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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2017
or
¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from              to             .
Commission file number: 001-37497
liveoakbancshareslogo.jpg
LIVE OAK BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
North Carolina
26-4596286
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
1741 Tiburon Drive
Wilmington, North Carolina
28403
(Address of principal executive offices)
(Zip Code)
(910) 790-5867
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  ý    NO  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  ý    NO  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 November 4, 2017, there were 35,233,241 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 September 30, 2017
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 September 30, 2017 (unaudited) and December 31, 2016*
(Dollars in thousands)
 
September 30,
2017
 
December 31,
2016*
Assets
 
 
 
Cash and due from banks
$
260,907

 
$
238,008

Certificates of deposit with other banks
3,250

 
7,250

Investment securities available-for-sale
76,575

 
71,056

Loans held for sale
692,586

 
394,278

Loans and leases held for investment
1,169,887

 
907,566

Allowance for loan and lease losses
(21,027
)
 
(18,209
)
Net loans and leases
1,148,860

 
889,357

Premises and equipment, net
129,233

 
64,661

Foreclosed assets
2,231

 
1,648

Servicing assets
53,392

 
51,994

Other assets
65,155

 
37,009

Total assets
$
2,432,189

 
$
1,755,261

Liabilities and Shareholders’ Equity
 
 
 
Liabilities
 
 
 
Deposits:
 
 
 
Noninterest-bearing
$
55,260

 
$
27,990

Interest-bearing
1,957,631

 
1,457,086

Total deposits
2,012,891

 
1,485,076

Long term borrowings
26,872

 
27,843

Other liabilities
27,835

 
19,495

Total liabilities
2,067,598

 
1,532,414

Shareholders’ equity
 
 
 
Preferred stock, no par value, 1,000,000 authorized, none issued or outstanding at September 30, 2017 and December 31, 2016

 

Class A common stock, no par value, 100,000,000 shares authorized, 35,218,617 and 29,530,072 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively
266,336

 
149,966

Class B common stock, no par value, 10,000,000 shares authorized, 4,643,530 and 4,723,530 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively
49,168

 
50,015

Retained earnings
49,707

 
23,518

Accumulated other comprehensive loss
(620
)
 
(652
)
Total equity
364,591

 
222,847

Total liabilities and shareholders’ equity
$
2,432,189

 
$
1,755,261

*    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 nine months ended September 30, 2017 and 2016 (unaudited)
(Dollars in thousands, except per share data)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Interest income
 
 
 
 
 
 
 
Loans and fees on loans
$
26,977

 
$
14,961

 
$
70,290

 
$
38,868

Investment securities, taxable
325

 
337

 
964

 
840

Other interest earning assets
870

 
264

 
1,682

 
650

Total interest income
28,172

 
15,562

 
72,936

 
40,358

Interest expense
 
 
 
 
 
 
 
Deposits
6,758

 
3,689

 
16,893

 
9,376

Borrowings
389

 
242

 
985

 
725

Total interest expense
7,147

 
3,931

 
17,878

 
10,101

Net interest income
21,025

 
11,631

 
55,058

 
30,257

Provision for loan and lease losses
2,426

 
3,806

 
5,481

 
8,692

Net interest income after provision for loan and lease losses
18,599

 
7,825

 
49,577

 
21,565

Noninterest income
 
 
 
 
 
 
 
Loan servicing revenue
6,490

 
5,860

 
18,587

 
15,725

Loan servicing asset revaluation
(3,691
)
 
(3,421
)
 
(6,864
)
 
(5,051
)
Net gains on sales of loans
18,148

 
21,833

 
55,276

 
52,813

Gain on sale of investment securities available-for-sale

 
1

 

 
1

Construction supervision fee income
362

 
502

 
1,077

 
1,799

Title insurance income
1,968

 

 
5,803

 

Other noninterest income
1,783

 
657

 
3,601

 
1,925

Total noninterest income
25,060

 
25,432

 
77,480

 
67,212

Noninterest expense
 
 
 
 
 
 
 
