EXHIBIT 13
ANNUAL REPORT TO STOCKHOLDERS FOR THE
FISCAL YEAR ENDED SEPTEMBER 30, 2005
COASTAL FINANCIAL CORPORATION
2005
ANNUAL REPORT
Quest for Excellence
Dedication 2005 - A Breakthrough Year In
The Guiding Vision of Coastal Transforming Our Very Good Organization
Financial Corporation Into An Exceptional Organization
- --------------------------------------------------------------------------------
In many ways, 2005 really was a breakthrough year in our quest to Transform Our
Very Good Organization Into An Exceptional Organization. Thanks to our
incredible Associates and their commitment, alignment and passion for delivering
The Experience of FANtastic! Customer Service, we experienced unprecedented
acceleration in the momentum which has been rapidly, but quietly, building over
the years since the adoption of our QUEST FOR EXCELLENCE Business Model and
Vision 2005 Strategic Plan.
Looking back at our Transformation from 1999, the inception of our Vision 2005
Strategic Plan, one of the most interesting questions relates to how Coastal
Financial Corporation came back from near extinction in the late 1980s to become
a Good Organization by the mid 1990s and a Very Good Organization, which U.S.
Banker Magazine, in its August 2005 edition, ranked #1 in the Carolinas and 29th
nationally among its peers.
The answer lies in the Vision and Values which are the essence of our QUEST FOR
EXCELLENCE Business Model that was formally adopted in 1993. At that transition
point in the history of our Company, we began the process of transforming our
Good Organization Into A Very Good Organization by "inculturating" every element
of Coastal Financial Corporation with our Vision and Values through both
Leadership example and curriculum offerings at Coastal Federal University. This
low key and deliberate approach has lead us to slowly, but continuously, build
focus on our QUEST FOR EXCELLENCE Business Model and positive momentum toward
evolving our organization in alignment with our Mission of Exceeding the
Expectations of our Customer.
While the momentum which has continued to build through the great strides we
have made in learning and practicing each of the tenets of our Business Model
over the years has been truly impressive, I think all of us at Coastal Financial
Corporation would agree that the progress we made in 2005 towardTransforming Our
Very Good Organization Into An Exceptional Organization constitutes a
breakthrough and establishes a new transition point in the life of our
exceptional organization.
Over the fifteen years since becoming a publicly owned company, we have always
viewed change and continuous improvement as essential to the accomplishment of
Our Basic Corporate Objective Of Maximizing The Value Of Our Stockholders'
Investment and Our Long-Term Goal Of Being The Best Financial Services Company
In Our Marketplace.
And, thanks to our incredible Associates and their commitment, alignment and
passion for delivering The Experience of FANtastic! Customer Service, 2005 was
certainly no exception. Our ever-increasing understanding of and commitment to
our QUEST FOR EXCELLENCE Business Model has allowed us to write the closing
chapter of our Vision 2005 Plan in a powerful and memorable way. A way which has
enabled another year of exceptional progress toward The Transformation Of Our
Very Good Organization Into An Exceptional Organization and produced outstanding
results for our Stockholders. Going forward, we remain absolutely convinced that
this approach will help to ensure that our best days are yet to come.
Share Price Performance
[THE FOLLOWING TABLE WAS REPRESENTED AS A BAR CHART IN THE PRINTED MATERIAL.]
$10.00 $10.00 $27.20 $68.31 $85.56 $85.92 $134.94 $217.16 $215.52 $177.72 $113.80 $217.36 $299.07 $374.19 $467.90 $535.19
- ------------------------------------------------------------------------------------------------------------------------------------
Initial Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept.
Public 30, 30, 30, 30, 30, 30, 30, 30, 30, 30, 30, 30, 30, 30, 30,
Offering 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
October 4,
1990
The share price performance of Coastal Financial Corporation's common
stock increased 14.4% since September 30, 2004 and has grown at a
compounded annual rate of over 30% since 1990. The share price performance
reflects all stock splits, stock dividends and reinvestment of cash
dividends. These historical results may not be indicative of future stock
price performance.
2
Financial Highlights
The following table sets forth certain information concerning the financial
position of the Company (including data from operations of its subsidiaries) as
of the dates and for the periods indicated. The consolidated data is derived
from, and should be read in conjunction with, the Consolidated Financial
Statements of the Company and its subsidiaries presented herein.
At or for Years Ended September 30,
-------------------------------------------------------------------
2001 2002 2003 2004 2005
--------- --------- ----------- ----------- -----------
(Dollars in thousands, except per share data)
Financial Condition Data:
Total assets ................................................ $ 763,214 $ 950,796 $ 1,181,209 $ 1,305,094 $ 1,543,459
Loans receivable, net ....................................... 488,754 536,851 682,737 790,730 924,260
Mortgage-backed securities .................................. 190,553 331,808 383,324 374,283 399,655
Cash, interest-bearing deposits and investment securities ... 36,320 27,816 37,484 62,304 127,141
Deposits .................................................... 530,364 637,081 697,012 753,379 1,070,918
Borrowings .................................................. 160,808 228,622 392,797 451,144 346,408
Stockholders' equity ........................................ 57,248 66,386 73,707 85,348 97,221
Operating Data:
Interest income ............................................. $ 60,255 $ 53,873 $ 59,214 $ 65,805 $ 78,558
Interest expense ............................................ 33,323 21,846 22,998 23,524 29,730
--------- --------- ----------- ----------- -----------
Net interest income ......................................... 26,932 32,027 36,216 42,281 48,828
Provision for loan losses ................................... 955 1,235 2,655 1,750 1,697
--------- --------- ----------- ----------- -----------
Net interest income after provision for loan losses ......... 25,977 30,792 33,561 40,531 47,131
--------- --------- ----------- ----------- -----------
Other Income:
Fees and service charges on loan and deposit accounts ....... 2,634 3,148 3,489 3,771 6,137
Gain on sales of loans held for sale ........................ 1,295 1,462 2,985 1,523 1,201
Gain (loss) on sales of investment securities, net .......... (56) 102 -- (100) 226
Gain (loss) on sales of mortgage-backed securities, net ..... 727 238 469 (997) (551)
Gain (loss) from real estate operations ..................... (453) (137) (18) 3 (76)
Other income ................................................ 3,755 3,326 3,983 4,971 5,587
--------- --------- ----------- ----------- -----------
Total other income .......................................... 7,902 8,139 10,908 9,171 12,524
Total general and administrative expense .................... 19,292 22,824 27,156 27,269 33,519
--------- --------- ----------- ----------- -----------
Income before income taxes .................................. 14,587 16,107 17,313 22,433 26,136
Income taxes ................................................ 5,287 5,901 6,141 7,627 8,982
--------- --------- ----------- ----------- -----------
Net income .................................................. $ 9,300 $ 10,206 $ 11,172 $ 14,806 $ 17,154
========= ========= =========== =========== ===========
Net income per common diluted share ......................... $ .48 $ .53 $ .57 $ .74 $ .84
========= ========= =========== =========== ===========
Cash dividends per common share ............................. $ .11 $ .12 $ .14 $ .15 $ .17
========= ========= =========== =========== ===========
Weighted average shares outstanding diluted ................. 19,478 19,381 19,679 20,116 20,423
========= ========= =========== =========== ===========
All share and per share data have been restated as applicable to reflect a 3 for
2 stock dividend declared on July 31, 2001, and 10% stock dividends declared on
May 27, 2003, August 28, 2003, February 18, 2004, July 30, 2004, December 15,
2004 and October 26, 2005.
Key Operating Ratios:
The table below sets forth certain performance ratios of the Company at the
dates or for the periods indicated.
At or for Years Ended September 30,
----------------------------------------------
2001 2002 2003 2004 2005
------ ------ ------ ------ ------
Other Data:
Return on assets (net income divided by average assets) .................... 1.20% 1.23% 1.04% 1.18% 1.20%
Return on average equity (net income divided by average equity) ............ 17.75% 16.92% 15.84% 18.77% 18.75%
Average equity to average assets ........................................... 6.59% 7.29% 6.59% 6.31% 6.38%
Book value per share ....................................................... $ 3.02 $ 3.54 $ 3.90 $ 4.44 $ 5.00
Dividend payout ratio ...................................................... 21.58% 21.77% 23.20% 19.91% 19.54%
Interest rate spread (difference between average yield
on interest-earning assets and average cost of interest-bearing
liabilities) ............................................................... 3.64% 4.14% 3.65% 3.64% 3.70%
Net interest margin (net interest income as a
percentage of average interest-earning assets).............................. 3.77% 4.24% 3.67% 3.64% 3.69%
Allowance for loan losses to total net loans at end of period .............. 1.42% 1.42% 1.40% 1.39% 1.25%
Ratio of non-performing assets to total assets (1) ......................... 0.74% 0.48% 0.77% 0.51% 0.22%
Tangible capital ratio ..................................................... 7.28% 6.57% 7.14% 7.44% 7.25%
Core capital ratio ......................................................... 7.28% 6.57% 7.14% 7.44% 7.25%
Risk-based capital ratio ................................................... 13.30% 12.74% 13.17% 13.55% 13.29%
(1) Non-performing assets consist of nonaccrual loans 90 days or more past due
and real estate acquired through foreclosure.
3
Dear Friends
Coastal Financial Corporation's performance was outstanding in 2005, the result
of five successive years of extraordinary progress by our entire team in
executing our Vision 2005 Strategic Plan in perfect alignment with our QUEST FOR
EXCELLENCE Business Model.
Continuing to drive our momentum was the tremendous progress we made over the
past three years in the Transformational Element of our Strategic Plan. The 2005
result of our ever-increasing focus on this powerful component of our Vision
2005 Plan was the launch of Coastal Federal as The Carolinas' Most Convenient
Bank. This initiative, which was a natural progression in our evolution toward
perfecting the execution of our Business Model, has created a much more aligned,
simplified and consistent process for ensuring that we always Exceed the
Expectations of our Customer.
Thanks largely to the launch of this new initiative, in addition to achieving
record results in Customer Satisfaction measurements, Customer Deposits, Loans
Receivable, Total Assets, Net Income and Share Price during 2005, we also
witnessed a new level of energy, enthusiasm and excitement throughout our
organization.
In the 2004 Annual Report, we reviewed and discussed our progress in
Transforming Coastal Financial Corporation From A Very Good Organization Into An
Exceptional Organization. And, based upon our growth and development to that
date, coupled with the advantages of our exceptional Associates, our great
markets, our new Customer Service and Convenience strategies and our
ever-increasing ability to work together, as a team, toward building even
stronger relationships with our Customers and our Communities, our conclusion
was that we were well positioned to realize even greater success in the years to
come.
Our progress this year, in addition to taking our confidence in and commitment
to our QUEST FOR EXCELLENCE Business Model and Vision 2005 Plan to new levels,
also produced another year of exceptional financial results and noteworthy
accomplishments:
o Coastal Financial Corporation's net income for 2005 totaled $17.2
million, compared to $14.8 million in 2004. On a fully diluted
basis, these results equated to a 13.5% increase, from $0.74 per
share in 2004 to $0.84 per share in 2005. This growth was fueled by
continued strong Customer Deposit and loan growth and effective
expense control.
o Customer Deposits which are Total Deposits less Brokered Deposits,
increased by approximately $147.6 million, or 19.6% to $901.0
million. Over the past three years, our average rate of Customer
Deposit growth has been 12% per year.
o Loans grew by 18%, primarily reflecting our continued strong focus
on the Business Banking element of our operations.
o Coastal Investor Services, our Investment Services division, saw
continued progress. Assets under our Raymond James Financial
Advisors' management increased by 18% to $292.5 million. Based upon
total revenues from this area of our operations, Raymond James
Financial Services ranked Coastal Investor Services #5, out of 218
Financial Institution Division offices.
o Our branch distribution system continued to expand to serve more of
the Communities of coastal North and South Carolina. Since the
inception of our Vision 2005 Strategic Plan in October of 1999,
Coastal Federal has added 11 new branches to our rapidly growing
network - 58 percent of our existing branches. During 2005, we
completed construction of a new branch facility on 17th Street in
the heart of the growing Wilmington, North Carolina marketplace,
commenced construction of new branch facilities on Oak Island Drive
in Oak Island, North Carolina and at the intersection of Hwy 701 and
Country Club Drive in Conway, South Carolina, and finalized plans
for construction starts at the intersection of Hwy 544 and Singleton
Ridge Road in Conway, South Carolina, at Sayebrook West on Hwy 544
in Surfside Beach, South Carolina and at the intersection of Hwys 90
and 57 in Longs, South Carolina.
o During 2005, our Finance Group, in an effort to create better
clarity on key result areas, radically revised our branch financial
management and reporting system. This new system has been a
significant enabler in our efforts to add profitable growth to our
balance sheet.
o Coastal Federal University experienced another solid year of growth
and progress in its Mission of providing a learning environment
centered around Coastal Financial Corporation's QUEST FOR EXCELLENCE
Business Model. Our philosophy of being a "Learning Organization,"
has resulted in the development of a continually enhanced array
4
Dear Friends
and number of curriculum offerings designed to enable each of our
Associates to achieve their full personal and professional
potential. This approach, which is crucial to our philosophy of
promoting our own Associates into the Leadership positions which are
created as a result of our growth, has enabled Coastal Financial
Corporation to significantly increase both individual and
organizational production capability and resulted in an empowered
culture with true competitive distinction.
In addition to the excellent operating results and transformational progress
achieved this past year, the market price of Coastal Financial's common stock,
at September 30, 2005, was 14.2% higher than the market price at September 30,
2004.
Equally as impressive is the fact that, since 1990, our net income has increased
at a compound annualized rate in excess of 17%.
Since becoming a publicly owned company in 1990, Coastal Financial Corporation's
stock has grown at a compounded annual rate of over 30%, taking our market
capitalization from $4.6 million in October 1990, to $265.7 million at the close
of this fiscal year. Put another way, an initial investment of $10,000 in
October of 1990, including the reinvestment of cash dividends, would have grown
to $535,000 at September 30, 2005.
One of the best indicators of performance is Return On Stockholders' Equity, and
this measure for 2005 was, again, outstanding. Our Return On Average
Stockholders' Equity of 18.8% ranks us among the top performing financial
services companies in America.
Our own sense of satisfaction with these financial results during 2005 was
augmented with continued public recognition of our progress toward the
attainment of Our Basic Corporate Objective Of Maximizing The Value Of Our
Stockholders' Investment and Our Long-Term Goal Of Being The Best Financial
Services Company In Our Marketplace. Consider these very good examples:
o Coastal Financial Corporation, for the 6th consecutive year, was
ranked the #1 Community Bank in the Carolinas by U. S. BANKER
MAGAZINE, in its August 2005 publication. In this edition, U. S.
BANKER MAGAZINE featured its Ranking of the Top 100 Publicly Traded
Mid - Tier Banks. This ranking spotlighted banks with assets between
$1 and $10 billion, based upon a 3-year average measure of Return On
Average Equity. Coastal Financial Corporation was ranked 1st in the
Carolinas and 29th nationally in this listing.
o The 2005 FDIC SUMMARY OF DEPOSITS REPORT, for the 5th consecutive
year, ranked Coastal Federal Bank the leader in deposit market share
for Horry County for the twelve months ended June 30, 2005. Coastal
Federal Bank has enjoyed this top ranking for seven of the past ten
years. This report also showed that Coastal Federal Bank is ranked
3rd in deposit market share for Brunswick County, North Carolina.
Examples like these continue to confirm that, through the efforts of the best
team imaginable, and their ever-increasing understanding of and commitment to
our QUEST FOR EXCELLENCE Business Model and our Vision 2005 Plan, we are
harnessing our potential and building momentum on a daily basis.
5
2005 Our Best Year Yet
The continuing evolution of our approach to the execution of our QUEST FOR
EXCELLENCE Business Model and the resulting growth and progress during 2005
continues to affirm what can be achieved through the aligned effort of an
organization which is anchored to the Vision and Values of a never-changing
Business Model. The consciously-held commitment our Associates have for
following our QUEST FOR EXCELLENCE Business Model in executing the strategies
established in our Vision 2005 Plan has enabled the financial performance during
fiscal 2005 which, again met our high expectations and which will serve to
further support our Transformation From A Very Good Organization To An
Exceptional Organization.
Noteworthy Financial Results for Fiscal 2005
DILUTED EARNINGS PER SHARE
o Net income for 2005 totaled $17.2 million, compared to $14.8 million
in 2004. On a fully diluted basis, these results equated to a 13.5%
increase, from $0.74 per share in 2004 to $0.84 per share in 2005.
[THE FOLLOWING TABLE WAS REPRESENTED AS A BAR CHART IN THE PRINTED MATERIAL.]
$0.48 $0.53 $0.57 $0.74 $0.84
- --------------------------------------------------------------------------------
2001 2002 2003 2004 2005
BOOK VALUE PER SHARE
o Book value per share grew 12.6% to $5.00.
o Stockholders' equity advanced 13.9% to $97.2 million.
[THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.]
$3.02 $3.54 $3.90 $4.44 $5.00
- --------------------------------------------------------------------------------
2001 2002 2003 2004 2005
6
2005 Our Best Year Yet
ASSETS
o Total assets increased 18.3%, from $1.3 billion to $1.5 billion.
o Customer Deposits increased 19.6%, from $753.4 million to $901.0
million.
o Net Loans increased 18.0%, from $799.0 million to $942.4 million.
[THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.]
(IN MILLIONS)
$763 $951 $1,181 $1,305 $1,543
- --------------------------------------------------------------------------------
2001 2002 2003 2004 2005
NON-PERFORMING ASSETS TO TOTAL ASSETS
o Non-performing Assets to Total Assets declined from 0.51% to 0.22%.
[THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.]
0.74% 0.48% 0.77% 0.51% 0.22%
- --------------------------------------------------------------------------------
2001 2002 2003 2004 2005
ALLOWANCE FOR LOAN LOSSES TO NET LOANS
o Allowance for Loan Losses to Net Loans was at 1.25%.
o The Company had Net Loan Charge-Offs as a percentage of Average
Loans of 0.12% in 2005
[THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.]
1.42% 1.42% 1.40% 1.39% 1.25%
- --------------------------------------------------------------------------------
2001 2002 2003 2004 2005
Our success in these key measures of performance is the result of the
commitment, dedication and aligned effort of a truly outstanding group of
Associates who share a passion for our QUEST FOR EXCELLENCE Business Model and
Vision 2005 Plan. This continuing trend of exceptional performance has been
rewarded in the financial markets by a 3,814% increase in the price of our
shares since becoming a public company in October of 1990, vs. 283% for the
Standard & Poors 500 Index over the same period.
7
2005 Our Best Year Yet
The momentum we have built since our conversion to public ownership has resulted
from the methodic focus of our individual and collective efforts on
accomplishing Our Basic Corporate Objective Of Maximizing The Value Of Our
Stockholders' Investment by working diligently toward the achievement of Our
Long-Term Goal Of Being The Best Financial Services Company In Our Marketplace.
Over the past fifteen years, our compounded Stockholder return of 30% has,
indeed, been impressive. In evaluating our progress toward the attainment of Our
Basic Corporate Objective since becoming publicly owned, it is both informative
and illustrative to compare the share price performance of Coastal Financial
Corporation to the share price performance of other publicly traded financial
services companies operating within our marketplace, and to the financial
markets as a whole.
In the following graphs, we have compared the share price performance of (CFCP)
Coastal Financial Corporation to the Nasdaq, S&P 500 and Dow Indices, and to
(TSFG) The South Financial Group, the parent company of Carolina First Bank,
(WB) Wachovia Corporation, the parent company of Wachovia Bank, (SNV) Synovus
Financial Corporation, the parent company of NBSC, (BBT) BB&T Corporation, the
parent company of BB&T, (BAC) Bank of America Corporation, the parent company of
Bank of America, (FFCH) First Financial Holdings, Inc., the parent company of
First Federal Savings and Loan Association of Charleston and (COOP) Cooperative
Bankshares, Inc., the parent company of Cooperative Bank.
As shown by these graphic representations, which take a look back over our
history as a publicly owned company, the price of Coastal Financial
Corporation's shares has significantly outperformed the price of the shares of
the other publicly traded financial services companies in our marketplace, as
well as the Nasdaq, S&P 500 and Dow Indices. These historical results may not be
indicative of future stock price performance.
15 Year Peer Group Price Performance
[THE FOLLOWING TABLE WAS REPRESENTED BY A LINE CHART IN THE PRINTED MATERIAL.]
Pricing Date CFCP($) COOP($) FFCH($) SNV($) BAC($) BBT($) TSFG($) WB($)
- ------------ ------- ------- ------- ------ ------ ------ ------- -----
Oct-90 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00
Oct-91 100.00 100.00 128.57 123.71 171.69 151.33 99.69 183.37
Oct-92 217.14 255.88 195.80 152.58 212.50 191.78 135.07 237.78
Oct-93 562.86 367.65 315.13 191.07 214.34 232.00 167.84 255.79
Oct-94 637.14 447.06 315.13 195.88 227.57 229.11 179.33 283.37
Oct-95 654.29 538.97 388.66 258.42 302.21 286.22 188.21 312.46
Oct-96 1,100.00 459.56 420.17 456.36 433.09 384.67 223.28 458.18
Oct-97 1,640.00 821.32 811.34 498.28 549.82 604.89 335.07 617.88
Oct-98 1,768.57 637.50 808.82 796.91 528.49 793.11 353.14 730.47
Oct-99 1,302.86 514.71 785.29 736.77 592.28 808.44 316.85 538.41
Oct-00 1,128.57 472.06 709.24 740.89 441.73 708.44 156.05 381.73
Oct-01 1,500.00 563.97 1,043.70 791.07 542.28 713.33 244.26 360.20
Oct-02 2,308.57 686.03 1,073.95 704.12 641.54 805.56 331.55 438.16
Oct-03 3,168.57 1,147.06 1,266.39 948.45 696.14 859.33 400.31 577.70
Oct-04 3,497.14 1,297.06 1,276.05 934.36 823.35 913.56 459.72 619.77
Oct-05 3,914.29 1,541.91 1,218.91 943.99 804.04 940.89 422.21 636.27
The financial results depicted above indicate that our business has continued to
grow and prosper over the years. And our 2005 operating and share price
performance clearly puts Coastal Financial among the top performing financial
services companies in the nation. But, as good as these results are, it's always
the future that we are most interested in, and it always leads to the question
we're often asked: "Can we keep it up?"
