UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to __________
Commission File Number: 0-19684
COASTAL FINANCIAL CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)
State of Delaware 57-0925911
-------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2619 OAK STREET, MYRTLE BEACH, S. C. 29577
----------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (843) 205-2000
--------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
YES |X| NO |_|
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of July 31, 2005.
Common Stock $.01 Par Value Per Share 17,671,273 Shares
- --------------------------------------------------------------------------------
(Class) (Outstanding)
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2005
TABLE OF CONTENTS PAGE
- ----------------- ----
PART I- Financial Information
Item
1. Consolidated Financial Statements (unaudited):
Consolidated Statements of Financial Condition
as of September 30, 2004 and June 30, 2005 3
Consolidated Statements of Operations for the three
months ended June 30, 2004 and 2005 4
Consolidated Statements of Operations for the nine
months ended June 30, 2004 and 2005 5
Consolidated Statements of Stockholders' Equity
and Comprehensive Income for the nine months ended
June 30, 2004 and 2005 6
Consolidated Statements of Cash Flows for the nine
months ended June 30, 2004 and 2005 7-8
Notes to Consolidated Financial Statements 9-14
2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15-28
3. Quantitative and Qualitative Disclosures About 28-29
Market Risk
4. Controls and Procedures 29
Part II - Other Information
Item
1. Legal Proceedings 29
2. Unregistered Sales of Equity Securities and Use of Proceeds 29
3. Defaults Upon Senior Securities 29
4. Submission of Matters to a Vote of Securities Holders 30
5. Other Information 30
6. Exhibits 30
Signatures 31
Exhibits
31(a) Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer) 32
(b) Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer) 33
32(a) Section 1350 Certification (Chief Executive Officer) 34
(b) Section 1350 Certification (Chief Financial Officer) 35
2
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, June 30,
2004 2005
---- ----
(Unaudited)
(In thousands,
Except share data)
ASSETS:
Cash and amounts due from banks $ 28,383 $ 37,807
Short-term interest-bearing deposits 1,251 19,743
Fed funds sold 18 1,842
Investment securities available for sale 23,449 21,876
Mortgage-backed securities available for sale 374,283 403,736
Investment securities held to maturity 7,840 10,000
Loans receivable (net of allowance for loan
losses of $11,077 at September 30, 2004 and
$11,854 at June 30, 2005) 790,730 902,702
Loans receivable held for sale 8,246 9,126
Real estate acquired through foreclosure 785 522
Office property and equipment, net 18,844 21,828
Federal Home Loan Bank stock, at cost 16,900 15,527
Accrued interest receivable on loans 2,877 3,622
Accrued interest receivable on securities 2,473 2,290
Cash value of life insurance 21,627 22,336
Other assets 7,779 13,101
------------- -------------
$ 1,305,485 $ 1,486,058
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY:
LIABILITIES:
Deposits $ 753,379 $ 1,007,606
Securities sold under agreements to repurchase 107,173 65,018
Advances from Federal Home Loan Bank 328,507 283,507
Junior subordinated debt 15,464 15,464
Drafts outstanding 2,792 4,162
Advances by borrowers for property taxes and insurance 1,750 1,414
Accrued interest payable 1,502 2,730
Other liabilities 9,570 10,328
------------- -------------
1,220,137 1,390,229
------------- -------------
STOCKHOLDERS' EQUITY:
Serial preferred stock, 1,000,000 shares authorized
and unissued -- --
Common stock, $.01 par value, 25,000,000 shares
authorized; 17,486,784 shares at September 30, 2004
and 17,668,277 shares at June 30, 2005 issued
and outstanding 175 177
Additional paid-in capital 10,624 11,170
Retained earnings, restricted 73,533 82,998
Treasury stock, at cost (108,557 shares at
September 30, 2004 and zero at June 30, 2005) (1,182) --
Accumulated other comprehensive income,
net of tax 2,198 1,484
------------- -------------
Total stockholders' equity 85,348 95,829
------------- -------------
$ 1,305,485 $ 1,486,058
============= =============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 30, 2004 AND 2005
2004 2005
---- ----
(Unaudited)
(In thousands,
Except per share)
Interest income:
Loans receivable $ 11,783 $ 14,807
Investment securities 750 1,277
Mortgage-backed securities 4,107 4,147
Other 21 106
------------ ------------
Total interest income 16,661 20,337
------------ ------------
Interest expense:
Deposits 2,445 3,856
Securities sold under agreements to repurchase 486 760
Advances from Federal Home Loan Bank 2,800 2,981
Other borrowings 161 234
------------ ------------
Total interest expense 5,892 7,831
------------ ------------
Net interest income 10,769 12,506
Provision for loan losses 200 550
------------ ------------
Net interest income after provision for loan losses 10,569 11,956
------------ ------------
Other income:
Fees and service charges on loan and deposit accounts 964 1,611
Gain on sales of loans held for sale 315 215
Loss on sales of investment securities available
for sale and mortgage-backed securities available
for sale (440) (127)
Gain(loss) from real estate owned, net 96 (28)
Income from sales of non-depository products 416 441
Federal Home Loan Bank stock dividends 132 183
Other income 638 806
------------ ------------
2,121 3,101
------------ ------------
General and administrative expenses:
Salaries and employee benefits 4,003 4,612
Net occupancy, furniture and fixtures and data
processing expenses 1,482 1,968
FDIC insurance premium 26 26
Marketing expenses 247 463
Other expense 1,015 1,351
------------ ------------
6,773 8,420
------------ ------------
Income before income taxes 5,917 6,637
Income taxes 2,018 2,281
------------ ------------
Net income $ 3,899 $ 4,356
============ ============
Net income per common share:
Basic $ .22 $ .25
============ ============
Diluted $ .21 $ .23
============ ============
Weighted average common shares outstanding:
Basic 17,430,000 17,657,000
============ ============
Diluted 18,356,000 18,634,000
============ ============
Dividends per share $ .041 $ .05
============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED JUNE 30, 2004 AND 2005
2004 2005
---- ----
(Unaudited)
(In thousands,
Except per share)
Interest income:
Loans receivable $ 34,182 $ 40,911
Investment securities 2,062 3,652
Mortgage-backed securities 12,048 12,403
Other 60 229
------------ ------------
Total interest income 48,352 57,195
------------ ------------
Interest expense:
Deposits 7,510 9,290
Securities sold under agreements to repurchase 1,662 2,074
Advances from Federal Home Loan Bank 7,811 9,277
Other borrowings 483 637
------------ ------------
Total interest expense 17,466 21,278
------------ ------------
Net interest income 30,886 35,917
Provision for loan losses 1,250 1,525
------------ ------------
Net interest income after provision for loan losses 29,636 34,392
------------ ------------
Other income:
Fees and service charges on loan and deposit accounts 2,746 4,124
Gain on sales of loans held for sale 1,115 769
Gain (loss) on sales of investment securities available
for sale and mortgage-backed securities available
for sale (707) 119
Gain on investment security held to maturity
called by issuer -- 160
Gain(loss) from real estate owned 5 (72)
Income from sales of non-depository products 1,441 1,371
Federal Home Loan Bank stock dividends 362 534
Other income 1,917 2,199
------------ ------------
6,879 9,204
------------ ------------
General and administrative expenses:
Salaries and employee benefits 12,006 13,532
Net occupancy, furniture and fixtures and data
processing expenses 4,547 5,567
FDIC insurance premium 79 79
FHLB prepayment penalties 77 --
Marketing expenses 625 1,456
Other expense 2,784 3,886
------------ ------------
20,118 24,520
------------ ------------
Income before income taxes 16,397 19,076
Income taxes 5,502 6,541
------------ ------------
Net income $ 10,895 $ 12,535
============ ============
Net income per common share:
Basic $ .63 $ .71
============ ============
Diluted $ .60 $ .68
============ ============
Weighted average common shares outstanding:
Basic 17,293,000 17,558,000
============ ============
Diluted 18,266,000 18,545,000
============ ============
Dividends per share $ .124 $ .14
============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE NINE MONTHS ENDED JUNE 30, 2004 AND 2005
Accumulated
Other
Compre-
Additional hensive Total
Common Paid-In Retained Treasury Income Stockholders'
Stock Capital Earnings Stock (Loss) Equity
-------- ---------- -------- -------- ------------ -------------
(Unaudited)
(In thousands)
Balance at September
30, 2003 $ 172 $ 10,192 $ 63,030 $ (3,375) $ 3,688 $ 73,707
Net income -- -- 10,895 -- -- 10,895
Other comprehensive
income:
Unrealized losses arising
during period, net of
tax benefit of $2,990 -- -- -- -- (4,878) --
Less: reclassification
adjustment for losses
included in net income,
net of tax benefit of $269 -- -- -- -- (438) --
--------
Other comprehensive loss -- -- -- -- (5,316) (5,316)
-------- --------
Comprehensive income -- -- -- -- -- 5,579
--------
Exercise of stock
options 2 296 (1,176) 1,867 -- 989
Cash dividends -- -- (2,153) -- -- (2,153)
-------- -------- -------- ------ -------- --------
Balance at June
30, 2004 $ 174 $ 10,488 $ 70,596 $ (1,508) $ (1,628) $ 78,122
======== ======== ======== ======== ======== ========
Balance at September
30, 2004 $ 175 $ 10,624 $ 73,533 $ (1,182) $ 2,198 $ 85,348
Net income -- -- 12,535 -- -- 12,535
Other comprehensive
income:
Unrealized losses arising
during period, net of
tax benefit of $543 -- -- -- -- (887) --
Less: reclassification
adjustment for gains
included in net income,
net of taxes of $106 -- -- -- -- 173 --
--------
Other comprehensive income -- -- -- -- (714) (714)
-------- --------
Comprehensive income -- -- -- -- -- 11,821
--------
Exercise of stock
options 2 546 (602) 1,182 -- 1,128
Cash dividends -- -- (2,468) -- -- (2,468)
-------- -------- -------- ------ -------- --------
Balance at June
30, 2005 $ 177 $ 11,170 $ 82,998 $ -- $ 1,484 $ 95,829
======== ======== ======== ======== ======== ========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 30, 2004 AND 2005
2004 2005
---- ----
(Unaudited)
(In thousands)
Cash flows from operating activities:
Net income $ 10,895 $ 12,535
Adjustments to reconcile net income to net cash
Used in operating activities:
Depreciation 1,611 2,010
Provision for loan losses 1,250 1,525
(Gain) loss on sale of investment securities
available for sale and mortgage-backed securities
available for sale 707 (119)
Gain on call of investment security called