Salaries and employee benefits
19,037

 
17,471

 
55,687

 
45,875

Travel expense
2,289

 
2,218

 
6,035

 
6,394

Professional services expense
1,068

 
907

 
4,228

 
2,345

Advertising and marketing expense
1,516

 
1,097

 
4,977

 
3,425

Occupancy expense
1,473

 
1,058

 
4,018

 
3,306

Data processing expense
1,982

 
1,252

 
5,536

 
3,864

Equipment expense
2,228

 
611

 
5,005

 
1,696

Other loan origination and maintenance expense
1,601

 
806

 
3,587

 
2,001

FDIC insurance
858

 
210

 
2,308

 
507

Title insurance closing services expense
687

 

 
1,877

 

Other expense
3,117

 
1,588

 
8,883

 
4,648

Total noninterest expense
35,856

 
27,218

 
102,141

 
74,061

Income before taxes
7,803

 
6,039

 
24,916

 
14,716

Income tax (benefit) expense
(5,059
)
 
2,561

 
(3,853
)
 
6,432

Net income
12,862

 
3,478

 
28,769

 
8,284

Net loss attributable to noncontrolling interest

 
1

 

 
9

Net income attributable to Live Oak Bancshares, Inc.
$
12,862

 
$
3,479

 
$
28,769

 
$
8,293

Basic earnings per share
$
0.34

 
$
0.10

 
$
0.81

 
$
0.24

Diluted earnings per share
$
0.33

 
$
0.10

 
$
0.78

 
$
0.24


2


Table of Contents

See Notes to Unaudited Consolidated Financial Statements

3


Table of Contents

Live Oak Bancshares, Inc.
Consolidated Statements of Comprehensive Income
For the three and nine months ended September 30, 2017 and 2016 (unaudited)
(Dollars in thousands)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
12,862

 
$
3,478

 
$
28,769

 
$
8,284

Other comprehensive income before tax:
 
 
 
 
 
 
 
Net unrealized (loss) gain on investment securities arising during the period
(168
)
 
(115
)
 
52

 
525

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

 
(1
)
 

 
(1
)
Other comprehensive income before tax
(168
)
 
(116
)
 
52

 
524

Income tax benefit (expense)
65

 
45

 
(20
)
 
(202
)
Other comprehensive (loss) income, net of tax
(103
)
 
(71
)
 
32

 
322

Total comprehensive income
$
12,759

 
$
3,407

 
$
28,801

 
$
8,606

See Notes to Unaudited Consolidated Financial Statements

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Live Oak Bancshares, Inc.
Consolidated Statements of Changes in Shareholders’ Equity
For the nine months ended September 30, 2017 and 2016 (unaudited)
(Dollars in thousands)
 
Common stock
 
Retained
earnings
 
Accumulated
other
comprehensive
income (loss)
 
Non-
controlling
interest
 
Total
equity
Shares
 
 
 
Class A
 
Class B
 
Amount
 
Balance at December 31, 2015
29,449,369

 
4,723,530

 
$
187,507

 
$
12,140

 
$
(192
)
 
$
33

 
$
199,488

Net income (loss)

 

 

 
8,293

 

 
(9
)
 
8,284

Other comprehensive income

 

 

 

 
322

 

 
322

Issuance of restricted stock
16,745

 

 

 

 

 

 

Stock option exercises
25,406

 

 
147

 

 

 

 
147

Stock option based compensation expense

 

 
1,752

 

 

 

 
1,752

Restricted stock expense

 

 
5,893

 

 

 

 
5,893

Acquisition of non-controlling interest

 

 

 

 

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

 

 

 
(1,710
)
 

 

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

 
4,723,530

 
$
195,299

 
$
18,723

 
$
130

 
$

 
$
214,152

Balance at December 31, 2016
29,530,072

 
4,723,530

 
$
199,981

 
$
23,518

 
$
(652
)
 
$

 
$
222,847

Net income

 

 

 
28,769

 

 

 
28,769

Other comprehensive income

 

 

 

 
32

 

 
32

Issuance of restricted stock
306,902

 

 

 

 

 

 

Withholding cash issued in lieu of restricted stock issuance

 

 
(4,891
)
 

 

 

 
(4,891
)
Employee stock purchase program
22,634

 

 
445

 

 

 

 
445

Stock option exercises
76,285

 

 
602

 

 

 

 
602

Stock option based compensation expense

 

 
1,496

 

 

 

 
1,496

Restricted stock expense

 

