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Equibles

10-Q

Live Oak Bancshares, Inc. (LOB)

10-Q 2021-11-03 For: 2021-09-30
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Added on April 08, 2026

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2021

or

☐ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from              to             .

Commission file number: 001-37497

LIVE OAK BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

North Carolina 26-4596286
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
1741 Tiburon Drive<br><br><br>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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 ☒
Non-accelerated filer ☐ Smaller reporting company ☐
Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ☐    NO  ☒

Securities registered pursuant to Section 12(b) of the Act:

Title of each class Trading Symbol(s) Name of each exchange on which registered
Voting Common Stock, no par value per share LOB The NASDAQ Stock Market LLC

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 2, 2021, there were 43,101,598 shares of the registrant’s voting common stock outstanding and 299,565 shares of the registrant’s non-voting common stock outstanding.

Live Oak Bancshares, Inc.

Form 10-Q

For the Quarterly Period Ended September 30, 2021

TABLE OF CONTENTS

Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited) 1
Condensed Consolidated Balance Sheets as of September 30, 2021 and December 31, 2020 1
Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2021 and 2020 2
Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2021 and 2020 3
Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months Ended September 30, 2021 and 2020 4
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2021 and 2020 6
Notes to Unaudited Condensed Consolidated Financial Statements 8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 36
Item 3. Quantitative and Qualitative Disclosures about Market Risk 59
Item 4. Controls and Procedures 59
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 60
Item 1A. Risk Factors 60
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 60
Item 3. Defaults Upon Senior Securities 60
Item 4. Mine Safety Disclosures 60
Item 5. Other Information 60
Item 6. Exhibits 61
Index to Exhibits 61
Signatures 62

Item 1. Financial Statements

Live Oak Bancshares, Inc.

Condensed Consolidated Balance Sheets

As of September 30, 2021 (unaudited) and December 31, 2020*

(Dollars in thousands)

December 31,<br><br><br>2020
Assets
Cash and due from banks 336,362 $ 297,167
Federal funds sold 10,672 21,153
Certificates of deposit with other banks 6,000 6,500
Investment securities available-for-sale 861,377 750,098
Loans held for sale (includes 27,366 and 36,111 measured at fair value,<br>   respectively) 1,042,756 1,175,470
Loans and leases held for investment (includes 698,042 and 815,374 measured<br>   at fair value, respectively) 5,418,611 5,144,930
Allowance for credit losses on loans and leases (59,681 ) (52,306 )
Net loans and leases 5,358,930 5,092,624
Premises and equipment, net 244,212 259,267
Foreclosed assets 883 4,155
Servicing assets 33,968 33,918
Other assets 242,181 231,951
Total assets 8,137,341 $ 7,872,303
Liabilities and Shareholders’ Equity
Liabilities
Deposits:
Noninterest-bearing 77,026 $ 75,287
Interest-bearing 6,739,587 5,637,541
Total deposits 6,816,613 5,712,828
Borrowings 575,021 1,542,093
Other liabilities 56,284 49,532
Total liabilities 7,447,918 7,304,453
Shareholders’ equity
Preferred stock, no par value, 1,000,000 shares authorized, none issued or outstanding<br>   at September 30, 2021 and December 31, 2020 — —
Class A common stock, no par value, 100,000,000 shares authorized, 42,870,687<br>   and 41,344,689 shares issued and outstanding at September 30, 2021 and<br>   December 31, 2020, respectively 304,085 298,890
Class B common stock, no par value, 10,000,000 shares authorized, 510,327 and<br>   1,107,757 shares issued and outstanding at September 30, 2021 and<br>   December 31, 2020, respectively 5,404 11,729
Retained earnings 371,869 235,724
Accumulated other comprehensive income 8,065 21,507
Total shareholders’ equity 689,423 567,850
Total liabilities and shareholders’ equity 8,137,341 $ 7,872,303

All values are in US Dollars.

* Derived from audited consolidated financial statements.

See Notes to Unaudited Condensed Consolidated Financial Statements

Live Oak Bancshares, Inc.

Condensed Consolidated Statements of Income

For the three and nine months ended September 30, 2021 and 2020 (unaudited)

(Dollars in thousands, except per share data)

Three Months Ended<br><br><br>September 30, Nine Months Ended<br><br><br>September 30,
2021 2020 2021 2020
Interest income
Loans and fees on loans $ 89,388 $ 70,621 $ 259,161 $ 191,604
Investment securities, taxable 3,174 4,123 9,078 11,671
Other interest earning assets 224 334 771 2,093
Total interest income 92,786 75,078 269,010 205,368
Interest expense
Deposits 14,159 22,155 45,923 70,531
Borrowings 892 1,560 3,940 2,415
Total interest expense 15,051 23,715 49,863 72,946
Net interest income 77,735 51,363 219,147 132,422
Provision for loan and lease credit losses 4,319 10,274 11,292 32,024
Net interest income after provision for loan<br><br><br>and lease credit losses 73,416 41,089 207,855 100,398
Noninterest income
Loan servicing revenue 6,278 6,803 18,930 19,916
Loan servicing asset revaluation (5,878 ) 2,061 (7,566 ) (4,202 )
Net gains on sales of loans 18,860 12,690 47,023 34,497
Net (loss) gain on loans accounted for under the fair value<br><br><br>option (1,030 ) 3,403 4,323 (8,324 )
Equity method investments income (loss) (1,250 ) (1,231 ) (4,685 ) (5,952 )
Equity security investments gains (losses), net 176 14,705 44,534 14,802
Gain on sale of investment securities available-for-sale, net — 1,225 — 1,880
Lease income 2,527 2,634 7,742 7,893
Management fee income 1,489 1,296 4,896 4,146
Other noninterest income 4,104 3,458 11,247 10,541
Total noninterest income 25,276 47,044 126,444 75,197
Noninterest expense
Salaries and employee benefits 28,202 24,203 92,468 83,048
Travel expense 1,819 250 4,027 2,395
Professional services expense 4,251 1,346 11,411 4,668
Advertising and marketing expense 1,631 552 3,158 2,537
Occupancy expense 2,042 2,079 6,378 6,455
Data processing expense 4,867 3,009 12,995 8,930
Equipment expense 4,567 4,314 13,306 13,601
Other loan origination and maintenance expense 3,489 2,669 10,123 7,617
Renewable energy tax credit investment impairment 60 — 3,187 —
FDIC insurance 1,670 2,095 5,139 5,326
Other expense 2,861 2,133 9,097 5,664
Total noninterest expense 55,459 42,650 171,289 140,241
Income before taxes 43,233 45,483 163,010 35,354
Income tax expense 9,394 11,703 26,162 5,399
Net income $ 33,839 $ 33,780 $ 136,848 $ 29,955
Basic earnings per share $ 0.78 $ 0.83 $ 3.18 $ 0.74
Diluted earnings per share $ 0.76 $ 0.81 $ 3.05 $ 0.73

See Notes to Unaudited Condensed Consolidated Financial Statements

Live Oak Bancshares, Inc.

Condensed Consolidated Statements of Comprehensive Income

For the three and nine months ended September 30, 2021 and 2020 (unaudited)

(Dollars in thousands)

Three Months Ended<br><br><br>September 30, Nine Months Ended<br><br><br>September 30,
2021 2020 2021 2020
Net income $ 33,839 $ 33,780 $ 136,848 $ 29,955
Other comprehensive (loss) income before tax:
Net unrealized (loss) gain on investment securities<br><br><br>arising during the period (6,656 ) 701 (17,687 ) 19,223
Reclassification adjustment for gain on sale of<br><br><br>securities available-for-sale included in net income — (1,225 ) — (1,880 )
Other comprehensive (loss) income before tax (6,656 ) (524 ) (17,687 ) 17,343
Income tax benefit (expense) 1,598 126 4,245 (4,162 )
Other comprehensive (loss) income, net of tax (5,058 ) (398 ) (13,442 ) 13,181
Total comprehensive income $ 28,781 $ 33,382 $ 123,406 $ 43,136

See Notes to Unaudited Condensed Consolidated Financial Statements

Live Oak Bancshares, Inc.

Condensed Consolidated Statements of Changes in Shareholders’ Equity

For the three and nine months ended September 30, 2021 and 2020 (unaudited)

(Dollars in thousands)
Accumulated<br><br><br>other
Retained comprehensive Total
Class B Amount earnings income equity
Balance at June 30, 2021 42,754,133 510,327 $ 305,213 $ 339,011 $ 13,123 $ 657,347
Net income — — — 33,839 — 33,839
Other comprehensive loss — — — — (5,058 ) (5,058 )
Issuance of restricted stock 16,819 — — — — —
Tax withholding related to vesting of<br>   restricted stock and other — — (504 ) — — (504 )
Employee stock purchase program 7,988 — 374 — — 374
Stock option exercises 91,747 — 693 — — 693
Stock option based compensation expense — — 384 — — 384
Restricted stock expense — — 3,329 — — 3,329
Transfer from retained earnings to other<br>   assets for pro rata portion of equity method<br>   investee stock compensation expense — — — 320 — 320
Cash dividends (0.03 per share) — — — (1,301 ) — (1,301 )
Balance at September 30, 2021 42,870,687 510,327 $ 309,489 $ 371,869 $ 8,065 $ 689,423
Balance at June 30, 2020 37,810,101 2,715,531 $ 348,295 $ 174,837 $ 25,303 $ 548,435
Net income — — — 33,780 — 33,780
Other comprehensive loss — — — — (398 ) (398 )
Issuance of restricted stock 13,057 — — — — —
Tax withholding related to vesting of<br>   restricted stock and other — — (126 ) — — (126 )
Employee stock purchase program 14,092 — 288 — — 288
Stock option exercises 23,201 — 147 — — 147
Stock option based compensation expense — — 461 — — 461
Restricted stock expense — — 2,794 — — 2,794
Non-voting common stock converted to<br>   voting common stock in private sale 250,000 (250,000 ) — — — —
Cash dividends (0.03 per share) — — — (1,217 ) — (1,217 )
Balance at September 30, 2020 38,110,451 2,465,531 $ 351,859 $ 207,400 $ 24,905 $ 584,164

All values are in US Dollars.

See Notes to Unaudited Condensed Consolidated Financial Statements

Live Oak Bancshares, Inc.

Condensed Consolidated Statements of Changes in Shareholders’ Equity (Continued)

For the three and nine months ended September 30, 2021 and 2020 (unaudited)

(Dollars in thousands)
Accumulated<br><br><br>other
Retained comprehensive Total
Class B Amount earnings income equity
Balance at December 31, 2020 41,344,689 1,107,757 $ 310,619 $ 235,724 $ 21,507 $ 567,850
Net income — — — 136,848 — 136,848
Other comprehensive loss — — — — (13,442 ) (13,442 )
Issuance of restricted stock 433,642 — — — — —
Tax withholding related to vesting of<br>   restricted stock and other — — (17,504 ) — — (17,504 )
Employee stock purchase program 13,674 — 670 — — 670
Stock option exercises 481,252 — 2,857 — — 2,857
Stock option based compensation expense — — 1,081 — — 1,081
Restricted stock expense — — 11,766 — — 11,766
Non-voting common stock converted to<br>   voting common stock in private sale 597,430 (597,430 ) — — — —
Transfer from retained earnings to other<br>   assets for pro rata portion of equity method<br>   investee stock compensation expense — — — 3,177 — 3,177
Cash dividends (0.09 per share) — — — (3,880 ) — (3,880 )
Balance at September 30, 2021 42,870,687 510,327 $ 309,489 $ 371,869 $ 8,065 $ 689,423
Balance at December 31, 2019 37,401,443 2,915,531 $ 340,397 $ 180,265 $ 11,724 $ 532,386
Net income — — — 29,955 — 29,955
Other comprehensive income — — — — 13,181 13,181
Issuance of restricted stock 42,446 — — — — —
Tax withholding related to vesting of<br>   restricted stock and other — — (235 ) — — (235 )
Employee stock purchase program 39,253 — 520 — — 520
Stock option exercises 87,382 — 553 — — 553
Stock option based compensation expense — — 1,233 — — 1,233
Restricted stock expense — — 8,269 — — 8,269
Issuance of common stock in connection with<br>   acquisition of wholly-owned subsidiary 89,927 — 1,122 — — 1,122
Non-voting common stock converted to<br>   voting common stock in private sale 450,000 (450,000 ) — — — —
Cumulative effect of accounting change for<br>   Accounting Standards Update 2016-13 — — — 822 — 822
Cash dividends (0.09 per share) — — — (3,642 ) — (3,642 )
Balance at September 30, 2020 38,110,451 2,465,531 $ 351,859 $ 207,400 $ 24,905 $ 584,164

All values are in US Dollars.

See Notes to Unaudited Condensed Consolidated Financial Statements

Live Oak Bancshares, Inc.

Condensed Consolidated Statements of Cash Flows

For the nine months ended September 30, 2021 and 2020 (unaudited)

(Dollars in thousands)

Nine Months Ended<br><br><br>September 30,
2021 2020
Cash flows from operating activities
Net income $ 136,848 $ 29,955
Adjustments to reconcile net income to net cash used by operating activities:
Depreciation and amortization 15,894 16,545
Provision for loan and lease credit losses 11,292 32,024
Amortization of premium on securities, net of accretion 5,005 1,778
Deferred tax expense (benefit) 9,493 (7,535 )
Originations of loans held for sale (1,062,694 ) (920,213 )
Proceeds from sales of loans held for sale 794,892 607,588
Net gains on sale of loans held for sale (47,023 ) (34,497 )
Net gain on sale of foreclosed assets (798 ) (17 )
Net (gain) loss on loans accounted for under fair value option (4,323 ) 8,324
Net increase in servicing assets (50 ) (2,466 )
Gain on sale of investment securities available-for-sale, net — (1,880 )
Net gain on disposal of long-lived asset (114 ) —
Net (gain) loss on disposal of property and equipment (48 ) 38
Impairment on premises and equipment, net 904 1,019
Equity method investments (income) loss 4,685 5,952
Equity security investments (gains) losses, net (44,534 ) (14,802 )
Renewable energy tax credit investment impairment 3,187 —
Stock option based compensation expense 1,081 1,233
Restricted stock expense 11,766 8,269
Stock based compensation excess tax benefit (shortfall) 8,882 (137 )
Changes in assets and liabilities:
Lease right-of-use assets and liabilities, net (3 ) 42
Other assets 4,276 (18,393 )
Other liabilities 2,279 3,267
Net cash used by operating activities (149,103 ) (283,906 )
Cash flows from investing activities
Purchases of securities available-for-sale (317,711 ) (343,245 )
Proceeds from sales, maturities, calls, and principal paydown of<br><br><br>securities available-for-sale 183,740 134,958
Proceeds from SBA reimbursement/sale of foreclosed assets 6,542 4,283
Maturities of certificates of deposits with other banks 500 —
Business combination, net of cash acquired — (895 )
Loan and lease originations and principal collections, net 167,475 (2,319,862 )
Proceeds from sale of long-lived asset 8,988 —
Proceeds from sale of equity security investment 15,000 —
Proceeds from sale of premises and equipment 84 4
Purchases of premises and equipment, net (1,664 ) (1,313 )
Net cash provided (used) by investing activities 62,954 (2,526,070 )

See Notes to Unaudited Condensed Consolidated Financial Statements

Live Oak Bancshares, Inc.

Condensed Consolidated Statements of Cash Flows (Continued)

For the nine months ended September 30, 2021 and 2020 (unaudited)

(Dollars in thousands)

Nine Months Ended<br><br><br>September 30,
2021 2020
Cash flows from financing activities
Net increase in deposits $ 1,103,785 $ 1,479,064
Proceeds from borrowings 594,820 1,808,033
Repayment of borrowings (1,565,885 ) (60,964 )
Stock option exercises 2,857 553
Employee stock purchase program 670 520
Withholding cash issued in lieu of restricted stock and other (17,504 ) (235 )
Shareholder dividend distributions (3,880 ) (3,642 )
Net cash provided by financing activities 114,863 3,223,329
Net increase in cash and cash equivalents 28,714 413,353
Cash and cash equivalents, beginning 318,320 221,397
Cash and cash equivalents, ending $ 347,034 $ 634,750
Supplemental disclosures of cash flow information
Interest paid $ 51,846 $ 71,899
Income tax paid, net 16,546 9,049
Supplemental disclosures of noncash operating, investing, and financing activities
Unrealized holding (losses) gains on available-for-sale securities, net of taxes $ (13,442 ) $ 13,181
Transfers from loans and leases to foreclosed real estate and other<br><br><br>repossessions or SBA receivable 10,782 10,229
Net transfers between foreclosed real estate and SBA receivable (1,643 ) 116
Transfer aircraft from premises and equipment, net to held for sale assets — 9,069
Transfer of loans held for sale to loans and leases held for investment 617,475 178,453
Transfer of loans and leases held for investment to loans held for sale 247,680 97,033
Transfer from retained earnings to other assets for pro rata portion of equity<br><br><br>method investee stock compensation expense 3,177 —
Recording of secured borrowing 3,993 —
Equity security investment commitments 2,250 —
Business combination:
Assets acquired (excluding goodwill) — 2,523
Liabilities assumed — 2,074
Goodwill recorded — 1,797

See Notes to Unaudited Condensed Consolidated Financial Statements

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed 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 the State 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 lending and deposit related services to small businesses nationwide. The Bank identifies and extends lending to credit-worthy borrowers both within specific industries, also called verticals, through expertise within those industries, and more broadly to select borrowers outside of those industries. A significant portion of the loans originated by the Bank are guaranteed by the Small Business Administration (“SBA”) under the 7(a) Loan Program and the U.S. Department of Agriculture’s ("USDA") Rural Energy for America Program ("REAP"), Water and Environmental Program (“WEP”) and Business & Industry ("B&I") loan programs.

The Company’s wholly owned subsidiaries are the Bank, Government Loan Solutions (“GLS”), Live Oak Grove, LLC (the “Grove”), Live Oak Ventures, Inc. (“Live Oak Ventures”), and Canapi Advisors, LLC (“Canapi Advisors”).

The Bank’s wholly owned subsidiaries are Live Oak Number One, Inc., Live Oak Clean Energy Financing LLC (“LOCEF”), and Live Oak Private Wealth, LLC.  Live Oak Number One, Inc. holds properties foreclosed on by the Bank. LOCEF provides financing to entities for renewable energy applications. Live Oak Private Wealth, LLC and its wholly owned subsidiary, Jolley Asset Management, LLC (“JAM”), provide high-net-worth individuals and families with strategic wealth and investment management services.

GLS is a management and technology consulting firm that advises and offers solutions and services to participants in the government guaranteed lending sector. GLS primarily provides services in connection with the settlement, accounting, and securitization processes for government guaranteed loans, including loans originated under the SBA 7(a) loan programs and USDA guaranteed loans. The Grove provides Company employees and business visitors an on-site restaurant location. Live Oak Ventures’ purpose is investing in businesses that align with the Company's strategic initiative to be a leader in financial technology.  Canapi Advisors provides investment advisory services to a series of funds focused on providing venture capital to new and emerging financial technology companies.

The Company generates revenue primarily from net interest income and secondarily through the origination and sale of government guaranteed loans.  Income from the retention of loans is comprised of interest income.  The Company had historically elected to account for certain loans under the fair value option with interest reported in interest income and changes in fair value reported in the net (loss) gain on loans accounted for under the fair value option line item of the consolidated statements of income.  During the first quarter of 2021, the Company chose not to elect fair value for all retained participating interests arising from new government guaranteed loan sales.  Income from the sale of loans is comprised of loan servicing revenue and revaluation of related servicing assets along with net gains on sales of loans. Offsetting these revenues are the cost of funding sources, provision for loan and lease credit 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.  The Company also has less routinely generated gains and losses arising from its financial technology investments in its fintech segment.

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, 2021 are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2021. The Unaudited Condensed Consolidated Balance Sheet as of December 31, 2020 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, 2020, filed with the Securities Exchange Commission on February 25, 2021 (SEC File No. 001-37497) (the "2020 Form 10-K"). 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 2020 Form 10-K. These unaudited interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes in the Company's 2020 Form 10-K.

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed 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 Condensed 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

Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Management has determined that the Company has two significant operating segments: Banking and Fintech, as discussed more fully in Note 12. Segments. In determining the appropriateness of segment definition, the Company considers the criteria of ASC 280, Segment Reporting.

Business Combination

On April 1, 2020, the Company acquired 100% of the equity interests of JAM, a registered investment advisor based in Rocky Mount, North Carolina.  Goodwill, intangible assets and contingent consideration of $1.8 million, $2.3 million and $2.1 million, respectively, were recorded by the Company.  Intangible assets are almost entirely comprised of customer relationships that are being amortized using the straight-line method over 15 years.  As a result of this acquisition, the Bank's subsidiary Live Oak Private Wealth, LLC, has broadened service offerings to existing high-net-worth individuals and families, attracts new clients from an expanded footprint and benefits from economies of scale.  The acquisition did not materially impact the Company's financial position, results of operations or cash flows.  Given the impact of the above acquisition was immaterial to the Company and its result of operations, pro forma information has not been included.

Reclassifications

Certain reclassifications have been made to the prior period’s condensed 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 December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes” (“ASU 2019-12”). ASU 2019-12 simplifies accounting for income taxes by removing specific technical exceptions in ASC 740 related to the incremental approach for intra-period tax allocation, the methodology for calculating income taxes in an interim period and the recognition for deferred tax liabilities for outside basis differences. ASU 2019-12 also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The Company adopted the standard on January 1, 2021 with no material effect on its consolidated financial statements.

In January 2020, the FASB issued ASU No. 2020-01, “Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)-Clarifying the Interactions between Topic 321, Topic 323, and Topic 815” (“ASU 2020-01”).  ASU 2020-01 clarifies the interaction between accounting standards related to equity securities, equity method investments, and certain derivatives including accounting for the transition into and out of the equity method and measuring certain purchased options and forward contracts to acquire investments. The Company adopted the standard on January 1, 2021 with no material effect on its consolidated financial statements.

In March 2020, the FASB issued ASU No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (“ASU 2020-04”).  ASU 2020-04 provides optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting. The amendments are effective for and can be adopted by the Company as of March 12, 2020 through December 31, 2022. The Company does not believe this standard will have a material impact on its consolidated financial statements.

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed 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 share in the net income of the Company.

Three Months Ended<br><br><br>September 30, Nine Months Ended<br><br><br>September 30,
2021 2020 2021 2020
Basic earnings per share:
Net income $ 33,839 $ 33,780 $ 136,848 $ 29,955
Weighted-average basic shares outstanding 43,329,889 40,542,696 43,061,642 40,461,479
Basic earnings per share $ 0.78 $ 0.83 $ 3.18 $ 0.74
Diluted earnings per share:
Net income, for diluted earnings per share $ 33,839 $ 33,780 $ 136,848 $ 29,955
Total weighted-average basic shares outstanding 43,329,889 40,542,696 43,061,642 40,461,479
Add effect of dilutive stock options and restricted stock<br><br><br>grants 1,710,801 1,006,936 1,874,372 787,387
Total weighted-average diluted shares outstanding 45,040,690 41,549,632 44,936,014 41,248,866
Diluted earnings per share $ 0.76 $ 0.81 $ 3.05 $ 0.73
Anti-dilutive shares 207,811 395,582 207,811 395,582

Note 4. Securities

Available-for-Sale

The carrying amount of securities and their approximate fair values are reflected in the following table:

September 30, 2021 Amortized<br><br><br>Cost Unrealized<br><br><br>Gains Unrealized<br><br><br>Losses Fair<br><br><br>Value
US government agencies $ 10,443 $ 264 $ — $ 10,707
Mortgage-backed securities 834,570 18,340 8,329 844,581
Municipal bonds 3,252 340 3 3,589
Other debt securities 2,500 — — 2,500
Total $ 850,765 $ 18,944 $ 8,332 $ 861,377
December 31, 2020
US government agencies $ 15,440 $ 479 $ — $ 15,919
Mortgage-backed securities 703,092 28,302 940 730,454
Municipal bonds 3,267 462 4 3,725
Total $ 721,799 $ 29,243 $ 944 $ 750,098

During the three months ended September 30, 2021, two mortgage-backed securities totaling $6.2 million were settled. During the three months ended September 30, 2020, one US government agency matured at $2.0 million, one US Treasury note matured at $5.0 million, and five mortgage-backed securities totaling $10.2 million were sold resulting in a net gain of $1.2 million.

