10-Q: Coastal Financial Q2: BaaS Drives Growth Amid Expense Rise

Coastal Financial Corporation reports strong asset and deposit growth, particularly in its CCBX segment, despite a quarterly net income dip and rising noninterest expenses.

Summary

• Net income for the three months ended June 30, 2025, was $11.0 million ($0.71 diluted EPS), a decrease from $11.6 million ($0.84 diluted EPS) in the comparable prior year quarter.
• Net income for the six months ended June 30, 2025, increased to $20.8 million ($1.36 diluted EPS) from $18.4 million ($1.34 diluted EPS) in the prior year period.
• Total assets grew 8.7% to $4.48 billion at June 30, 2025, from $4.12 billion at December 31, 2024.
• Total loans receivable increased 1.5% to $3.54 billion at June 30, 2025, compared to $3.49 billion at December 31, 2024, driven by a $76.7 million (4.8%) increase in CCBX loans.
• Community bank loans decreased $23.0 million (1.2%) to $1.86 billion at June 30, 2025.
• Total deposits increased 9.2% to $3.91 billion at June 30, 2025, from $3.59 billion at December 31, 2024, with CCBX deposits rising $296.1 million (14.3%) to $2.36 billion.
• Net interest income for Q2 2025 was $76.7 million, up 16.0% from $66.2 million in Q2 2024, primarily due to loan growth.
• Provision for credit losses for Q2 2025 was $32.2 million, a significant decrease from $62.3 million in Q2 2024, attributed to improved CCBX portfolio performance and a focus on higher quality loan originations.
• Net charge-offs for Q2 2025 totaled $49.3 million (5.54% of total average loans), down from $53.0 million (6.54%) in Q2 2024.
• BaaS indemnification income decreased $28.5 million (45.6%) in Q2 2025, directly related to the lower provision for credit losses.
• Total noninterest expense increased $14.9 million (25.7%) in Q2 2025, driven by higher salaries and employee benefits, legal and professional expenses, data processing and software licenses, and BaaS loan/fraud expenses.
• The Allowance for Credit Losses (ACL) decreased to $164.8 million (4.65% of total loans) at June 30, 2025, from $177.0 million (5.08%) at December 31, 2024.
• Uninsured deposits were $579.9 million (14.8% of total deposits) at June 30, 2025.
• The 2018 Omnibus Incentive Plan was amended on May 28, 2025, increasing authorized shares by 600,000.
• CEO Eric M. Sprink and CFO Joel G. Edwards adopted Rule 10b5-1 trading arrangements in June 2025.
• CFO Joel G. Edwards entered into an Employee Retirement and Retention Agreement effective May 7, 2025, with a retention period until April 1, 2026, and specific vesting terms for unvested equity.

Sentiment

Score: 7

Explanation: The company demonstrates strong underlying growth in assets, loans, and deposits, particularly in its strategic CCBX segment. Net interest income is robust, and credit quality in the CCBX portfolio is improving, leading to lower provisions. While net income for the quarter is slightly down due to accounting offsets and increased investment-related expenses, the overall half-year performance shows net income growth. The company maintains strong liquidity and capital positions. The identified material weaknesses in internal controls are a concern, but remediation efforts are underway. Strategic partnerships and future product launches indicate continued growth potential.

Positives

• Total assets increased by $359.4 million (8.7%) to $4.48 billion, indicating strong balance sheet expansion.
• Total deposits grew by $328.2 million (9.2%) to $3.91 billion, with significant growth in CCBX deposits (up $296.1 million or 14.3%).
• Net interest income increased by $10.6 million (16.0%) for Q2 2025 and $24.4 million (19.0%) for H1 2025, driven by loan growth.
• Provision for credit losses decreased significantly due to improved performance and higher quality originations in the CCBX portfolio, reflecting better credit risk management.
• Net charge-offs as a percentage of average loans decreased in Q2 2025 (5.54%) compared to Q2 2024 (6.54%), indicating improving loan quality.
• A high percentage of CCBX charge-offs (97.3% in Q2 2025, 97.5% in H1 2025) are covered by credit enhancements from partners, mitigating direct loss exposure for the Bank.
• The Company and Bank remain well-capitalized, exceeding all applicable regulatory capital requirements, with strong Tier 1 Leverage Capital and Total Capital ratios.
• Ample liquidity is maintained, with $719.8 million in cash and $642.7 million in available borrowing capacity from FHLB and FRB, totaling $1.41 billion, which significantly exceeds uninsured deposits of $579.9 million.
• Strategic partnerships with Robinhood and Dave are progressing to production and beta launch phases, respectively, expected to diversify and grow deposits.
• The company's strategy of selling CCBX loans to originating partners provides recurring fee income without additional on-balance-sheet risk or capital requirements.

