SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------------
FORM 10-K
+-+
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
+-+ SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended September 30, 2005
OR
+-+
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
+-+ SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-19684
COASTAL FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 57-0925911
- -------------------------------------------- ------------
(State or other jurisdiction of incorporation (I.R.S. Employer I.D.)
or organization)
2619 Oak Street, Myrtle Beach, South Carolina 29577-3129
- --------------------------------------------- ------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (843) 205-2000
--------------
Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
--------------------------------------
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act. YES [X] NO [_].
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES [_] NO [X].
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant, based upon the closing sales price of the
registrant's common stock as quoted on the NASDAQ System under the symbol "CFCP"
as of the last business day of the registrant's most recently completed second
fiscal quarter, was $265,362,136 (19,412,007 shares at $13.67 per share.) It is
assumed for purposes of this calculation that none of the registrant's officers,
directors and 5% stockholders are affiliates.
As of December 5, 2005, there were issued and outstanding 19,479,469 shares of
the registrant's Common Stock.
1
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Annual Report to Stockholders for the Fiscal Year Ended
September 30, 2005 (Parts I and II)
2. Portions of the Proxy Statement for the 2006 Annual Meeting of
Stockholders. (Part III)
2
PART I
Item 1. Business
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General
Coastal Financial Corporation ("Coastal Financial" or the "Company") was
incorporated in the State of Delaware in June 1990, for the purpose of becoming
a savings and loan holding company for Coastal Federal Bank, formerly named
Coastal Federal Savings Bank, ("Coastal Federal" or the "Bank"). On January 28,
1991, the stockholders of the Bank approved a plan to reorganize the Bank into
the holding company form of ownership. The reorganization was completed on
November 6, 1991, on which date the Bank became the wholly owned subsidiary of
the Company, and the stockholders of the Bank became stockholders of the
Company. Prior to completion of the reorganization, the Company had no material
assets or liabilities and engaged in no business activities. The financial
results contained herein relate primarily to the Company's principal subsidiary,
Coastal Federal.
Coastal Federal conducts its business from its main office in Myrtle
Beach, South Carolina, thirteen additional branch offices located in South
Carolina, and seven branch offices located in North Carolina. Two of these
branches were opened after September 30, 2005. The deposits of the Bank are
insured by the Federal Deposit Insurance Corporation ("FDIC") under the Savings
Association Insurance Fund ("SAIF"). The corporate offices of the Bank are
located at 2619 Oak Street, Myrtle Beach, South Carolina and the telephone
number is (843) 205-2000.
Coastal Federal's twenty-one offices are located in Horry and Georgetown
Counties of South Carolina, and Brunswick and New Hanover Counties of North
Carolina. The economy of these four counties depends primarily on tourism. To
the extent area businesses rely heavily on tourism for business, decreased
tourism would have a significant adverse effect on Coastal Federal's primary
deposit base and lending area. Moreover, Coastal Federal would likely experience
a higher degree of loan delinquencies should the local economy be materially and
adversely affected.
Coastal Federal's principal business currently consists of attracting
deposits from the general public and using these funds to originate consumer,
commercial business loans, commercial real estate loans and residential mortgage
loans.
The Company maintains an Internet website at
http://www.coastalfederal.com. The Company makes available its annual reports on
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Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to such reports filed or
3
furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act
of 1934, as amended, and other information related to the Company, free of
charge, on this site as soon as reasonably practicable after it electronically
files those documents with, or otherwise furnishes them to the SEC. The
Company's Internet website and the information contained therein or connected
thereto are not intended to be incorporated into this annual report on Form
10-K.
4
Rate/Volume Analysis
The following table sets forth certain information regarding changes to interest
income and interest expense of the Company for the periods indicated. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributed to (i) changes in rate (changes in
rate multiplied by old volume); (ii) changes in volume (changes in volume
multiplied by old rate), (iii) changes in rate-volume (change in rate multiplied
by change in volume), and (iv) the net change (the sum of the prior columns).
Non-accrual loans are included in the average volume calculations.
Year Ended September 30,
------------------------------------------------------------------------------------------------------------
2003 Compared to 2002 2004 Compared to 2003 2005 Compared to 2004
Increase (Decrease) Increase (Decrease) Increase (Decrease)
Due to Due to Due to
------------------------------------ --------------------------------- ---------------------------------
Rate Volume Rate/ Net Rate Volume Rate/ Net Rate Volume Rate/ Net
Volume Volume Volume
------- ------- ------- ------- ------- ------- ------ ------- ------ ------- ------- -------
Interest-earning assets:
Loans $(4,869) $ 7,469 $ (903) $ 1,697 $(3,082) $ 8,515 $(626) $ 4,807 $2,506 $ 7,170 $ 385 $10,061
Mortgage-backed
securities/investments (2,695) 7,903 (1,564) 3,644 (383) 2,216 (49) 1,784 478 2,160 54 2,692
------- ------- ------- ------- ------- ------- ----- ------- ------ ------- ------- -------
Total net change in
income on interest-
earning assets (7,564) 15,372 (2,467) 5,341 (3,465) 10,731 (675) 6,591 2,984 9,330 439 12,753
------- ------- ------- ------- ------- ------- ----- ------- ------ ------- ------- -------
Interest-bearing
liabilities:
Deposits (3,487) 2,333 (597) (1,751) (2,233) 373 (115) (1,975) 855 584 93 1,532
Brokered CD's -- -- -- -- -- -- -- -- -- -- 2,523 2,523
FHLB advances (1,271) 3,184 (527) 1,386 (971) 2,942 (315) 1,656 59 1,550 8 1,617
Repurchase 1,534
agreements (4) -- (13) 1,517 (344) 925 (185) 396 1,322 (626) (392) 304
Other borrowings -- -- -- -- (46) 630 (135) 449 230 -- -- 230
------- ------- ------- ------- ------- ------- ----- ------- ------ ------- ------- -------
Total net change in
expense on interest-
bearing liabilities (4,762) 7,051 (1,137) 1,152 (3,594) 4,870 (750) 526 2,466 1,508 2,232 6,206
------- ------- ------- ------- ------- ------- ----- ------- ------ ------- ------- -------
Net change in net
interest income $(2,802) $ 8,321 $(1,330) $ 4,189 $ 129 $ 5,861 $ 75 $ 6,065 $ 518 $ 7,822 $(1,793) $ 6,547
======= ======= ======= ======= ======= ======= ===== ======= ====== ======= ======= =======
- ------------------------------------------------------------------------------------------------------------------------------------
5
Average Balance Sheet
The following table sets forth certain information relating to the
Company's average balance sheet and reflects the yield on average assets and
cost of average liabilities for the periods indicated. Such yields and costs are
derived by dividing income or expense by the average balance of assets or
liabilities, respectively, for the periods presented. Non-accrual loans are
included in average balance calculations.
Year Ended September 30,
-----------------------------------------------------------------------------------------------
2003 2004 2005
----------------------------- ------------------------------ -------------------------------
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate (2) Balance Interest Rate (2) Balance Interest Rate (2)
------- -------- -------- ------- -------- -------- ------- -------- --------
(Dollars in thousands)
ASSETS
Loans $629,817 $41,958 6.66% $ 757,633 $46,765 6.17% $ 873,797 $56,826 6.50%
Mortgage-backed securities
/investments(1)(3) 357,680 17,256 4.82 403,610 19,040 4.72 449,402 21,732 4.84
-------- ------- ------ ---------- ------- ------ ---------- ------- ------
Total interest-earning
assets $987,497 $59,214 6.00% $1,161,243 $65,805 5.67% $1,323,199 $78,558 5.94%
======== ======= ====== ========== ======= ====== ========== ======= ======
LIABILITIES
Transaction accounts (4) 369,871 3,925 1.06 418,405 3,331 .80 505,340 4,457 .88
Statement savings accounts 40,913 427 1.04 50,509 405 .80 64,973 663 1.02
Certificate accounts 258,355 7,647 2.96 250,211 6,288 2.51 241,310 6,436 2.67
Brokered certificate
accounts -- -- -- -- -- -- 79,369 2,523 3.18
FHLB advances 212,501 9,068 4.27 281,437 10,724 3.81 322,108 12,341 3.83
Securities sold under
repurchase agreements 93,496 1,718 1.84 143,842 2,114 1.47 101,221 2,418 2.39
Other borrowings 3,792 213 5.62 15,000 662 4.41 15,000 892 5.95
-------- ------- ------ ---------- ------- ------ ---------- ------- ------
Total interest-bearing
liabilities $978,928 $22,998 2.35% $1,159,404 $23,524 2.03% $1,329,321 $29,730 2.24%
======== ======= ====== ========== ======= ====== ========== ======= ======
Net interest income/
interest rate spread $36,216 3.65% $42,281 3.64% $48,828 3.70%
Net yield on interest earning assets 3.67% 3.64% 3.69%
Ratio of interest earning assets
to interest-bearing liabilities 1.01 1.00 1.00
(1) Includes short-term interest-bearing deposits, Federal funds sold, and
investments held to maturity.
(2) Yield for average investments classified as available for sale is computed
using historical cost balances and does not give effect to changes in fair
value that are reflected as a component of stockholders' equity.
(3) Investment securities include taxable and tax-exempt securities. Net
interest income has not been adjusted to produce a tax-equivalent yield.
(4) Average noninterest-bearing deposits included in average transaction
accounts above for 2003, 2004 and 2005 are $75,321, $101,298 and $163,278,
respectively.
6
Lending Activities
General. The principal lending activities of Coastal Federal are the
origination of consumer loans, commercial business loans, commercial real estate
loans and residential mortgage loans. The Bank originates construction and
permanent loans on single family and multi-unit dwellings, as well as on
commercial structures. The Bank emphasizes the origination of adjustable rate
residential and commercial real estate mortgages.
The Bank's net loan portfolio, including loans held for sale, totaled
approximately $942.4 million at September 30, 2005, representing approximately
61.1% of its total assets. On that date, approximately 37.8% of Coastal
Federal's gross loan portfolio was secured by mortgages on one-to-four family
residential properties.
In an effort to ensure that the yields on its loan portfolio and
investments are interest-rate sensitive, the Bank has implemented a number of
measures, including: (i) emphasis on the origination of adjustable rate
mortgages on residential and commercial properties; (ii) origination of
construction loans secured by residential properties, generally with terms for a
one-year period or less; and (iii) origination of commercial and consumer loans
having either adjustable rates or relatively short maturities. At September 30,
2005, adjustable rate loans constituted approximately $752.3 million (or 79.8%)
of the Bank's total loan portfolio. Therefore, at such date, fixed rate loans
comprised only 20.2% of the total loan portfolio. These lending practices are
intended to shorten the term of the Bank's assets and make the loan portfolio
more responsive to interest rate volatility.
The Company has identified one concentration of credit risk that it is
monitoring. This involves loans for the acquisition of land and loans for the
development of land, which totaled $121.2 million as September 30, 2005, and
which is included in the Mortgage Loans - Land, land development and other,
primarily commercial real estate line in the Loan Portfolio Analysis on the
following page. See Note 1(h) of the Notes to Consolidated Financial Statements
in the Annual Report to Stockholders for a complete discussion of this monitored
credit risk.
7
Loan Portfolio Analysis
The following table set forth the composition of the Company's loan portfolio by
type of loan as of the dates indicated.