During the nine months ended September 30, 2021, one US government agency matured at $5.0 million and eight mortgage-backed securities totaling $23.1 million were settled.  During the nine months ended September 30, 2020, two US government agencies matured at $4.5 million, one US Treasury note matured at $5.0 million, eighteen mortgage-backed securities totaling $24.4 million were sold resulting in a net gain of $1.3 million, and two municipal bonds totaling $5.2 million were sold resulting in a net gain of $620 thousand.

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Accrued interest receivable on available-for-sale securities totaled $1.9 million and $1.8 million at September 30, 2021 and December 31, 2020, respectively, and is included in other assets in the accompanying Unaudited Condensed Consolidated Balance Sheets.

The following tables show debt securities available-for-sale in an unrealized loss position for which an allowance for credit losses has not been recorded, 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, 2021 Fair<br><br><br>Value Unrealized<br><br><br>Losses Fair<br><br><br>Value Unrealized<br><br><br>Losses Fair<br><br><br>Value Unrealized<br><br><br>Losses
Mortgage-backed securities $ 421,511 $ 6,961 $ 55,902 $ 1,368 $ 477,413 $ 8,329
Municipal bonds — — 97 3 97 3
Total $ 421,511 $ 6,961 $ 55,999 $ 1,371 $ 477,510 $ 8,332
Less Than 12 Months 12 Months or More Total
December 31, 2020 Fair<br><br><br>Value Unrealized<br><br><br>Losses Fair<br><br><br>Value Unrealized<br><br><br>Losses Fair<br><br><br>Value Unrealized<br><br><br>Losses
Mortgage-backed securities $ 156,904 $ 917 $ 1,853 $ 23 $ 158,757 $ 940
Municipal bonds — — 96 4 96 4
Total $ 156,904 $ 917 $ 1,949 $ 27 $ 158,853 $ 944

Management evaluates available-for-sale debt securities to determine whether the unrealized loss is due to credit-related factors or non-credit-related factors. The evaluation considers the extent to which the security’s fair value is less than cost, the financial condition and near-term prospects of the issuer, and intent and ability of the Company to retain its investment in the security for a period of time sufficient to allow for any anticipated recovery in fair value.

At September 30, 2021, there were twelve mortgage-backed securities and one municipal bond in unrealized loss positions for greater than 12 months and one hundred twenty two mortgage-backed securities in unrealized loss positions for less than 12 months. Unrealized losses at December 31, 2020 were comprised of three mortgage-backed securities and one municipal bond in unrealized loss positions for greater than 12 months and twenty-nine mortgage-backed securities in unrealized loss positions for less than 12 months.

These unrealized losses are primarily the result of non-credit-related volatility in the market and 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 losses have been recognized in the Company’s Unaudited Condensed Consolidated Statements of Income.

All mortgage-backed securities in the Company’s portfolio at September 30, 2021 and December 31, 2020 were backed by U.S. government sponsored enterprises (“GSEs”).

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

The following is a summary of investment securities by maturity:

September 30, 2021
Available-for-Sale
Amortized<br><br><br>cost Fair<br><br><br>value
US government agencies
One to five years $ 7,509 $ 7,663
Five to ten years 2,934 3,044
Total 10,443 10,707
Mortgage-backed securities
Within one year 203 203
One to five years 15,649 16,415
Five to ten years 250,504 260,077
After 10 years 568,214 567,886
Total 834,570 844,581
Municipal bonds
After 10 years 3,252 3,589
Total 3,252 3,589
Other debt securities
One to five years 2,500 2,500
Total 2,500 2,500
Total $ 850,765 $ 861,377

The table above reflects contractual maturities. Actual results will differ as the loans underlying the mortgage-backed securities may repay sooner than scheduled.

There were no securities pledged at September 30, 2021 or December 31, 2020.

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Other

Other investments, largely comprised of non-marketable equity investments, are generally accounted for under the equity method or equity security accounting.  The below tables provide additional information related to investments accounted for under these two methods.

Equity Method Accounting

The carrying amount and ownership percentage of each equity investment over which the Company has significant influence at September 30, 2021 and December 31, 2020 is reflected in the following table:

September 30, 2021 December 31, 2020
Amount Ownership % Amount Ownership %
Apiture, Inc. $ 52,755 39.1 % $ 53,344 39.1 %
Canapi Ventures SBIC Fund, LP ^(1) (3)^ 16,525 2.9 % 14,843 3.1 %
Canapi Ventures Fund, LP ^(2) (3)^ 1,881 1.5 % 1,686 1.5 %
Other fintech investments in private companies ^(4)^ 5,418 Various 1,634 Various
Other ^(5)^ 4,443 Various 6,421 Various
Total $ 81,022 $ 77,928
(1) Includes unfunded commitments of $7.6 million and $11.3 million as of September 30, 2021 and December 31, 2020, respectively.
--- ---
(2) Includes unfunded commitments of $860 thousand and $1.0 million as of September 30, 2021 and December 31, 2020, respectively.
--- ---
(3) Investee is accounted for under equity method due to the Company's participation as an investment advisor.
--- ---
(4) Other fintech investments include Finxact, Inc., Payrailz, Inc. and Kwipped, Inc.
--- ---
(5) Includes unfunded commitments of $2.9 million at December 31, 2020.
--- ---

Equity Security Accounting

The carrying amount of the Company’s investments in non-marketable equity securities with no readily determinable fair value and amounts recognized in earnings for the nine months ended September 30, 2021, and on a cumulative basis is reflected in the following table:

As of and for the nine month period ended September 30, 2021
Amount Cumulative Adjustments
Carrying value ^(1)^ $ 62,341
Carrying value adjustments:
Impairment — $ —
Upward changes for observable prices ^(2)^ 30,197 48,469
Downward changes for observable prices — (86 )
Net upward change $ 30,197 $ 48,383
(1) Includes $2.6 million in unfunded commitments.
--- ---
(2) Excludes $13.9 million in realized cash gains for the sale of an investment in the second quarter of 2021.
--- ---

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Note 5. Loans and Leases Held for Investment and Credit Quality

The following tables present total loans and leases held for investment and an aging analysis for the Company’s portfolio segments. 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.

Current or Less than 30 Days Past Due 30-89 Days<br><br><br>Past Due 90 Days or More Past Due Total Past Due Total Carried at Amortized Cost^1^ Loans Accounted for Under the Fair Value Option^2^ Total Loans and Leases
September 30, 2021
Commercial & Industrial
Small Business Banking $ 1,038,352 $ 5,018 $ 6,968 $ 11,986 $ 1,050,338 $ 265,556 $ 1,315,894
Specialty Lending 687,119 — — — 687,119 68,427 755,546
Paycheck Protection Program 502,986 — — — 502,986 — 502,986
Total 2,228,457 5,018 6,968 11,986 2,240,443 333,983 2,574,426
Construction & Development
Small Business Banking 241,903 — 1,366 1,366 243,269 — 243,269
Specialty Lending 67,445 — — — 67,445 — 67,445
Total 309,348 — 1,366 1,366 310,714 — 310,714
Commercial Real Estate
Small Business Banking 1,549,107 4,873 8,265 13,138 1,562,245 274,756 1,837,001
Specialty Lending 251,202 — 3,384 3,384 254,586 19,460 274,046
Total 1,800,309 4,873 11,649 16,522 1,816,831 294,216 2,111,047
Commercial Land
Small Business Banking 355,810 1,832 2,055 3,887 359,697 69,843 429,540
Total 355,810 1,832 2,055 3,887 359,697 69,843 429,540
Total $ 4,693,924 $ 11,723 $ 22,038 $ 33,761 $ 4,727,685 $ 698,042 $ 5,425,727
Net deferred fees $ (7,116 )
Loans and Leases, Net $ 5,418,611

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Current or Less than 30 Days Past Due 30-89 Days<br><br><br>Past Due 90 Days or More Past Due Total Past Due Total Carried at Amortized Cost^1^ Loans Accounted for Under the Fair Value Option^2^ Total Loans and Leases
December 31, 2020
Commercial & Industrial
Small Business Banking $ 695,090 $ 10,341 $ 10,765 $ 21,106 $ 716,196 $ 308,341 $ 1,024,537
Specialty Lending 341,952 337 — 337 342,289 71,090 413,379
Paycheck Protection Program 1,528,180 — — — 1,528,180 — 1,528,180
Total 2,565,222 10,678 10,765 21,443 2,586,665 379,431 2,966,096
Construction & Development
Small Business Banking 183,087 — — — 183,087 — 183,087
Specialty Lending 88,890 — 3,723 3,723 92,613 — 92,613
Total 271,977 — 3,723 3,723 275,700 — 275,700
Commercial Real Estate
Small Business Banking 987,358 3,730 8,609 12,339 999,697 321,352 1,321,049
Specialty Lending 148,264 5,374 1,693 7,067 155,331 20,317 175,648
Total 1,135,622 9,104 10,302 19,406 1,155,028 341,669 1,496,697
Commercial Land
Small Business Banking 329,638 — 2,243 2,243 331,881 94,274 426,155
Total 329,638 — 2,243 2,243 331,881 94,274 426,155
Total $ 4,302,459 $ 19,782 $ 27,033 $ 46,815 $ 4,349,274 $ 815,374 $ 5,164,648
Net deferred fees $ (19,718 )
Loans and Leases, Net $ 5,144,930
(1) Total loans and leases include $2.31 billion of U.S. government guaranteed loans as of September 30, 2021, of which $14.0 million is 90 days or more past due, $8.1 million is past due 30-89 days and $2.29 billion are current.  Total loans and leases include $2.61 billion of U.S. government guaranteed loans as of December 31, 2020, of which $12.9 million is 90 days or more past due, $16.7 million is past due 30-89 days and $2.58 billion are current.
--- ---
(2) The Company measures the carrying value of the retained portion of loans sold at fair value under ASC Subtopic 825-10. See Note 9. Fair Value of Financial Instruments for additional information.
--- ---

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Credit Quality Indicators

The following tables present asset quality indicators by portfolio class and origination year.  See Note 5. Loans and Leases Held for Investment and Credit Quality in the Company’s 2020 Form 10-K for additional discussion around the asset quality indicators that the Company uses to manage and monitor credit risk.

Term Loans and Leases Amortized Cost Basis by Origination Year
2021 2020 2019 2018 2017 Prior Revolving Loans Amortized Cost Basis Revolving Loans Converted to Term Total^1,2^
September 30, 2021
Small Business Banking
Risk Grades 1 - 4 $ 738,982 $ 890,756 $ 539,137 $ 337,509 $ 217,673 $ 138,604 $ 29,622 $ 1,497 $ 2,893,780
Risk Grade 5 8,248 23,945 77,220 63,090 40,701 17,757 17,471 511 248,943
Risk Grades 6 - 8 — 4,786 18,187 15,784 15,144 17,672 869 384 72,826
Total 747,230 919,487 634,544 416,383 273,518 174,033 47,962 2,392 3,215,549
Specialty Lending
Risk Grades 1 - 4 433,189 246,483 81,492 48,171 51,388 — 80,169 971 941,863
Risk Grade 5 2,576 17,305 4,666 5,635 17,285 — 4,359 672 52,498
Risk Grades 6 - 8 — 17 3,256 8,102 — 3,384 30 — 14,789
Total 435,765 263,805 89,414 61,908 68,673 3,384 84,558 1,643 1,009,150
Paycheck Protection<br><br><br>Program
Risk Grades 1 - 4 383,013 119,973 — — — — — — 502,986
Risk Grade 5 — — — — — — — — —
Risk Grades 6 - 8 — — — — — — — — —
Total 383,013 119,973 — — — — — — 502,986
Total $ 1,566,008 $ 1,303,265 $ 723,958 $ 478,291 $ 342,191 $ 177,417 $ 132,520 $ 4,035 $ 4,727,685
2020 2019 2018 2017 2016 Prior Revolving Loans Amortized Cost Basis Revolving Loans Converted to Term Total^1,2^
--- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
December 31, 2020
Small Business Banking
Risk Grades 1 - 4 $ 724,506 $ 475,593 $ 287,712 $ 230,653 $ 159,877 $ 59,065 $ 32,373 $ 1,392 $ 1,971,171
Risk Grade 5 16,080 59,595 62,857 44,478 11,203 3,666 2,131 212 200,222
Risk Grades 6 - 8 81 8,976 14,639 15,090 11,424 8,418 631 209 59,468
Total 740,667 544,164 365,208 290,221 182,504 71,149 35,135 1,813 2,230,861
Specialty Lending
Risk Grades 1 - 4 296,537 96,553 48,930 40,626 — — 55,229 632 538,507
Risk Grade 5 7,672 6,379 2,752 18,718 — — 1,711 — 37,232
Risk Grades 6 - 8 — — 8,635 — 5,782 — 77 — 14,494
Total 304,209 102,932 60,317 59,344 5,782 — 57,017 632 590,233
Paycheck Protection Program
Risk Grades 1 - 4 1,528,180 — — — — — — — 1,528,180
Risk Grade 5 — — — — — — — — —
Risk Grades 6 - 8 — — — — — — — — —
Total 1,528,180 — — — — — — — 1,528,180
Total $ 2,573,056 $ 647,096 $ 425,525 $ 349,565 $ 188,286 $ 71,149 $ 92,152 $ 2,445 $ 4,349,274

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

(1) Total loans and leases include $2.31 billion of U.S. government guaranteed loans as of September 30, 2021, segregated by risk grade as follows: Risk Grades 1 – 4 = $2.12 billion, Risk Grade 5 = $139.3 million, Risk Grades 6 – 8 = $53.0 million. As of December 31, 2020, total loans and leases include $2.61 billion of U.S. government guaranteed loans, segregated by risk grade as follows: Risk Grades 1 – 4 = $2.44 billion, Risk Grade 5 = $128.0 million, Risk Grades 6 – 8 = $40.9 million. Total loans and leases exclude loans accounted for under the fair value option.
(2) Excludes $698.0 million and $815.4 million of loans accounted for under the fair value option as of September 30, 2021 and December 31, 2020, respectively.
--- ---

Nonaccrual Loans and Leases

As of September 30, 2021 and December 31, 2020 there were no loans greater than 90 days past due and still accruing. There was no interest income recognized on nonaccrual loans and leases during the three and nine months ended September 30, 2021 and 2020. Nonaccrual loans and leases are generally included in the held for investment portfolio. Accrued interest receivable on loans totaled $31.2 million and $41.0 million at September 30, 2021 and December 31, 2020, respectively, and is included in other assets in the accompanying Unaudited Condensed Consolidated Balance Sheets.

Nonaccrual loans and leases held for investment as of September 30, 2021 and December 31, 2020 are as follows:

September 30, 2021 Loan and Lease<br><br><br>Balance^1^ Guaranteed<br><br><br>Balance Unguaranteed Balance Unguaranteed<br><br><br>Exposure with No ACL
Commercial & Industrial
Small Business Banking $ 22,147 $ 15,929 $ 6,218 $ 3,906
Payroll Protection Program 1,482 1,482 — —
Total 23,629 17,411 6,218 3,906
Construction & Development
Small Business Banking 1,366 1,201 165 —
Specialty Lending 3,440 — 3,440 3,440
Total 4,806 1,201 3,605 3,440
Commercial Real Estate
Small Business Banking 10,801 3,852 6,949 6,016
Specialty Lending 8,046 4,883 3,163 3,163
Total 18,847 8,735 10,112 9,179
Commercial Land
Small Business Banking 2,056 1,541 515 —
Total 2,056 1,541 515 —
Total $ 49,338 $ 28,888 $ 20,450 $ 16,525

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

December 31, 2020 Loan and Lease<br><br><br>Balance^1^ Guaranteed<br><br><br>Balance Unguaranteed Balance Unguaranteed<br><br><br>Exposure with No ACL
Commercial & Industrial
Small Business Banking $ 17,992 $ 12,046 $ 5,946 $ —
Total 17,992 12,046 5,946 —
Construction & Development
Specialty Lending 3,723 — 3,723 3,723
Total 3,723 — 3,723 3,723
Commercial Real Estate
Small Business Banking 15,085 6,725 8,360 5,327
Specialty Lending 7,068 5,533 1,535 —
Total 22,153 12,258 9,895 5,327
Commercial Land
Small Business Banking 2,242 1,728 514 —
Total 2,242 1,728 514 —
Total $ 46,110 $ 26,032 $ 20,078 $ 9,050
(1) Excludes nonaccrual loans accounted for under the fair value option. See Note 9. Fair Value of Financial Instruments for additional information.
--- ---

The following table presents the amortized cost basis of collateral-dependent loans and leases, which are individually evaluated to determine expected credit losses, as of September 30, 2021 and December 31, 2020:

Total Collateral Dependent Loans Unguaranteed Portion
September 30, 2021 Real Estate Business Assets Other Real Estate Business Assets Other Allowance for Credit Losses
Commercial & Industrial
Small Business Banking $ 954 $ 4,359 $ 178 $ 206 $ 302 $ 46 $ 19
Total 954 4,359 178 206 302 46 19
Construction & Development
Small Business Banking 1,354 — — 153 — — 5
Total 1,354 — — 153 — — 5
Commercial Real Estate
Small Business Banking 6,051 990 64 4,470 14 13 83
Specialty Lending 3,391 — — 2,004 — — —
Total 9,442 990 64 6,474 14 13 83
Commercial Land
Small Business Banking 3,894 — — 2,414 — — 295
Total 3,894 — — 2,414 — — 295
Total $ 15,644 $ 5,349 $ 242 $ 9,247 $ 316 $ 59 $ 402

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Total Collateral Dependent Loans Unguaranteed Portion
December 31, 2020 Real Estate Business Assets Other Real Estate Business Assets Other Allowance for Credit Losses
Commercial & Industrial
Small Business Banking $ 1,279 $ 9,440 $ 197 $ 531 $ 4,077 $ 66 $ 1,281
Total 1,279 9,440 197 531 4,077 66 1,281
Construction & Development
Specialty Lending 3,767 — — 3,767 — — —
Total 3,767 — — 3,767 — — —
Commercial Real Estate
Small Business Banking 11,568 258 332 6,873 9 335 175
Specialty Lending 13,196 — — 7,663 — — 23
Total 24,764 258 332 14,536 9 335 198
Commercial Land
Small Business Banking 2,263 — — 534 — — 302
Total 2,263 — — 534 — — 302
Total $ 32,073 $ 9,698 $ 529 $ 19,368 $ 4,086 $ 401 $ 1,781

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Allowance for Credit Losses - Loans and Leases

During the quarter ended September 30, 2021, management updated the Company’s policy for estimating expected credit losses on certain relationships that would otherwise meet the criteria for individual evaluation. Relationships with unguaranteed exposure of less than $250 thousand are now collectively evaluated using an average of loss rates applied to individually evaluated relationships with unguaranteed exposure between $250 thousand and $1.0 million. See Note 1. Organization and Summary of Significant Accounting Policies of the Notes to the Consolidated Financial Statements in the Company’s 2020 Form 10-K for further description of the methodologies used to estimate the allowance for credit losses.

The following table details activity in the allowance for credit losses (“ACL”) by portfolio segment allowance for the periods presented:

Three Months Ended Commercial<br><br><br>& Industrial Construction &<br><br><br>Development Commercial<br><br><br>Real Estate Commercial<br><br><br>Land Total
September 30, 2021
Beginning Balance $ 27,439 $ 6,232 $ 22,162 $ 2,014 $ 57,847
Charge offs (2,535 ) — — — (2,535 )
Recoveries 12 — 38 — 50
Provision 3,883 (1,941 ) 2,392 (15 ) 4,319
Ending Balance $ 28,799 $ 4,291 $ 24,592 $ 1,999 $ 59,681
September 30, 2020
Beginning Balance $ 21,503 $ 4,861 $ 16,097 $ 1,622 $ 44,083
Charge offs — — (10,155 ) — (10,155 )
Recoveries 8 — — — 8
Provision (567 ) 131 10,842 (132 ) 10,274
Ending Balance $ 20,944 $ 4,992 $ 16,784 $ 1,490 $ 44,210
Nine Months Ended Commercial<br><br><br>& Industrial Construction &<br><br><br>Development Commercial<br><br><br>Real Estate Commercial<br><br><br>Land Total
--- --- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
September 30, 2021
Beginning Balance $ 26,941 $ 5,663 $ 18,148 $ 1,554 $ 52,306
Charge offs (2,912 ) (262 ) (2,691 ) (12 ) (5,877 )
Recoveries 158 — 1,802 — 1,960
Provision 4,612 (1,110 ) 7,333 457 11,292
Ending Balance $ 28,799 $ 4,291 $ 24,592 $ 1,999 $ 59,681
September 30, 2020
Beginning Balance, prior to adoption of ASC 326 $ 15,757 $ 2,732 $ 8,427 $ 1,318 $ 28,234
Impact of adopting ASC 326 (4,561 ) 1,131 1,916 193 (1,321 )
Charge offs (4,170 ) — (10,264 ) (408 ) (14,842 )
Recoveries 72 — 43 — 115
Provision 13,846 1,129 16,662 387 32,024
Ending Balance $ 20,944 $ 4,992 $ 16,784 $ 1,490 $ 44,210

During the three and nine months ended September 30, 2021, increases to the ACL were primarily related to loan growth which has outpaced the improvement in forecasted unemployment rates and other conditions related to the COVID-19 pandemic. Unemployment rates were forecasted for twelve months followed by a twelve-month straight-line reversion period. Additionally, the provision expense was impacted by net charge-offs during the periods.

During the three and nine months ended September 30, 2020, increases to the ACL were primarily related to the severity of forecasted unemployment rates and ongoing developments as a result of the COVID-19 pandemic. Unemployment rates were forecasted for twelve months followed by a twelve-month straight-line reversion period. Additionally, the provision expense was impacted by loan and lease growth and net charge-offs during the periods.

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

The following tables represent the types of TDRs that were made during the periods presented:

Three Months Ended September 30, 2021
Interest Only Payment Deferral Extend Amortization Other Total TDRs^(1)^
Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end
Commercial Real Estate
Small Business Banking — $ — 1 $ 2,830 — $ — — $ — 1 $ 2,830
Total — — 1 2,830 — — — — 1 2,830
Total — $ — 1 $ 2,830 — $ — — $ — 1 $ 2,830
(1) Excludes loans accounted for under the fair value option. See Note 9. Fair Value of Financial Instruments for additional information.
--- ---
Nine Months Ended September 30, 2021
--- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
Interest Only Payment Deferral Extend Amortization Other^(1)^ Total TDRs^(2)^
Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end
Commercial & Industrial
Small Business Banking — $ — 3 $ 6,097 — $ — — $ — 3 $ 6,097
Total — — 3 6,097 — — — — 3 6,097
Commercial Real Estate
Small Business Banking — — 5 6,613 — — 1 3,124 6 9,737
Total — — 5 6,613 — — 1 3,124 6 9,737
Total — $ — 8 $ 12,710 — $ — 1 $ 3,124 9 $ 15,834
(1) Includes one small business banking loan with extend amortization and a rate concession TDR.
--- ---
(2) Excludes loans accounted for under the fair value option. See Note 9. Fair Value of Financial Instruments for additional information.
--- ---
Three Months Ended September 30, 2020
--- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
Interest Only Payment Deferral Extend Amortization Other Total TDRs^(1)^
Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end
Commercial & Industrial
Small Business Banking — $ — 1 $ 24 — $ — — $ — 1 $ 24
Specialty Lending — — — — 1 116 — — 1 116
Total — — 1 24 1 116 — — 2 140
Construction & Development
Small Business Banking — — — — 1 879 — — 1 879
Total — — — — 1 879 — — 1 879
Commercial Real Estate
Small Business Banking — — 1 326 — — — — 1 326
Specialty Lending — — 1 3,627 — — — — 1 3,627
Total — — 2 3,953 — — — — 2 3,953
Total — $ — 3 $ 3,977 2 $ 995 — $ — 5 $ 4,972
(1) Excludes loans accounted for under the fair value option. See Note 9. Fair Value of Financial Instruments for additional information.
--- ---

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Nine Months Ended September 30, 2020
Interest Only Payment Deferral Extend Amortization Other Total TDRs^(1)^
Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end Number of<br><br><br>Loans Recorded investment at period end
Commercial & Industrial
Small Business Banking — $ — 6 $ 1,903 — $ — — $ — 6 $ 1,903
Specialty Lending — — — — 2 526 — — 2 526
Total — — 6 1,903 2 526 — — 8 2,429
Construction & Development
Small Business Banking — — — — 1 879 — — 1 879
Total — — — — 1 879 — — 1 879
Commercial Real Estate
Small Business Banking — — 2 3,738 — — — — 2 3,738
Specialty Lending — — 1 3,627 — — — — 1 3,627
Total — — 3 7,365 — — — — 3 7,365
Commercial Land
Small Business Banking — — — — 1 4,885 — — 1 4,885
Total — — — — 1 4,885 — — 1 4,885
Total — $ — 9 $ 9,268 4 $ 6,290 — $ — 13 $ 15,558
(1) Excludes loans accounted for under the fair value option. See Note 9. Fair Value of Financial Instruments for additional information.
--- ---

One TDR that was modified within the twelve months ended September 30, 2021 subsequently defaulted during the nine months ended September 30, 2021. The TDR that defaulted was a Commercial Real Estate Small Business Banking loan that had previously been modified for a payment deferral and had a recorded investment of $50 thousand at September 30, 2021. No TDRs that were modified within the twelve months ended September 30, 2021 subsequently defaulted during the three months ended September 30, 2021.

