Live Oak Bancshares

Introduction

This report consists of a CAMELS analysis of Live Oak Bancshares (LOB). Live Oak is a bank headquartered in Wilmington, NC whose primary service is small business loans. LOB recently went public in July of 2015, and their shares trade in the NASDAQ under the ticker LOB. The bank’s 29.4 million available shares currently trade at $15.26, for a market capitalization of 449.37 M.

A CAMELS analysis measures a bank’s overall condition by looking at 6 different factors for the bank. These factors are capital adequacy, assets, management capability, earnings, liquidity, and sensitivity. After a thorough analysis of Live Oak’s available financials and business information, our team has given the bank an official CAMELS rating of 2. The following report describes in detail how we came to this conclusion.

Capital Adequacy

The Capital Adequacy rating is the measure of a bank’s ability to meet its obligations relative to its exposure to risk. The rating exists to ensure that a bank is able to handle losses and fulfill its obligations to account holders without ceasing operations. It is calculated by adding the Tier 1 Capital and Tier 2 Capital obligations and dividing that by the Risk weighted assets. The Tier 1 Capital assets in a bank are easy to liquidate. Under the Basel I Accord the Tier 1 Capital assets are as follows, retained earnings, common stock, preferred stock as well as the bank’s core capital. Tier 2 Capital is difficult to liquidate. It includes revaluation reserves, general provisions (money that the bank has lost or been un-able to liquidate) and subordinated debt. Finally, the risk weighted assets are the capital that a bank must keep to cover its liabilities. Government bonds have a 0% risk while all other assets have a risk weight of 100%. To look at the entire capital adequacy rating of a bank or credit union there are many factors to consider and break down. The following list is what to look for when defining the capital adequacy level Live Oak Bancshares.

● Capital level and trend analysis;● Compliance with risk-based net worth requirements;● Composition of capital;● Interest and dividend policies and practices;● Adequacy of the Allowance for Loan and Lease Losses account;● Quality, type, liquidity and diversification of assets, with particular reference to

classified assets;● Loan and investment concentrations;● Growth plans;● Volume and risk characteristics of new business initiatives;● Ability of management to control and monitor risk, including credit and interest rate risk;

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● Earnings. Good historical and current earnings performance enables a credit union to fund its growth, remain competitive, and maintain a strong capital position;

● Liquidity and funds management;● Extent of contingent liabilities and existence of pending litigation;● Field of membership;● Economic environment.

Live Oak Bancshares, Inc. operates with 1.012 billion dollars in total assets as of September 30, 2015. This is compared to a total liabilities value of 818.67 million dollars in total liabilities. The assets are broken into the following components.

As the chart shows above, Live Oak Bancshares has most of their assets in different types

of loans. Loans held for sale are most likely primarily residential mortgage loans. It is hard to tell from the information given in the 10-Q how risky each of these mortgages are. The bank keeps a good amount of cash on hand and can liquidate some of the loans for sale and investment if needed. The bank also operates with a small amount of foreclosed assets. This is a good indicator that the bank has minimized its asset risk and most of the loans are going to be paid back on a consistent schedule. To further evaluate the capital adequacy of the bank we need to look into the Liabilities and Shareholder Equity shown below.

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The values shown in the figure above represent from left to right, September 30, 2015 and December 31, 2014. These figures paint a positive picture in the past year for Live Oak Bancshares. The retained earnings have gone from a loss of 6.9 million to retained earnings of 7.1 million. The interest and dividend policies of the bank can be extracted from the table as well. The bank did not issue a dividend in this statement and the majority of their liabilities are in interest bearing deposits. This means that they have deposits from other individuals or entities that they must pay back with a withdrawal. This means that if there is a bank run the bank will have to take their loan assets and use them to pay off the deposits within 30 days. The bank has the ability to pay all of their deposits if this technique is used.