 
4,210

 

 

 

 
4,210

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

 

 
565

 

 

 

 
565

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

 
(80,000
)
 

 

 

 

 

Issuance of common stock in connection with secondary offering, net of issue costs
5,175,000

 

 
113,096

 

 

 

 
113,096

Dividends (distributions to shareholders)

 

 

 
(2,580
)
 

 

 
(2,580
)
Balance at September 30, 2017
35,218,617

 
4,643,530

 
$
315,504

 
$
49,707

 
$
(620
)
 
$

 
$
364,591

See Notes to Unaudited Consolidated Financial Statements

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Live Oak Bancshares, Inc.
Consolidated Statements of Cash Flows
For the nine months ended September 30, 2017 and 2016 (unaudited)
(Dollars in thousands)
 
Nine Months Ended
September 30,
 
2017
 
2016
Cash flows from operating activities
 
 
 
Net income
$
28,769

 
$
8,284

Adjustments to reconcile net income to net cash used by operating activities:
 
 
 
Depreciation and amortization
7,020

 
3,201

Provision for loan losses
5,481

 
8,692

Amortization of premium on securities, net of accretion
355

 
135

Amortization of discount on unguaranteed loans, net
1,263

 
773

Deferred tax expense (benefit)
413

 
(510
)
Originations of loans held for sale
(884,741
)
 
(701,415
)
Proceeds from sales of loans held for sale
648,300

 
555,192

Net gains on sale of loans held for sale
(55,276
)
 
(52,813
)
Net loss on sale of foreclosed assets
30

 
61

Net increase in servicing assets
(1,398
)
 
(5,499
)
Gain on sale of securities available-for-sale

 
(1
)
Net loss on disposal of premises and equipment
213

 

Stock option based compensation expense
1,496

 
1,752

Restricted stock expense
4,210

 
5,893

Stock based compensation expense excess tax benefits
1,073

 

     Business combination contingent consideration fair value adjustment
350

 

Changes in assets and liabilities:
 
 
 
Other assets
(17,661
)
 
(858
)
Other liabilities
3,875

 
2,652

Net cash used by operating activities
(256,228
)
 
(174,461
)
Cash flows from investing activities
 
 
 
Purchases of securities available-for-sale
(13,009
)
 
(24,946
)
Proceeds from sales, maturities, calls, and principal paydowns of securities available-for-sale
7,187

 
8,764

Proceeds from sale/collection of foreclosed assets
50

 
680

Business combination, net of cash acquired
(7,696
)
 

Maturities of certificates of deposit with other banks
4,000

 
2,750

Loan and lease originations and principal collections, net
(273,501
)
 
(154,738
)
Purchases of premises and equipment, net
(71,420
)
 
(1,194
)
Net cash used in investing activities
(354,389
)
 
(168,684
)
See Notes to Unaudited Consolidated Financial Statements

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Live Oak Bancshares, Inc.
Consolidated Statements of Cash Flows (Continued)
For the nine months ended September 30, 2017 and 2016 (unaudited)
(Dollars in thousands)
 
Nine Months Ended
September 30,
 
2017
 
2016
Cash flows from financing activities
 
 
 
Net increase in deposits
527,815

 
598,229

Proceeds from long term borrowings
16,900

 

Repayment of long term borrowings
(25,971
)
 
(301
)
Proceeds from short term borrowings
23,100

 

Repayment of short term borrowings
(15,000
)
 

Stock option exercises
602

 
147

Employee stock purchase program
445

 

Withholding cash issued in lieu of restricted stock
(4,891
)
 

Sale of common stock, net of issuance costs
113,096

 

Shareholder dividend distributions
(2,580
)
 
(2,052
)
Net cash provided by financing activities
633,516

 
596,023

Net increase in cash and cash equivalents
22,899

 
252,878

Cash and cash equivalents, beginning
238,008

 
102,607

Cash and cash equivalents, ending
$
260,907

 
$
355,485

 
 
 
 
Supplemental disclosure of cash flow information
 
 
 
Interest paid
$
17,927

 
$
10,120

Income tax
7,094

 
5,739

 
 
 
 
Supplemental disclosures of noncash operating, investing, and financing activities
 
 
 
