Coastal Financial Corporation — Q3 2023 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2023. Unaudited results. Coastal Financial operates a Washington community bank and CCBX, its Banking-as-a-Service (BaaS) business, alongside treasury and administration.
Key financial results
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net interest income | $62.2m | $49.2m | $179.1m | $118.3m |
| Noninterest income | $34.6m | $34.4m | $142.5m | $81.9m |
| Provision for loan credit losses | $27.2m | $18.4m | $123.3m | $45.5m |
| Noninterest expense | $56.5m | $51.1m | $153.1m | $119.7m |
| Net income | $10.3m | $11.1m | $35.6m | $27.5m |
| Diluted EPS | $0.75 | $0.82 | $2.61 | $2.04 |
Q3 net interest margin was 7.10%, up from 6.58% a year earlier but down from 7.58% in Q2 2023. Q3 cost of deposits rose to 3.14% from 0.82% a year earlier. For the nine months, net interest margin was 7.27%, versus 5.61%.
At September 30, 2023, total assets were $3.68bn, loans net of deferred fees were $2.97bn, deposits were $3.29bn, and shareholders’ equity was $284.5m. The allowance for credit losses was $101.1m, or 3.41% of loans. Total debt was $47.7m: $44.1m subordinated debt and $3.6m junior subordinated debentures.
Nine-month operating cash flow was $146.2m, investing cash outflow was $486.2m, and financing cash inflow was $472.8m. Cash and due from banks plus interest-earning deposits totaled $474.9m at quarter-end.
Material changes and drivers
- Q3 net income fell 7.5% year over year as higher interest expense, credit-loss provision and operating costs outweighed higher interest income. Nine-month net income increased 29.3%, supported by growth in net interest income and BaaS-related income.
- Loans grew 12.9% from year-end 2022 to $2.97bn, while deposits rose 16.8% to $3.29bn. During Q3, management reduced loans by $40.5m, including $320.9m of CCBX loan sales, as it sought to reduce risk and reshape that portfolio.
- Credit costs rose sharply: nine-month net charge-offs were $100.1m versus $14.8m in 2022, largely from CCBX loans. The company recorded $122.3m of CCBX loan provision for the nine months. It reported that partner credit enhancements covered the $100.0m of CCBX net charge-offs in that period.
- CCBX drove much of the growth in income and expenses. Nine-month BaaS indemnification income was $125.7m, including $119.3m of credit enhancements, while BaaS loan and fraud expense totaled $69.0m. These items reflect the company’s accounting for expected losses and partner reimbursements and should not be viewed as ordinary fee revenue alone.
- Q3 noninterest expense rose 10.6% year over year. Nine-month salaries and benefits increased 32.1%, and legal and professional expense increased 206.8%; management cited growth, risk and data-management initiatives, and infrastructure projects.
Liquidity, capital, outlook and risks
- Management reported $474.9m of cash and borrowing capacity of up to $577.9m from the FHLB and Federal Reserve discount window; neither facility was drawn during the nine months. These sources totaled $1.05bn, or 32.0% of deposits, compared with estimated uninsured deposits of $599.0m, or 18.2% of deposits.
- The Bank was classified as well capitalized. At September 30, its CET1 ratio was 10.21%, Tier 1 risk-based capital was 10.21%, and total risk-based capital was 11.48%.
- Management expects additional CCBX loan sales and portfolio repositioning over the next two to three quarters. It anticipates lower near-term earnings, lower loan yields and compressed margins as it emphasizes enhanced underwriting and lower-risk loans. It also plans to pursue larger, more established BaaS partners and use technology to improve efficiency and moderate expense growth.
- Key risks include elevated CCBX delinquencies and charge-offs, partner ability to meet credit-enhancement obligations, interest-rate and deposit-cost pressure, real-estate and economic conditions, and reliance on large partner relationships. One CCBX partner represented 28% of total deposits; one program leaves the Bank responsible for approximately 10% of a $231.9m loan portfolio.
- Unrealized losses on securities were attributed mainly to interest rates and market conditions; management reported no credit-loss allowance was required. HTM securities had a $1.7m difference between carrying value and fair value. The company adopted CECL in January 2023, increasing opening retained earnings by $734,000 after tax. A change in tax estimate also reduced the deferred tax asset and increased prepaid taxes.
- Management stated disclosure controls were effective and reported no material change in internal control over financial reporting. It did not believe pending litigation would materially affect the company. No material risk-factor changes from the 2022 Form 10-K were reported.
Investor facts to verify
- Whether CCBX partner credit enhancements and cash reserves remain collectible as losses emerge, including the uncovered exposure and concentration by partner.
- Whether CCBX loan sales and tighter underwriting reduce future charge-offs without materially impairing earnings, yields or margins.
- Deposit stability, repricing costs and the concentration of deposits with the partner representing 28% of deposits; verify available borrowing capacity and collateral requirements.
- Trends in 90-days-past-due CCBX loans, net charge-offs, allowance adequacy and commercial real-estate credit quality.
- The sustainability and comparability of BaaS indemnification income and related provisions, expenses and cash recoveries, given their material effect on reported results.