by issuer -- (160)
Gain on sale of real estate acquired through foreclosure -- (11)
Loss on disposal of office properties and equipment -- 124
Prepayment penalties on FHLB advances 77 --
Origination of loans receivable held for sale (42,896) (46,843)
Proceeds from sales of loans receivable held for sale 22,465 12,306
Recovery from write-down of mortgage
servicing rights (81) (223)
(Increase) decrease in:
Cash value of life insurance (720) (709)
Accrued interest receivable (346) (562)
Other assets (3,984) (5,098)
Increase (decrease) in:
Accrued interest payable 80 1,228
Other liabilities (572) 1,314
---------- ----------
Net cash used in operating activities (11,514) (22,683)
---------- ----------
Cash flows from investing activities:
Proceeds from sales of investment securities available
for sale 1,893 3,643
Proceeds from issuer call of investment securities
available for sale 2,000 1,950
Proceeds from issuer call of investment securities held
to maturity -- 8,000
Purchases of investment securities available for sale (5,371) (3,659)
Purchases of investment securities held to maturity -- (10,000)
Proceeds from sales of mortgage-backed securities
available for sale 143,190 179,049
Purchases of mortgage-backed securities available for sale (206,612) (243,250)
Principal collected on mortgage-backed securities
available for sale 91,008 66,892
Origination of loans receivable, net (424,686) (587,153)
Proceeds from sale of commercial loan participations -- 19,456
Principal collected on loans receivable 329,366 453,382
Purchase of bank-owned life insurance (4,500) --
Proceeds from sales of real estate acquired through
foreclosure, net 1,087 1,092
Purchases of office properties and equipment (3,147) (5,118)
Proceeds from sales of office properties and equipment 58 --
Purchase of feds fund sold -- (1,824)
Change in FHLB stock, net (661) 1,373
---------- ----------
Net cash used in investing activities (76,375) (116,167)
---------- ----------
(CONTINUED)
7
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 30, 2004 AND 2005 (CONTINUED)
2004 2005
---- ----
(Unaudited)
(In thousands)
Cash flows from financing activities:
Increase in deposits $ 66,978 $ 254,227
Decrease in securities sold under agreements
to repurchase, net (9,583) (42,155)
Proceeds from FHLB advances 533,176 544,400
Repayment of FHLB advances (493,248) (589,400)
Repayment of other borrowings (81) --
Prepayment penalties on early extinguishment of debt (77) --
Decrease in advance payments by borrowers for
Property taxes and insurance, net (333) (336)
Increase in drafts outstanding, net 630 1,370
Cash dividends to stockholders (2,153) (2,468)
Proceeds from exercise of stock options 989 1,128
----------- -----------
Net cash provided by financing activities 96,298 166,766
----------- -----------
Net increase (decrease) in cash and cash equivalents 8,409 27,916
Cash and cash equivalents at beginning of period 21,575 29,634
----------- -----------
Cash and cash equivalents at end of period $ 29,984 $ 57,550
=========== ===========
Supplemental information:
Interest paid $ 17,386 $ 20,050
=========== ===========
Income taxes paid $ 5,638 $ 5,040
=========== ===========
Supplemental schedule of non-cash investing and
financing transactions:
Securitization of mortgage loans into mortgage-backed
Securities $ 31,736 $ 33,657
=========== ===========
Transfer of mortgage loans to real estate acquired
Through foreclosure $ 515 $ 818
=========== ===========
Increase in other assets and junior subordinated debt
resulting from deconsolidation under FIN 46R $ 464 $ --
=========== ===========
Unrealized gain (loss) in investment securities and
mortgage-backed securities available for sale,
net of tax $ (4,878) $ (887)
=========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements were prepared in
accordance with instructions for Form 10-Q and, therefore, do not include all
disclosures necessary for a complete presentation of financial condition,
results of operations, cash flows and changes in stockholders' equity in
conformity with accounting principles generally accepted in the United States of
America. All adjustments, consisting only of normal recurring accruals, which in
the opinion of management are necessary for fair presentation of the interim
financial statements, have been included. The results of operations for the
three-month and the nine-month periods ended June 30, 2005 are not necessarily
indicative of the results that may be expected for the entire fiscal year. These
unaudited consolidated financial statements should be read in conjunction with
Coastal Financial Corporation and Subsidiaries' (the "Company") audited
consolidated financial statements and related notes for the year ended September
30, 2004, included in the Company's 2004 Annual Report to Stockholders. The
principal business of the Company is conducted by its wholly-owned subsidiary,
Coastal Federal Bank (the "Bank"). The information presented herein, therefore,
relates primarily to the Bank.
Certain prior period amounts have been reclassified to conform to current year
presentation.
(2) INVESTMENT SECURITIES AVAILABLE FOR SALE
The unrealized losses on investment securities were attributable to increases in
interest rates, rather than credit quality deterioration. Securities with
continuous losses less than 12 months at September 30, 2004 consisted of four
securities with an aggregate unrealized loss of $3,000. There were no securities
with continuous losses less than twelve months at June 30, 2005. Securities with
continuous losses 12 months or longer at September 30, 2004 consisted of ten
securities with an aggregate unrealized loss of $81,000. Securities with
continuous losses 12 months or longer at June 30, 2005 consisted of six
securities with an aggregate unrealized loss of $27,000. None of the individual
investment securities had an unrealized loss that exceeded 5% of its amortized
cost at either date.
(3) MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE
Gross unrealized losses on mortgage-backed securities and the length of time the
securities have been in a continuous loss position were as follows:
September 30, 2004
-----------------------------------------------------------------------------------------
Less than 12 Months 12 Months or Longer Total
------------------------- ------------------------- -------------------------
(Unaudited)
(Dollars in thousands)
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----- ------ ----- ------ ----- ------
Collateralized Mortgage $ 29,362 (221) 2,113 (98) 31,475 (319)
Obligations
FNMA 21,027 (116) 22,117 (545) 43,144 (661)
GNMA 6,456 (5) -- -- 6,456 (5)
FHLMC 46,457 (226) 20,829 (567) 67,286 (793)
--------- --------- --------- --------- --------- ---------
$ 103,302 (568) 45,059 (1,210) 148,361 (1,778)
========= ========= ========= ========= ========= =========
June 30, 2005
-----------------------------------------------------------------------------------------
Less than 12 Months 12 Months or Longer Total
------------------------- ------------------------- -------------------------
(Unaudited)
(Dollars in thousands)
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----- ------ ----- ------ ----- ------
Collateralized Mortgage $ 34,183 (101) 14,140 (122) 48,323 (223)
Obligations
FNMA 25,846 (140) 36,548 (538) 62,394 (678)
GNMA 32,751 (158) 2,051 (2) 34,802 (160)
FHLMC 29,398 (190) 23,032 (280) 52,430 (470)
--------- --------- --------- --------- --------- ---------
$ 122,178 (589) 75,771 (942) 197,949 (1,531)
========= ========= ========= ========= ========= =========
9
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
(3) MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE - CONTINUED
The unrealized losses on mortgage-backed securities were attributable to
increases in interest rates, rather than credit quality deterioration. The
unrealized losses are comprised of 25 securities at September 30, 2004 and 31
securities at June 30, 2005 that have had continuous losses of less than 12
months. There were 8 securities at September 30, 2004 and 21 securities at June
30, 2005, with continuous losses 12 months or longer. None of the individual
investment securities had an unrealized loss that exceeded 5% of its amortized
cost at either date.
(4) LOANS RECEIVABLE, NET
Loans receivable, net consists of the following:
September 30, June 30,
2004 2005
------------- -----------
(Unaudited)
(Dollars in thousands)
First mortgage loans:
Single family to four family units $ 329,287 $ 356,757
Land and land development 99,697 108,952
Residential lots 29,839 33,183
Other, primarily commercial real estate 182,924 214,824
Construction loans on residential properties 82,789 119,735
Construction loans on commercial properties 10,503 10,998
Consumer and commercial loans:
Installment consumer loans 18,024 19,591
Mobile home loans 4,618 4,213
Savings account loans 2,058 1,910
Equity lines of credit 30,906 34,170
Commercial and other loans 32,101 37,037
----------- -----------
822,746 941,370
Less:
Allowance for loan losses 11,077 11,854
Deferred loan costs, net (674) (408)
Undisbursed portion of loans in process 21,613 27,222
----------- -----------
$ 790,730 $ 902,702
=========== ===========
The changes in the allowance for loan losses consist of the following for the
nine months ended:
Nine months Ended June 30,
--------------------------
2004 2005
---- ----
(Unaudited)
(Dollars in thousands)
Allowance at beginning of period $ 9,832 $ 11,077
Provision for loan losses 1,250 1,525
----------- -----------
Recoveries:
Residential loans -- --
Commercial loans 149 22
Consumer loans 41 66
----------- -----------
Total recoveries 190 88
----------- -----------
Charge-offs:
Residential loans -- --
Commercial loans 109 504
Consumer loans 321 332
----------- -----------
Total charge-offs 430 836
----------- -----------
Net charge-offs 240 748
----------- -----------
Allowance at end of period $ 10,842 $ 11,854
=========== ===========
10
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(4) LOANS RECEIVABLE, NET - CONTINUED
Nine months Ended June 30,
--------------------------
2004 2005
---- ----
(Unaudited)
Ratio of allowance to total net loans
outstanding at the end of the period 1.38% 1.30%
==== ====
Ratio of net charge-offs to average
total loans outstanding during the period (annualized) .04% .12%
==== ====
Non-accrual loans, which are primarily loans over ninety days delinquent,
totaled approximately $4.8 million and $3.8 million at June 30, 2004 and 2005,
respectively. For the nine months ended June 30, 2004 and 2005, interest income,
which would have been recorded, would have been approximately $184,000 and
$241,000, respectively, had non-accruing loans been current in accordance with
their original terms.