No TDRs that were modified within the twelve months ended September 30, 2020 subsequently defaulted during the three and nine months ended September 30, 2020.

Note 6. Leases

Lessor Equipment Leasing

The Company purchases new equipment for the purpose of leasing such equipment to customers within its verticals. Equipment purchased to fulfill commitments to commercial renewable energy projects is rented out under operating leases while leases of equipment outside of the renewable energy vertical are generally direct financing leases.  Accordingly, leased assets under operating leases are included in premises and equipment while leased assets under direct financing leases are included in loans and leases held for investment.

Direct Financing Leases

Interest income on direct financing leases is recognized when earned.  Unearned interest is recognized over the lease term on a basis which results in a constant rate of return on the unrecovered lease investment.  The term of each lease is generally 3-7 years which is consistent with the useful life of the equipment with no residual value.  The gross lease payments receivable and the net investment included in accounts receivable for such leases are as follows:

September 30, 2021 December 31, 2020
Gross direct finance lease payments receivable $ 8,276 $ 10,629
Less – unearned interest (1,159 ) (1,685 )
Net investment in direct financing leases $ 7,117 $ 8,944

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Future minimum lease payments under finance leases are as follows:

As of September 30, 2021 Amount
2021 $ 683
2022 2,620
2023 2,182
2024 1,570
2025 1,104
Thereafter 117
Total $ 8,276

Interest income of $159 thousand and $199 thousand was recognized in the three months ended September 30, 2021 and 2020, respectively. Interest income of $517 thousand and $644 thousand was recognized in the nine months ended September 30, 2021 and 2020, respectively.

Operating Leases

The term of each operating lease is generally 10 to 15 years.  The Company retains ownership of the equipment and associated tax benefits such as investment tax credits and accelerated depreciation.  At the end of the lease term, the lessee has the option to renew the lease for two additional terms or purchase the equipment at the then-current fair market value.

Rental revenue from operating leases is recognized on a straight-line basis over the term of the lease.  Rental equipment is recorded at cost and depreciated to an estimated residual value on a straight-line basis over the estimated useful life.  The useful lives generally range from 20 to 25 years and residual values generally range from 20% to 50%, however, they are subject to periodic evaluation.  Changes in useful lives or residual values will impact depreciation expense and any gain or loss from the sale of used equipment. The estimated useful lives and residual values of the Company's leasing equipment are based on industry disposal experience and the Company's expectations for future sale prices.

If the Company decides to sell or otherwise dispose of rental equipment, it is carried at the lower of cost or fair value less costs to sell or dispose.   Repair and maintenance costs that do not extend the lives of the rental equipment are charged to direct operating expenses at the time the costs are incurred.

As of September 30, 2021 and December 31, 2020, the Company had a net investment of $126.3 million and $134.5 million, respectively, in assets included in premises and equipment that are subject to operating leases. Of the net investment, the gross balance of the assets was $163.4 million and $164.3 million as of September 30, 2021 and December 31, 2020, respectively, and accumulated depreciation was $37.1 million and $29.8 million as of September 30, 2021 and December 31, 2020, respectively. Depreciation expense recognized on these assets for the three and nine months ended September 30, 2021 and 2020 was $2.4 million and $7.3 million, respectively.

Lease income of $2.4 million was recognized in the three months ended September 30, 2021 and 2020. Lease income of $7.2 million and $7.1 million were recognized in the nine months ended September 30, 2021 and 2020, respectively.

A maturity analysis of future minimum lease payments to be received under non-cancelable operating leases is as follows:

As of September 30, 2021 Amount
2021 $ 1,969
2022 9,044
2023 9,075
2024 8,808
2025 8,935
Thereafter 31,175
Total $ 69,006

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Note 7. Servicing Assets

Loans serviced for others are not included in the accompanying Unaudited Condensed Consolidated Balance Sheets. The unpaid principal balances of loans serviced for others requiring recognition of a servicing asset were $2.26 billion and $2.21 billion at September 30, 2021 and December 31, 2020, respectively. The unpaid principal balance for all loans serviced for others was $3.21 billion at September 30, 2021 and December 31, 2020.

The following summarizes the activity pertaining to servicing rights:

Three Months Ended<br><br><br>September 30, Nine Months Ended<br><br><br>September 30,
2021 2020 2021 2020
Balance at beginning of period $ 36,966 $ 33,834 $ 33,918 $ 35,365
Additions, net 2,880 1,936 7,616 6,668
Fair value changes:
Due to changes in valuation inputs or assumptions (2,768 ) 3,758 119 1,596
Decay due to increases in principal paydowns or runoff (3,110 ) (1,697 ) (7,685 ) (5,798 )
Balance at end of period $ 33,968 $ 37,831 $ 33,968 $ 37,831

The fair value of servicing rights was determined using a weighted average discount rate of 12.3% on September 30, 2021 and 9.1% on September 30, 2020. The fair value of servicing rights was determined using a weighted average prepayment speed of 16.7% on September 30, 2021 and 19.1% on September 30, 2020, with the actual rate depending on the stratification of the specific right. Changes to fair value are reported in loan servicing asset revaluation within the Unaudited Condensed Consolidated Statements of Income.

The fair value of servicing rights is highly sensitive to changes in underlying assumptions. Changes in prepayment speed assumptions typically have the most significant impact on the fair value of servicing rights. Generally, as interest rates rise on variable rate loans, loan prepayments increase due to an increase in refinance activity, which results in a decrease in the fair value of servicing assets, however, weakening economic conditions or significant declines in interest rates can also increase loan prepayment activity. Measurement of fair value is limited to the conditions existing and the assumptions used as of a particular point in time, and those assumptions may not be appropriate if they are applied at a different time.

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Note 8. Borrowings

Total outstanding borrowings consisted of the following:

December 31,<br><br><br>2020
Borrowings
In March 2021, the Company entered into a 60-month term loan agreement of 50.0 million with a third party correspondent bank.  The loan accrues interest at a fixed rate of 2.95% with a monthly payment sufficient to fully amortize the loan, with all remaining unpaid principal and interest due at maturity on March 30, 2026.  The Company paid the Lender a non-refundable 325 thousand loan origination fee upon signing of the Note that is presented as a direct deduction from the carrying amount of the loan and will be amortized into interest expense over the life of the loan. 45,069 $ —
In September 2020, the Company renewed a 50.0 million revolving line of credit originally issued in 2017 with a third party correspondent bank. On October 20, 2021, the Company renewed and increased the revolving line of credit from 50.0 million to 100.0 million. The line of credit is unsecured and accrues interest at 30-day SOFR plus 1.25%, with a minimum rate of 2.75% and maximum rate of 4.75%, for a term of 36 months.  Payments are interest only with all unpaid principal and accrued interest due on maturity at October 10, 2024. There was 50.0 million of available credit remaining at September 30, 2021. — 14,488
In April 2020, the Company entered into the Federal Reserve Bank's Paycheck Protection Program Liquidity Facility ("PPPLF"). Under the PPPLF, advances must be secured by pledges of loans to small businesses originated by the Company under the U.S. Small Business Administration's 7(a) loan program titled the Paycheck Protection Program. The PPPLF accrues interest at thirty-five basis points and matures at various dates equal to the maturity date of the PPPLF collateral pledged to secure the advance, ranging from April 6, 2022 to May 5, 2026, and will be accelerated on and to the extent of any 7(a) loan forgiveness reimbursement by the SBA for any PPPLF collateral or the date of purchase by the SBA from the borrower of any PPPLF collateral. On the maturity date of each advance, the Company shall repay the advance plus accrued interest. This 526.0 million borrowing was fully advanced at September 30, 2021. 525,953 1,527,596
Other long term debt(1) 3,999 9
Total borrowings 575,021 $ 1,542,093

All values are in US Dollars.

(1) Includes finance leases and loan participations accounted for as secured borrowings.

The Company may purchase federal funds through unsecured federal funds lines of credit with various correspondent banks, which totaled $167.5 million as of September 30, 2021 and December 31, 2020. These lines are intended for short-term borrowings and are subject to restrictions limiting the frequency and terms of advances. These lines of credit are payable on demand and bear interest based upon the daily federal funds rate. The Company had no outstanding balances on the lines of credit as of September 30, 2021 and December 31, 2020.

The Company has entered into a repurchase agreement with a third party for $5.0 million as of September 30, 2021 and December 31, 2020.  At the time the Company enters into a transaction with the third party, the Company must transfer securities or other assets against the funds received.  The terms of the agreement are set at market conditions at the time the Company enters into such transaction. The Company had no outstanding balance on the repurchase agreement as of September 30, 2021 and December 31, 2020.

On June 18, 2018, the Company entered into a borrowing agreement with the Federal Home Loan Bank of Atlanta. These borrowings must be secured with eligible collateral approved by the Federal Home Loan Bank of Atlanta. At September 30, 2021 and December 31, 2020, the Company had approximately $2.04 billion and $2.01 billion, respectively, in borrowing capacity available under these agreements.  There are no advances outstanding and no collateral pledged as of September 30, 2021 and December 31, 2020.

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

The Company may borrow funds through the Federal Reserve Bank’s discount window. These borrowings are secured by a blanket floating lien on qualifying loans with a balance of $2.27 billion and $2.22 billion as of September 30, 2021 and December 31, 2020, respectively.  At September 30, 2021 and December 31, 2020, the Company had approximately $1.87 billion and $1.77 billion, respectively, in borrowing capacity available under these arrangements with no outstanding balance as of September 30, 2021 and December 31, 2020.

Note 9. Fair Value of Financial Instruments

Fair Value Hierarchy

There are three levels of inputs in the fair value hierarchy that may be used to measure fair value. Financial instruments are considered Level 1 when valuation can be based on quoted prices in active markets for identical assets or liabilities. Level 2 financial instruments are valued using quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or models using inputs that are observable or can be corroborated by observable market data of substantially the full term of the assets or liabilities. Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable and when determination of the fair value requires significant management judgment or estimation.

Recurring Fair Value

The following sections provide a description of the valuation methodologies used for instruments measured at fair value on a recurring basis, as well as the general classification of such instruments pursuant to the fair value hierarchy:

Investment securities: Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, discounted cash flow or at net asset value per share. Level 2 securities would include U.S. government agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset backed mutual fund and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy.

Loans held for sale: The fair values of loans held for sale are determined by discounting estimated cash flows using interest rates approximating prevailing market rates for similar loans adjusted to reflect the inherent credit risk. Due to the nature of the valuation inputs, loans held for sale are classified within Level 3 of the valuation hierarchy.

Loans held for investment: The fair values of loans held for investment are typically determined based on discounted cash flow analyses using market-based interest rate spreads. Discounted cash flow analyses are adjusted, as appropriate, to reflect current market conditions and borrower-specific credit risk. If the loan is collateral dependent, the fair value is determined based on the difference between the fair value of the collateral and the amortized cost basis of the loan as of the measurement date. Fair value of the loan’s collateral is determined by appraisals, independent valuation, or management’s estimation of fair value which is then adjusted for the cost related to liquidation of the collateral. Due to the nature of the valuation inputs, loans held for investment are classified within Level 3 of the valuation hierarchy.

Servicing assets: Servicing rights do not trade in an active, open market with readily observable prices. While sales of servicing rights do occur, the precise terms and conditions typically are not readily available. Accordingly, the Company estimates the fair value of servicing rights using discounted cash flow models incorporating numerous assumptions from the perspective of a market participant including servicing income, servicing costs, market discount rates and prepayment speeds. Due to the nature of the valuation inputs, servicing rights are classified within Level 3 of the valuation hierarchy.

Mutual fund: The below mutual fund is registered with the Securities and Exchange Commission as a closed-end, non-diversified management investment company and operates as an interval fund. The fund primarily invests in the unguaranteed portion of SBA504 First Lien Loans secured by owner-occupied commercial real estate. This investment is valued using quoted prices in markets that are not active and is classified as Level 2 within the valuation hierarchy.

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Equity warrant assets: Fair value measurements of equity warrant assets of private companies are priced based on a Black-Scholes option pricing model to estimate the asset value by using stated strike prices, option expiration dates, risk-free interest rates and option volatility assumptions. Option volatility assumptions used in the Black-Scholes model are based on public companies that operate in similar industries as the companies in the Company’s private company portfolio. Option expiration dates are modified to account for estimates of actual life relative to stated expiration. Values are further adjusted for a general lack of liquidity due to the private nature of the associated underlying company.  The Company classifies equity warrant assets within Level 3 of the valuation hierarchy.

The table below provides a rollforward of the Level 3 equity warrant asset fair values.

Three Months Ended September 30, Nine Months Ended September 30,
Equity Warrant Assets 2021 2020 2021 2020
Balance at beginning of period $ 1,580 $ 855 $ 908 $ 570
Issuances 135 — 172 179
Net gains on derivative instruments 310 14 1,080 120
Settlements (353 ) — (488 ) —
Balance at end of period $ 1,672 $ 869 $ 1,672 $ 869

The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis.

September 30, 2021 Total Level 1 Level 2 Level 3
Investment securities available-for-sale
US government agencies $ 10,707 $ — $ 10,707 $ —
Mortgage-backed securities 844,581 — 844,581 —
Municipal bonds^1^ 3,589 — 3,492 97
Other debt securities 2,500 — 2,500 —
Loans held for sale 27,366 — — 27,366
Loans held for investment 698,042 — — 698,042
Servicing assets^2^ 33,968 — — 33,968
Mutual fund 2,379 — 2,379 —
Equity warrant assets 1,672 — — 1,672
Total assets at fair value $ 1,624,804 $ — $ 863,659 $ 761,145
December 31, 2020 Total Level 1 Level 2 Level 3
--- --- --- --- --- --- --- --- ---
Investment securities available-for-sale
US government agencies $ 15,919 $ — $ 15,919 $ —
Mortgage-backed securities 730,454 — 730,454 —
Municipal bonds^1^ 3,725 — 3,629 96
Loans held for sale 36,111 — — 36,111
Loans held for investment 815,374 — — 815,374
Servicing assets^2^ 33,918 — — 33,918
Mutual fund 2,351 — 2,351 —
Equity warrant assets 908 — — 908
Total assets at fair value $ 1,638,760 $ — $ 752,353 $ 886,407
(1) During the three and nine months ended September 30, 2021, the Company recorded a fair value adjustment gain of $1 thousand. During the three and nine months ended September 30, 2020, the Company recorded a fair value adjustment gain of $1 thousand and $3 thousand, respectively.
--- ---
(2) See Note 7 for a rollforward of recurring Level 3 fair values for servicing assets.
--- ---

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Fair Value Option

The Company has historically elected to account for retained participating interests of all government guaranteed loans under the fair value option in order to align the accounting presentation with the Company’s viewpoint of the economics of the loans. Interest income on loans accounted for under the fair value option is recognized in loans and fees on loans on the Company’s Unaudited Condensed Consolidated Statements of Income. Beginning in the first quarter of 2021, the Company chose not to elect fair value for all retained participating interests arising from new government guaranteed loan sales.  Not electing fair value generally results in a larger discount being recorded on the date of the sale. This discount is subsequently accreted into interest income over the underlying loan’s remaining term using the effective interest method. Management made this change of election in alignment with its ongoing effort to reduce volatility and drive more predictable revenue. In accordance with accounting standards, any loans for which fair value was previously elected will continue to be measured as such.

There were no loans accounted for under the fair value option that were 90 days or more past due and still accruing interest at September 30, 2021 or December 31, 2020. The unpaid principal balance of unguaranteed exposure for nonaccruals was $7.9 million and $6.9 million at September 30, 2021 and December 31, 2020, respectively.

The following tables provide more information about the fair value carrying amount and the unpaid principal outstanding of loans accounted for under the fair value option at September 30, 2021 and December 31, 2020.

September 30, 2021
Total Loans Nonaccruals 90 Days or More Past Due
Fair Value Carrying Amount Unpaid Principal Balance Difference Fair Value Carrying Amount Unpaid Principal Balance Difference Fair Value Carrying Amount Unpaid Principal Balance Difference
Fair Value Option Elections
Loans held for sale $ 27,366 $ 28,839 $ (1,473 ) $ — $ — $ — $ — $ — $ —
Loans held for investment 698,042 720,456 (22,414 ) 43,011 47,184 (4,173 ) 24,100 27,252 (3,152 )
$ 725,408 $ 749,295 $ (23,887 ) $ 43,011 $ 47,184 $ (4,173 ) $ 24,100 $ 27,252 $ (3,152 )
December 31, 2020
--- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- --- ---
Total Loans Nonaccruals 90 Days or More Past Due
Fair Value Carrying Amount Unpaid Principal Balance Difference Fair Value Carrying Amount Unpaid Principal Balance Difference Fair Value Carrying Amount Unpaid Principal Balance Difference
Fair Value Option Elections
Loans held for sale $ 36,111 $ 38,135 $ (2,024 ) $ — $ — $ — $ — $ — $ —
Loans held for investment 815,374 845,082 (29,708 ) 35,499 39,318 (3,819 ) 25,532 28,741 (3,209 )
$ 851,485 $ 883,217 $ (31,732 ) $ 35,499 $ 39,318 $ (3,819 ) $ 25,532 $ 28,741 $ (3,209 )

The following table presents the net gains (losses) from changes in fair value.

Three Months Ended September 30, Nine Months Ended September 30,
Gains (Losses) on Loans Accounted for under the Fair Value<br><br><br>Option 2021 2020 2021 2020
Loans held for sale $ 85 $ 109 $ 549 $ 123
Loans held for investment (1,115 ) 3,294 3,774 (8,447 )
$ (1,030 ) $ 3,403 $ 4,323 $ (8,324 )

Gains/(losses) related to borrower-specific credit risk were $81 thousand and $(212) thousand for the three and nine months ended September 30, 2021, respectively, and $(1.5) million and $(3.3) million for the three and nine months ended September 30, 2020, respectively.

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

The following tables summarize the activity pertaining to loans accounted for under the fair value option.

Three Months Ended September 30, Nine Months Ended September 30,
Loans held for sale 2021 2020 2021 2020
Balance at beginning of period $ 29,048 $ 32,071 $ 36,111 $ 16,198
Issuances & repurchases — 4,560 — 20,759
Fair value changes 85 109 549 123
Sales — (6,082 ) — (6,082 )
Settlements (1,767 ) (215 ) (9,294 ) (555 )
Balance at end of period $ 27,366 $ 30,443 $ 27,366 $ 30,443
Three Months Ended September 30, Nine Months Ended September 30,
--- --- --- --- --- --- --- --- --- --- --- --- ---
Loans held for investment 2021 2020 2021 2020
Balance at beginning of period $ 743,226 $ 834,602 $ 815,374 $ 824,520
Issuances & repurchases 10,005 37,346 31,790 136,718
Fair value changes (1,115 ) 3,294 3,774 (8,447 )
Settlements (54,074 ) (29,495 ) (152,896 ) (107,044 )
Balance at end of period $ 698,042 $ 845,747 $ 698,042 $ 845,747

Non-recurring Fair Value

The following sections provide a description of the valuation methodologies used for instruments measured at fair value on a non-recurring basis, as well as the general classification of such instruments pursuant to the fair value hierarchy:

Collateral-dependent loans: Loans are considered collateral-dependent when the Company has determined that foreclosure of the collateral is probable or when a borrower is experiencing financial difficulty and the loan is expected to be repaid substantially through the operation or sale of collateral. A collateral-dependent loan’s ACL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the loan as of the measurement date. Fair value of the loan’s collateral is determined by appraisals, independent valuation, or management’s estimation of fair value which is then adjusted for the cost related to liquidation of the collateral. Collateral-dependent loans are generally classified as Level 3 based on management’s judgment and estimation. Loans with agreed upon sales prices are classified as Level 1.

Foreclosed assets: Foreclosed real estate is adjusted to fair value less selling costs upon transfer of the loans to foreclosed real estate. Subsequently, foreclosed real estate is carried at the lower of carrying value or fair value less selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Given the lack of observable market prices for identical properties and market discounts applied to appraised values, the Company generally classifies foreclosed assets as nonrecurring Level 3.

Long-lived asset held for sale: Long-lived assets held for sale are carried at the lower of carrying value or fair value less selling costs. Fair value is based upon an independent market valuation of the property. Given the lack of observable market prices for identical assets and market discounts applied to market prices, the Company generally classifies long-lived assets held for sale as nonrecurring Level 3.

Equity security investments with a non-readily determinable fair value: Equity security investments are measured at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer. When an observable price change in an orderly transaction occurs for an identical investment of the same issuer, the investment is generally classified as nonrecurring Level 1 within the valuation hierarchy. When an observable price change in an orderly transaction occurs for a similar investment of the same issuer, the investment is generally classified as nonrecurring Level 2 within the valuation hierarchy.

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

The tables below present the recorded amount of assets and liabilities measured at fair value on a non-recurring basis.

September 30, 2021 Total Level 1 Level 2 Level 3
Collateral-dependent loans $ 919 $ — $ — $ 919
Foreclosed assets 883 — — 883
Total assets at fair value $ 1,802 $ — $ — $ 1,802
December 31, 2020 Total Level 1 Level 2 Level 3
--- --- --- --- --- --- --- --- ---
Collateral-dependent loans $ 4,159 $ — $ — $ 4,159
Foreclosed assets 4,155 — — 4,155
Long-lived asset held for sale 8,874 8,874 — —
Equity security investment with a non-readily<br><br><br>determinable fair value 25,367 — 25,367 —
Total assets at fair value $ 42,555 $ 8,874 $ 25,367 $ 8,314

Level 3 Analysis

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of September 30, 2021 and December 31, 2020 the significant unobservable inputs used in the fair value measurements were as follows:

September 30, 2021

Level 3 Assets with Significant<br><br><br>Unobservable Inputs Fair Value Valuation Technique Significant<br><br><br>Unobservable<br><br><br>Inputs Range
Recurring fair value
Municipal bond $ 97 Discounted expected cash flows Discount rate<br><br><br>Prepayment speed 4.8%<br><br><br>5.0%
Loans held for sale $ 27,366 Discounted expected cash flows Discount rate<br><br><br>Prepayment speed 5.1% to 21.4%<br><br><br>WAVG 18.0%
Loans held for<br><br><br>investment $ 698,042 Discounted expected cash flows<br><br><br>Discounted appraisals Loss rate<br><br><br>Discount rate<br><br><br>Prepayment speed<br><br><br>Appraisal adjustments 0.0% to 72.0% (WAVG 1.4%)<br><br><br>5.1% to 21.4%<br><br><br>WAVG 18.0%<br><br><br>10.0% to 75.0%
Equity warrant assets $ 1,672 Black-Scholes option pricing model Volatility<br><br><br>Risk-free interest rate<br><br><br>Marketability discount<br><br><br>Remaining life 26.4-88.9%<br><br><br>0.98% to 1.48%<br><br><br>20.0%<br><br><br>4-10 years
Non-recurring fair value
Collateral-dependent<br><br><br>loans $ 919 Discounted appraisals Appraisal adjustments ^(1)^ 10.0% to 65.0%
Foreclosed assets $ 883 Discounted appraisals Appraisal adjustments ^(1)^ 4.0% to 10.0%

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

December 31, 2020

Level 3 Assets with Significant<br><br><br>Unobservable Inputs Fair Value Valuation Technique Significant<br><br><br>Unobservable<br><br><br>Inputs Range
Recurring fair value
Municipal bond $ 96 Discounted expected cash flows Discount rate<br><br><br>Prepayment speed 4.3%<br><br><br>5.0%
Loans held for sale $ 36,111 Discounted expected cash flows Discount rate<br><br><br>Prepayment speed 4.2% to 18.5%<br><br><br>WAVG 19.0%
Loans held for<br><br><br>investment $ 815,374 Discounted expected cash flows<br><br><br>Discounted appraisals Loss rate<br><br><br>Discount rate<br><br><br>Prepayment speed<br><br><br>Appraisal adjustments 0.0% to 73.2% (WAVG 1.5%)<br><br><br>4.2% to 18.5%<br><br><br>WAVG 19.0%<br><br><br>10.0% to 83.0%
Equity warrant assets $ 908 Black-Scholes option pricing model Volatility<br><br><br>Risk-free interest rate<br><br><br>Marketability discount<br><br><br>Remaining life 26.5-87.1%<br><br><br>0.36% to 0.93%<br><br><br>20.0%<br><br><br>5-10 years
Non-recurring fair value
Collateral-dependent<br><br><br>loans $ 4,159 Discounted appraisals Appraisal adjustments ^(1)^ 10.0% to 83.0%
Foreclosed assets $ 4,155 Discounted appraisals Appraisal adjustments ^(1)^ 10.0% to 20.0%
(1) Appraisals may be adjusted by management for customized discounting criteria, estimated sales costs, and other qualitative adjustments.
--- ---

Estimated Fair Value of Other Financial Instruments

GAAP also requires disclosure of the fair value of financial instruments carried at book value on the consolidated balance sheets.

