Document

Table of Contents


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2018
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
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12394015&doc=12
LIVE OAK BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
North Carolina
26-4596286
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
1741 Tiburon Drive
Wilmington, North Carolina
28403
(Address of principal executive offices)
(Zip Code)
(910) 790-5867
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ý    NO  ¨
Indicate by check mark whether the registrant has submitted electronically 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  ý    NO  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See 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
 
¨
 
Accelerated filer
 
x
 
 
 
 
Non-accelerated filer
 
¨ (Do not check if smaller reporting company)
 
Smaller reporting company
 
¨
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
x
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  ý
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of August 6, 2018, there were 35,473,289 shares of the registrant’s voting common stock outstanding and 4,643,530 shares of the registrant’s non-voting common stock outstanding.




Table of Contents

Live Oak Bancshares, Inc. and Subsidiaries
Form 10-Q
For the Quarterly Period Ended June 30, 2018
TABLE OF CONTENTS

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




Table of Contents

PART I. FINANCIAL INFORMATION
Item 1.        Financial Statements
Live Oak Bancshares, Inc.
Consolidated Balance Sheets
As of June 30, 2018 (unaudited) and December 31, 2017*
(Dollars in thousands)
 
June 30,
2018
 
December 31,
2017*
Assets
 
 
 
Cash and due from banks
$
392,941

 
$
295,271

Certificates of deposit with other banks
2,250

 
3,000

Investment securities available-for-sale
384,943

 
93,355

Loans held for sale
757,494

 
680,454

Loans and leases held for investment
1,534,368

 
1,343,973

Allowance for loan and lease losses
(29,350
)
 
(24,190
)
Net loans and leases
1,505,018

 
1,319,783

Premises and equipment, net
234,817

 
178,790

Foreclosed assets
1,725

 
1,281

Servicing assets
52,689

 
52,298

Other assets
141,092

 
134,242

Total assets
$
3,472,969

 
$
2,758,474

Liabilities and Shareholders’ Equity
 
 
 
Liabilities
 
 
 
Deposits:
 
 
 
Noninterest-bearing
$
46,192

 
$
57,868

Interest-bearing
2,923,044

 
2,202,395

Total deposits
2,969,236

 
2,260,263

Long term borrowings
3,385

 
26,564

Other liabilities
37,362

 
34,714

Total liabilities
3,009,983

 
2,321,541

Shareholders’ equity
 
 
 
Preferred stock, no par value, 1,000,000 authorized, none issued or outstanding at June 30, 2018 and December 31, 2017

 

Class A common stock, no par value, 100,000,000 shares authorized, 35,442,879 and 35,252,053 shares issued and outstanding at June 30, 2018 and December 31, 2017, respectively
274,043

 
268,557

Class B common stock, no par value, 10,000,000 shares authorized, 4,643,530 shares issued and outstanding at June 30, 2018 and December 31, 2017
49,168

 
49,168

Retained earnings
144,791

 
120,241

Accumulated other comprehensive loss
(5,016
)
 
(1,033
)
Total equity
462,986

 
436,933

Total liabilities and shareholders’ equity
$
3,472,969

 
$
2,758,474

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

1


Table of Contents

Live Oak Bancshares, Inc.
Consolidated Statements of Income
For the three and six months ended June 30, 2018 and 2017 (unaudited)
(Dollars in thousands, except per share data)
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Interest income
 
 
 
 
 
 
 
Loans and fees on loans
$
36,267

 
$
23,559

 
$
68,958

 
$
43,313

Investment securities, taxable
2,530

 
316

 
3,647

 
639

Other interest earning assets
2,179

 
470

 
3,394

 
812

Total interest income
40,976

 
24,345

 
75,999

 
44,764

Interest expense
 
 
 
 
 
 
 
Deposits
13,927

 
5,592

 
24,345

 
10,135

Borrowings
1

 
361

 
130

 
596

Total interest expense
13,928

 
5,953

 
24,475

 
10,731

Net interest income
27,048

 
18,392

 
51,524

 
34,033

Provision for loan and lease losses
2,087

 
1,556

 
6,479

 
3,055

Net interest income after provision for loan and lease losses
24,961

 
16,836

 
45,045

 
30,978

Noninterest income
 
 
 
 
 
 
 
Loan servicing revenue
6,965

 
6,174

 
13,863

 
12,097

Loan servicing asset revaluation
(3,670
)
 
(1,164
)
 
(8,758
)
 
(3,173
)
Net gains on sales of loans
23,061

 
18,176

 
47,479

 
37,128

Lease income
1,920

 
9

 
3,528

 
9

Construction supervision fee income
597

 
286

 
1,376

 
715

Title insurance income
996

 
2,397

 
2,296

 
3,835

Other noninterest income
744

 
789

 
1,585

 
1,809

Total noninterest income
30,613

 
26,667

 
61,369

 
52,420

Noninterest expense
 
 
 
 
 
 
 