At June 30, 2005 and 2004, impaired loans totaled $3.4 million. Included in the
allowance for loan losses at June 30, 2005 was $553,000 related to impaired
loans compared to $266,000 at June 30, 2004. The average recorded investment in
impaired loans for the nine months ended June 30, 2005 was $3.9 million compared
to $4.1 million for the nine months ended June 30, 2004. Interest income of
$133,000 and $232,000 was recognized on impaired loans for the quarter and nine
months ended June 30, 2005. Interest income of $60,000 and $240,000 was
recognized on impaired loans for the quarter and nine months ended June 30,
2004.
(5) DEPOSITS
Deposits consist of the following:
September 30, 2004 June 30, 2005
--------------------------- ---------------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
------ ---- ------ ----
(Unaudited)
(Dollars in thousands)
Checking accounts $ 233,128 0.22% $ 335,480 0.22%
Money market accounts 224,468 1.37 223,579 1.97
Statement savings accounts 55,205 0.80 74,604 1.22
Certificate accounts 240,578 2.49 373,943 3.03
---------- ----------
$ 753,379 1.33% $1,007,606 1.72%
========== ==========
Included in certificate accounts ("CDs") are $125.5 million of brokered CDs at
June 30, 2005. There were no brokered CDs at September 20, 2004. The average
rate and remaining term of brokered CDs at June 30, 2005 was 3.19% and five
months, respectively.
(6) ADVANCES FROM FEDERAL HOME LOAN BANK
Advances from Federal Home Loan Bank ("FHLB") consist of the following:
September 30, 2004 June 30, 2005
--------------------------- ---------------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
------ ---- ------ ----
(Unaudited)
(Dollars in thousands)
Maturing within:
1 year $ 64,500 2.78% $ 14,742 5.13%
2 years 4,177 2.79 3,294 2.53
3 years 11,560 2.23 5,951 3.08
4 years 3,977 3.18 29,130 2.15
5 years 31,803 2.36 17,650 4.33
After 5 years 212,490 4.20 212,740 4.21
---------- ----------
$ 328,507 3.64% $ 283,507 4.01%
========== ==========
11
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(6) ADVANCES FROM FEDERAL HOME LOAN BANK - CONTINUED
At September 30, 2004, and June 30, 2005, the Bank had pledged first mortgage
loans and mortgage-backed securities with unpaid balances of approximately
$357.3 million and $433.1 million, respectively, as collateral for FHLB
advances.
At June 30, 2005, included in the one, two, three, four, five, and after five
years maturities were advances of $200.0 million, with a weighted average rate
of 3.86%, subject to call provisions. Callable advances at June 30, 2005 are
summarized as follows: $75.0 million callable in fiscal 2005, with a weighted
average rate of 5.52%; $28.0 million callable in fiscal 2006, with a weighted
average rate of 2.29%; $35.0 million callable in fiscal 2007, with a weighted
average rate of 3.00%; $37.0 million callable in fiscal 2008 with a weighted
average rate of 2.98%, and $25.0 million callable in fiscal 2009, with a
weighted average rate of 3.13%. Call provisions are more likely to be exercised
by the FHLB when market interest rates rise.
(7) EARNINGS PER SHARE
Basic earnings per share for the three and nine months ended June 30, 2004 and
2005 are computed by dividing net income by the weighted average common shares
outstanding during the respective periods. Diluted earnings per share for the
three and nine months ended June 30, 2004 and 2005 are computed by dividing net
earnings by the weighted average dilutive shares outstanding during the
respective periods.
The following is a reconciliation of average shares outstanding used to
calculate basic and fully diluted earnings per share.
For the Quarter Ended June 30,
(Unaudited)
2004 2004 2005 2005
-------------------------- --------------------------
BASIC DILUTED BASIC DILUTED
-------------------------- --------------------------
Weighted average shares outstanding 17,430,000 17,430,000 17,657,000 17,657,000
Effect of dilutive securities-
Stock options -- 926,000 -- 977,000
-------------------------- --------------------------
17,430,000 18,356,000 17,657,000 18,634,000
========================== ==========================
For the Nine months Ended June 30,
(Unaudited)
2004 2004 2005 2005
-------------------------- --------------------------
BASIC DILUTED BASIC DILUTED
-------------------------- --------------------------
Weighted average shares outstanding 17,293,000 17,293,000 17,558,000 17,558,000
Effect of dilutive securities-
Stock options -- 973,000 -- 987,000
-------------------------- --------------------------
17,293,000 18,266,000 17,558,000 18,545,000
========================== ==========================
(8) STOCK BASED COMPENSATION
At June 30, 2005, the Company had a stock option plan that provides for stock
options to be granted primarily to directors, officers and other key Associates.
The plan is more fully described in Note 17 of the Notes to Consolidated
Financial Statements included in the Company's Annual Report for the year ended
September 30, 2004. The Company accounts for the plan under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees", and related interpretations. No stock-based employee or director
compensation cost is reflected in net income, as all options granted under the
plan had an exercise price equal to the market value of the underlying common
stock on the date of grant.
12
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(8) STOCK BASED COMPENSATION - CONTINUED
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of FASB
Statement 123, "Accounting for Stock-Based Compensation", to stock-based
employee and non-employee compensation.
Three Months Ended June 30,
---------------------------
2004 2005
---- ----
(Unaudited)
(Dollars in thousands)
Net income, as reported $ 3,899 $ 4,356
Deduct: Total stock-based employee and director
compensation expense determined under
fair value based method for all awards,
net of related tax effects (156) (201)
------------ ------------
Pro forma net income $ 3,743 $ 4,155
============ ============
Basic earnings per share:
As reported $ .22 $ .25
============ ============
Pro forma $ .21 $ .24
============ ============
Diluted earnings per share:
As reported $ .21 $ .23
============ ============
Pro forma $ .20 $ .22
============ ============
Nine months Ended June 30,
--------------------------
2004 2005
---- ----
(Unaudited)
(Dollars in thousands)
Net income, as reported $ 10,895 $ 12,535
Deduct: Total stock-based employee and director
compensation expense determined under
fair value based method for all awards,
net of related tax effects (442) (577)
------------ ------------
Pro forma net income $ 10,453 $ 11,958
============ ============
Basic earnings per share:
As reported $ .63 $ .71
============ ============
Pro forma $ .60 $ .68
============ ============
Diluted earnings per share:
As reported $ .60 $ .68
============ ============
Pro forma $ .57 $ .64
============ ============
(9) COMMON STOCK DIVIDEND
On July 30, 2004 and December 15, 2004, the Company declared 10% stock
dividends, aggregating approximately 1,442,000 and 1,594,000 shares,
respectively. All share and per share data have been retroactively restated for
the stock dividends.
13
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(10) GUARANTEES
Standby letters of credit obligate the Company to meet certain financial
obligations of its customers, if, under the contractual terms of the agreement,
the customers are unable to do so. Payment is only guaranteed under these
letters of credit upon the borrower's failure to perform its obligations to the
beneficiary. The Company can seek recovery of the amounts paid from the
borrower. These standby letters of credit are generally collateralized.
Commitments under standby letters of credit are usually one year or less. At
June 30, 2005, the Company has recorded no liability for the current carrying
amount of the obligation to perform as a guarantor. The maximum potential amount
of undiscounted future payments related to standby letters of credit at
September 30, 2004 and 2005 was $5.5 million and $5.8 million, respectively.
(11) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITES
The Bank originates certain fixed rate residential loans with the intention of
selling these loans in the secondary market. Between the time that the Bank
enters into an interest rate lock or a commitment to originate a fixed rate
residential loan with a potential borrower and the time the closed loan is sold,
the Company is subject to variability in the market prices related to these
commitments. The Company believes that it is prudent to limit the variability of
expected proceeds from the sales through forward sales of "to be issued"
mortgage-backed securities and loans ("forward sales commitments"). The
commitment to originate fixed rate residential loans and forward sales
commitments are freestanding derivative instruments. Since such instruments do
not qualify for hedge accounting treatment, their fair value adjustments are
recorded through the income statement in net gains on sales of loans held for
sale. The commitments to originate fixed rate conforming loans totaled $6.5
million at June 30, 2005. The fair value of the loan commitments was an asset of
approximately $50,000 at June 30, 2005. As of June 30, 2005, the Company had
sold $8.0 million in forward commitments to deliver fixed rate mortgage-backed
securities, which were recorded as a derivative liability of $11,000.
14
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis should be read in conjunction with the
consolidated financial statements of Coastal Financial Corporation and
Subsidiaries and the notes thereto.
FORWARD LOOKING STATEMENTS
- --------------------------
This report may contain certain "forward-looking statements" within the meaning
of Section 27A of the Securities Exchange Act of 1934, as amended, that
represent the Company's expectations or beliefs concerning future events. All
forward-looking statements are based on assumptions and involve risks and
uncertainties, many of which are beyond the Company's control and which may
cause its actual results, performance or achievements to differ materially from
the results, performance or achievements contemplated by the forward-looking
statements. Forward-looking statements can be identified by the fact that they
do not relate strictly to historical or current facts. They often include words
such as "believe," "expect," "anticipate," "intend," "plan," "estimate" or words
of similar meaning, or future or conditional verbs such as "will," "would,"
"should," "could" or "may." Forward-looking statements speak only as of the date
they are made. Such risks and uncertainties include, among other things:
o Competitive pressures among depository and other financial
institutions in the Company's market areas may increase
significantly.
o Adverse changes in the economy or business conditions, either
nationally or in the Company's market areas, could increase
credit-related losses and expenses and/or limit growth.
o Increases in defaults by borrowers and other delinquencies could
result in increases in the Company's provision for losses on loans
and related expenses.
o The Company's inability to manage growth effectively, including the
successful expansion of the Company's Customer support,
administrative infrastructure and internal management systems, could
adversely affect the Company's results of operations and prospects.
o Fluctuations in interest rates and market prices could reduce the
Company's net interest margin and asset valuations and increase
expenses.
o The consequences of continued bank acquisitions and mergers in the
Company's market areas, resulting in fewer but much larger and
financially stronger competitors, could increase competition for
financial services to the Company's detriment.
o The Company's continued growth will depend in part on its ability to
enter new markets successfully and capitalize on other growth
opportunities.
o Changes in legislative or regulatory requirements, or actions by the
Securities and Exchange Commission ("SEC"), the Financial Accounting
Standards Board ("FASB"), or the Public Company Accounting Oversight
Board, applicable to the Company and its subsidiaries could increase
costs, limit certain operations and adversely affect results of
operations.
o Changes in tax requirements, including tax rate changes, new tax
laws and revised tax law interpretations may increase the Company's
tax expense or adversely affect its Customers' businesses.
o Company initiatives now in place or introduced in the future, not
producing results consistent with historic growth rates or results
which justify their costs.
