018
Balance, December 31, 2018
Note 3. Unconsolidated Joint Venture
$
$
1,900
(260 )
(1,640 )
—
On October 1, 2017, the Company closed a digital banking joint venture between Live Oak Banking Company and First Data
Corporation ("First Data"). The new company, Apiture, LLC (“Apiture”), combined First Data's and the Bank's digital banking
platforms, products, services, and certain human resources used in the creation and delivery of technology solutions for financial
institutions. The contributed assets of both the Company and First Data were considered businesses in accordance with relevant
accounting standards. At closing both the Bank and First Data received equal voting interests in Apiture in exchange for their
respective contributions. As a term of the closing agreements, First Data was entitled to a preference in Apiture's cash earnings
from the date of closing through December 31, 2017 and all of 2018, not to exceed $18.0 million and $18.9 million, respectively.
This joint venture has been accounted for as an equity method investment. Under the equity method of accounting, the net equity
investment of the Bank and the Bank's share of net income or loss from the unconsolidated entity will be reflected in the
Company's consolidated balance sheets and the consolidated statements of income.
The estimated fair value of Apiture at the date of the 2017 closing was approximately $150 million. Based on the aforementioned
cash earnings preference to First Data during 2017 and 2018, the valuation of equity interests received in exchange for
contributions by the two initial investors was unequal. As a consequence of this preference, the initial economic interest in Apiture
for First Data was equal to 54.7% or $82.0 million, while the Company's initial economic interest in Apiture was equal to 45.3%,
or $68.0 million. As the Company had no carrying amount for its contribution in the formation of Apiture, the transaction on
October 1, 2017 resulted in the recognition of a $68.0 million equity method investment included in other assets on the
consolidated balance sheet and a one-time pre-tax gain of the same amount reflected in gain on contribution to equity method
investment on the consolidated income statement at the date of closing. The estimated fair value of Apiture and the related initial
economic interests of investors were based on a discounted cash flows which are inherently subjective by nature.
As a result of unequal economic interests arising from the cash earnings preference, distribution rights and priorities set forth in
the Contribution Agreement differ from what is reflected by the underlying percentage voting interests of First Data and Live
Oak. Accordingly, GAAP income (loss) is allocated utilizing the hypothetical liquidation at book value ("HLBV") method. Under
the HLBV method, we allocate income or loss based on the change in each unitholders’ claim on the net assets of Apiture at
period end, after adjusting for any distributions or contributions made during such period. The HLBV method is commonly
108
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
applied to equity investments where cash distribution percentages vary at different points in time and are not directly linked to an
equity holder’s ownership percentage.
The HLBV method is a balance sheet-focused approach. A calculation is prepared at each balance sheet date to determine the
amount that unitholders would receive if Apiture were to liquidate all of its assets (at GAAP net book value) and distribute the
resulting proceeds to its creditors and unitholders based on the contractually defined liquidation priorities. The difference between
the calculated liquidation distribution amounts at the beginning and the end of the reporting period, after adjusting for capital
contributions and distributions, is used to derive each unitholder's share of the income (loss) for the period. Due to the stated cash
earnings preference to First Data and because the HLBV method incorporates non-cash items such as amortization expense, in
any given period, income or loss may be allocated disproportionately to unitholders as compared to their respective ownership
percentage in our operating partnership, and net income (loss) attributable to the Bank could be more or less net income than
actual cash distributions received and more or less income (loss) than what may be received in the event of an actual liquidation.
Additionally, the HLBV method could result in no net income attributable to the Company during a period when Apiture reports
net income. The Company recognized $4.4 million in net losses in 2019 and no net income or loss in 2018 and 2017 as a result
of its investment in Apiture.
In the third quarter of 2018 Apiture sold additional units, representing 5.24% ownership, to a third-party investor in exchange for
cash. As a result of this transaction the Company recognized a $1.1 million gain upon dilution of its investment which is included
in the “Other Noninterest Income” line of the 2018 consolidated statement of income. The Company has evaluated the new and
existing partners’ participating rights under Apiture’s governing documents and determined that equity method investment
accounting continues to be appropriate.
Note 4. Securities
The carrying amount of securities and their approximate fair values are reflected in the following table:
December 31, 2019
US treasury securities
US government agencies
Mortgage-backed securities
Municipal bonds
Total
December 31, 2018
US treasury securities
US government agencies
Mortgage-backed securities
Municipal bond
Total
Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Fair
Value
4,988
$
22,444
488,694
8,493
524,619
$
27
335
15,530
469
16,361
$
$
—
—
927
8
935
$
$
5,015
22,779
503,297
8,954
540,045
4,969 $
31,121
345,606
1,000
382,696 $
$
—
48
1,340
—
1,388 $
3 $
225
3,365
1
3,594 $
4,966
30,944
343,581
999
380,490
$
$
$
$
Eleven securities totaling $36.2 million were sold resulting in a net gain of $620 thousand during the year ended December 31,
2019.
There were no sales of securities during the year ended December 31, 2018, and 2017.
109
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
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.
December 31, 2019
Mortgage-backed securities
Municipal bonds
Total
December 31, 2018
US treasury securities
US government agencies
Mortgage-backed securities
Municipal bond
Total
Less Than 12 Months
Fair
Value
Unrealized
Losses
12 Months or More
Fair
Value
Unrealized
Losses
Total
Fair
Value
Unrealized
Losses
$ 42,835 $
—
$ 42,835 $
460 $ 36,518 $
92
460 $ 36,610 $
—
467 $ 79,353 $
92
475 $ 79,445 $
8
927
8
935
Less Than 12 Months
Fair
Value
Unrealized
Losses
12 Months or More
Fair
Value
Unrealized
Losses
Total
Fair
Value
Unrealized
Losses
$
4,966 $
—
164,836
999
$ 170,801 $
— $
3 $
— 16,268
1,177 51,371
—
1,181 $ 67,639 $
1
— $
4,966 $
225 16,268
2,188 216,207
999
2,413 $ 238,440 $
—
3
225
3,365
1
3,594
At December 31, 2019, there were twenty-two residential mortgage-backed securities and one municipal bond in unrealized loss
positions for greater than 12 months and ten residential mortgage-backed securities and ten commercial mortgage-backed
securities in unrealized loss positions for less than 12 months. Unrealized losses at December 31, 2018 consisted of thirty-one
residential mortgage-backed securities and six US government agencies for greater than 12 months and twenty-five residential
mortgage-backed securities, one US Treasury security and one municipal bond in unrealized loss positions 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, and the
Company has the intent and ability to hold these securities until they recover their value, none of the securities are deemed to be
other than temporarily impaired.
All residential mortgage-backed securities in the Company’s portfolio at December 31, 2019 and 2018 were backed by US
government sponsored enterprises (“GSEs”).
110
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The following is a summary of investment securities by maturity:
US treasury securities
Within one year
Total
US government agencies
Within one year
One to five years
Five to ten years
Total
Mortgage-backed securities
One to five years
Five to ten years
After 10 years
Total
Municipal bonds
After 10 years
Total
Total
December 31, 2019
Available-for-sale
Amortized
cost
Fair
value
$
4,988 $
4,988
5,015
5,015
7,008
12,520
2,916
22,444
5,030
152,561
331,103
488,694
8,493
8,493
7,052
12,673
3,054
22,779
5,131
159,082
339,084
503,297
8,954
8,954
$
524,619
$
540,045
The table above reflects contractual maturities. Actual results will differ as the loans underlying the mortgage-backed securities
may repay sooner than scheduled.
There were no investment securities pledged at December 31, 2019. At December 31, 2018, investment securities with a fair
market value of $2.5 million were pledged to the Company's trust department for uninsured trust assets held by the trust
department and $100 thousand was pledged to the Ohio State Treasurer to allow the Company's trust department to conduct
business in the State of Ohio.
111
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Note 5. Loans and Leases Held for Investment and Credit Quality
Loans and leases consist of the following:
Commercial & Industrial
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Land
Agriculture
Total
Total Loans and Leases 1
Net Deferred Costs
Discount on SBA 7(a) and USDA Unguaranteed 2
Loans and Leases, Net of Unearned
December 31,
2019
December 31,
2018
$
$
9,344 $
26,388
45,581
106,096
99,191
51,251
557,146
894,997
44,571
9,033
94,742
443
2,404
22,132
173,993
347,318
50,365
113,517
247,625
26,379
7,431
146,319
461,157
1,052,793
344,732
344,732
2,639,840
11,400
(3,941 )
2,647,299 $
6,400
17,378
51,082
108,783
94,338
45,604
295,163
618,748
43,454
9,874
81,619
2,149
1,232
14,094
96,482
248,904
53,085
71,344
188,531
20,597
7,905
136,721
260,847
739,030
243,798
243,798
1,850,480
5,960
(13,021 )
1,843,419
1 Total loans and leases include $700.6 million and $305.4 million of U.S. government guaranteed loans as of December 31,
2019 and December 31, 2018, 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.
112
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Credit Quality Indicators
The Bank uses internal loan and lease reviews to assess the performance of individual loans and leases by industry segment. An
independent review of the loan and lease portfolio is performed annually by an external firm. The goal of the Bank’s annual
review of each borrower’s 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 and lease. The grade is periodically evaluated and adjusted as
performance dictates. Loan and lease grades 1 through 4 are passing grades and grade 5 is special mention. Collectively, grades
6 through 8 represent classified loans and leases in the Bank’s portfolio. The following guidelines govern the assignment of these
risk grades:
Exceptional (1 Rated): These loans and leases are of the highest quality, with strong, well-documented sources of repayment.
These loans and leases will typically have multiple demonstrated sources of repayment with no significant identifiable risk to
collection, exhibit well-qualified management, and have liquid financial statements relative to both direct and indirect obligations.
Quality (2 Rated): These loans and leases are of very high credit quality, with strong, well-documented sources of repayment.
These loans and leases exhibit very strong, well defined primary and secondary sources of repayment, with no significant
identifiable risk of collection and have internally generated cash flow that more than adequately covers current maturities of long-
term debt.
Satisfactory (3 rated): These loans and leases exhibit satisfactory credit risk and have excellent sources of repayment, with no
significant identifiable risk of collection. These loans and leases have documented historical cash flow that meets or exceeds
required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources. They have adequate
secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the
net worth of the borrower or guarantor.
Acceptable (4 rated): These loans and leases show signs of weakness in either adequate sources of repayment or collateral but
have demonstrated mitigating factors that minimize the risk of delinquency or loss. These loans and leases may have unproved,
insufficient or marginal primary sources of repayment that appear sufficient to service the debt at this time. Repayment
weaknesses may be due to minor operational issues, financial trends, or reliance on projected performance. They may also contain
marginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation
value to the net worth of the borrower or guarantor.
Special mention (5 rated): These loans and leases show signs of weaknesses in either adequate sources of repayment or collateral.
These loans and leases may contain underwriting guideline tolerances and/or exceptions with no mitigating factors; and/or
instances where adverse economic conditions develop subsequent to origination that do not jeopardize liquidation of the debt but
substantially increase the level of risk.
Substandard (6 rated): Loans and leases graded Substandard are inadequately protected by current sound net worth, paying
capacity of the obligor, or pledged collateral. Loans and leases classified as Substandard must have a well-defined weakness or
weaknesses that jeopardize the liquidation of the debt; are characterized by the distinct possibility that the Bank will sustain some
loss if the deficiencies are not corrected. These loans and leases are consistently not meeting the repayment schedule.
Doubtful (7 rated): Loans and leases graded Doubtful have all the weaknesses inherent in those classified as Substandard, plus
the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts,
conditions, and values highly questionable and improbable. The ability of the borrower to service the debt is extremely weak,
overdue status is constant, the debt has been placed on non-accrual status, and no definite repayment schedule exists. Once the
loss position is determined, the amount is charged off.
Loss (8 rated): Loss rated loans and leases are considered uncollectible and of such little value that their continuance as assets is
not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not
practical or desirable to defer writing off this credit even though partial recovery may be affected in the future.