We continue to believe the answer is a resounding "Yes," as long as we remain
focused on our QUEST FOR EXCELLENCE Business Model.
CFCP Relative Price Performance
[THE FOLLOWING TABLE WAS REPRESENTED BY A LINE CHART IN THE PRINTED MATERIAL.]
Pricing Date CFCP($) DJIA S&P 500 NASDAQ
------------ ------- ---- ------- ------
Oct-90 100.00 2,442.33 304.00 329.84
Oct-91 100.00 3,068.87 392.45 542.98
Oct-92 217.14 3,226.28 418.68 605.17
Oct-93 562.86 3,680.59 467.83 779.26
Oct-94 637.14 3,908.12 472.35 777.49
Oct-95 654.29 4,755.48 581.50 1,036.06
Oct-96 1,100.00 6,029.38 705.27 1,221.51
Oct-97 1,640.00 7,442.08 914.62 1,593.61
Oct-98 1,768.57 8,592.10 1,098.67 1,771.39
Oct-99 1,302.86 10,729.86 1,362.93 2,966.43
Oct-00 1,128.57 10,971.14 1,429.39 3,369.63
Oct-01 1,500.00 9,075.14 1,059.78 1,690.20
Oct-02 2,308.57 8,397.03 885.76 1,329.75
Oct-03 3,168.57 9,801.12 1,050.71 1,932.21
Oct-04 3,497.14 10,027.47 1,130.20 1,974.99
Oct-05 3,914.29 10,440.07 1,207.01 2,120.30
8
A Look Back
Henry David Thoreau once wrote "Man's capabilities have never been measured; nor
are we to judge of what he can do by any precedents, so little has been tried."
Thoreau was describing the process of continuous improvement, which is essential
to the future success of both organizations and individuals.
Our Corporate Philosophy at Coastal Financial has long been about embracing
change as the essential ingredient of continuous improvement. We are constantly
doing things differently and re-engineering things that aren't broken today, so
they can't slow us down tomorrow. Likewise, we maintain a strong focus on
ensuring continuous improvement in strategic areas that can further set us apart
and distinguish us from other financial services companies in ways which can
offer sustainable competitive advantages.
[GRAPHIC OMITTED]
With this basic understanding of our organization, it is easy to see that the
discussion we began in 2003 about Transforming Our Very Good Organization Into
An Exceptional Organization was not merely a description of yet another
initiative. Rather, it was intended to explain how the momentum which had been
building over the years from our philosophy of viewing change and continuous
improvement as essential to the achievement of our long-term objectives was now
beginning to rapidly accelerate the evolution of our culture and the growth of
our business in alignment with our QUEST FOR EXCELLENCE Business Model.
This evolution began to gain significant traction in 1999 with the introduction
of our Vision 2005 Strategic Plan and our early conversations about the
Transformational Element of that plan. The Transformational Element, in very
simple terms, describes our goals related to Exceeding The Expectations of our
Customer. It means "We want to consistently provide every Customer, on every
visit, for every transaction, The Experience of FANtastic! Customer Service; We
want to fulfill all of our Customers' financial services needs; We want to help
them be financially successful; We want to be the preferred provider of
financial services in each of the Communities we serve, and We want to be known
as The Carolinas' Most Convenient Bank."
In looking back at our growth and progress since 1999, it is clear that 2005
really was a breakthrough year for us in terms of evolving our understanding of
our QUEST FOR EXCELLENCE Business Model, Our Vision 2005 Strategic Plan and,
particularly the Transformational Element of that strategic vision. That
increased understanding, and the results which have followed, have allowed us to
continue to plan our future growth with confidence and optimism.
9
Looking Ahead
While our progress toward The Transformation Of Coastal Financial From A Very
Good Organization Into An Exceptional Organization was exceptional in 2005, it
is very important that we not lose sight of the fact that our efforts can never
be viewed as a sprint to a well-defined finishing point, but rather, as merely
one more waypoint in a never-ending marathon.
Accordingly, we must continue to raise the bar in further distinguishing Coastal
Federal Bank from other banks by maintaining a laser-like focus on ensuring that
we become known as The Carolinas' Most Convenient Bank. We will do that by
honing our skills in our two primary focus areas. The first is providing every
Customer, on every visit, for every transaction, The Experience of FANtastic!
Customer Service by executing our Customer Service and Convenience strategies
with consistency, precision and alignment. And the second is to excel at
marketing and selling The Carolinas' Best Totally Free Checking With A Gift by
mastering and then improving upon our skills in executing our sales and
marketing processes. In looking ahead, it is clear that we must consistently
raise the bar in each of these areas by looking ever more closely at our
business through the lens of our Customer.
By remaining focused on our Mission of Exceeding the Expectations of our
Customer, our continuous moves to each of the next legs in our quest for
Transforming Coastal Financial Corporation From A Very Good Organization Into An
Exceptional Organization will be a natural occurrence.
The progress, success and building momentum we have enjoyed over the past
fifteen years as a public company has well positioned us for this ambitious
quest. And, while we are very fortunate to be located in one of the best markets
in America, and enjoy many competitive advantages, all of the success that
Coastal Financial has achieved over these years is due to our exceptional team
of Associates. And we have the best team imaginable.
My sincere appreciation goes to our Board of Directors, Leadership Group and
Associates for all they do for all of us and our Customers on a daily basis. Our
2005 results speak volumes about their commitment to Our Basic Corporate
Objective Of Maximizing The Value Of Our Stockholders' Investment by working
diligently toward the achievement of Our Long-TermGoal Of Being The Best
Financial Services Company In Our Marketplace.
Over the past five years, revenue, net income and share price have continuously
reached record levels. In fact, in the past two years alone, our net income has
surged over 54%, and in the last five years, our net income has increased by
more than 103%. Since becoming a publicly owned Company in 1990, we have roughly
doubled our earnings every 4.5 years.
While we are very pleased with our past achievements, thanks to the momentum
which continues to build as the result of our exceptional Associates and their
firm belief in our Vision and Values, we have great confidence that our quest
for Transforming Our Very Good Organization Into An Exceptional Organization
will continue to progress well and that, as a result, we will continue to be
better enabled to achieve superior returns for our Stockholders in the future.
All of us at Coastal Financial Corporation appreciate your continued
encouragement, loyalty and support, and look to the future with great enthusiasm
and excitement.
/s/ Michael C. Gerald
Michael C. Gerald
President and
Chief Executive Officer
10
Management's Report on Internal Control Over Financial Reporting
The management of Coastal Financial Corporation and subsidiaries (the "Company")
is responsible for establishing and maintaining adequate internal control over
financial reporting. The internal control process has been designed under our
supervision to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of the Company's financial statements
for external reporting purposes in accordance with accounting principles
generally accepted in the United States of America.
Management conducted an assessment of the effectiveness of the Company's
internal control over financial reporting as of September 30, 2005, utilizing
the framework established in Internal Control - Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission. Based on
this assessment, management has determined that the Company's internal control
over financial reporting as of September 30, 2005 is effective.
Our internal control over financial reporting includes policies and procedures
that pertain to the maintenance of records that accurately and fairly reflect,
in reasonable detail, transactions and dispositions of assets; and provide
reasonable assurance that (i) transactions are recorded as necessary to permit
preparation of financial statements in accordance with accounting principles
generally accepted in the United States; (ii) receipts and expenditures are
being made only in accordance with authorizations of management and the
directors of the Company; and (iii) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition
of the Company's assets that could have a material effect on the Company's
financial statements.
All internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Management's assessment of the effectiveness of the Company's internal control
over financial reporting as of September 30, 2005 has been audited by KPMG LLP,
an independent registered public accounting firm, as stated in their report.
11
Report of Independent Registered Public Accounting Firm
The Board of Directors
Coastal Financial Corporation:
Myrtle Beach, South Carolina
We have audited the consolidated statements of financial condition of Coastal
Financial Corporation and subsidiaries (the "Company") as of September 30, 2005
and 2004, and the related consolidated statements of operations, stockholders'
equity and comprehensive income, and cash flows for each of the years in the
three-year period ended September 30, 2005. We also have audited management's
assessment, included in the accompanying Management's Report on Internal Control
Over Financial Reporting, that the Company maintained effective internal control
over financial reporting as of September 30, 2005, based on criteria established
in Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). The Company's management is
responsible for these consolidated financial statements, for maintaining
effective internal control over financial reporting, and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on these consolidated financial
statements, an opinion on management's assessment, and an opinion on the
effectiveness of the Company's internal control over financial reporting based
on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of financial statements included examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. Our
audit of internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, evaluating
management's assessment, testing and evaluating the design and operating
effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audits provide a
reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
September 30, 2005 and 2004, and the results of its operations and its cash
flows for each of the years in the three-year period ended September 30, 2005,
in conformity with U.S. generally accepted accounting principles. Also, in our
opinion, management's assessment that the Company maintained effective internal
control over financial reporting as of September 30, 2005, is fairly stated, in
all material respects, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Furthermore, in our opinion,
the Company maintained, in all material respects, effective internal control
over financial reporting as of September 30, 2005, based on criteria established
in Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
/s/ KPMG LLP
Raleigh, NC
December 14, 2005
12
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Financial Condition
September 30, 2004 and 2005
2004 2005
----------- -----------
(Dollars in thousands)
ASSETS
Cash and amounts due from banks........................................ $ 29,746 52,592
Short-term interest-bearing deposits................................... 1,251 33,742
Federal funds sold..................................................... 18 5,191
Investment securities available for sale............................... 23,449 25,616
Mortgage-backed securities available for sale.......................... 374,283 399,655
Investment securities held to maturity (market value of $7,840
September 30, 2004 and $10,049 at September 30,2005)................ 7,840 10,000
Loans receivable (net of allowance for loan losses of $11,077
at September 30, 2004 and $11,748 at September 30, 2005)............ 790,730 924,260
Loans receivable held for sale......................................... 8,246 18,121
Real estate acquired through foreclosure, net.......................... 785 818
Office property and equipment, net..................................... 18,844 22,758
Federal Home Loan Bank (FHLB) stock, at cost........................... 16,900 15,775
Accrued interest receivable on loans................................... 2,877 3,807
Accrued interest receivable on securities.............................. 2,473 2,351
Bank-owned life insurance.............................................. 21,627 22,574
Other assets........................................................... 6,025 6,199
----------- -----------
$ 1,305,094 1,543,459
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits............................................................. 753,379 1,070,918
Securities sold under agreements to repurchase....................... 107,173 41,937
Advances from FHLB................................................... 328,507 289,007
Junior subordinated debt............................................. 15,464 15,464
Drafts outstanding................................................... 2,792 12,890
Advances by borrowers for property taxes and insurance............... 1,750 1,221
Accrued interest payable............................................. 1,502 3,415
Other liabilities.................................................... 9,179 11,386
----------- -----------
Total liabilities................................................ 1,219,746 1,446,238
----------- -----------
Stockholders' equity:
Serial preferred stock, 1,000,000 shares authorized and unissued..... -- --
Common stock $.01 par value, 25,000,000 shares authorized;
19,235,462 shares at September 30, 2004 and 19,457,492
shares at September 30, 2005 issued and outstanding................. 192 195
Additional paid-in capital........................................... 10,607 11,410
Retained earnings, restricted........................................ 73,533 86,723
Treasury stock, at cost (108,557 shares at September 30, 2004)....... (1,182) --
Accumulated other comprehensive income (loss), net of tax............ 2,198 (1,107)
----------- -----------
Total stockholders' equity....................................... 85,348 97,221
----------- -----------
$ 1,305,094 1,543,459
=========== ===========
See accompanying notes to consolidated financial statements.
13
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended September 30, 2003, 2004 and 2005
2003 2004 2005
------------ ----------- -----------
(In thousands, except share data)
Interest:
Loans receivable .................................................... $ 41,958 46,765 56,826
Investment securities ............................................... 1,840 2,886 4,971
Mortgage-backed securities .......................................... 15,279 16,067 16,392
Other ............................................................... 137 87 369
------------ ----------- -----------
Total interest income ................................................. 59,214 65,805 78,558
------------ ----------- -----------
Interest expense:
Deposits ............................................................ 11,999 10,024 14,079
Securities sold under agreements to repurchase ...................... 1,718 2,114 2,418
Advances from FHLB .................................................. 9,068 10,724 12,341
Other borrowings .................................................... 213 662 892
------------ ----------- -----------
Total interest expense ........................................... 22,998 23,524 29,730
------------ ----------- -----------
Net interest income .............................................. 36,216 42,281 48,828
Provision for loan losses ............................................. 2,655 1,750 1,697
------------ ----------- -----------
Net interest income after provision for loan losses .............. 33,561 40,531 47,131
------------ ----------- -----------
Other income:
Fees and service charges on loan and deposit accounts ............... 3,489 3,771 6,137
Gain on sales of loans held for sale ................................ 2,985 1,523 1,201
Gain (loss) on sales of investment securities, net .................. -- (100) 66
Gain (loss) on sales of mortgage-backed securities, net ............. 469 (997) (551)
Gain on call of investment securities held to maturity .............. -- -- 160
Gain (loss) from real estate acquired through foreclosure ........... (18) 3 (76)
Income from sales of non-depository products ........................ 1,176 1,909 1,840
Federal Home Loan Bank stock dividends .............................. 453 499 668
Income from ATM and debit card transactions ......................... 906 954 1,532
Bank-owned life insurance ........................................... 664 962 948
Other income ........................................................ 784 647 599
------------ ----------- -----------
Total other income ............................................... 10,908 9,171 12,524
------------ ----------- -----------
General and administrative expenses:
Salaries and employee benefits ...................................... 13,452 16,099 18,460
Net occupancy, furniture and fixtures and
data processing expense ........................................... 3,543 4,001 4,844
Depreciation ........................................................ 2,374 2,175 2,757
FDIC insurance premium .............................................. 104 104 108
FHLB prepayment penalties ........................................... 2,824 77 --
Marketing expense ................................................... 649 905 1,809
Expense from ATM and debit card transactions ........................ 552 630 1,039
Other expense ....................................................... 3,658 3,278 4,502
------------ ----------- -----------
Total general and administrative expense .......................... 27,156 27,269 33,519
------------ ----------- -----------
Income before income taxes ........................................ 17,313 22,433 26,136
Income taxes .......................................................... 6,141 7,627 8,982
------------ ----------- -----------
Net income ............................................................ $ 11,172 14,806 17,154
============ =========== ===========
Net income per common share
Basic ............................................................... $ 0.59 0.78 0.89
============ =========== ===========
Diluted ............................................................. $ 0.57 0.74 0.84
============ =========== ===========
Dividends declared per common share ................................... $ 0.14 0.15 0.17
Average common shares outstanding ============ =========== ===========
Basic ............................................................... 18,818,000 19,060,000 19,340,000
============ =========== ===========
Diluted ............................................................. 19,679,000 20,116,000 20,423,000
============ =========== ===========
See accompanying notes to consolidated financial statements.
14
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity and Comprehensive Income
Years ended September 30, 2003, 2004 and 2005
Accumulated
Additional Other Total
Common Paid-in Retained Treasury Comprehensive Stockholders'
Stock Capital Earnings Stock Income Equity
------- ------- ------- ------- ------- -------
(In thousands)
Balance at September 30, 2002 ........................... $ 188 9,862 54,954 (4,376) 5,758 66,386
Exercise of stock options ............................... 1 313 (504) 1,343 -- 1,153
Cash dividends .......................................... -- -- (2,592) -- -- (2,592)
Net income .............................................. -- -- 11,172 -- -- 11,172
Other comprehensive income, net of tax:
Unrealized losses arising during period,
net of taxes of $1,097 ................................ -- -- -- -- (1,779) --
Less: reclassification adjustment for gains
included in net income, net of taxes of $178 ........ -- -- -- -- (291) --
------- ------- ------- ------- ------- -------
Other comprehensive loss ................................ -- -- -- -- (2,070) (2,070)
------- ------- ------- ------- ------- -------
Comprehensive income .................................... -- -- -- -- -- 9,102
------- ------- ------- ------- ------- -------
Treasury stock repurchases .............................. -- -- -- (342) -- (342)
------- ------- ------- ------- ------- -------
Balance at September 30, 2003 ........................... 189 10,175 63,030 (3,375) 3,688 73,707
Exercise of stock options ............................... 3 432 (1,355) 2,193 -- 1,273
Cash dividends .......................................... -- -- (2,948) -- -- (2,948)
Net income .............................................. -- -- 14,806 -- -- 14,806
Other comprehensive income, net of tax:
Unrealized losses arising during period,
net of taxes of $1,330 ................................ -- -- -- -- (2,170) --
Less: reclassification adjustment for losses included
in net income, net of tax benefit of $417 ............. -- -- -- -- 680 --
------- ------- ------- ------- ------- -------
Other comprehensive loss ................................ -- -- -- -- (1,490) (1,490)
------- ------- ------- ------- ------- -------
Comprehensive income .................................... -- -- -- -- -- 13,316
------- ------- ------- ------- ------- -------
Balance at September 30, 2004 ........................... 192 10,607 73,533 (1,182) 2,198 85,348
Exercise of stock options ............................... 3 727 (603) 1,182 -- 1,309
Stock compensation related to accelerated vesting ....... -- 76 -- -- -- 76
Cash dividends .......................................... -- -- (3,361) -- -- (3,361)
Net income .............................................. -- -- 17,154 -- -- 17,154
Other comprehensive income, net of tax:
Unrealized losses arising during period,
net of taxes of $2,210 ................................ -- -- -- -- (3,606) --
Less: reclassification adjustment for losses included
in net income, net of tax benefit of $184 ............. -- -- -- -- 301 --
------- ------- ------- ------- ------- -------
Other comprehensive loss ................................ -- -- -- -- (3,305) (3,305)
------- ------- ------- ------- ------- -------
Comprehensive income .................................... -- -- -- -- -- 13,849
------- ------- ------- ------- ------- -------
Balance at September 30, 2005 ........................... $ 195 11,410 86,723 -- (1,107) 97,221
======= ======= ======= ======= ======= =======
See accompanying notes to consolidated financial statements.
15
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended September 30, 2003, 2004 and 2005
2003 2004 2005
--------- --------- ---------
(In thousands)
Cash flows from operating activities:
Net income .......................................................................... $ 11,172 14,806 17,154
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation ...................................................................... 2,374 2,175 2,757
Provision for loan losses ......................................................... 2,655 1,750 1,697
(Gain) loss on sale of mortgage-backed securities available for sale .............. (469) 997 551
(Gain) loss on sale of investment securities available or sale .................... -- 100 (66)
Gain on call of investment security called by issuer .............................. -- -- (160)
Loss on disposal of office properties and equipment ............................... -- -- 128
Stock compensation related to accelerated vesting ................................. -- -- 76
Origination of loans receivable held for sale ..................................... (141,404) (63,448) (81,207)
Proceeds from sales of loans receivable held for sale ............................. 45,367 27,453 18,704
Proceeds from securitization and sales of loans receivable held for sale .......... 95,635 46,845 52,628
Loss on early extinguishment of debt .............................................. 2,824 77 --
Increase in:
Cash value of life insurance .................................................... (665) (962) (947)
Other assets .................................................................... (157) (536) (174)
Accrued interest receivable ..................................................... (81) (1,018) (808)
Increase (decrease) in:
Accrued interest payable ........................................................ (210) 239 1,913
Other liabilities ............................................................... (65) (559) 4,233
--------- --------- ---------
Net cash provided by operating activities ....................................... 16,976 27,919 16,479
--------- --------- ---------
Cash flows from investing activities:
Proceeds from sales of investment securities available for sale ..................... -- 2,881 4,163
Proceeds from issuer call of investment securities available for sale ............... -- -- 1,950
Proceeds from issuer call of investment securities held to maturity ................. -- -- 8,000
Proceeds from maturities of investment securities available for sale ................ 2,000 2,000 --
Purchases of investment securities available for sale ............................... (16,141) (11,866) (8,255)
Purchases of investment securities held to maturity ................................. -- (7,840) (10,000)
Proceeds from sales of mortgage-backed securities available for sale ................ 39,778 124,479 178,849
Purchases of mortgage-backed securities available for sale .......................... (328,245) (234,672) (312,217)
Principal collected on mortgage-backed securities available for sale ................ 234,321 115,179 102,155
Origination of loans receivable, net ................................................ (628,172) (513,858) (718,477)
Proceeds from sale of commercial loan participations ................................ -- -- 21,228
Principal collected on loans receivable ............................................. 477,676 403,501 560,469
Purchase of bank-owned life insurance ............................................... (15,500) (4,500) --
Proceeds from sales of real estate acquired through foreclosure ..................... 1,374 1,456 1,521
Proceeds from sale of office properties and equipment ............................... -- 58 --
Purchases of office properties and equipment ........................................ (4,749) (4,989) (6,800)
Change in FHLB stock, net ........................................................... (3,432) (2,909) 1,125
--------- --------- ---------
Net cash used in investing activities ........................................... (241,090) (131,080) (176,289)
--------- --------- ---------
Cash flows from financing activities:
Increase in deposits ................................................................ 59,931 56,367 317,539
Increase (decrease) in securities sold under agreements to repurchase ............... 96,718 (26,429) (65,236)
Proceeds from FHLB advances ......................................................... 715,705 686,476 565,650
Repayment of FHLB advances .......................................................... (661,260) (602,083) (605,150)
Repayments of other borrowings, net ................................................. (1,988) (81) --
Issuance of debt associated with trust preferred securities ......................... 15,000 -- --
Cash payments for debt issuance costs ............................................... (150) -- --
Prepayment penalties on early extinguishment of debt ................................ (2,824) (77) --
Increase (decrease) in advance payments by borrowers for property
taxes and insurance ............................................................. 409 (45) (529)
Increase in drafts outstanding, net ................................................. 127 148 10,098
Repurchase of treasury stock, at cost ............................................... (342) -- --
Cash dividends to stockholders and cash for fractional shares ....................... (2,592) (2,948) (3,361)
Proceeds from exercise of stock options ............................................. 1,153 1,273 1,309
--------- --------- ---------
Net cash provided by financing activities ....................................... 219,887 112,601 220,320
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents .................................. (4,227) 9,440 60,510
--------- --------- ---------
Cash and cash equivalents at beginning of year ........................................ 25,802 21,575 31,015
--------- --------- ---------
Cash and cash equivalents at end of year .............................................. $ 21,575 31,015 91,525
--------- --------- ---------
Supplemental information:
Interest paid ....................................................................... $ 23,208 23,285 27,817
========= ========= =========
Income taxes paid ................................................................... $ 5,325 7,762 6,970
========= ========= =========
Supplemental schedule of non-cash investing and financing transactions:
Securitization of mortgage loans into mortgage-backed securities ...................... $ 95,635 46,845 52,628
========= ========= =========
Transfer of mortgage loans to real estate acquired through foreclosure ................ $ 1,955 614 1,554
========= ========= =========
Increase in other assets and junior subordinated debt resulting from
deconsolidation under FIN 46R ................................................... $ -- 464 --
========= ========= =========
Stock compensation related to accelerated vesting ................................... $ -- -- 76
========= ========= =========
See accompanying notes to consolidated financial statements.
