Coastal Financial Corporation — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Coastal Financial is a Washington-based bank holding company operating Coastal Community Bank, with 15 branches in the Puget Sound region and a banking-as-a-service (BaaS) business.
Financial performance and condition
- Q2 earnings: Net income was $3.7 million, or $0.30 diluted EPS, versus $3.3 million, or $0.27, in Q2 2019. For the first half, net income was $6.4 million, or $0.52 diluted EPS, versus $6.1 million, or $0.50.
- Revenue and margins: Q2 net interest income rose 37.4% to $14.0 million; first-half net interest income rose 27.1% to $25.4 million. Q2 net interest margin declined to 3.78% from 4.24%; first-half margin was 3.93% versus 4.19%. Q2 noninterest income fell 28.7% to $1.5 million, while noninterest expense rose 17.0% to $8.9 million.
- Credit costs: Provision for loan losses was $1.9 million in Q2 and $3.5 million in the first half, compared with $0.5 million and $1.1 million in the respective 2019 periods. The allowance was $14.8 million, or 1.03% of loans (1.46% excluding SBA-guaranteed PPP loans). First-half net charge-offs were $131,000.
- Balance sheet and funding: Total assets were $1.679 billion, up 48.8% from year-end 2019. Gross loans were $1.460 billion, including $438.1 million in PPP loans; deposits were $1.306 billion, up 35.0%. The loan-to-deposit ratio was 110.8%, elevated partly by PPP activity. Cash and due from banks totaled $26.5 million and interest-earning deposits at other banks were $147.7 million.
- Debt and capital: Borrowings included $190.2 million under the PPPLF, $25.0 million of FHLB advances, $10.0 million of subordinated debt and $3.6 million of junior subordinated debentures. The Bank was reported well-capitalized; its leverage ratio was 9.61%, common equity Tier 1 ratio 12.86%, and total capital ratio 14.11%.
- Cash flow: First-half operating cash flow was $8.0 million versus $4.7 million in 2019; investing activities used $569.1 million, largely reflecting loan growth, while financing activities provided $543.7 million. Cash, due from banks and restricted cash decreased $17.4 million to $26.5 million.
Material changes versus comparable periods
- PPP lending drove exceptional loan growth: PPP loans made up 30.0% of gross loans at quarter-end and generated $2.8 million of Q2 interest and fee income. Related deferred fees are recognized over loan lives, or sooner upon forgiveness or payoff.
- Growth in loan volume more than offset lower yields in net interest income. Lower market rates reduced loan yields and net interest margin; lower deposit pricing reduced funding costs.
- The allowance increased from $11.5 million at year-end 2019 to $14.8 million, reflecting loan growth and heightened economic uncertainty. Nonperforming loans increased to $4.4 million from $1.0 million at year-end; none were 90 days past due and still accruing.
- Revenue mix shifted: Q2 loan referral fees and loan-sale gains were lower, while first-half BaaS and mortgage broker fees increased. Operating expenses rose, particularly salaries, data processing, software and professional fees.
Outlook, risks and unusual items
- No quantified earnings or financial guidance is provided. Management expects deposits funded by PPP disbursements to decline as customers spend those funds; the timing and extent are uncertain. Management also anticipates ongoing PPP forgiveness work and potential increases in BaaS-related revenue and costs as partnerships become active.
- At June 30, 215 loans totaling $207.2 million had payment deferrals or restructurings under COVID-19 relief guidance; these short-term modifications were not classified as troubled debt restructurings. Management warned some borrowers may be unable to resume payments and further credit deterioration could require additional provisions.
- COVID-19, business restrictions, unemployment, real-estate conditions and government relief measures create significant uncertainty for borrowers, collateral values, asset quality, liquidity and operations. Commercial real estate is a major concentration; hotel/motel exposure was $99.4 million.
- The company reported ample liquidity and available borrowing capacity, while noting PPP-related deposits may run off and PPPLF advances must be repaid as PPP loans are forgiven or paid down. It reported no material pending legal proceedings and effective disclosure controls.
- Subsequent events: the PPP application deadline was extended to August 8, 2020; the company funded $10.0 million of additional PPP loans from July 1 through August 5. It registered as a Main Street Lending Program lender but had not made loans under that program. In August, the Bank announced plans with Google to offer digital bank accounts through Google Pay in 2021.
Important facts for investors to verify
- How much of reported earnings and loan growth depends on PPP fees, forgiveness timing and temporary customer deposits.
- Whether deferred borrowers resume payments and whether nonperforming loans, charge-offs or allowance needs rise as relief programs expire.
- Credit performance and collateral values in commercial real estate, particularly hospitality, and in construction and small-business lending.
- The durability of core deposit growth, liquidity after PPP funds are spent, and the effect of PPP loan paydowns on PPPLF borrowings and the loan-to-deposit ratio.
- Whether margin pressure from low interest rates and rising operating costs offsets loan growth and future BaaS revenue.