113
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The following tables summarize the risk grades of each category:
December 31, 2019
Commercial & Industrial
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Land
Agriculture
Total
Total1
Risk Grades
1 - 4
Risk Grade
5
Risk Grades
6 - 8
Total
$
8,684 $
24,446
36,151
92,964
95,613
46,936
506,070
810,864
44,571
9,033
90,454
443
2,404
22,132
162,098
331,135
47,187
105,753
201,322
16,385
7,431
127,893
415,536
921,507
219 $
1,942
1,429
6,986
2,066
1,718
38,217
52,577
—
—
3,582
—
—
—
11,895
15,477
1,093
5,987
16,740
2,037
—
8,671
37,254
71,782
441 $
—
8,001
6,146
1,512
2,597
12,859
31,556
—
—
706
—
—
—
—
706
9,344
26,388
45,581
106,096
99,191
51,251
557,146
894,997
44,571
9,033
94,742
443
2,404
22,132
173,993
347,318
2,085
50,365
1,777
113,517
29,563
247,625
7,957
26,379
—
7,431
9,755
146,319
461,157
8,367
59,504 1,052,793
306,046
306,046
$ 2,369,552 $
10,118
10,118
149,954 $
28,568
28,568
344,732
344,732
120,334 $ 2,639,840
114
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
December 31, 2018
Commercial & Industrial
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Land
Agriculture
Total
Total1
Risk Grades
1 - 4
Risk Grade
5
Risk Grades
6 - 8
Total
$
6,187 $
17,085
38,908
93,976
88,614
42,175
272,771
559,716
43,454
9,874
79,814
2,149
1,232
14,094
96,482
247,099
52,518
64,487
161,026
12,509
7,780
117,879
255,651
671,850
213 $
287
2,502
5,734
2,381
1,190
18,463
30,770
—
—
1,805
—
—
—
—
1,805
567
3,711
7,696
2,495
125
4,205
5,196
23,995
— $
6
9,672
9,073
3,343
2,239
3,929
28,262
—
—
—
—
—
—
—
—
—
3,146
19,809
5,593
—
14,637
—
43,185
6,400
17,378
51,082
108,783
94,338
45,604
295,163
618,748
43,454
9,874
81,619
2,149
1,232
14,094
96,482
248,904
53,085
71,344
188,531
20,597
7,905
136,721
260,847
739,030
223,826
223,826
$ 1,702,491 $
8,914
8,914
65,484 $
243,798
11,058
11,058
243,798
82,505 $ 1,850,480
1 Total loans and leases include $700.6 million of U.S. government guaranteed loans as of December 31, 2019, segregated by
risk grade as follows: Risk Grades 1 – 4 = $561.6 million, Risk Grade 5 = $57.5 million, Risk Grades 6 – 8 = $81.6 million.
As of December 31, 2018, total loans and leases include $305.4 million of U.S. government guaranteed loans, segregated by
risk grade as follows: Risk Grades 1 – 4 = $236.1 million, Risk Grade 5 = $10.1 million, Risk Grades 6 – 8 = $59.2 million.
115
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Past Due Loans and Leases
Loans and leases are considered past due if the required principal and interest payments have not been received as of the date
such payments were due. Loans and leases less than 30 days past due and accruing are included within current loans and leases
shown below. The following tables show an age analysis of past due loans and leases as of the dates presented.
December 31, 2019
Commercial & Industrial
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment
Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment
Advisors
Veterinary Industry
Other Industries
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment
Advisors
Veterinary Industry
Other Industries
Total
Commercial Land
Agriculture
Total
Total1
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 Current
Total Loans
and Leases
90
Days or More
Past Due &
Still Accruing
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
$
269 $
—
28
2,725
— $
—
—
59
— $ — $
—
—
1,725 4,731
— 3,261
9,344 $
9,075 $
269 $
26,388
26,388
—
6,484
45,581
39,097
6,045 100,051 106,096
—
—
—
3,022
252
—
8,366
8,677
1,132
143
99,191
51,251
504 1,457
517 6,395 15,278 541,868 557,146
3,878 15,987 31,564 863,433 894,997
97,664
49,290
1,527
1,961
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
44,571
9,033
94,742
443
44,571
9,033
94,742
443
2,404
22,132
2,404
—
—
22,132
— 173,993 173,993
— 347,318 347,318
2,085
127
—
—
—
2,542
4,976
—
—
865
—
—
586
7,027
3,077 15,131
2,085
50,365
48,280
—
—
— 1,650
4,319 109,198 113,517
28 12,766 17,770 229,855 247,625
26,379
930 5,708
19,741
6,638
—
—
—
1,727 2,964
—
7,431
7,431
6,142 140,177 146,319
7,027 454,130 461,157
2,685 23,088 43,981 1,008,812 1,052,793
—
— 25,535 319,197 344,732
24,570
24,570
— 25,535 319,197 344,732
$ 30,669 $ 24,773 $ 6,563 $ 39,075 $ 101,080 $ 2,538,760 $ 2,639,840 $
965
965
—
—
116
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
December 31, 2018
Commercial & Industrial
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment
Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment
Advisors
Veterinary Industry
Other Industries
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment
Advisors
Veterinary Industry
Other Industries
Total
Commercial Land
Agriculture
Total
Total1
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 Current
90
Days or More
Past Due &
Still Accruing
Total Loans
and Leases
$ — $
—
41
1,399
— $
—
1,027
29
— $ — $
— —
665 6,821
— 7,570
— $
—
8,554
8,998
6,400 $
6,400 $
17,378
17,378
51,082
42,528
99,785 108,783
—
—
2,669
4,109
232
—
166
1,454
320 2,741
906
600
504
—
94,338
91,045
3,293
45,604
44,098
1,506
3,339 291,824 295,163
1,585 18,542 25,690 593,058 618,748
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
— —
— —
— —
— —
— —
— —
— —
— —
—
—
—
—
43,454
9,874
81,619
2,149
43,454
9,874
81,619
2,149
1,232
14,094
96,482
1,232
—
14,094
—
—
96,482
— 248,904 248,904
—
248
42
—
—
—
1,668
3,400
— —
— 2,762
— 7,417
— 2,193
53,085
53,085
—
3,010
71,344
68,334
9,127 179,404 188,531
20,597
15,004
5,593
—
1,644
—
3,757
— 10,743
1,934 19,568
— —
7,905
—
2,899 5,191 13,491 123,230 136,721
— — 10,743 250,104 260,847
2,899 17,563 41,964 697,066 739,030
7,905
6,277
—
—
6,277
$ 12,320 $ 21,022 $
— 4,781 11,058 232,740 243,798
— 4,781 11,058 232,740 243,798
4,484 $ 40,886 $ 78,712 $ 1,771,768 1,850,480 $
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
1 Total loans and leases include $700.6 million of U.S. government guaranteed loans as of December 31, 2019, of which $30.1
million is greater than 90 days past due, $20.7 million is 30-89 days past due and $649.8 million is included in current loans
and leases as presented above. As of December 31, 2018, total loans and leases include $305.4 million of U.S. government
guaranteed loans, of which $33.4 million is greater than 90 days past due, $9.0 million is 30-89 days past due and $263.0
million is included in current loans and leases as presented above.
117
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Nonaccrual Loans and Leases
Loans and leases that become 90 days delinquent, or in cases where there is evidence that the borrower’s ability to make the
required payments is impaired, are placed in nonaccrual status and interest accrual is discontinued. If interest on nonaccrual loans
and leases had been accrued in accordance with the original terms, interest income would have increased by approximately $3.4
million, $2.8 million and $1.1 million for the years ended December 31, 2019, 2018, and 2017, respectively. All nonaccrual loans
and leases are included in the held for investment portfolio.
Nonaccrual loans and leases as of December 31, 2019 and December 31, 2018 are as follows:
December 31, 2019
Commercial & Industrial
Agriculture
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Veterinary Industry
Total
Commercial Land
Agriculture
Total
Total
December 31, 2018
Commercial & Industrial
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Commercial Real Estate
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Veterinary Industry
Total
Commercial Land
Agriculture
Total
Total
Loan and Lease
Balance
Guaranteed
Balance
Unguaranteed
Exposure
$
269 $
6,484
5,986
1,275
1,961
6,912
22,887
2,085
1,777
12,794
6,638
5,556
28,850
215 $
5,516
5,187
956
1,812
5,577
19,263
1,564
1,293
7,616
5,673
4,602
20,748
54
968
799
319
149
1,335
3,624
521
484
5,178
965
954
8,102
24,570
24,570
76,307 $
18,388
18,388
58,399 $
6,182
6,182
17,908
$
Loan and Lease
Balance
Guaranteed
Balance
Unguaranteed
Exposure
$
$
7,527 $
8,969
3,061
1,506
3,173
24,236
3,010
7,459
2,193
9,734
22,396
11,058
11,058
57,690 $
6,517 $
7,896
2,427
1,361
2,147
20,348
2,260
4,963
1,863
8,271
17,357
5,497
5,497
43,202 $
1,010
1,073
634
145
1,026
3,888
750
2,496
330
1,463
5,039
5,561
5,561
14,488
118
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Allowance for Loan and Lease Loss Methodology
The methodology and the estimation process for calculating the Allowance for Loan and Lease Losses (“ALLL”) is described
below:
Estimated credit losses should meet the criteria for accrual of a loss contingency, i.e., a provision to the ALLL, set forth in
GAAP. The Company’s methodology for determining the ALLL is based on the requirements of GAAP, the Interagency Policy
Statement on the Allowance for Loan and Lease Losses and other regulatory and accounting pronouncements. The ALLL is
determined by the sum of three separate components: (i) the impaired loan and lease component, which addresses specific
reserves for impaired loans and leases; (ii) the general reserve component, which addresses reserves for pools of homogeneous
loans and leases; and (iii) an unallocated reserve component (if any) based on management’s judgment and experience. The loan
and lease pools and impaired loans and leases are mutually exclusive; any loan or lease that is impaired is excluded from its
homogenous pool for purposes of that pool’s reserve calculation, regardless of the level of impairment.
The ALLL policy for pooled loans and leases is governed in accordance with banking regulatory guidance for homogenous pools
of non-impaired loans and leases that have similar risk characteristics. The Company follows a consistent and structured approach
for assessing the need for reserves within each individual loan and lease pool. Quantitative allowances are calculated based on
the loss experience of specific types of loans. Internal and external risk indicators are considered when calculating qualitative
allowances. These risk indicators include business type concentrations, vertical maturity, unemployment rates, experience of the
bank’s servicing staff, and changes in asset quality.
Loans and leases are considered impaired when, based on current information and events, it is probable that the creditor will be
unable to collect all interest and principal payments due according to the originally contracted, or reasonably modified, terms of
the loan or lease agreement. The Company has determined that loans and leases that meet the criteria defined below must be
reviewed quarterly to determine if they are impaired.
• All commercial loans and leases classified substandard or worse.
• Any other delinquent loan or lease that is in a nonaccrual status, or any loan or lease that is delinquent 90 days or more
and still accruing interest.
• Any loan or lease which has been modified such that it meets the definition of a Troubled Debt Restructuring (“TDR”).
The Company’s policy for impaired loan accounting subjects all loans and leases to impairment recognition; however, loan and
lease relationships with unguaranteed credit exposure of less than $100,000 are generally not evaluated on an individual basis for
impairment and instead are evaluated collectively using a methodology based on historical specific reserves on similar sized loans
or leases. Any loan or lease not meeting the above criteria and determined to be impaired is subjected to an impairment analysis,
which is a calculation of the probable loss on the loan or lease. This portion is the loan’s “impairment,” and is established as a
specific reserve against the loan or lease, or charged against the ALLL.
Individual specific reserve amounts imply probability of loss and may not be carried in the reserve indefinitely. When the amount
of the actual loss becomes reasonably quantifiable, the amount of the loss is charged off against the ALLL, whether or not all
liquidation and recovery efforts have been completed. If the total amount of the individual specific reserve that will eventually
be charged off cannot yet be sufficiently quantified but some portion of the impairment can be viewed as a confirmed loss, then
the confirmed loss portion should be charged off against the ALLL and the individual specific reserve reduced by a corresponding
amount.
For impaired loans and leases, the reserve amount is calculated on a loan or lease-specific basis. The Company utilizes two
methods of analyzing impaired loans and leases not guaranteed by the SBA:
• The Fair Market Value of Collateral method utilizes the value at which the collateral could be sold considering the
appraised value, appraisal discount rate, prior liens and selling costs. The amount of the reserve is the deficit of the
estimated collateral value compared to the loan or lease balance.
• The Present Value of Future Cash Flows method takes into account the amount and timing of cash flows and the effective
interest rate used to discount the cash flows.