Salaries and employee benefits
22,146

 
17,968

 
42,355

 
36,650

Travel expense
2,041

 
2,148

 
3,884

 
3,746

Professional services expense
1,119

 
1,424

 
2,417

 
3,160

Advertising and marketing expense
1,868

 
1,976

 
3,530

 
3,461

Occupancy expense
1,882

 
1,350

 
3,739

 
2,545

Data processing expense
2,906

 
1,858

 
5,743

 
3,554

Equipment expense
3,368

 
1,703

 
6,445

 
2,777

Other loan origination and maintenance expense
1,414

 
981

 
2,743

 
1,986

FDIC insurance
1,010

 
724

 
1,582

 
1,450

Title insurance closing services expense
372

 
785

 
798

 
1,190

Other expense
2,704

 
2,383

 
5,666

 
5,766

Total noninterest expense
40,830

 
33,300

 
78,902

 
66,285

Income before taxes
14,744

 
10,203

 
27,512

 
17,113

Income tax expense
491

 
408

 
806

 
1,206

Net income
$
14,253

 
$
9,795

 
$
26,706

 
$
15,907

Basic earnings per share
$
0.36

 
$
0.28

 
$
0.67

 
$
0.46

Diluted earnings per share
$
0.34

 
$
0.27

 
$
0.64

 
$
0.44

See Notes to Unaudited Consolidated Financial Statements

2


Table of Contents

Live Oak Bancshares, Inc.
Consolidated Statements of Comprehensive Income
For the three and six months ended June 30, 2018 and 2017 (unaudited)
(Dollars in thousands)
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
14,253

 
$
9,795

 
$
26,706

 
$
15,907

Other comprehensive (loss) income before tax:
 
 
 
 
 
 
 
Net unrealized (loss) gain on investment securities arising during the period
(1,965
)
 
293

 
(4,920
)
 
220

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

 

 

 

Other comprehensive (loss) income before tax
(1,965
)
 
293

 
(4,920
)
 
220

Income tax benefit (expense)
471

 
(113
)
 
1,181

 
(85
)
Other comprehensive (loss) income, net of tax
(1,494
)
 
180

 
(3,739
)
 
135

Total comprehensive income
$
12,759

 
$
9,975

 
$
22,967

 
$
16,042

See Notes to Unaudited Consolidated Financial Statements

3


Table of Contents

Live Oak Bancshares, Inc.
Consolidated Statements of Changes in Shareholders’ Equity
For the six months ended June 30, 2018 and 2017 (unaudited)
(Dollars in thousands)
 
Common stock
 
Retained
earnings
 
Accumulated
other
comprehensive
loss
 
Total
equity
Shares
 
 
 
Class A
 
Class B
 
Amount
 
Balance at December 31, 2016
29,530,072

 
4,723,530

 
$
199,981

 
$
23,518

 
$
(652
)
 
$
222,847

Net income

 

 

 
15,907

 

 
15,907

Other comprehensive income

 

 

 

 
135

 
135

Issuance of restricted stock
287,190

 

 

 

 

 

Withholding cash issued in lieu of restricted stock issuance

 

 
(4,828
)
 

 

 
(4,828
)
Employee stock purchase program
12,411

 

 
241

 

 

 
241

Stock option exercises
58,921

 

 
456

 

 

 
456

Stock option based compensation expense

 

 
924

 

 

 
924

Restricted stock expense

 

 
2,768

 

 

 
2,768

Stock issued in acquisition of Reltco, Inc.
27,724

 

 
565

 

 

 
565

Non-voting common stock converted to voting common stock-private sale
80,000

 
(80,000
)
 

 

 

 

Dividends (distributions to shareholders)

 

 

 
(1,384
)
 

 
(1,384
)
Balance at June 30, 2017
29,996,318

 
4,643,530

 
$
200,107

 
$
38,041

 
$
(517
)
 
$
237,631

Balance at December 31, 2017
35,252,053

 
4,643,530

 
$
317,725

 
$
120,241

 
$
(1,033
)
 
$
436,933

Net income

 

 

 
26,706

 

 
26,706

Other comprehensive loss

 

 

 

 
(3,739
)
 
(3,739
)
Issuance of restricted stock
39,133

 

 

 

 

 

Withholding cash issued in lieu of restricted stock issuance

 

 
(495
)
 

 

 
(495
)
Employee stock purchase program
7,022

 

 
165

 

 

 
165

Stock option exercises
144,671

 

 
1,252

 

 

 
1,252

Stock option based compensation expense

 

 
809

 

 

 
809

Restricted stock expense

 

 
3,755

 

 

 
3,755

Reclassification of accumulated other comprehensive income due to tax rate change

 

 

 
244

 
(244
)
 

Dividends (distributions to shareholders)

 

 

 
(2,400
)
 

 
(2,400
)
Balance at June 30, 2018
35,442,879

 
4,643,530

 
$
323,211

 
$
144,791

 
$
(5,016
)
 
$
462,986

See Notes to Unaudited Consolidated Financial Statements

4


Table of Contents

Live Oak Bancshares, Inc.
Consolidated Statements of Cash Flows
For the six months ended June 30, 2018 and 2017 (unaudited)
(Dollars in thousands)
 
Six Months Ended
June 30,
 
2018
 
2017
Cash flows from operating activities
 
 
 
Net income
$
26,706

 
$
15,907

Adjustments to reconcile net income to net cash used by operating activities:
 
 
 