Negatives

• Net income for the three months ended June 30, 2025, decreased to $11.0 million from $11.6 million in the prior year quarter.
• BaaS indemnification income decreased by $28.5 million (45.6%) in Q2 2025, which, while offsetting lower provision for credit losses, reduced total noninterest income.
• Total noninterest expense increased substantially by $14.9 million (25.7%) in Q2 2025 and $30.3 million (26.5%) in H1 2025, driven by higher salaries, legal, data processing, and BaaS loan/fraud expenses.
• The efficiency ratio worsened to 60.98% in Q2 2025 from 42.84% in Q2 2024, indicating higher costs relative to revenue.
• An unrealized net loss of $439,000 on equity securities was recognized in Q2 2025 due to the re-valuation of a privately held equity stake.
• Community bank loans decreased by $23.0 million (1.2%) at June 30, 2025.
• Average CCBX loan yield decreased to 16.22% in Q2 2025 from 17.75% in Q2 2024, attributed to lower rates and a shift in loan mix towards lower-rate capital call lines.
• Previously identified material weaknesses in internal control over financial reporting persist, requiring ongoing remediation efforts.

Risks

• Difficult market conditions and unfavorable economic conditions, including declines in housing markets, increased unemployment levels, and slowdowns in economic growth.
• Changes in U.S. trade policies, including the imposition of tariffs and retaliatory tariffs, may adversely impact business, financial condition, and results of operations.
• Impacts related to or resulting from bank failures and mergers and other economic and industry volatility, including potential increased regulatory requirements and costs.
• Credit risk associated with the loan portfolio, the level of nonperforming assets, and the costs associated with resolving problem loans.
• Ability to maintain an adequate level of allowance for credit losses, especially given the continuously changing macroeconomic environment (inflation, interest rates, global unrest, natural disasters).
• Ability to successfully manage liquidity risk, particularly if a relationship with a large CCBX partner terminates, leading to a significant exit of deposits.
• Ability to implement growth strategy and manage costs effectively, as noninterest expenses continue to rise with growth and technology investments.
• Ability to attract and retain key personnel, including the composition of the senior leadership team.
• Ability to raise additional capital to implement the business plan.
• Changes in market interest rates and impacts of such changes on profits and business.
• Occurrence of fraudulent activity, breaches or failures of information security controls, or cybersecurity-related incidents.
• Interruptions involving information technology and telecommunications systems or third-party servicers.
• Ability to maintain reputation.
• Increased competition in the financial services industry.
• Regulatory guidance on commercial lending concentrations.
• Relationship with digital financial service providers and potential increased regulatory focus on third-party deposit arrangements, such as the FDIC's proposed rule on recordkeeping for custodial accounts, which could increase operating costs.
• Effectiveness of the risk management framework.
• Costs and obligations associated with being a publicly traded company and other unanticipated costs.
• Commencement and outcome of litigation and other legal proceedings and regulatory actions.
• Extensive regulatory framework that applies to the company.
• Impact of recent and future legislative and regulatory changes and economic stimulus programs.
• Fluctuations in the value of securities held in the securities portfolio.
• Material weaknesses in internal control over financial reporting, which could adversely affect the ability to record, process, summarize, and report financial information.
• Counterparty risk if a CCBX partner is unable to fulfill its contracted obligations to indemnify or reimburse credit and fraud losses.