119
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The following tables detail activity in the allowance for loan and lease losses by portfolio segment allowance for the periods
presented:
December 31, 2019
Beginning Balance
Charge offs
Recoveries
Provision
Ending Balance
December 31, 2018
Beginning Balance
Charge offs
Recoveries
Provision
Ending Balance
December 31, 2017
Beginning Balance
Charge offs
Recoveries
Provision
Ending Balance
Construction &
Development
Commercial
Real Estate
Commercial
& Industrial
Commercial
Land
Total
$
$
$
$
$
$
2,042 $
—
—
689
2,731 $
11,044 $
(1,179 )
33
4,684
14,582 $
14,562 $
(2,784 )
492
13,143
25,413 $
4,786 $
(327 )
5
1,057
5,521 $
32,434
(4,290 )
530
19,573
48,247
2,030 $
—
—
12
2,042 $
9,180 $
(1,041 )
190
2,715
11,044 $
10,751 $
(4,215 )
493
7,533
14,562 $
2,229 $
(241 )
—
2,798
4,786 $
24,190
(5,497 )
683
13,058
32,434
1,693 $
—
—
337
2,030 $
5,897 $
(1,177 )
191
4,269
9,180 $
8,413 $
(2,617 )
101
4,854
10,751 $
2,206 $
(58 )
5
76
2,229 $
18,209
(3,852 )
297
9,536
24,190
The following tables detail the recorded allowance for loan and lease losses and the investment in loans and lease related to each
portfolio segment, disaggregated on the basis of impairment evaluation methodology:
December 31, 2019
Allowance for Loan and Lease Losses:
Loans and leases individually evaluated for
impairment
Loans and leases collectively evaluated for
impairment
Total allowance for loan and lease losses
Loans and leases receivable 1:
Loans and leases individually evaluated for
impairment
Loans and leases collectively evaluated for
impairment
Total loans and leases receivable
Construction &
Development
Commercial
Real Estate
Commercial
& Industrial
Commercial
Land
Total
$
$
17 $
4,818 $
7,676 $
4,426 $
16,937
2,714
2,731 $
9,764
17,737
14,582 $ 25,413 $
1,095
5,521 $
31,310
48,247
$
719 $
70,873 $ 34,434 $ 45,621 $ 151,647
346,599 981,920 860,563 299,111 2,488,193
347,318 $ 1,052,793 $ 894,997 $ 344,732 $ 2,639,840
$
120
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
December 31, 2018
Allowance for Loan and Lease Losses:
Loans and leases individually evaluated for
impairment
Loans and leases collectively evaluated for
impairment
Total allowance for loan and lease losses
Loans and Leases Receivable 1:
Loans and leases individually evaluated for
impairment
Loans and leases collectively evaluated for
impairment
Total loans and leases receivable
Construction &
Development
Commercial
Real Estate
Commercial
& Industrial
Commercial
Land
Total
$
118 $
2,424 $
2,598 $
3,951 $
9,091
1,924
2,042 $
8,620
11,044 $
11,964
14,562 $
835
4,786 $
23,343
32,434
$
$
5,027 $
46,731 $
28,659 $
21,997 $ 102,414
243,877 692,299 590,089 221,801 1,748,066
248,904 $ 739,030 $ 618,748 $ 243,798 $ 1,850,480
$
1 Loans and leases receivable includes $700.6 million of U.S. government guaranteed loans as of December 31, 2019, of which
$103.8 million are impaired. As of December 31, 2018, loans and leases receivable includes $305.4 million of U.S.
government guaranteed loans, of which $72.4 million are considered impaired.
Loans and leases classified as impaired as of the dates presented are summarized in the following tables.
December 31, 2019
Commercial & Industrial
Agriculture
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Healthcare
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Veterinary Industry
Other Industries
Total
Commercial Land
Agriculture
Total
Total
Recorded
Investment
Guaranteed
Balance
Unguaranteed
Exposure
$
455 $
8,023
6,148
1,506
2,645
15,657
34,434
289 $
5,516
5,187
956
2,186
8,019
22,153
719
719
530
530
2,085
1,780
29,676
7,964
12,648
16,720
70,873
1,564
1,293
17,025
6,662
8,850
11,620
47,014
45,621
45,621
151,647 $
34,121
34,121
103,818 $
$
166
2,507
961
550
459
7,638
12,281
189
189
521
487
12,651
1,302
3,798
5,100
23,859
11,500
11,500
47,829
121
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
December 31, 2018
Commercial & Industrial
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Agriculture
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Veterinary Industry
Total
Commercial Land
Agriculture
Total
Total
Recorded
Investment
Guaranteed
Balance
Unguaranteed
Exposure
$
7 $
6
9,668
9,356
3,347
2,326
3,949
28,659
— $
—
7,229
7,896
2,427
1,819
2,304
21,675
5,027
5,027
3,704
3,704
1,798
3,143
20,442
5,633
15,715
46,731
21,997
21,997
102,414 $
$
1,299
2,261
14,559
4,079
11,613
33,811
13,177
13,177
72,367 $
7
6
2,439
1,460
920
507
1,645
6,984
1,323
1,323
499
882
5,883
1,554
4,102
12,920
8,820
8,820
30,047
122
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The following table presents evaluated balances of loans and leases classified as impaired at the dates presented that carried an
associated reserve as compared to those with no reserve. The recorded investment includes accrued interest and net deferred loan
and lease fees or costs.
Commercial & Industrial
Agriculture
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Healthcare
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Veterinary Industry
Other Industries
Total
Commercial Land
Agriculture
Total
Total Impaired Loans and Leases
December 31, 2019
With a
Recorded
Allowance
Recorded Investment
With No
Recorded
Allowance
Total
Unpaid
Principal
Balance
Related
Allowance
Recorded
$
449 $
8,023
6,047
1,506
2,486
15,459
33,970
6 $
—
101
—
159
198
464
455 $
8,023
6,148
1,506
2,645
15,657
34,434
465 $
8,729
7,195
1,512
2,935
16,403
37,239
719
719
—
—
719
719
706
706
2,085
1,653
27,834
7,964
11,952
16,001
67,489
—
127
1,842
—
696
719
3,384
2,085
1,780
29,676
7,964
12,648
16,720
70,873
2,085
1,851
29,581
8,248
13,816
16,358
71,939
99
1,422
327
381
140
5,307
7,676
17
17
45
193
2,765
352
1,207
256
4,818
45,621
45,621
$ 147,799 $
—
—
45,696
45,621
45,696
45,621
3,848 $ 151,647 $ 155,580 $
4,426
4,426
16,937
123
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Commercial & Industrial
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Agriculture
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Veterinary Industry
Total
Commercial Land
Agriculture
Total
Total Impaired Loans and Leases
December 31, 2018
With a
Recorded
Allowance
Recorded Investment
With No
Recorded
Allowance
Total
Unpaid
Principal
Balance
Related
Allowance
Recorded
$
— $
—
9,604
9,032
3,347
2,160
3,496
27,639
7 $
6
64
324
—
166
453
1,020
7 $
6
9,668
9,356
3,347
2,326
3,949
28,659
6 $
6
10,432
10,564
3,839
2,593
4,097
31,537
5,027
5,027
—
—
5,027
5,027
4,939
4,939
1,798
2,859
20,211
5,184
15,606
45,658
—
284
231
449
109
1,073
1,798
3,143
20,442
5,633
15,715
46,731
1,732
3,281
20,461
5,884
16,677
48,035
21,997
21,997
$ 100,321 $
—
—
22,147
21,997
22,147
21,997
2,093 $ 102,414 $ 106,658 $
—
—
827
478
811
65
417
2,598
118
118
93
30
1,145
220
936
2,424
3,951
3,951
9,091
124
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The following table presents the average recorded investment of impaired loans and leases for each period presented and interest
income recognized during the period in which the loans and leases were considered impaired.
Commercial & Industrial
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Registered Investment Advisors
Veterinary Industry
Other Industries
Total
Construction & Development
Agriculture
Healthcare
Total
Commercial Real Estate
Agriculture
Funeral Home & Cemetery
Healthcare
Independent Pharmacies
Veterinary Industry
Other Industries
Total
Commercial Land
Agriculture
Total
Total
December 31, 2019
December 31, 2018
December 31, 2017
Average
Balance
Interest
Income
Recognized
Average
Balance
Interest
Income
Recognized
Average
Balance
Interest
Income
Recognized
$
405 $
—
8,446
6,452
1,733
2,682
15,390
35,108
6 $
2 $
6
—
9,825
113
8,510
19
3,197
18
2,451
49
189
3,997
390 27,992
— $
—
95
40
38
69
48
— $
8
6,101
6,018
759
2,523
—
290 15,409
—
722
722
—
22
22
4,951
—
4,951
20
—
20
—
1,240
1,240
1,773
1,898
27,980
7,276
13,126
13,681
65,734
—
2
1,738
3,204
955 19,845
6,021
111
—
406
377 16,735
1,851 47,543
10
91
515
22
—
—
2,882
4,381
1,708
—
437 14,605
1,075 23,576
37,217
37,217
$ 138,781 $
954 22,138
954 22,138
3,217 $ 102,624 $
188
188
113
113
1,573 $ 40,338 $
—
—
53
100
50
45
—
248
—
11
11
—
50
49
—
—
536
635
—
—
894
125
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The following table represent the types of TDRs that were made during the periods presented:
December 31, 2019
All Restructurings
December 31, 2018
All Restructurings
December 31, 2017
All Restructurings
Number of
Loans and
Leases
Recorded
Investment
at period
end
Number of
Loans and
Leases
Recorded
Investment
at period
end
Number of
Loans and
Leases
Recorded
Investment
at period
end
Interest Only
Construction and Development
Healthcare
Commercial & Industrial
Other Industries
Total Interest Only
Rate Concession
Commercial Land
Agriculture
Total Rate Concession
Interest Only & Rate Concession
Commercial Land
Agriculture
Total Interest Only & Rate Concession
Extended Amortization
Construction and Development
Agriculture
Commercial Land
Agriculture
Total Extended Amortization
Extended Amortization and Rate Concession
Construction and Development
Agriculture
Commercial Real Estate
Agriculture
Commercial & Industrial
— $
—
1 $
634
— $
1
1
1
1
—
—
348
348
—
1
—
634
87
87
—
—
—
—
—
—
4
4
10,240
10,240
—
—
—
—
—
—
—
—
1
3,067
—
1
1
1,566
1,566
1
2
6
3,073
—
—
—
—
1
1,872
—
—
—
1
1,732
—
Registered Investment Advisors
—
—
1
1,254
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
Commercial Land
Agriculture
Total Extended Amortization and Rate
Concession
Payment Deferral and Extended Amortization
Commercial Land
Agriculture
Commercial & Industrial
Independent Pharmacies
Total Payment Deferral and Extended
Amortization
Payment Deferral & Rate Concession
Commercial Real Estate
Other Industries
Total Payment Deferral & Rate Concession
Payment Deferral
Commercial & Industrial
Veterinary Industry
Healthcare
Commercial Real Estate
Healthcare
Total Payment Deferral
Total
4
7,525
—
—
—
4
7,525
3
4,858
—
—
—
1
608
—
—
—
—
—
—
1
1,102
—
—
1
608
1
1,102
2
2
3,701
3,701
—
—
—
1
1
2
11 $
—
574
1,841
2,415
15,642
—
—
—
—
11 $
—
—
—
—
—
—
19,413
—
—
—
—
2
—
—
2
3 $
127
—
—
127
1,229
126
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Concessions made to improve a loan and lease’s performance have varying degrees of success. During the twelve months ended
December 31, 2019, two TDRs that were modified within the twelve months ended December 31, 2019 subsequently defaulted.
One TDR default was a commercial real estate healthcare loan that was previously modified for payment deferral and had a
recorded investment of $1.8 million at December 31, 2019. The second TDR default was a commercial & industrial healthcare
loan that was previously modified for payment deferral and had a recorded investment of $574 thousand at December 31, 2019.
During the twelve months ended December 31, 2018, no TDRs that were modified within the twelve months ended December 31,
2018 subsequently defaulted. During the twelve months ended December 31, 2017, one TDR that was modified within the twelve
months ended December 31, 2017 subsequently defaulted. This TDR was a commercial and industrial independent pharmacy
loan that was previously modified for payment deferral and extended amortization. The recorded investment for this TDR at
December 31, 2017 was $1.1 million.
Note 6. Leases
Lessor Equipment Leasing
The Company purchases new equipment for the purpose of leasing such equipment to customers within its verticals. Equipment
purchased to fulfill commitments to commercial renewable energy projects is rented out under operating leases while leases of
equipment outside of the renewable energy vertical are generally direct financing leases. Accordingly, leased assets under
operating leases are included in premises and equipment while leased assets under direct financing leases are included in loans
and leases held for investment.
Direct Financing Leases
The gross lease payments receivable and the net investment included in accounts receivable for such leases are as follows:
As of December 31,
2019
2018
Gross direct finance lease payments receivable
Less - unearned interest
Net investment in direct financing leases
$
$
13,959 $
(2,562 )
11,397 $
Future minimum lease payments receivable under direct finance leases are as follows:
As of December 31, 2019
2020
2021
2022
2023
2024
Thereafter
Total
Amount
$
$
12,541
(2,635 )
9,906
3,081
2,969
2,705
2,260
1,635
1,309
13,959
Interest income of $991 thousand, $401 thousand and $55 thousand was recognized in the twelve months ended December 31,
2019, 2018 and 2017, respectively.
Operating Leases
As of December 31, 2019 and 2018, the Company had a net investment of $144.3 million and $148.8 million, respectively, in
assets included in premises and equipment that are subject to operating leases. Of the net investment, the gross balance of the
assets was $164.3 million and $159.2 million and accumulated depreciation was $20.0 million and $10.4 million as of December
31, 2019 and 2018, respectively. Depreciation expense recognized on these assets for the twelve months ended December 31,
2019, 2018 and 2017 was $9.7 million, $8.2 million and $2.2 million, respectively.
127
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Lease income of $9.4 million, $8.0 million and $1.9 million was recognized in the twelve months ended December 31, 2019,
2018 and 2017, respectively.