The 10-Q statement also says that the company primarily earns revenue from the sale of SBA-guaranteed loans. A Small Business Administration (SBA) – guaranteed loan is a term loan from a bank or commercial institution that the SBA guarantees as much as 80% of the loan principal. This loan format helps reduce the lender’s risk and helps the lender provide financing that would not be available from traditional resources. The primary reason for this loan is form a business loan, the company that is applying for the loan must qualify as a small business according to the SBA standard guidelines. This increases their score for capital adequacy because the loans they give out are much safer than traditional loans given for mortgages. It is their way of mitigating risk against loans that usually carry a higher degree of risk for a variety of reasons – illiquid collateral, specialized equipment, highly depreciable assets, uncollectable accounts receivable, revolving balances, or being unsecured.

Asset Quality

According to Live Oak Bank’s 10-Q, as of September 30, 2015, the company has total assets worth $1,012,766,000, with most of the assets concentrated in loans, loans held for sale, and cash and due from banks. LOB has $253,399,000 in net loans, an increase of roughly ~27% from December 31, 2014. The bank has customer deposits worth $762,628,000, a ~43% increase from December 31, 2014.

The overall asset quality of a financial institution is rated based upon, but not limited to, an assessment of the following evaluation factors:• The adequacy of underwriting standards, soundness of credit administration practices, and appropriateness of risk identification practices.

LOB has a strong understanding of how important the selection of quality borrowers is to sustaining success as lender to small businesses. According to the bank’s Chief Risk Officer, “banks must be correct in evaluating a borrower’s ability to repay at least 98% of the time.” Although the bank’s management have a good understanding of this, the bank actually utilizes an

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algorithmic selection process that is typically scrutinized by industry experts. Although this method does take much less time, some argue there is substantial risk with not evaluating each and every loan application by hand. LOB has also tried a tactic of hiring industry professionals to evaluate sector specific loans, as opposed to hiring a typical financial analyst.

• The level, distribution, severity, and trend of problem, classified, nonaccrual, restructured, delinquent, and nonperforming assets for both on- and off-balance sheet transactions.

The analysis of the status of the outstanding loans that Live Oak Bancshares has provides good insight into how management has been selecting worthy borrowers, and can all be observed on the company’s 10-Q. As of September 30, 2015, Live Oak’s loan distribution by industry (as observed by the figure below) was: 37.8% Commercial and Industrial, 9.8% Construction and Development, and 47.8% Owner Occupied Commercial Real Estate. Within these general industries, the sectors that the majority of loans are concentrated in are Healthcare, Dental Care Management, Independant Pharmacies, and Agriculture.

There is also a loan rating system in place to measure the quality of outstanding loans. Loans are put on a scale of 1 to 8 in order to measure their relative risk: risk grade 1 being an

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“exceptional loan” and risk grade 8 being a “Loss” (or uncollectable). Love Oak’s 10-Q provides the number of loans in 3 different rating groups, and the distribution on those groups as of September 30, 2015 (as observed by the figure below) is: 83.6% risk grades 1-4, 3.7% risk grade 5, and 12.7% risk grades 6-8.

• The adequacy of the allowance for loan and lease losses and other asset valuation reserves.

The adequacy of allowance for loan losses was measured by analyzing two different metrics - the ratio of delinquent loans to all loans. Live Oak has a reasonable ratio of delinquent loans to all loans. In December of 2014 it was 2.17% and in September of 2015 it was 2.37%. Because the most recent percentage falls in the range of a score of 3, and the percentage has worsened over the course of the last year, the score for this section was a 3. Another measure of loan quality is a ratio of net loan charge-offs to average loans. This information was also found in the 10-Q report, and the ratios were listed as 0.20% and 0.13% in 2014 and 2015, respectively. Because both of these percentages fall in the lowest category, and because the ratio has been improving, Live Oak receives a 1 in this category.

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“Annualized net charge-offs in the first nine months of 2015 were 0.13% of average loans, compared to annualized net charge-offs of 0.20% in the same period of 2014.” - 10-Q

• The ability of management to properly administer its assets, including the timely identification and collection of problem assets.

