Coastal Financial Corporation — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; unaudited. Amounts below are in U.S. dollars. Coastal Financial is a Washington bank holding company operating a community bank, a Banking-as-a-Service business (CCBX), and treasury and administration activities.
Financial performance and condition
- Earnings: Net income was $12.4 million, versus $6.2 million in Q1 2022. Diluted earnings per share were $0.91, up from $0.46. Return on average assets was 1.58% and return on average equity was 19.89%.
- Interest income and margins: Net interest income rose 86% to $54.5 million. Net interest margin was 7.15%, versus 4.45%; loan yield was 9.95%, versus 6.80%. Deposit cost increased to 2.13% from 0.09%.
- Noninterest items: Noninterest income rose to $49.3 million from $22.0 million, largely reflecting BaaS indemnification income of $44.4 million, compared with $17.6 million a year earlier. Noninterest expense increased to $44.7 million from $30.4 million. The filing explains that BaaS credit-loss provisions and partner credit-enhancement income are recognized separately; these amounts should not be read as equivalent to ordinary fee revenue.
- Credit costs: Provision for loan credit losses was $43.5 million, versus $12.9 million. Net charge-offs were $32.3 million, mostly in CCBX; the company said partner credit enhancements covering CCBX losses were collected in full. The allowance for credit losses was $89.1 million, or 3.14% of loans, at quarter-end.
- Balance sheet: Assets were $3.45 billion, up 9.7% from year-end 2022. Loans receivable were $2.84 billion, deposits $3.10 billion, and shareholders’ equity $258.8 million. Loans-to-deposits were 92.5%.
- Cash flow and liquidity: Operating cash flow was $46.6 million; investing activities used $273.1 million, largely reflecting loan growth, while financing activities provided $278.3 million, mainly from deposit growth. Cash and interest-earning deposits totaled $393.9 million. The company reported $575.1 million of available FHLB and Federal Reserve borrowing capacity, with no outstanding advances at quarter-end.
- Debt and capital: Subordinated debt was $44.0 million net and junior subordinated debentures were $3.6 million net. The Bank was classified as well-capitalized and reported regulatory capital ratios above applicable well-capitalized thresholds.
Material changes versus the comparable period
- CCBX average loans increased to $1.06 billion from $382.2 million, helping drive higher loan interest income and net interest income. Total loans grew $209.9 million from December 31, 2022.
- Deposits rose $277.7 million, or 9.9%, from year-end, mainly through CCBX growth. The mix shifted toward interest-bearing deposits and deposit costs increased sharply year over year.
- Credit-loss expense and charge-offs increased substantially alongside CCBX loan growth. Nonperforming loans were $31.5 million, or 1.11% of loans, compared with $33.2 million, or 1.26%, at year-end.
- The company adopted CECL on January 1, 2023. The day-one adoption adjustment increased retained earnings by $734,000 after tax; prior-year comparisons were not recast.
- The company transferred $101.2 million of CCBX loans to held-for-sale, sold $73.9 million, and had $27.3 million remaining held for sale at quarter-end.
Outlook, commentary, and risks
- No specific earnings or financial guidance is provided. Management expects higher market rates to affect loan yields and deposit costs; it stated that further rate increases may raise deposit expense, with potential offsets from repricing CCBX loans and interest on cash.
- Management described liquidity as ample, citing cash and borrowing capacity, but noted that one CCBX partner’s deposits exceeded 10% of total deposits and represented 26% of deposits. A partner exit or failure to meet credit-enhancement obligations could pressure liquidity or expose the Bank to additional losses.
- Estimated uninsured deposits were $768.3 million, or 24.8% of deposits, down from $835.8 million, or 29.7%, at year-end. The filing also discusses heightened industry uncertainty following recent bank failures and possible regulatory changes or FDIC assessments.
- Key risks include CCBX partner and counterparty performance, CCBX consumer credit losses, deposit competition and rate sensitivity, real estate and economic conditions, and interest-rate changes. The company noted $201.1 million of loans and $3.6 million of junior subordinated debentures still tied to LIBOR as of March 31, 2023, and said it had identified these instruments for transition.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It said pending legal proceedings were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether CCBX partner credit-enhancement assets are collectible and partners continue to fund required reserves; quarter-end CCBX allowance was $68.4 million.
- The drivers and sustainability of CCBX charge-offs, delinquency trends, and the large increase in consumer-loan credit costs.
- Deposit concentration and stability, uninsured-deposit levels, deposit pricing, and the availability of stated borrowing capacity under stress.
- How net earnings and margins evolve as loan yields, deposit costs, and BaaS indemnification and expense amounts change.
- Potential consequences of new bank regulation or FDIC assessments, and completion of the LIBOR transition for identified loans and debt.