Coastal Financial Corporation — Q2 2022 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2022. Unaudited results. Coastal Financial operates a Washington community bank and CCBX, its Banking-as-a-Service (BaaS) business serving through broker-dealer and digital-finance partners.
Financial performance and position
| Metric | Q2 2022 | Comparable period |
|---|---|---|
| Net interest income | $39.9 million | $18.6 million in Q2 2021 |
| Net interest margin | 5.66% | 3.70% in Q2 2021 |
| Provision for loan losses | $14.1 million | $0.4 million in Q2 2021 |
| Noninterest income | $25.5 million | $4.8 million in Q2 2021 |
| Noninterest expense | $38.2 million | $13.7 million in Q2 2021 |
| Net income; diluted EPS | $10.2 million; $0.76 | $7.0 million; $0.56 in Q2 2021 |
For the first six months, net income was $16.4 million, or $1.22 diluted EPS, versus $13.0 million, or $1.05, in 2021. Net interest income was $69.2 million and net interest margin was 5.08%, compared with $35.9 million and 3.73%, respectively.
- Balance sheet at June 30: Assets were $2.97 billion, loans receivable $2.33 billion, deposits $2.70 billion and shareholders’ equity $217.7 million. Since December 31, 2021, assets rose 12.7%, loans 33.9% and deposits 14.1%.
- Liquidity and funding: Cash and due from banks totaled $40.8 million and interest-earning deposits at other banks $364.9 million. The six-month cash-flow statement reports $20.8 million operating cash provided, $303.4 million used in investing, $308.8 million provided by financing, and a $26.3 million increase in cash. The loan-to-deposit ratio was 86.5%, up from 73.7% at year-end.
- Debt and capital: No FHLB advances remained at June 30 after repayment of $25.0 million during the first half. Outstanding debt included $24.3 million subordinated debt and $3.6 million junior subordinated debentures. The Bank was described as well capitalized; its leverage ratio was 8.33% and total risk-based capital ratio 10.65%.
Material changes and drivers
- CCBX expansion was the primary growth and earnings driver: CCBX loans reached $804.0 million, up 131.9% from year-end, and CCBX deposits reached $1.07 billion, up 48.8%. The company reported 29 CCBX partners, including 23 active relationships.
- Higher-yielding CCBX loans and rising rates lifted loan yields and net interest margin. Consolidated loan yield was 7.34% in Q2 versus 4.44% a year earlier; CCBX average loan yield was 12.35%, before partner-related BaaS loan expense.
- Reported BaaS income included $14.2 million of credit enhancements and $6.5 million of fraud enhancements in Q2. These indemnification amounts are recognized alongside related credit-loss provisions or fraud expenses; BaaS loan and fraud expense was $18.7 million. Accordingly, headline noninterest income and expense growth reflects substantial associated pass-through/offsetting items, not solely recurring fee income.
- Loan-loss provision rose sharply, principally with CCBX portfolio growth. The allowance for loan losses was $49.4 million, or 2.11% of loans, versus $28.6 million, or 1.64%, at year-end. Q2 net charge-offs were $3.5 million, primarily CCBX consumer loans; the company said CCBX partner enhancements had covered charge-offs collected to date.
- Available-for-sale securities had $1.7 million of unrealized losses at June 30, versus a small unrealized gain at year-end. Management attributed the decline mainly to market rates, did not consider it other-than-temporary impairment, and said it did not intend or expect to be required to sell the securities.
Outlook, risks and unusual items
- No specific earnings or financial guidance was provided. Management anticipated additional 2022 rate increases and expected higher deposit costs, which it said could be offset by higher yields on CCBX loans and cash investments. It also expected continued CCBX growth and related hiring and operating costs.
- Interest-rate risk is material. The company described itself as asset-sensitive; modeled results indicated higher net interest income under rising-rate scenarios, subject to uncertain assumptions and actual rate movements. It noted that some modeled falling-rate scenarios were no longer viable at prevailing rates.
- CCBX concentration and counterparty performance are key risks. Two partners each had deposits exceeding 10% of total deposits and together represented 29% of deposits. If a partner cannot meet contractual credit or fraud indemnification obligations, the Bank could bear additional losses. An additional $269.5 million of CCBX customer deposits was being transferred off balance sheet to other institutions daily.
- Other stated risks include rapid loan and commitment growth, consumer credit performance, real-estate values, inflation, economic uncertainty, COVID-19 variants, the war in Ukraine, competition for deposits, and LIBOR transition. At June 30, $215.7 million of loans and $3.6 million of junior subordinated debentures were tied to LIBOR.
- 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. The FDIC had proposed a two-basis-point increase in assessment rates, which, if adopted, could take effect in 2023.
- Loans past due 90 days or more and still accruing totaled $5.8 million, up from $1.5 million at year-end; the increase was primarily CCBX partner-originated consumer loans. Management said community-bank credit quality remained strong. The filing reported no material change in risk factors, no pending litigation expected to materially affect results, and effective disclosure controls.
Important facts for investors to verify
- How much of CCBX indemnification income is recurring, and whether partner reimbursements continue to be collected promptly and in full.
- CCBX loan performance, charge-offs, delinquency trends, allowance adequacy and the financial strength of partners backing credit and fraud enhancements.
- Deposit concentration and retention, including the effect of rate increases, off-balance-sheet CCBX deposit transfers and competition on funding costs and liquidity.
- Whether rapid loan and unused-commitment growth changes credit concentration, capital needs or the loan-to-deposit ratio.
- The eventual CECL adoption impact, LIBOR transition outcomes and sensitivity of earnings to further interest-rate changes.