Coastal Financial Corporation (NASDAQ: CCB), Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. Unaudited results. Coastal operates a Washington community bank and CCBX, its nationwide Banking-as-a-Service (BaaS) business.
Financial results and position
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Interest income | $55.2 million | $19.6 million | $127.1 million | $57.5 million |
| Net interest income | $49.2 million | $18.8 million | $118.3 million | $54.7 million |
| Provision for loan losses | $18.4 million | $0.3 million | $45.5 million | $1.0 million |
| Noninterest income | $34.4 million | $6.1 million | $81.9 million | $13.9 million |
| Noninterest expense | $51.1 million | $16.1 million | $119.7 million | $42.2 million |
| Net income | $11.1 million | $6.7 million | $27.5 million | $19.7 million |
| Diluted earnings per share | $0.82 | $0.54 | $2.04 | $1.58 |
| Net interest margin | 6.58% | 3.48% | 5.61% | 3.64% |
At September 30, total assets were $3.13 billion, loans receivable were $2.51 billion, deposits were $2.84 billion and shareholders’ equity was $228.7 million. Loans grew 43.9% from year-end 2021; deposits grew 20.0%. The loan-to-deposit ratio was 89.9%. Cash and interest-earning deposits totaled $410.7 million.
For the first nine months, operating cash flow was $42.0 million, investing cash flow was negative $467.6 million and financing cash flow was positive $448.6 million. The allowance for loan losses was $59.3 million, or 2.36% of loans. Existing subordinated debt and junior subordinated debentures totaled $27.9 million at quarter-end; no FHLB advances were outstanding. The Bank was reported as well-capitalized, with a 9.34% common equity Tier 1 ratio and 10.60% total capital ratio.
Changes and drivers
- Net income rose 66% year over year in Q3 and 40% for the nine-month period. Management attributed the improvement mainly to loan growth, higher loan yields, rising market rates and CCBX expansion.
- CCBX average loans were $893.7 million in Q3, versus $160.0 million a year earlier. Its average loan yield rose to 13.96% from 3.65%, before BaaS loan expenses; net BaaS loan income yield was 7.05%.
- Higher rates also increased deposit costs: Q3 cost of deposits was 0.82%, versus 0.10% a year earlier. CCBX deposits shifted substantially from noninterest-bearing to interest-bearing accounts.
- Q3 noninterest income included $29.6 million of BaaS indemnification income, including credit and fraud enhancements; corresponding BaaS loan and fraud expenses were $27.3 million. These items, along with related loan-loss provisions, are significant to interpreting reported growth.
- Allowance for loan losses increased from $28.6 million at year-end 2021 to $59.3 million. Nine-month net charge-offs were $14.8 million, mostly CCBX; the company reported collecting partner credit enhancements for CCBX net charge-offs.
Outlook, risks and unusual items
- Management expected further rate increases to raise deposit expense, with higher yields on CCBX loans and cash expected to partly offset the impact. The company is asset-sensitive in its rate simulations, but actual results may differ from modeled outcomes.
- Management cited inflation, higher rates, economic uncertainty and potential deterioration in real estate and borrower conditions as risks to credit quality. It also noted that CCBX partner failures to meet contractual credit or fraud enhancement obligations could expose the Bank to losses.
- CCBX growth creates partner, operational, liquidity and credit exposure. Two partners represented 32% of deposits; estimated uninsured deposits were $867.7 million. The filing also reported $266.7 million of CCBX customer deposits being transferred to other institutions daily.
- Nonperforming loans rose to $22.9 million, or 0.91% of loans, from $1.7 million and 0.10% at year-end 2021. This included $15.8 million of CCBX loans 90 days or more past due that continued to accrue interest under the company’s policy.
- On November 1, 2022, after quarter-end, the company issued $20 million of subordinated notes: 7.00% fixed interest for five years, then quarterly resets at three-month SOFR plus 290 basis points; proceeds are for general corporate purposes.
- CECL adoption was scheduled for January 1, 2023. The company expected a one-time allowance adjustment but could not estimate its amount or overall effect. No material change in risk factors was reported; pending litigation was not expected to have a material adverse effect.
Important facts for investors to verify
- How CCBX loan performance, charge-offs and past-due balances evolve, and whether partner credit enhancements are collected promptly and remain enforceable.
- Whether BaaS indemnification income and related expenses, provisions and receivables are understood together when assessing recurring earnings and cash generation.
- Deposit concentration, uninsured balances, transfers of CCBX deposits and the effect of rising rates on funding costs and liquidity.
- The effect of CECL adoption and any changes in the allowance as portfolio composition and economic conditions evolve.
- The impact of the new subordinated notes on interest expense and capital, and whether the Bank maintains regulatory capital and liquidity buffers as lending grows.