According to LOB’s 10-Q, from December of 2014 to September of 2015, the amount of past due loans due loans has decreased from ~13% to only ~10%. This reduction can be seen as an indication of a quality selection process and good identification of failing loans.

Conclusion

Asset Quality September 30, 2015 December 31, 2014 Quality Score

Delinquent Loans / Loans

6,153 / 259,283 = 2.37%

4,407 / 203,451 = 2.17%

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Net Charge Offs / Avg. Loans

0.13% 0.20% 1

High Risk Grade Loans / Total Loans

~10% ~13% 2

Qualitative Components

- - 3

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OVERALL SCORE

- - 3

Management

Business Strategy:

Live Oak Bancshares Inc. (LOB) specializes in providing lending services to small businesses nationwide in target industries. In addition to banking, LOB owns Independence Aviation, LLC, Live Oak Grove, LLC, and Government Loan Solutions Inc. Independence Aviation, LLC, was formed for the purpose of purchasing and operating aircraft for the use of LOB. Live Oak Grove, LLC, recently opened in September 2015, for the purpose of providing employees and visitors with an on-site dining location. Government Loan Solutions Inc. (GLS) is a management and technology consulting firm that specializes in settlement, accounting, and securitization processes for government guaranteed loans.

LOB’s strategic plan focuses on achieving high growth in specialized small businesses around the nation by focusing on lender expertise and high quality customer service. In broader terms, they hope to focus on capital accumulation and have high growth expectations for the company. LOB’s industry focused lending is a key part of their business plan, and advertised highly as what sets it apart from other credit unions. By using Industry Focused Lending, LOB hopes to stray away from an overly broad clientele, while maintaining highly specialized lenders that will be able to provide quality service. Some of the industries focused on by LOB include Veterinary (LOB’s starting industry), Self-Storage, Wine & Craft Beverages, and funeral homes.

As for their customer service, LOB attempts to achieve a higher quality in two main ways. First, by focusing on only a handful of specialized industries, they aim to keep specialized lenders employed that will be able to provide clients with more knowledgeable service, thereby keeping client retention rates high and hopefully obtaining new clients within these industries along the way. Second, LOB attempts to make its banking experience as pleasurable as possible. With the creation of Independence Aviation, LLC and Live Oak Grove, LLC, it is clear that LOB wants to cater to their clients, and expand their services beyond that of standard credit unions.

Financial Performance:

LOB has only recently went public in July, 2015. Therefore, financial information obtained by our group is limited to filed consolidated financial statements for the years 2014 and 2015 at 3, 6, and 9 months ended.

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The Company primarily earns its revenue from the sale of SBA (Small Business Administration)-guaranteed loans, and net interest income. As seen in the figure below, LOB reported revenues of $7.44 million in loan servicing and revaluation for nine months ended September 30, 2015. This was a decrease from 2014, where they reported $9.52 million in revenues. Fortunately, this loss was offset by an increase in Net gain on sales of loans of $9.14 million. This gain, along with a non-recurring gain on the sale of an investment in a non-consolidated affiliate, and other noninterest income, led to an increase of Total noninterest income of 37%.

As for net interest income, the figure below shows that LOB was able to raise its total interest income to $23.62 million for Nine Months Ended in 2015, compared to $14.43 million in 2014. This is over a 60% increase in total interest income.

After interest expense, Net Interest Income was $17.1 million, a 64% increase from the 2014 Net Interest Income of $10.42 million.

Overall, LOB has performed well financially in terms of the sale of SBA-guaranteed loans and net interest income. Particularly in the case of increased loans (the company’s biggest

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revenue producer), LOB was able to see an increase in overall net income, as explained in an excerpt from the performance summary in the company’s 10-Q below.