16
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of the more significant accounting policies
used in the preparation and presentation of the accompanying consolidated
financial statements. The preparation of financial statements in conformity with
U.S. generally accepted accounting principles requires management to make
estimates and assumptions. These estimates and assumptions affect the reported
amount of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements. In addition, they affect
the reported amounts of income and expenses during the reporting period. Actual
results could differ from these estimates and assumptions. Material estimates
that are particularly susceptible to significant change relate to the
determination of the allowance for loan losses and income tax assets or
liabilities. To a lesser extent, significant estimates are also associated with
the valuation of derivative instruments and valuation of mortgage servicing
rights.
(a) Principles of Consolidation
The accompanying consolidated financial statements include the accounts of
Coastal Financial Corporation (the "Company"), and its wholly-owned
subsidiaries, Coastal Financial Capital Trust I, a statutory trust, Coastal
Investor Services, Inc., Coastal Planners Holding Corporation (and Coastal
Planners Holding Corporation's wholly-owned subsidiary, Coastal Retirement,
Estate and Tax Planners, Inc.), Coastal Federal Bank (the "Bank") (and the
Bank's wholly-owned subsidiaries, Coastal Federal Holding Company (and Coastal
Federal Holding Company's wholly-owned subsidiary, Coastal Real Estate
Investment Corporation)), and Coastal Mortgage Bankers and Realty Co., Inc. (and
Coastal Mortgage Bankers and Realty Co. Inc.'s wholly-owned subsidiary, Sherwood
Development Corporation).
In consolidation, all significant intercompany balances and transactions
have been eliminated. Coastal Financial Corporation is a unitary thrift holding
company organized under the laws of the state of Delaware.
(b) Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include
cash and amounts due from banks, short-term interest-bearing deposits and
federal funds sold. Cash and cash equivalents have maturities of three months or
less. Accordingly, the carrying amount of such instruments is considered to be a
reasonable estimate of fair value.
(c) Investment and Mortgage-backed Securities
Investment and mortgage-backed securities are accounted for in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting
for Certain Investments in Debt and Equity Securities". Investments are
classified into three categories as follows: (1) Held to Maturity - debt
securities that the Company has the positive intent and ability to hold to
maturity, which are reported at amortized cost; (2) Trading - debt and equity
securities that are bought and held principally for the purpose of selling them
in the near term, which are reported at fair value, with unrealized gains and
losses included in earnings and (3) Available for Sale - debt and equity
securities that may be sold under certain conditions, which are reported at fair
value, with unrealized gains and losses excluded from earnings and reported in
accumulated other comprehensive income as a separate component of stockholders'
equity, net of income taxes.
The Company determines investment and mortgage-backed securities
classification at the time of purchase. Premiums and discounts on securities are
accreted or amortized as an adjustment to income over the estimated life of the
security using a method which approximates a level yield. Dividends and interest
income are recognized when earned. Unrealized losses on securities, reflecting a
decline in value judged by the Company to be other than temporary, are charged
to income in the consolidated statements of operations.
The cost basis of securities sold is determined by specific
identification. Purchases and sales of securities are recorded on a trade date
basis. The fair value of securities is based on quoted market prices or dealer
quotes.
(d) Loans Receivable Held for Sale
Mortgage loans originated and intended for sale in the secondary market
are carried at the lower of cost or estimated market value in the aggregate. Net
unrealized losses are provided for in a valuation allowance by charges to
operations. At September 30, 2004 and 2005, the Company had approximately $8.2
million and $18.1 million in mortgage loans held for sale, respectively. Gains
or losses on sales of loans are recognized when control over these assets has
been surrendered in accordance with SFAS No. 140, "Accounting for Transfer and
Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS No.
140").
17
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
(e) Loans Receivable
Loans receivable are stated at unpaid principal balances adjusted for
unamortized premiums and unearned discounts and deferred loan fees/costs. The
Company recognizes interest income on loans using the simple interest method.
The Company follows SFAS No. 114, "Accounting by Creditors for Impairment
of a Loan," for determining impairment on certain loans. SFAS No. 114 requires
that nonhomogenous impaired loans and certain restructured loans be measured at
the present value of expected future cash flows discounted at the loan's
effective interest rate, at the loan's observable market price or at the fair
value of the collateral if the loan is collateral dependent. A specific reserve
is set up for each impaired loan. Accrual of interest income on impaired loans
is suspended when, in management's judgment, doubt exists as to the
collectibility of principal and interest. If amounts are received on impaired or
restructured loans for which the accrual of interest has been discontinued, a
determination is made as to whether payments received should be recorded as a
reduction of the principal balance or as interest income depending on
management's judgment as to the collectibility of principal. The loan is
returned to accrual status when, in management's judgment, the borrower has
demonstrated the ability to make periodic interest and principal payments on a
timely basis.
Loans are charged-off when the amount of loss is reasonably quantifiable
and the loss is likely to occur. Commercial loans are generally placed in
nonaccrual status when they become 90-days delinquent or earlier if full
collection of principal and interest becomes doubtful. Consumer and mortgage
loans are placed in nonaccrual status when they become 90 days delinquent or
earlier if full collection of principal and interest becomes doubtful. Interest
payments received after a loan is placed in nonaccrual are applied as a
principal reduction until such time as the loan is returned to accrual status.
Generally, loans are returned to accrual status when the loan is brought current
and the ultimate collectibility of principal and interest is no longer in doubt.
The Company maintains an allowance for the loss of uncollected interest
primarily on loans which are 90 days or more past due. This allowance is
reviewed periodically and necessary adjustments, if any, are included in the
determination of current interest income. The allowance for uncollectible
interest totaled $605,000 and $528,000 as of September 30, 2004 and 2005,
respectively.
(f) Loan Fees and Discounts
The net of origination fees received and direct costs incurred in the
origination of loans are deferred as part of the basis of loans and amortized to
interest income over the contractual life of the loans adjusted for actual
principal repayments using a method approximating a level yield.
(g) Allowance for Loan Losses
The allowance for loan loss is based on management's ongoing evaluation of
the loan portfolio and reflects an amount, that in management's opinion, is
adequate to absorb probable losses in the existing portfolio. All loan losses
are charged to the allowance and all recoveries are credited to the allowance.
Additions to the allowance for loan losses are provided by charges to operations
based on various factors which, in management's judgment, deserve current
recognition in estimating losses. Such factors considered by management include
the market value of the underlying collateral, growth and composition of credit
risk within the loan portfolio, loss experience, review of problem assets,
delinquency trends, and local and regional economic conditions. Management
evaluates the carrying value of loans periodically and the allowance is adjusted
accordingly. While management uses the best information available to make
evaluations, future adjustments to the allowance may be necessary if economic
conditions differ substantially from the assumptions used in making the
evaluation. The allowance for loan losses is subject to periodic evaluation by
various regulatory authorities and may be subject to adjustment upon their
examination.
(h) Concentration of Credit Risk
The Company's primary market area includes northeastern South Carolina and
southeastern North Carolina, predominately along the coastal regions. At
September 30, 2005, the majority of the total loan portfolio, as well as a
substantial portion of the commercial and real estate loan portfolios, were to
borrowers within this region.
The Company has identified one concentration of credit risk that it is
monitoring. This concentration involves loans for the acquisition of land and
loans for the development of land, which totaled $121.2 million at September 30,
2005 representing 124.6% of total equity and 13.1% of net loans receivable. At
September 30, 2004 this concentration totaled $99.7 million representing 116.8%
of total equity and 12.6% of net loans receivable. Economic growth and low
interest rate environments have created opportunities for land acquisition and
development activities in the Company's market area. Adverse changes in such
factors can also slow absorption of developing projects and moderate market
values of land and developed lots. Management continues to monitor this
concentration of credit risk at this time and has considered this concentration
in its evaluation of the allowance for loan losses. The Company experienced no
loan losses related to this identified risk during the years ending September
30, 2003, 2004 and 2005.
18
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
(i) Loan Securitizations
The Company packages and sells loans receivable as securities to
investors. These transactions are recorded as sales in accordance with SFAS No.
140 when control over these assets has been surrendered. The Company does not
retain any interest in the securities sold other than the servicing rights.
(j) Real Estate Owned
Real estate acquired in settlement of loans is initially recorded at the
lower of cost or net fair value (less estimated costs to sell). If cost exceeds
net fair value, the asset is written down to net fair value with the difference
being charged against the allowance for loan losses. Subsequent to foreclosure,
such assets are carried at the lower of cost or net fair value with any
additional write downs being charged as real estate losses.
(k) Office Properties and Equipment
Office properties and equipment are carried at cost less accumulated
depreciation. Depreciation is computed primarily on the straight-line method
over estimated useful lives. Estimated lives range up to thirty-nine years for
buildings and improvements and up to ten years for furniture, fixtures and
equipment. Maintenance and repairs are charged to expense as incurred.
Improvements which extend the lives of the respective assets are capitalized.
When property or equipment is sold or otherwise disposed of, the cost and
related accumulated depreciation are removed from the respective accounts and
the resulting gain or loss is reflected in income.
(l) Mortgage Servicing Rights
SFAS No. 140 requires the recognition of originated mortgage servicing
rights ("mortgage servicing rights" or "MSRs") as assets by allocating total
costs incurred between the originated loan and the servicing rights retained
based on their relative fair values. SFAS No. 140 also requires the recognition
of purchased mortgage servicing rights at fair value, which is presumed to be
the price paid for the rights. MSRs are amortized in proportion to the servicing
income over the estimated life of the related mortgage loan. The amortization
method is designed to approximate a level-yield method, taking into
consideration the estimated prepayment of the underlying loans. For purposes of
measuring impairment, MSRs are reviewed for impairment by management on a
quarterly basis, primarily considering prepayments and interest rates.
Impairment is measured on a disaggregated basis. The Company establishes an
impairment valuation allowance to record any impairment for MSRs. Subsequent
increases in value are recognized only to the extent of the impairment valuation
allowance within the same tranche. (See Note 5).
(m) Income Taxes
Deferred tax assets and liabilities are recognized for the estimated
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis. Deferred tax assets and liabilities are measured using the
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
of a change in tax rates on deferred tax assets and liabilities is recognized in
the period that includes the statutory enactment date. A deferred tax asset
valuation allowance is recorded when it is more likely than not that deferred
tax assets will not be realized.
(n) Drafts Outstanding
The Company invests all excess funds on deposit at other banks (including
amounts on deposit for payment of outstanding disbursement checks) on a daily
basis in an overnight interest-bearing account. Accordingly, outstanding checks
are reported as a liability.
(o) Securities Sold Under Agreement to Repurchase
The Company maintains collateral for certain Customers who wish to deposit
amounts greater than $100,000. These agreements function similarly to a
certificate of deposit in that the agreement is for a fixed length of time at a
fixed interest rate. However, these deposits are not insured by the Federal
Deposit Insurance Corporation (the "FDIC"), but are collateralized by an
interest in the pledged securities. The Company has classified these borrowings
separately from deposits.
The Company enters into sales of securities under agreements to
repurchase. Fixed-coupon, repurchase agreements are treated as financing, with
the obligation to repurchase securities sold being reflected as a liability and
the securities underlying the agreements remaining as assets.
19
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
(p) Stock Based Compensation
At September 30, 2005, the Company has one stock option plan, which is
described more fully in note 17.
The Company applies the intrinsic value method of APB Opinion Number 25,
"Accounting for Stock Issued to Employees" ("APB Opinion No. 25") and related
interpretations, including FASB Interpretation Number 44, "Accounting for
Certain Transactions involving Stock Compensation" ("FIN No. 44") in accounting
for its plan. Accordingly, no compensation cost has been recognized for its
fixed option plans as all options granted under those plans had an exercise
price equal to or greater than the market value of the underlying stock at the
date of grant. In October 1995, Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123"), was issued and
encourages, but does not require, adoption of a fair value method of accounting
for employee stock-based compensation plans. In December 2002, the FASB Issued
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based
Compensation-Transition and Disclosure-an Amendment of FASB Statement No. 123"
("SFAS 148"). As permitted by SFAS 123 and SFAS 148, the Company has elected to
disclose the proforma net income and earnings per share as if the fair value
method had been applied in measuring compensation cost.
Effective September 21, 2005, upon recommendation of the Compensation
Committee of the Board of Directors of Coastal Financial Corporation, the
Company's Board of Directors accelerated the vesting of, and vested, all
unvested outstanding options to acquire the Company's common stock granted in
fiscal years 2003, 2004 and 2005, totaling approximately 731,000 options, that
would otherwise vest at various times through the end of fiscal 2010 (the
"Acceleration"). All other terms and conditions of such options remain unchanged
as a result of the Acceleration.
The Board of Directors determined that the Acceleration is in the best
interests of the Company and its stockholders because it reduced compensation
expense that the Company would otherwise be required to record in future periods
when the Company becomes subject to the requirements of Financial Accounting
Standards Board ("FASB") Statement No. 123 "Share-Based Payment (Revised 2004)"
("SFAS 123R"). The Company becomes subject to SFAS 123R on October 1, 2005
(i.e., the first day of its fiscal year ending September 30, 2006). SFAS 123R
will generally require that the Company record compensation expense equal to the
fair value of all equity-based compensation over the vesting period of each
award. As a result of the Acceleration and based on estimated Black-Scholes
value calculations, the Company expects to not incur pre-tax compensation
expense related to the options subject to the Acceleration of approximately
$965,000 in fiscal 2006, $885,000 in fiscal 2007, $670,000 in fiscal 2008,
$400,000 in fiscal 2009, and $50,000 in fiscal 2010.
The Acceleration meets the criteria for variable accounting under FIN No.
44. Based upon past experience, the Company believes that the majority of the
holders of the options subject to the Acceleration will remain employed or
otherwise affiliated with the Company and/or its affiliates over the full term
of the original vesting period. Consequently, under the provisions included in
FIN No. 44, the Company recorded in the fourth fiscal quarter ending September
30, 2005, a pre-tax charge to earnings of $76,000, in the form of compensation
expense, related to the Acceleration.
In addition, in September 2005, the Company granted options to employees,
officers and directors of approximately 390,000 shares, without a vesting
requirement.
Had compensation cost for the Company's stock-based compensation plans
been determined consistent with the SFAS 123, the Company's net income and
earnings per share would have been reduced to the proforma amounts indicated
below for the years ended September 30, (in thousands, except per share data):
2003 2004 2005
---------- ---------- ----------
Reported Net Income $ 11,172 14,806 17,154
Less: Stock option compensation expense
determined under fair value method, net of tax (504) (599) (3,710)
---------- ---------- ----------
Proforma net income $ 10,668 14,207 13,444
========== ========== ==========
Reported net income per share:
Basic $ 0.59 0.78 0.89
========== ========== ==========
Diluted 0.57 0.74 0.84
========== ========== ==========
Proforma net income per share:
Basic $ 0.57 0.74 0.70
========== ========== ==========
Diluted 0.54 0.70 0.67
========== ========== ==========
20
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED
(p) Stock Based Compensation - CONTINUED
The weighted average fair value of all of the options granted during the
periods indicated have been estimated using the Black-Scholes option-pricing
model with the following assumptions:
2003 2004 2005
----- ----- -----
Dividend yield 1.86% 1.25% 1.50%
Weighted average risk-free interest rate 3.96% 4.21% 4.01%
Weighted average expected volatility 46.00% 40.00% 29.00%
Weighted average expected life in years 7.50 7.50 5.00
Included in fiscal 2005 proforma net income was pre-tax expense of
approximately $3.0 million related to the acceleration of vesting requirements
for the stock option awards granted in fiscal 2003, 2004 and 2005. In addition,
included in fiscal 2005 proforma net income was pre-tax expense of approximately
$1.4 million related to the grant of options in September 2005, with no vesting
requirements.
(q) Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income" establishes standards for
the reporting and presentation of comprehensive income and its components in a
full set of financial statements. Comprehensive income consists of net income
and net unrealized gains (losses) on securities and is presented in the
statements of stockholders' equity and comprehensive income.
(r) Disclosures Regarding Segments
The Company reports operating segments in accordance with SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS No.
131"). Operating segments are components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and assess
performance. SFAS No. 131 requires that a public enterprise report a measure of
segment profit or loss, certain specific revenue and expense items, segment
assets, information about the way that the operating segments were determined
and other items. The Company has one reportable operating segment, Coastal
Federal Bank.
(s) Derivative Instruments and Hedging Activities
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133") as amended by SFAS
No. 137, 138, and 149 establishes accounting and reporting standards for
derivatives and hedging activities. It requires an entity to recognize all
derivatives as either assets or liabilities in the balance sheet, and measures
those instruments at fair value. Changes in the fair value of those derivatives
are reported in current earnings or other comprehensive income depending on the
purpose for which the derivative is held and whether the derivative qualifies
for hedge accounting. The Company does not currently engage in any activities
that qualify for hedge accounting under SFAS 133. Accordingly, changes in fair
value of these derivative instruments are included in gain on sales of loans
held for sale in the consolidated statements of operations. (See Note 23).
(t) Reclassifications
Certain amounts in the 2003 and 2004 consolidated financial statements
have been reclassified to conform with the 2005 presentation. Such
reclassifications did not change net income or equity as previously reported.
(2) INVESTMENT SECURITIES
The amortized cost and fair value of investment securities available for
sale at September 30, 2004 are summarized as follows:
2004
--------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -----
(In thousands)
U.S. Government and agency obligations:
Due after five years ..................... $ 2,901 12 -- 2,913
State and municipal obligations:
Due after five years ..................... 20,123 497 (84) 20,536
------- ------- ------- -------
$23,024 509 (84) 23,449
======= ======= ======= =======
21
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(2) INVESTMENT SECURITIES- Continued
The amortized cost and fair value of investment securities available for
sale at September 30, 2005 are summarized as follows:
2005
----------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ------
(In thousands)
U.S. Government and agency obligations:
Due after five years ............................ $ 3,947 -- (13) 3,934
State and municipal obligations:
Due after five years ............................ 21,285 434 (37) 21,682
------- ------- ------- -------
$25,232 434 (50) 25,616
======= ======= ======= =======
The Company had no gross realized gains or losses for the year ended
September 30, 2003. For the year ended September 30, 2004, there were no gross
realized gains and losses were $100,000. For the year ended September 30, 2005,
gross realized gains were $92,000 and gross realized losses were $26,000.
The unrealized losses on investment securities were attributable to
increases in interest rates, rather than credit quality. The unrealized losses
are comprised of seven securities that have had continuous losses of less than
12 months and six securities that have had continuous losses 12 months or
longer. None of the individual investment securities had an unrealized loss
which exceeded 5% of its amortized cost. At September 30, 2005, substantially
all investment securities were rated AAA or higher.
At September 30, 2004 and 2005, investment securities held to maturity due
after five years totaled $7.8 million and $10.0 million, respectively.
The Company had one investment security held to maturity with an amortized
cost and fair value of $7.8 million that was called by the issuer, which
resulted in a gross realized gain of $160,000 in fiscal 2005.
The following table sets forth the final maturities and weighted average
yields of the securities available for sale and held to maturity at fair value
at September 30, 2005:
2005
-----------------------------------------------------------------------------
One year More than one More than five More than
or less to five years to ten years ten years
------------------ ------------------ ------------------ -----------------
Fair Value Yield Fair Value Yield Fair Value Yield Fair Value Yield
---------- ----- ---------- ----- ---------- ----- ---------- -----
(Dollars in thousands)
U.S. Government and agency obligations:
FNMA ................................ $ -- --% $ -- --% $ 2,982 5.33% $ -- --%
FHLB ................................ -- -- -- -- 10,049 2.05 952 4.25
State and municipal obligations ..... -- -- -- -- 4,509 4.03 17,173 4.29
Total ............................. $ -- --% $ -- --% $17,540 3.11% $18,125 4.29%
The yield on state and municipal obligations is not computed on a tax-equivalent
basis.