At September 30,
--------------------------------------------------------------------------------------------------
2001 2002 2003 2004 2005
------------------ ------------------ ------------------ ------------------ ------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in thousands)
Mortgage loans:
Construction $ 60,765 11.56% $ 45,544 7.99% $ 81,227 11.16% $ 93,292 11.23% $ 42,959 14.56%
Single family to 4 family units 268,670 51.10 261,296 45.88 308,293 42.37 337,533 40.62 371,014 37.79
Land, land development and
other, primarily commercial
real estate 137,282 26.11 202,117 35.49 263,688 36.24 312,460 37.60 369,714 37.66
Commercial business loans 18,886 3.59 18,377 3.23 24,475 3.36 32,101 3.86 38,691 3.94
Consumer loans:
Mobile home 2,056 0.39 3,446 0.61 4,607 0.63 4,618 0.56 4,308 0.44
Automobiles 6,599 1.26 7,117 1.25 8,516 1.17 8,177 0.98 8,221 0.84
Equity lines of credit 22,379 4.26 24,273 4.26 26,639 3.66 30,906 3.72 34,019 3.47
Other 9,161 1.73 7,378 1.29 10,234 1.41 11,905 1.43 12,777 1.30
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans and loans
held for sale, gross $525,798 100.00% $569,548 100.00% $727,679 100.00% $830,992 100.00% $981,703 100.00%
====== ====== ====== ====== ======
Add (Subtract):
Loans in process (13,983) (6,365) (16,570) (21,613) (28,345)
Deferred loan costs, net 372 245 556 674 771
Allowance for loan losses (7,159) (7,883) (9,832) (11,077) (11,748)
-------- -------- -------- -------- --------
Total loans and loans held
for sale, net $505,028 $555,545 $701,833 $798,976 $942,381
======== ======== ======== ======== ========
8
Commercial Business Loans. The Bank is permitted under OTS regulations to
make secured or unsecured loans for commercial, corporate, business or
agricultural purposes, including the issuance of letters of credit secured by
real estate, business equipment, inventories, accounts receivable and cash
equivalents. The aggregate amount of such loans outstanding may not exceed 20%
of such institution's assets.
Coastal Federal has been making commercial business loans since 1983 on
both a secured and unsecured basis. The majority of these loans have interest
rates that adjust with changes in the prime rate as published in The Wall Street
---------------
Journal. The Bank's non-real estate commercial loans primarily consist of
- -------
short-term loans for working capital purposes, seasonal loans and lines of
credit. The Bank customarily requires a personal guaranty of payment by the
principals of any borrowing entity and reviews the financial statements and
income tax returns of the guarantors. At September 30, 2005, the Bank had $38.7
million outstanding in commercial business loans, which represented
approximately 3.9% of its gross loan portfolio and 2.5% of total assets.
Commercial business lending is inherently riskier than secured mortgage
lending and involves risks that are different from those associated with
residential and commercial real estate lending. Real estate lending is generally
considered to be collateral based lending with loan amounts based on
predetermined loan to collateral values and liquidation of the underlying real
estate collateral is viewed as the primary source of repayment in the event of
borrower default. Although commercial business loans are often collateralized by
equipment, inventory, accounts receivable or other business assets, the
liquidation of such collateral in the event of a borrower default is often not a
sufficient source of repayment because accounts receivable may be uncollectible
and inventories and equipment may be obsolete, of limited use, or have limited
marketability, among other things. Accordingly, the repayment of a commercial
business loan depends primarily on the creditworthiness of the borrower (and any
guarantors), while liquidation of collateral is a secondary and potentially
insufficient source of repayment.
Commercial Real Estate Loans. The Bank may invest, by OTS regulation, in
non-residential real estate loans up to 400% of its capital as computed under
GAAP plus general loan loss reserves. At September 30, 2005, this limited
Coastal Federal's aggregate non-residential real estate loans to approximately
$455.5 million. At such date, the Bank had non-residential real estate loans
outstanding of $369.7 million compared to $312.5 million at September 30, 2004.
During fiscal 2002 through 2005, the Bank opened four offices. The Bank hired
commercial lending officers to reside in many of these offices and intends to
have commercial lending officers or business banking officers in the majority of
its banking offices. As a result of this focus, the Bank has significantly
increased the number of its
9
commercial lending officers over the last two years. The Bank expects to
continue to focus significant origination efforts in commercial real estate and
commercial lending. It is expected that the Bank's commercial real estate loans
will continue to comprise the most significant portion of the Bank's loan growth
in future years.
The commercial real estate loans originated by the Bank are primarily
secured by shopping centers, office buildings, warehouse facilities, retail
outlets, hotels, motels and multi-family apartment buildings. The interest rate
of the commercial real estate loans presently offered by the Bank generally
adjusts every one, three or five years and is indexed to U.S. Treasury
securities or adjusts daily indexed to the prime interest rate. Such loans
generally have a fifteen to twenty year term, with the payments based on a
similar amortization schedule. In some cases, the Bank may require the loan to
include a call option at the Bank's option in three to ten years. The Bank
generally requires that such loans have a minimum debt service coverage of 120%
of projected net operating income together with other generally accepted
underwriting criteria.
Commercial real estate lending entails significant additional risks
compared to residential lending. Commercial real estate loans typically involve
large loan balances to single borrowers or groups of related borrowers. The
payment experience of such loans is typically dependent upon the successful
operation of the real estate project. These risks can be significantly affected
by supply and demand conditions in the market for office and retail space and
for apartments and, as such may be subject, to a greater extent, to adverse
conditions in the economy. In dealing with these risk factors, Coastal Federal
generally limits itself to a real estate market or to borrowers with which it
has experience. The Bank concentrates on originating commercial real estate
loans secured by properties located within its market areas of Horry and
Georgetown Counties, South Carolina and Brunswick and New Hanover Counties,
North Carolina. Additionally, the Bank has, on a limited basis, originated
commercial real estate loans secured by properties located in other parts of
North and South Carolina.
Consumer Loans. The Bank is permitted by OTS regulations to invest up to
35% of its assets in consumer loans. The Bank currently offers a wide variety of
consumer loans on a secured and unsecured basis including home improvement
loans, loans secured by savings accounts and automobile, truck and boat loans.
The Bank also offers a revolving line of credit secured by owner-occupied real
estate. Total consumer loans, including equity lines of credit generally secured
by one-to-four family residences, amounted to $59.3 million, or 6.0% of the
gross loan portfolio, and 3.8% of total assets, at September 30, 2005.
Coastal Federal offers consumer loans in order to provide a wider range of
financial services to its customers. These loans also
10
have a shorter term and normally higher interest rates than residential real
estate loans.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of consumer loans that are unsecured or secured by
assets that may depreciate rapidly, such as automobiles, boats and other moving
vehicles. In such cases, repossessed collateral for a defaulted consumer loan
may not provide an adequate source of repayment of the outstanding loan and the
remaining deficiency often does not warrant further substantial collection
efforts against the borrower. In addition, consumer loan collections are
dependent on the borrower's continuing financial stability and, thus, are more
likely to be adversely affected by job loss, a change in family status such as
divorce, illness or personal bankruptcy. Furthermore, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount recoverable on such loans. Such loans may also give
rise to claims and defenses by the borrower against Coastal Federal as the
holder of the loan, and a borrower may be able to assert claims and defenses
that it has against the seller of the underlying collateral.
Residential Mortgage Loans. The Bank originates loans to enable borrowers
to purchase existing homes or residential lots, refinance existing mortgage
loans or construct new homes. Residential mortgage loans originated by the Bank
are generally long-term loans, amortized on a monthly basis, with principal and
interest due each month. The contractual loan payment period for residential
mortgage loans typically ranges from 10 to 30 years. The Bank's experience
indicates that real estate loans remain outstanding for significantly shorter
periods than their contractual terms. Borrowers may refinance or prepay loans at
their option, subject to any prepayment penalty provisions included in the note.
The Bank generally requires mortgagee title insurance on all single-family first
mortgage and residential mortgage loans.
The Bank offers adjustable rate residential mortgage loans ("ARMs"), the
interest rates of which generally adjust based upon treasury securities indices.
Although Coastal Federal's ARMs are beneficial in helping the Bank improve the
interest rate sensitivity of its assets, such loans may pose potential
additional risks to Coastal Federal. A precipitous increase in interest rates
could be expected to result in an increase in delinquencies or defaults on such
loans, whereas a significant decrease in rates could cause repayments to
increase significantly.
Coastal Federal also offers residential mortgage loans with fixed rates of
interest. These loans generally can be sold in the secondary market or are
portfolio loans where the Bank offers such loans at rates above conforming loan
rates. In addition, Coastal Federal securitized loans into FHLMC mortgage-backed
securities of
11
$46.8 million and $52.6 million in 2004 and 2005, respectively. The securitized
mortgage-backed securities were generally sold in the secondary market within a
few days of securitization.
At September 30, 2005, approximately $371.0 million or 37.8% of the Bank's
loan portfolio, and 24.0% of total assets, consisted of one-to-four family
residential loans.
Construction Loans. The Bank originates residential construction loans
that generally have a term of six to twelve months for individuals or one year
for builders. The individual's loans are generally tied to a commitment by the
Bank to provide permanent financing upon completion of construction. The
interest rate charged on construction loans is generally indexed to the prime
rate as published in The Wall Street Journal or the current permanent loan rate
-----------------------
and varies depending on the terms of the loan and the loan amount. The Bank
customarily requires personal guaranties of payment from the principals of the
borrowing entities.
The interest rate on commercial real estate construction loans presently
offered by the Bank is generally indexed to the prime rate as published in The
---
Wall Street Journal. Residential and commercial real estate construction
- ---------------------
financing generally expose the Bank to a greater risk of loss than long-term
financing on improved, occupied real estate, due in part to the fact that the
loans are underwritten on projected, rather than historical, income and rental
results. The Bank's risk of loss on such loans generally depends largely upon
the accuracy of the initial appraisal of the property's value at completion of
construction and the estimated cost (including interest) of completion. If
either estimate proves to have been inaccurate and the borrower is unable to
provide additional funds pursuant to his guaranty, the lender either may be
required to advance funds beyond the amount originally committed to permit
completion of the development and/or be confronted at the maturity of the loan
with a project whose value is insufficient to assure full repayment. Coastal
Federal generally provides a permanent financing commitment on residential and
commercial properties at the time the Bank provides the construction financing.
The Bank's underwriting criteria are designed to evaluate and to minimize
the risks of each residential and commercial real estate construction loan. The
Bank considers evidence of the financial stability and reputation of both the
borrower and the contractor, the amount of the borrower's cash equity in the
project, independent evaluation and review of the building costs, local market
conditions, pre-construction sale and leasing information based upon evaluation
of similar projects and the borrower's cash flow projections upon completion.
The Bank generally requires personal guaranties of payment by the principals of
any borrowing entity.
12
At September 30, 2005, approximately $143.0 million or 14.6% of the Bank's
gross loan portfolio consisted of construction loans on both residential ($128.0
million) and commercial properties ($15.0 million).
13
Loan Maturity
The following table sets forth certain information at September 30, 2005
regarding the dollar amount of loans maturing in the Company's loan portfolio
based on their contractual terms to maturity including scheduled payments and
potential prepayments. Specific prepayment speeds applied to loans are a
function of their underlying coupons, lifetime rate caps and maturities. Demand
loans (without a stated maturity), loans having no stated schedule of repayments
and no stated maturity and overdrafts are reported as due in one year or less.
More than
One Year
One Year Through More than
or Less Five Years Five Years Totals
------- ---------- ---------- ------
(In thousands)
First mortgage loans $ 147,475 $ 212,591 $ 125,562 $ 485,628
Land, land development and
other, primarily
commercial real estate 80,340 227,824 61,550 369,714
Equity lines of credit 6,812 15,617 11,590 34,019
Consumer loans 5,671 16,299 3,336 25,306
Commercial loans 16,402 22,289 -- 38,691
--------- --------- --------- ---------
Total loans, gross $ 256,700 $ 494,620 $ 202,038 $ 953,358
========= ========= =========
Add (Subtract):
Deferred loan costs, net 771
Allowance for loan losses (11,748)
---------
Total loans, net $ 942,381
=========
The following table sets forth the dollar amount of all loans expected to
be repaid one year or later after September 30, 2005, which have fixed interest
rates and those which have floating or adjustable interest rates.