Unrealized holding gains on available-for-sale securities, net of taxes
$
32

 
$
322

Transfers from loans to foreclosed real estate and other repossessions
663

 
406

Transfers from foreclosed real estate to SBA receivable

 
96

Transfer of loans held for sale to loans held for investment
5,713

 
339,322

Transfer of loans held for investment to loans held for sale
18,990

 
2,296

Contingent consideration in acquisition of controlling interest in equity method investment

 
24

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
8,363

 

Goodwill recorded
7,278

 

See Notes to Unaudited Consolidated Financial Statements

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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 in targeted industries, which we refer to as verticals. The Bank identifies and grows within credit-worthy industries through expertise within those industries. A significant portion of the loans originated by the Bank are guaranteed by the Small Business Administration (“SBA”) under the 7(a) Loan Program and to a lesser extent by 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.
The Company acquired control over 504FA, previously carried as an equity method investment, on February 2, 2015 by increasing its ownership from 50.0% to 91.3%. The acquisition of an additional 41.3% of ownership occurred in exchange for contingent consideration estimated to total $170 thousand. Transactions in the third quarter of 2015 and first quarter of 2016 increased the Company’s ownership to 92.9%. On September 1, 2016, the Company acquired the remaining 7.1% ownership from a third party investor in exchange for contingent consideration estimated to total $24 thousand.
In August 2016, the Company formed Live Oak Ventures, Inc. for the purpose of investing in businesses that align with the Company's strategic initiative to be a leader in financial technology.
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 4. Business Combination for a further discussion of this transaction.
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, advertising and marketing and tax expense.
General
In the opinion of management, all adjustments necessary for a fair presentation of the financial position and results of operations for the periods presented have been included, and all intercompany transactions have been eliminated in consolidation. Results of operations for the nine months ended September 30, 2017 are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2017. The consolidated balance sheet as of December 31, 2016 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, 2016, filed with the Securities Exchange Commission on March 9, 2017 (SEC File No. 001-37497) (the "2016 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 2016 Annual Report. These unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes in the Company's 2016 Annual Report.

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

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.
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.
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
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 4-6 years which is consistent with the useful life of the equipment with no residual value.  As of September 30, 2017 the Company had net investments in direct financing lease receivables of $1.1 million.
Operating Leases
The term of each operating lease is generally 10 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 the then current fair market value.
Rental revenue from operating leases is recognized over 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 and residual values are generally 15 years and 30%, respectively; 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.
As of September 30, 2017 the Company had a net investment of $47.5 million in assets included in premises and equipment that are subject to operating leases.
A maturity analysis of future minimum lease payments under non-cancelable operating leases is as follows:

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

As of September 30, 2017
 
Amount
2017
 
$
463

2018
 
3,204

2019
 
3,214

2020
 
3,233

2021
 
3,254

Thereafter
 
19,625

Total
 
$
32,993


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

Impairment of Long-Lived Assets
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. Goodwill and identifiable indefinite lived 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. There have been no impairments of long-lived assets.
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:
 
 
Three months ended
September 30, 2017
 
Nine months ended
September 30, 2017
Decrease in:
 
 
 