In light of these risks, uncertainties and assumptions, you should not place
undue reliance on any forward-looking statements in this report. The Company
undertakes no obligation to publicly update or otherwise revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
15
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
OVERVIEW
- --------
Coastal Financial Corporation is a unitary thrift holding company incorporated
in Delaware with one wholly-owned banking subsidiary, Coastal Federal Bank (the
"Bank" or "Coastal Federal"). The Company also owns Coastal Planners Holding
Corporation, whose subsidiary, Coastal Retirement, Estate and Tax Planners,
Inc., offers fee-based financial planning and tax preparation services. The
primary business activities of the Company are conducted by the Bank. The
Company and Bank's principal executive offices are located in Myrtle Beach,
South Carolina.
Coastal Federal Bank is a full service financial services company with 19
branches located in four counties throughout the coastal regions of South
Carolina and North Carolina. The Bank has twelve offices in Horry County, South
Carolina; one office in Georgetown County, South Carolina; three offices in
Brunswick County, North Carolina; and three offices in New Hanover County, North
Carolina.
The Bank's primary market areas are located along the coastal regions of South
Carolina and North Carolina and predominately center around the Metro regions of
Myrtle Beach, South Carolina and Wilmington, North Carolina, and their
surrounding counties. Coastal Federal's primary market is Horry County, South
Carolina where the Bank has the number one market share of deposits as of June
30, 2004 (the most recent date for which published data is available) with 16.4%
of deposits as reported by the FDIC Summary of Deposits Report. The Bank also
has the third highest market share of deposits as of June 30, 2004 in Brunswick
County, North Carolina with 8.9% of deposits as reported by the FDIC Summary of
Deposits Report.
The primary business activities in Horry County are centered around the tourism
industry. To the extent that Horry County businesses rely heavily on tourism
business, decreased tourism would have a significant adverse effect on Coastal
Federal's primary deposit base and lending area. Moreover, the Bank would likely
experience a higher degree of loan delinquencies should the local economy be
materially and adversely affected.
Coastal Federal's principal business consists of attracting core deposits from
Customers in its primary market locations and using these funds to meet the
lending needs of its Customers as well as providing numerous financial products
and services for its Customers.
Through its branch locations, the Bank provides a wide range of banking
products, including interest-bearing and non-interest bearing checking accounts;
business sweep accounts; business cash management services; statement savings
accounts; money market accounts; certificate of deposit accounts; individual
retirement accounts; merchant services; commercial, business, personal, real
estate, residential mortgage and home equity loans; safe deposit boxes; and
electronic banking services. The Bank has six ATMs at off-site locations and an
ATM at each branch. The Bank also makes available a wide range of financial
products through its relationship with Raymond James Financial Services,
including stocks, bonds, mutual funds, annuities, insurance, and retirement
products.
In the fourth fiscal quarter of 2004, the Bank began two significant new
initiatives. The first was "The Experience of FANtastic! Customer Service". This
initiative focuses on Customer service and convenience. The Bank is in the
process of redesigning its infrastructure, software and products to improve
Customer service and convenience and Associate productivity. In addition, in
order to improve Customer service and convenience, the Bank added an
extended-hours Call Center and introduced "6 Day Branch Banking" with extended
operating hours. The Call Center employs 20 to 25 Associates. The Bank
experienced increased salary and benefit expenses in the first nine months of
fiscal 2005 and anticipates these expenses continuing thereafter associated with
the hiring, training and placement of these new Associates.
16
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
OVERVIEW - CONTINUED
- --------------------
The second initiative was "Totally Free Checking With A Gift" that was
introduced in September 2004. The Bank has incurred, and will continue to incur,
significant marketing costs associated with this campaign. In the first three
fiscal quarters of 2005, marketing expenses were $1,456,000 compared to $625,000
in the comparable 2004 period. The Bank expects to realize significant benefits
from this strategy consisting of increased Bank lobby traffic, increased number
of personal checking accounts and higher fee income as a result of those
checking accounts. In the first three fiscal quarters of fiscal 2005, checking
account balances grew approximately 44%. This rate of growth could necessitate
the hiring of additional Associates to open and service these accounts. The
Associates being hired for these two initiatives are expected to have total
compensation averaging between $28,000 and $35,000 per Associate.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
The Company's accounting policies are in accordance with accounting principles
generally accepted in the United States of America and with general practice
within the banking industry. In order to understand the Company's financial
condition and results of operations, it is important to understand the more
critical accounting policies and the extent to which judgment and estimates are
used in applying those policies. The Company considers its policies regarding
the allowance for loan losses and income taxes to be its most critical
accounting policies due to the significant degree of the levels of subjectivity
and management judgment necessary to account for these matters. Different
assumptions in the application of these policies could result in material
changes in the Company's consolidated financial statements. The Company's
accounting policies are set forth in Note 1 of the Notes to Consolidated
Financial Statements in the Company's 2004 Annual Report to Stockholders. For
additional discussion concerning the Company's allowance for loan losses and
related matters, see "Allowance for Loan Losses" and see "Income Taxes" for
additional discussion concerning income taxes in the Company's 2004 Annual
Report to Stockholders.
OFF-BALANCE SHEET ARRANGEMENTS
- ------------------------------
In the normal course of operations, the Company engages in a variety of
financial transactions that, in accordance with generally accepted accounting
principles, are recorded in amounts that differ from the notional amounts. These
transactions involve, to varying degrees, elements of credit risk, interest
rate, and liquidity risk. Such transactions are used by the Company for general
corporate purposes or to satisfy customer needs. Corporate purpose transactions
are used to help manage customers' requests for funding. The Bank's off-balance
sheet arrangements, which principally include lending commitments and
derivatives, are described below.
Lending Commitments. Lending Commitments include loan commitments, standby
letters of credit, unused business and personal credit card lines, and unused
business and personal lines of credit. These instruments are not recorded in the
consolidated balance sheet until funds are advanced under the commitments. The
Bank provides these lending commitments to customers in the normal course of
business. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company applies essentially the same
credit policies and standards as it does in the lending process when making
these loans. For business customers, commercial loan commitments generally take
the form of revolving credit arrangements to finance customers' working capital
requirements. For personal customers, loan commitments are generally lines of
credit that are unsecured or are secured by residential property. Standby
letters of credit obligate the Company to meet certain financial obligations of
its customers, if, under the contractual terms of the agreement, the customers
are unable to do so. Payment is only guaranteed under these letters of credit
upon the borrower's failure to perform its obligations to the beneficiary. The
Company can seek recovery of the amounts paid from the borrower. Standby letters
of credit are generally collateralized and are usually one year or less.
17
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
OFF-BALANCE SHEET ARRANGEMENTS, CONTINUED
- -----------------------------------------
At June 30, 2005, the Company recorded no liability for the current carrying
amount of the obligation to perform as a guarantor, as such amounts are not
considered material. The maximum potential amount of undiscounted future
payments related to standby letters of credit at September 30, 2004 and June
30,2005 was $5.5 million and $5.8 million, respectively.
A summary of loans receivable with undisbursed commitments to extend credit at
September 30, 2004 and June 30, 2005 follows:
September 30, June 30,
------------- --------
2004 2005
---- ----
(Unaudited)
(Dollars In thousands)
Residential mortgage loans in process $ 21,613 $ 27,222
Business and consumer credit card lines 14,171 14,249
Consumer home equity lines 37,031 39,789
Other consumer lines of credit 8,361 7,295
Commercial real estate and construction
and land development 52,978 100,460
Other commercial lines of credit 8,071 9,552
------------ ------------
Total loans receivable with undisbursed commitments $ 142,225 $ 198,567
============ ============
Derivatives and Hedging Activities. The Bank originates certain fixed rate
residential loans with the intention of selling these loans. Between the time
that the Bank enters into an interest rate lock or a commitment to originate a
fixed rate residential loan with a potential borrower and the time the closed
loan is sold, the Company is subject to variability in the market prices related
to these commitments. The Company believes that it is prudent to limit the
variability of expected proceeds from the sales through forward sales of "to be
issued" mortgage-backed securities and loans ("forward sales commitments"). The
commitment to originate fixed rate residential loans and forward sales
commitments are freestanding derivative instruments. Since such instruments do
not qualify for hedge accounting treatment, their fair value adjustments are
recorded through the income statement in net gains on sale of loans. The
commitments to originate fixed rate conforming loans totaled $6.5 million at
June 30, 2005. The fair value of the loan commitments was an asset of
approximately $50,000 at June 30, 2005. As of June 30, 2005, the Company had
sold $8.0 million in forward commitments to deliver fixed rate mortgage-backed
securities, which were recorded as a derivative liability of $11,000.
DISCUSSION OF FINANCIAL CONDITION CHANGES FROM SEPTEMBER 30, 2004 TO
- --------------------------------------------------------------------
JUNE 30, 2005
- -------------
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Historically, the Company has maintained its liquidity at levels believed by
management to be adequate to meet the requirements of normal operations,
potential deposit out-flows and strong loan demand and still allow for optimal
investment of funds and return on assets. The principal sources of funds for the
Company are cash flows from operations, consisting mainly of loan payments,
Customer deposits, advances from the FHLB, securitization of loans and
subsequent sales, and loan sales.