Floating or
Fixed Adjustable
Rates Rates Totals
----- ----- ------
(In thousands)
First mortgage loans $ 71,775 $266,378 $338,153
Land, land development and
other, primarily
commercial real estate 55,619 233,756 289,375
Equity lines of credit 163 27,044 27,207
Consumer loans 12,280 7,355 19,635
Commercial loans 9,922 12,366 22,288
-------- -------- --------
Total loans $149,759 $546,899 $696,658
======== ======== ========
14
Loan Solicitation and Processing. The Bank actively solicits mortgage loan
applications from the communities it serves. Detailed loan applications are
obtained to determine the borrower's ability to repay, and more significant
items on these applications are verified. After analysis of the loan application
and property or collateral involved, including an independent appraisal of
property, the Bank's underwriter or Credit Administration Group reviews the
loan, and the Bank makes a lending decision. With respect to commercial loans,
the Bank also reviews the capital adequacy of the business, the ability of the
borrower to repay the loan and honor its other obligations and general economic
and industry conditions. Loans are approved based on size, requiring higher
levels of authorization for larger dollar loan amounts. A member of the Bank's
Internal Loan Committee must approve all residential mortgage loan applications
in excess of 80% of the lesser of appraised value or purchase price of the
property, unless the borrowers have private mortgage insurance.
The Bank's general policy is to obtain customary title and flood insurance
on real estate loans. Borrowers must also obtain paid hazard insurance policies
prior to closing. Borrowers on residential mortgage loans, which exceed 80% of
the value of the security property, are also generally required to escrow funds
on a monthly basis for real estate taxes, hazard insurance premiums, and private
mortgage insurance premiums.
Residential Mortgage Loan Originations, Purchases and Sales. The Bank may,
depending on economic conditions, purchase or sell mortgage loans to manage the
interest rate sensitivity of interest-earning assets and interest-bearing
liabilities, to provide additional funding for lending activities, and generate
service fee income. The Bank retains a portion of the interest paid by the
borrower on the loans as consideration for its servicing activities.
Residential Loan Commitments. The Bank, upon the submission of a
residential loan application, generally provides a written commitment as to the
interest rate applicable to such loan. If the loan has not been closed within
the rate lock period, the rate may be adjusted to reflect current market
conditions at the Bank's option. Loans that require closing time in excess of
the rate lock period from the date of application are issued a written
commitment, with a term ranging from three to six months. The Bank charges
either a higher interest rate or a fee to lock in the rate for an extended rate
lock period. Refer to Note 4 of the Notes to Consolidated Financial Statements
for more information.
Delinquencies. Coastal Federal's collection procedures provide for a
series of contacts with delinquent borrowers. If the delinquency continues, more
formal efforts are made to contact the delinquent borrower. If a residential
mortgage loan continues in a delinquent status for 90 days or more, Coastal
Federal generally initiates foreclosure proceedings. Coastal Federal generally
initiates collection activities on a commercial or consumer loan if the loan
continues in a delinquent status for 30 days or more. In certain limited
instances, however, Coastal Federal may modify the loan or grant a limited
moratorium on loan payments to enable the borrower to reorganize his financial
affairs.
15
Problem Assets and Asset Classification. Loans are reviewed on a regular
basis and a reserve for uncollectible interest is established on loans where
collection of interest is questionable, generally when such loans become 90 days
delinquent. Loan balances that relate to interest amounts reserved are
considered to be on a nonaccrual basis.
The following table sets forth information with respect to the Bank's
non-performing assets at the dates indicated.
At September 30,
----------------------------------------------
2001 2002 2003 2004 2005
---- ---- ---- ---- ----
(Dollars in thousands)
Loans accounted for on a nonaccrual basis:
Real estate -
Residential $1,554 $ 785 $3,538 $3,852 $ 998
Commercial 1,185 18 2,816 1,106 1,048
Commercial business 322 2,423 793 783 488
Consumer 193 288 302 115 107
------ ------ ------ ------ ------
Total 3,254 3,514 7,449 5,856 2,641
------ ------ ------ ------ ------
Accruing loans which are
contractually past due
90 days or more:
Real estate -
Residential -- -- -- -- --
Commercial -- -- -- -- --
Commercial business -- -- -- -- --
Consumer -- -- -- -- --
------ ------ ------ ------ ------
Total -- -- -- -- --
------ ------ ------ ------ ------
Restructured loans 1,693 970 369 731 771
Real estate owned, net 2,363 1,046 1,627 785 818
Other nonperforming assets -- -- -- -- --
------ ------ ------ ------ ------
Total nonperforming assets $7,310 $5,530 $9,445 $7,372 $4,230
====== ====== ====== ====== ======
Total nonaccrual loans to
net loans 0.64% 0.63% 1.06% 0.73% 0.28%
Total nonaccrual loans to
total assets 0.43% 0.37% 0.63% 0.45% 0.17%
Total nonperforming assets
to total assets 0.96% 0.58% 0.80% 0.56% 0.27%
Total nonperforming
assets, excluding restructured
loans which are generally
performing under the restructured
terms, to total assets 0.74% 0.48% 0.77% 0.51% 0.22%
16
Please refer to Note 4 of the Notes to Consolidated Financial Statements
for additional information on impaired loans and reserved accrued interest.
The allowance for uncollectible interest which is netted against accrued
interest receivable totaled $605,000 and $528,000 at September 30, 2004 and 2005
respectively.
OTS regulations require that each insured institution review and classify
its assets on a regular basis. In addition, in connection with examinations of
insured institutions, OTS examiners have authority to identify problem assets
and, if appropriate, require them to be classified. There are four
classifications for problem assets: special mention, substandard, doubtful and
loss. Assets categorized as special mention have potential credit weakness and
require close management attention, but are not yet classified further. Assets
classified as substandard or doubtful have well defined weaknesses and the
institution may sustain some loss if the weaknesses are not corrected. If an
asset or portion thereof is classified loss, the insured institution must either
establish specific allowances for loan losses in the amount of 100% of the
portion of the asset classified loss or charge off such amount. A portion of
general loss allowances established to cover possible losses related to assets
classified substandard or doubtful may be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses generally do not qualify as regulatory capital.
Coastal Federal had two individually classified assets in excess of $1.5
million as of September 30, 2005. At that date, classified assets amounted to
$18.7 million ($9.4 million substandard; $345,000 doubtful; and $9.0 million
special mention). Substandard assets consist primarily of fifteen loans with
aggregate balances of approximately $7.6 million at September 30, 2005. The
largest amount to any one borrower was $2.5 million. Special mention assets
consist primarily of twenty-seven loans with aggregate balances of approximately
$7.9 million at September 30, 2005.
Allowance for Loan Losses. The adequacy of the allowance is analyzed on a
quarterly basis. For purposes of this analysis, adequacy is defined as a level
of reserves sufficient to absorb probable losses inherent in the loan portfolio.
The methodology employed for this analysis considers historical loan loss
experience, the results of loan reviews, current economic conditions, and other
qualitative and quantitative factors that warrant current consideration in
determining an adequate allowance.
The evaluation of the allowance is segregated into general allocations and
specific allocations. For general allocations, the portfolio is segregated into
risk-similar segments for which historical loss ratios are calculated and
adjusted for identified trends or changes in current portfolio characteristics.
Historical loss ratios are calculated by product type for consumer loans
(installment and revolving), mortgage loans, and commercial loans. To allow for
modeling error, a range of probable loss ratios is then derived for each
segment. The resulting percentages are then applied to the dollar amounts of the
loans in each segment to arrive at each segment's range of probable loss levels.
17
Certain nonperforming loans are individually assessed for impairment under
SFAS 114 and assigned specific allocations. Other identified high-risk loans or
credit relationships based on internal risk ratings are also individually
assessed and assigned specific allocations.
The general allocation also includes a component for probable losses
inherent in the portfolio, based on management's analysis, that are not fully
captured elsewhere in the allowance. This component serves to address the
inherent estimation and imprecision risk in the methodology as well as address
management's evaluation of various factors or conditions not otherwise directly
measured in the evaluation of the general and specific allocations. Such factors
or conditions may include evaluation of current general economic and business
conditions; geographic, collateral, or other concentrations; system, procedural,
policy, or underwriting changes; experience of lending staff; entry into new
markets or new product offerings; and results from internal and external
portfolio examinations.
The allocation of the allowance to the respective loan segments is an
approximation and not necessarily indicative of future losses or future
allocations. The entire allowance is available to absorb losses occurring in the
overall loan portfolio.
Assessing the adequacy of the allowance is a process that requires
considerable judgment. Management's methodology and judgments are based on the
information currently available and includes numerous assumptions about current
events, which are believed to be reasonable, but which may or may not be valid.
Thus, there can be no assurance that loan losses in future periods will not
exceed the current allowance amount or that future increases in the allowance
will not be required. No assurance can be given that management's ongoing
evaluation of the loan portfolio in light of changing economic conditions and
other relevant circumstances will not require significant future additions to
the allowance, thus adversely affecting the operating results of the Company.
Management believes that the current level of the allowance for loan losses is
presently adequate considering the composition of the loan portfolio, the
portfolio's loss experience, delinquency trends, current regional and local
economic conditions and other factors.
The allowance is also subject to examination and adequacy testing by
regulatory agencies, which may consider such factors as the methodology used to
determine adequacy and the size of the allowance relative to that of peer
institutions, and other adequacy tests. In addition, such regulatory agencies
could require management to adjust the allowance based on information available
to them at the time of their examination.
See Note 4 of the Notes to Consolidated Financial Statements and
"Management's Discussion and Analysis - Non-performing Assets" in the 2005
Annual Report to Stockholders attached hereto and incorporated by reference.
18
Loan Loss Allowance Analysis
The following table sets forth analysis of the Company's allowance for
loan losses for the periods indicated. Where specific loan loss reserves have
been established, any difference between the loss reserve and the amount of the
loss realized has been charged or credited to the loan loss allowance as a
charge-off or recovery.
Year Ended September 30,
------------------------------------------------
2001 2002 2003 2004 2005
---- ---- ---- ---- ----
(Dollars in thousands)
Allowance at beginning of
period $ 7,064 $ 7,159 $ 7,883 $ 9,832 $11,077
Provision for loan losses 955 1,235 2,655 1,750 1,697
------- ------- ------- ------- -------
Recoveries:
Residential loans 3 4 -- -- --
Commercial loans -- -- 92 200 108
Construction loans -- -- -- -- --
Consumer loans 57 62 44 49 116
------- ------- ------- ------- -------
Total recoveries 60 66 136 249 224
------- ------- ------- ------- -------
Charge-offs:
Residential loans 167 -- 46 -- 27
Commercial loans 226 90 388 268 781
Construction loans -- -- -- -- --
Consumer loans 527 487 408 486 442
------- ------- ------- ------- -------
Total charge-offs 920 577 842 754 1,250
------- ------- ------- ------- -------
Net charge-offs 860 511 706 505 1,026
------- ------- ------- ------- -------
Allowance at end of period $ 7,159 $ 7,883 $ 9,832 $11,077 $11,748
======= ======= ======= ======= =======
Ratio of allowance to net
loans outstanding at the
end of the period 1.42% 1.42% 1.40% 1.39% 1.25%
Ratio of net charge-offs
to average loans outstanding
during the period 0.17% 0.10% 0.11% 0.07% 0.12%
19
Loan Loss Allowance by Category
The following table sets forth the breakdown of the allowance for loan
losses by loan category for the periods indicated.