Future Outlook

The company expects continued positive impact on noninterest income from increased partner activity and transaction counts as current products grow and new ones are introduced. It plans to continue selling loans to optimize the CCBX portfolio, manage growth, credit quality, and partner limits, while retaining future fee income for transaction processing. The company aims to cultivate new relationships and expand product offerings with existing partners to grow its customer base with modest regulatory risk. Robinhood and Dave's product introductions are anticipated to diversify and grow deposits. While some continued growth in employees is expected to support business lines, the company is also focused on automating processes to slow future hiring growth. Marketing costs are projected to increase with an expanded marketing plan, and excise taxes are expected to rise due to increased taxable income. The company intends to monitor and control growth to maintain compliance with regulatory capital standards and believes it has ample liquidity to fund future growth and cash needs. The impact of the recently signed 'One Big Beautiful Bill Act' (H.R. 1) on future tax periods is currently being evaluated.

Management Comments

• "We continue to monitor and manage the CCBX loan portfolio, and will continue to sell CCBX loans to the originating partner in the coming months as part of our strategy to optimize our CCBX portfolio, manage growth, credit quality, portfolio and partner limits."
• "At the same time we will be focused on increasing our efficiency and using technology to reduce future expense growth."
• "We continue to refine the criteria for CCBX partnerships, exploring relationships with larger more established partners, with experienced management teams, existing customer bases and strong financial positions."
• "We also will consider promising medium and smaller sized partners that align with our approach and terms including financial wherewithal and will continue to exit relationships where it makes sense for us to do so."
• "As we become more proficient in the BaaS space we aim to cultivate new relationships that align with our long-term goals."
• "We believe that a strategy of adding new partnerships and launching new products with existing partners allows us to expand and grow our customer base with a modest increase in regulatory risk given our operational history with them."
• "Increases in partner activity/transaction counts is positively impacting noninterest income and we expect this trend to continue as current products grow and new products are introduced."
• "We plan to continue selling loans as part of our strategy to balance partner and lending limits, and manage the loan portfolio and credit quality."
• "We retain a portion of the future fee income for our role in processing transactions on sold credit card balances, and will continue this strategy to provide an on-going and recurring revenue source with no on balance sheet risk or capital requirement."
• "As we build our deposit base, we will be better able to sweep deposits off and on the balance sheet as needed. This deposit sweep capability allows us to better manage liquidity and deposit programs."
• "Management doesn't believe the write-down [on equity securities] is indicative of longer-term concerns at this time."
• "We are using more cost-effective advertising options, but expect costs to increase as we expand our marketing plan."
• "We expect to monitor and control growth in order to remain in compliance with all regulatory capital standards applicable to us."
• "We believe we have ample liquidity resources to fund future growth and meet other cash needs as necessary and are closely monitoring liquidity in this uncertain economic environment."
• "We believe that these limitations [on Bank dividends to Company] will not impact the ability of the Bank to pay dividends to the Company to meet ongoing operating needs."
• "Although we believe that we have established our allowance for credit losses in accordance with GAAP and that the allowance for credit losses was adequate to provide for expected losses in the portfolio at all times shown above, future provisions for credit losses will be subject to ongoing evaluations of the risks in our loan portfolio."
• "We believe that this alignment of interests [with CCBX partners] ensures that CCBX partners are motivated to implement robust risk management practices and maintain the overall health of the portfolio."

Industry Context

Coastal Financial operates in the dynamic financial services sector, with its community bank serving the Puget Sound region and its CCBX segment engaging with digital financial service providers globally. The company's focus on Banking as a Service (BaaS) aligns with the broader industry trend of embedded finance and fintech partnerships. The filing highlights increasing regulatory scrutiny on third-party deposit arrangements, including a joint statement from federal agencies and a proposed FDIC rule on custodial accounts, which could impact the operational costs and risk management practices for BaaS businesses. The company's strategy of selling CCBX loans back to originating partners and retaining fee income reflects an industry adaptation to manage balance sheet risk in fintech collaborations. Partnerships with prominent digital platforms like Robinhood and Dave underscore the company's position within the evolving digital banking landscape.