A maturity analysis of future minimum lease payments receivable under non-cancelable operating leases is as follows:
As of December 31, 2019
2020
2021
2022
2023
2024
Thereafter
Total
Lessee Lease Arrangements
$
$
Amount
9,005
9,052
9,044
9,075
8,808
40,110
85,094
The Company has operating leases for real property, land, copiers and other equipment. These leases have remaining lease terms
of 1 year to 27 years, some of which include options to extend the leases for up to 20 years, and some of which include options
to terminate the leases. The Company has concluded that it is reasonably certain it will exercise the options to extend for only
one lease, which was therefore recognized as part of the ROU asset and lease liability.
The Company has a finance lease for fitness equipment, and it has a remaining lease term of approximately 2.92 years. There are
no options to extend or terminate this lease.
The components of lease expense are as follows:
Operating lease cost
Short-term lease cost
Finance lease cost:
Amortization of right-of-use assets
Interest expense on lease liabilities
Sublease income
Total net lease cost
December 31, 2019
December 31, 2018
$
$
186 $
25
1
—
(9 )
203 $
669
528
4
—
(35 )
1,166
13
14
Supplemental disclosure for the consolidated balance sheet related to finance leases is as follows:
Finance lease right-of-use asset
Finance lease liability
December 31, 2019
$
The weighted average remaining lease term and weighted average discount rate for leases are as follows:
Weighted average remaining lease term (years)
Operating leases
Finance lease
Weighted average discount rate
Operating leases
Finance lease
As of December 31, 2019
13.41
2.92
3.12 %
3.10 %
128
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
A maturity analysis of operating and finance lease liabilities is as follows:
As of December 31, 2019
2020
2021
2022
2023
2024
Thereafter
Total lease payments
Less: imputed interest
Total lease liabilities
Operating Leases
Finance Leases
$
$
670 $
459
434
306
194
1,245
3,308
(689 )
2,619 $
5
5
5
—
—
—
15
(1 )
14
Lease disclosures for the years ended December 31, 2018 and 2017 prior to the adoption of ASC 842 are as follows:
Pursuant to the terms of non-cancelable lease agreements in effect at December 31, 2018 pertaining to Company premises and
equipment, future minimum rent commitments under various operating leases are as follows:
As of December 31, 2018
2019
2020
2021
2022
2023
Thereafter
Total
$
$
Amount
1,068
512
316
275
144
107
2,422
Lease payments for renewal options are not included in the future minimum lease table as of December 31, 2018.
The Company’s total rent expense related to the aforementioned leases for 2018 and 2017 was $1.2 million and $848 thousand,
respectively.
Note 7. Servicing Assets
Loans serviced for others are not included in the accompanying consolidated balance sheet. The unpaid principal balances of
loans serviced for others requiring recognition of a servicing asset were $2.26 billion, $2.63 billion and $2.44 billion at
December 31, 2019, 2018 and 2017, respectively. The unpaid principal balance for all loans serviced for others was $2.97 billion,
$3.22 billion and $2.85 billion at December 31, 2019, 2018 and 2017, respectively.
The following summarizes the activity pertaining to servicing rights:
Balance at beginning of period
Additions, net
Fair value changes:
Due to changes in valuation inputs or assumptions
Decay due to increases in principal paydowns or runoff
Balance at end of period
2019
2018
$
$
47,641 $
4,305
(3,127 )
(13,454 )
35,365 $
52,298
16,568
(7,238 )
(13,987 )
47,641
The fair value of servicing rights was determined using a weighted average discount rate of 14.1% on December 31, 2019 and
14.5% on December 31, 2018. The fair value of servicing rights was determined using a weighted average prepayment speed of
16.4% on December 31, 2019 and 12.0% on December 31, 2018. Changes to fair value are reported in loan servicing asset
revaluation within the consolidated statements of income.
129
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The fair value of servicing rights is highly sensitive to changes in underlying assumptions. Changes in prepayment speed
assumptions have the most significant impact on the fair value of servicing rights. Generally, as interest rates rise on variable rate
loans, loan prepayments increase due to an increase in refinance activity, which results in a decrease in the fair value of servicing
assets. Measurement of fair value is limited to the conditions existing and the assumptions used as of a particular point in time,
and those assumptions may not be appropriate if they are applied at a different time.
Note 8. Premises, Equipment and Leases
Components of Premises and Equipment
Components of premises and equipment and total accumulated depreciation at December 31, 2019 and 2018 are as follows:
Buildings
Land improvements
Furniture and equipment
Computers and software
Leasehold improvements
Land
Transportation
Solar panels
Deposits on fixed assets
Premises and equipment, total
Less accumulated depreciation
Premises and equipment, net of depreciation
2019
2018
$
$
54,671 $
5,180
17,878
5,134
8,078
8,650
60,947
164,295
596
325,429
(46,330 )
279,099 $
31,880
3,592
10,878
665
7,757
8,650
30,867
159,161
36,180
289,630
(27,106 )
262,524
Deposits on fixed assets at December 31, 2019 consist primarily of construction costs related to building reconfiguration at the
Company’s headquarters, campus signage and tradeshow equipment. The decrease in deposits on fixed assets and the increases
in the fixed asset categories for premises, equipment and transportation from December 31, 2018 to 2019 is primarily related to
the completion of the Company’s third building and fitness facility at its headquarters campus and new airplane purchase.
Depreciation expense for the years ended December 31, 2019, 2018 and 2017 amounted to $19.3 million, $16.0 million and $9.6
million, respectively.
Note 9. Deposits
The types of deposits at December 31, 2019 and 2018 are:
Noninterest-bearing deposits
Interest-bearing deposits:
Interest-bearing checking
Money market
Savings
Time deposits
Total
Total deposits
2019
2018
$
54,107 $
53,993
—
86,754
1,101,065
2,987,196
4,175,015
4,229,122 $
2,099
89,329
886,718
2,117,444
3,095,590
3,149,583
$
130
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The aggregate amount of time deposits in denominations of $250 thousand or more at December 31, 2019 and 2018 was
approximately $554.4 million and $378.0 million, respectively. At December 31, 2019 the scheduled maturities of total time
deposits are as follows:
Year
2020
2021
2022
2023
2024
Thereafter
Total
There were no pledged certificates of deposit as of December 31, 2019 and 2018.
Note 10. Borrowings
Total outstanding borrowings consisted of the following:
Borrowings
In 2015, the Company transferred two related party loans to an unaffiliated
commercial bank in exchange for $4.7 million. The exchange price equated to the
unpaid principal balance plus accrued but uncollected interest at the time of transfer.
The terms of the transfer agreement with the unaffiliated commercial bank identified
the transaction as a secured borrowing for accounting purposes. Interest accrued at
prime plus 1% with monthly principal and interest payments over a term of 60
months. The maturity date was October 5, 2019. The pledged collateral was
classified in other assets with a fair value of $1.4 million at December 31, 2018. The
remaining loan with an outstanding balance of $1.3 million was repurchased by the
Company on November 7, 2019.
In 2019, the Company renewed a revolving line of credit issued in 2017. The line of
credit is unsecured and accrues interest at 30-day LIBOR plus 1.15% for a term of
13 months. Payments are interest only with all principal and accrued interest due on
October 20, 2020. The terms of this loan require the Company to maintain minimum
capital and debt service coverage ratios. No advances have been made to this line of
credit and there is $50 million of available credit remaining at December 31, 2019.
In October 2017, the Company entered into a financing lease of $19 thousand with
an unaffiliated equipment lease company, secured by fitness equipment which is
included in premises and equipment on the consolidated balance sheet. Payments are
principal and interest due monthly starting December 15, 2017 over a term of 60
months. At the end of the lease term there is a $1.00 bargain purchase option. As of
January 1, 2019, this borrowing was revised in accordance with ASU 2016-02.
Total borrowings
$
$
$
$
Amount
2,085,287
507,417
146,044
110,121
83,314
55,013
2,987,196
December 31,
2019
December 31,
2018
— $
1,441
—
—
14
14 $
16
1,457
The Company may purchase federal funds through unsecured federal funds lines of credit with various correspondent banks,
which totaled $72.5 million and $47.5 million as of December 31, 2019 and 2018. These lines are intended for short-term
borrowings and are subject to restrictions limiting the frequency and terms of advances. These lines of credit are payable on
demand and bear interest based upon the daily federal funds rate. The Company had no outstanding balances on the lines of credit
as of December 31, 2019 or 2018.
131
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The Company has entered into a repurchase agreement with a third party for up to $5.0 million as of December 31, 2019 and
2018. At the time the Company enters into a transaction with the third party, the Company must transfer securities or other assets
against the funds received. The terms of the agreement are set at market conditions at the time the Company enters into such
transaction. The Company had no outstanding balance on the repurchase agreement as of December 31, 2019 and 2018.
On June 18, 2018, the Company entered into a borrowing agreement with the Federal Home Loan Bank of Atlanta. These
borrowings must be secured with eligible collateral approved by the Federal Home Loan Bank of Atlanta. As of December 31,
2019 and 2018, there was $1.14 billion and $849.1 million, respectively, of potential borrowing capacity available under this
agreement. There is no collateral pledged and no advances outstanding as of December 31, 2019 or 2018.
The Company may borrow funds through the Federal Reserve Bank’s discount window. These borrowings are secured by a
blanket floating lien on qualifying loans with a balance of $526.8 million and $395.2 million as of December 31, 2019 and 2018,
respectively. At December 31, 2019 and 2018, the Company had approximately $294.5 million and $218.0 million, respectively,
in borrowing capacity available under these arrangements with no outstanding balance as of December 31, 2019 or 2018.
Note 11. Income Taxes
The components of income tax expense for the years ended December 31 are as follows:
Current income tax expense (benefit):
Federal
State
Total current tax expense (benefit)
Deferred income tax expense (benefit):
Federal
State
Total deferred tax expense (benefit)
Income tax expense (benefit), as reported
2019
2018
2017
$
$
1,339 $
2,625
3,964
3,031
(1,564 )
1,467
5,431 $
585 $
(51 )
534
(7,868 )
1,932
(5,936 )
(5,402 ) $
(15,424 )
1,162
(14,262 )
8,389
3,628
12,017
(2,245 )
Reported income tax expense (benefit) differed from the amounts computed by applying the U.S. federal statutory income tax
rate of 21% in 2019 and 2018 and 35% in 2017 to income before income taxes as follows:
Income tax expense computed at the statutory rate
$
4,928 $
9,670 $
34,389
2019
2018
2017
State income tax, net of federal benefit
Stock-based compensation expense
Change in U.S. tax rate
Decrease in taxes due to investment tax credit
Other
Total income tax expense (benefit)
838
443
—
(1,561 )
783
5,431 $
1,485
268
244
(17,846 )
777
(5,402 ) $
3,114
(380 )
(18,921 )
(20,509 )
62
(2,245 )
$
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cut and
Jobs Act (the “Tax Act”). The Tax Act made broad and complex changes to the U.S. tax code that affected 2018 and 2017,
including, but not limited to, accelerated depreciation that allows for full expensing of qualified property. The Tax Act also enacted
a reduction in the U.S. federal corporate income tax rate from 35% to 21% which became effective in 2018. The 21% tax rate
positively impacted 2017 due to the revaluation of the Company’s deferred tax assets and liabilities. As such, the Company
recorded a provisional net tax benefit of $18.9 million in 2017.
132
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
On December 22, 2017, the SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provided guidance on
accounting for the tax effects of the Tax Act. SAB 118 provided a measurement period that could not extend beyond one year
from the Tax Act enactment date for companies to complete the accounting under ASC 740, Income Taxes. In accordance with
SAB 118, a company must reflect the income tax effects of those aspects of the Tax Act for which the accounting under ASC 740
is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able
to determine a reasonable estimate, it must record a provisional estimate in the financial statements. During the measurement
period, a company must record adjustments to its provisional estimate upon obtaining, preparing, or analyzing additional
information about facts and circumstances that existed as of the enactment date that, if known, would have affected the provisional
estimate. As noted above, the Company recorded a provisional net tax benefit of $18.9 million in its 2017 consolidated financial
statements. Upon completing the accounting for the effects of the Tax Act, the Company recorded $244 thousand of additional
income tax expense during 2018.
Components of deferred tax assets and liabilities are as follows:
Deferred tax assets:
Tax credit carryforwards
Allowance for loan and lease losses
Net operating loss carryforwards
Mark to market on loans held for sale
Stock-based compensation expense
Goodwill and intangibles
Accrued expenses
Net unrealized losses on securities available for sale
Operating lease liabilities
Other
Total deferred tax assets
Deferred tax liabilities:
Investment in joint venture
Unguaranteed loan discount
Premises and equipment
Deferred loan fees and costs, net
Net unrealized gains on securities available for sale
Operating lease right-of-use assets
Other
Total deferred tax liabilities
Net deferred tax liability
2019
2018
$
$
37,619 $
11,579
83
10,501
4,918
720
1,372
—
629
977
68,398
15,538
13,076
45,291
1,417
3,702
584
538
80,146
11,748 $
39,560
7,784
5,046
1,780
3,004
720
430
529
—
1,573
60,426
16,596
8,535
40,032
987
—
—
326
66,476
6,050
The Company has recorded a deferred tax asset of $37.6 million related to federal tax credit carryforwards which will begin to
expire in 2037.