Depreciation and amortization
7,823

 
4,062

Provision for loan and lease losses
6,479

 
3,055

Amortization of premium on securities, net of accretion
353

 
219

Amortization of discount on unguaranteed loans, net
3,501

 
1,255

Deferred tax expense
807

 
1,427

Originations of loans held for sale
(621,290
)
 
(632,414
)
Proceeds from sales of loans held for sale
613,911

 
466,309

Net gains on sale of loans held for sale
(47,479
)
 
(37,128
)
Net loss on sale of foreclosed assets
1

 
3

Net increase in servicing assets
(391
)
 
(1,681
)
Net loss on disposal of premises and equipment

 
213

Stock option based compensation expense
809

 
924

Restricted stock expense
3,755

 
2,768

Stock based compensation expense excess tax benefits
24

 
874

     Business combination contingent consideration fair value adjustment
(260
)
 
350

Changes in assets and liabilities:
 
 
 
Other assets
(7,445
)
 
(9,463
)
Other liabilities
909

 
845

Net cash used by operating activities
(11,787
)
 
(182,475
)
Cash flows from investing activities
 
 
 
Purchases of securities available-for-sale
(316,588
)
 
(6,403
)
Proceeds from sales, maturities, calls, and principal paydowns of securities available-for-sale
19,727

 
4,467

Proceeds from sale/collection of foreclosed assets
212

 

Business combination, net of cash acquired

 
(7,684
)
Maturities of certificates of deposit with other banks
750

 
1,500

Loan and lease originations and principal collections, net
(217,743
)
 
(192,018
)
Purchases of premises and equipment, net
(61,217
)
 
(63,482
)
Net cash used by investing activities
(574,859
)
 
(263,620
)
See Notes to Unaudited Consolidated Financial Statements

5


Table of Contents

Live Oak Bancshares, Inc.
Consolidated Statements of Cash Flows (Continued)
For the six months ended June 30, 2018 and 2017 (unaudited)
(Dollars in thousands)
 
Six Months Ended
June 30,
 
2018
 
2017
Cash flows from financing activities
 
 
 
Net increase in deposits
708,973

 
386,645

Proceeds from long term borrowings
18

 
16,900

Repayment of long term borrowings
(23,197
)
 
(670
)
Proceeds from short term borrowings

 
23,100

Repayment of short term borrowings

 
(5,000
)
Stock option exercises
1,252

 
456

Employee stock purchase program
165

 
241

Withholding cash issued in lieu of restricted stock
(495
)
 
(4,828
)
Shareholder dividend distributions
(2,400
)
 
(1,384
)
Net cash provided by financing activities
684,316

 
415,460

Net increase (decrease) in cash and cash equivalents
97,670

 
(30,635
)
Cash and cash equivalents, beginning
295,271

 
238,008

Cash and cash equivalents, ending
$
392,941

 
$
207,373

 
 
 
 
Supplemental disclosure of cash flow information
 
 
 
Interest paid
$
24,308

 
$
10,858

Income tax (refunds) payments, net
(542
)
 
7,876

 
 
 
 
Supplemental disclosures of noncash operating, investing, and financing activities
 
 
 
Unrealized holding (losses) gains on available-for-sale securities, net of taxes
$
(3,739
)
 
$
135

Transfers from loans and leases to foreclosed real estate and other repossessions
346

 
495

Net transfers from SBA receivable to foreclosed real estate
311

 

Transfer of loans held for sale to loans and leases held for investment
19,774

 
4,149

Transfer of loans and leases held for investment to loans held for sale
51,614

 
18,410

Transfers from short term borrowings to long term borrowings

 
8,100

Business combination:
 
 
 
Assets acquired (excluding goodwill)