Comparison to Industry Standards

• The company is the largest community bank by deposit market share in Snohomish County, Washington, indicating strong local market penetration compared to other community banks.
• The average outstanding consumer loan balance for CCBX is small at $895 (June 30, 2025), which may indicate a focus on micro-lending or a different risk profile compared to traditional consumer loan portfolios.
• CCBX loans are noted to have a higher level of expected losses than the community bank loans, which is a common characteristic for fintech-originated loans compared to traditional bank portfolios.
• The company's internal policy for interest rate risk simulations specifies that estimated net income at risk should not decline by more than 10% for a 100 basis point shift, 15% for a 200 basis point shift, 20% for a 300 basis point shift, and 25% for a 400 basis point shift, aligning with standard banking risk management practices.
• The company has observed competitors increasing rates on time deposits but has chosen not to match them globally, prioritizing less costly core deposit growth, which reflects a distinct funding strategy compared to some market participants.

Management Changes

Corporate Governance

Legal Proceedings

• The company is a party to various litigation matters incidental to the conduct of its business from time to time.
• Management does not believe that any currently pending legal proceedings will have a material adverse effect on the company's business, financial condition, or earnings.

Related Party Transactions

• Arlington Olympic LLC, a wholly-owned subsidiary, owns the company's Arlington branch site, which the Bank leases from the LLC.

Stakeholder Impact

• Shareholders: Mixed quarterly net income but positive half-year net income, strong asset and deposit growth, and improving credit quality in the CCBX segment could be positive. Increased expenses and ongoing material weaknesses in internal controls are areas of concern. Management's adoption of Rule 10b5-1 trading arrangements is disclosed.
• Employees: Continued growth initiatives and hiring, alongside a focus on automation, will shape the workforce. The Employee Retirement and Retention Agreement for the CFO provides clarity and stability during a key leadership transition.
• Customers (Community Bank): The company remains focused on providing a wide range of banking products and services in the Puget Sound region.
• Customers (CCBX Partners and End Users): Expansion of product offerings and new partnerships (e.g., Robinhood, Dave) indicate broader service availability and innovation. Potential impacts from increased regulatory scrutiny on BaaS arrangements could affect service delivery or costs.
• Creditors: Strong liquidity and capital positions, along with a diversified loan portfolio and credit enhancement agreements, provide a favorable outlook for meeting financial obligations.

Next Steps

• Continue to monitor and manage the CCBX loan portfolio, including selling loans to originating partners to optimize the portfolio and manage growth, credit quality, and partner limits.
• Focus on increasing efficiency and using technology to reduce future expense growth.
• Refine criteria for CCBX partnerships, exploring relationships with larger, more established partners while also considering promising medium and smaller sized partners.
• Continue to exit relationships where it makes sense for the company to do so.
• Expand product offerings with existing CCBX partners.
• Cultivate new relationships that align with long-term goals as proficiency in the BaaS space grows.
• Robinhood is expected to enter the production testing phase for its suite of deposit products.
• Dave is poised to initiate its beta launch after finalizing production testing in Q2.
• Continue to invest in infrastructure and the automation of processes to ensure scalability.
• Monitor and control growth to remain in compliance with all regulatory capital standards applicable to the company.
• Evaluate the impact of the 'One Big Beautiful Bill Act' (H.R. 1) on future tax periods.
• Continue remediation efforts for previously identified material weaknesses in internal control over financial reporting.

Key Dates

Recommendation

Coastal Financial demonstrates strong underlying growth in its core banking and BaaS segments, with significant increases in assets, deposits, and net interest income. The improvement in CCBX loan portfolio quality, leading to lower provisions for credit losses, is a positive sign. However, the slight dip in quarterly net income, coupled with a notable increase in noninterest expenses and persistent material weaknesses in internal controls, presents areas of concern. While strategic investments in technology and new partnerships are promising for future growth, the immediate impact on profitability and efficiency needs close monitoring. The stock is likely to experience mixed sentiment given these offsetting factors, suggesting a 'hold' position until there is clearer evidence of expense management and full remediation of internal control issues, alongside continued strong performance from the BaaS segment.

Keywords

Banking, Financial Services, BaaS, Banking as a Service, Fintech, Community Bank, Loan Growth, Deposits, Net Interest Income, Credit Quality, Risk Management, Capital Adequacy, Liquidity, Earnings, SEC Filing, 10-Q, CCBX, Coastal Financial