22
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(3) MORTGAGE-BACKED SECURITIES
Mortgage-backed securities available for sale at September 30, 2004
consisted of the following:
2004
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -------
(In thousands)
Collateralized Mortgage Obligations ............ $ 51,644 82 (319) 51,407
FNMA ........................................... 162,371 3,090 (661) 164,800
GNMA ........................................... 42,205 799 (5) 42,999
FHLMC .......................................... 114,947 923 (793) 115,077
-------- -------- -------- --------
$371,167 4,894 (1,778) 374,283
======== ======== ======== ========
Mortgage-backed securities available for sale at September 30, 2005
consisted of the following:
2005
-----------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- -------
(In thousands)
Collateralized Mortgage Obligations ............ $ 84,387 37 (1,130) 83,294
FNMA ........................................... 152,075 1,052 (1,346) 151,781
GNMA ........................................... 45,963 274 (416) 45,821
FHLMC .......................................... 119,399 447 (1,087) 118,759
-------- -------- -------- --------
$401,824 1,810 (3,979) 399,655
======== ======== ======== ========
The Company had gross realized gains of $695,000 and gross realized losses
of $226,000 for the year ended September 30, 2003. For the year ended September
30, 2004, the Company had gross realized gains of $772,000 and gross realized
losses of $1.8 million. For the year ended September 30, 2005, the Company had
gross realized gains of $719,000 and gross realized losses of $1.3 million.
Gross unrealized losses on mortgage-backed securities and the length of
time the securities have been in a continuous unrealized loss position, at
September 30, 2005, were as follows:
2005
-----------------------------------------------------------------------------
Less than 12 Months 12 Months or Longer Total
--------------------- ----------------------- -----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
---- ---------- --------- ---------- --------- ----------
(In thousands)
Collateralized Mortgage Obligations .. $ 55,560 (770) 19,518 (360) 75,078 (1,130)
FNMA ................................. 78,664 (1,189) 5,893 (157) 84,557 (1,346)
GNMA ................................. 32,787 (416) -- -- 32,787 (416)
FHLMC ................................ 81,540 (988) 5,951 (99) 87,491 (1,087)
--------- --------- --------- --------- --------- ---------
$ 248,551 (3,363) 31,362 (616) 279,913 (3,979)
========= ========= ========= ========= ========= =========
The unrealized losses on mortgage-backed securities summarized above were
attributable to increases in interest rates, rather than credit quality. The
unrealized losses are comprised of 72 securities that have had continuous losses
of less than 12 months and 10 securities that have had continuous losses 12
months or longer. One of the individual mortgage-backed securities had an
unrealized loss which exceeded 5% of its amortized cost by a minor amount. None
of the Company's securities were considered impaired at September 30, 2005. At
September 30, 2005 all mortgage-backed securities were rated AAA or higher.
Certain mortgage-backed securities are pledged to secure other borrowed
money and customer deposits in excess of FDIC insurance coverage. The carrying
value of the securities pledged at September 30, 2005 was $258.4 million with a
fair value of $255.7 million.
23
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(3) MORTGAGE-BACKED SECURITIES - CONTINUED
The following table sets forth the final contractural maturities and
weighted average yields of the mortgage-backed securities at fair value at
September 30, 2005:
2005
---------------------------------------------------------------------------
One year More than one More than five More than
or less to five years to ten years ten years
----------------- ----------------- ----------------- ------------------
Fair Value Yield Fair Value Yield Fair Value Yield Fair Value Yield
---------- ----- ---------- ----- ---------- ----- ---------- -----
(Dollars in thousands)
Mortgage-backed securities:
FHLMC ................................ $ -- --% $ -- --% $ -- --% $118,759 5.34%
FNMA ................................. -- -- -- -- -- -- 151,781 5.45
GNMA ................................. -- -- -- -- -- -- 45,821 5.60
Collateralized Mortgage Obligations .. -- -- -- -- -- -- 83,294 4.80
------- ---- ------- ---- -------- --- -------- ----
Total ............................. $ -- --% $ -- --% $ -- --% $399,655 5.30%
======= ==== ======= ==== ======== === ======== ====
(4) LOANS RECEIVABLE, NET
Loans receivable, net at September 30 consisted of the following:
2004 2005
--------- ---------
(In thousands)
Mortgage loans:
Single family to 4 family units ................................. $ 329,287 352,893
Land and land development ....................................... 99,697 121,170
Residential lots ................................................ 29,839 37,112
Other, primarily commercial real estate ......................... 182,924 211,432
Residential construction loans .................................. 82,789 127,970
Commercial construction loans ................................... 10,503 14,989
Consumer and commercial loans:
Installment consumer loans ...................................... 18,024 19,115
Mobile home loans ............................................... 4,618 4,308
Savings account loans ........................................... 2,058 1,883
Equity lines of credit .......................................... 30,906 34,019
Commercial and other loans ...................................... 32,101 38,691
--------- ---------
822,746 963,582
Less:
Allowance for loan losses ....................................... 11,077 11,748
Deferred loan cost, net ......................................... (674) (771)
Undisbursed portion of loans in process ......................... 21,613 28,345
--------- ---------
$ 790,730 924,260
========= =========
The changes in the allowance for loan losses for the years ended September
30 consisted of the following:
2003 2004 2005
--------- --------- ---------
(In thousands)
Beginning allowance ........................................ $ 7,883 9,832 11,077
Provision for loan losses .................................. 2,655 1,750 1,697
Loan recoveries ............................................ 136 249 224
Loan charge-offs ........................................... (842) (754) (1,250)
--------- --------- ---------
$ 9,832 11,077 11,748
========= ========= =========
Nonaccrual loans, which are all loans ninety days or more delinquent,
totaled approximately $5.9 million and $2.6 million at September 30, 2004 and
2005, respectively. In fiscal years 2003, 2004 and 2005, interest income which
would have been recorded would have been approximately $623,000, $277,000 and
$285,000, respectively, had non accruing loans been current in accordance with
their original terms.
24
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(4) LOANS RECEIVABLE, NET - CONTINUED
There were $3.3 million in impaired loans at September 30, 2004. At
September 30, 2005, impaired loans totaled $2.6 million. Included in the
allowance for loan losses at September 30, 2004 was $359,000 related to impaired
loans compared to $434,000 at September 30, 2005. The average recorded
investment in impaired loans for the year ended September 30, 2004 was $3.9
million compared to $3.7 million for the year ended September 30, 2005. Interest
income recognized on impaired loans in fiscal 2003, 2004 and 2005 was $134,000,
$607,000 and $292,000, respectively. This decrease in fiscal 2005 over 2004 is
primarily due to a commercial loan that was placed in nonaccrual status in a
prior fiscal year. The loan paid off in the fourth fiscal quarter of 2004. As a
result, the Company recognized approximately $330,000 of interest in fiscal 2004
which had been previously reserved.
In the normal course of business, to meet the financing needs of its
Customers, the Company is a party to financial instruments with
off-balance-sheet risk. These financial instruments include commitments to
extend credit and stand by letters of credit. These instruments involve, to
varying degrees, elements of credit and interest rate risk in excess of the
amount recognized in the balance sheet.
The Company's exposure to credit loss in the event of non-performance by
the other party to the financial instrument is represented by the contractual
amount of these instruments. The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments.
Commitments to extend credit are agreements to lend as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since many of the commitments may expire without being drawn upon, the
total commitment amounts do not necessarily represent future cash requirements.
The Company evaluates each Customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Company upon
extension of credit, is based on management's credit evaluation.
Standby letters of credit obligate the Company to meet certain financial
obligations of its Customers, if, under the contractual terms of the agreement,
the Customers are unable to do so. Payment is only guaranteed under these
letters of credit upon the borrower's failure to perform its obligations to the
beneficiary. The Company can seek recovery of the amounts paid from the borrower
and the letters of credit are generally collateralized. Commitments under
standby letters of credit are usually one year or less. At September 30, 2005,
the Company has recorded no liability for the current carrying amount of the
obligation to perform as a guarantor, as such amounts are not considered
material. The maximum potential amount of undiscounted future payments related
to standby letters of credit at September 30, 2005 was $5.8 million.
A summary of loans receivable with undisbursed commitments to extend
credit at September 30, 2004 and September 30, 2005 follows (in thousands):
2004 2005
-------- --------
Residential mortgage loans in process ........................................ $ 21,613 28,345
Business and consumer credit card lines ...................................... 14,171 14,065
Consumer home equity lines ................................................... 37,031 43,388
Other consumer lines of credit ............................................... 8,361 4,547
Standby letters of credit .................................................... 5,502 5,777
Commercial real estate and construction and land development
lines of credit .......................................................... 52,978 107,731
Other commercial lines of credit ............................................. 8,071 10,527
-------- --------
$147,727 214,380
======== ========
In addition, the Company had commitments to originate $28.6 million in
residential loans at September 30, 2005.
Loans serviced for the benefit of others amounted to approximately $219.8
million, $250.5 million and $291.9 million at September 30, 2003, 2004 and 2005,
respectively. Loans serviced for others at September 30, 2003 and September 30,
2004 consisted primarily of residential mortgage loans. At September 30, 2005,
residential mortgage loans serviced for others was $274.7 million and commercial
mortgage loans serviced for others was $17.2 million.
During fiscal 2005, the Company securitized $52.6 million of mortgage
loans and concurrently sold these mortgage-backed securities to outside third
parties and recognized a net gain on sale of $1.0 million, which included the
recognition of a $690,000 mortgage servicing right asset. During fiscal 2004,
the Company securitized $46.8 million of mortgage loans and concurrently
25
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(4) LOANS RECEIVABLE, NET - CONTINUED
sold these mortgage-backed securities to outside third parties and recognized a
net gain on sale of $1.4 million, which included the recognition of a $637,000
mortgage servicing right asset. The gain is included in gains on sales of loans
held for sale in the consolidated statement of operations. The proceeds from
sale are included in proceeds from sales of mortgage-backed securities available
for sale in the consolidated statement of cash flows.
As disclosed in note 9, certain mortgage loans are pledged to secure
advances from the Federal Home Loan Bank ("FHLB") of Atlanta.
The Bank offers mortgage and consumer loans to its directors, and
Associates for the financing of their personal residences and for other personal
purposes. The Bank also offers commercial loans to companies affiliated with
directors. These loans are made in the ordinary course of business and, in
management's opinion, are made on substantially the same terms, including
interest rates and collateral, prevailing at the time for comparable
transactions with other persons and companies. Management does not believe these
loans involve more than the normal risk of collectibility or present other
unfavorable features. At September 30, 2005, such loans were current with
respect to their payment terms.
The following is a summary of the activity of loans outstanding to certain
executive officers, directors and their affiliates for the year ended September
30, 2005 (in thousands):
Balance at September 30, 2004 ................. $ 988
New loans ..................................... 409
Repayments .................................... (564)
-----
Balance at September 30, 2005 ................. $ 833
=====
(5) MORTGAGE SERVICING RIGHTS
Mortgage servicing rights, net of the valuation allowance, are included in
other assets and totaled $3.0 million and $3.2 million at September 30, 2004 and
2005, respectively. Amortization expense for MSRs, included in interest on loans
receivable, totaled $811,000, $1.0 million and $1.0 million for the years ended
September 30, 2003, 2004 and 2005, respectively. The estimated amortization
expense for MSRs held as of September 30, 2005, is $818,000, $783,000, $733,000,
$597,000 and $261,000 for fiscal 2006, 2007, 2008, 2009 and 2010 respectively.
The estimated amortization expense is based on current information regarding
loan payments and prepayments. Amortization expense could change in future
periods based on changes in the volume of prepayments and various economic
factors.
At September 30, 2004 and 2005, the valuation allowance for MSRs totaled
$299,000 and $5,000, respectively. In 2004 and 2005, the Company recorded
$162,000 and $294,000 for impairment recoveries, respectively. MSR impairment
recovery is included in other expense.
2004 2005
------- -------
(In thousands)
Balance at beginning of year ........... $ 2,843 3,005
MSRs capitalized ....................... 1,020 941
MSRs amortized ......................... (1,020) (1,053)
Recovery of impairment ................. 162 294
------- -------
Balance at end of year ................. $ 3,005 3,187
======= =======
(6) OFFICE PROPERTY AND EQUIPMENT, NET
Office property and equipment, net at September 30 consisted of the
following:
2004 2005
-------- --------
(In thousands)
Land ................................... $ 5,848 7,530
Building and improvements .............. 13,770 15,493
Furniture, fixtures and equipment ...... 17,341 20,510
-------- --------
36,959 43,533
Less accumulated depreciation (18,115) (20,775)
-------- --------
$ 18,844 22,758
======== ========
26
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(6) OFFICE PROPERTY AND EQUIPMENT, NET - CONTINUED
The Company leases office space and various equipment. Total rental
expense for the years ended September 30, 2003, 2004 and 2005 was approximately
$259,000, $285,000 and $307,000 respectively.
Future minimum rental payments for operating leases having remaining
noncancelable lease terms in excess of one year at September 30, 2005 are as
follows (in thousands):
2006 ............................. $ 286
2007 ............................. 232
2008 ............................. 157
2009 ............................. 67
2010 ............................. 55
Thereafter ............................ 215
-------
$ 1,012
=======
(7) INVESTMENT REQUIRED BY LAW
The Bank, as a member of the FHLB of Atlanta, is required to acquire and
hold shares of capital stock in the FHLB of Atlanta in an amount equal to the
greater of (i) $500 (ii) 1.0% of the aggregate outstanding principal amount of
home mortgage loans, home purchase contracts and similar obligations at the end
of each calendar year, or (iii) 5% of its advances (borrowings) from the FHLB of
Atlanta at the end of each calendar year. The Bank is in compliance with this
requirement with an investment in FHLB stock of $15.8 million, carried at cost,
at September 30, 2005. No ready market exists for this stock and it has no
quoted market value. However, redemption of this stock has historically been at
par value.
(8) DEPOSITS
Deposits at September 30 consisted of the following:
2004 2005
------------------------- ------------------------
Weighted Weighted
Amount Rate Amount Rate
---------- --------- ---------- ---------
(Dollars in thousands)
Transaction accounts:
Noninterest bearing ............................ $ 122,357 --% $ 219,080 --%
NOW ............................................ 110,802 0.46 139,810 0.52
Money market checking .......................... 224,437 1.37 213,078 2.26
---------- ----------
Total transaction accounts ................ 457,596 0.79 571,968 0.97
---------- ----------
Statement savings accounts:
Regular ......................................... 54,147 0.79 71,119 1.47
Money market .................................... 1,058 1.00 705 1.24
---------- ----------
Total statement savings accounts 55,205 0.80 71,824 1.47
---------- ----------
Certificate accounts:
0.00-1.99% ...................................... 69,014 15,660
2.00-3.99% ...................................... 148,493 381,253
4.00-5.99% ...................................... 22,470 29,545
6.00-7.99% ...................................... 8 8
8.00-10.00% ..................................... 593 660
---------- ----------
Total certificate accounts 240,578 2.49 427,126 3.39
---------- ----------
$ 753,379 1.33% $1,070,918 1.97%
========== ==========
The aggregate amount of all deposit accounts with a minimum denomination
of $100,000 or more was $364.2 million and $637.9 million at September 30, 2004
and 2005, respectively.
The amounts and scheduled maturities of certificate accounts at September
30, are as follows:
2004 2005
-------- --------
(In thousands)
Within 1 year ........................................... $208,130 392,731
After 1 but within 2 years .............................. 23,512 22,666
After 2 but within 3 years .............................. 4,960 8,555
Thereafter .............................................. 3,976 3,174
-------- --------
$240,578 427,126
======== ========
27
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(8) DEPOSITS - CONTINUED
Included in certificate accounts ("CDs") are $169.9 million of brokered
CDs at September 30, 2005. There were no brokered CDs at September 30, 2004. The
average rate and remaining term of brokered CDs at September 30, 2005 was 3.51%
and approximately four months, respectively.
Interest expense on deposits for the years ended September 30 consisted of
the following:
2003 2004 2005
------- ------- -------
(In thousands)
Transaction accounts ........................... $ 3,925 3,331 4,457
Passbook accounts .............................. 427 405 663
Certificate accounts ........................... 7,647 6,288 8,959
------- ------- -------
$11,999 10,024 14,079
======= ======= =======
(9) ADVANCES FROM FHLB
Advances from the FHLB at September 30 consisted of the following:
2004 2005
--------------------- ---------------------
Weighted Weighted
Amount Rate Amount Rate
-------- -------- -------- --------
Fiscal Year Maturity (Dollars in thousands)
2005 ........................................... $ 64,500 2.78% $ -- --%
2006 ........................................... 4,177 2.79 4,177 2.79
2007 ........................................... 11,560 2.23 3,560 2.83
2008 ........................................... 3,977 3.18 3,977 3.18
2009 ........................................... 31,803 2.36 31,803 2.36
2010 ........................................... 52,651 5.98 63,651 5.74
2011 or greater ................................ 159,839 3.61 181,839 3.64
-------- --------
$328,507 3.64% $289,007 3.93%
======== ========
Stock in the FHLB of Atlanta and specific first mortgage loans and
mortgage-backed securities of approximately $357.3 million and $362.5 million at
September 30, 2004 and 2005, respectively, are pledged as collateral for these
advances. The Bank has adopted the policy of pledging excess collateral to
facilitate future advances. At September 30, 2005, the excess first mortgage
loan collateral pledged to the FHLB will support additional borrowings of
approximately $73.5 million. At September 30, 2005, included in the one, two,
three, and four year maturities were $191.0 million with a weighted average rate
of 3.49% of advances subject to call provisions. Callable advances at September
30, 2005 are summarized as follows: $84.0 million callable in fiscal 2006, with
a weighted average rate of 3.99%; $45.0 million callable in fiscal 2007, with a
weighted average rate of 3.17%; $37.0 million callable in fiscal 2008, with a
weighted average rate of 2.98%; and $25.0 million callable in fiscal 2009, with
a weighted average rate of 3.13%. Call provisions are more likely to be
exercised by the FHLB when interest rates rise. If exercised, the Company may
have to replace called advances with borrowings at a higher interest rate.
During fiscal 2003, the Company prepaid approximately $54.6 million of
advances from FHLB and incurred gross penalties of approximately $2.8 million.
During fiscal 2004, the Company prepaid approximately $4.6 million of advances
from FHLB and incurred gross penalties of approximately $77,000. During fiscal
2005, the Company did not prepay any FHLB advances. Prepayment penalties are
included in general and administrative expenses in the statement of operations.
28
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(10) REPURCHASE AGREEMENTS
The following tables set forth certain information regarding repurchase
agreements 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
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
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
Approximate average outstanding with respect to:
Securities sold under agreements to repurchase:
Customer ............................................... $ 4,812 $ 9,033 $ 27,498
Broker ................................................. 92,476 134,809 73,723
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
Securities sold under agreements to repurchase represent borrowings by the
Company with maturities ranging from 1 to 12 months collateralized by securities
of the United States government or its agencies, which have been delivered to a
third party custodian for safekeeping. Assets pledged to collateralize
securities sold under agreements to repurchase had a fair value of $45.9 million
at September 30, 2005 and are included in mortgage-backed securities available
for sale in the consolidated balance sheet.
(11) JUNIOR SUBORDINATED DEBT
The Company determines whether it has a controlling financial interest in
an entity by first evaluating whether the entity is a voting interest entity or
a variable interest entity under accounting principles generally accepted in the
United States of America. Voting interest entities are entities in which the
total equity investment at risk is sufficient to enable each entity to finance
itself independently and provides the equity holders with the obligation to
absorb losses, the right to receive residual returns and the right to make
decisions about the entity's activities. The Company consolidates voting
interest entities in which it has all, or at least a majority of, the voting
interest. As defined in applicable accounting standards, variable interest
entities ("VIEs") are entities that lack one or more of the characteristics of a
voting interest entity described above. A controlling financial interest in an
entity is present when an enterprise has a variable interest or a combination of
variable interests that will absorb a majority of the entity's expected losses,
receive a majority of the entity's expected residual returns, or both. The
enterprise with a controlling financial interest, known as the primary
beneficiary, consolidates the VIE.
Prior to January 1, 2005, the Company consolidated its wholly-owned
subsidiary, Coastal Financial Capital Trust I ("Trust"). In December 2003, the
Financial Accounting Standards Board issued a revised version of Interpretation
No. 46 ("FIN 46") "Consolidation of Variable Interest Entities." The revised FIN
46 clarifies some of the provisions of the original interpretation and adds new
scope exceptions. As a result of the changes, the Company deconsolidated the
Trust, increasing other assets by $464,000, increasing junior subordinated
debt-trust preferred securities by $15.5 million and reducing debt associated
with trust preferred securities ("Capital Securities") by $15.0 million.
The junior subordinated debentures are unsecured obligations of the
Company and are subordinate and junior in right of payment to all present and
future senior indebtedness of the Company. The Company has entered into a
guarantee, which together with its obligations under the junior subordinated
debentures and the declaration of trust governing the Trust, provides a full and
unconditional guarantee of the Capital Securities.
The Capital Securities accrue and pay distributions at a rate per annum
equal to 90-day LIBOR plus 305 basis points. At September 30, 2005, the
distribution rate on the Capital Securities was 6.54%. The distributions payable
on the Capital Securities are cumulative and payable quarterly in arrears. The
Capital Securities interest payments for fiscal 2003, 2004 and 2005 were
$213,000, $662,000 an $892,000, respectively, and are included in interest
expense on other borrowings. The Company has the right, subject to events of
default, to defer payments of interest on the Capital Securities for a period
not to exceed 20 consecutive quarters. The Company has no current intention to
exercise its right to defer payment of interest on the Capital Securities.