The principal use of cash flows is the origination of loans receivable and
purchase of investment securities. The Company originated loans receivable of
$467.6 million for the nine months ended June 30, 2004, compared to $634.0
million for the nine months ended June 30, 2005. Loan principal repayments
amounted to $329.4 million in the first three quarters of 2004 compared to
$453.4 million for the nine months ended June 30, 2005. In addition, the Company
sells certain loans in the secondary market to finance future loan originations.
In the first three quarters of fiscal 2004, the Company sold mortgage loans or
securitized and sold mortgage loans totaling $54.2 million that compares to
$46.0 million for the first nine months ended June 30, 2005. In addition, the
Bank sold $19.5 million of commercial loan participations in the first nine
months ended June 30, 2005. No commercial loan participations were sold in the
nine months ended June 30, 2004.
18
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
LIQUIDITY AND CAPITAL RESOURCES, CONTINUED
- ------------------------------------------
During the nine month period ended June 30, 2005, the Company securitized $33.7
million of mortgage loans and concurrently sold these mortgage-backed securities
to outside third parties and recognized a net gain on sale of $769,000, which
included $454,000 related to mortgage servicing rights. The gain is included in
gains on sales of loans held for sale in the consolidated statement of
operations. The proceeds from sale are included in proceeds from sales of
mortgage-backed securities available for sale in the consolidated statement of
cash flows. The Company has no retained interest in the securities that were
sold other than servicing rights.
For the nine month period ended June 30, 2005, the Company purchased $256.9
million in investment and mortgage-backed securities. For the nine month period
ended June 30, 2004, the Company purchased $212.0 million in investment and
mortgage-backed securities. These purchases during the nine month period ended
June 30, 2005 were primarily funded by borrowings, repayments of $66.9 million
within the securities portfolio and sales of mortgage-backed securities of
$119.0 million.
During the nine month periods ended June 30, 2005 the Company sold commercial
loan participations totaling $19.5 million. No commercial loan participations
were sold in the same period in 2004.
Total customer deposits, which exclude certificates of deposits obtained through
brokers, increased $128.7 million between September 30, 2004 and June 30, 2005.
The Company places significant emphasis on growth in money market and checking
accounts. Money market and checking accounts have increased from approximately
$457.6 million at September 30, 2004 to $559.1 million at June 30, 2005, an
increase of $101.5 million or 22.2%. Core deposits (defined as money market
accounts, checking accounts and statement savings accounts) have increased from
$512.8 million at September 30, 2004 to $633.7 million at June 30, 2005, an
increase of 23.6%.
At June 30, 2005, the Company had $341.9 million of certificates of deposits
("CDs") that were due to mature within one year. Included in these CDs were
brokered CDs totaling $125.5 million. Based on past experience, the Company
believes that the majority of the non-brokered certificates of deposits will
renew with the Company. At June 30, 2005, the Company had commitments to
originate $27.2 million in residential mortgage loans, $56.6 million in
undisbursed business and retail lines of credit, $14.2 million in unused
business and personal credit card lines, and $100.5 million in commercial real
estate and construction and land development which the Company expects to fund
from normal operations. At June 30, 2005, the Company had $79.1 million
available in FHLB advances.
Additionally, at June 30, 2005, the Company had outstanding available lines for
federal funds of $20.0 million.
As a result of $12.5 million in net income, less the cash dividends paid to
stockholders of approximately $2.5 million, proceeds of approximately $1.1
million from the exercise of stock options, and the net decrease in unrealized
gain on securities available for sale, net of income tax of $714,000,
stockholders' equity increased from $85.3 million at September 30, 2004 to $95.8
million at June 30, 2005.
OTS regulations require that the Bank calculate and maintain a minimum
regulatory capital requirement on a quarterly basis and satisfy such requirement
as of the calculation date and throughout the quarter. The Bank's capital, as
calculated under OTS regulations, is approximately $108.1 million at June 30,
2005, exceeding the core capital requirement by $63.5 million. At June 30, 2005,
the Bank's risk-based capital of approximately $118.4 million exceeded its
current risk-based capital requirement by $47.7 million. (For further
information see Regulatory Capital Matters).
19
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
LIQUIDITY AND CAPITAL RESOURCES, CONTINUED
- ------------------------------------------
The table below summarizes future contractual obligations as of June 30, 2005
(unaudited):
Payments Due by Period
--------------------------------------------------------------------------
1 Year and 2-3 4-5 After 5
Total Less Years Years Years
---------- ---------- ---------- ---------- ----------
Time deposits $ 373,943 $ 341,864 $ 28,835 $ 2,468 $ 776
Short-term borrowings 79,760 79,760 -- -- --
Long-term debt 284,229 -- 9,245 46,780 228,204
Construction contracts 695,000 695,000 -- -- --
Operating leases 578 140 150 69 219
---------- ---------- ---------- ---------- ----------
Total contractual cash
obligations $1,433,510 $1,116,764 $ 38,230 $ 49,317 $ 229,199
========== ========== ========== ========== ==========
Purchase commitments. The Company signed a non-binding letter of intent to
purchase land for approximately $2.8 million, which is expected to close during
the fourth quarter.
Lease commitments. The Company has entered into a land lease for a new branch,
expected to close during the fourth quarter. Lease payments aggregate $2.6
million for the initial term of 30 years with six five-year renewal options.
Lease payments during the renewal periods aggregate $5.9 million.
EARNINGS SUMMARY
- ----------------
Net income increased from $10.9 million, or $.60 per diluted share, for the nine
months ended June 30, 2004 to $12.5 million, or $.68 per diluted share for the
nine months ended June 30, 2005. This 15.0% increase in net income resulted from
increased net interest income of $5.0 million, or 16.3%, an increase in other
income of $2.3 million, offset by increased provision for loan losses of
$275,000 increased general and administrative expenses of $4.4 million, and
increased income taxes of $1.0 million.
As a result of growth in loans receivable and investments and an increased net
interest margin, net interest income increased 16.3%. The net interest margin
increased from 3.58% for the nine months ended June 30, 2004 to 3.68% for the
nine months ended June 30, 2005. The increase in net interest income is
primarily attributable to an increase in average earning assets of $152.9
million, or 13.3%. Average loans receivable increased $109.8 million for the
nine months ended June 30, 2005 compared to June 30, 2004. In addition, average
balances of investment securities increased approximately $43.1 million. The
investment securities were primarily funded with deposits. The Company's
deposits increased from $753.4 million at June 30, 2004 to $1.0 billion at June
30, 2005.
The Company's provision for loan losses increased $275,000 for the nine months
ended June 30, 2005 when compared to the prior year primarily due to a
significant increase in the loan portfolio as result of a robust real estate
market and the risk factors related to the underlying portfolio. The allowance
for loan losses as a percentage of loans was 1.30% at June 30, 2005 as compared
to 1.38% at June 30, 2004.
Other income increased from $6.9 million for the nine months ended June 30, 2004
to $9.2 million for the nine months ended June 30, 2005. This was a result of an
increase in fees and service charges on loan and deposit accounts of $1.4
million and increased Federal Home Loan Bank stock dividends of $172,000 offset
by a decrease in gains on sales of loans held for sale of $346,000. The Company
also had gains on sales of securities available for sale and mortgage backed
securities available for sale of $119,000 for the nine months ended June 30,
2005, compared to losses of $707,000 for the nine months ended June 30, 2004. In
addition, the Company had gain on investment security held to maturity called by
issuer of $160,000 for the nine months ended June 30, 2005 and $0 for the nine
months ended June 30, 2004.
General and administrative expenses increased from $20.1 million for the nine
months ended June 30, 2004 to $24.5 million for the nine months ended June 30,
2005. Compensation increased from $12.0 million for the first three quarters of
fiscal 2004 to $13.5 million in the first three quarters of fiscal 2005,
primarily due to an increase in the number of banking Associates in business
banking, Associates in the Company's expanded hours call
20
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
LIQUIDITY AND CAPITAL RESOURCES, CONTINUED
- ------------------------------------------
center, Associates in new branches and normal salary increases. Marketing
expenses were $625,000 for the nine months ended June 30, 2004, compared to $1.5
million for the nine months ended June 30, 2005. In addition, other expense was
$2.8 million for the nine months ended June 30, 2004, compared to $3.9 million
for the nine months ended June 30, 2005.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED
- --------------------------------------------------------------------------------
JUNE 30, 2004 AND 2005
- ----------------------
INTEREST INCOME
- ---------------
Interest income for the three months ended June 30, 2005, increased to $20.3
million as compared to $16.7 million for the three months ended June 30, 2004.
The earning asset yield for the three months ended June 30, 2005, was 6.00%
compared to a yield of 5.61% for the three months ended June 30, 2004. The
average yield on loans receivable for the three months ended June 30, 2005, was
6.64% compared to 6.05% for three months ended June 30, 2004. The increased
yield on loans is primarily due to the increased yield on commercial loans with
interest rates tied to the prime lending rate. The prime rate was 6.25% at June
30, 2005, compared to 4.00% at June 30, 2004. The yield on investments decreased
to 4.77% for the three months ended June 30, 2005, from 4.79% for the three
months ended June 30, 2004. Long term interest rates have remained relatively
constant during the last year despite rising short term rates. Consequently,
most of the cash flows received from the investment portfolio have been
reinvested at approximately the same interest rate. Total average
interest-earning assets were $1.4 billion for the quarter ended June 30, 2005 as
compared to $1.2 billion for the quarter ended June 30, 2004, an increase of
14.2%. The increase in average interest-earning assets is primarily due to an
increase in average loans receivable of approximately $112.7 million resulting
primarily from growth in the commercial loan portfolio.
INTEREST EXPENSE
- ----------------
Interest expense on interest-bearing liabilities was $7.8 million for the three
months ended June 30, 2005, as compared to $5.9 million for the three months
ended June 30, 2004. The average cost of deposits for the three months ended
June 30, 2005, was 1.64% compared to 1.33% for the three months ended June 30,
2004. The cost of interest-bearing liabilities was 2.29% for the three months
ended June 30, 2005 compared to 1.98% for the three months ended June 30, 2004.