September 30,
-----------------------------------------------------------------------------------
2001 2002 2003
--------------------------- --------------------------- ---------------------------
As a % Loan Type As a % Loan Type As a % Loan Type
of out- As a % of out- As a % of out- As a %
standing of out- standing of out- standing of out-
loans in standing loans in standing loans in standing
Amount category loans Amount category loans Amount category loans
------ -------- ----- ------ -------- ----- ------ -------- -----
(Dollars in thousands)
Residential $2,148 0.65% 65.55% $2,272 0.72% 57.08% $1,992 0.61% 55.61%
Commercial 4,893 3.13 30.92 5,273 2.39 39.69 7,229 2.51 41.06
Consumer 118 0.66 3.53 338 1.88 3.23 611 2.62 3.33
------ ------ ------ ------ ------ ------
Total allowance for
loan losses $7,159 1.42% 100.00% $7,883 1.42% 100.00% $9,832 1.40% 100.00%
====== ====== ====== ====== ====== ======
September 30,
------------------------------------------------------------
2004 2005
------------------------------ -----------------------------
As a % Loan Type As a % Loan Type
of out- As a % of out- As a %
standing of out- standing of out-
loans in standing loans in standing
Amount category loans Amount category loans
------ -------- ----- ------ -------- -----
(Dollars in thousands)
Residential $ 1,007 0.23% 53.78% $ 980 0.19% 53.91%
Commercial 9,222 2.68 43.13 9,794 2.39 43.40
Consumer 848 3.43 3.09 974 3.85 2.69
------- ---- ------ ------- ---- ------
Total allowance for
loan losses $11,077 1.39% 100.00% $11,748 1.25% 100.00%
======= ==== ====== ======= ==== ======
20
Investment Activities
Under OTS regulations, the Bank has authority to invest in various types
of liquid assets, including U.S. Treasury obligations, securities of various
federal agencies and of state and municipal governments, deposits at the FHLB of
Atlanta, certificates of deposit of federally insured institutions, certain
bankers' acceptances and federal funds. Subject to various restrictions, such
regulated institutions may also invest a portion of their assets in commercial
paper, corporate debt securities and mutual funds, the assets of which conform
to the investments that OTS-chartered institutions are otherwise authorized to
make directly. These institutions are also required to maintain minimum levels
of liquid assets which vary from time to time. See "Regulation and Supervision -
Federal Home Loan Bank System." The Bank may decide to increase its liquidity
above the required levels depending upon the availability of funds and
comparative yields on investments in relation to return on loans.
Coastal Federal is required under federal regulations to maintain a
minimum amount of liquid assets and is also permitted to make certain other
securities investments. See "Regulation and Supervision" herein and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" in the Annual Report.
Investment decisions are made in accordance with the Bank's approved
Investment Policy by the Investment Officer who reports quarterly to the
Asset/Liability Management Committee ("ALCO Committee"). The ALCO Committee
meets quarterly and consists of Directors Benton, Bishop, Calliham, Clemmons,
Creel, Dusenbury, Gerald and Thompson, and Executive Vice Presidents Douglas,
Graham, Rexroad, Sherry and Stalvey and Senior Vice Presidents Benjamin and
Gehman and Vice President Loehr. The ALCO Committee acts within policies
established by the Board of Directors. At September 30, 2005 the Bank's
investment portfolio had a market value of approximately $435.3 million. The
investment securities portfolio consisted primarily of mortgage-backed
securities. For further information concerning the Bank's securities portfolio,
see Notes 2 and 3 of the Notes to Consolidated Financial Statements attached
hereto and incorporated by reference.
21
Service Corporation Activities
The Company has four wholly owned subsidiaries, Coastal Federal Bank,
Coastal Financial Capital Trust I (see Note 11 of the Notes to Consolidated
Financial Statements), Coastal Planners Holding Corporation, and Coastal
Investor Services, Inc (inactive).
Coastal Federal Bank has two wholly-owned subsidiaries: Coastal Mortgage
Bankers and Realty Co., Inc. ("Coastal Mortgage Bankers"), which was
incorporated in 1970 under the laws of South Carolina, and Coastal Federal
Holding Corporation ("CHFC"), which was incorporated in 1998 under the laws of
Delaware. As of September 30, 2005 Coastal Mortgage Bankers has one first tier
subsidiary, Sherwood Development Corporation, which is inactive. Coastal
Mortgage Bankers is not active in any real estate operations.
On February 20, 1998, Coastal Real Estate Investment Corporation ("CREIC")
was incorporated in North Carolina. CREIC is a wholly owned operating subsidiary
of CFHC and is a real estate investment trust ("REIT"). CREIC engages in the
investment in, and management of, real estate related assets, primarily mortgage
loans. CFHC engages in the management of its investment in CREIC and the
management of the related dividends received on that investment. On September 1,
1998, CREIC was capitalized with approximately $131.8 million of mortgage loans
from Coastal Federal. On December 10, 1998, CREIC became a wholly owned
subsidiary of CFHC through an exchange of stock transaction. In January 2003,
2004 and 2005, CREIC received capital contributions from CFHC of $50.0 million
each year to purchase loans.
Coastal Federal Capital Trust I was formed as a statutory trust under the
laws of the state of Delaware, for the purpose of issuing capital securities to
institutional investors in a trust preferred issue. During fiscal 2004, the
Company deconsolidated the Trust for financial reporting purposes as a result of
Financial Accounting Standards Board Interpretation No. 46 "Consolidation of
Variable Interest Entities". Refer to Note 11 of the Notes to Consolidated
Financial Statements for further information.
Coastal Planners Holding Corporation has one subsidiary, Coastal
Retirement, Estate and Tax Planners, Inc., which was formed during the fourth
fiscal quarter of 2003 and offers objective, fee-based financial planning and
tax preparation services.
Deposit Activities and Other Sources of Funds
General. Deposits and loan repayments are the major source of Coastal
Federal's funds for lending and other investment purposes. Loan repayments are a
relatively stable source of funds, while deposit inflows and outflows and loan
prepayments are significantly influenced by general interest rates and money
market conditions. Borrowings may be used to compensate for reductions in the
22
availability of funds from other sources. They may also be used for general
business purposes.
Deposit Accounts. Deposits are attracted from within Coastal Federal's
primary market area through the offering of a broad selection of deposit
instruments, including checking accounts, money market accounts, savings
accounts, certificates of deposit and retirement accounts. Deposit account terms
vary, according to the minimum balance required, the time periods the funds must
remain on deposit and the interest rate, among other factors. In determining the
terms of its deposit accounts, Coastal Federal considers the rates offered by
its competition, profitability to Coastal Federal, matching deposit and loan
products and its customer preferences and concerns. Coastal Federal generally
reviews its deposit mix and pricing at least monthly.
Time Deposits with balances of $100,000 or More
The following table sets forth the amount and maturities of time deposits
with balances of $100,000 or more at September 30, 2005.
Amount Due
- --------------------------------------------------------------------------------
Up to Over 3 Over 6 Over 12
3 Months through 6 months through 12 months Months Total
- --------------------------------------------------------------------------------
(In thousands)
$86,356 $127,388 $58,175 $20,241 $292,160
======= ======== ======= ======= ========
23
Deposit Flow
The following table sets forth the balances of deposits in the various types
of deposit accounts offered by the Bank at the dates indicated.
At September 30,
------------------------------------------------------------------------------------------------
2003 2004 2005
----------------------------- ------------------------------ ---------------------------------
Percent Increase Percent Increase Percent Increase
Amount of Total (Decrease) Amount of Total (Decrease) Amount of Total (Decrease)
------ -------- ---------- ------ -------- ---------- ------ -------- ----------
(Dollars in thousands)
Transaction accounts:
NOW checking $ 98,171 14.08% $ 30,790 $110,802 14.71% $ 12,631 $ 139,810 13.05% $ 29,008
Noninterest-bearing
checking 86,258 12.38 23,255 122,357 16.24 36,099 219,080 20.45 96,723
-------- ------ --------- -------- ------ --------- ----------- ------ ---------
Total transaction accounts 184,429 26.46 54,045 233,159 30.95 48,730 358,890 33.50 125,731
-------- ------ --------- -------- ------ --------- ----------- ------ ---------
Money market demand accounts 206,010 29.56 (6,914) 224,437 29.79 18,427 213,078 19.89 (11,359)
Statement savings accounts 46,236 6.63 7,144 55,205 7.33 8,969 71,824 6.71 16,619
Fixed-rate certificates
(original maturity):
3 months 3,477 0.50 (1,491) 3,865 .51 388 2,775 0.26 (1,090)
6 months 82,349 11.81 (7,828) 33,052 4.39 (49,297) 93,805 8.76 60,753
9 months 6,702 .96 (10,911) 51,159 6.79 44,457 17,204 1.61 (33,955)
12 months 57,777 8.29 571 57,696 7.66 (81) 56,980 5.32 (716)
18 months 46,044 6.61 15,050 37,978 5.04 (8,066) 215,767 20.15 177,789
24 months 36,313 5.21 8,374 28,264 3.75 (8,049) 21,795 2.04 (6,469)
30 months 2,923 0.42 (118) 2,673 .35 (250) 2,684 0.25 11
36 months 11,649 1.67 69 11,559 1.53 (90) 4,361 0.41 (7,198)
48 months 10,108 1.45 2,172 11,662 1.55 1,554 9,444 0.88 (2,218)
60 months 20 0.00 1 -- -- (20) -- -- --
-------- ------ --------- -------- ------ --------- ----------- ------ ---------
257,362 36.92 5,889 237,908 31.57 (19,454) 424,815 39.68 186,907
-------- ------ --------- -------- ------ --------- ----------- ------ ---------
Variable rate certificates:
(original maturity)
12 months 130 0.02 (33) 161 .02 31 170 0.02 9
18 months 1,311 0.19 (160) 1,115 .15 (196) 936 0.09 (179)
30 months 1,534 0.22 (40) 1,394 .19 (140) 1,205 0.11 (189)
-------- ------ --------- -------- ------ --------- ----------- ------ ---------
Total variable 2,975 0.43 (233) 2,670 .36 (305) 2,311 0.22 (359)
-------- ------ --------- -------- ------ --------- ----------- ------ ---------
Total certificates 260,337 37.35 5,656 240,578 31.93 (19,759) 427,126 39.90 186,548
-------- ------ --------- -------- ------ --------- ----------- ------ ---------
Total deposits $697,012 100.00% $ 59,931 $753,379 100.00% $ 56,367 $ 1,070,918 100.00% $ 317,539
======== ====== ========= ======== ====== ========= =========== ====== =========
24
Borrowings. Demand and time deposits are the primary source of funds for
Coastal Federal's lending and investment activities and for its general business
purposes. The Bank has in the past, however, relied upon advances from the FHLB
of Atlanta to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. The FHLB of Atlanta has served as one of the Bank's
primary borrowing sources. Advances from the FHLB of Atlanta are typically
secured by the Bank's first mortgage loans and certain of the Bank's
mortgage-backed securities portfolio. At September 30, 2005, Coastal Federal had
advances totaling $ 289.0 million from the FHLB of Atlanta due on various dates
through 2018 with a weighted average interest rate of 3.93%. Certain of these
advances are subject to call provisions. Call provisions are more likely to be
exercised by the FHLB when rates rise. See Note 9 of the Notes to Consolidated
Financial Statements of the 2005 Annual Report to Stockholders for further
information on the call provisions of various FHLB advances.
The FHLB of Atlanta functions as a central reserve bank providing credit
for financial institutions and certain other member financial institutions. As a
member, Coastal Federal is required to own capital stock in the FHLB of Atlanta
and is authorized to apply for advances on the security of such stock and
certain of its mortgage loans, certain commercial real estate loans, and other
assets (principally securities which are obligations of, or guaranteed by, the
United States) provided certain standards related to creditworthiness have been
met. The FHLB of Atlanta determines specific lines of credit for each member
institution.
In addition to the borrowing described above, the Bank may borrow funds
under reverse repurchase agreements pursuant to which it sells securities
(generally secured by government securities and mortgage-backed securities)
under an agreement to buy them back at a specified price at a later date. These
agreements to repurchase are deemed to be borrowings collateralized by the
securities sold. At September 30, 2005, the Company had repurchase agreement
lines of credit and available collateral consisting of investment securities and
mortgage-backed securities of $178.3 million, as well as a federal funds line
available of $20.0 million.
