COASTAL FINANCIAL CORP annual report, FY2019

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Coastal Financial Corporation — FY2019 Form 10-K

Reporting period: Fiscal year ended December 31, 2019; filed March 11, 2020. This is an annual report, not a standalone fourth-quarter report. Coastal Financial is a Washington bank holding company operating Coastal Community Bank, with 14 branches focused on the Puget Sound region and a Banking-as-a-Service (BaaS) business.

Financial performance and position

  • Profitability: Net income was $13.2 million, up 36.1% from $9.7 million in 2018. Diluted EPS rose to $1.08 from $0.91. Return on average assets was 1.28%; return on average equity was 11.29%.
  • Interest income and margins: Net interest income increased 20.7% to $42.0 million. Net interest margin was 4.23%, nearly unchanged from 4.24%; net interest spread narrowed to 3.76% from 3.92%. Loan yield increased to 5.38% from 5.18%, while the cost of interest-bearing deposits rose to 1.03% from 0.66%.
  • Noninterest income and expense: Noninterest income increased 51.1% to $8.3 million, including $2.1 million of BaaS fees, $1.4 million of loan referral fees, and $171,000 of securities-sale gains. Noninterest expense rose 18.5% to $31.1 million, led by compensation, branch costs, and legal and professional fees. The efficiency ratio improved to 61.79% from 65.08%.
  • Credit costs and quality: Provision for loan losses increased to $2.5 million from $1.8 million, primarily reflecting loan growth. The allowance was $11.5 million, or 1.22% of loans, versus $9.4 million, or 1.23%, a year earlier. Net charge-offs were 0.06% of average loans in both years. Nonperforming assets declined to $1.0 million (0.09% of assets) from $1.8 million (0.19%); there were no TDRs at year-end 2019.
  • Growth and funding: Assets increased 18.5% to $1.129 billion; loans grew 22.3% to $939.1 million and deposits grew 20.5% to $968.0 million. Core deposits were 89.1% of deposits, up from 86.6%. Loans equaled 97.0% of deposits. Cash and due from banks totaled $127.8 million; investment securities totaled $32.7 million.
  • Debt and capital: Year-end borrowings included $10.0 million of FHLB advances, $10.0 million principal of subordinated debt, and $3.6 million of junior subordinated debentures. Shareholders’ equity was $124.2 million. The Bank’s common equity Tier 1 ratio was 12.43%, total risk-based capital ratio 13.63%, and leverage ratio 11.22%; it qualified as well-capitalized.
  • Cash flow: Operating cash flow was $13.7 million, investing cash outflow was $164.5 million, and financing cash inflow was $154.5 million. Cash, due from banks, and restricted cash ended at $43.9 million, up $3.6 million. Loan growth was the main investing cash use; deposit growth was the main financing source.

Material changes versus 2018

  • Net income and net interest income rose with loan growth and higher loan yields, while deposit interest expense increased as funding costs rose.
  • BaaS fees grew to $2.1 million from $709,000, and loan referral fees increased to $1.4 million from $618,000. BaaS was in its first full year of operations.
  • Commercial real estate loans remained the largest concentration at 65.2% of loans, although their share declined from 67.1%. Construction, land, and development loans grew 51.5% to $97.0 million.
  • The securities portfolio was restructured during 2019: securities were sold and replaced to improve return and reduce maturity and market risk, generating $171,000 in net gains. Securities declined to 2.9% of assets from 4.0%.
  • Adoption of lease accounting brought operating lease right-of-use assets of $8.5 million and lease liabilities of $8.7 million onto the year-end balance sheet; adoption had no reported income-statement impact.

Outlook, risks, and other notable items

  • The filing provides no quantified earnings or growth guidance. Management described continued focus on local loan and deposit growth, BaaS expansion, and investment in staff and infrastructure; it was working with five fintech partners and anticipated adding partners in 2020.
  • Commercial real estate concentration is a key risk. Non-owner-occupied CRE exposure, including specified investor and construction categories, equaled 347.9% of Bank risk-based capital, above the 300% supervisory screening threshold. Management said it had implemented concentration-risk monitoring practices.
  • The portfolio is geographically concentrated in Puget Sound and heavily weighted to CRE. Real estate values, local economic conditions, construction projects, and borrower cash flows could affect asset quality. Management also cited competition, deposit retention and pricing, liquidity, interest-rate sensitivity, regulatory requirements, cybersecurity and third-party systems, and BaaS partner performance and compliance as risks.
  • Management characterized the Bank as asset sensitive: its model estimated that a 100-basis-point rate increase would raise 12-month net interest income 3.5% under a static balance sheet, while a 200-basis-point decrease would reduce it 3.8%. These are model estimates, not forecasts.
  • The company identified the emerging coronavirus outbreak in its risk discussion, noting possible effects on its region, customers, and operations. CECL adoption was scheduled for January 1, 2023 for the company; management had not determined the impact. LIBOR transition risk also applied to $112.1 million of loans and $3.6 million of floating-rate junior subordinated debentures.
  • No common dividends were paid in 2019, and the company said it did not intend to pay them in the near term. Management reported effective disclosure controls and effective internal control over financial reporting. The auditor issued an unqualified opinion on the financial statements but did not audit internal control effectiveness. Management said pending litigation was not expected to have a material adverse effect.

Important facts for investors to verify

  • Track CRE and construction exposure, borrower/property concentrations, criticized loan trends, and allowance adequacy as the loan book expands.
  • Assess the durability and profitability of BaaS and loan-referral income, partner concentration and termination rights, and the compliance obligations tied to partner programs.
  • Monitor deposit mix, deposit pricing and BaaS-related deposits; confirm liquidity capacity against loan commitments and deposit withdrawals. Commitments to extend credit were $160.4 million at year-end.
  • Review the effect of changing rates on both loan yields and deposit costs, including the assumptions behind management’s interest-rate sensitivity model.
  • Confirm the eventual CECL transition effect and LIBOR replacement terms, including any customer disputes or costs associated with benchmark-rate conversion.