 
5,766

Liabilities assumed

 
4,681

Purchase price

 
8,351

Goodwill recorded

 
7,266

See Notes to Unaudited Consolidated Financial Statements

6


Table of Contents

Live Oak Bancshares, Inc.
Notes to Unaudited Consolidated Financial Statements
Note 1. Basis of Presentation
Nature of Operations
Live Oak Bancshares, Inc. (the “Company” or “LOB”) is a bank holding company headquartered in Wilmington, North Carolina incorporated under the laws of North Carolina in December 2008. The Company conducts business operations primarily through its commercial bank subsidiary, Live Oak Banking Company (the “Bank”). The Bank was organized and incorporated under the laws of the State of North Carolina on February 25, 2008 and commenced operations on May 12, 2008. The Bank specializes in providing lending services to small businesses nationwide. The Bank identifies and grows 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") and Business & Industry ("B&I") loan programs. On July 28, 2015 the Company completed its initial public offering with a secondary offering completed in August of 2017.
In 2010, the Bank formed Live Oak Number One, Inc., a wholly-owned subsidiary, to hold properties foreclosed on by the Bank.
In addition to the Bank, the Company owns Live Oak Grove, LLC, opened in September 2015 for the purpose of providing Company employees and business visitors an on-site restaurant location; Government Loan Solutions, Inc. (“GLS”), a management and technology consulting firm that specializes in the settlement, accounting, and securitization processes for government guaranteed loans, including loans originated under the SBA 7(a) loan program and USDA-guaranteed loans; and 504 Fund Advisors, LLC (“504FA”), formed to serve as the investment adviser to the 504 Fund, a closed-end mutual fund organized to invest in SBA section 504 loans.
In August 2016, the Company formed Canapi, Inc. for the purpose of investing in businesses that align with the Company's strategic initiative to be a leader in financial technology. Canapi was formerly known as Live Oak Ventures, Inc.
In November 2016, the Company formed Live Oak Clean Energy Financing LLC for the purpose of providing financing to entities for renewable energy applications.
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. See Note 13. Subsequent Event for disposition of Reltco on August 1, 2018.
The Company earns revenue primarily from the sale of SBA and USDA-guaranteed loans and net interest income. Income from the sale of loans is comprised of net gains on the sale of loans, revenues on the servicing of sold loans and valuation of loan servicing rights. 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, occupancy, advertising and marketing and tax expense.
General
In the opinion of management, all adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included, and all intercompany transactions have been eliminated in consolidation. Results of operations for the six months ended June 30, 2018 are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2018. The consolidated balance sheet as of December 31, 2017 has been derived from the audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017, filed with the Securities Exchange Commission on March 8, 2018 (SEC File No. 001-37497) (the "2017 Annual Report"). A summary description of the significant accounting policies followed by the Company is set forth in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2017 Annual Report. These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes in the Company's 2017 Annual Report.
The preparation of financial statements in conformity with United States generally accepted accounting principles, or GAAP, requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period. Actual results could differ significantly from those estimates.
Amounts in all tables in the Notes to Unaudited Consolidated Financial Statements have been presented in thousands, except percentage, time period, stock option, share and per share data or where otherwise indicated.

7


Table of Contents

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

Business Segments
Management has determined that the Company has one significant operating segment, which is providing a lending platform for small businesses nationwide. In determining the appropriateness of segment definition, the Company considers the materiality of a potential segment, the components of the business about which financial information is available, and components for which management regularly evaluates relative to resource allocation and performance assessment.
Unconsolidated Joint Venture
On October 1, 2017, the Company started the digital banking joint venture between Live Oak Banking Company and First Data Corporation ("First Data"). The new company, named Apiture, combines 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 are 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 is 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.
As a result of the above cash earnings preference, 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. As a result of the HLBV method there was no net income or loss attributed to the Company related its ownership interest in Apiture during the three and six months ended June 30, 2018.
As of June 30, 2018 and December 31, 2017 the Company had a $68.0 million equity method investment included in other assets on the consolidated balance sheet for this investment.
Derivative Financial Instruments
Interest Rate Futures Contracts
During the fourth quarter of 2016, the Company began using 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. 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 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.

8


Table of Contents

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

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.
Revenue Recognition
On January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) No. 2014-09 “Revenue from Contracts with Customers” (Topic 606) and all subsequent ASUs that modified Topic 606. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue and a cumulative effect adjustment to opening retained earnings was not necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with the Company's historic accounting under Topic 605.
Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and lease financings or investment securities. In addition, certain noninterest income streams such as fees associated with servicing rights, financial guarantees, derivatives, title insurance, and equity and cost method investments are also not in scope of the new guidance. Therefore, the recognition of these revenue streams did not change upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below.
Other noninterest income
Other noninterest income consists of other recurring revenue streams from administration of trust assets held by the Company's trust department and from services provided by GLS to its clients for settlement, accounting, and valuation for government guaranteed loan sales and holdings. Trust account administration performance obligations are generally satisfied over time and fees are recognized monthly, based on the month-end market value of assets in fiduciary accounts and the applicable fee rate. Payment is generally received after month end through a direct charge to customers' accounts. The Company does not earn performance-based incentives from trust account administration services. 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.
Contract Balances
A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals such as trust administration fees based on month-end market values. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of June 30, 2018 and December 31, 2017, the Company did not have any significant contract balances.
Contract Acquisition Costs
In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, the Company did not capitalize any contract acquisition cost.
Reclassifications
Certain reclassifications have been made to the prior period’s consolidated financial statements to place them on a comparable basis with the current year. Net income and shareholders’ equity previously reported were not affected by these reclassifications.

9


Table of Contents

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

Note 2. Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”). This standard is intended to clarify the principles for recognizing revenue and to develop a common revenue standard for GAAP. The Company's revenue is comprised of loan servicing revenue, net gains on sales of loans and net interest income on financial assets and financial liabilities, all of which are explicitly excluded from the scope of ASU 2014-09, and non-interest income. The Company's revenue streams included in non-interest income that are within the scope of the guidance are primarily related to sales of foreclosed assets, construction supervision fees, title insurance income and trust fiduciary fees. The Company adopted the standard in the first quarter of 2018 with no material impact on the consolidated financial statements. Refer to Note 1. Basis of Presentation for additional information.
In January 2016, the FASB issued ASU 2016-01, “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). ASU 2016-01, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (viii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale. The Company adopted the standard in the first quarter of 2018 with no material impact on the consolidated financial statements. In accordance with (iv) above, the Company measured the fair value of the loan and lease portfolio using an exit price notion. See Note 10. Fair Value of Financial Instruments for additional information.
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). The FASB issued this ASU to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet by lessees for those leases classified as operating leases under current GAAP and disclosing key information about leasing arrangements. The amendments in this ASU are effective for the Company on January 1, 2019. The impact of this standard will depend on the Company's lease portfolio at the time of the adoption and the Company is currently assessing the effect that the adoption of this standard will have on the consolidated financial statements.
In June 2016, the FASB issued ASU No. 2016-13, “Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”). This new guidance replaces the incurred loss impairment methodology in current standards with an expected credit loss methodology and requires consideration of a broader range of information to determine credit loss estimates. ASU 2016-13 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 will be effective for the Company on January 1, 2020. The Company is currently evaluating the potential impact of ASU 2016-13 on the consolidated financial statements. In that regard, a cross-functional working group has been formed, under the direction of the Company's Chief Financial Officer and Chief Credit Officer. The working group is comprised of individuals from various functional areas including credit, risk management, finance and information technology, among others. The Company is currently developing an implementation plan to include assessment of processes, portfolio segmentation, model development, system requirements and the identification of data and resource needs, among other things. The Company has also selected a third-party vendor solution to assist in the application of the ASU 2016-13. While the Company is currently unable to reasonably estimate the impact of adopting ASU 2016-13, the impact of adoption is expected to be significantly influenced by the composition, characteristics and quality of loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date.