The cost of FHLB advances, repurchase and reverse repurchase agreements and
other borrowings was 3.96%, 2.76% and 6.24%, respectively, for the three months
ended June 30, 2005. For the three months ended June 30, 2004, the cost of FHLB
advances, reverse repurchase agreements and other borrowings was 3.73%, 1.36%
and 4.29%, respectively. The increased cost of funds on other borrowings is due
to the increased short-term interest rates. At June 30, 2005, the federal funds
rate was 3.35% compared to 1.38% at June 30, 2004. Total average
interest-bearing liabilities increased from $1.2 billion at June 30, 2004 to
$1.4 billion at June 30, 2005. The increase in average interest-bearing
liabilities is due to an increase in average deposits of approximately $206.6
million, increased average FHLB advances of $1.5 million used to fund loan and
investment securities growth and increased average Customer repurchase
agreements of $18.0 million. Included in increased deposits, were brokered CD's
which increased by $113.9 million in average balances when comparing the two
periods. This increase was partially offset by a decrease in average reverse
repurchase agreements of $51.4 million.
21
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED
- --------------------------------------------------------------------------------
JUNE 30, 2004 AND 2005 - CONTINUED
- ----------------------------------
NET INTEREST INCOME
- -------------------
Net interest income was $12.5 million for the three months ended June 30, 2005,
as compared to $10.8 million for the three months ended June 30, 2004. The net
interest margin was 3.71% for the three months ended June 30, 2005, compared to
3.64% for the three months ended June 30, 2004.
The following table summarizes the average balance sheet and the related yields
on interest-earning assets and deposits and borrowings for the three months
ended June 30, 2004 and 2005:
(Unaudited)
(Dollars in Thousands)
Three Months Ended June 30,
---------------------------
2004 2005
---- ----
Average Income/ Yield/ Average Income/ Yield/
Balance (1) Expense Rate Balance (1) Expense Rate
----------- ------- ---- ----------- ------- ----
Assets
Earning assets
Loans (2) $ 779,309 $ 11,783 6.05% $ 892,027 $ 14,807 6.64%
Investment
Securities, MBS
Securities and
Other (3) 407,674 4,878 4.79% 463,320 5,530 4.77%
---------- ---------- ---------- ----------
Total earning assets $1,186,983 $ 16,661 5.61% $1,355,347 $ 20,337 6.00%
========== ---------- ========== ----------
Liabilities
Deposits 732,994 2,445 1.33% 939,634 3,856 1.64%
Borrowings 458,269 3,447 3.01% 426,437 3,975 3.73%
---------- ---------- ---------- ----------
Total interest-bearing
Liabilities $1,191,263 5,892 1.98% $1,366,071 7,831 2.29%
========== ---------- ========== ----------
Net interest income $ 10,769 $ 12,506
========== ==========
Net interest margin 3.64% 3.71%
Net yield on earning 3.63% 3.69%
Assets
(1) The average balances are derived from monthly balances.
(2) Nonaccrual loans are included in average balances for yield computations.
(3) Investment securities include taxable and tax-exempt securities. Net
interest income has not been adjusted to produce a tax-equivalent yield.
PROVISION FOR LOAN LOSSES
- -------------------------
The Company's provision for loan losses increased from $200,000 for the three
months ended June 30, 2004, to $550,000 for the three months ended June 30, 2005
primarily due to growth in loan balances at June 30, 2005. The allowance for
loan losses as a percentage of loans was 1.30% at June 30, 2005 as compared to
1.38% at June 30, 2004. The allowance as a percentage of loans declined due to
improving economic conditions and the risk factors related to the underlying
portfolio. Loans delinquent 90 days or more were $3.8 million or .41% of total
loans at June 30, 2005, compared to $4.8 million or .61% of total loans at June
30, 2004. The allowance for loan losses was 314% of loans delinquent more than
90 days at June 30, 2005, compared to 226% at June 30, 2004. Net charge-offs for
the three months ended June 30, 2005 were $464,000 compared to $116,000 for the
three months ended June 30, 2004. Included in the charge-offs for the quarter
ended June 30, 2005 were two loans totaling $196,000 guaranteed by the Small
Business Administration (SBA). The guarantee has been denied by the SBA. The
Bank is appealing this decision.
22
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED
- --------------------------------------------------------------------------------
JUNE 30, 2004 AND 2005 - CONTINUED
- ----------------------------------
PROVISION FOR LOAN LOSSES CONTINUED
- -----------------------------------
Management believes that the current level of the allowance for loan losses at
June 30, 2005 is adequate considering the composition of the loan portfolio, the
portfolio's loss experience, delinquency trends, current regional and local
economic conditions and other factors at that date.
OTHER INCOME
- ------------
For the three months ended June 30, 2005, other income was $3.1 million compared
to $2.1 million for the three months ended June 30, 2004. Fees and service
charges from deposit accounts increased $647,000 or 67.1% to $1.6 million for
the three months ended June 30, 2005, compared to $964,000 for the three months
ended June 30, 2004. The majority of this increase is due to fee income from
increased number of personal checking accounts. In the first three quarters of
fiscal 2005, checking account balances grew approximately 44%. Gain on sale of
loans was $215,000 for the quarter ended June 30, 2005, compared to $315,000 for
the quarter ended June 30, 2004. Losses on sales of securities available for
sale were $127,000 for the quarter ended June 30, 2005, compared to losses of
$440,000 for the quarter ended June 30, 2004. Other income was $806,000 for the
three months ended June 30, 2005, as compared to $638,000 for the three months
ended June 30, 2004. The increase was primarily due to increased fee income from
ATM activity and debit card transaction fee income.
GENERAL AND ADMINISTRATIVE EXPENSES
- -----------------------------------
General and administrative expenses were $6.8 million for the quarter ended June
30, 2004 compared to $8.4 million for the quarter ended June 30, 2005. Salaries
and employee benefits were $4.0 million for the three months ended June 30,
2004, as compared to $4.6 million for the three months ended June 30, 2005, an
increase of 15.2%, primarily due to an increase in the number of banking
Associates in business banking, Associates in the Company's expanded hours call
center, Associates in new branches, and normal salary increases. The Company has
added several Associates in a Banking Group that is focused on growing small to
medium sized business banking relationships. Also as a result of new branches,
equipment purchased to improve Customer convenience and increased checking
activity, net occupancy, furniture and fixtures and data processing expenses
increased by $486,000, including increased depreciation of $208,000, when
comparing the two periods. Marketing expenses were $247,000 for the three months
ended June 30, 2004, compared to $463,000 for the three months ended June 30,
2005. This is primarily attributed to the Bank's "Totally Free Checking With A
Gift" initiative; introduction of Penny Pavilion, the Bank's totally free coin
counting service; marketing of the Bank's expanded banking hours, including
Saturday banking at all Bank branches; and marketing of the Bank's new branch in
Wilmington, NC. The Bank's "Totally Free Checking With A Gift" promotion
involves significant direct mail advertising as well as direct media
advertising. Other expenses were $1.0 million for the quarter ended June 30,
2004 compared to $1.4 million for the quarter ended June 30, 2005. Other expense
increased due to increased debit card and ATM transaction expenses of $138,000,
increased costs incurred related to compliance with Sarbanes-Oxley of $75,000
and increased deposit account losses of $86,000. The increase in net deposit
losses and increased debit card and ATM transaction expenses are tied directly
to the increased number of personal checking accounts. The Bank expects to incur
similar increased professional expenses related to the implementation of
Sarbanes-Oxley compliance throughout the remainder of the year.
INCOME TAXES
- ------------
Income taxes were $2.0 million for the three months ended June 30, 2004 compared
to $2.3 million for the three months ended June 30, 2005. The effective income
tax rate as a percentage of pretax income was 34.11% and 34.37% for the quarters
ended June 30, 2004 and 2005, respectively. The effective income tax rate
differs from the statutory rate primarily due to income generated by bank-owned
life insurance, municipal securities that are exempt from federal and certain
state taxes, and the increase in the current quarter earnings over the
comparable prior year earnings that are subject to higher incremental tax rates.
23
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED
- --------------------------------------------------------------------------------
JUNE 30, 2004 AND 2005 - CONTINUED
- ----------------------------------
INCOME TAXES CONTINUED
- ----------------------
The Company's effective income tax rates take into consideration certain
assumptions and estimates made by management. No assurance can be given that
either the tax returns submitted by management or the income tax reported on the
consolidated financial statements will not be adjusted by either adverse rulings
by the U.S. Tax court, changes in the tax code, or assessments made by the
Internal Revenue Service. The Company is subject to potential adverse
adjustments, including but not limited to: an increase in The statutory federal
or state income tax rates, the permanent non-deductibility of amounts currently
considered deductible either now or in future periods, and the dependency on the
generation of the future taxable income, in order to ultimately realize deferred
income tax assets.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE NINE MONTHS ENDED
- --------------------------------------------------------------------------------
JUNE 30, 2004 AND 2005
- ----------------------
INTEREST INCOME
- ---------------
Interest income for the nine months ended June 30, 2005, increased to $57.2
million as compared to $48.4 million for the nine months ended June 30, 2004.
The earning asset yield for the nine months ended June 30, 2005, was 5.86%
compared to a yield of 5.61% for the nine months ended June 30, 2004. The
average yield on loans receivable for the nine months ended June 30, 2005, was
6.38% compared to 6.12% for the nine months ended June 30, 2004. The increased
yield on loans is primarily due to the increased yield on commercial loans with
interest rates tied to the prime lending rate. The prime rate was 6.25% at June
30, 2005, compared to 4.00% at June 30, 2004. The yield on investments increased
to 4.85% for the nine months ended June 30, 2005, from 4.67% for the nine months
ended June 30, 2004. Total average interest-earning assets were $1.3 billion for
the nine months ended June 30, 2005 as compared to $1.1 billion for the nine
months ended June 30, 2004. The increase in average interest-earning assets is
primarily due to an increase in average loans receivable of approximately $109.8
million resulting primarily from growth in the commercial loan portfolio.
Securities increased $43.1 million, primarily funded by borrowings, including
brokered CD's.