“For the nine months ended September 30, 2015, the Company reported net income of $14.9 million, or $0.48 per diluted share, as compared to $7.6 million, or $0.33 per diluted share, for the nine months ended September 30, 2014. This increase in net income is primarily attributable to the following items:

• Increased net interest income of $6.6 million, or 63.7%, arising primarily from an

increase in levels of loans held for sale related to originations in newer verticals

that require a period of loan advances before being sold; and

• Increased noninterest income of $16.1 million, or 36.8%, predominately

comprised of $11.1 million, or 31.4%, growth in net gains on sale of loans, the

absence of (i) $2.4 million in one-time losses on investments in non-consolidated

affiliates and (ii) a one-time gain of $3.8 million related to the sale of an

investment in nCino, Inc., a former subsidiary of the Company (“nCino”),

partially offset by a $2.1 million, or 21.8%, decrease in loan servicing revenue

and revaluation arising from increased negative servicing asset valuation

adjustments of $3.1 million in the nine months ended September 30, 2015.”

Internal Controls:

LOB and each of its subsidiaries maintains a system of internal accounting controls that are aimed to provide reasonable and accurate representations of the company’s financial statement, with little to no material misstatements. The Internal Controls are also in place to ensure the company complies with all updated GAAP regulations, and to maintain all asset accountability. LOB ensures that the financials are made with respect to the oversight of the managers, and that all recordings and representations are only made when permitted by management's general or specific authorization. These representations are derived in timely intervals throughout the year, and compared to previous years in attempts to identify any possible misstatements.

Under the Sarbanes Oxley Act, LOB is not required to obtain an independent auditor's opinion on the company’s internal controls, as it is considered a growing business with under $1 billion in gross revenues. Below is an excerpt from the company’s auditor, regarding the situation and their required task at hand in reference to the audit.

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“We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Live Oak Bancshares, Inc. as of December 31, 2014, 2013 and 2012 and the results of their operations and their cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.”

The independent auditor hired by LOB, Dixon Hughes Goodman LLP, is the largest public accounting firm headquartered in the southeastern U.S., and is the 17th largest in the company. In this respect, there is safe assumption that the opinion of the auditor can be trusted. Furthermore, even though the auditor was not contracted to give an opinion on the internal controls, assumptions can be made from their clean opinion on the company’s financials. The auditor’s opinion that the financials can be publically be trusted with little material misstatement, and the fact that there have been no changes in the company's internal controls over the past year, allow one to form the opinion that the internal controls are currently satisfactory.

The company’s business strategy is unique and strong considering it is a growing company, and there is a strong focus on client experience, which we believe will differentiate the company from its competitors. The current financial performance has also been decently strong over the past two years. And while there may be trouble in the areas of liquidity and sensitivity in the future, our group is focusing on the current standings of company for the management rating. As for Internal Controls, our group has come to the conclusion that a good system can be assumed to be in place, due to the fact that the independent auditor issued a clean, unqualified opinion, and there have been no changes made to the internal controls since the opinion was issued. Because of these reasons, our group is rating Live Oak Bancshares Management a 1.

Earnings

Return on Assets

Return on Assets is an indicator of how profitable a company is relative to its assets. If done correctly, ROA will give a general idea of how efficient management is using its assets to generate revenue. For investors, ROA will give an idea of how well a company is investing its equity. If ROA is high, it can be assumed that a company is wisely using its equity to invest, and realizing a good return on these investments.

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ROA is calculated by dividing Net Income by Total Assets. For LOB, the ROA for Nine Months Ended September 30, 2015 is 1.47. While this may seem small, it is important to remember that ROA is subjective, and that companies/industries will have different uses for their investments. In order to keep numbers relative, analysts will usually compare ROA against a company’s previous ROA numbers. For LOB, the ROA for Nine Months Ended September 30, 2014 was 1.13. This shows a clear growth in efficiency by managements in terms of using assets to generate revenue.

Quality of Earnings

To assess the quality of earnings for Live Oaks, our group has looked at the cash flows of the company. We have done this in order to see the revenue producing actions by the company that are consistent year to year, and to minimize/point out any non-recurring expenses/revenues in our evaluation.