29
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(11) JUNIOR SUBORDINATED DEBT - CONTINUED
The Capital Securities are mandatorily redeemable upon maturity on July 3,
2033. The Company has the right to redeem the Capital Securities in whole or in
part, on or after July 3, 2008. If the Capital Securities are redeemed on or
after July 3, 2008, the redemption price will be 100% of the principal amount
plus accrued and unpaid interest. In addition, the Company may redeem the
Capital Securities in whole (but not in part) at any time within 90 days
following the occurrence of a tax event, an investment company event, or a
capital treatment event at a special redemption price (as defined in the
indenture).
(12) INCOME TAXES
Income tax expense (benefit) for the years ended September 30 consisted of
the following:
Current Deferred Total
-------- -------- --------
(In thousands)
2003:
Federal ................................... $ 4,946 507 5,453
State ..................................... 693 (5) 688
-------- -------- --------
$ 5,639 502 6,141
======== ======== ========
2004:
Federal ................................... $ 7,070 126 7,196
State ..................................... 433 (2) 431
-------- -------- --------
$ 7,503 124 7,627
======== ======== ========
2005:
Federal ................................... $ 7,739 582 8,321
State ..................................... 614 47 661
-------- -------- --------
$ 8,353 629 8,982
======== ======== ========
The tax effect of the Company's temporary differences between the
financial statement carrying amounts and tax basis of assets and liabilities
that give rise to the net deferred tax asset (liability) at September 30, 2004
and 2005 relate to the following:
2004 2005
-------- --------
Deferred tax assets: (In thousands)
Allowance for loan losses ......................................................... $ 4,031 4,406
Accrued medical reserves .......................................................... 91 85
Other real estate reserves and deferred gains on other real estate ................ 56 20
Net operating loss carryforwards .................................................. 38 81
Unrealized loss on securities available for sale .................................. -- 679
Other ............................................................................. 170 282
-------- --------
Total deferred tax assets .............................................................. 4,386 5,553
Less valuation allowance ............................................................... (38) (81)
-------- --------
Net deferred tax assets ................................................................ 4,348 5,472
-------- --------
Deferred tax liabilities:
Property and equipment principally due to differences in depreciation ............. 688 398
FHLB stock, due to stock dividends not recognized for tax purposes ................ 15 --
Deferred loan fees ................................................................ 719 885
Book over tax basis in investment in unconsolidated subsidiary .................... 4,009 5,053
Unrealized gain on securities available for sale .................................. 1,347 --
Mortgage servicing rights ......................................................... 1,120 1,221
Other ............................................................................. 349 417
-------- --------
Total deferred tax liabilities ......................................................... 8,247 7,974
-------- --------
Net deferred tax liability ............................................................. $ (3,899) (2,502)
======== ========
The valuation allowance for deferred tax assets was $38,000 and $81,000 at
September 30, 2004 and 2005, respectively. The net change in the total valuation
allowance for the years ended September 30, 2004 and 2005 was an increase of
$17,000 and $43,000, respectively. In assessing the realizability of deferred
tax assets, management considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income, and tax planning strategies in
making this assessment. In order to fully realize the deferred tax asset, the
company will need to generate future taxable income prior to the expiration of
the deferred tax assets governed by the tax code. Based upon the level of
historical taxable income and projections for future taxable income over the
periods, which the deferred tax assets are deductible, management believes it
more likely than
30
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(12) INCOME TAXES - CONTINUED
not the Company will realize the benefits of these deductible differences, net
of the existing valuation allowances at September 30, 2005. The amount of the
deferred tax asset considered realizable, however, could be reduced in the near
term if estimates of future taxable income during the carryforward period are
reduced.
The net deferred tax asset (liability) is included in other liabilities in
the consolidated financial statements. The valuation allowance relates to the
state loss carryforwards which may not be ultimately realized to reduce taxes of
the Company. A portion of the change in the net deferred tax liability relates
to unrealized gains and losses on securities available for sale. A current
period deferred tax benefit of $2.0 million unrealized loss on securities
available for sale has been recorded directly to stockholders' equity. The
balance of the change in the deferred tax liability results from the current
period deferred tax expense of $629,000.
Income taxes of the Company attributable to income before income taxes
differ from the amounts computed by applying the Federal income tax rate of 35%
for the years ended September 30 to earnings before income taxes as follows:
2003 2004 2005
-------- -------- --------
(In thousands)
Computed federal income taxes .................................... $ 6,059 7,852 9,148
State tax, net of federal benefit ................................ 447 280 430
Bank-owned life insurance ........................................ (233) (337) (332)
Tax exempt securities net ........................................ (39) (220) (275)
Other, net ....................................................... (93) 52 11
-------- -------- --------
Total income tax expense ......................................... $ 6,141 7,627 8,982
======== ======== ========
The Bank had been permitted under the Internal Revenue Code to deduct an
annual addition to the tax reserve for bad debts in determining taxable income,
subject to certain limitations. This addition may differ significantly from the
bad debt expense for financial reporting purposes and was based on either 8% of
taxable income (the "Percentage of Taxable Income Method") or actual loan loss
experience (the "Experience Method") for the years prior to 1997. As a result of
tax legislation, the Bank recaptured tax bad debt reserves in excess of pre-1988
based year amounts over a six-year period ended September 30, 2004.
Retained earnings at September 30, 2005 includes approximately $5.2
million representing pre-1988 tax bad debt base year reserve amounts for which
no deferred income tax liability has been provided since these reserves are not
expected to reverse until indefinite future periods and may never reverse.
Circumstances that would require an accrual of a portion or all of this
unrecorded tax liability are a reduction in qualifying loan levels relative to
the end of 1987, failure to meet the tax definition of a savings bank, dividend
payments in excess of current year or accumulated tax earnings and profits, or
other distributions in dissolution, liquidation or redemption of the Bank's
stock.
(13) BENEFIT PLAN
The Company has a defined contribution plan covering substantially all
Associates. The Company matches Associate contributions based upon the Company
meeting certain return on equity operating results. Matching contribution
expense was approximately $340,000, $684,000 and $435,000 for fiscal years 2003,
2004 and 2005, respectively.
(14) REGULATORY MATTERS
The Bank is subject to various capital requirements administered by
federal banking agencies. Failure to meet minimum capital requirements can
initiate mandatory and possibly additional discretionary actions by regulators
that, if undertaken, could have a direct material adverse effect on the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, the Bank must meet specific
capital guidelines that involve quantitative measures of the assets, liabilities
and certain off-balance sheet items as calculated under regulatory accounting
practices. The Bank's capital amounts and classifications are also subject to
qualitative judgments by the regulators about components, risk-weighting and
other factors. Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in
the following table) of total and tier 1 capital (as defined in the regulation)
to risk-weighted assets (as defined) and to average assets (as defined). At
September 30, 2005, the Bank's loans-to-one borrower limit was approximately
$18.4 million. Management believes, as of September 30, 2005, that the Bank met
all capital adequacy requirements and loans-to-one-borrower limits.
As of September 30, 2005, the most recent notification from federal
banking agencies categorized the Bank as "well capitalized" under the regulatory
framework. To be categorized as "well capitalized," the Bank must maintain
minimum total risk-based capital, tier 1 capital, and tier 1 leverage ratios as
set forth in the table. Since September 30, 2005, there have been no events or
conditions that management believes have changed the Bank's categories. (Dollars
in thousands)
31
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(14) REGULATORY MATTERS - CONTINUED
Amount to be
For Capital Categorized as
Actual Adequacy Purposes "Well Capitalized"
------------------ ------------------ ------------------
Amount Ratio Amount Ratio Amount Ratio
-------- ------ -------- ----- -------- ------
As of September 30, 2004:
Total Capital: ............................ $106,851 13.55% $ 63,077 8.00% $ 78,847 10.00%
(To Risk Weighted Assets)
Tier 1 Capital: ........................... $ 97,450 12.36% N/A N/A $ 47,308 6.00%
(To Risk Weighted Assets)
Tier 1 Capital: ........................... $ 97,450 7.44% $ 39,278 3.00% $ 65,574 5.00%
(To Adjusted Total Assets)
Tangible Capital: ........................ $ 97,450 7.44% $ 19,672 1.50% N/A N/A
(To Adjusted Total Assets)
As of September 30, 2005:
Total Capital: ............................ $122,693 13.29% $ 73,877 8.00% $ 92,347 10.00 %
(To Risk Weighted Assets)
Tier 1 Capital: ........................... $112,055 12.13% N/A N/A $ 55,408 6.00%
(To Risk Weighted Assets)
Tier 1 Capital: ........................... $112,055 7.25% $ 46,356 3.00% $ 77,260 5.00%
(To Adjusted Total Assets)
Tangible Capital: ........................ $112,055 7.25% $ 23,178 1.50% N/A N/A
(To Adjusted Total Assets)
(15) LIQUIDATION ACCOUNT
In conjunction with the Bank's conversion to stock form on October 4,
1990, the Bank established, as required by Office of Thrift Supervision (the
"OTS") regulations, a liquidation account and maintains this account for the
benefit of the remaining eligible account holders as defined under the Bank's
plan of conversion. The initial balance of this liquidation account was equal to
the Bank's net worth defined by OTS regulations as of the date of the latest
statement of financial condition contained in the final offering circular. In
the event of a complete liquidation of the Bank (and only in such event) each
eligible holder shall be entitled to receive a liquidation distribution from
this account in the amount of the then current adjusted balance for deposits
then held, before any liquidation distribution may be made to the stockholders.
The Bank is prohibited from declaring cash dividends or repurchasing its capital
stock if it would cause a reduction in the Bank's net worth below either the
balance of the liquidation account or the statutory net worth requirements set
by the OTS.
The Company's ability to pay dividends depends primarily on the Bank's
ability to pay dividends to the Company. The Bank is prohibited from declaring
cash dividends on its common stock or repurchasing its common stock if the
effect thereof would cause its net worth to be reduced below either the amount
required for the liquidation account or the minimum regulatory capital
requirement. In addition, the Bank is also prohibited from declaring cash
dividends and repurchasing its own stock without prior regulatory approval if
the total amount of all dividends and stock repurchases (including any proposed
dividends and stock repurchases) for the applicable year exceeds its current
year's net income plus its retained net income for the preceding two years.
(16) EARNINGS PER SHARE
Basic earnings per share are computed by dividing net income by the
weighted-average number of common shares outstanding. Diluted earnings per share
are computed by dividing net income by the weighted average number of common
shares and potential common shares outstanding. Potential common shares consist
of dilutive stock options determined using the treasury stock method and the
average market price of common stock. All share and per share data have been
retroactively restated for all common stock dividends. At September 30, 2005 the
Company had antidilutive securities of approximately 227,000 options to purchase
shares by Directors and Associates. The average exercise price for such shares
was $15.25 per share.
The following is a summary of the reconciliation of average shares outstanding
for the years ended September 30:
2003 2004 2005
------------------------ ------------------------ ------------------------
Basic Diluted Basic Diluted Basic Diluted
---------- ---------- ---------- ---------- ---------- ----------
Weighted average shares outstanding 18,818,000 18,818,000 19,060,000 19,060,000 19,340,000 19,340,000
Effect of dilutive securities -
Stock options -- 861,000 -- 1,056,000 -- 1,083,000
---------- ---------- ---------- ---------- ---------- ----------
Average shares outstanding 18,818,000 19,679,000 19,060,000 20,116,000 19,340,000 20,423,000
========== ========== ========== ========== ========== ==========
32
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(17) STOCK OPTION PLAN
The Company's stock option plan provides for stock options to be granted
primarily to directors, officers and other key Associates. Options granted under
the stock option plan may be incentive stock options or non-incentive stock
options. Options vest ratably over a five year period and expire after ten years
from the date of grant, except as discussed below. The remaining shares of stock
reserved for the stock option plan at September 30, 2005 amounted to
approximately 97,000 shares. Options awarded prior to September 21, 2005 vest
ratably over a five-year period. Effective September 21, 2005, the vesting
period for approximately 731,000 options awarded during fiscal 2003, 2004 and
2005 through September 20, 2005 that would otherwise vest at various times
through fiscal 2010 was accelerated, as more fully described in note 1(p). In
addition, in September 2005, the Company granted options to employees, officers
and directors of approximately 390,000 shares, without a vesting requirement.
All options expire after ten years from the date of grant. All other terms and
conditions of such options remain unchanged as a result of the Acceleration. All
outstanding options have been retroactively restated to reflect the effects of
the common stock dividends. At September 30, 2005, the Company had the following
options outstanding:
Weighted
Average Weighted Weighted
Number Remaining Average Number Average
Fiscal Options Contractual Exercise Options Exercise
Year Range of exercise prices: Outstanding Life Price Exercisable Price
---- ------------------------- ----------- ----------- -------- ----------- --------
1997 $3.63 - $3.76 ........... 116,369 1.2 Years $ 3.67 116,369 $ 3.67
1998 $5.29 - $8.06 ........... 293,717 2.2 Years $ 5.98 293,717 $ 5.98
1999 $5.86 - $6.35 ........... 254,841 3.1 Years $ 5.92 254,841 $ 5.92
2000 $3.57 - $4.65 ........... 212,587 4.2 Years $ 4.24 212,587 $ 4.24
2001 $3.43 - $5.36 ........... 233,702 5.1 Years $ 3.49 186,962 $ 3.49
2002 $5.14 - $8.44 ........... 246,622 6.1 Years $ 5.22 147,973 $ 5.22
2003 $6.83 - $8.68 ........... 321,490 7.1 Years $ 8.19 321,490 $ 8.19
2004 $11.00 - $11.98 ......... 343,230 8.2 Years $11.51 343,230 $11.51
2005 $12.32 - $15.62 ......... 789,051 9.6 Years $13.55 789,051 $13.55
--------- --------- ------ --------- ------
$3.43 - $15.62 .......... 2,811,609 7.6 Years $ 8.52 2,666,220 $ 8.74
========= ========= ====== ========= ======
The following is a summary of the activity of the stock option plans for
the years 2003, 2004, and 2005.
2003 2004 2005
--------------------- -------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- -------- --------- -------- --------- --------
Outstanding, October 1 ........... 2,186,474 $ 4.62 2,313,294 $ 5.21 2,303,342 $ 6.42
Granted .......................... 383,206 8.12 361,053 11.51 799,759 12.30
Cancelled ........................ (17,452) 6.24 (6,104) 7.53 (46,969) 9.25
Exercised ........................ (238,934) 4.35 (364,901) 3.74 (244,523) 4.96
--------- ------ --------- ------ --------- ------
Outstanding, September 30 ........ 2,313,294 $ 5.21 2,303,342 $ 6.42 2,811,609 $ 8.52
========= ====== ========= ====== ========= ======
(18) COMMON STOCK DIVIDENDS
On May 27, 2003, August 28, 2003, February 18, 2004, July 30, 2004,
December 15, 2004 and October 26, 2005 the Company declared a 10% stock dividend
aggregating approximately 1,065,000, 1,174,000, 1,308,000, 1,442,000, 1,594,000
and 1,770,000 shares, respectively. All share and per share data has been
retroactively restated to give effect to the common stock dividends.
(19) CASH DIVIDENDS
On each of December 18, 2002 and March 26, 2003, the Company declared
quarterly cash dividends of $0.031 per share. On each of June 24, 2003,
September 24, 2003, December 15, 2003, March 17, 2004 and June 16, 2004, the
Company declared quarterly cash dividends of $0.037 per share. On each of
September 29, 2004, December 17, 2004 and March 16, 2005, the Company declared
quarterly cash dividends of $0.041. On each of June 22, 2005 and September 21,
2005 the Company declared quarterly cash dividends of $0.045. Under Delaware
law, the Company is permitted to declare and pay dividends either out of its
surplus or, if there is no surplus, out of its net profits for the fiscal year
in which the dividend is declared and/or the preceding fiscal year.
(20) LEGAL MATTERS
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.
33
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(21) QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly operating data for the years ended September 30 is summarized as
follows (in thousands, except share data):
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------- ----------- ----------- -----------
2004:
Total interest income ............................... $ 15,535 16,155 16,661 17,453
Total interest expense .............................. 5,725 5,848 5,892 6,059
----------- ----------- ----------- -----------
Net interest income ................................. 9,810 10,307 10,769 11,394
Provision for loan losses ........................... 550 500 200 500
----------- ----------- ----------- -----------
Net interest income after provision for
loan losses ...................................... 9,260 9,807 10,569 10,894
Other income ........................................ 2,326 2,430 2,121 2,298
General and administrative expenses ................. 6,614 6,729 6,773 7,156
----------- ----------- ----------- -----------
Income before income taxes .......................... 4,972 5,508 5,917 6,036
Income taxes ........................................ 1,653 1,831 2,018 2,125
----------- ----------- ----------- -----------
Net income .......................................... $ 3,319 3,677 3,899 3,911
=========== =========== =========== ===========
Net income per common share - diluted ............... $ .16 .18 .19 .19
=========== =========== =========== ===========
Weighted average shares outstanding-diluted ......... 20,147,000 20,155,000 20,191,000 20,211,000
=========== =========== =========== ===========
First Second Third Fourth
Quarter Quarter Quarter Quarter
----------- ----------- ----------- -----------
2005:
Total interest income ............................... $ 17,946 18,912 20,337 21,363
Total interest expense .............................. 6,431 7,016 7,831 8,452
----------- ----------- ----------- -----------
Net interest income ................................. 11,515 11,896 12,506 12,911
Provision for loan losses ........................... 350 625 550 172
----------- ----------- ----------- -----------
Net interest income after provision for
loan losses ...................................... 11,165 11,271 11,956 12,739
Other income ........................................ 2,767 3,336 3,101 3,320
General and administrative expenses ................. 7,781 8,319 8,420 8,999
----------- ----------- ----------- -----------
Income before income taxes .......................... 6,151 6,288 6,637 7,060
Income taxes ........................................ 2,106 2,153 2,281 2,442
----------- ----------- ----------- -----------
Net income .......................................... $ 4,045 4,135 4,356 4,618
=========== =========== =========== ===========
Net income per common share - diluted ............... $ 0.20 0.20 0.21 0.23
=========== =========== =========== ===========
Weighted average shares outstanding-diluted ......... 20,364,000 20,524,000 20,497,000 20,515,000
=========== =========== =========== ===========
(22) COASTAL FINANCIAL CORPORATION FINANCIAL STATEMENTS (PARENT COMPANY ONLY)
The following is condensed financial information of Coastal Financial
Corporation (parent company only), the primary asset of which is its investment
in its bank subsidiary, for the periods indicated (In thousands):
Coastal Financial Corporation
Condensed Balance Sheets
September 30, 2004 and 2005
2004 2005
---------- ----------
Assets
Cash ................................................................................. $ 86 297
Investment in subsidiaries ........................................................... 99,754 111,034
Deferred tax asset ................................................................... 50 50
Other assets ......................................................................... 1,725 2,214
---------- ----------
Total assets .................................................................... $ 101,615 113,595
========== ==========
Liabilities and Stockholders' Equity
Accounts payable (principally dividends) ............................................. 803 910
Junior subordinated debt ............................................................. 15,464 15,464
Total stockholders' equity ........................................................... 85,348 97,221
---------- ----------
Total liabilities and stockholders' equity ...................................... $ 101,615 113,595
========== ==========
34
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(22) COASTAL FINANCIAL CORPORATION FINANCIAL STATEMENTS (PARENT COMPANY ONLY) -
CONTINUED
Coastal Financial Corporation
Condensed Statements of Operations
Years ended September 30, 2003, 2004 and 2005
2003 2004 2005
-------- -------- --------
Income:
Interest income ...................................................... $ 1 2 2
Management fees ...................................................... 300 242 242
Dividends from subsidiary ............................................ 1,221 2,230 3,400
Equity in undistributed earnings of subsidiaries ..................... 10,087 13,063 14,444
-------- -------- --------
Total income ................................................. 11,609 15,537 18,088
-------- -------- --------
Expenses:
Professional fees .................................................... 20 72 83
Supplies and printing ................................................ 12 33 40
Interest expense ..................................................... 213 662 892
Other expenses ....................................................... 277 213 280
Income tax benefit ................................................... (85) (249) (361)
-------- -------- --------
Total expenses ............................................... 437 731 934
-------- -------- --------
Net income ............................................................. $ 11,172 14,806 17,154
======== ======== ========
Coastal Financial Corporation
Condensed Statements of Cash Flows
Years ended September 30, 2003, 2004 and 2005
2003 2004 2005
-------- -------- --------
Operating activities:
Net income ........................................................... $ 11,172 14,806 17,154
Adjustments to reconcile net income to net cash provided
by operating activities:
Stock compensation related to accelerated vesting ................. -- -- 76
Equity in undistributed net income of subsidiary .................. (10,087) (13,063) (14,444)
(Increase) decrease in other assets ............................... (290) (624) (489)
Increase (decrease) in other liabilities .......................... 134 43 107
-------- -------- --------
Total cash provided by operating activities ................ 929 1,162 2,404
-------- -------- --------
Financing activities:
Cash dividends to stockholders ....................................... (2,592) (2,948) (3,361)
Treasury stock repurchases ........................................... (342) -- --
Proceeds from stock options .......................................... 1,153 1,273 1,309
Proceeds from trust preferred ........................................ 15,000 -- --
Repayment on line of credit .......................................... (1,988) (81) --
Capital contribution to subsidiary ................................... (12,125) (100) (150)
Other financing activities, net ...................................... -- 7 9
-------- -------- --------
Total cash used by financing activities .................... (894) (1,849) (2,193)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents ................. 35 (687) 211
Cash and cash equivalents at beginning of the year ................... 738 773 86
-------- -------- --------
Cash and cash equivalents at end of the years ........................ $ 773 86 297
======== ======== ========
35
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(23) CARRYING AMOUNTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and fair value of financial instruments as of
September 30, 2004 and 2005 are summarized below:
2004 2005
------------------------ ------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
---------- ---------- ---------- ----------
(In thousands)
Financial Assets
Cash and cash equivalents .................................... $ 31,015 31,015 $ 91,525 91,525
Investment securities available for sale ..................... 23,449 23,449 25,616 25,616
Mortgage-backed securities available for sale ................ 374,283 374,283 399,655 399,655
Investment securities held to maturity ....................... 7,840 7,840 10,000 10,049
Loans receivable held for sale ............................... 8,246 8,325 18,121 18,126
Loans receivable, net ........................................ 790,730 818,274 924,260 938,058
FHLB stock ................................................... 16,900 16,900 15,775 15,775
Bank-owned life insurance .................................... 21,267 21,267 22,574 22,574
Financial Liabilities
Deposits:
Demand accounts ........................................... 512,801 512,801 643,792 643,792
Certificate accounts ...................................... 240,578 241,133 427,126 426,482
Advances from Federal Home Loan Bank ......................... 328,507 333,612 289,007 286,993
Securities sold under agreements to repurchase
and reverse repurchase agreements ......................... 107,173 107,173 41,937 41,937
Junior subordinated debt ..................................... 15,464 15,464 15,464 15,464
Drafts outstanding ........................................... 2,792 2,792 12,890 12,890
SFAS 107, "Disclosures about Fair Value of Financial Instruments,"
requires disclosure of fair value information, whether or not recognized in the
statement of financial position, when it is practicable to estimate the fair
value. SFAS 107 defines a financial instrument as cash, evidence of an ownership
interest in an entity or contractual obligations, which require the exchange of
cash, or other financial instruments. Certain items are specifically excluded
from the disclosure requirements, including the Company's common stock, premises
and equipment, accrued interest receivable and payable, and other assets and
liabilities.