The Company had $15.5 million of junior subordinated debentures
outstanding on September 30, 2005. For more information on these debentures,
please see Note 11 of the Notes to Consolidated Financial Statements in the 2005
Annual Report to Stockholders attached hereto and incorporated by reference.
25
The following tables set forth certain information regarding short-term
borrowings by the Bank at the end of and during the periods indicated:
At September 30,
--------------------------------
2003 2004 2005
--------------------------------
(Dollars in thousands)
Outstanding balance:
Securities sold under agreements
to repurchase:
Customer $ 7,703 $ 12,931 $ 31,937
Broker 125,899 94,242 10,000
Short-term FHLB advances (1) 91,435 147,500 88,177
Weighted average rate(at month end)paid on:
Securities sold under agreements
to repurchase:
Customer 0.81% 1.42% 2.82%
Broker 1.64 1.74 2.39
Short-term FHLB advances (1) 3.81 4.15 3.94
Maximum amount of borrowings outstanding
At any month end:
Securities sold under agreements
to repurchase:
Customer $ 7,703 $ 12,931 $ 39,317
Broker 125,899 184,129 109,958
Short-term FHLB advances (1) 121,582 159,735 216,200
Approximate average short-term borrowings
outstanding with respect to:
Securities sold under agreements
to repurchase:
Customer $ 4,812 $ 9,033 $ 27,498
Broker 92,476 134,809 73,723
Short-term FHLB advances (1) 86,191 103,360 146,150
Weighted average rate (year to date)paid on:
Securities sold under agreements
to repurchase:
Customer 1.02% 1.01% 2.43%
Broker 2.04 1.50 2.37
Short-term FHLB advances (1) 3.81 4.15 3.94
(1) Short-term FHLB advances include various advances which are subject to
call by FHLB within one year.
26
Competition
As of June 30, 2005 the most recent date for which published data is
available, Coastal Federal held the largest share of deposits, a 17.9% share, in
Horry County, S.C. according to the Federal Deposit Insurance Corporation.
Coastal Federal also held the third highest market share of deposits in
Brunswick County, N.C. with an 8.1% share. The Bank faces strong competition in
the attraction of deposits (its primary source of lendable funds) and in the
origination of loans. Its most direct competition for deposits and loans has
historically come from other financial institutions located in its primary
market area. The Bank estimates that there are 96 offices of other financial
institutions in Horry County, and 31 offices in Brunswick County. Particularly
in times of high interest rates, the Bank has faced additional significant
competition for investors' funds from short-term money market securities and
other corporate and government securities. The Bank's competition for loans
comes principally from other financial institutions, mortgage banking companies
and mortgage brokers.
Personnel
As of September 30, 2005 the Company had 435 full-time Associates and 51
part-time Associates. The Associates are not represented by a collective
bargaining unit. The Bank believes its relationship with its Associates is
excellent.
REGULATION AND SUPERVISION
General
As a savings and loan holding company, the Company is required by federal
law to file reports with, and otherwise comply with, the rules and regulations
of the Office of Thrift Supervision. The Bank is subject to extensive
regulation, examination and supervision by the Office of Thrift Supervision, as
its primary federal regulator, and the Federal Deposit Insurance Corporation, as
the deposit insurer. The Bank is a member of the Federal Home Loan Bank System
and, with respect to deposit insurance, of the Savings Association Insurance
Fund managed by the Federal Deposit Insurance Corporation. The Bank must file
reports with the Office of Thrift Supervision and the Federal Deposit Insurance
Corporation concerning its activities and financial condition in addition to
obtaining regulatory approvals prior to entering into certain transactions such
as mergers with, or acquisitions of, other financial institutions. The Office of
Thrift Supervision and/or the Federal Deposit Insurance Corporation conduct
periodic examinations to test the Bank's safety and soundness and compliance
with various regulatory requirements. This regulation and supervision
establishes a
27
comprehensive framework of activities in which an institution can engage and is
intended primarily for the protection of the insurance fund and depositors. The
regulatory structure also gives the regulatory authorities extensive discretion
in connection with their supervisory and enforcement activities and examination
policies, including policies with respect to the classification of assets and
the establishment of adequate loan loss reserves for regulatory purposes. Any
change in such regulatory requirements and policies, whether by the Office of
Thrift Supervision, the Federal Deposit Insurance Corporation or the Congress,
could have a material adverse impact on the Company, the Bank and their
operations. Certain of the regulatory requirements applicable to the Bank and to
the Company are referred to below or elsewhere herein. The description of
statutory provisions and regulations applicable to OTS regulated institutions
and their holding companies set forth in this Form 10-K does not purport to be a
complete description of such statutes and regulations and their effects on the
Bank and the Company.
Holding Company Regulation
The Company is a nondiversified unitary savings and loan holding company
within the meaning of federal law. Under prior law, a unitary savings and loan
holding company, such as the Company, was not generally restricted as to the
types of business activities in which it may engage, provided that the Bank
continued to be a qualified thrift lender. See "Federal Savings Institution
Regulation - QTL Test." The Gramm-Leach-Bliley Act of 1999 provides that no
company may acquire control of an OTS regulated institution after May 4, 1999
unless it engages only in the financial activities permitted for financial
holding companies under the law or for multiple savings and loan holding
companies as described below. Further, the Gramm-Leach-Bliley Act specifies that
existing savings and loan holding companies may only engage in such activities.
The Gramm-Leach-Bliley Act, however, grandfathered the unrestricted authority
for activities with respect to unitary savings and loan holding companies
existing prior to May 4, 1999, so long as the Bank continues to comply with the
QTL Test. The Company does qualify for the grandfathering. Upon any
non-supervisory acquisition by the Company of another savings institution or
savings bank that meets the qualified thrift lender test and is deemed to be a
savings institution by the Office of Thrift Supervision, the Company would
become a multiple savings and loan holding company (if the acquired institution
is held as a separate subsidiary) and would generally be limited to activities
permissible for bank holding companies under Section 4(c)(8) of the Bank Holding
Company Act, subject to the prior approval of the Office of Thrift Supervision,
and certain activities authorized by Office of Thrift Supervision regulation.
A savings and loan holding company is prohibited from, directly or
indirectly, acquiring more than 5% of the voting stock of another financial
institution or savings and loan holding company, without prior written approval
of the Office of Thrift Supervision and from acquiring or retaining control of a
depository institution that is not insured by the Federal Deposit Insurance
Corporation. In evaluating applications
28
by holding companies to acquire savings institutions, the Office of Thrift
Supervision considers the financial and managerial resources and future
prospects of the Company and institution involved, the effect of the acquisition
on the risk to the deposit insurance funds, the convenience and needs of the
community and competitive factors.
The Office of Thrift Supervision may not approve any acquisition that
would result in a multiple savings and loan holding company controlling savings
institutions in more than one state, subject to two exceptions: (i) the approval
of interstate supervisory acquisitions by savings and loan holding companies and
(ii) the acquisition of a savings institution in another state if the laws of
the state of the target savings institution specifically permit such
acquisitions. The states vary in the extent to which they permit interstate
savings and loan holding company acquisitions.
Although savings and loan holding companies are not currently subject to
specific capital requirements or specific restrictions on the payment of
dividends or other capital distributions, federal regulations do prescribe such
restrictions on subsidiary savings institutions as described below. The Bank
must notify the Office of Thrift Supervision 30 days before declaring any
dividend to the Company. In addition, the financial impact of a holding company
on its subsidiary institution is a matter that is evaluated by the Office of
Thrift Supervision and the agency has authority to order cessation of activities
or divestiture of subsidiaries deemed to pose a threat to the safety and
soundness of the institution.
Acquisition of the Company. Under the Federal Change in Bank Control Act
("CIBCA"), a notice must be submitted to the Office of Thrift Supervision if any
person (including a company), or group acting in concert, seeks to acquire 10%
or more of the Company's outstanding voting stock, unless the Office of Thrift
Supervision has found that the acquisition will not result in a change of
control of the Company. Under the CIBCA, the Office of Thrift Supervision has 60
days from the filing of a complete notice to act, taking into consideration
certain factors, including the financial and managerial resources of the
acquirer and the anti-trust effects of the acquisition. Any company that so
acquires control would then be subject to regulation as a savings and loan
holding company.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002, which implemented legislative reforms
intended to address corporate and accounting fraud, restricts the scope of
services that may be provided by accounting firms to their public company audit
clients and any non-audit services being provided to a public company audit
client will require preapproval by the company's audit committee. In addition,
the Sarbanes-Oxley Act requires chief executive officers and chief financial
officers, or their equivalent, to certify to the accuracy of periodic reports
29
filed with the Securities and Exchange Commission, subject to civil and criminal
penalties if they knowingly or willingly violate this certification requirement.
Under the Sarbanes-Oxley Act, bonuses issued to top executives before
restatement of a company's financial statements are now subject to disgorgement
if such restatement was due to corporate misconduct. Executives are also
prohibited from insider trading during retirement plan "blackout" periods, and
loans to company executives (other than loans by financial institutions
permitted by federal rules and regulations) are restricted. The legislation
accelerates the time frame for disclosures by public companies and changes in
ownership in a company's securities by directors and executive officers.
The Sarbanes-Oxley Act also increases the oversight of, and codifies
certain requirements relating to audit committees of public companies and how
they interact with the company's "registered public accounting firm." Among
other requirements, companies must disclose whether at least one member of the
committee is a "financial expert" (as such term is defined by the Securities and
Exchange Commission) and if not, why not.
Although the Company has incurred additional expense in complying with the
provisions of the Sarbanes-Oxley Act and the resulting regulations, management
does not believe that such compliance had a material impact on results of
operations or financial condition.
Federal Savings Institution Regulation
Business Activities. Federal law and regulations govern the activities of
federal savings banks. These laws and regulations delineate the nature and
extent of the activities in which federal savings banks may engage. In
particular, certain lending authority for federal savings banks, e.g.,
commercial, non-residential real property loans and consumer loans, is limited
to a specified percentage of the institution's capital or assets.
Capital Requirements. The Office of Thrift Supervision capital regulations
require their regulated institutions to meet three minimum capital standards: a
1.5% tangible capital ratio, a 4% leverage ratio (3% for institutions receiving
the highest rating on the CAMELS examination rating system) and an 8% risk-based
capital ratio. In addition, the prompt corrective action standards discussed
below also establish, in effect, a minimum 2% tangible capital standard, a 4%
leverage ratio (3% for institutions receiving the highest rating on the CAMELS
system), and, together with the risk-based capital standard itself, a 4% Tier 1
risk-based capital standard. The Office of Thrift Supervision regulations also
require that, in meeting the tangible,
30
leverage and risk-based capital standards, institutions must generally deduct
investments in and loans to subsidiaries engaged in activities as principal that
are not permissible for a national bank.
The risk-based capital standard for savings institutions requires the
maintenance of Tier 1 (core) and total capital (which is defined as core capital
and supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, are multiplied by a risk-weight
factor of 0% to 100%, assigned by the Office of Thrift Supervision capital
regulation based on the risks believed inherent in the type of asset. Core (Tier
1) capital is defined as common stockholders' equity (including retained
earnings), certain noncumulative perpetual preferred stock and related surplus,
and minority interests in equity accounts of consolidated subsidiaries less
intangibles other than certain mortgage servicing rights and credit card
relationships. The components of supplementary capital currently include
cumulative preferred stock, long-term perpetual preferred stock, mandatory
convertible securities, subordinated debt and intermediate preferred stock, the
allowance for loan and lease losses limited to a maximum of 1.25% of
risk-weighted assets and up to 45% of unrealized gains on available-for-sale
equity securities with readily determinable fair market values. Overall, the
amount of supplementary capital included as part of total capital cannot exceed
100% of core capital.