 
Net income
 
$
202

 
$
692

Basic EPS
 
$
0.01

 
$
0.02

Diluted EPS
 
$
0.01

 
$
0.02

Reclassifications
Certain reclassifications have been made to the prior period’s consolidated financial statements to place them on a comparable basis with the current year. Net income and shareholders’ equity previously reported were not affected by these reclassifications.
Note 2. Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 does not expect the adoption of ASU 2014-09 to have a material effect on the consolidated financial statements. The Company expects to adopt the standard in the first quarter of 2018 with a cumulative effect adjustment to opening retained earnings, if such adjustment is deemed to be significant.
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 March 2016, the FASB issued ASU No. 2016-09, “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 simplifies the accounting for share-based payment transactions for items including income tax consequences, classification of awards as equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 was effective and adopted by the Company on January 1, 2017. Starting in the first quarter of 2017, stock-based compensation excess tax benefits or deficiencies are reflected in the Consolidated Statements of Income as a component of the income tax expense, where as they previously were recognized in equity. Additionally, the Consolidated Statements of Cash
Flows now present excess tax benefits as an operating activity while any cash paid in lieu of shares for tax-withholding being classified as a financing activity. There were no excess tax benefits in the prior period presented for reclassification. Finally, the Company will continue to incorporate actual forfeitures as they occur in the accrual of compensation expense. As a result of the adoption of ASU 2016-09, the Consolidated Statement of Cash Flows for the nine months ended September 30, 2017 was adjusted as follows: a $1.1 million increase to net cash provided by operating activities and a $4.8 million increase to net cash used in financing activities. The adoption of ASU 2016-09 further resulted in a $0.03 increase in basic and diluted EPS for the nine months ended September 30, 2017. See Note 9 for information regarding the additional impact on our 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 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 is also currently evaluating selected third-party vendor solutions 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.
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. ASU 2017-01 will be effective for the Company on January 1, 2018. The Company does not expect this amendment to have a material effect on its consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-04, “Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). ASU 2017-04 removes Step 2 from the goodwill impairment test. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. ASU 2017-04 will be effective for the Company on January 1, 2020, with early adoption permitted for interim or annual impairment tests performed after January 1, 2017. ASU 2017-04 is not expected to have a material impact on its 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. ASU 2017-05 will be effective for the Company on January 1, 2018 and is not expected to have a significant impact on its 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. ASU 2017-09 will be effective for the Company on January 1, 2018 and is not expected to have a significant impact on its consolidated financial statements.
In August 2017, the FASB issued ASU No. 2017-12, “Derivatives and Hedging (Topic 815) - Targeted Improvements to Accounting for Hedging Activities" ("ASU 2017-12"). ASU 2017-12 amends the hedge accounting recognition and presentation requirements in ASC 815 to improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities to better align the entity’s financial reporting for hedging relationships with those risk

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Table of Contents

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

management activities and to reduce the complexity of and simplify the application of hedge accounting. ASU 2017-12 will be effective for the Company on January 1, 2019 and is not expected to have a significant impact on its consolidated financial statements.
Note 3. Earnings Per Share
Basic and diluted earnings per share are computed based on the weighted average number of shares outstanding during each period. Diluted earnings per share reflects the potential dilution that could occur, upon the exercise of stock options or upon the vesting of restricted stock grants, any of which would result in the issuance of common stock that would then be shared in the net income of the Company.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
Basic earnings per share:
 
 
 
 
 
 
 
Net income available to common shareholders
$
12,862

 
$
3,479

 
$
28,769

 
$
8,293

Weighted-average basic shares outstanding
37,366,041

 
34,206,943

 
35,485,371

 
34,191,014

Basic earnings per share
$
0.34

 
$
0.10

 
$
0.81

 
$
0.24

Diluted earnings per share:
 
 
 
 
 
 
 
Net income available to common shareholders, for diluted earnings per share
$
12,862

 
$
3,479

 
$
28,769

 
$
8,293

Total weighted-average basic shares outstanding
37,366,041

 
34,206,943

 
35,485,371

 
34,191,014

Add effect of dilutive stock options and restricted stock grants
1,278,636

 
794,874

 
1,244,683

 
812,408

Total weighted-average diluted shares outstanding
38,644,677

 
35,001,817

 
36,730,054

 
35,003,422

Diluted earnings per share
$
0.33

 
$
0.10

 
$
0.78

 
$
0.24

Anti-dilutive shares
243,199

 
1,778,995

 
250,698

 
1,778,995

 

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Table of Contents

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

Note 4. 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 continues the Company's growth strategy, including vertically integrating with complementary 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. During the one year measurement period, 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. For the nine months ended September 30, 2017 the Company recorded expense of $350 thousand, related to the increased fair value of contingent consideration using the Monte Carlo Simulation. There was no expense recorded for this contingent consideration during the three months ended September 30, 2017. 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%.

