Coastal Financial Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Coastal Financial is a Washington bank holding company operating Coastal Community Bank, serving consumers and small and mid-sized businesses in the Puget Sound region through 14 branches, online banking and mobile banking. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Financial performance and condition
- Q3 earnings: Net income was $2.60 million, up 36.7% from $1.90 million a year earlier. Diluted EPS was $0.22 versus $0.21.
- Nine-month earnings: Net income was $6.65 million, up 30.5% from $5.09 million. Diluted EPS was $0.66 versus $0.55.
- Net interest income: Q3 was $8.85 million, up 17.3%; nine-month net interest income was $24.93 million, up 15.5%. Net interest margin was 4.13% for Q3 (4.14% prior year) and 4.17% for the nine months (4.09% prior year). Q3 net interest spread declined to 3.79% from 3.89%.
- Revenue and expenses: Q3 noninterest income was $1.55 million, up 23.7%, including $328,000 in new wholesale banking service fees. Noninterest expense rose 13.8% to $6.61 million, led by higher salaries and benefits. For the nine months, noninterest income rose 24.7% to $3.87 million and noninterest expense rose 14.3% to $19.03 million.
- Taxes: Q3 tax expense was $674,000 versus $957,000; the effective tax rate fell to 20.6% from 33.4%. The nine-month effective rate was 20.5% versus 32.4%, primarily reflecting the federal corporate tax rate reduction.
- Balance sheet: Total assets were $917.0 million at September 30, up 13.8% from year-end 2017. Loans were $744.3 million, up 13.3%; deposits were $774.7 million, up 10.2%. Shareholders’ equity was $105.3 million, compared with $65.7 million at year-end, reflecting the July IPO and retained earnings.
- Loan mix and credit: Commercial real estate loans were $502.8 million, or 67.5% of gross loans. The allowance for loan losses was $9.1 million, or 1.22% of loans. Nonperforming loans were $2.52 million, 0.34% of loans, versus $2.12 million and 0.32% at year-end. Nine-month net charge-offs were $307,000.
- Liquidity, funding and debt: Cash and due from banks were $16.8 million and interest-earning deposits at other banks were $98.7 million, including $22.6 million of restricted cash. Deposits were the primary funding source; FHLB advances were $20 million. Subordinated debt and junior subordinated debentures totaled approximately $13.5 million. The Bank reported that it was well capitalized; its September 30 total risk-based capital ratio was 14.03% and leverage ratio was 11.42%.
- Cash flow: Nine-month operating cash flow was $8.86 million. Investing activities used $110.82 million, substantially reflecting loan growth and increased interest-earning deposits; financing activities provided $105.01 million, including $33.24 million of IPO proceeds and deposit growth.
Material changes and management commentary
- Management attributed earnings growth mainly to loan-driven interest income, higher deposit and loan-related fees, new wholesale banking fees, and lower taxes. Higher funding costs and operating expenses partly offset those gains.
- Average loans grew year over year, while average deposit costs increased as market rates rose. Management noted that further Federal Reserve rate increases could raise deposit costs.
- Loan growth was concentrated in commercial real estate and construction and development lending. Commercial real estate loans increased 14.9% from year-end; construction, land and development loans increased 49.5%. Purchased loan participations reached $40.5 million from $8.1 million at year-end.
- The July 2018 IPO generated $33.2 million in net proceeds. The company said proceeds would support organic growth or acquisitions and general corporate purposes, potentially including debt repayment or regulatory capital needs. A one-for-five reverse stock split took effect in May.
- The Bank opened a full-service Edmonds branch on October 9, 2018. Management cited ongoing growth initiatives and described its intention to rebuild the SBA loan pipeline while emphasizing higher-quality loans.
Outlook, risks and unusual items
- No specific financial guidance or earnings forecast was provided. Management said it expects construction and development loans to continue paying off more quickly than historically, while balances have continued to grow.
- Management described the Bank as asset-sensitive: its modeling indicated that rising rates could increase net interest income, while falling rates could reduce it. Results depend on uncertain assumptions, including how quickly deposit rates respond.
- Key risks include local real estate conditions, commercial real estate concentration, credit quality and allowance adequacy, liquidity, competition, personnel and execution of growth plans, interest-rate movements, cybersecurity and technology disruptions, and regulatory or legal matters.
- Management stated that current litigation was not expected to have a material adverse effect and that risk factors had not materially changed from the July 2018 prospectus. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
- The expected January 2019 lease-accounting adoption was estimated to increase assets and liabilities by less than 1% of total assets. The company was still assessing the impact of the expected-credit-loss standard and could not estimate the one-time allowance adjustment.
Important facts for investors to verify
- Whether rapid loan growth, particularly in commercial real estate and construction lending, remains consistent with underwriting standards and credit performance.
- How deposit pricing and funding costs affect net interest margin as rates change, and whether loan and deposit growth can continue without materially higher expenses.
- The sustainability of new wholesale banking fees and other variable noninterest income, including loan referral and SBA-related fees.
- How IPO proceeds are deployed, the effect of share issuance and equity compensation on dilution, and the Bank’s capital position as assets grow.
- The amount and funding implications of unfunded credit commitments, including total commitments of $131.4 million at September 30, 2018, and the Bank’s liquidity under stressed conditions.