The OTS has authority to establish higher capital requirements where it
determines that the circumstances of a particular institution require it. At
September 30, 2005 the Bank met each of its capital requirements. See Note 14 of
the Notes to Consolidated Financial Statements for further information.
Prompt Corrective Regulatory Action. The Office of Thrift Supervision is
required to take certain supervisory actions against undercapitalized
institutions, the severity of which depends upon the institution's degree of
undercapitalization. Generally, an institution that has a ratio of total capital
to risk weighted assets of less than 8%, a ratio of Tier 1 (core) capital to
risk-weighted assets of less than 4% or a ratio of core capital to total assets
of less than 4% (3% or less for institutions with the highest examination
rating) is considered to be "undercapitalized." An institution that has a total
risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or
a leverage ratio that is less than 3% is considered to be "significantly
undercapitalized" and an institution that has a tangible capital to assets ratio
equal to or less than 2% is deemed to be "critically undercapitalized." Subject
to a narrow exception, the Office of Thrift Supervision is required to appoint a
receiver or conservator for an institution that is "critically
undercapitalized." The regulation also provides that a capital restoration plan
must be filed with the Office of Thrift Supervision within 45 days of the date
an institution receives notice that it is "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." Compliance with the plan
must be guaranteed by any parent holding
31
company. In addition, numerous mandatory supervisory actions become immediately
applicable to an undercapitalized institution, including, but not limited to,
increased monitoring by regulators and restrictions on growth, capital
distributions and expansion. The Office of Thrift Supervision could also take
any one of a number of discretionary supervisory actions, including the issuance
of a capital directive and the replacement of senior executive officers and
directors.
Insurance of Deposit Accounts. The Bank is a member of the Savings
Association Insurance Fund. The Federal Deposit Insurance Corporation maintains
a risk-based assessment system by which institutions are assigned to one of
three categories based on their capitalization and one of three subcategories
based on examination ratings and other supervisory information. An institution's
assessment rate depends upon the categories to which it is assigned. Assessment
rates for Savings Association Insurance Fund member institutions are determined
semi-annually by the Federal Deposit Insurance Corporation and currently range
from zero basis points for the healthiest institutions to 27 basis points of
assessable deposits for the riskiest.
The Federal Deposit Insurance Corporation has authority to increase
insurance assessments. A significant increase in Savings Association Insurance
Fund insurance premiums would likely have an adverse effect on the operating
expenses and results of operations of the Bank. Management cannot predict what
insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the Federal Deposit Insurance
Corporation upon a finding that the institution has engaged in unsafe or unsound
practices, is in an unsafe or unsound condition to continue operations or has
violated any applicable law, regulation, rule, order or condition imposed by the
Federal Deposit Insurance Corporation or the Office of Thrift Supervision. The
management of the Bank does not know of any practice, condition or violation
that might lead to termination of deposit insurance.
Loans to One Borrower. Federal law provides that OTS regulated
institutions are generally subject to the limits on loans to one borrower
applicable to national banks. Such an institution may not make a loan or extend
credit to a single or related group of borrowers in excess of 15% of its
unimpaired capital and surplus. An additional amount may be lent, equal to 10%
of unimpaired capital and surplus, if secured by specified readily marketable
collateral. At September 30, 2005 the Bank's limit on loans to one borrower was
$18.4 million, and the Bank's largest aggregate outstanding balance of loans to
one borrower was $16.0 million.
QTL Test. The HOLA requires OTS regulated institutions to meet a qualified
thrift lender test. Under the test, such an institution is required to either
qualify as a "domestic building and loan association" under the Internal Revenue
Code or maintain at least 65% of its "portfolio assets" (total assets less: (i)
specified liquid assets up to
32
20% of total assets; (ii) intangibles, including goodwill; and (iii) the value
of property used to conduct business) in certain "qualified thrift investments"
(primarily residential mortgages and related investments, including certain
mortgage-backed securities) in at least 9 months out of each 12 month period.
An institution that fails the qualified thrift lender test is subject to
certain operating restrictions and may be required to convert to a bank charter.
As of September 30, 2005 the Bank met the qualified thrift lender test. Recent
legislation has expanded the extent to which education loans, credit card loans
and small business loans may be considered "qualified thrift investments."
Limitation on Capital Distributions. Office of Thrift Supervision
regulations impose limitations upon all capital distributions by a regulated
institution, including cash dividends, payments to repurchase its shares and
payments to stockholders of another institution in a cash-out merger. Under the
regulations, an application to and the prior approval of the Office of Thrift
Supervision is required prior to any capital distribution if the institution
does not meet the criteria for "expedited treatment" of applications under
Office of Thrift Supervision regulations (i.e., generally, examination ratings
in the two top categories), the total capital distributions for the calendar
year exceed net income for that year plus the amount of retained net income for
the preceding two years, the institution would be undercapitalized following the
distribution or the distribution would otherwise be contrary to a statute,
regulation or agreement with Office of Thrift Supervision. If an application is
not required, the institution must still provide prior notice to Office of
Thrift Supervision of the capital distribution if, like the Bank, it is a
subsidiary of a holding company. In the event the Bank's capital fell below its
regulatory requirements or the Office of Thrift Supervision notified it that it
was in need of more than normal supervision, the Bank's ability to make capital
distributions could be restricted. In addition, the Office of Thrift Supervision
could prohibit a proposed capital distribution by any institution, which would
otherwise be permitted by the regulation, if the Office of Thrift Supervision
determines that such distribution would constitute an unsafe or unsound
practice.
Assessments. OTS regulated institutions are required to pay assessments to
the Office of Thrift Supervision to fund the agency's operations. The general
assessments, paid on a semi-annual basis, are computed upon the institution's
total assets, including consolidated subsidiaries, as reported in the Bank's
latest quarterly thrift financial report. The assessments paid by the Bank for
the fiscal year ended September 30, 2005 totaled $252,000.
Transactions with Related Parties. The Bank's authority to engage in
transactions with "affiliates" (e.g., any company that controls or is under
common control with an institution, including the Company and its non-OTS
regulated institution subsidiaries) is limited by federal law. The aggregate
amount of covered transactions with any individual
33
affiliate is limited to 10% of the capital and surplus of the institution. The
aggregate amount of covered transactions with all affiliates is limited to 20%
of the institution's capital and surplus. Certain transactions with affiliates
are required to be secured by collateral in an amount and of a type described in
federal law. The purchase of low quality assets from affiliates is generally
prohibited. The transactions with affiliates must be on terms and under
circumstances that are at least as favorable to the institution as those
prevailing at the time for comparable transactions with non-affiliated
companies. In addition, OTS regulated institutions are prohibited from lending
to any affiliate that is engaged in activities that are not permissible for bank
holding companies and no such institution may purchase the securities of any
affiliate other than a subsidiary.
The Bank's authority to extend credit to executive officers, directors and
10% shareholders ("insiders"), as well as entities such persons control, is also
governed by federal law. Such loans are required to be made on terms
substantially the same as those offered to unaffiliated individuals and not
involve more than the normal risk of repayment. Recent legislation created an
exception for loans made pursuant to a benefit or compensation program that is
widely available to all employees of the institution and does not give
preference to insiders over other employees. The law limits both the individual
and aggregate amount of loans the Bank may make to insiders based, in part, on
the Bank's capital position and requires certain board approval procedures to be
followed.
Enforcement. The Office of Thrift Supervision has primary enforcement
responsibility over their regulated institutions and has the authority to bring
actions against the institution and all institution-affiliated parties,
including stockholders, and any attorneys, appraisers and accountants who
knowingly or recklessly participate in wrongful action likely to have an adverse
effect on an insured institution. Formal enforcement action may range from the
issuance of a capital directive or cease and desist order, to removal of
officers and/or directors, to institution of receivership, conservatorship or
termination of deposit insurance. Civil penalties cover a wide range of
violations and can amount to $25,000 per day, or even $1 million per day in
especially egregious cases. The Federal Deposit Insurance Corporation has the
authority to recommend to the Director of the Office of Thrift Supervision that
enforcement action to be taken with respect to a particular regulated
institution. If the Director does not take action, the Federal Deposit Insurance
Corporation has authority to take such action under certain circumstances.
Federal law also establishes criminal penalties for certain violations.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines prescribing Standards for Safety and Soundness.
The guidelines set forth the safety and soundness standards that the federal
banking agencies use to identify and address problems at insured depository
institutions before capital becomes impaired. If the Office of Thrift
Supervision determines that a regulated
34
institution fails to meet any standard prescribed by the guidelines, the Office
of Thrift Supervision may require the institution to submit an acceptable plan
to achieve compliance with the standard.
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank System, which consists
of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a
central credit facility primarily for member institutions. The Bank, as a member
of the Federal Home Loan Bank, is required to acquire and hold shares of capital
stock in that Federal Home Loan Bank in an amount at least equal to $500, 1.0%
of the aggregate principal amount of its unpaid residential mortgage loans and
similar obligations at the beginning of each year, or 1/20 of its advances
(borrowings) from the Federal Home Loan Bank, whichever is greater. The Bank was
in compliance with this requirement with an investment in Federal Home Loan Bank
stock at September 30, 2005 of $15.8 million.
The Federal Home Loan Banks are required to provide funds for the
resolution of insolvent thrifts in the late 1980s and to contribute funds for
affordable housing programs. These requirements could reduce the amount of
dividends that the Federal Home Loan Banks pay to their members and could also
result in the Federal Home Loan Banks imposing a higher rate of interest on
advances to their members. If dividends were reduced, or interest on future
Federal Home Loan Bank advances increased, the Bank's net interest income would
likely also be reduced. Recent legislation has changed the structure of the
Federal Home Loan Banks funding obligations for insolvent thrifts, revised the
capital structure of the Federal Home Loan Banks and implemented entirely
voluntary membership for Federal Home Loan Banks. Management cannot predict the
effect that these changes may have with respect to its Federal Home Loan Bank
membership.
Federal Reserve System
The Federal Reserve Board regulations require OTS regulated institutions
to maintain non-interest earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The regulations generally provide
that reserves be maintained against aggregate transaction accounts as follows: a
3% reserve ratio is assessed on net transaction accounts up to and including
$47.6 million; a 10% reserve ratio is applied above $47.6 million. The first
$7.0 million of otherwise reservable balances (subject to adjustments by the
Federal Reserve Board) are exempted from the reserve requirements. The amounts
are adjusted annually. The Bank complies with the foregoing requirements.
Privacy Requirements of the GLBA
The Gramm-Leach-Bliley Act of 1999 provides for sweeping financial
35
modernization for commercial banks, savings banks, securities firms, insurance
companies, and other financial institutions operating in the United States.
Among other provisions, the Gramm-Leach-Bliley Act places limitations on the
sharing of consumer financial information with unaffiliated third parties.
Specifically, the Gramm-Leach-Bliley Act requires all financial institutions
offering financial products or services to retail customers to provide such
customers with the financial institution's privacy policy and provide such
customers the opportunity to "opt out" of the sharing of personal financial
information with unaffiliated third parties.
Anti-Money Laundering
The Uniting and Strengthening America by Providing Appropriate Tools
Required to Intercept and Obstruct Terrorism Act of 2001 (referred to as the
"USA PATRIOT Act") significantly expands the responsibilities of financial
institutions, including savings and loan associations, in preventing the use of
the U.S. financial system to fund terrorist activities. Title III of the USA
PATRIOT Act provides for a significant overhaul of the U.S. anti-money
laundering regime. Among other provisions, it requires financial institutions
operating in the United States to develop new anti-money laundering compliance
programs, due diligence policies and controls to ensure the detection and
reporting of money laundering. Such required compliance programs are intended to
supplement existing compliance requirements, also applicable to financial
institutions, under the Bank Secrecy Act and the Office of Foreign Assets
Control Regulations. Management has established policies and procedures to
ensure compliance with the USA PATRIOT Act's provisions, and the impact of the
USA PATRIOT Act on our operations has not been material.