INTEREST EXPENSE
- ----------------
Interest expense on interest-bearing liabilities was $21.3 million for the nine
months ended June 30, 2005, as compared to $17.5 million for the nine months
ended June 30, 2004. The average cost of deposits for the nine months ended June
30, 2005, was 1.47% compared to 1.42% for the nine months ended June 30, 2004.
The cost of interest-bearing liabilities was 2.17% for the nine months ended
June 30, 2005 compared to 2.03% for the nine months ended June 30, 2004. The
cost of FHLB advances, repurchase and reverse repurchase agreements and other
borrowings was 3.76%, 2.31% and 5.66%, respectively, for the nine months ended
June 30, 2005. For the nine months ended June 30, 2004, the cost of FHLB
advances, reverse repurchase agreements and other borrowings was 3.83%, 1.44%
and 4.29%, respectively. The increased cost of funds on other borrowings is due
to the increased short-term interest rates. At June 30, 2005, the federal funds
rate was 3.35% compared to 1.38% at June 30, 2004. Total average
interest-bearing liabilities increased from $1.1 billion at June 30, 2004 to
$1.3 billion at June 30, 2005. The increase in average interest-bearing
liabilities is due to an increase in average deposits of approximately $136.5
million as a result of the Company's focus on checking growth, increased average
FHLB advances of $56.7 million used to fund loan and investment securities
growth and increased average Customer repurchase agreements of $17.0 million.
Included in increased deposits, were brokered CD's which increased by $58.2
million in average balances when comparing the two periods. This increase was
partially offset by a decrease in average reverse repurchase agreements of $51.4
million.
24
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE NINE MONTHS ENDED
- --------------------------------------------------------------------------------
JUNE 30, 2004 AND 2005 - CONTINUED
- ----------------------------------
NET INTEREST INCOME
- -------------------
Net interest income was $35.9 million for the nine months ended June 30, 2005,
as compared to $30.9 million for the nine months ended June 30, 2004. The net
interest margin was 3.68% for the nine months ended June 30, 2005, compared to
3.58% for the nine months ended June 30, 2004.
The following table summarizes the average balance sheet and the related yields
on interest-earning assets and deposits and borrowings for the nine months ended
June 30, 2004 and 2005:
(Unaudited)
(Dollars in Thousands)
Nine months Ended June 30,
--------------------------
2004 2005
---- ----
Average Income/ Yield/ Average Income/ Yield/
Balance (1) Expense Rate Balance (1) Expense Rate
----------- ------- ---- ----------- ------- ----
Assets
Earning assets
Loans (2) $ 744,723 $ 34,182 6.12% $ 854,556 $ 40,911 6.38%
Investment
Securities, MBS
Securities and
Other (3) 404,572 14,170 4.67% 447,630 16,284 4.85%
---------- ---------- ---------- ----------
Total earning assets $1,149,295 $ 48,352 5.61% $1,302,186 $ 57,195 5.86%
========== ---------- ========== ---------
Liabilities
Deposits 705,096 7,510 1.42% 841,635 9,290 1.47%
Borrowings 440,792 9,956 3.01% 463,056 11,988 3.45%
---------- ---------- ---------- ----------
Total interest-bearing
Liabilities $1,145,888 17,466 2.03% $1,304,691 21,278 2.17%
========== ---------- ========== ----------
Net interest income $ 30,886 $ 35,917
========== ==========
Net interest margin 3.58% 3.68%
Net yield on earning
Assets 3.58% 3.68%
(1) The average balances are derived from monthly balances.
(2) Nonaccrual loans are included in average balances for yield computations.
(3) Investment securities include taxable and tax-exempt securities. Net
interest income has not been adjusted to produce a tax-equivalent yield.
PROVISION FOR LOAN LOSSES
- -------------------------
The Company's provision for loan losses increased $275,000 from $1.3 million for
the nine months ended June 30, 2004, to $1.5 million for the nine months ended
June 30, 2005 primarily due to a significant increase in the loan portfolio as
result of a robust real estate market and the risk factors related to the
underlying portfolio. The allowance for loan losses as a percentage of loans was
1.30% at June 30, 2005 as compared to 1.38% at June 30, 2004. Loans delinquent
90 days or more were $3.8 million or 0.41% of total loans at June 30, 2005,
compared to $4.8 million or 0.61% of total loans at June 30, 2004. The allowance
for loan losses was 314% of loans delinquent more than 90 days at June 30, 2005,
compared to 226% at June 30, 2004. Net charge-offs for the nine months ended
June 30, 2005 were $748,000 compared to $240,000 for the nine months ended June
30, 2004. Included in charge-offs for the nine months ended June 30, 2005 were
two loans totaling $196,000 guaranteed by the Small Business Administration
(SBA). The guarantee has been denied by the SBA. The Bank is appealing this
decision. Management believes that the level of the allowance for loan losses at
June 30, 2005 is adequate considering the composition of the loan portfolio, the
portfolio's loss experience, delinquency trends, current regional and local
economic conditions and other factors at that date.
25
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE NINE MONTHS ENDED
- --------------------------------------------------------------------------------
JUNE 30, 2004 AND 2005 - CONTINUED
- ----------------------------------
OTHER INCOME
- ------------
For the nine months ended June 30, 2005, other income was $9.2 million compared
to $6.9 million for the nine months ended June 30, 2004. Fees and service
charges from deposit accounts increased $1.4 million or 50% to $4.1 million for
the nine months ended June 30, 2005, compared to $2.7 million for the nine
months ended June 30, 2004. The majority of this increase is due to fee income
from increased number of personal checking accounts. In the first three quarters
of fiscal 2005, checking account balances grew approximately 44%. During the
nine months ended June 30, 2004, the Company securitized and concurrently sold
$31.7 million of mortgage loans compared to $33.7 million for the nine months
ended June 30, 2005. Gain on sale of loans was $769,000 for the nine months
ended June 30, 2005, compared to $1.1 million for the nine months ended June 30,
2004. Gains on sales of securities available for sale were $119,000 for the nine
months ended June 30, 2005, compared to losses of $707,000 for the nine months
ended June 30, 2004. In addition, the Company had gain on investment security
held to maturity called by issuer of $160,000 for the nine months ended June 30,
2005 and $0 for the nine months ended June 30, 2004. Other income was $2.2
million for the nine months ended June 30, 2005, as compared to $1.9 million for
the nine months ended June 30, 2004. The increase was primarily due to increased
fee income from ATM activity and debit card transaction fee income.
GENERAL AND ADMINISTRATIVE EXPENSES
- -----------------------------------
General and administrative expenses were $24.5 million for the nine months ended
June 30, 2005 compared to $20.1 million for the nine months ended June 30, 2004.
Salaries and employee benefits were $13.5 million for the nine months ended June
30, 2005, as compared to $12.0 million for the nine months ended June 30, 2004,
an increase of 12.7%, primarily due to an increase in the number of banking
Associates in business banking, Associates in the Company's expanded hours call
center, Associates in new branches and normal salary increases. The Company has
added several Associates in a Banking Group that is focused on growing small to
medium sized business banking relationships. Also as a result of new branches,
equipment purchased to improve Customer convenience and increased checking
activity, net occupancy, furniture and fixtures and data processing expenses
increased $1.0 million, including depreciation of $399,000, when comparing the
two periods. Marketing expenses were $625,000 for the nine months ended June 30,
2004, compared to $1.5 million for the nine months ended June 30, 2005. This is
primarily attributed to the Bank's "Totally Free Checking With A Gift"
initiative; introduction of Penny Pavilion, the Bank's free coin counting
service; marketing of the Bank's expanded banking hours, including Saturday
banking at all Bank branches; and marketing of the Bank's new branch in
Wilmington, NC. The Bank's "Totally Free Checking With A Gift" promotion
involves significant direct mail advertising as well as direct media
advertising. Other expenses were $2.8 million for the nine months ended June 30,
2004 compared to $3.9 million for the nine months ended June 30, 2005. Other
expense increased due to increased debit card and ATM transaction expenses of
$301,000, loss on write-off of signage related to the Bank's re-branding efforts
in conjunction with the initiation of "6 Day Branch Banking" of $122,000, costs
incurred related to compliance with Sarbanes-Oxley of $198,000 and increased
deposit account losses of $277,000. The increase in net deposit losses are tied
directly to the increased number of personal checking accounts. The Bank expects
to incur similar increased professional expenses related to the implementation
of Sarbanes-Oxley compliance throughout the remainder of the year.
INCOME TAXES
- ------------
Income taxes were $5.5 million for the nine months ended June 30, 2004 compared
to $6.5 million for the nine months ended June 30, 2005. The effective income
tax rate as a percentage of pretax income was 33.56% and 34.29% for the nine
months ended June 30, 2004 and 2005, respectively. The effective income tax rate
differs from the statutory rate primarily due to income generated by bank-owned
life insurance, municipal securities that are exempt from federal and certain
state taxes, and the increase in the current nine
26
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE NINE MONTHS ENDED
- --------------------------------------------------------------------------------
JUNE 30, 2004 AND 2005 - CONTINUED
- ----------------------------------
INCOME TAXES - CONTINUED
- ------------------------
months earnings over the comparable prior year earnings that are subject to
higher incremental tax rates. The Company's effective income tax rates take into
consideration certain assumptions and estimates made by management. No assurance
can be given that either the tax returns submitted by management or the income
tax reported on the consolidated financial statements will not be adjusted by
either adverse rulings by the U.S. Tax court, changes in the tax code, or
assessments made by the Internal Revenue Service. The Company is subject to
potential adverse adjustments, including but not limited to: an increase in the
statutory federal or state income tax rates, the permanent non-deductibility of
amounts currently considered deductible either now or in future periods, and the
dependency on the generation of the future taxable income, in order to
ultimately realize deferred income tax assets.
REGULATORY CAPITAL MATTERS
- --------------------------
To be categorized as "Well Capitalized" under the prompt corrective action
regulations adopted by the Federal Banking Agencies, the Bank must maintain a
total risk-based capital ratio as set forth in the following table and not be
subject to a capital directive order.