Management assesses the realizability of deferred tax assets at each reporting period and considers whether it is more likely than
not that a deferred tax asset will not be realized. The realization of a deferred tax asset is dependent upon the generation of future
taxable income during periods in which the related temporary difference becomes deductible or realizable prior to its expiration.
Management considers projected future taxable income, scheduled reversal of deferred tax liabilities, cessation of investing in
renewable energy assets that generate investment tax credits and tax planning strategies in making this assessment. Based on
these considerations, management believes it is more likely than not that the deferred tax assets will be realized.
The Company does not have any material uncertain tax positions and does not have any interest and penalties recorded in the
income statement for the years ended December 31, 2019, 2018 and 2017. The Company files a consolidated income tax return
in the U.S. federal tax jurisdiction.
133
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Generally, the Company’s federal and state tax returns are no longer subject to examination by the taxing authorities for years
prior to 2015.
Note 12. Fair Value of Financial Instruments
Fair Value Hierarchy
There are three levels of inputs in the fair value hierarchy that may be used to measure fair value. Financial instruments are
considered Level 1 when valuation can be based on quoted prices in active markets for identical assets or liabilities. Level 2
financial instruments are valued using quoted prices for similar assets or liabilities; quoted prices in markets that are not active;
or models using inputs that are observable or can be corroborated by observable market data of substantially the full term of the
assets or liabilities. Financial instruments are considered Level 3 when their values are determined using pricing models,
discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable
and when determination of the fair value requires significant management judgment or estimation.
Financial Instruments Measured at Fair Value
The following sections provide a description of the valuation methodologies used for instruments measured at fair value, as well
as the general classification of such instruments pursuant to the fair value hierarchy:
Investment securities: Where quoted prices are available in an active market, securities are classified within Level 1 of the
valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded
equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of
securities with similar characteristics, discounted cash flow or at net asset value per share. Level 2 securities would include US
government agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate,
asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation,
securities are classified within Level 3 of the valuation hierarchy.
Impaired loans: Impairment of a loan is based on the fair value of the collateral of the loan for collateral-dependent loans. Fair
value of the loan’s collateral, when the loan is dependent on collateral, is determined by appraisals or independent valuation
which is then adjusted for the cost related to liquidation of the collateral. Impaired loans classified as Level 3 are based on
management’s judgment and estimation.
Servicing assets: Servicing rights do not trade in an active, open market with readily observable prices. While sales of servicing
rights do occur, the precise terms and conditions typically are not readily available. Accordingly, the Company estimates the fair
value of servicing rights using discounted cash flow models incorporating numerous assumptions from the perspective of a market
participant including servicing income, servicing costs, market discount rates and prepayment speeds. Due to the nature of the
valuation inputs, servicing rights are classified within Level 3 of the valuation hierarchy.
Foreclosed assets: Foreclosed real estate is adjusted to fair value less selling costs upon transfer of the loans to foreclosed real
estate. Subsequently, foreclosed real estate is carried at the lower of carrying value or fair value less selling costs. Fair value is
based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral.
Given the lack of observable market prices for identical properties and market discounts applied to appraised values, the Company
generally classifies foreclosed assets as non-recurring Level 3.
Mutual fund: The mutual fund is registered with the Securities and Exchange Commission as a closed-end, non-diversified
management investment company and operates as an interval fund. The fund primarily invests in the unguaranteed portion of
SBA504 First Lien Loans secured by owner-occupied commercial real estate. This investment is valued using quoted prices in
markets that are not active and is classified as Level 2 within the valuation hierarchy.
134
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Equity warrant assets: Fair value measurements of equity warrant assets of private companies are priced based on a Black-
Scholes option pricing model to estimate the asset value by using stated strike prices, option expiration dates, risk-free interest
rates and option volatility assumptions. Option volatility assumptions used in the Black-Scholes model are based on public
companies that operate in similar industries as the companies in our private company portfolio. Option expiration dates are
modified to account for estimates of actual life relative to stated expiration. Values are further adjusted for a general lack of
liquidity due to the private nature of the associated underlying company. The Company classifies equity warrant assets within
Level 3 of the valuation hierarchy.
Equity security investment with a non-readily determinable fair value: The following equity security investment is measured at
cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for an
identical or similar investment of the same issuer. When an observable price change in an orderly transaction occurs, the
investment is classified as nonrecurring Level 1 within the valuation hierarchy.
Recurring Fair Value
The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis.
December 31, 2019
Investment securities available-for-sale
US treasury securities
US government agencies
Mortgage-backed securities
Municipal bonds1
Servicing assets2
Mutual fund
Equity warrant assets3
Total assets at fair value
December 31, 2018
Investment securities available-for-sale
US treasury securities
US government agencies
Mortgage-backed securities
Municipal bond1
Servicing assets2
Mutual fund
Equity warrant assets3
Total assets at fair value
Total
Level 1
Level 2
Level 3
5,015 $
22,779
503,297
8,954
35,365
2,206
570
578,186 $
— $
—
—
—
—
—
—
— $
5,015 $
22,779
503,297
8,862
—
2,206
—
542,159 $
—
—
—
92
35,365
—
570
36,027
Total
Level 1
Level 2
Level 3
4,966 $
30,944
343,581
999
47,641
2,099
527
430,757 $
— $
—
—
—
—
—
—
— $
4,966 $
30,944
343,581
—
—
2,099
—
381,590 $
—
—
—
999
47,641
—
527
49,167
$
$
$
$
1 During the year ended December 31, 2019, the Company sold $900 thousand of a municipal bond to a third party and
recorded a fair value adjustment loss of $8 thousand. During the year ended December 31, 2018, the Company purchased a
municipal bond with a value of $1.0 million and recorded a fair value adjustment loss of $1 thousand.
2 See Note 7 for a rollforward of recurring Level 3 fair values for servicing assets.
3 During the years ended December 31, 2019 and 2018, the Company recorded net losses on derivative instruments of $53
thousand and $24 thousand, respectively.
135
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Non-recurring Fair Value
The tables below present the recorded amount of assets and liabilities measured at fair value on a non-recurring basis.
December 31, 2019
Impaired loans
Foreclosed assets
Equity security investment with a non-readily
determinable fair value
Total assets at fair value
December 31, 2018
Impaired loans
Foreclosed assets
Total assets at fair value
Level 3 Analysis
Total
Level 1
Level 2
Level 3
3,909 $
5,612
— $
—
8,738
18,259 $
8,738
8,738 $
— $
—
—
— $
3,909
5,612
—
9,521
Total
Level 1
Level 2
Level 3
4,130 $
1,094
5,224 $
— $
—
— $
— $
—
— $
4,130
1,094
5,224
$
$
$
$
For Level 3 assets and liabilities measured at fair value on a non-recurring basis as of December 31, 2019 and December 31, 2018
the significant unobservable inputs used in the fair value measurements were as follows:
December 31, 2019
Level 3 Assets with Significant Unobservable Inputs
Municipal bond
Fair Value
$
92
Impaired loans
Foreclosed assets
Equity warrant assets
December 31, 2018
$
$
$
3,909
5,612
570
Valuation
Technique
Discounted
expected cash
flows
Discounted
appraisals
Discounted
appraisals
Black-Scholes
option pricing
model
Significant Unobservable Inputs
Discount rate
Prepayment speed
Range
4.55%
5.00%
Appraisal adjustments (1)
10% to 57%
Appraisal adjustments (1)
10% to 37%
Volatility
Risk-free interest rate
Marketability discount
Remaining life
21-75%
1.90%
20%
8 - 10 years
Level 3 Assets with Significant Unobservable Inputs
Municipal bond
Fair Value
$
999
Impaired loans
Foreclosed assets
Equity warrant assets
$
$
$
4,130
1,094
527
136
Valuation
Technique
Discounted
expected cash
flows
Discounted
appraisals
Discounted
appraisals
Black-Scholes
option pricing
model
Significant Unobservable Inputs
Discount rate
Prepayment speed
Range
5.14%
5.00%
Appraisal
adjustments (1)
Appraisal adjustments (1)
8% to 48%
9% to 37%
Volatility
Risk-free interest rate
Marketability discount
Remaining life
20.40%
2.69%
20.00%
9 - 10 years
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
(1) Appraisals may be adjusted by management for customized discounting criteria, estimated sales costs, and proprietary
qualitative adjustments.
Estimated Fair Value of Other Financial Instruments
GAAP also requires disclosure of fair value information about financial instruments carried at book value on the consolidated
balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or
other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and
estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of the Company.
The carrying amounts and estimated fair values of the Company’s financial instruments are as follows:
December 31, 2019
Financial assets
Quoted Price In
Active Markets
for Identical
Assets/Liabilities
(Level 1)
Significant
Other
Observable
Inputs (Level 2)
Carrying
Amount
Significant
Unobservable
Inputs (Level 3)
Total Fair
Value
Cash and due from banks
Federal funds sold
Certificates of deposit with other banks
Investment securities, available-for-sale
Loans held for sale
Loans and leases, net of allowance for loan
and lease losses
Servicing assets
Mutual fund
Equity warrant assets
$ 126,752 $
96,787
7,250
540,045
966,447
126,752 $
96,787
7,568
—
—
— $
—
—
539,953
— $ 126,752
96,787
—
7,568
—
540,045
92
— 1,020,567 1,020,567
2,599,052
35,365
2,206
570
—
—
—
—
— 2,659,681 2,659,681
35,365
35,365
—
2,206
—
2,206
570
570
—
Financial liabilities
Deposits
Borrowings
December 31, 2018
Financial assets
4,229,122
14
— 4,213,657
—
—
— 4,213,657
14
14
Quoted Price In
Active Markets
for Identical
Assets/Liabilities
(Level 1)
Significant
Other
Observable
Inputs (Level 2)
Carrying
Amount
Significant
Unobservable
Inputs (Level 3)
Total Fair
Value
Cash and due from banks
Certificates of deposit with other banks
Investment securities, available-for-sale
Loans held for sale
Loans and leases, net of allowance for loan
and lease losses
Servicing assets
Mutual fund
Equity warrant assets
$ 316,823 $
7,250
380,490
687,393
316,823 $
7,442
—
—
— $
—
380,490
—
— $ 316,823
7,442
—
380,490
—
695,154
695,154
1,810,985
47,641
2,099
527
—
—
—
—
— 1,807,528 1,807,528
47,641
47,641
—
2,099
—
2,099
527
527
—
Financial liabilities
Deposits
Borrowings
3,149,583
1,457
— 3,117,941
—
—
— 3,117,941
1,457
1,457
137
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Note 13. Commitments and Contingencies
Litigation
In the normal course of business, the Company is involved in various legal proceedings. Management believes that the outcome
of such proceedings will not materially affect the financial position, results of operations or cash flows of the Company.
Financial Instruments with Off-balance-sheet Risk
The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These
instruments involve, to varying degrees, credit risk in excess of the amount recognized in the balance sheet.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for
commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The
Company uses the same credit policies in making commitments and conditional obligations as for on-balance-sheet instruments.
A summary of the Company’s commitments is as follows:
Commitments to extend credit
Standby letters of credit
Airplane purchase agreement commitments
Total unfunded off-balance sheet credit risk
December 31, 2019 December 31, 2018
1,435,024
$
2,150
10,450
1,447,624
1,834,449 $
25,532
—
1,859,981 $
$
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established
in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a
fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s
credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment,
residential real estate and income-producing commercial properties. In 2012, the Company began issuing commitment letters
after approval of the loan by the Credit Department. Commitment letters generally expire ninety days after issuance.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a
third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved
in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies
as specified above and is required in instances which the Company deems necessary.
As of December 31, 2019 and 2018, the Company had commitments for on-balance sheet instruments in the amount of $16.9
million and $2.8 million, respectively.
Concentrations of Credit Risk
Although the Company is not subject to any geographic concentrations, a substantial amount of the Company’s loans and
commitments to extend credit have been granted to customers in the agriculture, healthcare and veterinary verticals. The
concentrations of credit by type of loan are set forth in Note 5. The distribution of commitments to extend credit approximates
the distribution of loans outstanding. The Company does not have a significant number of credits to any single borrower or group
of related borrowers whereby their retained exposure exceeds $7.5 million, except for twenty-four relationships that have a
retained unguaranteed exposure of $259.4 million of which $178.8 million of the unguaranteed exposure has been disbursed.
Additionally, the Company has future minimum lease payments receivable under non-cancelable operating leases totaling $85.1
million, of which $61.1 million is due from four relationships.
