Coastal Financial Corporation — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023; unaudited. Coastal Financial is a Washington bank holding company operating a community bank, a Banking-as-a-Service segment (CCBX), and treasury and administration. CCBX served 22 partners at quarter-end.
Financial performance and condition
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Net interest income | $62.4m | $39.9m | $116.8m | $69.2m |
| Noninterest income | $58.6m | $25.5m | $107.9m | $47.5m |
| Provision for loan credit losses | $52.6m | $14.1m | $96.1m | $27.0m |
| Noninterest expense | $51.9m | $38.2m | $96.6m | $68.6m |
| Net income | $12.9m | $10.2m | $25.3m | $16.4m |
| Diluted earnings per share | $0.95 | $0.76 | $1.86 | $1.22 |
| Net interest margin | 7.58% | 5.66% | 7.37% | 5.08% |
- Balance sheet at June 30: Assets were $3.54bn; loans receivable, $3.01bn; deposits, $3.16bn; and shareholders’ equity, $272.7m. Loans-to-deposits were 96.2%.
- Growth and funding: Since December 31, 2022, loans increased $380.3m (14.5%) and deposits increased $345.1m (12.2%). CCBX accounted for $282.0m of loan growth and $373.8m of deposit growth; community bank deposits declined $28.8m.
- Credit quality: The allowance for credit losses was $110.8m, or 3.68% of loans, versus $74.0m, or 2.82%, at year-end. Six-month net charge-offs were $63.3m, predominantly CCBX. CCBX partner agreements covered reported net charge-offs, subject to contractual and counterparty risk.
- Cash flow: For the first six months, operating cash flow was $81.1m, investing cash outflow $493.8m, and financing cash inflow $345.6m. Cash and cash equivalents ended at $275.1m.
- Liquidity and debt: Management reported $559.8m of available FHLB and Federal Reserve borrowing capacity and no advances under those facilities during the first half. Cash plus borrowing capacity totaled $834.8m. Borrowings included $45.0m principal of subordinated debt and $3.6m of junior subordinated debentures.
- Capital and securities: The Bank was classified as well capitalized; its total risk-based capital ratio was 10.80%, compared with 11.00% at December 31, 2022. Available-for-sale securities had $2.1m of unrealized losses; held-to-maturity fair value was $0.4m below carrying value.
Material changes and interpretation
- Q2 net income rose 26.8% year over year, while six-month net income rose 54.2%. Higher loan yields and CCBX growth lifted net interest income; increased provisions and operating expenses partially offset those gains.
- Reported noninterest income includes substantial BaaS credit-enhancement income recorded alongside provisions for expected CCBX credit losses. Q2 credit-enhancement income was $51.0m and the related loan provision was $52.6m. These gross-up accounting entries are not equivalent to cash earnings; net BaaS loan income after BaaS loan expense was $31.6m for Q2, versus $9.1m a year earlier.
- Deposit costs rose sharply with interest rates and deposit mix: Q2 cost of deposits was 2.72%, versus 0.25% a year earlier. CCBX deposits cost 4.42%; community bank deposits cost 0.98%.
- Nonperforming loans were $33.7m (1.12% of loans), including $26.3m of CCBX loans 90 or more days past due that were still accruing under the company’s partner-loan policies. The filing states that $25.2m of these CCBX loans were covered by partner credit enhancements.
Outlook, risks, contingencies, and unusual items
- No specific earnings or financial forecast is provided. Management expects deposit expense to rise if market rates increase further, with higher yields on CCBX loans and cash investments expected to provide a partial offset. It expects to continue growing deposits and loans and to add staff and technology spending to support CCBX and other growth.
- Management describes liquidity as ample, but notes that one CCBX partner accounts for 27% of total deposits. A partner exit or inability to honor credit-enhancement obligations could pressure liquidity or expose the Bank to losses.
- Credit risks include CCBX consumer-loan delinquency and charge-offs, commercial real estate and construction exposure, and possible deterioration from higher rates or weaker economic conditions. One CCBX arrangement leaves the Company responsible for approximately 10% of a specified $180.5m loan portfolio.
- The company adopted CECL on January 1, 2023. The transition increased opening retained earnings by $0.954m, excluding tax effects. The new expected-loss approach and growth in CCBX balances contributed to higher allowance and provision amounts.
- LIBOR ceased publication after June 30, 2023. The company identified 44 loans totaling $196.6m tied to LIBOR and said they will transition at repricing; its $3.6m junior debentures transition to a SOFR-based rate. Potential regulatory changes following bank failures and new small-business lending data requirements are also being evaluated.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. It said pending legal proceedings were not expected to have a material adverse effect and that risk factors had not materially changed from the 2022 Form 10-K.
Most important facts for investors to verify
- Whether CCBX partners continue to reimburse credit and fraud losses in full, replenish required reserves, and retain or grow their deposit relationships.
- Underlying CCBX credit performance, including delinquency migration, charge-offs, allowance assumptions, and the portion of losses not protected by contractual enhancements.
- Deposit retention and pricing, uninsured-deposit levels, concentration in the largest CCBX partner, and actual availability of contingent borrowing capacity.
- Commercial real estate and construction portfolio performance, collateral values, and the effect of economic or interest-rate changes on the allowance.
- How much reported income growth reflects recurring customer economics versus BaaS credit-enhancement accounting, and whether the margin benefit persists as funding costs rise.
- Execution and compliance costs from regulatory changes, LIBOR-linked contract transitions, and planned investments in staffing, systems, and risk management.