Other Regulations
Interest and other charges collected or contracted for by Coastal Federal
are subject to state usury laws and federal laws concerning interest rates.
Coastal Federal's loan operations are also subject to federal laws applicable to
credit transactions, such as the:
a. Truth-In-Lending Act, governing disclosures of credit terms to
consumer borrowers;
b. Home Mortgage Disclosure Act of 1975, requiring financial
institutions to provide information to enable the public and public
officials to determine whether a financial institution is fulfilling
its obligation to help meet the housing needs of the community it
serves;
c. Equal Credit Opportunity Act, prohibiting discrimination on the
basis of race, creed or other prohibited factors in extending
credit;
d. Fair Credit Reporting Act of 1978, governing the use and
36
provision of information to credit reporting agencies;
e. Fair Debt Collection Act, governing the manner in which consumer
debts may be collected by collection agencies; and
f. rules and regulations of the various federal agencies charged with
the responsibility of implementing such federal laws.
The deposit operations of Coastal Federal also are subject to the:
g. Right to Financial Privacy Act, which imposes a duty to maintain
confidentiality of consumer financial records and prescribes
procedures for complying with administrative subpoenas of financial
records;
h. Electronic Funds Transfer Act and Regulation E promulgated
thereunder, which governs automatic deposits to and withdrawals from
deposit accounts and customers' rights and liabilities arising from
the use of automated teller machines and other electronic banking
services; and
i. Check Clearing for the 21st Century Act (also known as "Check 21"),
which, effective October 28, 2004, gives "substitute checks," such
as digital check images and copies made from that image, the same
legal standing as the original paper check.
TAXATION
Federal Taxation
General. The Company and the Bank report their income via a consolidated
return on a fiscal year basis using the accrual method of accounting and are
subject to federal income taxation in the same manner as other corporations with
some exceptions, including particularly the Bank's reserve for bad debts
discussed below. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to the Bank or the Company.
Tax Bad Debt Reserves. For discussion related to the Bank's Tax Bad Debt
Reserves, please refer to Note 12 of the Notes to Consolidated Financial
Statements.
Distributions. To the extent that the Bank makes "nondividend
distributions" to the Company that are considered as made: (i) from the reserve
for losses on qualifying real property loans, to the extent the reserve for such
losses exceeds the amount that would have been allowed under the experience
method; or (ii) from the supplemental reserve for losses on loans ("Excess
Distributions"), then an amount based on the amount distributed will be included
in the Bank's taxable
37
income. Nondividend distributions include distributions in excess of the Bank's
current and accumulated earnings and profits, distributions in redemption of
stock, and distributions in partial or complete liquidation. However, dividends
paid out of the Bank's current or accumulated earnings and profits, as
calculated for federal income tax purposes, will not be considered to result in
a distribution from the Bank's bad debt reserve. Thus, any dividends to the
Company that would reduce amounts appropriated to the Bank's bad debt reserve
and deducted for federal income tax purposes would create a tax liability for
the Bank. The amount of additional taxable income attributable to an Excess
Distribution is an amount that, when reduced by the tax attributable to the
income, is equal to the amount of the distribution. Thus, if, the Bank makes a
"nondividend distribution," then approximately one and one-half times the amount
so used would be includable in gross income for federal income tax purposes,
assuming a 35% corporate income tax rate (exclusive of state and local taxes).
See "Regulation" for limits on the payment of dividends by the Bank. The Bank
does not intend to pay dividends that would result in a recapture of any portion
of its tax bad debt reserve.
Corporate Alternative Minimum Tax. The Code imposes a tax on alternative
minimum taxable income ("AMTI") at a rate of 20%. Generally, only 90% of AMTI
can be offset by net operating loss carryovers. AMTI is increased by an amount
equal to 75% of the amount by which the Bank's adjusted current earnings exceeds
its AMTI (prior to reduction for net operating losses).
Dividends-Received Deduction and Other Matters. The Company may exclude
from its income 100% of dividends received from the Bank as a member of the same
affiliated group of corporations. The corporate dividends-received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank owns more than 20% of the stock of a
corporation distributing a dividend, then 80% of any dividends received may be
deducted.
State Income Taxation. South Carolina has adopted the Code as it relates
to OTS regulated institutions, effective for taxable years beginning after
December 31, 1985. Coastal Federal is subject to South Carolina income tax at
the rate of 6% and North Carolina income tax at a rate of 6.9%. This rate of tax
is imposed on OTS regulated institutions in lieu of the general state business
corporation income tax.
For information regarding income taxes payable by Coastal Federal, see
Note 12 of the Notes to Consolidated Financial Statements.
Audits. There have not been any audits of the Company's federal or state
income tax returns during the past five years.
38
Risk Factors.
Our primary market areas depend substantially on tourism, and a downturn
in tourism could hurt our business and our prospects.
Our business is concentrated in and around Myrtle Beach, South Carolina, a
popular beach and golf resort area. The economy of Myrtle Beach significantly
depends on services and industries related to tourism. Any event that negatively
and materially impacts tourism will likely adversely impact the Myrtle Beach
economy.
Tourism revenue is vulnerable to fluctuations in the national economy. A
prolonged downturn in the national economy could have a significant adverse
effect on the economy of the Myrtle Beach area. Virtually any development or
event that could dissuade travel or spending related to tourism, whether inside
or outside of Myrtle Beach, could adversely affect the Myrtle Beach economy.
Consequently, the Myrtle Beach economy is more susceptible than the economies of
other cities to issues such as higher gasoline and other fuel prices,
unemployment levels, recession, rising interest rates, and other economic
conditions, whether domestic or foreign. Coastal North and South Carolina are
also more susceptible to severe weather, such as hurricanes and flooding.
A deterioration in economic conditions generally, and a slowdown in
tourism in particular, could result in the following consequences, any of which
could adversely affect our business, financial condition, results of operations
and prospects and expose us to a greater risk of loss:
- Loan delinquencies may increase;
- Problem assets and foreclosures may increase;
- Demand for our products and services may decline; and
- Collateral for loans made by us may decline in value, reducing the
borrowing power of our customers, and reducing the value of assets
and collateral associated with our loans.
Rising interest rates may reduce the Company's net income and future cash
flows.
Interest rates were recently at historically low levels. However, since
June 30, 2004, the U.S. Federal Reserve has increased its target for the federal
funds rate 11 times to 4.00%. If interest rates continue to rise, and if rates
on the Company's deposits and borrowings reprice upwards faster than the rates
on the Company's loans and investments, the Company would experience compression
of its interest rate spread and net interest margin, which would have a negative
effect on the Company's profitability.
39
The Company's allowance for loan losses may be inadequate, which could
hurt the Company's earnings.
The Company's allowance for loan losses may not be adequate to cover
actual loan losses. If the Company is required to increase its loan allowances,
future earnings may be reduced. When borrowers default and do not repay the
loans that the Bank makes to them, the Company may lose money. The Company's
experience shows that some borrowers either will not pay on time or will not pay
at all, which will require the Company to charge off the defaulted loan or
loans. The Company provides for losses by reserving what it believes to be an
adequate amount to absorb any probable inherent losses. A charge off reduces the
Company's allowance for loan losses. If the Company's allowance for loan losses
were to become insufficient, it would be required to increase its allowances by
recording a larger provision for loan losses, which would reduce earnings for
that future period.
Because the Company competes primarily on the basis of the interest rates
it offers depositors and the terms of its loans it offers borrowers, the
Company's margins could decrease if it were required to increase deposit rates
or lower interest rates on loans in response to competitive pressures.
The Company faces intense competition both in making loans and attracting
deposits. The Company competes primarily on the basis of its depository rates,
the terms of the loans it originates and the quality of the Company's financial
and depository services. This competition has made it more difficult for the
Company to make new loans and, at times, has forced the Company to offer higher
deposit rates in its market area. The Company expects competition to increase in
the future as a result of legislative, regulatory and technological changes and
the continuing trend of consolidation in the financial services industry.
Technological advances, for example, have lowered barriers to market entry,
enabled banks to expand their geographic reach by providing services over the
Internet and enabled non-depository institutions to offer products and services
that traditionally have been provided by banks. Recent changes in federal
banking law permit affiliation among banks, securities firms and insurance
companies, which also will change the competitive environment in which the
Company conducts business. Some of the institutions with which the Company
competes are significantly larger than the Company, and therefore, have
significantly greater resources.
Various factors could hinder or prevent takeover attempts.
Provisions of the Company's Certificate of Incorporation and Bylaws and
federal and state regulations make it difficult and expensive to pursue a
takeover attempt that management opposes. These provisions will also make the
removal of the current board of directors or management, or the appointment of
new directors, more difficult. For example, the Company's Certification of
Incorporation and Bylaws contain provisions that could impede a takeover or
prevent the Company from
40
being acquired, including a classified board of directors and limitations on the
ability of the Company's stockholders to remove a director from office without
cause. The Company's board of directors may issue additional shares of common
stock or establish classes or series of preferred stock with rights, preferences
and limitations as determined by the board of directors without stockholder
approval. These factors give the board of directors the ability to prevent, or
render more difficult or costly, the completion of a takeover transaction that
the Company's stockholders might view as being in their best interests.
Item 2. Properties
- -------------------
The principal offices of the Company are located in a 25,000 square foot
Main Office at 2619 Oak Street in Myrtle Beach, SC. This facility also houses
Coastal Mortgage Bankers and Realty Co, Inc, Coastal Investor Services, a
division of Coastal Federal Bank, and many corporate functions. Several of the
Bank's operations groups, including loan and deposit servicing, human resources,
marketing, and residential lending administration, are in separate buildings
owned and leased by the Bank in Myrtle Beach. The Bank also owns a facility in
Conway, SC, which houses its Item Processing and Technology functions.
At September 30, 2005 the Bank operated 13 branches in South Carolina and
6 branches in North Carolina. Of these, 4 are leased and 15 are owned.
The net book value of the Company's investment in office, properties and
equipment totaled $22.8 million at September 30, 2005. See Note 6 of the Notes
to Consolidated Financial Statements. Coastal Federal uses the services of an
independent data processing service to process customer records and monetary
transactions, post deposit and general ledger entries and record activity in
installment lending, loan servicing and loan originations.
Item 3. Legal Proceedings
- --------------------------
The Company is not a defendant in any lawsuits. The subsidiaries are
defendants in lawsuits arising out of the normal course of business. Based upon
current information received from counsel representing the subsidiaries in these
matters, the Company believes none of the lawsuits would have a material impact
on the Company's financial status.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
Not Applicable.
41
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters
- --------------------------------------------------------------------------------
and Issuer Purchases of Equity Securities
-----------------------------------------
The information contained under the section captioned "Market for the
Corporation's Common Stock and Related Stockholder Matters" in the Corporation's
Annual Report to Stockholders for the Fiscal Year Ended September 30, 2005
("Annual Report") is incorporated herein by reference.
Item 6. Selected Financial Data
- --------------------------------
The information contained in the section captioned "Financial Highlights"
in the Annual Report is incorporated herein by reference.
Item 7. Management's Discussion and Analysis of Financial
- ----------------------------------------------------------
Condition and Results of Operations
-----------------------------------
The information contained in the section captioned "Management's
Discussion and Analysis" in the Annual Report is incorporated herein by
reference.
Item 7A. Quantitative and Qualitative Disclosures about
- --------------------------------------------------------
Market Risk
-----------
The information contained in the section captioned "Interest Rate Risk
Disclosure" in the Annual Report is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
The consolidated financial statements contained in the Annual Report which
are listed under Item 14 herein are incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on
- ---------------------------------------------------------
Accounting and Financial Disclosure
-----------------------------------
The registrant has not, within the 24 months before the date of the most
recent financial statements, changed its accountants, nor have there been any
disagreements on accounting and financial disclosure.