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Table of Contents

Live Oak Bancshares, Inc.
Notes to Unaudited 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
$
102

Accounts receivable
159

Intangible assets
5,505

Total assets acquired
5,766

Fair value of liabilities assumed
 
Contingent consideration
4,300

Accounts payable and other liabilities
381

Total liabilities assumed
4,681

Net assets acquired
$
1,085

Purchase price
 
Common shares issued
27,724

Purchase price per share of the Company’s common stock
$
20.38

Company common stock issued
565

Cash
7,798

Total purchase price
8,363

Goodwill
$
7,278

Goodwill recorded represents future revenues and efficiencies gained through the Reltco acquisition. Goodwill in this transaction is expected to be deductible for income tax purposes. Intangible assets consist of trade names of $1.2 million, customer relationships of $3.9 million, and non-compete agreements of $405 thousand. The trade names have indefinite lives and the customer relationships and non-compete agreements range from five to eight years.
The Company recorded merger expenses of $766 thousand during the nine month period ended September 30, 2017. No merger expenses were recorded during the three month period ended September 30, 2017. The company recorded $52 thousand and $62 thousand in merger expenses during the three and nine months period ended September 30, 2016.
The following pro forma financial information for the quarters ended September 30, 2017 and 2016 reflects the Company's estimated consolidated pro forma results of operations as if the Reltco acquisition occurred on January 1, 2016:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Revenue (net interest income and noninterest income)
$
46,085

 
$
40,627

 
$
133,306

 
$
106,960

Net income available to common stockholders
12,862

 
4,183

 
28,807

 
9,952

Basic earnings per share
0.34

 
0.12

 
0.81

 
0.29

Diluted earnings per share
0.33

 
0.12

 
0.78

 
0.28

Note 5. Investment Securities
The carrying amount of investment securities and their approximate fair values are reflected in the following table:

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Table of Contents

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

 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
September 30, 2017
 
 
 
 
 
 
 
US government agencies
$
17,829

 
$
11

 
$
35

 
$
17,805

Residential mortgage-backed securities
57,685

 

 
936

 
56,749

Mutual fund
2,070

 

 
49

 
2,021

Total
$
77,584

 
$
11

 
$
1,020

 
$
76,575

 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
US government agencies
$
17,803

 
$
52

 
$
32

 
$
17,823

Residential mortgage-backed securities
52,301

 
3

 
1,031

 
51,273

Mutual fund
2,012

 

 
52

 
1,960

Total
$
72,116

 
$
55

 
$
1,115

 
$
71,056

There were no sales of securities during the three and nine months ended September 30, 2017.The following tables show gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.
 
Less Than 12 Months
 
12 Months or More
 
Total
September 30, 2017
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
US government agencies
$
4,996

 
$
16

 
$
1,496

 
$
19

 
$
6,492

 
$
35

Residential mortgage-backed securities
28,397

 
461

 
21,767

 
475

 
50,164

 
936

Mutual fund
2,021

 
49

 

 

 
2,021

 
49

Total
$
35,414

 
$
526

 
$
23,263

 
$
494

 
$
58,677

 
$
1,020

 
Less Than 12 Months
 
12 Months or More
 
Total
December 31, 2016
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
US government agencies
$
6,508

 
$
32

 
$

 
$

 
$
6,508

 
$
32

Residential mortgage-backed securities
49,109

 
1,017

 
1,635

 
14

 
50,744

 
1,031

Mutual fund
1,960

 
52

 

 

 
1,960

 
52

Total
$
57,577

 
$
1,101

 
$
1,635

 
$
14

 
$
59,212

 
$
1,115

At September 30, 2017, there were twelve residential mortgage-backed securities and one US government agency security in unrealized loss positions for greater than 12 months and fourteen residential mortgage-backed securities, two US government agency securities and the 504 Fund mutual fund investment in an unrealized loss position for less than 12 months. Unrealized losses at December 31, 2016 were comprised of two residential mortgage-backed securities in unrealized loss positions for greater than 12 months and three US government agency securities, twenty-two residential mortgage-backed securities and the 504 Fund mutual fund investment in an unrealized loss position for less than 12 months.
These unrealized losses are primarily the result of volatility in the market and are related to market interest rates. Since none of the unrealized losses relate to marketability of the securities or the issuer’s ability to honor redemption obligations 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 September 30, 2017 and December 31, 2016 were backed by US government sponsored enterprises (“GSEs”).