Some of the larger changes in Operating is shown in the figure below, taken from the cash flow statement.

The biggest negative change in cash is the increase of loans held for sale. In the year 2015, LOB had $740.4 million, compared to 2014’s $531.7 million. This raise alone caused net cash used by operating activities to increase by almost $1 million. While this would be a problem is other industries, this is not necessarily a bad thing in credit unions. LOB is merely planning for a large increase in loans sales. This prediction came true in 2015 as well, as loan sales increased to $508 million in 2015, from $391 million in 2014. This large increase means there is reason to believe sales from loans will continue to grow into 2016.

As for investing activities, the figure below shows that LOB saw cash provided to the company from investments in 2015, compared to a use of cash from investing in 2014.

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This almost $48 million difference from 2014 to 2015 was mainly due to a large decrease in available-for-sale security purchases, an increase in proceeds from sales of securities, and proceeds from the sale of a non-consolidated affiliate (which is non-recurring). LOB also saw an increase in collections of principals of over $10 million. These numbers can be seen below.

Under Financing, LOB saw a very large increase in net cash, going from $155.6 million in 2014 to $319.8 million in 2015. The biggest reason behind this is the increase is deposits in 2015. Deposits into the company grew to $240.5 million from $85.9 million in 2014. This is a good sign for the company as it shows an increase in clientele. (Unfortunately, dependency on this growth can be harmful in the long run in terms of liquidity. This will be discussed later in the report).

The second biggest change is the drop in dividend distribution in 2015. This unfortunately means that over $35 million of the increase in cash from financing activities in 2015 is derived from not issuing dividends, which is a non-recurring activity. Chances are, LOB will be issuing dividends sometime in the next few years, which means cash will be used. Fortunately, this drop should be immaterial when compared to the increase in deposits the bank should continue to see in the future.

The financing activity portion of the cash flow statement is shown in the following figure.

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Net Interest Margin

As of September 30, 2015, LOB saw a decrease in net interest margin from 2014 to 2015 of 3.13% to 3.11%, for three months ended on September 30. The margin also decreased from 3.08% to 3.08% over the same time period, for nine months ending on September 30. Although these drops are not too substantial, it is ideal for net interest margin to be increasing.

Future Earnings Prospectus

LOB is clearly in a growing stage, indicated by metrics such as increasing amounts of deposits, loans generated, etc. Unfortunately, the bank gave little insight into projections or forecasts for 2016 and beyond, but the earnings per share was analyzed to try to determine how the profitability of the bank is developing.

Due to the recent release of LOB’s IPO, it is not surprising their earnings per share is relatively low. The table below shows a breakdown of LOB’s earnings for 3 and 9 months ended on September 30th, respectively. EPS increased year of year from $0.03 to $0.09, and from $0.34 to $0.50 for 9 months ended.

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Earnings Summary

Although LOB is new to the public world, its financials concerning earnings do show some promise. The ROA the bank is seeing is a good sign, and does exhibit an indication of growth. Considering they offer a relatively low, the EPS of LOB exhibit some concern due to being less than the majority of peer banks who typically have an EPS near or above $1.00. In terms of quality of earnings, the bank’s cash has been growing, but with a good portion being due to a rise in deposits. While this is expected from a new bank, it should not continue to be the sole supporter of the financials due to liquidity risk (as discussed later in the report).Considering all these reasons, Live Oak Bank receives a rating of 2 for the Earnings category.

Liquidity

Liquidity is Live Oak’s ability to sell its assets quickly to minimize a potential loss. However, CAMELS liquidity is often referred to more specifically as Asset/Liability Management - i.e. controlling internal balance sheet risk. When evaluating a firm’s Liquidity score, examiners are often interested in:

● Interest rate risk exposure and sensitivity ● Sources and volume of liquid funds to meet obligations● Diversification of funding sources● Management’s plan and ability to effectively carry out ALM

The first item to look at is the balance sheet as referenced below

Current Assets: Live Oak Bank’s current assets should be the sum of all its: cash and due from banks, CD’s with other banks, investment securities available-for-sale, and Loans held for sale.