10


Table of Contents

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

In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805) - Clarifying the Definition of a Business” (“ASU 2017-01”).  ASU 2017-01 clarifies the definition and provides a more robust framework to use in determining when a set of assets and activities constitutes a business. ASU 2017-01 is intended to provide guidance when evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The Company adopted the standard in the first quarter of 2018 with no effect on the consolidated financial statements.
In February 2017, the FASB issued ASU No. 2017-05, “Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20) - Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets” (“ASU 2017-05”). ASU 2017-05 clarifies the scope of Subtopic 610-20 and adds guidance on nonfinancial asset derecognition as well as the accounting for partial sales of nonfinancial assets. The amendments conform the derecognition guidance on nonfinancial assets with the model for transactions in the new revenue standard. The Company adopted the standard in the first quarter of 2018 with no effect on the consolidated financial statements.
In May 2017, the FASB issued ASU No. 2017-09, “Compensation - Stock Compensation (Topic 718) - Scope of Modification Accounting” (“ASU 2017-09”). ASU 2017-09 clarifies when changes to the terms or conditions of a share-based payment award should be accounted for as a modification. This guidance indicates modification accounting is required when the fair value, vesting conditions, or classification of the award changes. The Company adopted the standard in the first quarter of 2018 with no effect on the consolidated financial statements.
In February 2018, the FASB issued ASU No. 2018-02, “Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” (“ASU 2018-02”). ASU 2018-02 addresses the income tax accounting treatment of the stranded tax effects within other comprehensive income. The ASU allows for an entity to reclassify the stranded tax effects resulting from the Tax Cuts and Jobs Act from accumulated other comprehensive income to retained earnings. ASU 2018-02 will be effective for the Company on January 1, 2019, with early adoption permitted. The Company early adopted ASU 2018-02 in the first quarter of 2018 and reclassified its stranded tax credit of $244 thousand within accumulated other comprehensive income to retained earnings at March 31, 2018.
In February 2018, the FASB issued ASU No. 2018-03, “Technical Corrections and Improvements to Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2018-03”). ASU 2018-03 amendments clarify certain aspects of the guidance issued in ASU 2016-01. The amendments are effective for the Company for fiscal year 2018 with adoption as of July 1, 2018. The Company does not expect these amendments to have a material effect on its consolidated financial statements.
In March 2018, the FASB issued ASU No. 2018-05, “Income Taxes (Topic 740) - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (SAB) No. 118” (“ASU 2018-05”). ASU 2018-05 amends Accounting Standard Codification 740 to include recent SEC guidance pursuant to the issuance of SAB 118. These amendments address situations when a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting for certain income tax effects of the Tax Cuts and Jobs Act. The amendments were effective upon issuance and do not have a material effect on the Company's consolidated financial statements.
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 amendments are effective for the Company on January 1, 2019 with early adoption permitted. The Company does not expect these amendments to have a material effect on its consolidated financial statements.


11


Table of Contents

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

Note 3. Earnings Per Share
Basic and diluted earnings per share are computed based on the weighted average number of shares outstanding during each period. Diluted earnings per share reflects the potential dilution that could occur, upon the exercise of stock options or upon the vesting of restricted stock grants, any of which would result in the issuance of common stock that would then be shared in the net income of the Company.
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
Basic earnings per share:
 
 
 
 
 
 
 
Net income available to common shareholders
$
14,253

 
$
9,795

 
$
26,706

 
$
15,907

Weighted-average basic shares outstanding
40,027,336

 
34,618,721

 
39,977,336

 
34,543,229

Basic earnings per share
$
0.36

 
$
0.28

 
$
0.67

 
$
0.46

Diluted earnings per share:
 
 
 
 
 
 
 
Net income available to common shareholders, for diluted earnings per share
$
14,253

 
$
9,795

 
$
26,706

 
$
15,907

Total weighted-average basic shares outstanding
40,027,336

 
34,618,721

 
39,977,336

 
34,543,229

Add effect of dilutive stock options and restricted stock grants
1,592,311

 
1,323,320

 
1,538,997

 
1,228,953

Total weighted-average diluted shares outstanding
41,619,647

 
35,942,041

 
41,516,333

 
35,772,182

Diluted earnings per share
$
0.34

 
$
0.27

 
$
0.64

 
$
0.44

Anti-dilutive shares

 
245,583

 
9,102

 
983,174

Note 4. Investment Securities
The carrying amount of investment securities and their approximate fair values are reflected in the following table:
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
June 30, 2018
 
