10-Q: Coastal Financial Corporation Reports Mixed Q1 Results Amidst Strategic Shift in CCBX Segment

Coastal Financial Corporation's first quarter results show a decrease in net income due to increased expenses, despite growth in loans and deposits, as the company focuses on optimizing its CCBX segment.

Summary

• Coastal Financial Corporation reported a net income of $6.8 million, or $0.50 per diluted share, for the first quarter of 2024, down from $12.4 million, or $0.91 per diluted share, in the same period last year.
• The decrease in net income was primarily due to a $13.9 million increase in interest expense, a $39.5 million increase in the provision for credit losses, and an $11.4 million increase in noninterest expense.
• These increases were partially offset by a $20.4 million increase in interest income and a $37.6 million increase in noninterest income.
• Total loans, net of deferred fees, increased by $173.5 million, or 5.7%, to $3.20 billion, with community bank loans increasing by $53.1 million and CCBX loans increasing by $120.3 million.
• The company sold $100.5 million in CCBX loans during the quarter as part of a strategy to reduce risk and optimize the CCBX loan portfolio.
• Deposits increased by $102.6 million, or 3.1%, to $3.46 billion, with CCBX deposits growing by $166.2 million and community bank deposits decreasing by $63.6 million.
• The net interest margin was 6.78% for the quarter, compared to 7.15% in the same period last year, primarily due to an increase in the cost of deposits.
• The company's cost of deposits was 3.49% for the quarter, up from 2.13% in the same period last year.
• The company had $515.1 million in cash and the capacity to borrow up to $659.5 million from the Federal Home Loan Bank and the Federal Reserve Bank discount window, with no borrowings taken during the quarter.

Sentiment

Score: 5

Explanation: The document presents a mixed picture. While there is growth in loans and deposits, the decrease in net income and net interest margin, along with increased expenses and credit loss provisions, raise concerns. The strategic shift in the CCBX segment and focus on larger partners is a positive sign, but the short-term financial impact is negative. The sentiment is neutral to slightly negative.

Positives

• Total loans increased by 5.7% to $3.20 billion, indicating growth in lending activities.
• CCBX deposits grew by 8.9%, showing strong growth in the Banking as a Service segment.
• The company has significant borrowing capacity from the Federal Home Loan Bank and the Federal Reserve Bank discount window.
• The company is actively managing its CCBX loan portfolio by selling loans to optimize the portfolio and strengthen the balance sheet.
• The company is focusing on larger, more established partners for its CCBX segment, which may lead to more stable and profitable relationships.

Negatives

• Net income decreased significantly due to increased interest expense, provision for credit losses, and noninterest expenses.
• The net interest margin decreased from 7.15% to 6.78% due to higher deposit costs.
• Community bank deposits decreased by 4.2%, indicating a potential challenge in retaining less costly core deposits.
• The company incurred $2.3 million in unanticipated expenses, net of income tax, during the quarter.
• The provision for credit losses increased significantly, primarily due to CCBX loan growth.

Risks

• The company faces risks related to the economic environment, including inflation, higher interest rates, and global unrest.
• The company is exposed to counterparty risk with its CCBX partners, as they may not be able to fulfill their obligations to replenish cash reserve accounts.
• The company's reliance on CCBX deposits as a source of liquidity could pose a risk if a large partner relationship terminates.
• The company's investment in technology requires significant upfront expenses, which may impact short-term profitability.
• The company's uninsured deposits represent 14.3% of total deposits, which could pose a risk in the event of a liquidity crisis.

Future Outlook

The company anticipates continuing to look for opportunities to grow and will focus on the long term, holding down deposit costs when possible and managing expenses through efficient use of technology. The company expects the CCBX loan portfolio to continue increasing as they work to grow the portfolio with loans that are subject to increased underwriting standards. The company will continue to sell CCBX loans in the coming months as they work to strengthen the balance sheet by optimizing the CCBX portfolio through new partners, products and building on existing relationships.

Management Comments

• Management is working to build back the CCBX portfolio with new loans, subject to enhanced credit standards.
• Management is focused on growing and retaining less costly core deposits.
• Management is being more intentional in the selection of products and partnerships that best serve customers and shareholders.
• Management is focused on the long term, holding down deposit costs when possible and managing expense through efficient use of technology.

Industry Context

The company's results reflect the broader challenges faced by financial institutions in the current economic environment, including rising interest rates and increased competition for deposits. The company's strategic shift towards larger, more established CCBX partners aligns with a trend in the industry towards more sustainable and profitable partnerships.

Comparison to Industry Standards

• The company's net interest margin of 6.78% is above the average for US banks, which is around 3.3% in Q1 2024, but is down from the previous year.
• The company's loan growth of 5.7% is above the average for US banks, which is around 1.5% in Q1 2024.
• The company's deposit growth of 3.1% is above the average for US banks, which is around 0.5% in Q1 2024.
• The company's cost of deposits of 3.49% is higher than the average for US banks, which is around 2.5% in Q1 2024.
• The company's provision for credit losses of $79.5 million is higher than the average for US banks, which is around 0.5% of total loans in Q1 2024, reflecting the higher risk profile of the CCBX segment.
• Compared to other regional banks like First Republic Bank, which failed in Q1 2023, Coastal Financial Corporation has a more diversified deposit base and a stronger liquidity position.
• Compared to other banks with significant BaaS operations, such as Cross River Bank, Coastal Financial Corporation has a more conservative approach to risk management, as evidenced by the sale of CCBX loans and the focus on larger, more established partners.

Stakeholder Impact

• Shareholders may be concerned about the decrease in net income and earnings per share.
• Employees may be affected by the company's efforts to manage expenses and improve efficiency.
• Customers may benefit from the company's focus on providing a broader range of banking products and services.
• Suppliers may be affected by the company's efforts to manage costs.
• Creditors may be concerned about the company's increased provision for credit losses.

Next Steps

• The company will continue to monitor and manage the CCBX loan portfolio and sell CCBX loans to strengthen the balance sheet.
• The company will focus on growing the CCBX portfolio with loans that are subject to increased underwriting standards.
• The company will continue to evaluate its methodology on allocating items to the Companys various segments to support strategic business decisions.
• The company will continue to evaluate its methodology on allocating items to the Companys various segments to support strategic business decisions.

Key Dates

Keywords

CCBX, Banking as a Service, BaaS, loans, deposits, net interest margin, credit losses, interest expense, noninterest expense, liquidity, capital, financial results, community bank