Fair value approximates book value for the following financial instruments
due to the short-term nature of the instrument: cash and due from banks,
interest-bearing bank balances, federal funds sold, federal funds purchased and
repurchase agreements (including reverse repurchase agreements), drafts
outstanding and other short-term borrowings. Investments and mortgage-backed
securities are valued using quoted market prices.
Fair value for variable rate loans and bank-owned life insurance that
reprice frequently is based on the carrying value. Fair values for mortgage
loans, consumer loans and all other loans (primarily commercial) which have
fixed rates of interest are based on the discounted present value of the
estimated future cash flows. Discount rates used in these computations
approximates the rates currently offered for similar loans of comparable terms
and credit quality.
Fair value for demand deposit accounts and interest-bearing accounts with
no fixed maturity date is equal to the carrying value. Certificate of deposit
accounts are estimated by discounting cash flows from expected maturities using
current interest rates on similar instruments.
Fair value for FHLB advances and fixed rate long-term debt is based on
discounted cash flows using the Company's current incremental borrowing rate.
The Company has used management's best estimate fair value based upon the
above assumptions. Therefore, the fair values presented may not be the amounts
which could be realized in an immediate sale or settlement of the instrument. In
addition, any income taxes or other expenses, which would be incurred in an
actual sale or settlement, are not taken into consideration in the fair values
presented.
The Company had $243.0 million of off-balance sheet financial commitments
as of September 30, 2005, which are commitments to originate loans, unused
consumer lines of credit, letters of credit and undisbursed portion of loans in
process. Since these obligations are based on current market rates, the carrying
amount is considered to be a reasonable estimate of fair value.
36
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements - Continued
(23) CARRYING AMOUNTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED
The Company originates certain fixed rate residential loans with the
intention of selling these loans. Between the time that the Company enters into
an interest rate lock or a commitment to originate a fixed rate residential loan
with a potential borrower and the time the closed loan is sold, the Company is
subject to variability in the market prices related to these commitments. The
Company believes that it is prudent to limit the variability of expected
proceeds from the sales through forward sales of "to be issued" mortgage backed
securities and loans ("forward sales commitments"). The commitment to originate
fixed rate residential loans and forward sales commitments are freestanding
derivative instruments. They do not generally qualify for hedge accounting
treatment so their fair value adjustments are recorded through the income
statement in net gains on sale of loans. The commitments to originate fixed rate
conforming loans totaled $4.8 million at September, 30 2005. The fair value of
these commitments was an asset of approximately $31,000 at September 30, 2005,
and is reflected in gain on sales of loans held for sale in the consolidated
statements of operations. The forward sales commitments totaled $10.0 million at
September 30, 2005. The fair value of these commitments was an asset of
approximately $77,000 at September 30, 2005, and is reflected in gain on sales
of loans held for sale in the consolidated statements of operations.
Fair value estimates are made at the dates indicated above, based on
relevant market information and information about the financial instrument.
These estimates do not reflect any premium or discount that could result from
offering for sale the Company's entire holdings of a particular financial
instrument. Because no active market exists for a significant portion of the
Company's financial instruments, fair value estimates are based on judgments
regarding future expected loss experience, current economic conditions, current
interest rates and prepayment trends, risk characteristics of various financial
instruments, and other factors. These estimates are subjective in nature and
involve uncertainties and matters of significant judgment and therefore cannot
be determined with precision. Changes in any of these assumptions used in
calculating fair value would also significantly affect the estimates. Changes in
market interest rates and prepayment assumptions could significantly change the
fair value.
Fair value estimates are based on existing on and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. For example, the Company has significant assets and
liabilities that are not considered financial assets or liabilities including
deposit franchise value, loan servicing portfolio, real estate, deferred tax
liabilities, premises and equipment, and goodwill. In addition, the tax
ramifications related to the realization of the unrealized gains and losses can
have a significant effect on fair value estimates and have not been considered
in any of these estimates.
(24) COMMITMENTS, CONTINGENCIES AND OTHER
The Company signed a letter of intent to lease approximately 5.5 acres of
land and building with an initial term of 20 years. Aggregate lease payments
during the initial term approximate $5.4 million. In addition, the Company has
the option to purchase this land and building after the first year for
approximately $2.8 million. The lease with purchase option is expected to close
during the first quarter of fiscal 2006.
The Company paid a $50,000 deposit to purchase a tract of land. The final
purchase price will be $19.00 per square foot purchased - estimated between $1.1
and $1.2 million. This transaction is expected to close during the first fiscal
quarter of 2006.
The Company has entered into a land lease for a new branch, expected to
close during the first fiscal quarter of 2006. Lease payments aggregate $2.6
million for the initial term of 30 years with six five-year renewal options.
Lease payments during the renewal periods aggregate $5.9 million.
The Company has entered into various construction contracts to build new
branches and build out leased facilities. At September 30, 2005 the undisbursed
future obligations under these signed contracts approximated $682,000.
The Company has an unsecured unused short-term line of credit to purchase
federal funds from an unrelated bank totaling $20.0 million. This line of credit
expires January 1, 2006.
37
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis
Forward Looking Statements
This report may contain certain "forward-looking statements" within the
meaning of Section 27A of the Securities Exchange Act of 1934, as amended, that
represent the Company's expectations or beliefs concerning future events. All
forward-looking statements are based on assumptions and involve risks and
uncertainties, many of which are beyond the Company's control and which may
cause its actual results, performance or achievements to differ materially from
the results, performance or achievements contemplated by the forward-looking
statements. Forward-looking statements can be identified by the fact that they
do not relate strictly to historical or current facts. They often include words
such as "believe," "expect," "anticipate," "intend," "plan," "estimate" or words
of similar meaning, or future or conditional verbs such as "will," "would,"
"should," "could" or "may." Forward-looking statements speak only as of the date
they are made. Such risks and uncertainties include, among other things:
o Competitive pressures among depository and other financial
institutions in the Company's market areas may increase
significantly.
o Adverse changes in the economy or business conditions, either
nationally or in the Company's market areas, could increase
credit-related losses and expenses and/or limit growth
o Increases in defaults by borrowers and other delinquencies could
result in increases in the Company's provision for losses on loans
and related expenses.
o The Company's inability to manage growth effectively, including the
successful expansion of the Company's Customer support,
administrative infrastructure and internal management systems, could
adversely affect the Company's results of operations and prospects.
o Fluctuations in interest rates and market prices could reduce the
Company's net interest margin and asset valuations and increase
expenses.
o The consequences of continued bank acquisitions and mergers in the
Company's market areas, resulting in fewer but much larger and
financially stronger competitors, could increase competition for
financial services to the Company's detriment.
o The Company's continued growth will depend in part on its ability to
enter new markets successfully and capitalize on other growth
opportunities.
o Changes in legislative or regulatory requirements, or actions by the
Securities and Exchange Commission ("SEC"), the Financial Accounting
Standards Board ("FASB"), or the Public Company Accounting Oversight
Board, applicable to the Company and its subsidiaries could increase
costs, limit certain operations and adversely affect results of
operations.
o Changes in tax requirements, including tax rate changes, new tax
laws and revised tax law interpretations may increase the Company's
tax expense or adversely affect its Customers' businesses.
o Company initiatives now in place or introduced in the future, not
producing results consistent with historic growth rates or results
which justify their costs.
In light of these risks, uncertainties and assumptions, you should not
place undue reliance on any forward-looking statements in this report. Except as
may be required by applicable law or regulation, the Company undertakes no
obligation to publicly update or otherwise revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
Overview
Coastal Financial Corporation is a unitary thrift holding company
incorporated in Delaware with one wholly-owned banking subsidiary, Coastal
Federal Bank (the "Bank" or "Coastal Federal"). The Company also owns Coastal
Planners Holding Corporation, whose subsidiary, Coastal Retirement, Estate and
Tax Planners, Inc., offers fee-based financial planning and tax preparation
services. The primary business activities of the Company are conducted by the
Bank. The Company and Bank's principal executive offices are located in Myrtle
Beach, South Carolina.
Coastal Federal Bank is a full service financial services company with 21
branches located in four counties throughout the coastal regions of South
Carolina and North Carolina. The Bank has thirteen offices in Horry County,
South Carolina; one office in Georgetown County, South Carolina; four offices in
Brunswick County, North Carolina; and three offices in New Hanover County, North
Carolina.
The Bank's primary market areas are located along the coastal regions of
South Carolina and North Carolina and predominately center around the Metro
regions of Myrtle Beach, South Carolina and Wilmington, North Carolina, and
their surrounding counties.
38
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis - Continued
Coastal Federal's primary market is Horry County, South Carolina, where the Bank
has the number one market share of deposits as of June 30, 2005 (the most recent
date for which published data is available) with 17.9% of deposits as reported
by the FDIC Summary of Deposits Report. The Bank also has the third highest
market share of deposits as of June 30, 2005 in Brunswick County, North
Carolina, with 8.1% of deposits as reported by the FDIC Summary of Deposits
Report.
The primary business activities in Horry County are centered around the
tourism industry. To the extent that Horry County businesses rely heavily on
tourism business, decreased tourism would have a significant adverse effect on
Coastal Federal's primary deposit base and lending area. Moreover, the Bank
would likely experience a higher degree of loan delinquencies should the local
economy be materially and adversely affected.
Coastal Federal's principal business consists of attracting core deposits
from Customers in its primary market locations and using these funds to meet the
lending needs of its Customers as well as providing numerous financial products
and services for its Customers.
Through its branch locations, the Bank provides a wide range of banking
products, including interest-bearing and non-interest bearing checking accounts;
business sweep accounts; business cash management services; statement savings
accounts; money market accounts; certificate of deposit accounts; individual
retirement accounts; merchant services; commercial, business, personal, real
estate, residential mortgage and home equity loans; safe deposit boxes; and
electronic banking services. The Bank has six ATMs at off-site locations and an
ATM at each branch. The Bank also makes available a wide range of financial
products through its relationship with Raymond James Financial Services,
including stocks, bonds, mutual funds, annuities, insurance, and retirement
products.
In the fourth fiscal quarter of 2004, the Bank began two significant new
initiatives. The first was "The Experience of FANtastic! Customer Service". This
initiative focuses on Customer service and convenience. The Bank is in the
process of redesigning its infrastructure, software and products to improve
Customer service and convenience and Associate productivity. In addition, in
order to improve Customer service and convenience, the Bank added an
extended-hours Call Center and introduced "6 Day Branch Banking" with extended
operating hours. The Call Center employs approximately 20 Associates. The Bank
experienced increased salary and benefit expenses in fiscal 2005 and anticipates
these expenses continuing thereafter associated with the hiring, training and
placement of these new Associates.
The second initiative was "The Carolinas' Best Totally Free Checking With
A Gift" that was introduced in September 2004. The Bank has incurred, and will
continue to incur, significant marketing costs associated with this campaign. In
fiscal 2005, marketing expenses were $1.8 million compared to $905,000 in the
comparable 2004 period. The Bank expects to realize significant benefits from
this strategy consisting of increased Bank lobby traffic, increased number of
personal checking accounts and higher fee income as a result of those checking
accounts. In fiscal 2005, checking account balances grew approximately 54%. This
rate of growth could necessitate the hiring of additional Associates to open and
service these accounts. The Associates being hired for these two initiatives are
expected to have total compensation averaging between $28,000 and $35,000 per
Associate.
In fiscal 2006, the Company plans to open six new branches; five locations
in South Carolina and one location in North Carolina. The Oak Island branch is
located in North Carolina and has opened in the first quarter of fiscal 2006
along with one of the branches located in South Carolina. One branch is
scheduled to open in the second fiscal quarter, two branches are scheduled to
open in the third fiscal quarter and the last planned location is scheduled to
open in the fourth fiscal quarter. It is anticipated that each location will
employ six to eight Associates. As a result of this growth, the Company expects
to incur an increase in salaries and employee benefit expenses, occupancy,
furniture and fixtures and data processing expenses, depreciation expense and
marketing expenses.
Critical Accounting Policies
The Company's significant accounting policies are set forth in Note 1 of
the Notes to Consolidated Financial Statements. Of these policies, the Company
considers the allowance for loan losses and the income taxes to be the most
critical accounting policies, because they require many of management's most
subjective and complex judgments. For additional discussion concerning the
Company's allowance for loan losses and related matters, see "Allowance for Loan
Losses" and see "Income Taxes" for additional discussion concerning income
taxes.
General
The Company reported $17.2 million in net income for the year ended
September 30, 2005, compared to $14.8 million for the year ended September 30,
2004. Net interest income increased $6.5 million as a result of increased
interest income of $12.8 million offset by an increase of $6.2 million in
interest expense. Provision for loan losses decreased slightly from $1.8 million
for the year
39
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis - Continued
ended September 30, 2004, to $1.7 million for the year ended September 30, 2005.
Other income increased 36.6% from $9.2 million in fiscal 2004, to $12.5 million
in 2005. General and administrative expenses increased $6.3 million, or 22.9%,
for fiscal 2005 as compared to fiscal 2004.
Total assets increased from $1.3 billion at September 30, 2004 to $1.5
billion at September 30, 2005, or 18.3%. Liquid assets, consisting of cash,
interest-bearing deposits, and securities, increased from $436.6 million at
September 30, 2004, to $526.8 million at September 30, 2005. Loans receivable
increased 16.9% from $790.7 million at September 30, 2004, to $924.3 million at
September 30, 2005. Total loan originations for fiscal 2005 were $799.7 million
as compared to $577.3 million for fiscal 2004.
The growth in liquid assets was funded by increased deposits of $317.5
million offset by decreased advances from the Federal Home Loan Bank ("FHLB") of
Atlanta of $39.5 million. As a result of an increased number of branches and a
strong emphasis on growing local deposits during fiscal 2005, deposits increased
42.1% from $753.4 million at September 30, 2004, to $1.1 billion at September
30, 2005. During this same period, noninterest bearing checking accounts and NOW
accounts increased $125.7 million, money market checking accounts decreased
$11.4 million, statement savings accounts increased $16.6 million and
certificate accounts increased $186.5 million. The increase in certificate
accounts is primarily related to brokered CDs of $169.9 million at September 30,
2005. There were no brokered CDs at September 30, 2004.
As a result of $17.2 million in net earnings, proceeds from the exercise
of stock options of approximately $1.3 million, less the cash dividends paid to
stockholders of approximately $3.4 million, and the net change in unrealized
gain (loss) on securities available for sale, net of income tax of $3.3 million,
stockholders' equity increased from $85.3 million at September 30, 2004 to $97.2
million at September 30, 2005.
Liquidity and Capital Resources
Historically, the Company has maintained its liquidity at levels believed
by management to be adequate to meet requirements of normal operations,
potential deposit outflows and strong loan demand and still allow for optimal
investment of funds and return on assets. The following table summarizes future
contractual obligations as of September 30, 2005.
Payment Due by Period
-------------------------------------------------------------
Less than 1-3 4-5 After 5
Total 1 Year Years Years Years
--------- --------- --------- --------- ---------
Contractual Obligations (Dollars in thousands)
Time deposits ......................................... $ 427,126 $ 392,731 $ 31,221 $ 2,479 $ 695
Short-term borrowings ................................. 36,114 36,114 -- -- --
Long-term debt ........................................ 310,294 -- 7,537 95,454 207,303
Construction contracts ................................ 682 682 -- -- --
Operating leases ...................................... 1,012 286 389 122 215
--------- --------- --------- --------- ---------
Total contractual cash obligations .................... $ 775,228 $ 429,813 $ 39,147 $ 98,055 $ 208,213
========= ========= ========= ========= =========
The Company has entered into various purchase and lease commitments. See
Note 24 for information regarding these commitments.
The principal sources of cash flows for the Company consist mainly of
mortgage, consumer and commercial loan payments, retail customer deposits,
repurchase agreements securitized by mortgage-backed securities and advances
from the FHLB of Atlanta.
The principal use of cash flows is the origination of loans receivable.
The Company originated loans receivable of $769.6 million, $577.3 million and
$799.7 million for the years ended September 30, 2003, 2004 and 2005,
respectively. A large portion of these loan originations were financed through
loan principal repayments which amounted to $477.7 million, $403.5 million and
$560.5 million for the years ended September 30, 2003, 2004 and 2005,
respectively. In addition, the Company has generally sold conforming fixed rate
mortgage loans, primarily servicing retained, to correspondent financial
institutions in the secondary market to finance future loan originations. For
the years ended September 30, 2003, 2004 and 2005, the Company sold residential
loans amounting to $45.4 million, $27.5 million and $18.7 million, respectively.
During fiscal 2005, the Company sold commercial loan participations totaling
$21.2 million. The Company sold no commercial loan participations in fiscal 2003
or 2004.
During fiscal 2005, the Company securitized $52.6 million of mortgage
loans, concurrently sold these mortgage-backed securities to outside third
parties and recognized a net gain on sale of $1.0 million, which included
$690,000 related to mortgage servicing rights. The gain is included in gains on
sales of loans held for sale in the consolidated statement of operations. The
proceeds from sale are included in proceeds from sales of mortgage-backed
securities available for sale in the consolidated statement of cash flows. The
Company has no retained interest in the securities that were sold other than the
servicing rights.
In fiscal 2005 deposits increased from $753.4 million at September 30,
2004, to $1.1 billion at September 30, 2005. During fiscal
40
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis - Continued
2004 and 2005, the Company has placed significant emphasis on growth in checking
accounts. As a result, Core Deposits (defined as transaction and statement
savings accounts) increased $131.0 million or 25.5%. This was accompanied by a
$186.5 million increase in certificate accounts of which $169.9 million of the
increase is from brokered CDs.
At September 30, 2005, the Company had commitments to originate $28.6
million in loans, disburse $28.3 million in mortgage loans, and $186.0 million
in unused lines of credit, which the Company expects to fund from normal
operations. Traditionally, a significant portion of the unused lines of credit
may never be used by the Customer.
At September 30, 2005, the Company had $392.7 million of certificates of
deposit, including $169.9 million of brokered CDs, which were due to mature
within one year. Based upon previous experience, the Company believes that a
major portion of these certificates, excluding the brokered CDs, will be
redeposited. At September 30, 2005, the Company had excess collateral pledged to
the FHLB which would support additional FHLB advance borrowings of $73.5
million. Additionally, 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.
As a condition of deposit insurance, OTS regulations require that the Bank
calculate and maintain a minimum regulatory capital requirement on a quarterly
basis and satisfy such requirement at the calculation date and throughout the
ensuing quarter. The Bank's tangible and core capital approximated $112.1
million at September 30, 2005, exceeding the Bank's tangible and core capital
requirements by $88.9 million and $50.2 million, respectively. At September 30,
2005, the Bank's capital exceeded its current risk-based minimum capital
requirement by $48.8 million. The risk-based capital requirement may increase in
the future. Also see Note 14 of the Notes to Consolidated Financial Statements.
Results of Operations
Comparison of the Years Ended September 30, 2004 and 2005
Interest Income
Interest income for the year ended September 30, 2005, increased to $78.6
million as compared to $65.8 million for the year ended September 30, 2004. The
earning asset yield for the year ended September 30, 2005, was 5.94% compared to
a yield of 5.67% for the year ended September 30, 2004. The average yield on
loans receivable for the year ended September 30, 2005, was 6.50% compared to
6.17% for the year ended September 30, 2004. The increased yield on loans is
primarily due to the increased yield on commercial loans with interest rates
tied to the prime lending rate. The prime rate was 6.75% at September 30, 2005,
compared to 4.75% at September 30, 2004. The yield on investments increased to
4.84% for the year ended September 30, 2005, from 4.72% for the year ended
September 30, 2004. Total average interest-earning assets were $1.3 billion for
the year ended September 30, 2005 as compared to $1.2 billion for the year ended
September 30, 2004. The increase in average interest-earning assets is primarily
due to an increase in average loans receivable of approximately $116.2 million
resulting primarily from growth in the commercial loan portfolio. Average
investment securities, mortgage-backed securities and other interest-earning
assets increased $45.8 million, primarily funded by borrowings, including
brokered CD's.