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(These last two items would be considered current assets because they are specifically marked for sale meaning they intend to liquidate the assets). Total assets over the period rose by ~$340M, most of the coming from an increase in cash and loans held for sale.

Current Liabilities: LOB’s current liabilities would be the sum of its deposits both interest-bearing and noninterest-bearing. Almost all of the liability growth can be contributed to increased deposits.

So what does this mean for overall balance sheet liquidity? The liquidity of the firm may seem to be getting better because the ratio of liquid cash to liabilities has increased from year end (from 5.1% to 17%), however the absolute level of the loan book has increased and as loans are less liquid than deposits, the story becomes more mixed.

As stated in their 10Q, “Liquidity is immediately available from four major sources: (a) cash on hand and on deposit at other banks; (b) the outstanding balance of federal funds sold; (c) the market value of unpledged investment securities; and (d) availability under lines of credit. At September 30, 2015, the total amount of these four items was $313.4 million, or 30.9% of total assets”

This ratio has remained consistent over the past several year ~30%, so I see no warning signals from a function of liquid assets to total assets.

Interest rate risk management is a critical matter for a firm whose deposits are mostly interest-bearing. In many places throughout their 10Q, Live Oak states it recognizes that “Changes in interest rates that affect the level and composition of deposits, loan demand, and the values of loan collateral, securities, and interest sensitive assets/liabilities.” Having said that, they seem markedly unprepared for a rate high having a balance sheet that is liability sensitive with a total cumulative gap position of -1.44%. This means that if a rate hike should happen, their interest expense on their liabilities would go up more than their interest income from their assets (loans). However, Live Oak has few debt liabilities ($42M), so from an interest rate risk perspective the impact of interest rate change would be minimal on debt interest obligations.

From a forward looking perspective, the company anticipates a growth in the portfolio of loans held for sale. “In addition, if loan production continues to increase… the Company also anticipates a decline over the next several quarters in the amount of loans sold as a percentage of the loans the Company originates… combined with longer retention times of loans held for sale, comprised largely of loans to newer verticals which require a period of loan advances prior to being sold”. The company obviously intends to expand, but in a way that seems to increases the liquidity risk. They are attempting to add more loans held for sale to its book which will further increase the duration gap between deposits and the loans. Additionally, they expect an increase of time each loan will sit on the company books which decreases liquidity.

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The Company currently seems to have the capability to fulfill its short term obligations. However, Live Oak is not ideally positioned for a interest rate increase as seen by its -1.44% Asset/Liability duration gap. As the firm stands, 93% of its funding come from deposits 98% of which are interest-bearing. This supposes significant liquidity risk because deposits can be withdrawn at any time (whereas if they were funded by debt, their liability duration would be longer). I am skeptical on management’s forward approach to managing liquidity risk. It seems as if they are trying to expand the firm in a way that will hurt liquidity and increase their risk. As a result, I rate Live Oak Bank a 3 on the CAMELS scale.

For reference, “A rating of 3 indicates that the risk exposure of the credit union is substantial, and management's ability to manage and control risk requires improvement. Liquidity may be insufficient to meet anticipated operational needs, necessitating unplanned borrowing. Improvements are needed to strengthen policies, procedures, or the organization's understanding of balance sheet risks. A rating of 3 may also indicate the credit union is not meeting its self-imposed risk limits or is not taking timely action to bring performance back into compliance. The level of earnings and capital may not adequately support the degree of balance sheet risk taken by the credit union.”