The carrying amounts and estimated fair values of the Company’s financial instruments not measured at fair value on a recurring or non-recurring basis are as follows:

September 30, 2021 Carrying<br><br><br>Amount Quoted Price<br><br><br>In Active<br><br><br>Markets for<br><br><br>Identical Assets<br><br><br>/Liabilities<br><br><br>(Level 1) Significant<br><br><br>Other<br><br><br>Observable<br><br><br>Inputs<br><br><br>(Level 2) Significant<br><br><br>Unobservable<br><br><br>Inputs<br><br><br>(Level 3) Total<br><br><br>Fair<br><br><br>Value
Financial assets
Cash and due from banks $ 336,362 $ 336,362 $ — $ — $ 336,362
Federal funds sold 10,672 10,672 — — 10,672
Certificates of deposit with other banks 6,000 6,253 — — 6,253
Loans held for sale 1,015,390 — — 1,116,657 1,116,657
Loans and leases, net of allowance for<br><br><br>credit losses on loans and leases 4,660,888 — — 4,790,033 4,790,033
Financial liabilities
Deposits 6,816,613 — 6,690,754 — 6,690,754
Borrowings 575,021 — — 562,932 562,932

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

December 31, 2020 Carrying<br><br><br>Amount Quoted Price<br><br><br>In Active<br><br><br>Markets for<br><br><br>Identical Assets<br><br><br>/Liabilities<br><br><br>(Level 1) Significant<br><br><br>Other<br><br><br>Observable<br><br><br>Inputs<br><br><br>(Level 2) Significant<br><br><br>Unobservable<br><br><br>Inputs<br><br><br>(Level 3) Total<br><br><br>Fair<br><br><br>Value
Financial assets
Cash and due from banks $ 297,167 $ 297,167 $ — $ — $ 297,167
Federal funds sold 21,153 21,153 — — 21,153
Certificates of deposit with other banks 6,500 6,906 — — 6,906
Loans held for sale 1,139,359 — — 1,235,122 1,235,122
Loans and leases, net of allowance for<br><br><br>credit losses on loans and leases 4,277,250 — — 4,366,489 4,366,489
Financial liabilities
Deposits 5,712,828 — 5,711,781 — 5,711,781
Borrowings 1,542,093 — — 1,542,171 1,542,171

Note 10. Commitments and Contingencies

Litigation

In the normal course of business, the Company is involved in various legal proceedings. Management believes that the outcome of such proceedings will not materially affect the financial position, results of operations or cash flows of the Company.

On March 12, 2021, a purported class action was filed against the Company in the United States District Court for the Eastern District of North Carolina, Joseph McAlear, individually and on behalf of all others similarly situated v. Live Oak Bancshares, Inc. et al.  The complaint alleges the existence of an agreement between the Company, nCino, Inc. and Apiture, LLC in which those companies purportedly sought to restrain the mobility of employees in violation of antitrust laws by agreeing not to solicit or hire each other’s employees.  The complaint alleges violations of Section 1 of the federal Sherman Act (15 U.S.C. § 1) and violations of Sections 75-1 and 75-2 of the North Carolina General Statutes.  The plaintiff seeks monetary damages, including treble damages, entitlement to restitution, disgorgement, attorneys’ fees, and pre- and post-judgment interest.  On October 12, 2021, the Company reached an agreement to settle the case with a proposed class of all persons (with certain exclusions) employed by the Company or its wholly-owned subsidiary, Live Oak Banking Company, Apiture, Inc. or nCino, Inc. in North Carolina at any time from January 27, 2017, through March 31, 2021.  In the agreement, the Company agreed to pay $3.9 million.  On October 13, 2021, the plaintiff filed a motion for preliminary approval of the settlement, and that motion remains pending before the court.

Financial Instruments with Off-balance-sheet Risk

The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, credit risk in excess of the amount recognized in the balance sheet.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as for on-balance-sheet instruments. A summary of the Company’s commitments is as follows:

September 30,<br><br><br>2021 December 31,<br><br><br>2020
Commitments to extend credit $ 2,687,933 $ 2,054,910
Standby letters of credit 9,150 22,913
Total unfunded off-balance-sheet credit risk $ 2,697,083 $ 2,077,823

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate and income-producing commercial properties. Commitment letters are issued after approval of the loan by the Credit Department and generally expire ninety days after issuance.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Company deems necessary.

The balance of the allowance for off-balance sheet credit exposures was $611 thousand and $746 thousand at September 30, 2021 and December 31, 2020, respectively.

As of September 30, 2021 and December 31, 2020, the Company had unfunded commitments to provide capital contributions for on-balance-sheet investments in the amount of $11.0 million and $15.8 million, respectively.

Concentrations of Credit Risk

The distribution of commitments to extend credit approximates the distribution of loans outstanding. The Company does not have a significant number of credits to any single borrower or group of related borrowers whereby their retained unguaranteed exposure exceeds $15.0 million, except for 25 relationships that have a retained unguaranteed exposure of $637.7 million of which $284.8 million of the unguaranteed exposure has been disbursed.

Additionally, the Company has future minimum lease payments receivable under non-cancelable operating leases totaling $69.0 million, of which $21.2 million is due from one relationship.

The Company from time-to-time may have cash and cash equivalents on deposit with financial institutions that exceed federally-insured limits.

Note 11. Stock Plans

On March 20, 2015, the Company adopted the 2015 Omnibus Stock Incentive Plan which replaced the previously existing Amended Incentive Stock Option Plan and Nonstatutory Stock Option Plan. Subsequently on May 24, 2016 and May 15, 2018, the 2015 Omnibus Stock Incentive Plan was amended to authorize awards covering a maximum of 7,000,000 and 8,750,000 common voting shares, respectively. On May 11, 2021, the Amended and Restated 2015 Omnibus Stock Incentive Plan was amended to authorize awards covering a maximum of 10,750,000 common voting shares. Options or restricted shares granted under the Amended and Restated 2015 Omnibus Stock Incentive Plan (the "Plan") expire no more than 10 years from the date of grant. Exercise prices under the Plan are set by the Board of Directors at the date of grant, but shall not be less than 100% of fair market value of the related stock at the date of the grant. Options vest over a minimum of three years from the date of the grant. Restricted stock grants vest in equal installments ranging from immediate vesting to over a seven-year period from the date of the grant.  Market Restricted Stock Units also have a restriction based on the passage of time and have a restriction based on market price criteria related to the Company’s share price closing at or above a specified price defined at time of grant, but also may have non-market-related performance criteria.

Stock Options

There were no stock options granted during the three and nine months ended September 30, 2021.

At September 30, 2021, unrecognized compensation costs relating to stock options amounted to $1.2 million which will be recognized over a weighted average period of 0.98 years.

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Restricted Stock

Restricted stock awards are authorized in the form of restricted stock awards or units ("RSU"s) and restricted stock awards or units with a market price condition ("Market RSU"s).

RSUs have a restriction based on the passage of time and may also have a restriction based on a non-market-related performance criteria. The fair value of the RSUs is based on the closing price on the date of the grant.

There were no Market RSUs granted during the three and nine months ended September 30, 2021.

For the nine months ended September 30, 2021, 575,500 Market RSUs met the performance stock price condition for the $45.00, $48.00, $50.00 and $55.00 stock price for twenty (20) consecutive trading days. For the nine months ended September 30, 2021, the remaining expense of $3.7 million was fully recognized due to the accelerated vesting.  The weighted average grant date fair value for the 575,500 vested Market RSUs was $7.62.

There are no remaining Market RSUs at September 30, 2021.

For the three months ended September 30, 2021, 339,118 RSUs were granted with a weighted average grant date fair value of $61.11. For the nine months ended September 30, 2021, 1,155,694 RSUs were granted with a weighted average grant date fair value of $54.01. Of the RSUs granted in the nine-month period, 288,680 were awarded in connection with annual long term incentive stock compensation and 500,000 were awarded as a special retention RSU award.

At September 30, 2021, unrecognized compensation costs relating to RSUs amounted to $67.0 million which will be recognized over a weighted average period of 4.80 years.

Note 12. Segments

The Company's management reporting process measures the performance of its operating segments based on internal operating structure, which is subject to change from time to time.  Accordingly, the Company operates two reportable segments for management reporting purposes as discussed below:

Banking - This segment specializes in providing financing services to small businesses nationwide in targeted industries and deposit-related services to small businesses, consumers and other customers nationwide. The primary source of revenue for this segment is net interest income and secondarily the origination and sale of government guaranteed loans.

Fintech - This segment is involved in making strategic investments into emerging financial technology companies.  The primary sources of revenue for this segment are principally gains and losses on equity method and equity security investments and management fees.  The Fintech segment is comprised of the Company's wholly owned subsidiaries Live Oak Ventures and Canapi Advisors, and the investments held by those entities, as well as the Bank's investment in Apiture.

Live Oak Bancshares, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

The following tables provide financial information for the Company's segments. The information provided under the caption “Other” represents operations not considered to be reportable segments and/or general operating expenses of the Company, and includes the parent company, other non-bank subsidiaries and elimination adjustments to reconcile the results of the operating segments to the unaudited condensed consolidated financial statements prepared in conformity with GAAP.

Banking Fintech Other Consolidated
Three Months Ended September 30, 2021
Interest income $ 92,783 $ — $ 3 $ 92,786
Interest expense 14,667 — 384 15,051
Net interest income (loss) 78,116 — (381 ) 77,735
Provision for loan and lease credit losses 4,319 — — 4,319
Noninterest income 27,041 (283 ) (1,482 ) 25,276
Noninterest expense 52,423 1,223 1,813 55,459
Income tax expense (benefit) 9,363 (206 ) 237 9,394
Net income (loss) $ 39,052 $ (1,300 ) $ (3,913 ) $ 33,839
Total assets $ 7,984,677 $ 113,117 $ 39,547 $ 8,137,341
Three Months Ended September 30, 2020
Interest income $ 75,068 $ — $ 10 $ 75,078
Interest expense 23,679 — 36 23,715
Net interest income (loss) 51,389 — (26 ) 51,363
Provision for loan and lease credit losses 10,274 — — 10,274
Noninterest income 31,757 14,699 588 47,044
Noninterest expense 41,005 1,113 532 42,650
Income tax expense 7,942 3,478 283 11,703
Net income (loss) $ 23,925 $ 10,108 $ (253 ) $ 33,780
Total assets $ 7,998,576 $ 93,727 $ 1,078 $ 8,093,381
Banking Fintech Other Consolidated
--- --- --- --- --- --- --- --- --- ---
Nine Months Ended September 30, 2021
Interest income $ 268,856 $ 129 $ 25 $ 269,010
Interest expense 48,967 — 896 49,863
Net interest income (loss) 219,889 129 (871 ) 219,147
Provision for loan and lease credit losses 11,292 — — 11,292
Noninterest income 82,459 42,361 1,624 126,444
Noninterest expense 158,877 3,355 9,057 171,289
Income tax expense (benefit) 19,143 10,008 (2,989 ) 26,162
Net income (loss) $ 113,036 $ 29,127 $ (5,315 ) $ 136,848
Total assets $ 7,984,677 $ 113,117 $ 39,547 $ 8,137,341
Nine Months Ended September 30, 2020
Interest income $ 205,269 $ — $ 99 $ 205,368
Interest expense 72,623 — 323 72,946
Net interest income (loss) 132,646 — (224 ) 132,422
Provision for loan and lease credit losses 32,024 — — 32,024
Noninterest income 60,842 12,884 1,471 75,197
Noninterest expense 132,988 3,971 3,282 140,241
Income tax expense (benefit) 5,778 2,987 (3,366 ) 5,399
Net income $ 22,698 $ 5,926 $ 1,331 $ 29,955
Total assets $ 7,998,576 $ 93,727 $ 1,078 $ 8,093,381

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following presents management’s discussion and analysis of the financial condition and results of operations of Live Oak Bancshares, Inc. (the “Company” or “LOB”). This discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included elsewhere in this quarterly report on Form 10-Q and with the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2020 (the "2020 Form 10-K"). Results of operations for the periods included in this quarterly report on Form 10-Q are not necessarily indicative of results to be obtained during any future period.

Important Note Regarding Forward-Looking Statements

This quarterly report on Form 10-Q contains statements that management believes are forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995.

These statements generally relate to the financial condition, results of operations, plans, objectives, future performance or business of Live Oak Bancshares, Inc. (the "Company"). They usually can be identified by the use of forward-looking terminology, such as “believes,” “expects,” or “are expected to,” “plans,” “projects,” “goals,” “estimates,” “will,” “may,” “should,” “could,” “would,” “continues,” “intends to,” “outlook” or “anticipates,” or variations of these and similar words, or by discussions of strategies that involve risks and uncertainties. You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to, those described in this Report. When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements management may make. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information actually known to the Company at the time. Management undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. Forward-looking statements contained in this Report are based on current expectations, estimates and projections about the Company’s business, management’s beliefs and assumptions made by management. These statements are not guarantees of the Company’s future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in the forward-looking statements. These risks, uncertainties and assumptions include, without limitation:

• deterioration in the financial condition of borrowers resulting in significant increases in the Company’s loan and lease losses and provisions for those losses and other adverse impacts to results of operations and financial condition;
• changes in Small Business Administration ("SBA") rules, regulations and loan products, including specifically the Section 7(a) program, changes in SBA standard operating procedures or changes to the status of Live Oak Banking Company (the "Bank") as an SBA Preferred Lender;
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• changes in rules, regulations or procedures for other government loan programs, including those of the United States Department of Agriculture (“USDA”);
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• changes in interest rates that affect the level and composition of deposits, loan demand and the values of loan collateral, securities, and interest sensitive assets and liabilities;
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• the failure of assumptions underlying the establishment of reserves for possible loan and lease losses;
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• changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments;
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• the potential impacts of the Coronavirus Disease 2019 (“COVID-19”) pandemic on trade (including supply chains and export levels), travel, employee productivity and other economic activities that may have a destabilizing and negative effect on financial markets, economic activity and customer behavior;
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• a reduction in or the termination of the Company’s ability to use the technology-based platform that is critical to the success of the Company’s business model or to develop a next-generation banking platform, including a failure in or a breach of the Company’s operational or security systems or those of its third party service providers;
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• changes in financial market conditions, either internationally, nationally or locally in areas in which the Company conducts operations, including reductions in rates of business formation and growth, demand for the Company’s products and services, commercial and residential real estate development and prices, premiums paid in the secondary market for the sale of loans, and valuation of servicing rights;
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• changes in accounting principles, policies, and guidelines applicable to bank holding companies and banking;
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• fluctuations in markets for equity, fixed-income, commercial paper and other securities, which could affect availability, market liquidity levels, and pricing;
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• the effects of competition from other commercial banks, non-bank lenders, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and mutual funds, and other financial institutions operating in the Company’s market area and elsewhere, including institutions operating regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone and the Internet;
--- ---
• the Company's ability to attract and retain key personnel;
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• changes in governmental monetary and fiscal policies as well as other legislative and regulatory changes, including with respect to SBA or USDA lending programs and investment tax credits;
--- ---
• changes in political and economic conditions, including as a result of the 2020 federal elections;
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• the impact of heightened regulatory scrutiny of financial products and services, primarily led by the Consumer Financial Protection Bureau and various state agencies;
--- ---
• the Company's ability to comply with any requirements imposed on it by regulators, and the potential negative consequences that may result;
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• operational, compliance and other factors, including conditions in local areas in which the Company conducts business such as inclement weather or a reduction in the availability of services or products for which loan proceeds will be used, that could prevent or delay closing and funding loans before they can be sold in the secondary market;
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• the effect of any mergers, acquisitions or other transactions, to which the Company or the Bank may from time to time be a party, including management’s ability to successfully integrate any businesses acquired;
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• adverse results, including related fees and expenses, from pending or future lawsuits, government investigations or private actions;
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• other risk factors listed from time to time in reports that the Company files with the SEC, including those described under “Risk Factors” in this Report; and
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• the Company’s success at managing the risks involved in the foregoing.
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Except as otherwise disclosed, forward-looking statements do not reflect: (i) the effect of any acquisitions, divestitures or similar transactions that have not been previously disclosed; (ii) any changes in laws, regulations or regulatory interpretations; or (iii) any change in current dividend or repurchase strategies, in each case after the date as of which such statements are made. All forward-looking statements speak only as of the date on which such statements are made, and the Company undertakes no obligation to update any statement, to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.

Amounts in all tables in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) have been presented in thousands, except percentage, time period, stock option, share and per share data or where otherwise indicated.

Nature of Operations

LOB is a financial holding company and a bank holding company headquartered in Wilmington, North Carolina incorporated under the laws of the state 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 incorporated in February 2008 as a North Carolina-chartered commercial bank. The Bank specializes in providing lending and deposit related services to small businesses nationwide. The Bank identifies and extends lending to credit-worthy borrowers within both specified industries, also called verticals, through expertise within those industries, and more broadly to select borrowers outside of those industries. A significant portion of the loans originated by the Bank are guaranteed by the SBA under the 7(a) Loan Program and the U.S. Department of Agriculture’s ("USDA") Rural Energy for America Program ("REAP"), Water and Environmental Program (“WEP”) and Business & Industry ("B&I") loan programs.

The Company’s wholly owned subsidiaries are the Bank, Government Loan Solutions (“GLS”), Live Oak Grove, LLC (“Grove”), Live Oak Ventures, Inc. (“Live Oak Ventures”), and Canapi Advisors, LLC (“Canapi Advisors”).

The Bank’s wholly owned subsidiaries are Live Oak Number One, Inc., Live Oak Clean Energy Financing LLC (“LOCEF”), and Live Oak Private Wealth, LLC.  Live Oak Number One, Inc. holds properties foreclosed on by the Bank. LOCEF provides financing to entities for renewable energy applications and became a wholly owned subsidiary of the Bank during the first quarter of 2019. Live Oak Private Wealth, LLC and its wholly owned subsidiary, Jolley Asset Management, LLC (“JAM”), provide high-net-worth individuals and families with strategic wealth and investment management services.

GLS is a management and technology consulting firm that advises and offers solutions and services to participants in the government guaranteed lending sector. GLS primarily provides services in connection with the settlement, accounting, and securitization processes for government guaranteed loans, including loans originated under the SBA 7(a) loan programs and USDA guaranteed loans. The Grove provides Company employees and business visitors an on-site restaurant location. Live Oak Ventures’ purpose is investing in businesses that align with the Company's strategic initiative to be a leader in financial technology.  Canapi Advisors provides investment advisory services to a series of funds (the “Canapi Funds”) focused on providing venture capital to new and emerging financial technology companies.

The Company generates revenue primarily from net interest income and secondarily through origination and sale of government guaranteed loans.  Income from the retention of loans is comprised principally of interest income.  The Company had historically elected to account for certain loans under the fair value option with interest reported in interest income and changes in fair value reported in the net (loss) gain on loans accounted for under the fair value option line item of the consolidated statements of income.  Beginning in the first quarter of 2021, the Company chose not to elect fair value for all retained participating interests arising from new government guaranteed loan sales.  Income from the sale of loans is comprised of loan servicing revenue and revaluation of related servicing assets along with net gains on sales of loans. Offsetting these revenues are the cost of funding sources, provision for loan and lease credit 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.  The Company also has generated gains and losses arising from its financial technology investments in its fintech segment, as discussed more fully later in this section entitled “Results of Segment Operations.”

Recent Developments

Indications of recovery from the COVID-19 pandemic are continuing to appear in the United States; however, the fallout continues to have a complex and significant adverse impact on certain areas of the economy, the banking industry and the Company, all of which are subject to a high degree of uncertainty. This uncertainty is magnified with the risk of a resurgence of the virus or new variants.  While it is not possible to know the full universe or extent of these impacts as of the date of this filing, we are disclosing potentially material items of which we are currently aware.

Financial position and results of operations

Relating to our September 30, 2021 financial condition and results of operations, improving conditions around COVID-19 continued to have a positive impact on the allowance for credit losses (“ACL”) on loans and leases and net interest income while these same improving conditions were mitigated by current market fluctuations influencing loans carried at fair value, loan servicing asset revaluation and net gains on sales of loans, as discussed below in MD&A.  With improving conditions, the ACL and resulting provision for loan and lease credit losses continue to slowly return to pre-pandemic levels relative to credit exposure.  The Company continues to monitor pandemic-at-risk verticals, and is seeing a substantial number of borrowers showing signs of recovery by making regular payments in the absence of payment deferrals and payment subsidies provided by the SBA.  Accordingly, total credit related reserves were also positively impacted by this continued improvement during the third quarter.  Refer to the discussion of the ACL and loans at fair value in Notes 5 and 9, respectively, of the Unaudited Condensed Consolidated Financial Statements as well as further discussion below in MD&A.  The net interest margin continued to be positively impacted by the continued recognition of Paycheck Protection Program (“PPP”) income as discussed more fully below in MD&A.  Should economic conditions worsen, the Company could experience significant levels of provision in the ACL and negative fair value marks and record additional credit or market related loss expense. It is also possible that the Company’s asset quality measures could worsen at future measurement periods if there is a continued resurgence of COVID-19 cases or variants.

The income from gain on sale of loans in future periods could also be reduced due to COVID-19, the termination of pandemic response programs or other economic factors.  At this time, the Company is unable to project the materiality of such impacts but anticipates that the breadth of the economic impact could impact gains in future periods.

Interest income could be further reduced due to COVID-19.  In accordance with guidance from banking regulators, the Company has worked and continues to work with COVID-19 affected borrowers to help defer their payments, interest, and fees.  In addition to regulatory relief on deferrals from banking regulators, payment relief was available from the SBA for certain loans guaranteed by that agency pursuant to the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) and subsequently by the below discussed Economic Aid Act.   While interest will still accrue to interest income through GAAP accounting, should eventual credit losses on these loans with deferred payments emerge, interest income accrued would need to be reversed.  In such a scenario, interest income in future periods could be negatively impacted.  As of September 30, 2021, the Company carried $302 thousand in accrued interest on outstanding loans with deferrals made to COVID-19 affected borrowers. At this time, the Company is unable to project the materiality of such an impact on future deferrals to COVID-19 borrowers, but recognizes the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.

Capital and liquidity

As of September 30, 2021, all of the Company’s capital ratios, and the Bank’s capital ratios, were in excess of all minimum regulatory requirements.  While the Company believes that capital is sufficient to withstand a double-dip economic recession if brought about by a resurgence in COVID-19, reported and regulatory capital ratios could be adversely impacted by further credit losses.  The Company relies on cash on hand as well as dividends from the Bank to service any debt at the Company.  If our capital deteriorates such that the Bank is unable to pay dividends to the Company for an extended period of time, the Company may not be able to service its debt.

The Company maintains access to multiple sources of liquidity.  Wholesale funding markets have remained open to the Company, but rates for short-term funding can be volatile and the secondary market for guaranteed loans has shown reactionary and varying responses to the changing economic environment.  If funding costs are elevated for an extended period of time, it could have an adverse effect on the Company’s net interest margin.  If an extended recession causes large numbers of the Company’s deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding.

The Federal Reserve created the Paycheck Protection Program Liquidity Facility (“PPPLF”) to help provide financing for the origination of PPP loans.  The PPPLF extends loans to banks that have loaned money to small businesses under the PPP, discussed in more detail below. Amounts borrowed are non-recourse and have a 100% advance rate equal to the principal amount of PPP loans pledged as security. In addition, loans financed under the PPPLF have a neutral impact on regulatory leverage capital ratios.  The maturity date of a borrowing under the PPPLF is equal to the maturity date of the PPP loan pledged to secure the borrowing and would be accelerated (i) if the underlying PPP loan goes into default and is transferred to the SBA to realize on the SBA guarantee or (ii) to the extent that any loan forgiveness reimbursement is received from the SBA. Borrowings under the PPPLF bear interest at a rate of 0.35%, and there are no fees paid by the Company.  As of September 30, 2021, the Company had outstanding borrowings of $526.0 million from the PPPLF.