 
 
 
 
 
 
US treasury securities
$
4,961

 
$

 
$
9

 
$
4,952

US government agencies
32,896

 

 
395

 
32,501

Residential mortgage-backed securities
351,556

 
14

 
6,133

 
345,437

Mutual fund
2,129

 

 
76

 
2,053

Total
$
391,542

 
$
14

 
$
6,613

 
$
384,943

 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
US government agencies
$
22,778

 
$
3

 
$
157

 
$
22,624

Residential mortgage-backed securities
70,167

 
1

 
1,472

 
68,696

Mutual fund
2,090

 

 
55

 
2,035

Total
$
95,035

 
$
4

 
$
1,684

 
$
93,355

There were no sales of securities during the three and six months ended June 30, 2018 and 2017.

12


Table of Contents

Live Oak Bancshares, Inc.
Notes to Unaudited 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.
 
Less Than 12 Months
 
12 Months or More
 
Total
June 30, 2018
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
US treasury securities
$
4,952

 
$
9

 
$

 
$

 
$
4,952

 
$
9

US government agencies
21,045

 
343

 
6,462

 
52

 
27,507

 
395

Residential mortgage-backed securities
292,323

 
4,083

 
41,850

 
2,050

 
334,173

 
6,133

Mutual fund

 

 
2,053

 
76

 
2,053

 
76

Total
$
318,320

 
$
4,435

 
$
50,365

 
$
2,178

 
$
368,685

 
$
6,613

 
Less Than 12 Months
 
12 Months or More
 
Total
December 31, 2017
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
US government agencies
$
14,842

 
$
100

 
$
6,465

 
$
57

 
$
21,307

 
$
157

Residential mortgage-backed securities
23,481

 
439

 
40,648

 
1,033

 
64,129

 
1,472

Mutual fund

 

 
2,035

 
55

 
2,035

 
55

Total
$
38,323

 
$
539

 
$
49,148

 
$
1,145

 
$
87,471

 
$
1,684

At June 30, 2018, there were twenty-five residential mortgage-backed securities, three US government agency securities and the 504 Fund mutual fund in unrealized loss positions for greater than 12 months and one US treasury security, forty residential mortgage-backed securities and seven US government agency securities in unrealized loss positions for less than 12 months. Unrealized losses at December 31, 2017 were comprised of twenty-three residential mortgage-backed securities, three US government agencies and the 504 mutual fund in unrealized loss positions for greater than 12 months and five US government agency securities and eight residential mortgage-backed securities 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 the securities for a sufficient period of time to recover unrealized losses, none of the securities are deemed to be other than temporarily impaired.
All residential mortgage-backed securities in the Company’s portfolio at June 30, 2018 and December 31, 2017 were backed by U.S. government sponsored enterprises (“GSEs”).

13


Table of Contents

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

The following is a summary of investment securities by maturity:
 
June 30, 2018
 
Available-for-Sale
 
Amortized
cost
 
Fair
value
US treasury securities
 
 
 
One to five years
$
4,961

 
$
4,952

Total
4,961

 
4,952

 
 
 
 
US government agencies
 
 
 
Within one year
6,323

 
6,300

One to five years
26,573

 
26,201

Total
32,896

 
32,501

 
 
 
 
Residential mortgage-backed securities
 
 
 
One to five years
4,298

 
4,121

Five to ten years
51,439

 
50,648

After 10 years
295,819

 
290,668

Total
351,556

 
345,437

 
 
 
 
Total
$
389,413

 
$
382,890

The table above reflects contractual maturities. Actual results will differ as the loans underlying the residential mortgage-backed securities may repay sooner than scheduled. This table excludes the 504 Fund mutual fund investment.
At June 30, 2018 and December 31, 2017, an investment security with a fair market value of $100 thousand was pledged to the Ohio State Treasurer to allow the Company's trust department to conduct business in the state of Ohio and 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.