Categorized as "Well
Capitalized" under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provision
------ ----------------- ----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars In Thousands)
As of June 30, 2005:
Total Capital: $118,441 13.40% $70,702 8.00% $88,378 10.00%
(To Risk Weighted Assets)
Tier 1 Capital: $108,086 12.23% N/A N/A $53,027 6.00%
(To Risk Weighted Assets)
Tier 1 Capital: $108,086 7.27% $44,588 3.00% $74,313 5.00%
(To Total Assets)
Tangible Capital: $108,086 7.27% $22,294 1.50% N/A N/A
(To Total Assets)
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
- ------------------------------------------
In March 2004, the Financial Accounting Standards Board ("FASB") issued EITF No.
03-1 ("EITF 03-1"), "The Meaning of Other-Than-Temporary Impairment and Its
Application of Certain Investments," which provided guidance for evaluating
whether an investment is other-than-temporarily impaired and its application to
investments classified as either available for sale or held to maturity under
FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and investments accounted for under the cost or equity method of
accounting. In September 2004, the FASB issued FASB Staff Position ("FSP") EITF
No. 03-1-1, a delay of the effective date for the measurement and recognition
guidance contained in paragraphs 10-20 of EITF 03-1 until the FASB issues final
guidance, expected in 2005.
Paragraphs 10 through 20 of EITF 03-1 provide guidance on when impairment of
debt and equity securities is considered other-than-temporary. This guidance
generally states impairment is considered other-than-temporary unless the holder
of the security has both the intent and ability to hold the security until the
fair value recovers and evidence supporting the recovery outweighs evidence to
the contrary.
The Company adopted the guidance of EITF 03-1, excluding paragraphs 10-20
effective as of September 30, 2004. As a result of this adoption, the Company
provides additional
27
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS, CONTINUED
- -----------------------------------------------------
disclosures, which are found in Notes 2 and 3 of this report. The initial
adoption of this issue, which excludes paragraphs 10-20 did not have a material
impact on the financial condition or results of operations of the Company.
In July 2005, the FASB issued final guidance that eliminated paragraphs 10-18 of
EITF-03-1 (paragraphs 19-20 have no material impact on the financial condition
or results of operations of the Company) and will, in the near future, reissue
the final pronouncement as FSP FAS115-1 that will be effective for
other-than-temporary impairment analysis conducted in periods beginning after
September 15, 2005.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
- -----------------------------------------
In December 2004, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 123 (Revised 2004), "Share-Based Payment" ("SFAS 123R"). This
standard requires expensing of stock options and other share-based payments and
supersedes SFAS No. 123 that had allowed companies to choose between expensing
stock options or showing proforma disclosure only. This standard is effective
for the Company as of October 1, 2005 and will apply to all awards granted,
modified, cancelled or repurchased after that date. The Company is currently
evaluating the expected impact that the adoption of SFAS 123R will have on its
financial condition or results of operations.
On March 29, 2005 the SEC Staff issued Staff Accounting Bulletin No. 107 ("SAB
107"). SAB 107 expresses the views of the SEC staff regarding the interaction of
SFAS 123R and certain SEC rules and regulations and provides the SEC staff's
view regarding the valuation of share-based payment arrangements for public
companies. The Company is currently evaluating the expected impact that SAB 107
will have on its financial condition or results of operations.
EFFECT ON INFLATION AND CHANGING PRICES
- ---------------------------------------
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles which require the
measurement of financial position and results of operations in terms of
historical dollars, without consideration of change in the relative purchasing
power over time due to inflation. Unlike most industrial companies, virtually
all of the assets and liabilities of a financial institution are monetary in
nature. As a result, interest rates have a more significant impact on a
financial institution's performance than the effects of inflation. Interest
rates do not necessarily change in the same magnitude as the price of goods and
services.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------------------------------------------------------------------
The Bank's Asset Liability Management Committee ("ALCO") monitors and considers
methods of managing exposure to interest rate risk. The ALCO consists of members
of the Board of Directors and Senior Leadership of the Company and meets
quarterly. The Bank's exposure to interest rate risk is reviewed on at least a
quarterly basis by the ALCO. Interest rate risk exposure is measured using
interest rate sensitivity analysis to determine the Company's change in net
portfolio value in the event of hypothetical changes in interest rates. The ALCO
is charged with the responsibility to maintain the level of sensitivity of the
Bank's net portfolio value with Board approved limits.
Net portfolio value (NPV) represents the market value of portfolio equity and is
equal to the market value of assets minus the market value of liabilities, with
adjustments made for off-balance sheet items over a range of assumed changes in
market interest rates. The Bank's Board of Directors has adopted an interest
rate risk policy which establishes maximum allowable decreases in NPV in the
event of a sudden and sustained one hundred to three hundred basis point
increase or decrease in market interest rates. The following table presents the
Bank's change in NPV as computed by the OTS for various rate shock levels as of
June 30, 2005.
28
PART I. FINANCIAL INFORMATION
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK, CONTINUED
- -----------------------------------------------------------------------------
Market
Board Board Market Value
Limit Limit Value Portfolio
Minimum NPV Maximum Of Assets Equity NPV
Change in interest rates Ratio Decline in NPV 06/30/05 06/30/05 Ratio
- ------------------------- ----------- --------------- ---------- ------------ --------
300 basis point rise 5.00% 400 BPS $1,494,233 $148,376 9.93%
200 basis point rise 6.00% 300 BPS $1,513,595 $158,255 10.46%
100 basis point rise 6.00% 250 BPS $1,536,223 $167,864 10.93%
No change 6.00% $1,552,815 $175,433 11.30%
100 basis point decline 6.00% 250 BPS $1,562,035 $174,657 11.18%
200 basis point decline 6.00% 300 BPS $1,567,161 $166,048 10.60%
300 basis point decline 6.00% 350 BPS N/A N/A N/A
The preceding table indicates that at June 30, 2005, in the event of a sudden
and sustained increase in prevailing market interest rates, the Bank's Net
Portfolio Value (NPV) would be expected to decrease, and that in the event of a
sudden decrease in prevailing market interest rates, the Bank's NPV would be
expected to decrease minimally. A value for the 300 basis point decline is not
indicated due to the level of interest rates at June 30, 2005. At June 30, 2005,
the Bank's estimated changes in NPV were within the limits established by the
Board of Directors.
Computation of prospective effects of hypothetical interest rate changes are
based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit decay, and should not be relied upon as
indicative of actual results. Further, the computations do not contemplate any
actions the ALCO could undertake in response to sudden changes in interest
rates.
Item 4. CONTROLS AND PROCEDURES
- -------------------------------
The Company's management, including the Company's principal executive officer
and principal financial officer, have evaluated the effectiveness of the
Company's "disclosure controls and procedures," as such term is defined in Rule
13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). Based upon their evaluation, the principal executive officer and
principal financial officer concluded that, as of the end of the period covered
by this report, the Company's disclosure controls and procedures were effective
for the purpose of ensuring that the information required to be disclosed in the
reports that the Company files or submits under the Exchange Act with the
Securities and Exchange Commission (the "SEC") (1) is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and (2) is accumulated and communicated to the Company's management,
including its principal executive and principal financial officers, as
appropriate to allow timely decisions regarding required disclosure. In
addition, based on that evaluation, no material changes in the Company's
internal control over financial reporting occurred during the quarter ended June
30, 2005 that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Item 1. Legal Proceedings
-----------------
The Company is a defendant in one lawsuit related to activities in the
Bank, arising out of the normal course of business. The subsidiaries are also
defendants in lawsuits arising out of the normal course of business. Based upon
current information received from counsel representing the Company and its
subsidiaries in these matters, the Company believes none of the lawsuits would
have a material impact on the Company's financial condition or results of
operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
Not Applicable.
Item 3. Defaults Upon Senior Securities
-------------------------------
29
Not Applicable.
PART II. OTHER INFORMATION
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES - CONTINUED
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
Not Applicable.
Item 5. Other Information
-----------------
Not Applicable.
Item 6. Exhibits
--------
Exhibits
3 (a) Certificate of Incorporation of Coastal Financial
Corporation (1)
(b) Certificate of Amendment to Certificate of Incorporation
of Coastal Financial Corporation (4)
(c) Bylaws of Coastal Financial Corporation (1)
10 (a) Employment Agreement with Michael C. Gerald (6)
(b) Employment Agreement with Jerry L. Rexroad (6)
(c) Employment Agreement with Phillip G. Stalvey (6)
(d) Employment Agreement with Jimmy R. Graham (6)
(e) Employment Agreement with Steven J. Sherry (6)
(f) 1990 Stock Option Plan (2)
(g) Directors Performance Plan (3)
(h) Coastal Financial Corporation 2000 Stock Option Plan (5)
31 (a) Rule 13a-14(a)/15d-14(a) Certification (Chief Executive
Officer)
(b) Rule 13a-14(a)/15d-14(a) Certification (Chief Financial
Officer)
32 (a) Section 1350 Certification (Chief Executive Officer)
(b) Section 1350 Certification (Chief Financial Officer)
- ----------
(1) Incorporated by reference to Registration Statement on Form S-4 filed with
the Securities and Exchange Commission on November 26, 1990.
(2) Incorporated by reference to 1995 Form 10-K filed with the Securities and
Exchange Commission on December 29, 1995.
(3) Incorporated by reference to the definitive proxy statement for the 1996
Annual Meeting of Stockholders.
(4) Incorporated by reference to June 30, 1998 Form 10-Q filed with Securities
and Exchange Commission on May 15, 1998.
(5) Incorporated by reference to the definitive proxy statement for the 2000
Annual Meeting of Stockholders filed December 22, 1999.
(6) Incorporated by reference to 2003 Form 10-K filed with Securities and
Exchange Commission on December 22, 2003.
30
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COASTAL FINANCIAL CORPORATION
August 9, 2005 /s/ Michael C. Gerald
-------------- ----------------------
Date Michael C. Gerald
President and Chief Executive Officer
August 9, 2005 /s/ Jerry L. Rexroad
-------------- ---------------------
Date Jerry L. Rexroad
Executive Vice President and
Chief Financial Officer
31