COASTAL FINANCIAL CORP quarterly report, Q3 FY2020

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Coastal Financial Corporation — Q3 2020 Form 10-Q

Business context and period: Unaudited results for the three and nine months ended September 30, 2020. Coastal Financial is a Washington community bank holding company operating 15 branches in the Puget Sound region and offering banking-as-a-service (BaaS). Unless noted, financial amounts below are in millions of dollars.

Financial performance and condition

  • Q3 earnings: Net income was $4.09 million, or $0.34 diluted EPS, versus $3.51 million and $0.29 a year earlier. Net interest income rose 40.7% to $15.10 million; provision for loan losses increased to $2.20 million from $0.64 million. Noninterest income was $1.94 million, down 7.0%, while noninterest expense rose 24.8% to $9.67 million.
  • Nine-month earnings: Net income was $10.49 million, or $0.86 diluted EPS, versus $9.59 million and $0.79. Net interest income increased 31.9% to $40.45 million; loan-loss provision rose to $5.71 million from $1.72 million. Noninterest income was $6.13 million, down 1.1%, and noninterest expense increased 19.9% to $27.63 million.
  • Margins: Q3 net interest margin was 3.62%, down from 4.29% in Q3 2019; nine-month margin was 3.81%, versus 4.22%. Lower market rates and low-rate PPP loans pressured loan yields. Management reported a Q3 loan yield of 4.33%; its non-GAAP estimate excluding PPP was 4.78%.
  • Balance sheet at September 30: Total assets were $1.75 billion, up 55.0% from December 31, 2019; gross loans were $1.52 billion, up 60.7%; deposits were $1.36 billion, up 40.5%; and shareholders’ equity was $135.2 million. Loans-to-deposits were 111.0%, elevated in part by PPP lending.
  • Credit and reserves: Allowance for loan losses was $17.05 million, 1.13% of loans, versus $11.47 million and 1.22% at year-end 2019. The company’s non-GAAP allowance ratio excluding guaranteed PPP loans was 1.60%. Nine-month net charge-offs were $132,000. Nonperforming loans were $4.48 million, or 0.30% of loans, compared with $1.03 million and 0.11% at year-end.
  • Liquidity, cash flow and debt: Nine-month operating cash flow was $12.20 million; investing activities used $651.71 million, largely from loan growth; financing activities provided $609.73 million, mainly from deposit growth and PPP facility funding. Cash and due from banks was $14.14 million, while interest-earning deposits at other banks were $168.03 million. Period-end borrowings included $202.60 million under the PPP Liquidity Facility, $25.00 million of FHLB advances, $9.99 million of subordinated debt and $3.58 million of junior subordinated debentures. The Bank was reported well-capitalized and compliant with applicable regulatory capital requirements.

Material changes and operating developments

  • PPP lending drove much of the rapid loan and asset growth: $452.85 million outstanding across 2,879 loans at quarter-end, all 100% SBA-guaranteed. PPP loans represented about 29.8% of gross loans. The company reported approximately $14.5 million of SBA loan fees, net of agent fees; recognition is generally over loan lives, with remaining fees recognized upon forgiveness or payoff.
  • Commercial and industrial loans increased to $589.2 million from $111.4 million at year-end 2019, largely due to PPP. Commercial real estate loans were $705.2 million, or 46.4% of gross loans; excluding PPP, management said CRE was about 66.1% of the loan portfolio.
  • Deposits grew by $392.1 million, with core deposits increasing to $1.27 billion. Noninterest-bearing deposits were $570.7 million, or 42.0% of deposits. Management emphasized growth in core customer deposits and reduced reliance on time deposits.
  • Expense growth reflected hiring for BaaS and business expansion, the new Arlington branch, PPP processing, and higher legal, technology and other operating costs. Q3 salaries and benefits rose 20.1% year over year; full-time-equivalent employees increased to 234 from 192.
  • BaaS fees increased 26.3% year over year in Q3 to $576,000. Management reported four active CCBX relationships, one in trial, four in implementation and two signed letters of intent.

Outlook, risks and unusual items

  • Management expected low Federal funds rates to persist and said further deposit-rate reductions could occur in Q4 2020. It cautioned that lower rates could continue to pressure yields and net interest margin. Its interest-rate simulations showed the Bank as asset-sensitive, with modeled net interest income generally benefiting from rising rates; actual results may differ.
  • The PPP program closed to new applications on August 8, 2020. The company had begun accepting forgiveness applications and received some SBA forgiveness payments in October. Management anticipated forgiveness beginning in Q4 2020 and increasing in the first half of 2021, while noting uncertainty about processing timing.
  • At September 30, 44 loans totaling $52.5 million, with $1.4 million of unused commitments, remained on COVID-related deferred or modified payment status, down from $207.2 million across 215 loans at June 30. Management warned some borrowers might not resume payments as planned. As of October 31, it reported $9.2 million across 10 loans still deferred or modified.
  • COVID-19, possible renewed restrictions, unemployment and business disruption could weaken borrowers, collateral values, deposits and liquidity, and increase credit losses and required reserves. The company specifically cited exposure to commercial real estate and local Puget Sound economic conditions. PPP loans are guaranteed, but unforgiven amounts ultimately depend on borrower repayment, subject to the SBA guarantee.
  • Other risks include cybersecurity and operational disruption, regulatory and compliance demands tied to relief programs, interest-rate and LIBOR-transition risks, and the ability to manage growth. The company was registered under the Main Street Lending Program and had accepted one application as of September 30. Management expected to introduce a digital bank offering with Google in 2021; this is a forward-looking plan, not a reported result.
  • The company reported no subsequent events requiring recognition or disclosure, no material change to previously disclosed risk factors beyond COVID-19-related risks, and no pending litigation expected to have a material adverse effect. Disclosure controls were reported effective, with no material change in internal control over financial reporting during the quarter.

Investor verification priorities

  1. Track PPP forgiveness pace, fee recognition, and repayment of the $202.6 million PPPLF balance as pledged loans are forgiven or paid down.
  2. Monitor the performance of deferred loans as they return to payment status, nonperforming loan trends, and whether the allowance remains adequate under worsening economic conditions.
  3. Assess CRE and other real-estate concentration, including local-market and industry exposure, against collateral values and the $252.6 million in commitments to extend credit.
  4. Evaluate whether deposit growth remains durable and core-funded, and whether the 111.0% loans-to-deposits ratio and liquidity sources remain manageable as PPP balances change.
  5. Follow net interest margin, loan and deposit pricing, BaaS growth and related expenses, and execution of the planned 2021 Google digital-bank offering.