Item 9A. 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) promulgated under the
42
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 change in the Company's internal control over financial reporting
occurred during the year ended September 30, 2005 that has materially affected,
or is reasonably likely to materially affect, the Company's internal control
over financial reporting.
Management's annual report on internal control over financial reporting and the
attestation report of the registered public accounting firm are incorporated
herein by reference to the section captioned "Management's Report on Internal
Control over Financial Reporting" and "Report of Independent Registered Public
Accounting Firm" in the annual report.
Item 9B. Other Information
- ---------------------------
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
The information called for by Item 10 with respect to directors and
Section 16 matters is set forth in the Registrant's Proxy Statement for its 2006
Annual Meeting of Stockholders under the caption "Elections of Directors" and
"Section 16(a) Beneficial Ownership Reporting Compliance", respectively, and is
hereby incorporated by reference. The information called for by Item 10 with
respect to the identification of the members of the Registrant's Audit Committee
and the presence of an audit committee financial expert is set forth in the
Registrant's Proxy Statement for the 2006 Annual Meeting of Stockholders under
the captions "Committees of the Board of Directors" and is hereby incorporated
by reference.
Certain executive officers of the Bank also serve as executive officers of
the Corporation. The day-to-day management duties of the executive officers of
the Company and the Bank relate primarily to their duties as to the Bank. The
executive officers of the Company and the Bank are elected annually by the
respective Boards of
43
Directors and hold office until their successors have been elected and qualified
or until they are removed from office.
44
Executive Officers of the Registrant
- ------------------------------------
Name, Age and Position Business Experience
- ---------------------- -------------------
Michael C. Gerald, 56 Mr. Gerald has been associated with
President, Chief Executive Coastal Federal since 1974 and serves
Officer and a Director as Director, President and Chief
Executive Officer of the Corporation
and Bank. Mr. Gerald also serves as
Director and President of Coastal
Mortgage Bankers & Realty Company,
Inc., as Director and President of
Coastal Real Estate Investment
Corporation, and as a Director of
Coastal Retirement, Estate and Tax
Planners, Inc. He currently serves on
the Board of Visitors of Coastal
Carolina University's Wall School of
Business, as Chairman of the Board of
Directors of the Waccamaw Community
Foundation, on the Board of Directors
of the Coastal Education Foundation,
and on the Board of Trustees of the
USC Business Partnership Foundation.
Jimmy R. Graham, 57, Mr. Graham serves as Executive Vice
Executive Vice President and President and Chief Information
Chief Information Officer Officer of Coastal Federal. Mr. Graham
serves as Executive Vice President of
Coastal Financial Corporation. He has
been associated with the bank since
1977.
Jerry L. Rexroad, CPA, 45, Mr. Rexroad joined the Company in
Executive Vice President and April 1995 and is Executive Vice
Chief Financial Officer President and Chief Financial Officer
of Coastal Federal and Coastal
Financial Corporation. Mr. Rexroad
also serves as the Chief Financial
Officer and a Director for Coastal
Mortgage Bankers & Realty Company,
Inc., Coastal Investor Services, Inc.,
Coastal Planners Holding Corporation,
Coastal Retirement Estate and Tax
Planners, Coastal Federal Mortgage,
Coastal Real Estate Investment
Corporation and President of Coastal
Federal Holdings Corporation. He is a
Past Chairman of the Board of
Directors for Junior Achievement of
Horry County as well as Past Chairman
of the Board of Directors for Junior
Achievement of Greenville. Mr. Rexroad
is a Director of PowerHouse
Ministries, Inc. and Chairman of the
Board of Deacons at Grand Strand
Baptist Church. He is a certified
public accountant, and is a member of
the AICPA and SCACPA. Prior to joining
the Company, Mr. Rexroad was a partner
with KPMG LLP where he was partner in
charge of the Financial Institutions
practice in South Carolina.
45
Phillip G. Stalvey, 49, Mr. Stalvey is Executive Vice
Executive Vice President President and Banking Group Leader for
and Banking Group Leader the Bank. He also serves as an
Executive Vice President of the
Corporation and is a director of
Coastal Federal Mortgage and Coastal
Investor Services, Inc. He has been
associated with Coastal Federal for
the past 23 years. In addition, Mr.
Stalvey is a member of the Florence
Stake Presidency with his Church and a
member of the Myrtle Beach Air Force
Base Redevelopment Authority.
Steven J. Sherry, 54 Mr. Sherry joined the Company in May
Executive Vice President and 1998 and is Executive Vice President
Director of Marketing and Director of Marketing for the
Bank. He also serves as Executive Vice
President and Chief Marketing Officer
for Coastal Financial Corporation. Mr.
Sherry is a member of the Bank
Marketing Association. He is active
with Horry County United Way and
serves on the Executive Board of the
Franklin G. Burroughs-Simeon B. Chapin
Art Museum. Mr. Sherry holds numerous
achievement awards for marketing and
advertising.
Susan J. Cooke, 55 Ms. Cooke is Senior Vice President and
Senior Vice President and Corporate Secretary for Coastal
Corporate Secretary Federal and for Coastal Financial
Corporation, Corporate Secretary for
Coastal Mortgage Bankers & Realty
Company, Inc., and Coastal Investor
Services, Inc. Ms. Cooke has been
employed with Coastal Federal for
eighteen years. She is a member of the
American Society of Corporate
Secretaries, Inc., the National
Association for Female Executives, and
is a Board Member and Chairman of the
Community Kitchen of Myrtle Beach,
Inc.
46
Robert D. Douglas, 46 Mr. Douglas joined the corporation in
Executive Vice President June 1994 and serves as Executive Vice
Human Resources/Coastal President of the Bank and Coastal
Federal University Group Financial Corporation. He previously
served as Chairman of the Human
Resources Committee of the South
Carolina Community Bankers
Association. He has served on various
advisory committees for the Horry
County Drug and Alcohol Commission,
the South Carolina Employment Security
Commission, Coastal Carolina
University and Horry Georgetown
Technical College, and the Grand
Strand Area Chamber of Commerce. He is
a member of the Coastal Organization
for Human Resources Management and
serves as a member of Coastal Carolina
University Career Services Advisory
Board. He also serves on the Board of
Directors for the Coastal Samaritan
Counseling Center and is Chairman of
the Finance Committee.
The Company has adopted a Code of Ethics, a copy of which is incorporated
by reference to the September 30, 2003 Form 10-K filed on December 22, 2003. The
Company intends to disclose any changes or waivers from the Code of Ethics in a
report on Form 8-K.
Item 11. Executive Compensation
- --------------------------------
The information contained under the section captioned "Proposal I --
Election of Directors -- Executive Compensation" in the Proxy Statement is
incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and
- -------------------------------------------------------------
Management and Related Stockholder Matters
------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by
reference to the section captioned "Stock Ownership" of the Proxy
Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by
reference to the section captioned "Stock Ownership" of the Proxy
Statement.
(c) Management of the Corporation knows of no arrangements, including
any pledge by any person of securities of the Corporation, the
operation of which may at a subsequent date result in a change in
control of the registrant.
47
(d) Equity Compensation Plan Information as of September 30, 2005
- -------------------------------------------------------------------------------------------------------------
Number of securities
remaining available for
Number of securities future issuance under
to be issued upon Weighted-average equity compensation plans
exercise of price of outstanding (excluding
outstanding options, options, warrants securities reflected
Plan Category warrants and rights and rights in column (a))
(a) (b) (c) (d)
- -------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders 2,811,609 $8.52 97,292
- -------------------------------------------------------------------------------------------------------------
Equity compensation plans
not approved by security N/A N/A N/A
holders
- -------------------------------------------------------------------------------------------------------------
Total 2,811,609 $8.52 97,292
- -------------------------------------------------------------------------------------------------------------
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Transactions with Management" in the Proxy Statement.
Item 14. Principal Accountant Fees and Services
- -----------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Auditing and Related Fees" in the Proxy Statement.
PART IV
Item 15. Exhibits and Financial Statement Schedules
- ----------------------------------------------------
1. Report of Independent Registered Public Accounting Firm (1)
2. All Financial Statements (1)
(a) Consolidated Statements of Financial Condition as of September
30, 2004 and 2005.
(b) Consolidated Statements of Operations for the Years Ended
September 30, 2003, 2004 and 2005.
(c) Consolidated Statements of Stockholders' Equity and
Comprehensive Income for the Years Ended September 30, 2003,
2004 and 2005.
48
(d) Consolidated Statements of Cash Flows for the Years Ended
September 30, 2003, 2004 and 2005.
(e) Notes to Consolidated Financial Statements.
3. All Schedules have been omitted, as the required information is
either inapplicable or included in the Notes to consolidated
Financial Statements.
4. Exhibits
3 (a) Certificate of Incorporation of Coastal Financial
Corporation (1)
3 (b) Certificate of Amendment to Certificate of Incorporation
of Coastal Financial Corporation (5)
3 (c) Bylaws of Coastal Financial Corporation (1)
10 (a) Employment Agreement with Michael C. Gerald (7)
(b) Employment Agreement with Jerry L. Rexroad (7)
(c) Employment Agreement with Phillip G. Stalvey (7)
(d) Employment Agreement with Steven J. Sherry (7)
(e) Employment Agreement with Jimmy R. Graham (7)
(f) 1990 Stock Option Plan (2)
(g) Directors Performance Plan (3)
(h) 2000 Stock Option Plan (4)
13 Annual Report to Stockholders for the Fiscal Year Ended
September 30, 2005
14 Code of Ethics (6)
21 Subsidiaries of the Registrant
23 Consent of Independent Registered Public Accounting Firm
31 (a) Rule 13a-14(a)/15d-14(a) Certification of Chief
Executive Officer
49
31 (b) Rule 13a-14(a)/15d-14(a) Certification of Chief
Financial Officer
32 (a) Section 1350 Certification of Chief Executive Officer
32 (b) Section 1350 Certification of 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 proxy statement for the 1996 Annual
Meeting of Stockholders.
(4) Incorporated by reference to the proxy statement for the 2000 Annual
Meeting of Stockholders.
(5) Incorporated by reference to the March 31, 1998 Form 10-Q filed with the
Securities and Exchange Commission on May 15, 1998.
(6) Incorporated by reference to the September 30, 2003 Form 10-K filed with
the Securities and Exchange Commission on December 22, 2003.
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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
Date: December 14, 2005 By: /s/Michael C. Gerald
--------------------
Michael C. Gerald
President/Chief Executive
Officer
(Duly Authorized Representative)
Pursuant to the requirement of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By: /s/Michael C. Gerald By: /s/Jerry L. Rexroad
-------------------- -------------------
Michael C. Gerald Jerry L. Rexroad
President/Chief Executive Executive Vice President
Officer And a Director And Chief Financial Officer
(Principal Executive (Principal Financial and
Officer) Accounting Officer)
Date: December 14, 2005 December 14, 2005
By: /s/James T. Clemmons By: /s/Frank A. Thompson, II
-------------------- ------------------------
James T. Clemmons Frank A. Thompson, II
Chairman of the Board Director
Date: December 14, 2005 Date: December 14, 2005
By: /s/James C. Benton By: /s/James P. Creel
------------------ -----------------
James C. Benton James P. Creel
Director Director
Date: December 14, 2005 Date: December 14, 2005
By: /s/G. David Bishop By: /s/James H. Dusenbury
------------------ ---------------------
G. David Bishop James H. Dusenbury
Director Director
Date: December 14, 2005 Date: December 14, 2005
By: /s/E. Lawton Benton By: /s/J. Robert Calliham
------------------- ---------------------
E. Lawton Benton J. Robert Calliham
Director Director
Date: December 14, 2005 Date: December 14, 2005
51