Interest Expense
Interest expense on interest-bearing liabilities was $29.7 million for the
year ended September 30, 2005, as compared to $23.5 million for the year ended
September 30, 2004. The average cost of deposits for the year ended September
30, 2005, was 1.58% compared to 1.39% for the year ended September 30, 2004. The
cost of interest-bearing liabilities was 2.24% for the year ended September 30,
2005 compared to 2.03% for the year ended September 30, 2004. The cost of FHLB
advances, reverse repurchase agreements and other borrowings was 3.83%, 2.37%
and 5.95%, respectively, for the year ended September 30, 2005. For the year
ended September 30, 2004, the cost of FHLB advances, reverse repurchase
agreements and other borrowings was 3.81%, 1.50% and 4.41%, respectively. The
increased cost of funds on other borrowings is due to the increased short-term
interest rates. At September 30, 2005, the federal funds rate was 3.93% compared
to 1.94% at September 30, 2004. Total average interest-bearing liabilities
increased from $1.2 billion at September 30, 2004 to $1.3 billion at September
30, 2005. The increase in average interest-bearing liabilities is due to an
increase in average deposits of approximately $171.9 million as a result of the
Company's focus on checking growth, increased average FHLB advances of $40.7
million used to fund loan and investment securities growth and increased average
Customer repurchase agreements of $18.5 million. Included in increased average
deposits, were brokered CD's which increased by $79.4 million in average
balances when comparing the two periods. This increase was partially offset by a
decrease in average reverse repurchase agreements of $61.1 million.
41
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis - Continued
Net Interest Income
Net interest income was $48.8 million for the year ended September 30,
2005, as compared to $42.3 million for the year ended September 30, 2004. The
net interest margin was 3.70% for the year ended September 30, 2005, compared to
3.64% for the year ended September 30, 2004.
The following table summarizes the average balance sheet and the related
yields on interest-earning assets and deposits and borrowings for the year ended
September 30, 2004 and 2005 (Dollars in thousands):
2004 2005
------------------------------------ -------------------------------------
Average Income/ Average Income/
Balance (1) Expense Yield/Rate Balance (1) Expense Yield/Rate
----------- ------- ---------- ----------- ------- ----------
Assets
Earning assets
Loans (2) ...................................... $ 757,633 $ 46,765 6.17% $ 873,797 $ 56,826 6.50%
Investment securities,
MBS securities and others (3) ................ 403,610 19,040 4.72% 449,402 21,732 4.84%
---------- ---------- ---------- ----------
Total earning assets ............................. $1,161,243 $ 65,805 5.67% $1,323,199 $ 78,558 5.94%
========== ---------- ========== ----------
Liabilities
Deposits ....................................... $ 719,125 $ 10,024 1.39% $ 890,992 $ 14,079 1.58%
Borrowings ..................................... 440,279 13,500 3.07% 438,329 15,651 3.57%
---------- ---------- ---------- ----------
Total interest-bearing liabilities ............... $1,159,404 $ 23,524 2.03% $1,329,321 $ 29,730 2.24%
========== ---------- ========== ----------
Net interest income .............................. $ 42,281 $ 48,828
========== ==========
Net interest margin .............................. 3.64% 3.70%
Net yield on earning assets ...................... 3.64% 3.69%
(1) The average balances are derived from monthly balances.
(2) Nonaccrual loans are included in average balances for yield
computations.
(3) Investment securities include taxable and tax-exempt securities. Net
interest income has not been adjusted to produce a tax-equivalent
yield.
Provision for Loan Losses
The Company's provision for loan losses decreased slightly from $1.8
million for the year ended September 30, 2004, to $1.7 million for the year
ended September 30, 2005 primarily due to the risk factors related to the
underlying portfolio. The allowance for loan losses as a percentage of loans was
1.25% at September 30, 2005 as compared to 1.39% at September 30, 2004. Loans
delinquent 90 days or more were $2.6 million or 0.28% of total loans at
September 30, 2005, compared to $5.9 million or 0.73% of total loans at
September 30, 2004. The allowance for loan losses was 445% of loans delinquent
90 days or more at September 30, 2005, compared to 189% at September 30, 2004.
Net charge-offs for the year ended September 30, 2005 were $1.0 million compared
to $505,000 for the year ended September 30, 2004. Included in charge-offs for
the year ended September 30, 2005 were two loans totaling $196,000 guaranteed by
the Small Business Administration (SBA). The SBA has denied the guarantee. The
Bank is appealing this decision. Management believes that the level of the
allowance for loan losses at September 30, 2005 is adequate considering the
composition of the loan portfolio, the portfolio's loss experience, delinquency
trends, current regional and local economic conditions and other factors at that
date.
Other Income
For the year ended September 30, 2005, other income was $12.5 million
compared to $9.2 million for the year ended September 30, 2004. Fees and service
charges from deposit accounts increased $2.4 million or 62.7% to $6.1 million
for the year ended September 30, 2005, compared to $3.8 million for the year
ended September 30, 2004. The majority of this increase is due to fee income
from increased number of personal checking accounts. In fiscal 2005, checking
account balances grew approximately 54%. During the year ended September 30,
2004, the Company securitized and concurrently sold $46.8 million of mortgage
loans compared
42
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis - Continued
to $52.6 million for the year ended September 30, 2005. Gain on sale of loans
was $1.2 million for the year ended September 30, 2005, compared to $1.5 million
for the year ended September 30, 2004. Losses on sales of securities available
for sale were $485,000 for the year ended September 30, 2005, compared to losses
of $1.1 million for the year ended September 30, 2004. In addition, the Company
had a gain on call of an investment security held to maturity called by the
issuer of $160,000 for the year ended September 30, 2005 and $0 for the year
ended September 30, 2004. Due to the increase in checking accounts, income from
ATM and debit card transactions increased 60.6% from $954,000 in fiscal 2004 to
$1.5 million in fiscal 2005.
General and Administrative Expenses
General and administrative expenses were $33.5 million for the year ended
September 30, 2005 compared to $27.3 million for the year ended September 30,
2004. Salaries and employee benefits were $18.5 million for the year ended
September 30, 2005, as compared to $16.1 million for the year ended September
30, 2004, an increase of 14.7%, primarily due to an increase in the number of
banking Associates in business banking, Associates in the Company's expanded
hours call center, Associates in new branches and normal salary increases. The
Company has added several Associates in a Banking Group that is focused on
growing small to medium sized business banking relationships. Also, as a result
of new branches, equipment purchased to improve Customer convenience and
increased checking activity, net occupancy, furniture and fixtures and data
processing expenses increased $843,000 and depreciation expense increased
$582,000, when comparing the two periods. Marketing expenses were $905,000 for
the year ended September 30, 2004, compared to $1.8 million for the year ended
September 30, 2005. This is primarily attributed to the Bank's "The Carolinas'
Best Totally Free Checking With A Gift" initiative; introduction of Penny
Pavilion, the Bank's free coin counting service; marketing of the Bank's
expanded banking hours, including Saturday banking at all Bank branches; and
marketing of the Bank's new branch in Wilmington, NC. The Bank's "The Carolinas'
Best Totally Free Checking With A Gift" promotion involves significant direct
mail advertising as well as direct media advertising. Expenses related to ATM
and debit card transactions increased $409,000 or 64.9% when comparing fiscal
2004 to 2005. Other expense was $3.3 million for the year ended September 30,
2004 compared to $4.5 million for the year ended September 30, 2005. Other
expense increased due to loss on write-off of signage related to the Bank's
re-branding efforts in conjunction with the initiation of "6 Day Branch Banking"
of $122,000, increased costs incurred related to compliance with Sarbanes-Oxley
of $428,000 and increased deposit account losses of $370,000. The increase in
net deposit losses is directly attributed to the increased number of personal
checking accounts.
Income Taxes
Income taxes were $7.6 million for the year ended September 30, 2004
compared to $9.0 million for the year ended September 30, 2005. The effective
income tax rate as a percentage of pretax income was 34.0% and 34.4% for the
years ended September 30, 2004 and 2005, respectively. The effective income tax
rate differs from the statutory rate primarily due to income generated by
bank-owned life insurance, municipal securities that are exempt from federal and
certain state taxes, and the increase in the current fiscal year earnings over
the comparable prior year earnings that are subject to higher incremental tax
rates. The Company's effective income tax rates take into consideration certain
assumptions and estimates made by management. No assurance can be given that
either the tax returns submitted by management or the income tax reported on the
consolidated financial statements will not be adjusted by either adverse rulings
by the U.S. Tax court, changes in the tax code, or assessments made by the
Internal Revenue Service. The Company is subject to potential adverse
adjustments, including but not limited to: an increase in the statutory federal
or state income tax rates, the permanent non-deductibility of amounts currently
considered deductible either now or in future periods, and the dependency on the
generation of future taxable income, in order to ultimately realize deferred
income tax assets.
Results of Operations
Comparison of the Years Ended September 30, 2003 and 2004
Interest Income
Despite a reduction in the average yield, the Company's growth in average
interest earning assets of 17.6% resulted in an increase in interest income for
the year ended September 30, 2004, of $6.6 million to $65.8 million, or 11.1% as
compared to $59.2 million for the year ended September 30, 2003. The earning
asset yield for the year ended September 30, 2004, was 5.67% compared to 6.00%
for the year ended September 30, 2003. As a result of significant declining
interest rates over much of the previous two years, the Bank's yield on assets
and cost of funds has declined. Interest rates have very recently begun to
increase. At September 30, 2002, 2003 and 2004, the one-year treasury rate of
interest was approximately 1.68%, 1.22% and 2.14%, respectively. At September
30, 2002, 2003 and 2004, the prime rate of interest was approximately 4.75%,
4.00% and 4.75%, respectively. On July 1, 2004, the prime rate was increased to
4.25% and on September 22, 2004, the prime rate was increased to 4.75%. The
average yield on loans receivable for the year ended September 30, 2004, was
6.17% compared to 6.66% for year ended September 30, 2003. The yield on
investments decreased to 4.73% for the year ended September 30, 2004, from 4.88%
for the year ended September 30, 2003. The yield on investments has declined due
to payoff of higher yielding mortgage-backed securities (MBS) resulting from
significant
43
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis - Continued
prepayments during fiscal 2003. These higher yielding MBS were replaced with
lower yielding MBS. Total average interest-earning assets were $1.2 billion for
the year ended September 30, 2004 as compared to $987.5 million for the year
ended September 30, 2003. The increase in average interest-earning assets is
primarily due to an increase in average loans receivable of approximately $127.8
million and investment securities of approximately $50.1 million.
Interest Expense
Interest expense on interest-bearing liabilities was $23.5 million for the
year ended September 30, 2004, as compared to $23.0 million for the year ended
September 30, 2003. The average cost of deposits for the year ended September
30, 2004, was 1.39% compared to 1.79% for the year ended September 30, 2003. The
cost of interest-bearing liabilities was 2.03% for the year ended September 30,
2004, as compared to 2.34% for the year ended September 30, 2003. The cost of
FHLB advances, other borrowings and reverse repurchase agreements was 3.81%,
4.41% and 1.50%, respectively, for the year ended September 30, 2004. For the
year ended September 30, 2003, the cost of FHLB advances, other borrowings and
reverse repurchase agreements was 4.27%, 5.62% and 1.81%, respectively. Total
average interest-bearing liabilities increased from $982.7 million at September
30, 2003 to $1.2 billion at September 30, 2004. The increase in average
interest-bearing liabilities is due to an increase in average deposits of
approximately $50.0 million. This was accompanied by an increase in average
reverse repurchase agreements of $42.3 million, average FHLB advances of $68.9
million and average outstanding debt associated with trust preferred securities
of $11.2 million.
Net Interest Income
Net interest income was $42.3 million for the year ended September 30,
2004, as compared to $36.2 million for the year ended September 30, 2003. With
the reduction in interest rates over the last two years, the Bank continued to
experience a decrease in its net interest margin through December 31, 2003.
However, as rates stabilized over spring 2004, the Bank's net interest margin
declined at a much slower pace and actually increased slightly in the most
recent two quarters. The net interest margin for the quarters ended March 31,
2003, June 30, 2003, September 30, 2003, December 31, 2003, March 31, 2004, June
30, 2004 and September 30, 2004 was 3.87%, 3.61%, 3.65%, 3.48%, 3.58%, 3.63% and
3.81% respectively. For the year ended September 30, 2004, the net interest
margin was 3.64%.
Throughout the latter part of fiscal 2004, intermediate interest rates
have increased. From September 30, 2003 to September 30, 2004, the two year
treasury increased 116 basis points and the five year treasury increased 56
basis points. Management believes that over time this increase in intermediate
term interest rates should slow the refinancing of loans at lower rates. Based
upon the most recent information available, management believes that its net
interest margin should remain stable and could increase slightly if short-term
rates rise commensurately with long-term rates. Projection of the impact of
interest rates on the Bank's net interest margin is often imprecise due to the
fact that short-term and long-term interest rates often move very differently.
Provision for Loan Losses
The Company's provision for loan losses decreased from $2.7 million for
fiscal 2003 to $1.8 million for fiscal 2004 due to the nature and the risk
profile of the loans delinquent 90 days or more at September 30, 2004 as
compared to September 30, 2003. The allowance for loan losses as a percentage of
loans was 1.39% at September 30, 2004 compared to 1.40% at September 30, 2003.
Loans delinquent 90 days or more were $5.9 million or 0.73% of total loans at
September 30, 2004, compared to $7.4 million or 1.06% at September 30, 2003. The
allowance for loan losses was 189% of loans delinquent 90 days or more at
September 30, 2004, compared to 132% at September 30, 2003. Net charge-offs for
the year ended September 30, 2004 were $505,000 compared to $706,000 for the
year ended September 30, 2003. Net charge-offs were lower in 2004 due to
increased loss recoveries of $249,000 in 2004 versus $136,000 in 2003.
Management believes that the current level of the allowance for loan losses is
adequate considering the composition of the loan portfolio, the portfolio's loss
experience, delinquency trends, current regional and local economic conditions
and other factors. Also see "Non-performing Assets" and "Allowance for Loan
Losses."
Other Income
In fiscal 2004, total other income decreased from $10.9 million for the
period ended September 30, 2003, to $9.2 million for the period ended September
30, 2004. As a result of increased transaction account balances of $390.4
million at September 30, 2003 compared to $457.6 million at September 30, 2004,
fees and service charges on loan and deposit accounts were $3.8 million for
fiscal 2004, compared to $3.5 million for fiscal 2003. As a result of rising
interest rates which decreased refinancing activity, gain on sale of loans was
$1.5 million for the year ended September 30, 2004, compared to $3.0 million for
the year ended September 30, 2003. Loss on sales of securities, net was $1.1
million for fiscal 2004, compared to gains of $469,000 for fiscal 2003. Other
income increased from $2.4 million for the year ended September 30, 2003, to
$2.6 million for the year ended September 30, 2004. This increase is primarily
due to increased income of $298,000 on bank-owned life insurance when comparing
the two periods.
44
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis - Continued
General and Administrative Expenses
General and administrative expenses were $27.3 million for fiscal 2004 as
compared to $27.2 million for fiscal 2003. Salaries and employee benefits
increased to $16.1 million for fiscal 2004 as compared to $13.5 million for
fiscal 2003, or 19.7%. This is primarily due to the addition of new branches,
additional business banking Associates and increased expense related to
commission from the sale of non-depository products. The Company employed 354
Associates at September 30, 2004 compared to 303 Associates at September 30,
2003. Also as a result of new branches, net occupancy, furniture and fixtures
and data processing expense increased $259,000 for fiscal 2004, as compared to
fiscal 2003. Prepayment penalties on FHLB advances were $77,000 for fiscal 2004,
compared to $2.8 million for fiscal 2003. Other expenses decreased slightly from
$4.9 million in fiscal 2003 to $4.8 million in fiscal 2004. Other expenses
included $162,000 of mortgage servicing rights impairment recovery for fiscal
2004 compared to $461,000 of mortgage servicing rights impairment for fiscal
2003.
Income Taxes
Income taxes increased from $6.1 million in fiscal 2003 to $7.6 million in
fiscal 2004 as a result of increased earnings before income taxes.
The effective income tax rate as a percentage of pretax income was 34.0%
in fiscal 2004 and 35.5% in fiscal 2003. The effective income tax rate declined
in connection with an increase in investment interest income generated by
bank-owned life insurance and municipal securities that are exempt from federal
and certain state taxes.
The Company's effective income tax rates take into consideration certain
assumptions and estimates made by management. No assurance can be given that
either the tax returns submitted by management or the income tax reported on the
consolidated financial statements will not be adjusted by either adverse rulings
by the U.S. Tax court, changes in the tax code, or assessments made by the
Internal Revenue Service. The Company is subject to potential adverse
adjustments, including but not limited to: an increase in the statutory federal
or state income tax rates, the permanent nondeductibility of amounts currently
considered deductible either now or in future periods, and the dependency on the
generation of future taxable income, in order to ultimately realize deferred
income tax assets. Income tax returns for 2001 and subsequent years are exposed
to examination by taxing authorities.
Non-performing Assets
Non-performing assets were $3.5 million at September 30, 2005 compared to
$6.6 million at September 30, 2004. Loans past due 90 days or more decreased
from $5.9 million at September 30, 2004, to $2.6 million at September 30, 2005.
Real estate acquired through foreclosure increased slightly from $785,000 at
September 30, 2004, to $818,000 at September 30, 2005.
At September 30, 2004, impaired loans totaled $3.3 million. There were
$2.6 million in impaired loans at September 30, 2005. Included in the allowance
for loan losses at September 30, 2004 was $359,000 related to impaired loans
compared to $434,000 at September 30, 2005. The average recorded investment in
impaired loans for the year ended September 30, 2004 was $3.9 million compared
to $3.7 million for the year ended September 30, 2005. Interest income
recognized on impaired loans in fiscal 2004 was $607,000. Interest income
recognized on impaired loans in fiscal 2005 was $292,000. This decrease is
primarily due to a commercial loan that was placed in nonaccrual status in a
prior fiscal year. The loan paid off in the fourth fiscal quarter of 2004. As a
result, in fiscal 2004 the Company recognized approximately $330,000 of interest
which had been previously reserved.
Loans are reviewed on a regular basis and an allowance for uncollectible
interest is established on loans where collection is questionable, generally
when such loans become 90 days delinquent. Loan balances for which interest
amounts have been reserved and all loans more than 90 days delinquent are placed
on nonaccrual status. Typically, payments received on a nonaccrual loan are
applied to the outstanding principal or recognized as interest based upon the
collectability of the loan as determined by management.
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 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
45
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis - Continued
changes in current portfolio characteristics. Historical loss ratios are
calculated by product type for consumer loans (installment and revolving),
mortgage loans, and commercial loans and may be adjusted for other risk factors.
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.
Certain non-performing 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 we believe 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 the Company to adjust the allowance based on information available
to them at the time of their examination.
The Company established provisions for loan losses for the years ended
September 30, 2003, 2004 and 2005, of $2.7 million, $1.8 million and $1.7
million, respectively. For the years ended September 30, 2003, 2004 and 2005,
the Company had net charge-offs of $706,000, $505,000 and $1.0 million,
respectively. Net charge-offs as a percentage of average outstanding loans were
..11%, .07%, and .12% for fiscal years ended 2003, 2004 and 2005, respectively.
At September 30, 2005, the Company had an allowance for loan losses of $11.7
million, which was 1.25% of net loans.
Off-Balance Sheet Arrangements
In the normal course of operations, the Company engages in a variety of
financial transactions that, in accordance with generally accepted accounting
principles, are not recorded in the financial statements, or are recorded in
amounts that differ from the notional amounts. These transactions involve, to
varying degrees, elements of credit, interest rate, and liquidity risk. Such
transactions are used by the Company for general corporate purposes or for
Customer needs. Corporate purpose transactions are used to help manage credit,
interest rate, and liquidity risk or to optimize capital. Customer transactions
are used to manage Customers' requests for funding.
The Company's off-balance sheet arrangements, which principally include
lending commitments and derivatives are described below.
Lending Commitments. Lending commitments include loan commitments, standby
letters of credit and unused business and personal credit card lines. These
instruments are not recorded in the consolidated statements of financial
condition until funds are advanced under the commitments. The Company provides
these lending commitments to Customers in the normal course of business.
Loan commitments for residential housing and land totaled $28.6 million.
For retail Customers, loan commitments are generally lines of credit secured by
residential property. At September 30, 2005 retail loan commitments totaled
$47.9 million. Standby letters of credit are conditional commitments to
guarantee performance, typically contract or financial integrity, of a Customer
to a third party and totaled $5.8 million at September 30, 2005. Commercial
lines of credit and unused business and personal credit card lines, which
totaled $132.3 million at September 30, 2005, are generally for short-term
borrowings.
46
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis - Continued
The Company applies essentially the same credit policies and standards as
it does in the lending process when making these commitments.
Derivatives. In accordance with SFAS No. 133, the Company records
derivatives at fair value, as either assets or liabilities, on the consolidated
balance sheet. Derivative transactions are measured in terms of the notional
amount, but this amount is not recorded on the balance sheet and is not, when
viewed in isolation, a meaningful measure of the risk profile of the instrument.
The notional amount is not exchanged, but is used only as the basis upon which
interest and other payments are calculated.
At September 30, 2005, the fair value of derivative assets totaled
$108,000. The related notional amounts, which are not recorded on the
consolidated balance sheet, totaled $4.8 million for the derivative assets and
$10.0 million for the derivative liabilities. (See Note 23).