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

The following is a summary of investment securities by maturity:
 
September 30, 2017
 
Available-for-Sale
 
Amortized
cost
 
Fair
value
US government agencies
 
 
 
Within one year
$
11,302

 
$
11,312

One to five years
6,527

 
6,492

Total
17,829

 
17,804

 
 
 
 
Residential mortgage-backed securities
 
 
 
Five to ten years
7,264

 
7,200

After 10 years
50,421

 
49,550

Total
57,685

 
56,750

 
 
 
 
Total
$
75,514

 
$
74,554

The table above reflects contractual maturities. Actual results will differ as the loans underlying the mortgage-backed securities may repay sooner than scheduled. This table excludes the 504 Fund mutual fund investment.
At December 31, 2016, an investment security with a fair market value of $1.5 million was pledged to secure a line of credit with the Company’s correspondent bank. At September 30, 2017, the security pledged to secure a line of credit with the Company's correspondent bank was released. At September 30, 2017 and December 31, 2016, 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 and $1.2 million, respectively, were pledged to the Company's trust department for uninsured trust assets held by the trust department.
Note 6. 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.


16


Table of Contents

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

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.

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Table of Contents

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

Loans and leases consist of the following:
 
September 30,
2017
 
December 31,
2016
Commercial & Industrial
 
 
 
Agriculture
$
2,698

 
$
1,714

Death Care Management
12,101

 
9,684

Healthcare
41,454

 
37,270

Independent Pharmacies
97,171

 
83,677

Registered Investment Advisors
91,241

 
68,335

Veterinary Industry
45,570

 
38,930

Other Industries
142,115

 
94,836

Total
432,350

 
334,446

Construction & Development
 
 
 
Agriculture
34,636

 
32,372

Death Care Management
4,744

 
3,956

Healthcare
46,814

 
30,467

Independent Pharmacies
1,696

 
2,013

Registered Investment Advisors
329

 
294

Veterinary Industry
13,265

 
11,514

Other Industries
45,052

 
31,715

Total
146,536

 
112,331

Commercial Real Estate
 
 
 
Agriculture
14,689

 
5,591

Death Care Management
61,462

 
52,510

Healthcare
121,331

 
114,281

Independent Pharmacies
18,508

 
15,151

Registered Investment Advisors
13,550

 
11,462

Veterinary Industry
110,028

 
102,906

Other Industries
106,418

 
46,245

Total
445,986

 
348,146

Commercial Land
 
 
 
Agriculture
146,814

 
113,569

Total
146,814

 
113,569

Total Loans and Leases1
1,171,686

 
908,492

Net Deferred Costs
8,038

 
7,648

Discount on SBA 7(a) and USDA Unguaranteed2
(9,837
)
 
(8,574
)
Loans and Leases, Net of Unearned
$
1,169,887

 
$
907,566

1
Total loans and leases include $40.4 million and $37.7 million of U.S. government guaranteed loans as of September 30, 2017 and December 31, 2016, 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.

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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.

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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
September 30, 2017
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
Agriculture
$
2,470

 
$
228

 
$

 
$
2,698

Death Care Management
11,976

 
118

 
7

 
12,101

Healthcare
32,350

 
1,716

 
7,388

 
41,454

Independent Pharmacies
87,173

 
6,523

 
3,475

 
97,171

Registered Investment Advisors
87,940

 
2,566

 
735

 
91,241

Veterinary Industry
41,738

 
1,833

 
1,999

 
45,570

Other Industries
142,096

 
19

 

 
142,115

Total
405,743

 
13,003

 
13,604

 
432,350

Construction & Development
 
 
 
 
 
 
 
Agriculture
34,636

 

 

 
34,636

Death Care Management
4,744

 

 

 
4,744

Healthcare
44,937

 
704

 
1,173

 
46,814

Independent Pharmacies
1,696

 

 

 
1,696

Registered Investment Advisors
329

 

 

 
329

Veterinary Industry
13,265

 

 

 
13,265

Other Industries
45,052

 

 

 
45,052

Total
144,659

 
704

 
1,173

 
146,536

Commercial Real Estate
 
 
 
 
 
 
 
Agriculture
14,689

 

 

 
14,689

Death Care Management
54,684

 
4,288

 
2,490

 
61,462

Healthcare
111,943

 
5,050

 
4,338

 
121,331

Independent Pharmacies
15,043

 
1,843

 
1,622

 
18,508

Registered Investment Advisors
13,406

 
144

 

 
13,550

Veterinary Industry
95,055

 
2,680

 
12,293

 
110,028

Other Industries
105,738

 
680

 