Lending operations and accommodations to borrowers

With the establishment of the PPP administered by the SBA, the Company implemented new loan programs and systems using its technology platform while participating in assisting its customers and other small businesses in need of resources through the program.  PPP loans earn interest at 1% and currently have a two-year or five-year contractual term depending on the origination date.  For the earlier loans with a two-year term there is an option to extend to five years if agreed upon by the borrower and lender. The Company continues to receive substantial levels of forgiveness for these loans.  As of September 30, 2021, the Company carried 3,211 PPP loans on its balance sheet representing a book balance of $489.8 million, which includes $13.2 million in net deferred fees, expected to be amortized and recognized in interest income over the remaining lives of the loans.  In comparison, the Company carried 6,580 PPP loans on its balance sheet with a book balance of $927.3 million at June 30, 2021.  The Company recognized $10.9 million and $39.3 million of interest income in the third quarter and first nine months of 2021, respectively, related to amortization of net PPP fees.  Loans funded through the PPP are fully guaranteed by the SBA, subject to the terms and conditions of the program. Should those circumstances change, the Company could be required to record additional credit loss expense through earnings.

With the passage of the CARES Act on March 27, 2020, the SBA was making six months of principal and interest payments on all fully disbursed SBA 7(a) and SBA Express loans in regular servicing status that closed by September 25, 2020.   In addition, with regulatory guidance to work with borrowers during this unprecedented situation, the Company has also mobilized to provide a payment deferral program when needed by customers that are adversely affected by the pandemic. Depending on the demonstrated need of the client, the Company was deferring either the full loan payment or the principal component of the loan payment for 60 or 90 days.  In accordance with interagency guidance issued in March 2020, these short-term deferrals were not considered troubled debt restructurings.  After 60 or 90 days, borrowers may apply for an additional deferral.  In the absence of other intervening factors, such short-term modifications made on a good faith basis are not categorized as a troubled debt restructuring, nor are loans granted payment deferrals related to COVID-19 placed on non-accrual (provided the loans were not past due or on non-accrual status prior to the deferral). At September 30, 2021, and December 30, 2020, the Company estimated that as a percentage of total loans and leases at amortized cost, excluding PPP loans, 8% and 20%, respectively, of its loans were receiving the six months of payments from the SBA and that 0.5% and 11%, respectively, of its loans had a payment deferral in place.  The decrease in loans on payment deferral was largely a product of the Economic Aid Act introduced late in 2020, as discussed below.   The Company estimated that 8% of its loans and leases at amortized cost, excluding PPP loans, were receiving payments from the SBA and that 0.5% had a payment deferral in place as of October 31, 2021.  On October 2, 2020, the SBA began approving PPP forgiveness applications and remitting forgiveness payments to PPP lenders for PPP borrowers.  As of October 31, 2021, the Company has received approximately $1.90 billion in PPP loan forgiveness from approximately 12,600, or 85% of total PPP loans originated by count.

On December 27, 2020 the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “Economic Aid Act”) was enacted which allows the SBA to make payments of up to $9,000 per month for up to six months of principal and interest payments on certain fully disbursed SBA 7(a) and SBA 504 loans in regular servicing status based upon the origination date.  In addition, this legislation increased the 75% guarantee on many SBA 7(a) loans to 90%, among other things.

Credit

While some industries have experienced and continue to experience impacts as a result of COVID-19, the Company has $472.5 million in total unguaranteed exposure in six verticals considered by management to be “at-risk” of significant impact: hotels, educational services, wine and craft beverage, entertainment centers, fitness centers, and quick service restaurants, each comprising $127.5 million or 4.1%, $117.9 million or 3.8%, $97.8 million or 3.1%, $49.0 million or 1.6%, $41.3 million or 1.3%, and $39.0 million or 1.3% of total unguaranteed loans and leases (all at amortized cost, inclusive of loans carried at fair value) as of September 30, 2021, respectively.  A substantial number of borrowers continue to show signs of recovery by making regular payments in the absence of payment deferrals and payment subsidies provided by the SBA.  As of September 30, 2021 there are only 17 loans with an aggregate balance of $20.8 million in at-risk verticals still on payment deferral and 30 that continue to receive SBA payment subsidies with an aggregate balance of $53.8 million.  While the third quarter reflected positive signs of emerging from at-risk status, management continues to closely monitor these vulnerable verticals for signs of weakness.

The Company continues to work with customers directly affected by COVID-19 and is prepared to offer short-term assistance in accordance with regulatory guidelines.  As a result of the uncertain economic environment caused by COVID-19, the Company continues to engage in more frequent communication with borrowers in an effort to better understand their situation and the challenges faced as circumstances evolve, which the Company anticipates will enable it to respond proactively as needs and issues arise.

Results of Operations

Performance Summary

Three months ended September 30, 2021 compared with three months ended September 30, 2020

For the three months ended September 30, 2021, the Company reported net income of $33.8 million, or $0.76 per diluted share, compared to net income of $33.8 million, or $0.81 per diluted share, for the third quarter of 2020.  While net income was relatively the same for both periods, the primary changes are described in the following items:

Increasing net income:

• Increase in net interest income of $26.4 million, or 51.3%, predominately driven by significant growth in total loan and lease portfolios combined with lower costs of interest bearing deposits;
• A decrease in the provision for loan and lease credit losses of $6.0 million, or 58.0%;
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• Increased net gains on sales of loans of $6.2 million, or 48.6%; and
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• Decreased income tax expense of $2.3 million primarily due to renewable energy tax credit investment activities.
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Decreasing net income:

• A net loss on the loan servicing asset revaluation of $5.9 million, increasing by $7.9 million, or 385.2%, compared to a net gain of $2.1 million for the third quarter of 2020;
• A net loss on loans accounted for under the fair value option of $1.0 million, increasing by $4.4 million, or 130.3%, compared to a net gain of $3.4 million for the third quarter of 2020;
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• Decrease in equity security gains of $14.5 million.  Gains in the third quarter of 2020 were principally comprised of $13.7 million associated with the Company’s investment in Greenlight Financial Technologies, Inc. (“Greenlight”); and
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• An increase in total noninterest expense of $12.8 million, or 30.0%, comprised principally of increased salaries and employee benefits of $4.0 million, travel expense of $1.6 million, professional services of $2.9 million and data processing of $1.9 million.
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Nine months ended September 30, 2021 compared with nine months ended September 30, 2020

For the nine months ended September 30, 2021, the Company reported a net income of $136.8 million, or $3.05 per diluted share, as compared to $30.0 million, or $0.73 per diluted share, for the nine months ended September 30, 2020.  This increase in net income was largely due to the following items:

• Increase in net interest income of $86.7 million, or 65.5%, also predominately driven by significant growth in total loan and lease portfolios combined with lower costs of interest bearing deposits;
• A decrease in the provision for loan and lease credit losses of $20.7 million, or 64.7%;
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• Increased net gains on sales of loans of $12.5 million, or 36.3%;
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• A net gain on loans accounted for under the fair value option of $4.3 million, increasing by $12.6 million, or 151.9%, compared to a net loss of $8.3 million for the first nine months of 2020;
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• Increase in equity security gains of $29.7 million.  This increase is principally the result of a second quarter 2021 gain of $44.1 million associated with the Company’s investment in Greenlight.
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Key factors partially offsetting the increase in net income for the first nine months of 2021 were:

• An increase in total noninterest expense of $31.0 million, or 22.1%, comprised principally of increased salaries and employee benefits of $9.4 million, travel expense of $1.6 million, professional services of $6.7 million, data processing of $4.1 million, loan related expenses of $2.5 million, renewable energy tax credit investment impairment of $3.2 million and other expense of $3.4 million; and
• Increased income tax expense of $20.8 million primarily due to the above discussed increase in net income.
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Net Interest Income and Margin

Net interest income represents the difference between the income that the Company earns on interest-earning assets and the cost of interest-bearing liabilities. The Company’s net interest income depends upon the volume of interest-earning assets and interest-bearing liabilities and the interest rates that the Company earns or pays on them, respectively. Net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as “volume changes.” It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as “rate changes.” As a bank without a branch network, the Bank gathers deposits over the Internet and in the community in which it is headquartered. Due to the nature of a branchless bank and the relatively low overhead required for deposit gathering, the rates that the Bank offers are generally above the industry average.

Three months ended September 30, 2021 compared with three months ended September 30, 2020

For the three months ended September 30, 2021, net interest income increased $26.4 million, or 51.3%, to $77.7 million compared to $51.4 million for the three months ended September 30, 2020. The increase was principally due to the significant growth in the loan and lease portfolios reflecting the Company's ongoing initiative to grow recurring revenue sources combined with lower costs of interest bearing deposits.  Accordingly, average interest earning assets increased by $377.9 million, or 5.1%, to $7.74 billion for the three months ended September 30, 2021, compared to $7.36 billion for the three months ended September 30, 2020, while the yield on average interest earning assets increased 71 basis points to 4.76%. The cost of funds on interest bearing liabilities for the three months ended September 30, 2021 decreased 47 basis points to 0.80%, and the average balance of interest bearing liabilities increased by $25.3 million, or 0.3%, over the same period in 2020. While average interest bearing liabilities were largely flat between periods there was increased levels of interest bearing deposits to support continued loan originations and growth.  Largely offsetting the increase in interest bearing deposits was curtailment of sizable PPPLF borrowings as PPP loan forgiveness continues. As indicated in the rate/volume table below, increased interest earning asset volume and yields, outpaced the higher volume and greater levels of cost declines of interest bearing liabilities, resulting in increases to interest income of $17.7 million and decreases to interest expense of $8.7 million for the three months ended September 30, 2021 compared to the three months ended September 30, 2020.  For the three months ended September 30, 2020, compared to the three months ended September 30, 2021, net interest margin increased from 2.77% to 3.99%, respectively, due to significant loan portfolio growth and the maturity of longer term deposits which are repricing at lower rates.

Nine months ended September 30, 2021 compared with nine months ended September 30, 2020

For the nine months ended September 30, 2021, net interest income increased $86.7 million, or 65.5%, to $219.1 million compared to $132.4 million for the nine months ended September 30, 2020. The increase was principally due to the significant growth in the loan and lease portfolios reflecting the Company's ongoing strategy to grow recurring revenue sources combined with lower costs of interest bearing deposits. This increase over the prior year was further enhanced by the origination of $547.5 million in PPP loans during the nine months ended September 30, 2021, with a $25.6 million increase in interest income related to the amortization of net deferred fees combined with a 1% annualized interest rate.  Accordingly, average interest earning assets increased by $1.59 billion, or 26.0%, to $7.69 billion for the nine months ended September 30, 2021, compared to $6.10 billion for the nine months ended September 30, 2020, while the yield on average interest earning assets increased 20 basis points to 4.68%. The cost of funds on interest bearing liabilities for the nine months ended September 30, 2021 decreased 72 basis points to 0.89%, while the average balance of interest bearing liabilities increased by $1.45 billion, or 23.9%, over the same period in 2020. The increase in average interest bearing liabilities was largely driven by funding for significant loan originations and growth from the prior year.  As indicated in the rate/volume table below, increased interest earning asset volume and yields outpaced the higher volume and greater levels of cost declines of interest bearing liabilities, resulting in increases to interest income of $63.6 million and decreases to interest expense of $23.1 million for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020.  For the nine months ended September 30, 2020 compared to the nine months ended September 30, 2021, net interest margin increased from 2.89% to 3.81%, respectively, due primarily to recognition of PPP related income, which is being accelerated with forgiveness efforts, in combination with significant loan portfolio growth and the maturity of longer term deposits which are repricing at lower rates.

Average Balances and Yields. The following table presents information regarding average balances for assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amount of interest expense on average interest-bearing liabilities, and the resulting average yields and costs. The yields and costs for the periods indicated are derived by dividing the income or expense by the average balances for assets or liabilities, respectively, for the periods presented and annualizing that result. Loan fees are included in interest income on loans.

Three Months Ended September 30,
2021 2020
Average<br><br><br>Balance Interest Average<br><br><br>Yield/Rate Average<br><br><br>Balance Interest Average<br><br><br>Yield/Rate
Interest earning assets:
Interest earning balances in other banks $ 452,830 $ 221 0.19 % 681,408 320 0.19 %
Federal funds sold 9,260 3 0.13 54,979 14 0.10
Investment securities 808,697 3,174 1.56 755,412 4,123 2.17
Loans held for sale 1,098,940 15,090 5.45 1,084,019 14,399 5.27
Loans and leases held for<br><br><br>investment^(1)^ 5,366,088 74,298 5.49 4,782,051 56,222 4.66
Total interest earning assets 7,735,815 92,786 4.76 7,357,869 75,078 4.05
Less: Allowance for credit losses on loans<br><br><br>and leases (56,411 ) (44,054 )
Non-interest earning assets 581,771 778,855
Total assets $ 8,261,175 $ 8,092,670
Interest bearing liabilities:
Interest bearing checking $ — $ — — % $ 500,007 $ 747 0.59 %
Savings 3,367,168 4,359 0.51 1,669,199 3,674 0.87
Money market accounts 104,576 74 0.28 95,151 83 0.35
Certificates of deposit 3,156,834 9,726 1.22 3,423,643 17,651 2.05
Total deposits 6,628,578 14,159 0.85 5,688,000 22,155 1.55
Borrowings 818,511 892 0.43 1,733,805 1,560 0.36
Total interest bearing liabilities 7,447,089 15,051 0.80 7,421,805 23,715 1.27
Non-interest bearing deposits 79,006 43,993
Non-interest bearing liabilities 46,907 55,353
Shareholders' equity 688,173 571,519
Total liabilities and<br><br><br>shareholders' equity $ 8,261,175 $ 8,092,670
Net interest income and interest<br><br><br>rate spread $ 77,735 3.96 % $ 51,363 2.78 %
Net interest margin 3.99 % 2.77 %
Ratio of average interest-earning<br><br><br>assets to average interest-bearing<br><br><br>liabilities 103.88 % 99.14 %
(1) Average loan and lease balances include non-accruing loans and leases.
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Nine Months Ended September 30,
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2021 2020
Average<br><br><br>Balance Interest Average<br><br><br>Yield/Rate Average<br><br><br>Balance Interest Average<br><br><br>Yield/Rate
Interest earning assets:
Interest earning balances in other banks $ 433,219 $ 752 0.23 % $ 476,243 $ 1,823 0.51 %
Federal funds sold 22,151 19 0.11 83,799 270 0.43
Investment securities 769,890 9,078 1.58 616,386 11,671 2.52
Loans held for sale 1,127,924 45,383 5.38 1,026,104 43,379 5.63
Loans and leases held for<br><br><br>investment^(1)^ 5,336,824 213,778 5.36 3,899,277 148,225 5.06
Total interest earning assets 7,690,008 269,010 4.68 6,101,809 205,368 4.48
Less: Allowance for credit losses on loans<br><br><br>and leases (53,589 ) (35,675 )
Non-interest earning assets 599,902 629,552
Total assets $ 8,236,321 $ 6,695,686
Interest bearing liabilities:
Interest bearing checking $ 102,566 $ 442 0.58 % $ 321,649 $ 1,393 0.58 %
Savings 2,945,535 12,180 0.55 1,398,146 13,332 1.27
Money market accounts 105,048 239 0.30 85,263 272 0.42
Certificates of deposit 3,129,084 33,062 1.41 3,425,109 55,534 2.16
Total deposits 6,282,233 45,923 0.98 5,230,167 70,531 1.80
Borrowings 1,203,240 3,940 0.44 809,323 2,415 0.40
Total interest bearing liabilities 7,485,473 49,863 0.89 6,039,490 72,946 1.61
Non-interest bearing deposits 76,304 44,709
Non-interest bearing liabilities 43,819 53,142
Shareholders' equity 630,725 558,345
Total liabilities and<br><br><br>shareholders' equity $ 8,236,321 $ 6,695,686
Net interest income and interest<br><br><br>rate spread $ 219,147 3.79 % $ 132,422 2.87 %
Net interest margin 3.81 % 2.89 %
Ratio of average interest-earning<br><br><br>assets to average interest-bearing<br><br><br>liabilities 102.73 % 101.03 %
(1) Average loan and lease balances include non-accruing loans and leases.
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Rate/Volume Analysis. The following table sets forth the effects of changing rates and volumes on net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, increases or decreases attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume.

Three Months Ended September 30, Nine Months Ended September 30,
2021 vs. 2020 2021 vs. 2020
Increase (Decrease) Due to Increase (Decrease) Due to
Rate Volume Total Rate Volume Total
Interest income:
Interest earning balances in other<br><br><br>banks $ 10 $ (109 ) $ (99 ) $ (951 ) $ (120 ) $ (1,071 )
Federal funds sold 2 (13 ) (11 ) (125 ) (126 ) (251 )
Investment securities (1,199 ) 250 (949 ) (4,951 ) 2,358 (2,593 )
Loans held for sale 489 202 691 (2,197 ) 4,201 2,004
Loans and leases held for investment 10,600 7,476 18,076 9,438 56,115 65,553
Total interest income 9,902 7,806 17,708 1,214 62,428 63,642
Interest expense:
Interest bearing checking — (747 ) (747 ) (5 ) (946 ) (951 )
Savings (2,283 ) 2,968 685 (11,729 ) 10,577 (1,152 )
Money market accounts (16 ) 7 (9 ) (87 ) 54 (33 )
Certificates of deposit (6,826 ) (1,099 ) (7,925 ) (18,508 ) (3,964 ) (22,472 )
Borrowings 243 (911 ) (668 ) 292 1,233 1,525
Total interest expense (8,882 ) 218 (8,664 ) (30,037 ) 6,954 (23,083 )
Net interest income $ 18,784 $ 7,588 $ 26,372 $ 31,251 $ 55,474 $ 86,725

Provision for Loan and Lease Credit Losses

The provision for loan and lease credit losses represents the amount necessary to be charged against the current period’s earnings to maintain the ACL on loans and leases at a level that the Company believes is appropriate in relation to the estimated losses inherent in the loan and lease portfolio.

Losses inherent in loan relationships are mitigated if a portion of the loan is guaranteed by the SBA or USDA. Typical SBA 7(a) and USDA guarantees range from 50% to 90% depending on loan size and type, which serve to reduce the risk profile of these loans. The Company believes that its focus on compliance with regulations and guidance from the SBA and USDA are key factors to managing this risk.

For the third quarter of 2021, there was a provision for loan and lease credit losses of $4.3 million compared to $10.3 million for the same period in 2020, a decrease in provision of $6.0 million.  For the first nine months of 2021, there was a provision for loan and lease credit losses of $11.3 million compared to $32.0 million for the same period in 2020, a decrease in provision of $20.7 million. The decrease in provision for both periods was primarily the result of continued improvement in forecasts related to employment and default expectations combined with the effects of the below discussed performance metrics, partially offset by the impact of growth in the Company’s loan and lease portfolios.

Loans and leases held for investment at historical cost were $4.72 billion as of September 30, 2021, increasing by $529.2 million, or 12.6%, compared to September 30, 2020.  Excluding PPP loans and net unearned fees on those loans, the balance in loans and leases held for investment at historical cost was $4.23 billion at September 30, 2021, an increase of $1.75 billion, or 70.8%, over September 30, 2020.  This growth outside of PPP activity was fueled by robust loan originations.

Net charge-offs for loans and leases carried at historical cost were $2.5 million, or 0.21% of average quarterly loans and leases held for investment, carried at historical cost, on an annualized basis, for the three months ended September 30, 2021, compared to net charge-offs of $10.1 million, or 1.03%, for the three months ended September 30, 2020.   For the nine months ended September 30, 2021, net charge-offs totaled $3.9 million compared to $14.7 million for the nine months ended September 30, 2020, a decrease of $10.8 million, or 73.4%. The decrease in net charge-offs for the three and nine months ended September 31, 2021 as compared to the same periods of 2020 was principally the result of a third quarter of 2020 reclassification of fifteen hotel loans from held for investment to held for sale totaling $81.2 million in net investment.  This third quarter of 2020 reclassification resulted in a write down reflected in charge-offs of $9.8 million.  Net charge-offs are a key element of historical experience in the Company's estimation of the allowance for credit losses on loans and leases.

In addition, nonperforming loans and leases not guaranteed by the SBA or USDA, excluding $6.3 million and $7.5 million accounted for under the fair value option at September 30, 2021 and 2020, respectively, totaled $20.5 million, which was 0.43% of the held for investment loan and lease portfolio carried at historical cost at September 30, 2021, compared to $20.2 million, or 0.48% of loans and leases held for investment at September 30, 2020.  Nonperforming loans and leases carried at historical cost which are not guaranteed by the SBA or USDA were 0.48% and 0.81% of the historical cost portion of the held for investment loan and lease portfolio, excluding PPP loans, at September 30, 2021 and 2020, respectively.

Noninterest Income

Noninterest income is principally comprised of net gains from the sale of SBA and USDA-guaranteed loans along with loan servicing revenue and related revaluation of the servicing asset. Revenue from the sale of loans depends upon the volume, maturity structure and rates of underlying loans as well as the pricing and availability of funds in the secondary markets prevailing in the period between completed loan funding and closing of sale. In addition, the loan servicing revaluation is significantly impacted by changes in market rates and other underlying assumptions such as prepayment speeds and default rates. Net gain (loss) on loans accounted for under the fair value option is also significantly impacted by changes in market rates, prepayment speeds and inherent credit risk.  Other less common elements of noninterest income include less consistent gains and losses on investments.

The following table shows the components of noninterest income and the dollar and percentage changes for the periods presented.

Three Months Ended September 30, 2021/2020 Increase (Decrease)
2021 2020 Amount Percent
Noninterest income
Loan servicing revenue $ 6,278 $ 6,803 $ (525 ) (7.72 )%
Loan servicing asset revaluation (5,878 ) 2,061 (7,939 ) (385.20 )
Net gains on sales of loans 18,860 12,690 6,170 48.62
Net (loss) gain on loans accounted for under the fair<br><br><br>value option (1,030 ) 3,403 (4,433 ) (130.27 )
Equity method investments income (loss) (1,250 ) (1,231 ) (19 ) (1.54 )
Equity security investments gains (losses), net 176 14,705 (14,529 ) (98.80 )
Gain on sale of investment securities<br><br><br>available-for-sale, net — 1,225 (1,225 ) (100.00 )
Lease income 2,527 2,634 (107 ) (4.06 )
Management fee income 1,489 1,296 193 14.89
Other noninterest income 4,104 3,458 646 18.68
Total noninterest income $ 25,276 $ 47,044 $ (21,768 ) (46.27 )%
Nine Months Ended September 30, 2021/2020 Increase (Decrease)
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2021 2020 Amount Percent
Noninterest income
Loan servicing revenue $ 18,930 $ 19,916 $ (986 ) (4.95 )%
Loan servicing asset revaluation (7,566 ) (4,202 ) (3,364 ) (80.06 )
Net gains on sales of loans 47,023 34,497 12,526 36.31
Net gain (loss) on loans accounted for under the fair<br><br><br>value option 4,323 (8,324 ) 12,647 151.93
Equity method investments income (loss) (4,685 ) (5,952 ) 1,267 21.29
Equity security investments gains (losses), net 44,534 14,802 29,732 200.86
Gain on sale of investment securities<br><br><br>available-for-sale, net — 1,880 (1,880 ) (100.00 )
Lease income 7,742 7,893 (151 ) (1.91 )
Management fee income 4,896 4,146 750 18.09
Other noninterest income 11,247 10,541 706 6.70
Total noninterest income $ 126,444 $ 75,197 $ 51,247 68.15 %

For the three months ended September 30, 2021, noninterest income decreased by $21.8 million, compared to the three months ended September 30, 2020.  The decrease from the prior year is primarily the result of the aforementioned decrease in in equity security gains of $14.5 million associated with the Company’s $13.7 million gain in Greenlight during the third quarter of 2020, a higher net loss on the loan servicing asset of $7.9 million and a decrease in net gain on loans accounted for under the fair value option of $4.4 million.

For the nine months ended September 30, 2021, noninterest income increased by $51.2 million, compared to the nine months ended September 30, 2020.  The increase from the prior year is primarily the result of increased net gains on sales of loans of $12.5 million, an increase in equity security gains of $29.7 million, principally the result of a second quarter 2021 gain of $44.1 million associated with the Company’s investment in Greenlight and an increased net gain on loans accounted for under the fair value option of $12.6 million.  Both gains on loans accounted for under the fair value option and net gains on sales of loans were a product of improved market conditions in 2021.