The Company from time-to-time may have cash and cash equivalents on deposit with financial institutions that exceed federally-
insured limits.
138
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Note 14. Benefit Plans
Defined Contribution Plan
The Company maintains an employee benefit plan pursuant to Section 401(k) of the Internal Revenue Code. The plan covers
substantially all employees. Participants may contribute a percentage of compensation, subject to a maximum allowed under the
Code. In addition, the Company makes certain matching contributions and may make additional contributions at the discretion
of the board of directors. Company expense relating to the plan for the years ended December 31, 2019, 2018, and 2017 amounted
to $3.0 million, $2.7 million and $2.5 million, respectively.
Flexible Benefits Plan
The Company maintains a Flexible Benefits Plan which covers substantially all employees. Participants may set aside pre-tax
dollars to provide for future expenses such as dependent care.
Employee Stock Purchase Plan
The Company adopted an Employee Stock Purchase Plan (2014 ESPP) on October 8, 2014. On May 24, 2016, the 2014 ESPP
was amended and the Amended and Restated Employee Stock Purchase Plan became effective (ESPP), within the meaning of
Section 423 of the Internal Revenue Code of 1986, as amended. Under this plan, eligible employees are able to purchase available
shares with post-tax dollars as of the grant date. In order for employees to be eligible to participate in this plan they must be
employed or on an authorized leave of absence from the Company or any subsidiary immediately prior to the grant date. ESPP
stock purchases cannot exceed $25 thousand in fair market value per employee per calendar year. Options to purchase shares
under the ESPP are granted at a 15% discount to fair market value. Expense recognized in relation to the ESPP was $77 thousand,
$60 thousand and $79 thousand for fiscal years 2019, 2018 and 2017, respectively.
Stock Option Plans
On March 20, 2015, the Company adopted the 2015 Omnibus Stock Incentive Plan which replaced the previously existing
Amended Incentive Stock Option Plan and Nonstatutory Stock Option Plan. Subsequently on May 24, 2016, the 2015 Omnibus
Stock Incentive Plan was amended and restated to authorize awards covering a maximum of 7,000,000 common voting shares
and has an expiration date of March 20, 2025. On May 15, 2018, the Amended and Restated 2015 Omnibus Stock Incentive Plan
was amended to authorize awards covering a maximum of 8,750,000 common voting shares. Options or restricted shares granted
under the Amended and Restated 2015 Omnibus Stock Incentive Plan (the "Plan") expire no more than 10 years from date of
grant. Exercise prices under the Plan are set by the Board of Directors at the date of grant, but shall not be less than 100% of fair
market value of the related stock at the date of the grant. Options vest over a minimum of three years from the date of the grant.
Forfeitures are recognized as they occur.
Compensation cost relating to share-based payment transactions are recognized in the financial statements with measurement
based upon the fair value of the equity or liability instruments issued. For the years ended December 31, 2019, 2018, and 2017
the Company recognized $1.6 million, $1.7 million, and $1.7 million in compensation expense for stock options, respectively.
Stock option activity under the Plan during the year ended December 31, 2019 is summarized below.
Shares
Weighted Average
Exercise Price
Weighted Average
Remaining
Contractual Term
Aggregate
Intrinsic Value
Outstanding at December 31, 2018
Exercised
Forfeited
Outstanding at December 31, 2019
Exercisable at December 31, 2019
2,656,855 $
(75,088 )
(66,040 )
2,515,727 $
1,030,331 $
11.27
7.51
9.68
11.42
11.03
5.04 years $
4.92 years $
19,115,278
8,232,263
139
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The following is a summary of non-vested stock option activity for the Company for the years ended December 31, 2019, 2018,
and 2017.
Non-vested at December 31, 2016
Vested
Forfeited
Non-vested at December 31, 2017
Vested
Forfeited
Non-vested at December 31, 2018
Vested
Forfeited
Non-vested at December 31, 2019
Shares
3,016,100 $
(340,362 )
(310,739 )
2,364,999
(308,373 )
(216,796 )
1,839,830
(288,394 )
(66,040 )
1,485,396 $
Weighted
Average Grant
Date Fair
Value
4.78
4.36
6.25
4.65
7.51
5.90
4.60
4.20
3.50
4.73
The total intrinsic value of options exercised during the years ended December 31, 2019, 2018, and 2017 was $785 thousand,
$3.5 million, and $1.5 million, respectively.
At December 31, 2019, unrecognized compensation costs relating to stock options amounted to $4.2 million which will be
recognized over a weighted average period of 2.59 years.
There were no options granted in 2019, 2018 or 2017.
Restricted Stock Plan
In 2010, the Company adopted a Restricted Stock Plan. Under this plan, a total of 1,350,000 shares of Common Stock were
available for issuance to eligible employees. Restricted stock grants vest in equal installments ranging from immediate vesting
to over a seven year period from the date of the grant. Under the 2015 Omnibus Stock Incentive Plan, which replaced the
previously existing Restricted Stock Plan, during 2017, 340,318 restricted stock units were granted to eligible employees and
outside directors at a weighted average grant date fair value of $17.00 per share, of which 233,791 restricted stock units had
market price conditions or non-market-related performance criteria restrictions. During 2018, 840,150 restricted stock units were
granted to eligible employees and outside directors at a weighted average grant date fair value of $19.72, of which 485,000
restricted stock units had market price conditions or non-market-related performance criteria restrictions. During 2019, 164,828
restricted stock units were granted to eligible employees and outside directors at a weighted average grant date fair value of
$17.00, and 500,000 restricted stock units had market price conditions or non-market-related performance criteria restrictions at
a weighted average grant date fair value of $8.81.
The fair value of each restricted stock unit is based on the market value of the Company’s stock on the date of the grant. Restricted
stock awards are authorized in the form of restricted stock awards or units ("RSUs") and restricted stock awards or units with a
market price condition ("Market RSUs").
RSUs have a restriction based on the passage of time and may also have a restriction based on a non-market-related performance
criteria. The fair value of the RSUs is based on the closing price on the date of the grant.
Market RSUs also have a restriction based on the passage of time and may have non-market-related performance criteria, but also
have a restriction based on market price criteria related to the Company’s share price closing at or above a specified price ranging
from $34.00 to $55.00 per share for at least twenty (20) consecutive trading days at any time prior to the expiration date of the
grants. The amount of Market RSUs earned will not exceed 100% of the Market RSUs awarded. The fair value of the Market
RSUs and the implied service period is calculated using the Monte Carlo Simulation method.
140
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
The following is a summary of non-vested RSU stock activity for the Company for the year ended December 31, 2019.
Non-vested at December 31, 2018
Granted
Vested
Forfeited
Non-vested at December 31, 2019
Weighted
Average Grant
Date Fair
Value
23.85
17.00
23.23
22.04
21.54
Shares
388,187 $
164,828
(84,608 )
(11,006 )
457,401 $
During 2018 and 2017, the Company granted 355,150 and 106,527 RSUs, respectively. The weighted average grant date fair
value for RSUs granted in 2018 and 2017 were $25.17 and $23.71, respectively.
For the years ended December 31, 2019, 2018, and 2017 the Company recognized $2.2 million, $2.6 million, and $741 thousand
in compensation expense for RSUs, respectively.
At December 31, 2019, unrecognized compensation costs relating to RSUs amounted to $8.7 million which will be recognized
over a weighted average period of 4.72 years.
The following is a summary of non-vested Market RSU stock activity for the Company for the year ended December 31, 2019.
Non-vested at December 31, 2018
Granted
Forfeited
Non-vested at December 31, 2019
1 Adjusted for modification in 2019, as described below.
Weighted
Average Grant
Date Fair
Value
9.87
8.81
9.21
8.44 1
Shares
2,709,202 $
500,000
(54,878 )
3,154,324 $
During 2018 and 2017, the Company granted 485,000 and 233,791 Market RSUs with a weighted average grant date fair value
of $7.93, as modified, and $13.94, respectively.
The compensation expense for Market RSUs is measured based on their grant date fair value as calculated using the Monte Carlo
Simulation and is recognized on a straight-line basis over the average vesting period. The Monte Carlo Simulation used 100,000
simulation paths to assess the expected date of achieving the market price criteria.
Related to the 500,000 Market RSUs granted on February 11, 2019, the share price simulation was based on the Cox, Ross &
Rubinstein option pricing methodology for a period of 10.0 years. The implied term of the restricted stock ranges from 4.5 to 5.8
years. The Monte Carlo Simulation used various assumptions that included a risk free rate of return of 2.62%, expected volatility
of 37.6% and a dividend yield of 0.78%.
On February 11, 2019, 75,000 Market RSUs granted on May 14, 2018 to one employee were modified to lengthen the vesting
term from 7 to 10 years and change the target stock price from $48.00 to a range of $35.00 to $48.00 per share for at least twenty
(20) consecutive trading days. Additionally, 410,000 Market RSUs granted on August 10, 2018, to eleven employees were
modified to lengthen the vesting term from 7 to 10 years and change the amount of Market RSUs that vest at various target stock
prices to 20% per tier. As a result of the modification, the Company recognized additional compensation expense of $543
thousand for the year ended December 31, 2019.
For the years ended December 31, 2019, 2018 and 2017, the Company recognized $7.9 million, $4.9 million, and $5.0 million
respectively, in compensation expense for Market RSUs.
141
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
At December 31, 2019, unrecognized compensation costs relating to Market RSUs amounted to $14.8 million which will be
recognized over a weighted average period of 3.02 years.
Employee/Outside Director Bonus Plan
In 2014, the Company adopted a Bonus Plan whereby eligible employees and outside directors were qualified to receive quarterly
and annual bonus payments based on each individual’s base pay/annual director fees and the profitability of the Company. In
2016, the Company approved a revised Incentive Compensation Plan and the payout criteria was adjusted for exceeding
thresholds based on certain performance metrics and the profitability of the Company and applied to full-time employees only.
Beginning in 2016, this plan no longer applied to outside directors. Total expenses related to the bonus plan for employees were
$7.2 million, $632 thousand, and $3.2 million for the years ended December 31, 2019, 2018, and 2017, respectively.
Note 15. Regulatory Matters
Dividends
The Bank, as a North Carolina banking corporation, may pay dividends to shareholders provided the bank does not make
distributions that reduce its capital below its applicable required capital, pursuant to North Carolina General Statutes Section 53C-
4-7. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is
in the public interest and is necessary to ensure financial soundness of the bank.
Capital Requirements
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies.
The Basel III Capital Rules, a comprehensive capital framework for U.S. banking organizations, became effective for the
Company and Bank on January 1, 2015. The framework’s requirements are phased in over a multi-year schedule, to be fully
phased in by January 1, 2019. Under Basel III, requirements include a common equity Tier 1 ratio minimum of 4.50 percent,
Tier 1 risk-based capital minimum of 6.00 percent, total risk-based capital ratio minimum of 8.00 percent and Tier 1 leverage
capital ratio minimum of 4.00 percent. Failure to meet minimum capital requirements may result in certain actions by regulators
that could have a direct material effect on the consolidated financial statements. A new capital conservation buffer, comprised of
common equity Tier 1 capital, was also established by Basel III above the regulatory minimum requirements. This capital
conservation buffer was phased in beginning January 1, 2016 at 0.625 percent of risk-weighted assets and increases each
subsequent year by an additional 0.625 percent until reaching its final level of 2.50 percent on January 1, 2019.
Based on the most recent notification from the Federal Deposit Insurance Corporation, the Bank is well capitalized under the
regulatory framework for prompt corrective action. As of December 31, 2019, the Company and the Bank met all capital adequacy
requirements to which they are subject and were not aware of any conditions or events that would change each entity’s well
capitalized status.
142
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Capital amounts and ratios as of December 31, 2019 and 2018, are presented in the following table.