- Wikipedia

Sensitivity

Similar to Liquidity, the CAMELS sensitivity measure includes interest rate risk and maturity mismatch risk. In June 1996, a Joint Agency Policy Statement was issued by the OCC, Treasury, Fed and FDIC defining the risk in the following way:

Maturity Mismatch Risk

Like previously mentioned in the Liquidity section, risk can arise from a difference of asset/liability maturities. In the case of Live Oak Bank, their balance sheet is liability sensitive meaning the maturity of Live Oak’s deposits are shorter than its loans. We know more or less the duration of its liabilities because of the table below. Rounding the maturities given below, the liability duration of Live Bank should be around 1.86. The cumulative gap position is -1.44% making the asset duration of Live Bank around .42. This is highly irregular for a bank to have higher liability duration than asset duration, which is a huge warning flag. This gap possibly stems from their high cash balance as of September 30th which they did not seem to have at year end.

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Yield Curve Risk

Similarly, Live Oak Bank will also experience yield curve risk. The firm has exposures to different parts of the yield curve, but how are they managing that risk? We generally know what part of the yield curve their liabilities fall under, and we know that they have a significant amount in cash which has a 0 duration. Knowing this, I assume Live Oak has a barbell shape yield curve exposure for its assets and has a fairly grouped duration/yield curve exposure for its liabilities taken from the above table. If they do indeed have this barbell yield curve structure, that will certainly increase risk. Even if the duration of assets and liabilities were the same, the structure of their exposure to the yield curve will make some of their securities more or less sensitive to interest rate changes and means essentially we are not comparing apples to apples.

Basis Risk

Yes as interest rates change, the rates on both assets and liabilities will change similarly, but no information is given within their financial statements or 10Q that would indicate which index they use for each (deposits, loans, etc.).

Option RiskThere is no information about options or hedging instruments within the financial

statements or 10Q. However, they do have US government agency debt and MBS securities (as shown below). Some US government agencies have a call feature, but it is not disclosed from the information we have available. Additionally, MBS securities have embedded options, but they are fairly insignificant when looking at the whole.

Because of the high maturity mismatch between Live Oak’s assets and liabilities and the perceived yield curve risk stemming from the barbell shape of its assets, I rate Live Oak’s Sensitivity measure a 4. Using the September 30th as a snapshot, they have not currently positioned themselves in a way minimize the risk factors stemming from the market and their portfolio.

Conclusion

Live Oak is a new, growing bank that has very recently gone public. There is a lot of uncertainty as to just how successful they will be. To stay on the current path, they must continue

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with quality customer service, maintain consistent growth, and continue to generate quality loans to creditworthy customers. After analyzing each of the CAMELS components, we combined the scores of each of these sections to come up with one final score to rate the current, overall state of Live Oak as a financial institution. The way we combined each individual score into one composite score is laid out in the table below.

Component Score Weight Score*Weight

“C” - Capital Adequacy 2 20% .4

“A” - Asset Quality 3 20% .6

“M” - Management 1 25% .25

“E” - Earnings 2 15% .3

“L” - Liquidity 3 10% .3

“S” - Sensitivity 4 10% .4

TOTAL - 100% 2.25

Combining these ratings resulted in a composite score of 2.25. This score is associated with a final CAMELS rating of 1 to 5 based on which range it falls into in the table shown below.

CAMELS Rating Composite Score Description

1 1.00 - 1.49 Strong

2 1.50 - 2.49 Satisfactory

3 2.50 - 3.49 Fair

4 3.50 - 4.49 Marginal

5 4.50 - 5.00 Unsatisfactory

As shown on the table, Live Oak is given a final CAMELS rating of 2. This is a relatively positive rating that is derived in strong management, good capital adequacy, and high quality earnings.

Works Cited

1. http://investor.liveoakbank.com/phoenix.zhtml?c=253224&p=irol-sec 2. http://www.slideshare.net/parveenbari/camels-rating 3. https://en.wikipedia.org/wiki/CAMELS_rating_system

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4. http://www.ncua.gov/resources/documents/lcu2000-08.pdf

5. http://fitsmallbusiness.com/live-oak-bank-sba-loans/

6. http://seekingalpha.com/article/3594336-live-oak-bancshares-massive-unlock-risk-seeking-business-model- target-5_58

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