The following table reflects loan and lease production, sales of guaranteed loans and the aggregate balance in guaranteed loans sold. These components are key drivers of the Company's noninterest income.

Three months ended September 30, Three months ended June 30, Three months ended March 31,
2021 2020 2021 2020 2021 2020
Amount of loans and leases<br><br><br>originated $ 1,063,190 $ 966,499 $ 1,153,693 $ 2,175,055 $ 1,180,219 $ 500,634
Guaranteed portions<br><br><br>of loans sold 201,903 114,731 130,858 154,980 136,747 162,297
Outstanding balance of<br><br><br>guaranteed loans sold ^(1)^ 2,731,031 2,878,664 2,694,931 2,840,429 2,843,963 2,761,015
Nine Months Ended September 30, For years ended December 31,
--- --- --- --- --- --- --- --- --- --- --- --- ---
2021 2020 2020 2019 2018 2017
Amount of loans and leases<br><br><br>originated $ 3,397,102 $ 3,642,188 $ 4,450,198 $ 2,001,886 $ 1,765,680 $ 1,934,238
Guaranteed portions of<br><br><br>loans sold 469,508 432,008 542,596 340,374 945,178 787,926
Outstanding balance of<br><br><br>guaranteed loans sold^(1)^ 2,731,031 2,878,664 2,819,625 2,746,840 3,045,460 2,680,641
(1) This represents the outstanding principal balance of guaranteed loans serviced, as of the last day of the applicable period, which have been sold into the secondary market.
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Changes in various components of noninterest income are discussed in more detail below.

Loan Servicing Revaluation: The Company revalues its serviced loan portfolio at least quarterly. The revaluation considers the amortization of the portfolio, current market conditions for loan sale premiums, and current prepayment speeds. For the three months ended September 30, 2021, loan servicing revaluation decreased $7.9 million, or 385.2%, compared to the three months ended September 30, 2020.  For the nine months ended September 30, 2021, loan servicing revaluation decreased $3.4 million, or 80.1%, as compared to the nine months ended September 30, 2020. The lower servicing valuation for the quarter over quarter and year over year periods is principally due to the amortization of the guaranteed serviced loan portfolio combined with increased inventory levels in the market.

Net Gains on Sale of Loans: For the three months ended September 30, 2021, net gains on sales of loans increased $6.2 million, or 48.6%, compared to the three months ended September 30, 2020. For the three months ended September 30, 2021, the volume of guaranteed loans sold increased $87.2 million, or 76.0%, to $201.9 million from $114.7 million for the three months ended September 30, 2020 and the average net gain on guaranteed loan sales decreased from $110.2 thousand to $91.0 thousand, per million sold, in the third quarters of 2020 and 2021, respectively.  The overall increase in loan sale volume in the third quarter of 2021 drove the increase in net gains on sales of loans over the third quarter of 2020, while the gain per million was reduced largely due to the mix of loans being sold and to a lesser extent lower market premiums arising from negative market conditions discussed above.

For the nine months ended September 30, 2021, net gains on sales of loans increased $12.5 million, or 36.3%, compared to the nine months ended September 30, 2020. For the nine months ended September 30, 2021, the volume of guaranteed loans sold increased $37.5 million, or 8.7%, to $469.5 million from $432.0 million for the nine months ended September 30, 2020 and the average net gain on guaranteed loan sales increased from $77.2 thousand to $95.5 thousand, per million sold, in the first nine months of 2020 and 2021, respectively.  With higher loan sale volume and higher premium levels in the secondary market in the first nine months of 2021 compared to the same period of 2020, the average net gain on guaranteed loan sales increased, largely as a result of improvement in market premium levels which were magnified by stimulus associated with the SBA program which removes the ongoing guarantee fee, typically paid by the purchaser, on loans originated under the Economic Aid Act. The magnitude of the increase in net gains on sale of loans was muted somewhat due the Company’s choice to not elect fair value for all retained participating interests arising from new government guaranteed loan sales beginning in the first quarter of 2021. Not electing fair value generally results in a larger discount, which will reduce the amount of gain recognized at the date of sale. This larger discount is subsequently accreted into interest income over the underlying loan’s remaining term using the effective interest method. Management made this change of election in alignment with its ongoing effort to reduce volatility and drive more predictable revenue. In accordance with accounting standards, any loans for which fair value was previously elected continue to be measured as such.

Net (Loss) Gain on Loans Accounted for Under the Fair Value Option:  For the three months ended September 30, 2021, the net loss on loans accounted for under the fair value option increased $4.4 million, or 130.3%, compared to the three months ended September 30, 2020.  For the nine months ended September 30, 2021, the net gain on loans accounted for under the fair value option increased $12.6 million, or 151.9%, compared to the nine months ended September 30, 2020.  The carrying amount of loans accounted for under the fair value option at September 30, 2021 and 2020 was $725.4 million ($27.4 million classified as held for sale and $698.0 million classified as held for investment) and $876.2 million ($30.4 million classified as held for sale and $845.7 million classified as held for investment), respectively, a decrease of $150.8 million, or 17.2%.  The net loss on loans accounted for under the fair value option during third quarter of 2021 was largely due to negative market conditions discussed above while the net gain in the first nine months of 2021 was largely due to improving market conditions compared to COVID-19 pandemic economic impacts in the prior year.

Noninterest Expense

Noninterest expense comprises all operating costs of the Company, such as employee related costs, travel, professional services, advertising and marketing expenses, exclusive of interest and income tax expense.

The following table shows the components of noninterest expense and the related dollar and percentage changes for the periods presented.

Three Months Ended September 30, 2021/2020 Increase (Decrease)
2021 2020 Amount Percent
Noninterest expense
Salaries and employee benefits $ 28,202 $ 24,203 $ 3,999 16.52 %
Non-staff expenses:
Travel expense 1,819 250 1,569 627.60
Professional services expense 4,251 1,346 2,905 215.82
Advertising and marketing expense 1,631 552 1,079 195.47
Occupancy expense 2,042 2,079 (37 ) (1.78 )
Data processing expense 4,867 3,009 1,858 61.75
Equipment expense 4,567 4,314 253 5.86
Other loan origination and maintenance expense 3,489 2,669 820 30.72
Renewable energy tax credit investment impairment 60 — 60 100.00
FDIC insurance 1,670 2,095 (425 ) (20.29 )
Other expense 2,861 2,133 728 34.13
Total non-staff expenses 27,257 18,447 8,810 47.76
Total noninterest expense $ 55,459 $ 42,650 $ 12,809 30.03 %
Nine Months Ended September 30, 2021/2020 Increase (Decrease)
--- --- --- --- --- --- --- --- --- --- ---
2021 2020 Amount Percent
Noninterest expense
Salaries and employee benefits $ 92,468 $ 83,048 $ 9,420 11.34 %
Non-staff expenses:
Travel expense 4,027 2,395 1,632 68.14
Professional services expense 11,411 4,668 6,743 144.45
Advertising and marketing expense 3,158 2,537 621 24.48
Occupancy expense 6,378 6,455 (77 ) (1.19 )
Data processing expense 12,995 8,930 4,065 45.52
Equipment expense 13,306 13,601 (295 ) (2.17 )
Other loan origination and maintenance expense 10,123 7,617 2,506 32.90
Renewable energy tax credit investment impairment 3,187 — 3,187 100.00
FDIC insurance 5,139 5,326 (187 ) (3.51 )
Other expense 9,097 5,664 3,433 60.61
Total non-staff expenses 78,821 57,193 21,628 37.82
Total noninterest expense $ 171,289 $ 140,241 $ 31,048 22.14 %

Total noninterest expense for the three and nine months ended September 30, 2021, increased $12.8 million, or 30.0%, and $31.0 million, or 22.1%, respectively, compared to the same periods in 2020. The increase in noninterest expense for the comparable three and nine month periods was largely driven by various components, as discussed below.

Salaries and employee benefits: Total personnel expense for the three and nine months ended September 30, 2021 increased by $4.0 million, or 16.5%, and $9.4 million, or 11.3%, respectively, compared to the same periods in 2020.  The increase in salaries and employee benefits for both periods was principally related to continued investment in human resources to support strategic and growth initiatives.  Total full-time equivalent employees increased from 628 at September 30, 2020, to 755 at September 30, 2021.  Salaries and employee benefits expense included $3.7 million and $12.8 million of stock-based compensation for the three and nine months ended September 30, 2021, respectively, compared to $3.3 million and $9.5 million for the three and nine months ended September 30, 2020, respectively.  Expenses related to the employee stock purchase program, stock grants, stock option compensation and restricted stock expense are all considered stock-based compensation.

Travel expense:  For the three and nine months ended September 30, 2021, travel expenses increased $1.6 million, or 627.6%, and $1.6 million, or 68.1%, respectively, compared to the same periods in 2020.  Travel expenses increased primarily to support the growth in loan origination volume and customer base as travel restrictions have continued to ease in recent months.

Professional services expense:  For the three and nine months ended September 30, 2021, professional services expense increased $2.9 million, or 215.8%, and $6.7 million, or 144.5%, respectively, compared to the same periods in 2020.  The increase compared to the prior periods was largely driven by an increase in legal fees related to the previously disclosed letter the Company received in December 2020 and the resulting putative class action filed against the Company and other parties in March 2021.  See Note 10. Commitments and Contingencies for additional information.

Data processing expense: Total data processing expense for the three and nine months ended September 30, 2021 increased by $1.9 million, or 61.8%, and $4.1 million, or 45.5%, respectively, compared to the same periods in 2020.  The increase for both periods was principally due to enhanced investments in the Company’s internal software technology resources.

Loan related expenses:  Total loan related expenses for the three and nine months ended September 30, 2021 increased by $820 thousand, or 30.7%, and $2.5 million, or 32.9%, respectively, compared to the same periods in 2020.  The nine month over nine month increase was principally due to heightened levels of SBA guaranty fees arising from the Company retaining more guaranteed loans.

Renewable energy tax credit investment impairment:  For the nine months ended September 30, 2021, the Company recognized $3.1 million in impairment charges related to a $3.9 million renewable energy tax credit investment that was fully funded during the first quarter of 2021. Investments of this type generate a return primarily through the realization of income tax credits and other benefits; accordingly, impairment of the investment amount is recognized in conjunction with the realization of related tax benefits. This investment generated a federal investment tax credit of $3.4 million which is included in the Company’s estimated annual effective tax rate.

Other expense:  For the three and nine months ended September 30, 2021, other expense increased $728 thousand, or 34.1%, and $3.4 million, or 60.6%, respectively, compared to the same periods in 2020.  The increase over the first nine months of 2020 was primarily driven by a $1.2 million increase in charitable donations combined with $904 thousand of impairment expense on solar panels due to lower than expected energy production capability recognized in the first quarter of 2021.  Also included in other expense is a $3.9 million accrual related to the settlement of a putative class action filed against the Company and other parties in March 2021 for which the Company entered into a final settlement agreement on October 12, 2021.  See Note 10. Commitments and Contingencies for additional information.  Largely offsetting this $3.9 million accrual in the third quarter of 2021 is a $3.7 million receivable related to an insurance recovery in regards to the same litigation.

Income Tax Expense

For the three months ended September 30, 2021, income tax expense decreased by $2.3 million, while the Company’s effective tax rates were 21.7% and 25.7%, respectively, as compared to the same period in 2020.  The lower effective rate for the third quarter of 2021 is principally due to earlier discussed items related to renewable energy tax credit investments.

For the nine months ended September 30, 2021, income tax expense was $26.2 million compared to $5.4 million for the first nine months of 2020, and the Company’s effective tax rates were 16.0% and 15.3%, respectively.  The effective rate for the first nine months of 2021 is principally due to the impact of renewable energy tax credit investments and vesting of approximately 576 thousand restricted stock unit awards with market price conditions, as the fair value of these awards exceeded the total compensation cost recognized by the Company for book purposes.  The effective rate during the first nine months of 2020 was partially a result of a discrete, estimated income tax benefit of $3.7 million related to the enactment of the CARES Act on March 27, 2020.  The CARES Act allows taxpayers to carryback certain net operating losses to each of the five taxable years preceding the taxable year of such losses.  As a result, the Company was allowed to carryback its 2018 net operating loss which had been utilized and measured under the prior law using a 21% corporate income tax rate to pre-2018 taxable years during which the corporate income tax rate was 35%.

Results of Segment Operations

The Company’s operations are managed along two primary operating segments Banking and Fintech.  A description of each business and the methodologies used to measure financial performance is described in Note 12. Segments in the accompanying Notes to the Unaudited Condensed Consolidated Financial Statements.  Net income (loss) by operating segment is presented below:

Three Months Ended<br><br><br>September 30, Nine Months Ended<br><br><br>September 30,
2021 2020 2021 2020
Banking $ 39,052 $ 23,925 $ 113,036 $ 22,698
Fintech (1,300 ) 10,108 29,127 5,926
Other (3,913 ) (253 ) (5,315 ) 1,331
Consolidated net income $ 33,839 $ 33,780 $ 136,848 $ 29,955

Banking

For the three and nine months ended September 30, 2021, net income increased $15.1 million and $90.3 million, respectively, compared to the same periods of 2020.  The increase for both periods was primarily the result of increased net interest income and lower levels of provision expense while the year to date period was also significantly increased due to higher levels of noninterest income.

For the three and nine months ended September 30, 2021, net interest income increased $26.7 million, or 52.0%, and $87.2 million, or 65.8%, respectively, compared to the same periods of 2020.  See the analysis of net interest income included in the above section captioned “Net Interest Income and Margin” as it is predominantly related to the Banking segment.

See the analysis of provision for loan and lease credit losses included in the above section captioned “Provision for Loan and Lease Credit Losses” as it is entirely related to the Banking segment.

For the three and nine months ended September 30, 2021, noninterest income decreased $4.7 million and increased $21.6 million, respectively, compared to the same periods of 2020.  The quarter over quarter decrease was largely comprised of an increase in the net loss on the loan servicing asset revaluation of $7.9 million, or 385.2% combined with a net loss on loans accounted for under the fair value increasing by $4.4 million, or 130.3% and partially offset by increased net gains on sales of loans of $6.2 million, or 48.6%.  The increase over the first nine months of 2020 was principally comprised of increased net gains on loans accounted for under the fair value option increasing by $12.6 million, or 151.9% combined with an increase in net gains on sales of loans of $12.5 million, or 36.3% and partially offset by an increase in the net loss on the loan servicing asset revaluation of $3.4 million, or 80.1%.  See the analysis of these categories of noninterest income included in the above section captioned “Noninterest Income” for additional discussion.

For the three and nine months ended September 30, 2021, noninterest expense increased $11.4 million, or 27.8%, and $25.9 million, or 19.5%, respectively, compared to same periods of 2020.  See the analysis of these categories of noninterest expense included in the above section captioned “Noninterest Expense” for additional discussion.

For the three and nine months ended September 30, 2021, income tax expense increased $1.4 million, or 17.9%, and $13.4 million, or 231.3%, respectively, compared to the same periods of 2020. See the above section captioned “Income Tax Expense.”

Fintech

For the three and nine months ended September 30, 2021, the net income decreased by $11.4 million and increased $23.2 million, respectively, compared to same periods of 2020.  The quarter over quarter decrease was principally due to the earlier referenced $13.7 million Greenlight gain in the third quarter of 2020 while the increase over the first nine months of 2020 was principally the result of the aforementioned $44.1 million Greenlight gain recognized in the second quarter of 2021.

For the three and nine months ended September 30, 2021, noninterest income decreased $15.0 million and increased $29.5 million, respectively, compared to the same periods of 2020.  This increase was largely due to the above mentioned Greenlight gains.

For the three and nine months ended September 30, 2021, noninterest expense increased $110 thousand, or 9.9%, and decreased $616 thousand, or 15.5%, respectively, compared to the same periods of 2020. This decrease over the first nine months of 2020 was largely due to a reduction in compensation expense.

For the three and nine months ended September 30, 2021, income tax expense decreased $3.7 million, and increased $7.0 million, respectively, compared to the same periods of 2020. This increase in income tax expense was principally driven by the significant changes in net income before taxes arising from the above discussed gains arising from the Company’s investment in Greenlight during the third quarter of 2020 and second quarter of 2021.

Discussion and Analysis of Financial Condition

September 30, 2021 vs. December 31, 2020

Total assets at September 30, 2021 were $8.14 billion, an increase of $265.0 million, or 3.4%, compared to total assets of $7.87 billion at December 31, 2020. The growth in total assets was principally driven by the following:

• Growth in total loans and leases held for investment and held for sale of $141.0 million resulting from strong origination activity in the first nine months of 2021.  Total originations during the first nine months of 2021 were $3.40 billion, comprised of $2.85 billion in loans and leases exclusive of PPP and an additional $547.5 million in PPP loans; and
• Total investment securities increased $111.3 million during the first nine months of 2021, from $750.1 million at December 31, 2020, to $861.4 million at September 30, 2021, an increase of 14.8%.  The Company increased its investment securities position during the first nine months of 2021 largely as a part of its annual investment asset-liability planning. At September 30, 2021, the investment portfolio was comprised of U.S. government agencies, U.S. government-sponsored entity mortgage-backed securities, municipal bonds and other debt securities.
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Cash and cash equivalents, comprised of cash and due from banks and federal funds sold, was $347.0 million at September 30, 2021, an increase of $28.7 million, or 9.0%, compared to $318.3 million at December 31, 2020.  This increase reflects liquidity planning through increased levels of deposits for funding expected loan and lease originations.

Loans and leases held for sale decreased $132.7 million, or 11.3%, during the first nine months of 2021, from $1.18 billion at December 31, 2020, to $1.04 billion at September 30, 2021. The decrease was primarily the result of strong loan sales in the first nine months of 2021 combined with higher levels of loans being retained as held for investment.

Loans and leases held for investment increased $273.7 million, or 5.3%, during the first nine months of 2021, from $5.14 billion at December 31, 2020, to $5.42 billion at September 30, 2021. The increase was primarily the result of the above-mentioned loan originations in 2021 combined with increased levels of loans retained as held for investment.  All PPP loans are classified as held for investment.

Total deposits were $6.82 billion at September 30, 2021, an increase of $1.10 billion, or 19.3%, from $5.71 billion at December 31, 2020. The increase in deposits was largely driven by significant loan origination efforts during the first nine months of 2021.

Borrowings decreased to $575.0 million at September 30, 2021 from $1.54 billion at December 31, 2020.  This decrease was related principally to net curtailments of borrowings through the PPPLF in the first nine months of 2021 as PPP loan forgiveness outpaced new PPPLF advances. These PPPLF borrowings are used to help fund PPP loans.

Shareholders’ equity at September 30, 2021 was $689.4 million as compared to $567.9 million at December 31, 2020. The book value per share was $15.89 at September 30, 2021 compared to $13.38 at December 31, 2020. Average equity to average assets was 7.7% for the nine months ended September 30, 2021 compared to 8.1% for the year ended December 31, 2020. The increase in shareholders’ equity for the first nine months of 2021 was principally the result of net income of $136.8 million and stock-based compensation expense of $12.8 million, partially offset by other comprehensive loss of $13.4 million and $17.5 million in cash paid in lieu of stock for employee tax obligations in settlement of vested stock grants.

Asset Quality

Management considers asset quality to be of primary importance. A formal loan review function, independent of loan origination, is used to identify and monitor problem loans. This function reports directly to the Audit & Risk Committee of the Board of Directors.

Nonperforming Assets

The Bank places loans and leases on nonaccrual status when they become 90 days past due as to principal or interest payments, or prior to that if management has determined based upon current information available to them that the timely collection of principal or interest is not probable. When a loan or lease is placed on nonaccrual status, any interest previously accrued as income but not actually collected is reversed and recorded as a reduction of loan or lease interest and fee income. Typically, collections of interest and principal received on a nonaccrual loan or lease are applied to the outstanding principal as determined at the time of collection of the loan or lease.

Troubled debt restructurings (“TDRs”) occur when, because of economic or legal reasons pertaining to the debtor’s financial difficulties, debtors are granted concessions that would not otherwise be considered. Such concessions would include, but are not limited to, the transfer of assets or the issuance of equity interests by the debtor to satisfy all or part of the debt, modification of the terms of debt or the substitution or addition of debtor(s).

Nonperforming assets and TDRs, excluding loans measured at fair value, at September 30, 2021 were $93.1 million, which represented a $10.6 million, or 12.8%, increase from December 31, 2020. These nonperforming assets, at September 30, 2021 were comprised of $49.3 million in nonaccrual loans and leases and $883 thousand in foreclosed assets. Of the $93.1 million of nonperforming assets and TDRs, $50.0 million carried a government guarantee, leaving an unguaranteed exposure of $43.1 million in total nonperforming assets and TDRs at September 30, 2021. This represents an increase of $3.8 million, or 9.6%, from an unguaranteed exposure of $39.3 million at December 31, 2020.

The following table provides information with respect to nonperforming assets and troubled debt restructurings, excluding loans measured at fair value, at the dates indicated.

September 30, 2021 ^(1)^ December 31, 2020 ^(1)^
Nonaccrual loans and leases:
Total nonperforming loans and leases (all on nonaccrual) (2) $ 49,338 $ 46,110
Total accruing loans and leases past due 90 days or more — —
Foreclosed assets 883 4,155
Total troubled debt restructurings (3) 55,010 39,803
Less nonaccrual troubled debt restructurings (12,160 ) (7,592 )
Total performing troubled debt restructurings (3) 42,850 32,211
Total nonperforming assets and troubled debt restructurings (2)(3) $ 93,071 $ 82,476
Allowance for credit losses on loans and leases $ 59,681 $ 52,306
Total nonperforming loans and leases to total loans and leases held for<br><br><br>investment (2) 1.05 % 1.06 %
Total nonperforming loans and leases to total assets (2) 0.67 % 0.66 %
Total nonperforming assets and troubled debt restructurings to total<br><br><br>assets (2) (3) 1.26 % 1.17 %
Allowance for credit losses on loans and leases to loans and leases held for<br><br><br>investment 1.26 % 1.21 %
Allowance for credit losses on loans and leases to total nonperforming loans<br><br><br>and leases (2) 120.96 % 113.44 %
(1) Excludes loans measured at fair value.
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(2) The period ended December 31, 2020 excludes one $6.1 million hotel loan classified as held for sale.
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(3) The period ended December 31, 2020 excludes one $5.1 million hotel loan classified as held for sale.
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September 30, 2021 (1) December 31, 2020 ^(1)^
--- --- --- --- --- --- ---
Nonaccrual loans and leases guaranteed by U.S. government:
Total nonperforming loans and leases guaranteed by the U.S government (all on<br><br><br>nonaccrual) $ 28,888 $ 26,032
Total accruing loans and leases past due 90 days or more guaranteed by the<br><br><br>U.S government — —
Foreclosed assets guaranteed by the U.S. government 692 3,220
Total troubled debt restructurings guaranteed by the U.S. government 26,606 18,160
Less nonaccrual troubled debt restructurings guaranteed by the U.S.<br><br><br>government (6,215 ) (4,271 )
Total performing troubled debt restructurings guaranteed by U.S. government 20,391 13,889
Total nonperforming assets and troubled debt restructurings guaranteed<br><br><br>by the U.S. government $ 49,971 $ 43,141
Allowance for credit losses on loans and leases $ 59,681 $ 52,306
Total nonperforming loans and leases not guaranteed by the U.S. government to<br><br><br>total held for investment loans and leases 0.43 % 0.46 %
Total nonperforming loans and leases not guaranteed by the U.S. government to<br><br><br>total assets 0.28 % 0.29 %
Total nonperforming assets and troubled debt restructurings not guaranteed by<br><br><br>the U.S. government to total assets 0.58 % 0.56 %
Allowance for credit losses on loans and leases to total nonperforming loans<br><br><br>and leases not guaranteed by the U.S government 291.84 % 260.51 %
(1) Excludes loans measured at fair value.
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Total nonperforming assets and TDRs, including loans measured at fair value, at September 30, 2021 were $173.1 million, which represented a $20.0 million, or 13.0%, increase from December 31, 2020. These nonperforming assets, at September 30, 2021 were comprised of $96.5 million in nonaccrual loans and leases and $883 thousand in foreclosed assets. Of the $173.1 million of nonperforming assets and TDRs, $107.6 million carried a government guarantee, leaving an unguaranteed exposure of $65.5 million in total nonperforming assets and TDRs at September 30, 2021. This represents an increase of $10.0 million, or 18.1%, from an unguaranteed exposure of $55.5 million at December 31, 2020.