14


Table of Contents

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

Note 5. Loans and Leases Held for Investment and Allowance for Loan and Lease Losses
Loan and Lease Portfolio Segments
The following describes the risk characteristics relevant to each of the portfolio segments. Each loan and lease category is assigned a risk grade during the origination and closing process based on criteria described later in this section.
Commercial and Industrial
Commercial and industrial loans (C&I) receive similar underwriting treatment as commercial real estate loans in that the repayment source is analyzed to determine its ability to meet cash flow coverage requirements as set forth by Bank policies. Repayment of the Bank’s C&I loans generally comes from the generation of cash flow as the result of the borrower’s business operations. This business cycle itself brings a certain level of risk to the portfolio. In some instances, these loans may carry a higher degree of risk due to a variety of reasons – illiquid collateral, specialized equipment, highly depreciable assets, uncollectable accounts receivable, revolving balances, or simply being unsecured. As a result of these characteristics, the SBA guarantee on these loans is an important factor in mitigating risk.
Construction and Development
Construction and development loans are for the purpose of acquisition and development of land to be improved through the construction of commercial buildings. Such loans are usually paid off through the conversion to permanent financing for the long-term benefit of the borrower’s ongoing operations. At the completion of the project, if the loan is converted to permanent financing or if scheduled loan amortization begins, it is then reclassified to the “Commercial Real Estate” segment. Underwriting of construction and development loans typically includes analysis of not only the borrower’s financial condition and ability to meet the required debt obligations, but also the general market conditions associated with the area and type of project being funded.
Commercial Real Estate
Commercial real estate loans are extensions of credit secured by owner occupied and non-owner occupied collateral. Underwriting generally involves intensive analysis of the financial strength of the borrower and guarantor, liquidation value of the subject collateral, the associated unguaranteed exposure, and any available secondary sources of repayment, with the greatest emphasis given to a borrower’s capacity to meet cash flow coverage requirements as set forth by Bank policies. Such repayment of commercial real estate loans is commonly derived from the successful ongoing operations of the business occupying the property. These typically include small businesses and professional practices.
Commercial Land
Commercial land loans are extensions of credit secured by farmland. Such loans are often for land improvements related to agricultural endeavors that may include construction of new specialized facilities. These loans are usually repaid through the conversion to permanent financing, or if scheduled 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.
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.

15


Table of Contents

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

Loans and leases consist of the following:
 
June 30,
2018
 
December 31,
2017
Commercial & Industrial
 
 
 
Agriculture
$
5,813

 
$
3,274

Death Care Management
15,720

 
13,495

Healthcare
44,524

 
43,301

Independent Pharmacies
102,995

 
99,920

Registered Investment Advisors
96,473

 
93,770

Veterinary Industry
49,156

 
46,387

Other Industries
217,551

 
184,903

Total
532,232

 
485,050

Construction & Development
 
 
 
Agriculture
34,971

 
34,188

Death Care Management
7,542

 
6,119

Healthcare
61,114

 
49,770

Independent Pharmacies
2,186

 
1,496

Registered Investment Advisors
1,286

 
376

Veterinary Industry
18,198

 
13,184

Other Industries
74,450

 
58,120

Total
199,747

 
163,253

Commercial Real Estate
 
 
 
Agriculture
49,009

 
46,717

Death Care Management
66,671

 
67,381

Healthcare
152,025

 
126,631

Independent Pharmacies
19,368

 
19,028

Registered Investment Advisors
11,040

 
11,789

Veterinary Industry
122,593

 
113,932

Other Industries
194,266

 
134,172

Total
614,972

 
519,650

Commercial Land
 
 
 
Agriculture
193,613

 
178,897

Total
193,613

 
178,897

Total Loans and Leases1
1,540,564

 
1,346,850

Net Deferred Costs
8,470

 
8,545

Discount on SBA 7(a) and USDA Unguaranteed2
(14,666
)
 
(11,422
)
Loans and Leases, Net of Unearned
$
1,534,368

 
$
1,343,973

1
Total loans and leases include $141.5 million and $99.7 million of U.S. government guaranteed loans as of June 30, 2018 and December 31, 2017, 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.

16


Table of Contents

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

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

17


Table of Contents

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

The following tables summarize the risk grades of each category:
 
Risk Grades
1 - 4
 
Risk Grade
5
 
Risk Grades
6 - 8
 
Total
June 30, 2018
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
Agriculture
$
5,596

 
$
217

 
$

 
$
5,813

Death Care Management
15,517

 
197

 
6

 
15,720

Healthcare
36,461

 
3,256

 
4,807

 
44,524

Independent Pharmacies
88,684

 
6,554

 
7,757

 
102,995

Registered Investment Advisors
92,254

 
1,420

 
2,799

 
96,473

Veterinary Industry
44,754

 
1,649

 
2,753

 
49,156

Other Industries
203,813

 
12,366

 
1,372

 
217,551

Total
487,079

 
25,659

 
19,494

 
532,232

Construction & Development
 
 
 
 
 
 
 
Agriculture
32,431

 

 
2,540

 
34,971

Death Care Management
7,542

 

 

 
7,542

Healthcare
56,542

 
2,534

 
2,038

 
61,114

Independent Pharmacies
2,186

 

 

 
2,186

Registered Investment Advisors
1,286

 

 

 
1,286

Veterinary Industry
17,012

 
1,186

 

 
18,198

Other Industries
72,558

 
1,892

 

 
74,450

Total
189,557

 
5,612

 
4,578

 
199,747

Commercial Real Estate
 
 
 
 
 
 
 
Agriculture
49,009

 

 

 
49,009

Death Care Management
59,696

 
3,862

 
3,113

 
66,671

Healthcare
129,714

 
9,378

 
12,933

 
152,025

Independent Pharmacies
13,603

 
2,930

 
2,835

 
19,368

Registered Investment Advisors
10,908

 
132

 

 
11,040

Veterinary Industry
103,055

 
3,655

 
15,883

 
122,593

Other Industries
192,441

 
1,825

 

 
194,266

Total
558,426

 
21,782

 
34,764

 
614,972

Commercial Land
 
 
 
 
 
 
 