Consolidated - December 31, 2019
Common Equity Tier 1
(to Risk-Weighted Assets)
Total Capital
Actual
Minimum Capital
Requirement
Minimum To Be
Well Capitalized
Amount
Ratio
Amount
Ratio
Amount
Ratio
$ 499,513
14.85 % $ 151,365
4.50 %
N/A
N/A
(to Risk-Weighted Assets)
$ 541,635
16.10 % $ 269,093
8.00 %
N/A
N/A
Tier 1 Capital
(to Risk-Weighted Assets)
$ 499,513
14.85 % $ 201,820
6.00 %
N/A
N/A
Tier 1 Capital
(to Average Assets)
Bank - December 31, 2019
Common Equity Tier 1
$ 499,513
10.65 % $ 187,582
4.00 %
N/A
N/A
(to Risk-Weighted Assets)
$ 451,807
13.61 % $ 149,370
4.50 % $ 215,757
6.50 %
Total Capital
(to Risk-Weighted Assets)
$ 493,382
14.86 % $ 265,547
8.00 % $ 331,934
10.00 %
Tier 1 Capital
(to Risk-Weighted Assets)
$ 451,807
13.61 % $ 199,161
6.00 % $ 265,547
8.00 %
Tier 1 Capital
(to Average Assets)
Consolidated - December 31, 2018
Common Equity Tier 1
(to Risk-Weighted Assets)
Total Capital
$ 451,807
9.68 % $ 186,627
4.00 % $ 233,283
5.00 %
$ 467,033
17.10 % $ 122,937
4.50 %
N/A
N/A
(to Risk-Weighted Assets)
$ 499,467
18.28 % $ 218,555
8.00 %
N/A
N/A
Tier 1 Capital
(to Risk-Weighted Assets)
$ 467,033
17.10 % $ 163,917
6.00 %
N/A
N/A
Tier 1 Capital
(to Average Assets)
Bank - December 31, 2018
Common Equity Tier 1
$ 467,033
13.40 % $ 139,453
4.00 %
N/A
N/A
(to Risk-Weighted Assets)
$ 385,030
14.35 % $ 120,706
4.50 % $ 174,353
6.50 %
Total Capital
(to Risk-Weighted Assets)
$ 417,609
15.57 % $ 214,588
8.00 % $ 268,235
10.00 %
Tier 1 Capital
(to Risk-Weighted Assets)
$ 385,030
14.35 % $ 160,941
6.00 % $ 214,588
8.00 %
Tier 1 Capital
(to Average Assets)
$ 385,030
11.22 % $ 137,304
4.00 % $ 171,630
5.00 %
143
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Note 16. Transactions with Related Parties
The Company has entered into transactions with its directors, officers, significant shareholders and their affiliates (related parties).
Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest
rates, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of
management, involve more than normal risk or present other unfavorable features.
There were no related party loans at December 31, 2019 and 2018, other than those disclosed as secured borrowings in Note 10.
Deposits from related parties held by the Company at December 31, 2019 and 2018 amounted to $46.9 million and $31.4 million,
respectively.
During the years ended December 31, 2019 and 2018, the Company invested $1.1 million and $675 thousand, respectively, in
Plexus Fund II, III, and IV-C, L.P (“Plexus”), which is included in other assets in the consolidated balance sheets at December 31,
2019 and 2018 with a balance of $2.8 million and $3.5 million, respectively. A member of the Company’s board of directors is
also a principal of Plexus Capital, the administrator of Plexus. Plexus is accounted for as an equity security investment.
During the year ended December 31, 2019, the Company invested $156 thousand in DefenseStorm, Inc. ("DefenseStorm"), which
is included in other assets in the consolidated balance sheets with a balance of $2.1 million and $2.0 million at December 31,
2019 and 2018, respectively. The Company holds voting and non-voting equity in DefenseStorm which is accounted for as an
equity security investment. DefenseStorm provides a broad range of IT and cyber security solutions principally designed for
financial institutions. As of December 31, 2019, the Company held approximately 5.8% of DefenseStorm on a fully diluted basis
in the form of both voting and non-voting common equity, including approximately 3.2% voting control. Directors and officers
of the Company and their affiliates collectively own approximately 5.8% of DefenseStorm on a fully diluted basis as of
December 31, 2019, including approximately 1.0% voting control. During 2018 and 2017, the Company expensed $71 thousand
and $405 thousand for cyber security event monitoring services. No payments were made for the year ended December 31, 2019.
During the year ended December 31, 2018, the Company invested $5.1 million in Finxact LLC ("Finxact"), a developer of core
processing software and services for the banking industry, which is included in other assets in the consolidated balance sheet with
a balance of $4.5 million and $6.8 million as of December 31, 2019 and 2018, respectively. At December 31, 2019, the Company
holds approximately 16.1% of Finxact on a fully diluted basis in the form of both voting and non-voting equity, including
approximately 14.3% voting control. This investment is accounted for as an equity method investment due to the Company's
ability to exercise significant influence over financial and operating policies of Finxact. Certain officers and directors of the
Company collectively own approximately 6.4% of Finxact on a fully diluted basis in the form of non-voting equity at
December 31, 2019. During 2019, the Company expensed $24 thousand for core processor services. No payments were made
for the years ended December 31, 2018 and 2017.
During the year ended December 31, 2018, the Company invested $628 thousand in Payrailz, LLC ("Payrailz"), an entity that
provides digital payment services and solutions to the financial services industry, which is included in other assets in the
consolidated balance sheet with a balance of $0 and $1.0 million at December 31, 2019 and 2018, respectively. At December 31,
2019, the Company holds approximately 14.7% of Payrailz on a fully diluted basis in the form of voting equity. This investment
is accounted for as an equity method investment due to the Company's ability to exercise significant influence over financial and
operating policies of Payrailz. Certain officers and directors of the Company collectively own approximately 3.9% of Payrailz
on a fully diluted basis in the form of voting equity at December 31, 2019. During 2019 and 2018, the Company expensed $250
thousand and $4 thousand for digital payment services. No payments were made for the year ended December 31, 2017.
The Company’s digital banking joint venture between Live Oak Banking Company and First Data Corporation, Apiture, which
is included in other assets in the consolidated balance sheet had a balance of $64.7 million and $69.1 million at December 31,
2019 and 2018, respectively. See Note 3. Unconsolidated Joint Venture for further discussion. During the years ended December
31, 2019, 2018 and 2017, the Company expensed $524 thousand, $5.5 million and $304 thousand, respectively, for professional
services. During 2019 and 2018, the Company recognized income of $446 thousand and $255 thousand, respectively for shared
services and rent. The Company recognized no income from Apiture during the year ended December 31, 2017.
During the year ended December 31, 2019, the Company committed to invest $1.8 million in Canapi Ventures Fund, L.P. (“The
Fund”), an investment fund which centers around early to growth stage financial technology companies. The Fund is included
144
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
in other assets in the consolidated balance sheet, with $257 thousand of the commitment invested during 2019. The Fund is
accounted for as an equity method investment.
During the year ended December 31, 2019, the Company committed to invest $15.2 million in Canapi Ventures SBIC Fund, L.P.
(“The SBIC Fund”), an investment fund which centers around early to growth stage financial technology companies. The SBIC
Fund is included in other assets in the consolidated balance sheet, with $461 thousand of the commitment invested during 2019.
The SBIC Fund is accounted for as an equity method investment.
Note 17. Significant Equity Method Investments
In accordance with Rules 3-09 and 4-08(g) of Regulation S-X, the Company must assess whether any of its equity method
investments are significant equity method investments. In evaluating the significance of these investments, the Company
performed the income test, the investment test and the asset test described in S-X 3-05 and S-X 1-02(w). Rule 3-09 of Regulation
S-X requires separate audited financial statements of an equity method investee in an annual report if either the income or
investment test exceeds 20%. As of December 31, 2019, and 2018, none of our investments was considered a significant
subsidiary under Rule 3-09. Rule 4-08(g) of Regulation S-X requires summarized financial information in an annual report if
any of the three tests exceeds 10%. Under the income test, the Company’s proportionate share of its equity method investees'
aggregated net losses exceeded the applicable threshold of 10% and is accordingly required to provide summarized financial
information for these investees for all periods presented in this Form 10-K.
The following table provides summarized balance sheet information for the Company’s equity method investments as of
December 31, 2019 and 2018. The Company’s equity method investments are included in the other assets line on the consolidated
balances sheet and are largely concentrated in new or emerging financial service technology companies.
Balance sheet data
Current assets
Noncurrent assets
Total assets
Current liabilities
Noncurrent liabilities
Total liabilities
Equity interests
Total liabilities and equity
As of December 31,
2019
2018
$
$
$
$
56,710
162,304
219,014
19,910
683
20,593
198,421
219,014
$
$
$
$
63,048
156,858
219,906
12,229
432
12,661
207,245
219,906
The following table provides summarized income statement information for the Company’s equity method investments for the
years ended December 31, 2019, 2018, and 2017.
Summary of operations
Total revenues
2019
Years ended December 31,
2018
2017
$
56,472
$
54,567
$
Net loss
(25,778 )
(10,582 )
13,855
(4,614 )
145
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Note 18. Parent Company Only Financial Statements
The following balance sheets, statements of income and statements of cash flows for Live Oak Bancshares, Inc. should be read
in conjunction with the consolidated financial statements and the notes thereto.
Balance Sheets
Assets
Cash and cash equivalents
Investment in subsidiaries
Other assets
Total assets
Liabilities and Shareholders' Equity
Borrowings
Other liabilities
Total liabilities
Shareholders' equity:
Common stock
Retained earnings
Accumulated other comprehensive income (loss)
Total equity
Total liabilities & shareholders' equity
Interest income
Interest expense
Net interest loss
Noninterest income:
Other noninterest income
Total noninterest income
Noninterest expense:
Statements of Income
$
Salaries and employee benefits
Professional services expense
Renewable energy tax credit investment impairment
Impairment expense on goodwill and other intangibles, net
Other expense
Total noninterest expense
Net loss before equity in undistributed
income of subsidiaries
Income tax benefit
Net loss
As of December 31,
2019
2018
$
$
$
$
13,585 $
499,335
21,182
534,102 $
— $
1,716
1,716
340,397
180,265
11,724
532,386
534,102 $
14,780
452,426
28,094
495,300
1,441
299
1,740
328,113
167,124
(1,677 )
493,560
495,300
2019
Years ended December 31,
2018
2017
236 $
—
236
140
140
12,408
825
602
—
999
14,834
46 $
129
(83 )
562
562
10,117
853
—
2,680
1,844
15,494
(14,458 )
(27 )
(14,431 )
(15,015 )
(3,658 )
(11,357 )
5
1,210
(1,205 )
2,114
2,114
10,531
1,192
690
(4,350 )
2,588
10,651
(9,742 )
(320 )
(9,422 )
Equity in undistributed income of subsidiaries in
excess of dividends from subsidiaries
Net income attributable to Live Oak Bancshares, Inc.
$
32,465
18,034 $
62,805
51,448 $
109,921
100,499
146
Live Oak Bancshares, Inc.
Notes to Consolidated Financial Statements
Statements of Cash Flows
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Equity in undistributed net income of subsidiaries in
excess of dividends of subsidiaries
Depreciation
Impairment expense on goodwill and other intangibles, net
Deferred income tax
Renewable energy tax credit investment impairment
Stock option based compensation expense
Restricted stock expense
Business combination contingent consideration fair value
adjustments
Net change in other assets
Net change in other liabilities
Net cash provided by (used in) operating activities
Cash flows from investing activities
Capital investment in subsidiaries
Net change in advances to subsidiaries
Business combination, net of cash acquired
Purchases of premises and equipment
Net cash used in investing activities
Cash flows from financing activities
Proceeds from borrowings
Repayments of borrowings
Stock option exercises
Employee stock purchase program
Withholding cash issued in lieu of restricted stock
Sale of common stock, net
Shareholder dividend distributions
Net cash (used in) provided by financing activities
Net change in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
2019
Years ended December 31,
2018
2017
$
18,034 $
51,448 $
100,499
(32,465 )
—
—
(790 )
602
1,723
10,025
—
7,100
1,417
5,646
(1,109 )
—
—
—
(1,109 )
—
(1,441 )
508
437
(409 )
—
(4,827 )
(5,732 )
(1,195 )
14,780
13,585 $
(62,805 )
199
2,680
(6,633 )
—
1,713
7,463
(260 )
4,396
142
(1,657 )
(9,325 )
—
—
(20 )
(9,345 )
—
(25,123 )
1,626
342
(756 )
—
(4,809 )
(28,720 )
(39,722 )
54,502
14,780 $
(109,921 )
1,188
(4,350 )
(5,376 )
690
1,786
5,717
1,950
11,649
(820 )
3,012
(55,240 )
640
(7,696 )
(4,864 )
(67,160 )
25,000
(26,279 )
1,026
445
(4,891 )
113,096
(3,776 )
104,621
40,473
14,029
54,502
$
147
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
Item 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Annual Report on Form 10-K, the Company carried out an evaluation, under the
supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the design and operation of its disclosure controls and procedures. In designing and evaluating the disclosure
controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated,
can provide only reasonable assurance of achieving the desired control objectives, and management was required to apply
judgment in evaluating its controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief
Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Exchange Act), were effective as of the end of the period covered by this report.
Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) that occurred during the quarter ended December 31, 2019, that have materially affected, or are
reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management's Report on Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting.
Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. A company’s internal control over financial reporting includes those policies and procedures that pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements
in accordance with generally accepted accounting principles in the United States of America, and that receipts and expenditures
of the company are being made only in accordance with authorizations of management and directors of the company; and provide
reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting might not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As of December 31, 2019, management assessed the effectiveness of the Company’s internal control over financial reporting
based on the criteria for effective internal control over financial reporting established in “Internal Control-Integrated Framework
(2013),” issued by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission. Based on the
assessment, management determined that the Company maintained effective internal control over financial reporting as of
December 31, 2019.
Dixon Hughes Goodman LLP, the independent registered public accounting firm, audited the consolidated financial statements
of the Company included in this Annual Report on Form 10-K and has issued an audit report on the Company’s internal control
over financial reporting as of December 31, 2019. This report entitled “Report of Independent Registered Public Accounting
Firm” appears in Item 8.