See the below discussion related to the change in potential problem and impaired loans and leases for management’s overall observations regarding growth in total nonperforming loans and leases.

As a percentage of the Bank’s total capital, nonperforming loans and leases, excluding loans measured at fair value, represented 7.4% at September 30, 2021, compared to 8.8% at December 31, 2020. Adjusting the ratio to include only the unguaranteed portion of nonperforming loans and leases at historical cost to reflect management’s belief that the greater magnitude of risk resides in this portion, the ratios at both September 30, 2021 and December 31, 2020 were 3.1% and 3.8%, respectively.

As of September 30, 2021, and December 31, 2020, potential problem (also referred to as criticized) and classified loans and leases, excluding loans measured at fair value, totaled $387.5 million and $311.4 million, respectively.  The following is a discussion of these loans and leases.  Risk Grades 5 through 8 represent the spectrum of criticized and classified loans and leases.  For a complete description of the risk grading system, see Note 5. Loans and Leases Held for Investment and Credit Quality in the Company’s 2020 Form 10-K.  At September 30, 2021, the portion of criticized and classified loans and leases guaranteed by the SBA or USDA totaled $192.3 million resulting in unguaranteed exposure risk of $195.3 million, or 8.1% of total held for investment unguaranteed exposure carried at historical cost. This compares to the December 31, 2020 portion of criticized and classified loans and leases guaranteed by the SBA or USDA which totaled $168.9 million resulting in unguaranteed exposure risk of $142.5 million, or 8.2% of total held for investment unguaranteed exposure carried at historical cost.  As of September 30, 2021, loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases: Wine and Craft Beverage at 18.6%, Educational Services at 15.7%, Entertainment Centers at 11.5%, Hotels at 11.2%, Healthcare at 7.7%, Fitness Centers at 5.2%, Self Storage at 4.6%, and Agriculture at 4.6%.  As of December 31, 2020, loans and leases carried at historical cost within the following verticals comprise the largest portion of the total potential problem and classified loans and leases: Educational Services at 15.3%, Wine and Craft Beverage at 14.3%, Hotels at 13.6%, Entertainment Centers at 12.5%, Healthcare at 10.3%, Fitness Centers at 7.2%, Self Storage at 6.4% and Veterinary at 4.5%.  Other than Hotels which are a part of the Company’s Specialty Lending division, all of the above listed verticals are within the Company’s Small Business Banking division.  The majority of the $76.1 million first nine months of 2021 increase in potential problem and classified loans and leases was comprised of borrowers largely concentrated in the Company’s more mature verticals.  Furthermore, the Company believes that its underwriting and credit quality standards have remained high with an emphasis on new production in pandemic resilient verticals and increased monitoring of existing loans in pandemic susceptible verticals as the impacts of COVID-19 continue to evolve.

Loans and leases that experience insignificant payment delays and payment shortfalls are generally not individually evaluated for the purpose of estimating the allowance for credit losses. The Bank generally considers an “insignificant period of time” from payment delays to be a period of 90 days or less, unless the borrower was not past due at the time of a modification as a part of a COVID-19 assistance program. The Bank would consider a modification for a customer experiencing what is expected to be a short-term event that has temporarily impacted cash flow. This could be due, among other reasons, to illness, weather, impact from a one-time expense, slower than expected start-up, construction issues or other short-term issues. Credit personnel will review the request to determine if the customer is stressed and how the event has impacted the ability of the customer to repay the loan or lease long term.  At September 30, 2021, the Company had $11.4 million in modified unguaranteed loans and leases for borrowers impacted by the COVID-19 pandemic. These modifications were primarily short-term payment deferrals generally no more than six-months in duration and accordingly are not considered troubled debt restructurings.  As of October 31, 2021, the Company’s modified unguaranteed loans and leases for borrowers impacted by the COVID-19 pandemic was approximately $11.5 million.

Management endeavors to be proactive in its approach to identify and resolve problem loans and leases and is focused on working with the borrowers and guarantors of these loans and leases to provide loan and lease modifications when warranted.  Management implements a proactive approach to identifying and classifying loans and leases as special mention (also referred to as criticized), Risk Grade 5. At September 30, 2021, and December 31, 2020, Risk Grade 5 loans and leases, excluding loans measured at fair value, totaled $301.4 million and $237.5 million, respectively. The increase in Risk Grade 5 loans and leases, exclusive of loans measured at fair value, during the nine months of 2021 was principally confined to six verticals: Wine and Craft Beverage ($22.8 million or 42.3%), Agriculture ($12.2 million or 22.7%), Educational Services ($12.2 million or 22.7%), Independent Pharmacies ($6.2 million or 11.4%), Hotels ($4.2 million or 7.8%) and Asset Based ($2.7 million or 5.1%).  Partially offsetting the above increases were declines in Risk Grade 5 loans principally concentrated in three verticals: Senior Care ($5.1 million or 9.4%), Sponsor Finance ($3.0 million or 5.5%) and Fitness Centers ($2.8 million or 5.3%).  Other than Hotels, Asset Based and Sponsor Finance, which are a part of the Company’s Specialty Lending division, all of the above listed verticals are within the Company’s Small Business Banking division.  Lower levels of Risk Grade 5 loans in Senior Care, Sponsor Finance and Fitness Centers were principally due to two previous Risk Grade 5 relationships continuing to experience stress and being downgraded to Risk Grade 6 during the first quarter.

At September 30, 2021, approximately 99.1% of loans and leases classified as Risk Grade 5 are performing with only one relationship having payments past due more than 30 days.  While the level of nonperforming assets fluctuates in response to changing economic and market conditions, in light of the relative size and composition of the loan and lease portfolio and management’s degree of success in resolving problem assets, management believes that a proactive approach to early identification and intervention is critical to successfully managing a small business loan portfolio. In conjunction with this, management believes that volumes of delinquencies may not be an accurate depiction of the borrower’s repayment abilities under the current pandemic induced circumstances due to payments being made by the SBA on behalf of borrowers with loans under its programs.  As government payment assistance began to expire toward the end of 2020, borrowers with continuing difficulties arising from the pandemic were provided additional relief through payment deferrals.  Management monitors these borrowers closely and has observed financial conditions continuing to improve.  Management has also noted that most loans with expired government assistance have been able to resume making regular payments in the first nine months of 2021.

Allowance for Credit Losses on Loans and Leases

During the quarter ended September 30, 2021, management updated the Company’s policy for estimating expected credit losses on certain relationships that would otherwise meet the criteria for individual evaluation. Relationships with unguaranteed exposure of less than $250 thousand are now collectively evaluated using an average of loss rates applied to individually evaluated relationships with unguaranteed exposure between $250 thousand and $1.0 million. See Note 1. Organization and Summary of Significant Accounting Policies of the Notes to the Consolidated Financial Statements in the Company’s 2020 Form 10-K for further description of the methodologies used to estimate the allowance for credit losses.

The ACL of $52.3 million at December 31, 2020, increased by $7.4 million, or 14.1%, to $59.7 million at September 30, 2021. The ACL as a percentage of loans and leases held for investment at historical cost amounted to 1.3% and 1.2% at September 30, 2021 and December 31, 2020, respectively. Excluding PPP loans and related reserves, the ACL as a percentage of loans and leases held for investment at historical cost amounted to 1.4% and 1.8% at September 30, 2021 and December 31, 2020, respectively.  The increase in the ACL during the first nine months of 2021 was primarily due to impact of growth in loan and lease originations somewhat mitigated by the effects of improved forecasts related to employment and default expectations as the economic outlook has continued to improve, as addressed more fully in the above section captioned “Provision for Loan and Lease Credit Losses” in “Results of Operations.”

Actual past due held for investment loans and leases, inclusive of loans measured at fair value, have decreased by $20.8 million since December 31, 2020.   Total loans and leases 90 or more days past due decreased $12.6 million, or 20.4%, compared to December 31, 2020.  The decrease was comprised of a $13.7 million decrease in unguaranteed combined with a $1.0 million increase in the guaranteed portions of past due loans compared to December 31, 2020.  At September 30, 2021, and December 31, 2020, total held for investment unguaranteed loans and leases past due as a percentage of total held for investment unguaranteed loans and leases, inclusive of loans measured at fair value, was 0.5% and 1.1%, respectively.  Total unguaranteed loans and leases past due were comprised of $11.4 million carried at historical cost, a decrease of $11.6 million, and $5.0 million measured at fair value, a decrease of $1.3 million, as of September 30, 2021 compared to December 31, 2020.  Management continues to actively monitor and work to improve asset quality. Management believes the ACL of $59.7 million at September 30, 2021 is appropriate in light of the risk inherent in the loan and lease portfolio. Management’s judgments are based on numerous assumptions about current and expected events that it believes to be reasonable, but which may or may not be valid, including but not limited to factors related to the above mentioned SBA delinquency effect and pandemic-susceptible verticals. Accordingly, no assurance can be given that management’s ongoing evaluation of the loan and lease portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the ACL, thus adversely affecting the Company’s operating results. Additional information on the ACL is presented in Note 5. Loans and Leases Held for Investment and Credit Quality of the Notes to the Unaudited Condensed Consolidated Financial Statements in this report.

Liquidity Management

Liquidity management refers to the ability to meet day-to-day cash flow requirements based primarily on activity in loan and deposit accounts of the Company’s customers. Liquidity is immediately available from four major sources: (a) cash on hand and on deposit at other banks; (b) the outstanding balance of federal funds sold; (c) the market value of unpledged investment securities; and (d) availability under lines of credit. At September 30, 2021, the total amount of these four items was $3.30 billion, or 40.6% of total assets, an increase of $247.7 million from $3.06 billion, or 38.8% of total assets, at December 31, 2020.

Loans and other assets are funded by loan sales, wholesale deposits, core deposits and PPPLF borrowings. To date, an increasing retail deposit base and an increased long term wholesale deposit base along with PPPLF borrowings have been adequate to meet loan obligations while maintaining the desired level of immediate liquidity. Additionally, the investment securities portfolio is available for both immediate and secondary liquidity purposes.

At September 30, 2021, none of the investment securities portfolio was pledged to secure public deposits or pledged to retail repurchase agreements, leaving $858.9 million available to pledge as collateral.

Contractual Obligations

The following table presents the Company’s significant fixed and determinable contractual obligations by payment date as of September 30, 2021. The payment amounts represent those amounts contractually due to the recipient. The table excludes liabilities recorded where management cannot reasonably estimate the timing of any payments that may be required in connection with these liabilities.

Payments Due by Period
Total Less than<br><br><br>One Year One to<br><br><br>Three Years Three to<br><br><br>Five Years More than<br><br><br>Five Years
Contractual Obligations
Deposits without stated maturity $ 3,619,836 $ 3,619,836 $ — $ — $ —
Time deposits 3,196,777 1,797,908 658,642 342,196 398,031
Borrowings 575,021 535,410 19,855 15,763 3,993
Operating lease obligations 2,924 734 862 157 1,171
Total $ 7,394,558 $ 5,953,888 $ 679,359 $ 358,116 $ 403,195

As of September 30, 2021, and December 31, 2020, the Company had unfunded commitments to provide capital contributions for on-balance sheet investments in the amount of $11.0 million and $15.8 million, respectively.

Asset/Liability Management and Interest Rate Sensitivity

One of the primary objectives of asset/liability management is to maximize the net interest margin while minimizing the earnings risk associated with changes in interest rates. One method used to manage interest rate sensitivity is to measure, over various time periods, the interest rate sensitivity positions, or gaps. As of September 30, 2021, the balance sheet’s total cumulative gap position was asset-sensitive at 4.0%.

The interest rate gap method, however, addresses only the magnitude of asset and liability repricing timing differences as of the report date and does not address earnings, market value, changes in account behaviors based on the interest rate environment, nor growth. Therefore, management also uses an earnings simulation model to prepare, on a regular basis, earnings projections based on a range of interest rate scenarios to measure interest rate risk.  As of September 30, 2021, the Company’s interest rate risk profile under the earnings simulation model method remained asset-sensitive. An asset-sensitive position means that net interest income will generally move in the same direction as interest rates. For instance, if interest rates increase, net interest income can be expected to increase, and if interest rates decrease, net interest income can be expected to decrease. The Company attempts to mitigate interest rate risk by match funding assets and liabilities with similar rate instruments. The quarterly revaluation adjustment to the servicing asset, however, adjusts in an opposite direction to interest rate changes. Asset/liability sensitivity is primarily derived from the prime-based loans that adjust as the prime interest rate changes, rates on cash accounts that adjusts as the federal funds rate changes and the longer duration of indeterminate term deposits.

Capital

The maintenance of appropriate levels of capital is a management priority and is monitored on a regular basis. The Company’s principal goals related to the maintenance of capital are the following: to provide adequate capital to support the Company’s risk profile consistent with the risk appetite approved by the Board of Directors; to provide financial flexibility to support future growth and client needs; comply with relevant laws, regulations, and supervisory guidance; to achieve optimal ratings for the Company and its subsidiaries; and to provide a competitive return to shareholders. Management regularly monitors the capital position of the Company on both a consolidated and bank level basis. In this regard, management’s goal is to maintain capital at levels that are in excess of the regulatory “well capitalized” levels. Risk-based capital ratios, which include Tier 1 Capital, Total Capital and Common Equity Tier 1 Capital, are calculated based on regulatory guidance related to the measurement of capital and risk-weighted assets.

Capital amounts and ratios as of September 30, 2021 and December 31, 2020, are presented in the table below.

Actual Minimum Capital<br><br><br>Requirement Minimum To Be<br><br><br>Well Capitalized<br><br><br>Under Prompt<br><br><br>Corrective Action<br><br><br>Provisions ^(1)^
Amount Ratio Amount Ratio Amount Ratio
Consolidated - September 30, 2021
Common Equity Tier 1 (to Risk-Weighted Assets) $ 657,340 12.56 % $ 235,590 4.50 % N/A N/A
Total Capital (to Risk-Weighted Assets) 717,633 13.71 418,827 8.00 N/A N/A
Tier 1 Capital (to Risk-Weighted Assets) 657,340 12.56 314,121 6.00 N/A N/A
Tier 1 Capital (to Average Assets) 657,340 8.82 298,033 4.00 N/A N/A
Bank - September 30, 2021
Common Equity Tier 1 (to Risk-Weighted Assets) $ 605,634 12.13 % $ 224,732 4.50 % $ 324,612 6.50 %
Total Capital (to Risk-Weighted Assets) 665,927 13.33 399,523 8.00 499,403 10.00
Tier 1 Capital (to Risk-Weighted Assets) 605,634 12.13 299,642 6.00 399,523 8.00
Tier 1 Capital (to Average Assets) 605,634 8.24 294,053 4.00 367,566 5.00
Consolidated - December 31, 2020
Common Equity Tier 1 (to Risk-Weighted Assets) $ 521,568 12.15 % $ 193,172 4.50 % N/A N/A
Total Capital (to Risk-Weighted Assets) 574,621 13.39 343,417 8.00 N/A N/A
Tier 1 Capital (to Risk-Weighted Assets) 521,568 12.15 257,563 6.00 N/A N/A
Tier 1 Capital (to Average Assets) 521,568 8.40 248,417 4.00 N/A N/A
Bank - December 31, 2020
Common Equity Tier 1 (to Risk-Weighted Assets) $ 470,069 11.25 % $ 188,012 4.50 % $ 271,573 6.50 %
Total Capital (to Risk-Weighted Assets) 522,305 12.50 334,243 8.00 417,804 10.00
Tier 1 Capital (to Risk-Weighted Assets) 470,069 11.25 250,683 6.00 334,243 8.00
Tier 1 Capital (to Average Assets) 470,069 7.60 247,288 4.00 309,110 5.00
(1) Prompt corrective action provisions are not applicable at the bank holding company level.
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Critical Accounting Policies and Estimates

The preparation of consolidated financial statements in accordance with GAAP requires the Company to make estimates and judgments that affect reported amounts of assets, liabilities, income and expenses and related disclosure of contingent assets and liabilities. The Company bases estimates on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. Estimates are evaluated on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.

Accounting policies, as described in detail in the Notes to the Company’s Unaudited Condensed Consolidated Financial Statements in this report and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, are an integral part of the Company’s consolidated financial statements. A thorough understanding of these accounting policies is essential when reviewing the Company’s reported results of operations and financial position. Management believes that the critical accounting policies and estimates listed below require the Company to make difficult, subjective or complex judgments about matters that are inherently uncertain.

• Determination of the allowance for credit losses on loans and leases;
• Valuation of loans accounted for under the fair value option;
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• Valuation of servicing assets;
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• Valuation of equity security investments where no readily available market price exists;
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• Consideration of significant influence for certain relationships where we have equity interests;
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• Income taxes;
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• Restricted stock unit awards with market price conditions;
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• Valuation of foreclosed assets; and
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• Business combination and goodwill.
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Changes in these estimates, that are likely to occur from period to period, or the use of different estimates that the Company could have reasonably used in the current period, would have a material impact on the Company’s financial position, results of operations or liquidity.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Management considers interest rate risk the most significant market risk. Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates. Consistency of net interest income is largely dependent upon the effective management of interest rate risk.

The Company’s Asset/Liability Management Committee (“ALCO”), which includes senior management representatives and reports to the Board of Directors, monitors and manages interest rate risk. See “Asset/Liability Management and Interest Rate Sensitivity” in Item 2 of this Form 10-Q for further discussion.

The objective of asset/liability management is the maximization of net interest income within the Company’s risk guidelines. This objective is accomplished through management of the balance sheet composition, maturities, liquidity, and interest rate risk exposures arising from changing economic conditions, interest rates and customer preferences.

To identify and manage its interest rate risk, the Company employs an earnings simulation model to analyze net interest income sensitivity to changing interest rates. The model is based on contractual cash flows and repricing characteristics and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain assets and liabilities. The model also includes management projections for activity levels in each of the product lines offered by the Bank. Assumptions are inherently uncertain, and the measurement of net interest income or the impact of rate fluctuations on net interest income cannot be precisely predicted. Actual results may differ materially from simulated results due to timing, magnitude, and frequency of interest rate changes as well as changes in market conditions and management strategies.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13(a)-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), was carried out under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer as of September 30, 2021, the last day of the period covered by this Quarterly Report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of September 30, 2021, in ensuring that the information required to be disclosed in the reports the Company files or submits under the Exchange Act is (i) accumulated and communicated to management (including the Company’s Chief Executive Officer and Chief Financial Officer) as appropriate to allow timely decisions regarding required disclosures, and (ii) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.

Changes in Internal Control Over Financial Reporting

During the three months ended September 30, 2021, the Company converted its core deposit system to a new platform.  During the three months ended June 30, 2021, the Company migrated its human capital, accounting and financial management systems to a new platform. As a result of these implementations, the Company modified existing internal controls and implemented new processes and controls related to these new platforms. The Company will continue to monitor and evaluate internal controls over financial reporting as it relates to these new systems.

Except as related to the implementation of the new systems, there were no changes in the Company’s internal control over financial reporting during the three and nine months ended September 30, 2021, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Item 1. Legal Proceedings

In the ordinary course of operations, the Company is at times involved in legal proceedings. In the opinion of management, as of September 30, 2021, there are no material pending legal proceedings to which the Company or any of its subsidiaries is a party or of which any of their property is the subject.  In addition, the Company is not aware of any threatened litigation, unasserted claims or assessments that could have a material adverse effect on its business, operating results or financial condition.

On March 12, 2021, a purported class action was filed against the Company in the United States District Court for the Eastern District of North Carolina, Joseph McAlear, individually and on behalf of all others similarly situated v. Live Oak Bancshares, Inc. et al.  The complaint alleges the existence of an agreement between the Company, nCino, Inc. and Apiture, LLC in which those companies purportedly sought to restrain the mobility of employees in violation of antitrust laws by agreeing not to solicit or hire each other’s employees.  The complaint alleges violations of Section 1 of the federal Sherman Act (15 U.S.C. § 1) and violations of Sections 75-1 and 75-2 of the North Carolina General Statutes.  The plaintiff seeks monetary damages, including treble damages, entitlement to restitution, disgorgement, attorneys’ fees, and pre- and post-judgment interest. On October 12, 2021, the Company reached an agreement to settle the case with a proposed class of all persons (with certain exclusions) employed by the Company or its wholly-owned subsidiary, Live Oak Banking Company, Apiture, Inc. or nCino, Inc. in North Carolina at any time from January 27, 2017, through March 31, 2021.  In the agreement, the Company agreed to pay $3.9 million.  On October 13, 2021, the plaintiff filed a motion for preliminary approval of the settlement, and that motion remains pending before the court.

Item 1A. Risk Factors

There have been no material changes in the Company’s risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits.

Exhibits to this report are listed in the Index to Exhibits section of this report.

INDEX TO EXHIBITS

Exhibit<br><br><br>No. Description of Exhibit
3.1 Amended and Restated Articles of Incorporation of Live Oak Bancshares, Inc. (incorporated by reference to Exhibit 3.1 of the registration statement on Form S-1, filed on June 19, 2015)
3.2 Amended Bylaws of Live Oak Bancshares, Inc. (incorporated by reference to Exhibit 3.2 of the amended registration statement on Form S-1, filed on July 13, 2015)
4.1 Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 of the registration statement on Form S-1, filed on June 19, 2015)
4.2 Registration and Other Rights Agreement between Live Oak Bancshares, Inc. and Wellington purchasers (incorporated by reference to Exhibit 4.2 of the registration statement on Form S-1, filed on June 19, 2015)
10.1 Form of 2021 RSU Award Agreement for non-employee directors* #
10.2 RSU Award Agreement for William C. Losch, III* #
31.1 Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
31.2 Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
32 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002**
101 Interactive data files pursuant to Rule 405 of Regulation S-T, formatted in Inline XBRL: (i) Condensed Consolidated Balance Sheets as of September 30, 2021 and December 31, 2020; (ii) Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2021 and 2020; (iii) Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2021 and 2020; (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months Ended September 30, 2021 and 2020; (v) Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2021 and 2020; and (vi) Notes to Unaudited Condensed Consolidated Financial Statements*
104 Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)
* Indicates a document being filed with this Form 10-Q.
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** Furnished herewith. This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that Section. Such exhibit shall not be deemed incorporated into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.
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# Denotes management contract or compensatory plan.
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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Live Oak Bancshares, Inc.
(Registrant)
Date: November 3, 2021 By: /s/ William C. Losch III
William C. Losch III
Chief Financial Officer

62

lob-ex101_14.htm

Exhibit 10.1

LIVE OAK BANCSHARES, INC.

2015 OMNIBUS STOCK INCENTIVE PLAN

RESTRICTED STOCK UNIT AWARD AGREEMENT

THIS RESTRICTED STOCK UNIT AWARD AGREEMENT is made and entered into effective as of May 11, 2021 (the “Date of Grant”), by and between LIVE OAK BANCSHARES, INC., a North Carolina corporation (the “Company”), and [NAME] (the “Grantee”).  This Agreement sets forth the terms and conditions associated with the Company’s award to Grantee of restricted stock units payable as described below in shares of Common Stock pursuant to the Company’s 2015 Omnibus Stock Incentive Plan (as amended from time to time, the “Plan”).  Capitalized terms not explicitly defined in this Agreement but defined in the Plan will have the meanings ascribed to them under the Plan.

NOW, THEREFORE, in consideration of the foregoing and Grantee’s continued provision of valuable services as a director of the Company, the parties hereto, intending to be legally bound, agree as follows:

1.Grant of Units.  Effective as of the Date of Grant, the Company grants the Grantee [####] Restricted Stock Units (the “Units”) subject to the provisions of this Agreement and the Plan.  Each Unit is subject to settlement into one share of Common Stock (a “Share”) that will be delivered to Grantee pursuant to this Agreement when and if such Unit becomes vested in accordance with this Agreement.

2.Vesting.  The Units are unvested when granted and will vest May 1, 2022, subject to Grantee’s provision of Continuous Service to the Company through such date.  In addition, to the extent not previously forfeited, all unvested Units will vest immediately upon: (a) the consummation of a Corporate Transaction provided that Grantee provides Continuous Service to the Company through the date of such Corporate Transaction; (b) the termination of Grantee’s Continuous Service as a result of Grantee’s death; or (c) the termination of Grantee’s Continuous Service as a result of Grantee’s Disability.

3.Effect of Termination of Continuous Service.  Except as provided in Section 2 in connection with the termination of Grantee’s Continuous Service as a result of Grantee’s death or Disability, in the event of the termination of Grantee’s Continuous Service, all Units that are not vested will be immediately, automatically, and without consideration forfeited.

4.Delivery of Shares to Settle Units.  When Units become vested as provided in Section 3, the vested Units will be settled by delivering to Grantee the number of Shares equal to the number of vested Units, subject to the following provisions.