Agriculture
183,117

 
5,371

 
5,125

 
193,613

Total
183,117

 
5,371

 
5,125

 
193,613

Total1
$
1,418,179

 
$
58,424

 
$
63,961

 
$
1,540,564


18


Table of Contents

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

 
Risk Grades
1 - 4
 
Risk Grade
5
 
Risk Grades
6 - 8
 
Total
December 31, 2017
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
Agriculture
$
3,052

 
$
222

 
$

 
$
3,274

Death Care Management
13,371

 
117

 
7

 
13,495

Healthcare
36,530

 
2,246

 
4,525

 
43,301

Independent Pharmacies
86,152

 
5,541

 
8,227

 
99,920

Registered Investment Advisors
90,911

 
2,134

 
725

 
93,770

Veterinary Industry
42,313

 
1,704

 
2,370

 
46,387

Other Industries
184,540

 
363

 

 
184,903

Total
456,869

 
12,327

 
15,854

 
485,050

Construction & Development
 
 
 
 
 
 
 
Agriculture
31,738

 
2,450

 

 
34,188

Death Care Management
6,119

 

 

 
6,119

Healthcare
47,813

 
699

 
1,258

 
49,770

Independent Pharmacies
1,496

 

 

 
1,496

Registered Investment Advisors
376

 

 

 
376

Veterinary Industry
13,184

 

 

 
13,184

Other Industries
58,120

 

 

 
58,120

Total
158,846

 
3,149

 
1,258

 
163,253

Commercial Real Estate
 
 
 
 
 
 
 
Agriculture
46,717

 

 

 
46,717

Death Care Management
60,671

 
3,881

 
2,829

 
67,381

Healthcare
112,321

 
9,992

 
4,318

 
126,631

Independent Pharmacies
15,641

 
1,825

 
1,562

 
19,028

Registered Investment Advisors
11,649

 
140

 

 
11,789

Veterinary Industry
97,065

 
2,948

 
13,919

 
113,932

Other Industries
133,493

 
679

 

 
134,172

Total
477,557

 
19,465

 
22,628

 
519,650

Commercial Land
 
 
 
 
 
 
 
Agriculture
176,811

 
2,086

 

 
178,897

Total
176,811

 
2,086

 

 
178,897

Total1
$
1,270,083

 
$
37,027

 
$
39,740

 
$
1,346,850

1
Total loans and leases include $141.5 million of U.S. government guaranteed loans as of June 30, 2018, segregated by risk grade as follows: Risk Grades 1 – 4 = $84.8 million, Risk Grade 5 = $12.0 million, Risk Grades 6 – 8 = $44.7 million. As of December 31, 2017, total loans and leases include $99.7 million of U.S. government guaranteed loans, segregated by risk grade as follows: Risk Grades 1 – 4 = $65.0 million, Risk Grade 5 = $6.7 million, Risk Grades 6 – 8 = $28.0 million.

19


Table of Contents

Live Oak Bancshares, Inc.
Notes to Unaudited 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.
 
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
June 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture
$

 
$

 
$

 
$

 
$

 
$
5,813

 
$
5,813

 
$

Death Care Management

 

 

 

 

 
15,720

 
15,720

 

Healthcare

 
49

 
757

 
2,287

 
3,093

 
41,431

 
44,524

 

Independent Pharmacies
338

 

 

 
7,308

 
7,646

 
95,349

 
102,995

 

Registered Investment Advisors

 
577

 
2,102

 

 
2,679

 
93,794

 
96,473

 

Veterinary Industry
170

 
126

 
620

 
1,072

 
1,988

 
47,168

 
49,156

 

Other Industries
596

 
615

 

 

 
1,211

 
216,340

 
217,551

 

Total
1,104

 
1,367

 
3,479

 
10,667

 
16,617

 
515,615

 
532,232

 

Construction & Development
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture

 

 

 
2,539

 
2,539

 
32,432

 
34,971

 

Death Care Management

 

 

 

 

 
7,542

 
7,542

 

Healthcare

 

 

 

 

 
61,114

 
61,114

 

Independent Pharmacies

 

 

 

 

 
2,186

 
2,186

 

Registered Investment Advisors

 

 

 

 

 
1,286

 
1,286

 

Veterinary Industry

 
1,186

 

 

 
1,186

 
17,012

 
18,198

 

Other Industries

 
37

 

 

 
37

 
74,413

 
74,450

 

Total

 
1,223

 

 
2,539

 
3,762

 
195,985

 
199,747

 

Commercial Real Estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture

 

 

 

 

 
49,009

 
49,009

 

Death Care Management
158

 
1,447

 

 
1,358

 
2,963

 
63,708

 
66,671

 

Healthcare
2,334

 

 
37

 
6,596

 
8,967

 
143,058

 
152,025

 

Independent Pharmacies
2,835

 

 

 

 
2,835

 
16,533

 
19,368

 

Registered Investment Advisors

 

 

 

 

 
11,040

 
11,040

 

Veterinary Industry
1,867

 
3,185

 
2,506

 
5,500

 
13,058

 
109,535

 
122,593

 

Other Industries

 

 

 

 

 
194,266

 
194,266

 

Total
7,194

 
4,632

 
2,543

 
13,454

 
27,823

 
587,149

 
614,972

 

Commercial Land
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture
5,125

 

 

 

 
5,125