 
106,418

Total
410,558

 
14,685

 
20,743

 
445,986

Commercial Land
 
 
 
 
 
 
 
Agriculture
144,687

 
2,104

 
23

 
146,814

Total
144,687

 
2,104

 
23

 
146,814

Total1
$
1,105,647

 
$
30,496

 
$
35,543

 
$
1,171,686


20


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, 2016
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
Agriculture
$
1,656

 
$
58

 
$

 
$
1,714

Death Care Management
9,452

 
121

 
111

 
9,684

Healthcare
28,723

 
681

 
7,866

 
37,270

Independent Pharmacies
73,948

 
6,542

 
3,187

 
83,677

Registered Investment Advisors
65,297

 
2,246

 
792

 
68,335

Veterinary Industry
34,407

 
1,967

 
2,556

 
38,930

Other Industries
94,736

 
100

 

 
94,836

Total
308,219

 
11,715

 
14,512

 
334,446

Construction & Development
 
 
 
 
 
 
 
Agriculture
32,061

 

 
311

 
32,372

Death Care Management
3,956

 

 

 
3,956

Healthcare
30,467

 

 

 
30,467

Independent Pharmacies
2,013

 

 

 
2,013

Registered Investment Advisors
294

 

 

 
294

Veterinary Industry
9,725

 
1,789

 

 
11,514

Other Industries
31,715

 

 

 
31,715

Total
110,231

 
1,789

 
311

 
112,331

Commercial Real Estate
 
 
 
 
 
 
 
Agriculture
5,591

 

 

 
5,591

Death Care Management
46,427

 
4,314

 
1,769

 
52,510

Healthcare
103,097

 
7,142

 
4,042

 
114,281

Independent Pharmacies
12,654

 
1,968

 
529

 
15,151

Registered Investment Advisors
11,462

 

 

 
11,462

Veterinary Industry
88,168

 
3,995

 
10,743

 
102,906

Other Industries
46,245

 

 

 
46,245

Total
313,644

 
17,419

 
17,083

 
348,146

Commercial Land
 
 
 
 
 
 
 
Agriculture
112,333

 
1,138

 
98

 
113,569

Total
112,333

 
1,138

 
98

 
113,569

Total1
$
844,427

 
$
32,061

 
$
32,004

 
$
908,492

1
Total loans and leases include $40.4 million of U.S. government guaranteed loans as of September 30, 2017, segregated by risk grade as follows: Risk Grades 1 – 4 = $12.1 million, Risk Grade 5 = $3.7 million, Risk Grades 6 – 8 = $24.6 million. As of December 31, 2016, total loans and leases include $37.7 million of U.S. government guaranteed loans, segregated by risk grade as follows: Risk Grades 1 – 4 = $8.7 million, Risk Grade 5 = $7.7 million, Risk Grades 6 – 8 = $21.3 million.

21


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
September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial & Industrial
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture
$

 
$

 
$

 
$

 
$

 
$
2,698

 
$
2,698

 
$

Death Care Management

 

 

 

 

 
12,101

 
12,101

 

Healthcare
535

 
76

 
16

 
6,152

 
6,779

 
34,675

 
41,454

 

Independent Pharmacies
331

 
44

 

 
2,274

 
2,649

 
94,522

 
97,171

 

Registered Investment Advisors

 

 

 

 

 
91,241

 
91,241

 

Veterinary Industry
224

 
29

 
536

 
796

 
1,585

 
43,985

 
45,570

 

Other Industries

 

 

 

 

 
142,115

 
142,115

 

Total
1,090

 
149

 
552

 
9,222

 
11,013

 
421,337

 
432,350

 

Construction & Development
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agriculture

 

 

 

 

 
34,636

 
34,636

 

Death Care Management

 

 

 

 

 
4,744

 
4,744

 

Healthcare

 

 

 

 

 
46,814

 
46,814

 

Independent Pharmacies

 

 

 

 

 
1,696

 
1,696

 

Registered Investment Advisors

 

 

 

 

 
329

 
329

 

Veterinary Industry

 

 

 

 

 
13,265

 
13,265

 

Other Industries

 

 

 

 

 
45,052

 
45,052

 

Total

 

 

 

 

 
146,536

 
146,536