(a)Delivery of the Shares will be made as soon as practicable after the date on which the Units vest, provided that the Company may provide for a reasonable delay in the delivery of the Shares to address tax and other administrative matters, and provided further that delivery of the Shares will occur no later than two and one-half months following the conclusion of the year in which the vesting occurs.

(b)Subject to the conditions described herein, as soon as practicable after the date on which the Units vest, the Company will, at its election, either: (i) issue a certificate representing the Shares deliverable pursuant to this Agreement; or (ii) not issue any certificate representing the Shares deliverable pursuant to this Agreement and instead document the Grantee’s interest in the Shares by registering such Shares with the Company’s transfer agent (or another custodian selected by the Company) in book­entry form in the Grantee’s name.

(c)No Shares will be issued pursuant to this Agreement unless and until all then-applicable requirements imposed by U.S., foreign, and state securities and other laws, rules and regulations and by any regulatory agencies having jurisdiction, and by any exchanges upon which the Shares may be listed, have been fully met, and the Company may condition the issuance of Shares pursuant to this Agreement on the Grantee’s taking any reasonable action to meet those requirements.  The Company may impose such conditions on any Shares issuable pursuant to this Agreement as it may deem advisable, including, without limitation, restrictions under the Securities Act of 1933, as amended, under the requirements of any exchange upon which shares of the same class are then listed, and under any blue sky or other securities laws applicable to those shares.

5.Rights as a Shareholder.  The Units represent a right to payment from the Company if the conditions of the Agreement are met and do not give the Grantee ownership of any Common Stock prior to delivery as provided in Section 4.  Grantee will not have any rights and/or privileges of a stockholder of the Company with respect to the Units prior to such delivery, but Grantee will have all rights associated with the ownership of the Shares upon such delivery.

6.Non-Transferability of the Units.  The Units and the right to payment under this Agreement are not transferable, and may not be sold, exchanged, transferred, pledged, hypothecated, encumbered or otherwise disposed of except by the laws of descent or distribution, or as otherwise provided by the Plan.  Any purported transfer of the Units or the right to payment under this Agreement not in compliance with the preceding sentence is null and void and will not be given effect.

7.Tax Consequences.  Grantee acknowledges that Grantee understands the federal, state, local, and foreign tax consequences of the award of the Units and the provisions of this Agreement.  Grantee is relying solely on the advice of Grantee’s own tax advisors and not on any statements or representations of the Company or any of its agents in connection with such tax consequences.  Grantee understands that Grantee (and not the Company nor any Related Entity) will be responsible for Grantee’s own tax liability that may arise as a result of the granting, vesting, and/or settlement of the Units (or otherwise in connection with this Agreement).

8.Withholding Obligations.  As a condition to delivery of the Shares, the Grantee hereby authorizes the Company to withhold from the Shares deliverable under this Agreement a number of Shares with a Fair Market Value (measured as of the date tax withholding obligations are to be determined) equal to the federal, state, local and foreign tax withholding obligations of the Company or a Related Entity, if any.  In the event that the Administrator determines in its discretion that such withholding of Shares is not permitted pursuant to the Applicable Laws, the rules and regulations of any regulatory agencies having jurisdiction over the Company, or the rules of any exchanges upon which the Shares may be listed, then the Administrator may, in its

discretion, make alternative arrangements for satisfying the Company’s (or a Related Entity’s) withholding obligations, utilizing any method permitted by the Plan, including but not limited to requiring Grantee to tender a cash payment or withholding from salary or other compensation payable to Grantee.

9.Application of Section 409A of the Code.  The parties intend that the delivery of Shares in respect of the Units provided under this Agreement satisfies, to the greatest extent possible, the exemption from the application of Section 409A of the Code and the regulations and other guidance thereunder and any state law of similar effect (collectively, “Section 409A”) provided under Treasury Regulations Section 1.409A-1(b)(4) (or any other applicable exemption), and this Agreement will be construed to the greatest extent possible as consistent with those provisions.  To the extent not so exempt, the delivery of Shares in respect of the Units provided under this Agreement will be conducted, and this Agreement will be construed, in a manner that complies with Section 409A and is consistent with the requirements for avoiding taxes or penalties under Section 409A.  The parties further intend that each installment of any payments provided for in this Agreement is a separate “payment” for purposes of Section 409A.  To the extent that (a) one or more of the payments received or to be received by Grantee pursuant to this Agreement would constitute deferred compensation subject to the requirements of Section 409A, and (b) Grantee is a “specified employee” within the meaning of Section 409A, then solely to the extent necessary to avoid the imposition of any additional taxes or penalties under Section 409A, the commencement of any payments under this Agreement will be deferred until the date that is six months following the Grantee’s termination of Continuous Service (or, if earlier, the date of death of the Grantee) and will instead be paid on the date that immediately follows the end of such six-month period (or death) or as soon as administratively practicable within thirty (30) days thereafter.  The Company makes no representations to Grantee regarding the compliance of this Agreement or the Units with Section 409A, and Grantee is solely responsible for the payment of any taxes or penalties arising under Section 409A(a)(1), or any state law of similar effect, with respect to the grant or vesting of the Units or the delivery of the Shares hereunder.

10.Adjustments.  All references to the number of Units will be appropriately adjusted to reflect any stock split, stock dividend, or other change in capitalization that may be made by the Company after the date of this Agreement, as provided in Section 13 of the Plan.

11.Electronic Delivery.  Grantee hereby consents to receive documents related to the Units and any other Awards granted under the Plan by electronic delivery and agrees to participate in the Plan through an online or electronic system established and maintained by the Company or another third party designated by the Company, and such consent shall remain in effect throughout until withdrawn in writing by Grantee.

12.Data Privacy.  Grantee acknowledges that the Company holds certain personal information about him/her, including, but not limited to, name, home address and telephone number, date of birth, social security number or other identification number, salary, nationality, job title, details of the Units and any other entitlement to Shares awarded, cancelled, exercised, vested or unvested.  Grantee consents to the collection, use and transfer (including but not limited to transfers to parties assisting in the implementation, administration and management of the Plan), in electronic or other form, of such personal data for the purpose of implementing, administering, and managing Grantee’s participation in the Plan.

13.Binding Effect.  This Agreement is binding upon and inures to the benefit of Grantee and Grantee’s heirs, executors, and personal representatives, and the Company and its successors and assigns.

14.Multiple Originals.  This Agreement may be executed in one or more counterparts, each of which will be deemed an original but all of which together will constitute one and the same agreement.  Facsimile or PDF reproductions of original signatures will be deemed binding for the purpose of the execution of this Agreement.

15.Notices.  Any notice, demand or request required or permitted to be given pursuant to the terms of this Agreement must be in writing and will be deemed given when delivered personally, one day after deposit with a recognized international delivery service (such as FedEx), or three days after deposit in the U.S. mail, first class, certified or registered, return receipt requested, with postage prepaid, in each case addressed to the parties at the addresses of the parties set forth at the end of this Agreement or such other address as a party may designate by notifying the other in writing.

16.Choice of Law; Venue.  This Agreement shall be construed and enforced in accordance with and governed by the laws of the State of North Carolina, without giving effect to the choice of law rules of any jurisdiction.  The parties agree that any litigation arising out of or related to the Units or this Agreement will be brought exclusively in any state or federal court in New Hanover County, North Carolina.  Each party (i) consents to the personal jurisdiction of said courts, (ii) waives any venue or inconvenient forum defense to any proceeding maintained in such courts, and (iii) agrees not to bring any proceeding arising out of or relating to this Agreement in any other court.

17.Modification of Agreement; Waiver.  This Agreement may be modified, amended, suspended, or terminated, and any terms, representations or conditions may be waived, but only by a written instrument signed by each of the parties hereto, except as otherwise provided in the Plan.  No waiver hereunder will constitute a waiver with respect to any subsequent occurrence or other transaction hereunder or of any other provision hereof.

18.Severability.  The provisions of this Agreement are severable, and if any one or more provisions are determined to be illegal or otherwise unenforceable, in whole or in part, then the remaining provisions will nevertheless be binding and enforceable.

19.Entire Agreement.  This Agreement, along with the Plan, constitutes and embodies the entire understanding and agreement of the parties hereto with respect to the subject matter hereof and there are no other agreements or understandings, written or oral, in effect between the parties hereto relating to the matters addressed herein.

20.Grantee’s Acknowledgements.  Grantee hereby acknowledges receipt of a copy of the Plan and the Company’s prospectus covering the Shares issued pursuant to the Plan (the “Prospectus”).  Grantee has read and understands the terms of this Agreement, the Plan, and the Prospectus.  The Units are subject to all the provisions of the Plan, the provisions of which are hereby made a part of this Agreement, and are further subject to all interpretations, amendments, rules and regulations, which may from time to time be promulgated and adopted pursuant to the

Plan.  In the event of any conflict between the provisions of this Agreement and those of the Plan, the provisions of the Plan shall control.

[SIGNATURE PAGE FOLLOWS]

IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by its duly authorized officer, and the Grantee has hereunto set the Grantee’s hand and seal, all as of the day and year first above written.

COMPANY:
Live Oak Bancshares, Inc.
By:
Name:
Title:
Address: 1741 Tiburon Drive
Wilmington, NC 28403
GRANTEE:
(SEAL)
Print Name:
Address:

lob-ex102_17.htm

Exhibit 10.2

LIVE OAK BANCSHARES, INC.

2015 OMNIBUS STOCK INCENTIVE PLAN

RESTRICTED STOCK UNIT AWARD AGREEMENT

THIS RESTRICTED STOCK UNIT AWARD AGREEMENT is made and entered into effective as of August 10, 2021 (the “Date of Grant”), by and between LIVE OAK BANCSHARES, INC., a North Carolina corporation (the “Company”), and William c. losch, III (the “Grantee”).  This Agreement sets forth the terms and conditions associated with the Company’s award to Grantee of restricted stock units payable as described below in shares of Common Stock pursuant to the Company’s 2015 Omnibus Stock Incentive Plan (as amended from time to time, the “Plan”).  Capitalized terms not explicitly defined in this Agreement but defined in the Plan will have the meanings ascribed to them under the Plan.

NOW, THEREFORE, in consideration of the foregoing and Grantee’s continued provision of valuable services as an employee of the Company, the parties hereto, intending to be legally bound, agree as follows:

1.Grant of Units.  Effective as of the Date of Grant, the Company grants the Grantee 210,000 Restricted Stock Units (the “Units”) subject to the provisions of this Agreement and the Plan.  Each Unit is subject to settlement into one share of Common Stock (a “Share”) that will be delivered to Grantee pursuant to this Agreement when and if such Unit becomes vested in accordance with this Agreement.

2.Condition to Grant of Units.  This award of Units is conditioned upon Grantee’s electronic acceptance of this Agreement through the online portal established by the Company’s equity plan administrator (i.e., Fidelity) within thirty (30) days of the Date of Grant (the “Acceptance Period”).  In the event Grantee fails to accept this Agreement through such online portal within the Acceptance Period, then this Agreement is void and the Units will not be issued.

3.Vesting.  The Units are unvested when granted and will vest as described on Exhibit A, the terms of which are incorporated herein by reference.

4.Effect of Termination of Continuous Service.  In the event of the termination of Grantee’s Continuous Service, all Units that are not vested will be immediately and automatically forfeited except as expressly provided on Exhibit A.

5.Delivery of Shares to Settle Units.  When Units become vested as provided in Section 3, the vested Units will be settled by delivering to Grantee the number of Shares equal to the number of vested Units, subject to the following provisions.

(a)Delivery of the Shares will be made as soon as practicable after the date on which the Units vest, provided that the Company may provide for a reasonable delay in the delivery of the Shares to address tax and other administrative matters, and provided further that delivery of the Shares will occur no later than two and one-half months following the conclusion of the year in which the vesting occurs.

(b)Subject to the conditions described herein, as soon as practicable after the date on which the Units vest, the Company will, at its election, either: (i) issue a certificate representing the Shares deliverable pursuant to this Agreement; or (ii) not issue any certificate representing the Shares deliverable pursuant to this Agreement and instead document the Grantee’s interest in the Shares by registering such Shares with the Company’s transfer agent (or another custodian selected by the Company) in book­entry form in the Grantee’s name.

(c)No Shares will be issued pursuant to this Agreement unless and until all then-applicable requirements imposed by U.S., foreign, and state securities and other laws, rules and regulations and by any regulatory agencies having jurisdiction, and by any exchanges upon which the Shares may be listed, have been fully met, and the Company may condition the issuance of Shares pursuant to this Agreement on the Grantee’s taking any reasonable action to meet those requirements.  The Company may impose such conditions on any Shares issuable pursuant to this Agreement as it may deem advisable, including, without limitation, restrictions under the Securities Act of 1933, as amended, under the requirements of any exchange upon which shares of the same class are then listed, and under any blue sky or other securities laws applicable to those shares.

6.Rights as a Shareholder.  The Units represent a right to payment from the Company if the conditions of the Agreement are met and do not give the Grantee ownership of any Common Stock prior to delivery as provided in Section 5.  Grantee will not have any rights and/or privileges of a stockholder of the Company with respect to the Units prior to such delivery, but Grantee will have all rights associated with the ownership of the Shares upon such delivery.

7.Non-Transferability of the Units.  The Units and the right to payment under this Agreement are not transferable, and may not be sold, exchanged, transferred, pledged, hypothecated, encumbered or otherwise disposed of except by the laws of descent or distribution, or as otherwise provided by the Plan.  Any purported transfer of the Units or the right to payment under this Agreement not in compliance with the preceding sentence is null and void and will not be given effect.

8.Tax Consequences.  Grantee acknowledges that Grantee understands the federal, state, local, and foreign tax consequences of the award of the Units and the provisions of this Agreement.  Grantee is relying solely on the advice of Grantee’s own tax advisors and not on any statements or representations of the Company or any of its agents in connection with such tax consequences.  Grantee understands that Grantee (and not the Company nor any Related Entity) will be responsible for Grantee’s own tax liability that may arise as a result of the granting, vesting, and/or settlement of the Units (or otherwise in connection with this Agreement).

9.Withholding Obligations.  As a condition to delivery of the Shares, the Grantee hereby authorizes the Company to withhold from the Shares deliverable under this Agreement a number of Shares with a Fair Market Value (measured as of the date tax withholding obligations are to be determined) equal to the federal, state, local and foreign tax withholding obligations of the Company or a Related Entity, if any.  In the event that the Administrator determines in its discretion that such withholding of Shares is not permitted pursuant to the Applicable Laws, the rules and regulations of any regulatory agencies having jurisdiction over the Company, or the rules of any exchanges upon which the Shares may be listed, then the Administrator may, in its

discretion, make alternative arrangements for satisfying the Company’s (or a Related Entity’s) withholding obligations, utilizing any method permitted by the Plan, including but not limited to requiring Grantee to tender a cash payment or withholding from salary or other compensation payable to Grantee.

10.Application of Section 409A of the Code.  The parties intend that the delivery of Shares in respect of the Units provided under this Agreement satisfies, to the greatest extent possible, the exemption from the application of Section 409A of the Code and the regulations and other guidance thereunder and any state law of similar effect (collectively, “Section 409A”) provided under Treasury Regulations Section 1.409A-1(b)(4) (or any other applicable exemption), and this Agreement will be construed to the greatest extent possible as consistent with those provisions.  To the extent not so exempt, the delivery of Shares in respect of the Units provided under this Agreement will be conducted, and this Agreement will be construed, in a manner that complies with Section 409A and is consistent with the requirements for avoiding taxes or penalties under Section 409A.  The parties further intend that each installment of any payments provided for in this Agreement is a separate “payment” for purposes of Treasury Regulation Section 1.409A-2(b)(2)(i).  To the extent that (a) one or more of the payments received or to be received by Grantee pursuant to this Agreement would constitute deferred compensation subject to the requirements of Section 409A, and (b) Grantee is a “specified employee” within the meaning of Section 409A, then solely to the extent necessary to avoid the imposition of any additional taxes or penalties under Section 409A, the commencement of any payments under this Agreement will be deferred until the date that is six months following the Grantee’s termination of Continuous Service (or, if earlier, the date of death of the Grantee) and will instead be paid on the date that immediately follows the end of such six-month period (or death) or as soon as administratively practicable within thirty (30) days thereafter.  The Company makes no representations to Grantee regarding the compliance of this Agreement or the Units with Section 409A, and Grantee is solely responsible for the payment of any taxes or penalties arising under Section 409A(a)(1), or any state law of similar effect, with respect to the grant or vesting of the Units or the delivery of the Shares hereunder.

11.Clawback.  Grantee acknowledges and agrees all compensation payable pursuant to this Agreement will be subject to forfeiture and repayment pursuant to (i) the Company’s compensation recovery, “clawback” or similar policy, if any, as may be in effect from time to time, or (ii) any compensation recovery, “clawback” or similar policy made applicable by law, including the provisions of Section 945 of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the rules, regulations and requirements adopted thereunder by the Securities and Exchange Commission and/or any national securities exchange on which the Company’s equity securities may be listed, as may be in effect from time to time (the policies described in clauses (i) and (ii) collectively, the “Policy”).  In the event that Grantee receives compensation hereunder that is subject to forfeiture or repayment under such Policy, then Grantee will, upon the written request of the Administrator and in the Administrator’s sole discretion, forfeit and repay to the Company all amounts subject to repayment under the Policy.  In addition, Grantee agrees to reimburse the Company with respect to the Units to the extent required under Section 304 of the Sarbanes-Oxley Act of 2002 or as otherwise required by law.

12.Adjustments.  All references to the number of Units will be appropriately adjusted to reflect any stock split, stock dividend, or other change in capitalization that may be made by the Company after the date of this Agreement, as provided in Section 13 of the Plan.

13.Electronic Delivery.  Grantee hereby consents to receive documents related to the Units and any other Awards granted under the Plan by electronic delivery and agrees to participate in the Plan through an online or electronic system established and maintained by the Company or another third party designated by the Company, and such consent shall remain in effect throughout until withdrawn in writing by Grantee.

14.Data Privacy.  Grantee acknowledges that the Company holds certain personal information about him/her, including, but not limited to, name, home address and telephone number, date of birth, social security number or other identification number, salary, nationality, job title, details of the Units and any other entitlement to Shares awarded, cancelled, exercised, vested or unvested.  Grantee consents to the collection, use and transfer (including but not limited to transfers to parties assisting in the implementation, administration and management of the Plan), in electronic or other form, of such personal data for the purpose of implementing, administering, and managing Grantee’s participation in the Plan.

15.No Right to Continued Service.  Neither this Agreement nor the award of the Units will confer upon the Grantee any right to continued employment or other service with the Company or a Related Entity, nor interfere in any way with the right of the Company or any Related Entity to terminate the Continuous Service of Grantee.

16.Binding Effect.  This Agreement is binding upon and inures to the benefit of Grantee and Grantee’s heirs, executors, and personal representatives, and the Company and its successors and assigns.

17.Counterparts; Electronic Signatures.  This Agreement may be executed in one or more counterparts, each of which will be deemed an original but all of which together will constitute one and the same agreement.  Each party agrees that this Agreement may be executed by means of electronic signatures, and that electronic signatures (whether digital or encrypted) of the parties included in this Agreement are intended to authenticate this writing and to have the same force and effect as manual signatures.  For this purpose, electronic signature means any electronic sound, symbol, or process attached to or logically associated with a record and executed and adopted by a party with the intent to sign such record, including facsimile, signatures on scanned documents or email electronic signatures.

18.Notices.  Any notice, demand or request required or permitted to be given pursuant to the terms of this Agreement must be in writing and will be deemed given when delivered personally, one day after deposit with a recognized international delivery service (such as FedEx), or three days after deposit in the U.S. mail, first class, certified or registered, return receipt requested, with postage prepaid, in each case addressed to the parties at the addresses of the parties set forth at the end of this Agreement or such other address as a party may designate by notifying the other in writing.

19.Choice of Law; Venue.  This Agreement shall be construed and enforced in accordance with and governed by the laws of the State of North Carolina, without giving effect to the choice of law rules of any jurisdiction.  The parties agree that any litigation arising out of or related to the Units or this Agreement will be brought exclusively in any state or federal court in New Hanover County, North Carolina.  Each party (i) consents to the personal jurisdiction of said courts, (ii) waives any venue or inconvenient forum defense to any proceeding maintained in such courts, and (iii) agrees not to bring any proceeding arising out of or relating to this Agreement in any other court.

20.Modification of Agreement; Waiver.  This Agreement may be modified, amended, suspended, or terminated, and any terms, representations or conditions may be waived, but only by a written instrument signed by each of the parties hereto, except as otherwise provided in the Plan.  No waiver hereunder will constitute a waiver with respect to any subsequent occurrence or other transaction hereunder or of any other provision hereof.

21.Severability.  The provisions of this Agreement are severable, and if any one or more provisions are determined to be illegal or otherwise unenforceable, in whole or in part, then the remaining provisions will nevertheless be binding and enforceable.

22.Entire Agreement.  This Agreement, along with the Plan, constitutes and embodies the entire understanding and agreement of the parties hereto with respect to the subject matter hereof and there are no other agreements or understandings, written or oral, in effect between the parties hereto relating to the matters addressed herein.

23.Grantee’s Acknowledgements.  Grantee hereby acknowledges receipt of a copy of the Plan and the Company’s prospectus covering the Shares issued pursuant to the Plan (the “Prospectus”).  Grantee has read and understands the terms of this Agreement, the Plan, and the Prospectus.  The Units are subject to all the provisions of the Plan, the provisions of which are hereby made a part of this Agreement, and are further subject to all interpretations, amendments, rules and regulations, which may from time to time be promulgated and adopted pursuant to the Plan.  In the event of any conflict between the provisions of this Agreement and those of the Plan, the provisions of the Plan shall control.

[SIGNATURE PAGE FOLLOWS]

IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by its duly authorized officer, and the Grantee has hereunto set the Grantee’s hand and seal, all as of the day and year first above written.

COMPANY:
Live Oak Bancshares, Inc.
By:
Name: Courtney C. Spencer
Title: Chief Administrative Officer
Address: 1741 Tiburon Drive
Wilmington, NC 28403
GRANTEE:
[ELECTRONIC ACCEPTANCE]

Exhibit A

Vesting Schedule

The Units will vest as follows, subject to Grantee’s Continuous Service to the Company or a Related Entity on each such date:

• 20% of the Units will vest on each of the first, second, third, fourth and fifth anniversaries of the Date of Grant.

Vesting will cease upon the termination of Grantee’s Continuous Service.  Notwithstanding the foregoing, to the extent not previously vested or forfeited, all unvested Units will become fully vested immediately if Grantee’s Continuous Service is terminated by the Company or a Related Entity within twelve (12) months following a Corporate Transaction for a reason other than Cause.

lob-ex311_11.htm

Exhibit 31.1

Certification of Principal Executive Officer

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, James S. Mahan III, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Live Oak Bancshares, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
--- ---
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
--- ---
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
--- ---
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
--- ---
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
--- ---
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
--- ---
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
--- ---
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
--- ---
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
--- ---
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
--- ---
Date: November 3, 2021 /s/  James S. Mahan III
--- ---
James S. Mahan III
Chief Executive Officer
(principal executive officer)

lob-ex312_9.htm

Exhibit 31.2

Certification of Principal Financial Officer

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, William C. Losch III, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Live Oak Bancshares, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
--- ---
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
--- ---
4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
--- ---
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
--- ---
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
--- ---
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
--- ---
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
--- ---
5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
--- ---
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
--- ---
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
--- ---
Date: November 3, 2021 /s/  William C. Losch III
--- ---
William C. Losch III
Chief Financial Officer
(principal financial officer)

lob-ex32_10.htm

Exhibit 32

Certification

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code)

Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code), each of the undersigned officers of Live Oak Bancshares, Inc., a North Carolina corporation (the “Company”), does hereby certify that:

The Quarterly Report on Form 10-Q for the quarter ended September 30, 2021 (the “Form 10-Q”) of the Company fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: November 3, 2021 /s/  James S. Mahan III
James S. Mahan III
Chief Executive Officer
(principal executive officer)
Date: November 3, 2021 /s/  William C. Losch III
William C. Losch III
Chief Financial Officer
(principal financial officer)

This certification is being furnished solely to accompany the Form 10-Q pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and shall not be deemed “filed” by the registrant for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and shall not be incorporated by reference into any filing of the registrant under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of the Form 10-Q, irrespective of any general incorporation language contained in such filing.

A signed original of this written statement required by Section 906 of the Sarbanes-Oxley Act of 2002 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.

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