Item 9B. OTHER INFORMATION
None.
148
PART III
Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by Item 10 will be included in LOB’s definitive proxy statement for the 2020 Annual Meeting of
Shareholders (the “Proxy Statement”), under the headings “Proposal 1: Election of Directors,” “Qualifications of Directors,”
“Code of Ethics and Conflict of Interest Policy,” “Director Relationships,” “Committees of the Board or Directors,” “Executive
Officers,” “Report of the Audit and Risk Committee,” and “Delinquent Section 16(a) Reports” and is incorporated herein by
reference. The Proxy Statement will be filed with the Securities and Exchange Commission pursuant to Regulation 14A within
120 days of the end of our 2019 fiscal year.
Item 11. EXECUTIVE COMPENSATION
The information required by Item 11 will be included in the section of the Proxy Statement entitled “Executive Compensation
and Other Matters” under the following headings: “Compensation Discussion and Analysis,” “Compensation Committee Report,”
“Summary Compensation and Other Tables,” “Potential Payments upon Termination or Change in Control,” “Principal Executive
Officer Pay Ratio,” and “Director Compensation,” and in the section of the Proxy Statement entitled “Corporate Governance”
under the heading “Compensation Committee Interlocks and Insider Participation.”
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
The information required by Item 12 will be included in the Proxy Statement under the headings “Beneficial Ownership of Our
Common Stock” and “Executive Compensation and Other Matters - Equity Compensation Plan Information” and is incorporated
herein by reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by Item 13 will be included in the Corporate Governance section of the Proxy Statement under the
headings “Director Independence,” "Director Relationships,” “Indebtedness of and Transactions with Management,” and “Certain
Relationships and Related Person Transactions” and is incorporated herein by reference.
Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by Item 14 will be included in the Proxy Statement under the heading “Proposal 3: Ratification of
Independent Auditors” and is incorporated herein by reference.
149
PART IV
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements. The following financial statements are filed as part of this report.
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2019 and 2018
Consolidated Statements of Income for the Years Ended December 31, 2019, 2018 and 2017
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2019, 2018 and 2017
Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2019, 2018 and 2017
Consolidated Statements of Cash Flows for the Years Ended December 31, 2019, 2018 and 2017
Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules. All applicable financial statement schedules required under Regulation S-X have been
included in the Notes to the Consolidated Financial Statements.
(a)(3) Exhibits. The exhibits listed below are filed or furnished as a part of this Annual Report on Form 10-K.
Exhibit No. Description of Exhibit
3.1
Amended and Restated Articles of Incorporation of Live Oak Bancshares, Inc. (incorporated by reference to Exhibit
3.1 of the registration statement on Form S-1, filed on June 19, 2015)
3.2
Amended Bylaws of Live Oak Bancshares, Inc. (incorporated by reference to Exhibit 3.2 of the amended
registration statement on Form S-1, filed on July 13, 2015)
4.1
Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 of the registration statement on Form
S-1, filed on June 19, 2015)
4.2
Registration and Other Rights Agreement between Live Oak Bancshares, Inc. and Wellington purchasers
(incorporated by reference to Exhibit 4.2 of the registration statement on Form S-1, filed on June 19, 2015)
4.3 Description of Securities Registered under Section 12 of the Exchange Act*
10.1
2008 Incentive Stock Option Plan, as amended (incorporated by reference to Exhibit 10.1 of the registration
statement on Form S-1, filed on June 19, 2015) #
10.2.1
2008 Nonstatutory Stock Option Plan, as amended (incorporated by reference to Exhibit 10.2 of the registration
statement on Form S-1, filed on June 19, 2015) #
10.2.2 Amendment to 2008 Nonstatutory Stock Option Plan effective July 1, 2019 (incorporated by reference to Exhibit
10.2 of the quarterly report on Form 10-Q, filed on August 6, 2019) #
10.3
Amended and Restated Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.4 of the quarterly
report on Form 10-Q filed on August 8, 2016) #
10.4.1
2015 Omnibus Stock Incentive Plan (incorporated by reference to Exhibit 10.4 of the registration statement on Form
S-1 filed on June 19, 2015) #
10.4.2
Amendment to 2015 Omnibus Stock Incentive Plan dated December 17, 2015 (incorporated by reference to Exhibit
10.4.2 of the 2015 10-K) #
10.4.3
2015 Omnibus Stock Incentive Plan as Amended and Restated effective May 24, 2016 (incorporated by reference
to Exhibit 10.1 of the current report on Form 8-K filed on May 27, 2016) #
10.4.4 Amendment to 2015 Omnibus Stock Incentive Plan dated May 15, 2018 (incorporated by reference to Exhibit 10.1
of the current report on Form 8-K filed on May 18, 2018) #
10.5.1
Software Service Agreement between Live Oak Banking Company and nCino, LLC, dated November 1, 2012
(incorporated by reference to Exhibit 10.10 of the registration statement on Form S-1 filed on June 19, 2015)
150
10.5.2
Amendment to Software Service Agreement dated October 9, 2015, between Live Oak Banking Company and
nCino, Inc. (incorporated by reference to Exhibit 10.7.2 of the 2015 10-K)
10.5.3 Renewal Amendment to Software Service Agreement dated January 18, 2019, between Live Oak Banking Company
and nCino, Inc. (incorporated by reference to Exhibit 10.5.3 of the 2018 10-K)
10.6.1
Form of Stock Option Award Agreement for executive officers under the 2015 Omnibus Stock Incentive Plan
(incorporated by reference to Exhibit 10.8 of the 2015 10-K) #
10.6.2
Performance RSU Award Agreement for Neil L. Underwood (incorporated by reference to Exhibit 99.1 of the
current report on Form 8-K filed on March 25, 2016) #
10.6.3
Performance RSU Award Agreement with Stock Price Condition for Neil L. Underwood (incorporated by reference
to Exhibit 99.2 of the current report on Form 8-K filed on March 25, 2016) #
10.6.4
Form of Performance RSU Award Agreement with Stock Price Condition for certain executive officers
(incorporated by reference to Exhibit 99.1 of the current report on Form 8-K filed on December 2, 2016) #
10.6.5
Form of Performance RSU Award Agreement with Stock Price Condition for certain executive officers
(incorporated by reference to Exhibit 99.1 of the current report on Form 8-K filed on February 2, 2017) #
10.6.6
Form of Performance RSU Award Agreement with Stock Price Condition for certain executive officers
(incorporated by reference to Exhibit 10.7.6 of the 2017 10-K) #
10.6.7 Amended Performance RSU Award Agreement with Stock Price Condition for Susan N. Janson (incorporated by
reference to Exhibit 10.6.8 of the 2018 10-K) #
10.6.8
Amended form of Performance RSU Award Agreement with Stock Price Condition for certain executive officers
(incorporated by reference to Exhibit 99.1 of the current report on Form 8-K filed on February 15, 2019) #
10.6.9 RSU Award Agreement for M. Huntley Garriott (incorporated by reference to Exhibit 10.6.10 of the 2018 10-K) #
10.6.10 Performance RSU Award Agreement with Stock Price Condition for M. Huntley Garriott (incorporated by reference
to Exhibit 10.6.11 of the 2018 10-K) #
10.6.11 Form of 2019 RSU Award Agreement for non-employee directors (incorporated by reference to Exhibit 10.1 of the
quarterly report on Form 10-Q, filed on August 6, 2019) #
10.6.12 Form of RSU Award Agreement for certain executive officers (incorporated by reference to Exhibit 99.1 of the
current report on Form 8-K filed on February 14, 2020) #
21.1
Subsidiaries of the Registrant*
23.1
Consent of the Independent Registered Public Accounting Firm - Dixon Hughes Goodman LLP*
31.1
Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2
Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**
101.INS
Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its
XBRL tags are embedded within the Inline XBRL document)
101.SCH Inline XBRL Taxonomy Extension Schema Document
101.CAL Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE Inline XBRL Taxonomy Extension Presentation Linkbase Document
104 Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)
*
Indicates a document being filed with this Form 10-K.
151
** Furnished herewith. This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of
1934, or otherwise subject to the liability of that Section. Such exhibit shall not be deemed incorporated into any filing under
the Securities Act of 1933 or the Securities Exchange Act of 1934.
# Denotes management contract or compensatory plan.
Item 16. FORM 10-K SUMMARY
Registrants may voluntarily include a summary of information required by Form 10-K under this Item 16. We have elected not
to include such summary information.
152
Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
SIGNATURES
Date: February 27, 2020
Live Oak Bancshares, Inc.
(Registrant)
By: /s/ James S. Mahan III
James S. Mahan III
Chairman and Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated.
153
Date
February 27, 2020
February 27, 2020
February 27, 2020
February 27, 2020
February 27, 2020
February 27, 2020
February 27, 2020
February 27, 2020
February 27, 2020
February 27, 2020
February 27, 2020
/s/ James S. Mahan III
James S. Mahan III
Chairman and Chief Executive Officer (Principal Executive Officer)
/s/ S. Brett Caines
S. Brett Caines
Chief Financial Officer
(Principal Financial Officer)
/s/ J. Wesley Sutherland
J. Wesley Sutherland
Chief Accounting Officer
(Principal Accounting Officer)
/s/ William L. Williams III
William L. Williams III
Vice Chairman of the Board of Directors
/s/ William H. Cameron
William H. Cameron
Director
/s/ Diane B. Glossman
Diane B. Glossman
Director
/s/ Glen F. Hoffsis
Glen F. Hoffsis
Director
/s/ Howard K. Landis
Howard K. Landis
Director
/s/ Miltom E. Petty
Miltom E. Petty
Director
/s/ David G. Salyers
David G. Salyers
Director
/s/ Neil L. Underwood
Neil L. Underwood
Director
154
Stock Performance Graph
Our voting common stock is listed for trading on the NASDAQ Global Select Market under the symbol “LOB.” The Stock
Performance Graph set forth below compares the cumulative total stockholder return on our common stock for the period from
July 23, 2015, through December 31, 2019, with the cumulative total return of the Nasdaq Composite Index and the Nasdaq Bank
Index over the same period. The comparison assumes $100 was invested on July 23, 2015, in the common stock of Live Oak
Bancshares, Inc., in the Nasdaq Composite Index and in the Nasdaq Bank Index and assumes reinvestment of dividends,
if any.
155
C O R P O R A T E I N F O R M A T I O N
C O R P O R A T E H E A D Q U A R T E R S
Live Oak Bancshares, Inc.
1741 Tiburon Drive
Wilmington, NC 28403
S T O C K I N F O R M A T I O N
The voting common stock of Live Oak Bancshares, Inc. is traded on the
NASDAQ Global Select Market under the symbol "LOB".
T R A N S F E R A G E N T
Broadridge Corporate Issuer Solutions, Inc.
1717 Arch Street, Suite 1300
Philadelphia, PA 19103
I N D E P E N D E N T A U D I T O R S
Dixon Hughes Goodman LLP
E X E C U T I V E O F F I C E R S
James S. Mahan III - Chairman and Chief Executive Officer
Neil L. Underwood - President and Director
M. Huntley Garriott, Jr. - President, Live Oak Banking Company
William L. Williams III - Executive Vice President and Vice Chairman
S. Brett Caines - Chief Financial Officer
Susan N. Janson – Chief Risk Officer, Live Oak Banking Company
Gregory W. Seward - General Counsel
Steven J. Smits - Chief Credit Officer
J. Wesley Sutherland - Chief Accounting Officer
D I R E C T O R S
William H. Cameron
Diane B. Glossman
Glen F. Hoffsis
Howard K. Landis III
Miltom E. Petty
David G. Salyers
1 7 4 1 T I B U R O N D R I V E | W I L M I N G T O N , N C 2 8 4 0 3 | L I V E O A K B A N K . C O M
All content included in this Annual Report, including graphics, logos and other materials, is the property of Live Oak
Banchshares, Inc., and/or its affiliates, or others as noted herein, and is protected by copyright and other laws. All
trademarks and logos displayed in this Annual Report are the property of their respective owners.
IMPORTANT NOTE REGARDING FORWARD-LOOKING STATEMENTS: This report contains forward-looking statements,
within the meaning of the Private Securities Litigation Reform Act of 1995. These statements generally relate to the
Company’s financial condition, results of operations, plans, objectives, future performance or business. They usually
can be identified by the use of forward-looking terminology, such as “believes,” “expects,” or “are expected to,” “plans,”
“projects,” “goals,” “estimates,” “may,” “should,” “could,” “would,” “intends to,” “outlook” or “anticipates,” or variations of
these and similar words. Forward-looking statements are based on current management expectations and, by their
nature, are subject to risks and uncertainties. Actual results may differ materially from those contained in the forward-
looking statements. Factors which may cause actual results to differ materially from those contained in such forward-
looking statements include those identified in the company’s most recent Form 10-K and subsequent SEC filings.