Interest Rate Risk Disclosure
The Bank's Asset Liability Management Committee ("ALCO") monitors and
considers methods of managing exposure to interest rate risk. The ALCO consists
of members of the Board of Directors and Senior Leadership of the Company and
meets quarterly. The Bank's exposure to interest rate risk is reviewed on at
least a quarterly basis by the ALCO. Interest rate risk exposure is measured
using interest rate sensitivity analysis to determine the Bank's change in net
portfolio value in the event of hypothetical changes in interest rates. The ALCO
is charged with the responsibility to maintain the level of sensitivity of the
Bank's net portfolio value within Board approved limits.
Net portfolio value (NPV) represents the market value of portfolio equity
and is equal to the market value of assets minus the market value of
liabilities, with adjustments made for off-balance sheet items over a range of
assumed changes in market interest rates. The Bank's Board of Directors has
adopted an interest rate risk policy which establishes maximum allowable
decreases in NPV in the event of a sudden and sustained one hundred to four
hundred basis point increase or decrease in market interest rates. The following
table presents the Bank's projected change in NPV as computed by the OTS for the
various rate shock levels as of September 30, 2005.
Board Limit Board Limit Market Value Market Value
Minimum NPV Maximum Of Assets Portfolio Equity NPV
Change in Interest Rates Ratio Decline in NPV 9/30/05 9/30/05 Ratio
------------------------ ----------- -------------- ------------ ---------------- ------
300 basis point rise 5.00% 400 BPS $1,543,703 $ 150,927 9.78%
200 basis point rise 6.00% 300 BPS $1,566,175 $ 163,446 10.44%
100 basis point rise 6.00% 250 BPS $1,588,105 $ 171,604 10.81%
No Change 6.00% $1,607,528 $ 181,058 11.26%
100 basis point decline 6.00% 250 BPS $1,621,093 $ 183,898 11.34%
200 basis point decline 6.00% 300 BPS $1,629,407 $ 177,613 10.90%
300 basis point decline 6.00% 350 BPS N/A N/A N/A
The preceding table indicates that at September 30, 2005, in the event of
a sudden and sustained increase in prevailing market interest rates, the Bank's
NPV would be expected to decrease, and that in the event of a sudden decrease in
prevailing market interest rates, the Bank's NPV would be expected to increase
minimally. At September 30, 2005, the Bank's estimated changes in NPV were
within the limits established by the Board of Directors.
Computation of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit decay, and should not be relied upon as
indicative of actual results. Further, the computations do not contemplate any
actions the ALCO could undertake in response to sudden changes in interest
rates.
The Bank also uses interest rate sensitivity gap analysis to monitor the
relationship between the maturity and repricing of its interest-earning assets
and interest-bearing liabilities. Interest rate sensitivity gap is defined as
the difference between the amount of interest-earning assets maturing or
repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within the same time period. A gap is
considered positive when the amount of interest-rate-sensitive assets exceeds
the amount of interest-rate-sensitive liabilities. Generally, during a period of
rising rates, a positive gap would result in an increase in net interest income.
Conversely, during a period of falling interest rates, a positive gap would
result in a decrease in net interest income. It is ALCO's goal to maintain
reasonable balance between exposure to interest rate fluctuations and earnings.
47
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis - Continued
Recently Adopted Accounting Pronouncements
In March 2004, the Financial Accounting Standards Board ("FASB") issued
EITF No. 03-1 ("EITF 03-1"), "The Meaning of Other-Than-Temporary Impairment and
Its Application of Certain Investments," which provided guidance for evaluating
whether an investment is other-than-temporarily impaired and its application to
investments classified as either available for sale or held to maturity under
FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and investments accounted for under the cost or equity method of
accounting.
Paragraphs 10 through 20 of EITF 03-1 provide guidance on when impairment
of debt and equity securities is considered other-than-temporary. This guidance
generally states impairment is considered other-than-temporary unless the holder
of the security has both the intent and ability to hold the security until the
fair value recovers and evidence supporting the recovery outweighs evidence to
the contrary.
The Company adopted the guidance of EITF 03-1, excluding paragraphs 10-20
effective as of September 30, 2004. As a result of this adoption, the Company
provides additional disclosures, which are found in Notes 2 and 3 of this
report. The initial adoption of this issue, which excludes paragraphs 10-20 did
not have a material impact on the financial condition or results of operations
of the Company.
In July 2005, the FASB issued final guidance that eliminated paragraphs
10-18 of EITF-03-1 (paragraphs 19-20 have no material impact on the financial
condition or results of operations of the Company) and have reissued the final
pronouncement as FSP FAS 115-1 that will be effective for other-than-temporary
impairment analysis conducted in periods beginning after December 15, 2005.
Recently Issued Accounting Pronouncements
In December 2004, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 123 (Revised 2004), "Share-Based Payment" ("SFAS 123R").
This standard requires expensing of stock options and other share-based payments
and supersedes SFAS No. 123 that had allowed companies to choose between
expensing stock options or showing proforma disclosure only. This standard is
effective for the Company as of October 1, 2005 and will apply to all awards
granted, modified, cancelled or repurchased after that date. Based upon unvested
options outstanding at September 30, 2005, the Company expects to incur expense
related to options of approximately $145,000 in fiscal 2006. See Note 1 (p).
On March 29, 2005 the SEC Staff issued Staff Accounting Bulletin No. 107
("SAB 107"). SAB 107 expresses the views of the SEC staff regarding the
interaction of SFAS 123R and certain SEC rules and regulations and provides the
SEC staff's view regarding the valuation of share-based payment arrangements for
public companies.
In December 2004, the FASB issued SFAS No. 153 ("SFAS 153"), "Exchanges of
Nonmonetary Assets-an amendment of APB Opinion No. 29," which eliminates the
exception for nonmonetary exchanges of similar productive assets and replaces it
with a general exception for exchanges of nonmonetary assets that do not have
commercial substance. A nonmonetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result
of the exchange. SFAS 153 is effective for nonmonetary transactions occurring in
fiscal years beginning after June 15, 2005. The initial adoption of this
pronouncement will not have a material impact on the financial condition and
results of operations of the Company.
In May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154 ("SFAS 154"), Accounting Changes and Error Corrections - a replacement
of APB Opinion No. 20 and FASB Statement No. 3," which eliminates the
requirement to reflect changes in accounting principles as cumulative
adjustments to net income in the period of the change and requires retrospective
application to prior periods' financial statements for voluntary changes in
accounting principle, unless it is impracticable to determine either the
period-specific effects or the cumulative effect of the change. If it is
impracticable to determine the cumulative effect of the change to all prior
periods, SFAS 154 requires that the new accounting principle be adopted
prospectively. For new accounting pronouncements, the transition guidance in the
pronouncement should be followed. Retrospective application refers to the
application of a different accounting principle to previously issued financial
statements as if that principle had always been used.
SFAS 154 did not change the guidance for reporting corrections of errors,
changes in estimates or for justification of a change in accounting principle on
the basis of preferability. SFAS 154 is effective for accounting changes made in
fiscal years beginning after December 15, 2005. The initial adoption of this
pronouncement will not have a material impact on the financial condition and
results of operations of the Company.
48
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis - Continued
Capital Standards and Regulatory Matters
The Bank's capital standards include: (1) a leverage limit requiring all
OTS chartered financial institutions to maintain core capital in an amount not
less than 4% of the financial institution's total assets; (2) a tangible capital
requirement of not less than 1.5% of total assets; and (3) a risk-based capital
requirement of not less than 8.0% of risk weighted assets. For further
information concerning the Bank's capital standards, refer to Note 14 of the
Notes to the Consolidated Financial Statements.
Effects of Inflation and Changing Prices
The consolidated financial statements have been prepared in accordance
with U.S. generally accepted accounting principles which require the measurement
of financial position and results of operations in terms of historical dollars,
without consideration of change in the relative purchasing power over time due
to inflation. Unlike most industrial companies, virtually all of the assets and
liabilities of a financial institution are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effect of inflation. Interest rates do not necessarily
change in the same magnitude as the price of goods and services.
49
Board of Directors
Coastal Financial Corporation Coastal Federal Bank Coastal Planners Holding Corporation
E. Lawton Benton E. Lawton Benton James T. Clemmons
President President Chairman
C.L. Benton & Sons, Inc. C.L. Benton & Sons, Inc. Coastal Financial Corporation
G. David Bishop G. David Bishop Michael C. Gerald
Managing Director Managing Director President and Chief Executive Officer
White Harvest Trading Co., LLC White Harvest Trading Co., LLC Coastal Financial Corporation
J. Robert Calliham J. Robert Calliham Jerry L. Rexroad, CPA
President and Chief Executive Officer President and Chief Executive Officer Chief Financial Officer
Smith, Sapp, Bookhout, Crumpler & Smith, Sapp, Bookhout, Crumpler & Coastal Planners Holding Corporation
Calliham, P.A. Calliham, P.A.
James T. Clemmons James T. Clemmons
Chairman Chairman
Coastal Financial Corporation Coastal Federal Bank
James P. Creel James P. Creel
President President
Creel Corporation Creel Corporation
James. H. Dusenbury James. H. Dusenbury
Retired - Attorney Retired - Attorney
Dusenbury and Clarkson Law Firm Dusenbury and Clarkson Law Firm
Michael C. Gerald Michael C. Gerald
President and Chief Executive Officer President and Chief Executive Officer
Coastal Financial Corporation Coastal Federal Bank
William O. Marsh William O. Marsh
President President
Palmetto Chevrolet Palmetto Chevrolet
Frank A. Thompson, II Frank A. Thompson, II
President President
Peoples Underwriters, Inc. Peoples Underwriters, Inc.
W. Cecil Worsley, III W. Cecil Worsley, III
President and Chief Executive Officer President and Chief Executive Officer
Worsley Companies Worsley Companies
50
COASTAL FINANCIAL CORPORATION
Leadership Group
Sherri J. Adams Tamra T. Cannon Joel P. Foster
Branch Manager Assistant Vice President Senior Vice President
N. Myrtle Beach Senior Branch Manager Area Banking Leader
Conway Myrtle Beach Community
Ginger Allen
Assistant Vice President Shonda C. Chestnut William A. Gehman III, CPA
In-house Underwriting Assistant Vice President Senior Vice President
Leader Senior Branch Manger Corporate Controller
Surfside
Anthony Ambuhl Mary L. Geist
Assistant Vice President Susan J. Cooke Vice President
Commercial Banking Senior Vice President Data Services Leader
Officer Corporate Secretary
Administrative Services Michael C. Gerald
Phillip G. Ammons Leader President and Chief Executive
Vice President Officer
Community Banking Benjamin D. Corley
Leader Senior Branch Manager Jimmy R. Graham
Pawleys Island & Murrells Southport Executive Vice President
Inlet Chief Information Officer
Jerry J. Cox, Jr.
Donna P. Bailey Vice President Don C. Hamilton
Assistant Vice President Community Banking Leader Vice President
Delivery Systems Resource Loris Community Residential Brokerage Leader
Administrator
John L. Creamer E. Haden Hamilton, Jr.
James R. Baker, MCSE Vice President President
Assistant Vice President Coastal Investor Services Coastal Investor Services
Network Services Group
Leader Gwendolyn Davis Kathy D. Hane
Branch Manager Assistant Vice President
Jeffrey A. Benjamin Murrells Inlet Senior Branch Manager
Senior Vice President Pawleys Island
Credit Administration Deborah S. Dillard
Leader Branch Manager Lauren E. Henson
Sunset Beach Vice President
April C. Benton Dean of Coastal Federal
Staffing Leader Robert D. Douglas University
Executive Vice President
Steven Brockmann Human Resources Leader J. Michael Hill
Assistant Vice President Vice President
Coastal Investor Services Tiffany Dudley Coastal Investor Services
Electronic Banking Leader
Cynthia L. Buffington Debra Hinson
Assistant Vice President Trina S. Dusenbury Assistant Vice President
Item Processing Leader Senior Vice President Operations Leader
Residential Banking Coastal Investor Services
Nancy G. Bundy Operations Leader
Branch Manager Chris Hipp
Surfside Michael L. Evans Branch Manager
Vice President Stephen's Crossroads
Ronnie L. Burbank Loan Review Leader
Vice President Glenn D. Humbert
Senior Banking Leader Rita E. Fecteau Senior Vice President
Wilmington CBD Vice President Area Banking Leader
Accounting Leader Brunswick County
Glenn T. Butler, MCSE,
CCNA Patricia A. Floyd Cameron Jackson
Vice President Vice President Assistant Vice President
Chief Technology Officer Retail Banking Resource Consumer Loan Administrator
Leader
Anne R. Caldwell Lisa B. James
Assistant Vice President J. Daniel Fogle Senior Vice President
Deposit Servicing Leader Vice President Operations Leader
Community Banking Leader
Marie H. Canaday Carolina Forest / Wendy Johhnson
Mortgage Specialist Waccamaw / Conway Branch Manager
Loris
51
COASTAL FINANCIAL CORPORATION
Leadership Group - Continued
Jennifer Julian Janice B. Metz Joseph Shumbo
Assistant Vice President Assistant Vice President Assistant Vice President
Facility Services Leader Advertising Officer Residential Banking Officer
Stephanie L. Karnap Abigail E. Mishoe Leeann Slack
Branch Manager Assistant Vice President Support Group Leader
Waccamaw Residential Banking Officer
Lorie D. Smith
Ruth S. Kearns Leslie Morse Associate Dean of Coastal
Senior Vice President Commercial/Consumer Operations Federal University
Community Relations Officer Leader
J. Marcus Smith, Jr.
Kara Kessinger Lynn T. Murray Senior Vice President
President Senior Vice President Internal Audit Leader
Coastal Retirement Estate & Checking Account Product
Tax Planners Development & Management Phillip G. Stalvey
Officer Executive Vice President
L. Eric Keys Banking Leader
Vice President Ronald A. Nolan
Community Banking Leader Assistant Vice President S. Annette Stroud
South Horry Community Security Officer Branch Manager
Carolina Forest
Linwood E. Koonce, Jr. Deborah A. Orobello
Banking Closing Leader Branch Manager Charlene P. Sullivan
Little River Branch Manager
John L. Kosicki Socastee
Senior Vice President Charles S. Page
Resource Leader Vice President Sandra J. Szarek
Senior Banking Leader Assistant Vice President
James Louis LaBruce Carolina Forest Commercial Loan Servicing
Vice President Leader
Senior Banking Leader Orit Perez
Assistant Vice President Andrea M. Taiani
Justin M. Lee Senior Branch Manager Customer Contact Center
Assistant Vice President Oak Street and 38th Avenue Leader
Commercial/Residential Bi-Lo
Officer Gary Thompson
Socastee Jerry L. Rexroad, CPA Vice President
Executive Vice President Financial Reporting and
Pauline M. Lewis Chief Financial Officer Compliance Leader
Branch Manager
Shallotte David L. Roe Terry B. Thornton
Senior Vice President Vice President
Edward L. Loehr, Jr. Small Business Banking Leader Senior Branch Manager
Vice President Wilmington
Budgeting and Treasury Eulette W. Sauls
Assistant Vice President Matthew J. Towns
Mary M. Lundy Information Management Leader Vice President
Branch Manager Credit Administration
Southport Collier J. Schettig
Branch Manager Audrey Waldron
Kathleen M. Lutes Dunes Branch Manager
Assistant Vice President Oak Island
Secondary Marketing Leader Sherry G. Schoolfield
Vice President Douglas W. Walters
Patsy Madden Compliance Officer Vice President
Residential Loan Residential Banking Leader
Servicing Leader Douglas E. Shaffer North Myrtle Beach
Senior Vice President
Michael C. Mauney Area Leader Theresa M. Whitley
Vice President North and West Communities Closing and Construction
Collections Leader Leader
Steven J. Sherry
Amy E. McLaurin Executive Vice President Sandra R. Zanfini
Assistant Vice President Chief Marketing Officer Assistant Vice President
Senior Banking Leader Assistant Corporate Secretary
Sunset Beach Corporate Support Leader
52
Branch Locations
Coastal Federal Bank
Oak Street Branch Oak Island Branch Surfside Branch
2619 Oak Street 8001 East Oak Island Drive 112 Highway 17 South
Myrtle Beach, SC 29577-3129 Oak Island, NC 28465 & Glenns Bay Road
843.205.2000 843.205.2036 Surfside Beach, SC 29575
910.201.1481 843.205.2003
Carolina Forest Branch
3894 Renee Drive Pawleys Island Branch Waccamaw Medical Park Branch
Myrtle Beach, SC 29579 Coastal Federal Town Center 112 Waccamaw Medical Park Drive
843.205.2016 11403 Ocean Highway Conway, SC 29526
Pawleys Island, SC 29585 843.205.2009
Conway Branch 843.205.2020
310 Wright Boulevard 38th Avenue Branch (BI-LO)
Conway, SC 29526 Shallotte Branch 1245 38th Avenue North
843.205.2005 200 Smith Avenue Myrtle Beach, SC 29577
Shallotte, NC 28470 843.205.2041
Dunes Branch 843.205.2035
7500 North Kings Highway 910.754.6186 Wilmington Branch
Myrtle Beach, SC 29572 4320 17th Street Extension
843.205.2001 Socastee Branch Wilmington, NC 28412
4801 Socastee Boulevard 843.205.2034
Little River Branch Myrtle Beach, SC 29575 910.392.2265
1602 Highway 17 843.205.2007
Little River, SC 29566 Wilmington Branch
843.205.2014 Southport Branch 5710 Oleander Drive, Suite 209
4956-1 Long Beach Road SE Wilmington, NC 28403
Loris Branch Southport, NC 28461 843.205.2031
3610 Broad Street 843.205.2032 910.313.1161
Loris, SC 29569 910.454.4173
843.205.2018 Wilmington Branch
Stephens Crossroads Branch 109 Market Street
Murrells Inlet Branch 2496 Highway 9 East Wilmington, NC 28401
3348 Highway 17 South Highways 9 and 57 843.205.2033
& Inlet Crossing Little River, SC 29566 910.763.2372
Murrells Inlet, SC 29576 843.205.2013
843.205.2008 843.390.3355
North Myrtle Beach Branch Sunset Beach Branch
521 Main Street 1625 Seaside Road SW
North Myrtle Beach, SC 29582 Sunset Beach, NC 28468
843.205.2002 843.205.2012
910.579.8160
53
Corporate Information
Common Stock and Dividend Information
The common stock of Coastal Financial Corporation is quoted through the Nasdaq
Stock Market under the symbol CFCP. For information contact the Stockholder
Relations office.
As of December 5, 2005, the Corporation had 1,137 stockholders and 19,479,469
shares of Common Stock outstanding. This does not reflect the number of persons
or entities who hold stock in nominee or "street name."
The Company's ability to pay dividends depends primarily on the ability of
Coastal Federal Bank to pay dividends to the Company. See Notes 14, 15, and 19
of the Notes to Consolidated Financial Statements for further information.
Market Price of Common Stock
The table below reflects the high and low bid stock prices published by Nasdaq
for each quarter. Such prices may reflect inter-dealer prices, without retail
mark-up, mark-down or commissions, and may not necessarily represent actual
transactions. The prices have been adjusted retroactive to reflect stock
dividends.
HIGH LOW CASH
BID BID DIVIDEND
Fiscal Year 2005:
First Quarter $15.83 $11.16 $0.041
Second Quarter 16.40 11.20 0.041
Third Quarter 12.84 11.58 0.045
Fourth Quarter 13.02 11.71 0.045
Fiscal Year 2004:
First Quarter $12.95 $ 9.50 $0.037
Second Quarter 12.40 9.36 0.037
Third Quarter 11.79 8.87 0.037
Fourth Quarter 12.55 10.55 0.041
Form 10-K
A copy of Coastal Financial Corporation's Annual Report on Form 10-K, as filed
with the Securities Exchange Commission for the year ended September 30, 2005,
may be obtained or viewed on www.coastalfederal.com by clicking on Investor
Services.
Annual Meeting of Stockholders
The Annual Meeting of Stockholders of Coastal Financial Corporation will be held
at The Breakers Resort, 2006 North Ocean Boulevard, Myrtle Beach, South
Carolina, on Tuesday, January 31, 2006 at 2:00 p.m., Eastern Standard Time.
Additional Information
If you are receiving duplicate mailing of stockholder reports due to multiple
accounts, we can consolidate the mailings without affecting your account
registration. To do this, or for additional information, contact the Stockholder
Relations Office, at the Corporate address shown below.
Corporate Offices
Coastal Financial Corporation
2619 Oak Street
Myrtle Beach, South Carolina 29577
843.205.2000
Transfer Agent and Registrar
Registrar and Transfer Company
P.O. Box 1010
Cranford, NJ 07016
1.800.866.1340 Ext. 2514
Independent Registered Public Accounting Firm
KPMG LLP
150 Fayetteville Street Mall
Suite 1200
Raleigh, NC 27601
Special Counsel
Muldoon Murphy & Aguggia LLP
5101 Wisconsin Avenue
Washington, DC 20016
Stockholder Relations Officer
Susan J. Cooke
Coastal Financial Corporation
2619 Oak Street
Myrtle Beach, South Carolina 29577
843.205.2000
[LOGO]
Member
FDIC
Coastal Financial Corporation is an equal opportunity employer and pledges equal
opportunities without regard to religion, citizenship, race, color, creed, sex,
age, national origin, disability or status as a disabled or Vietnam-Era veteran.
---------
* COASTAL RAYMOND JAMES(R) Securities and investment advisory services offered exclusively through
INVESTOR FINANCIAL SERVICES, INC. Raymond James Financial Services, Inc., member NASD/SIPC, an independent
SERVICES Member NASD/SIPC broker/dealer, and are not insured by the FDIC or any other bank
---------- insurance, are not deposits or obligations of the bank, are not
guaranteed by the bank, and are subject to risk, including the possible
loss of principal.
Coastal Investor Services is a division of Coastal Federal Bank.
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