UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to __________
Commission File Number: 0-19684
COASTAL FINANCIAL CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)
State of Delaware 57-0925911
----------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2619 OAK STREET, MYRTLE BEACH, S. C. 29577
----------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (843) 205-2000
--------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer or non-accelerated filer. See definition of "accelerated
filer and a large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer |_| Accelerated Filer |X| Non-accelerated Filer |_|
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act)
YES |_| NO |X|
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of April 30, 2006.
Common Stock $.01 Par Value Per Share 19,594,784 Shares
- --------------------------------------------------------------------------------
(Class) (Outstanding)
1
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2006
TABLE OF CONTENTS PAGE
- ----------------- ----
PART I- Financial Information
Item
1. Consolidated Financial Statements (unaudited):
Consolidated Statements of Financial Condition
as of September 30, 2005 and March 31, 2006 3
Consolidated Statements of Operations for the three
months ended March 31, 2005 and 2006 4
Consolidated Statements of Operations for the six
Months ended March 31, 2005 and 2006 5
Consolidated Statements of Stockholders' Equity
and Comprehensive Income for the six months ended
March 31, 2005 and 2006 6
Consolidated Statements of Cash Flows for the six
months ended March 31, 2005 and 2006 7-8
Notes to Consolidated Financial Statements 9-16
2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 17-29
3. Quantitative and Qualitative Disclosures About 29-30
Market Risk
4. Controls and Procedures 30
Part II - Other Information
Item
1. Legal Proceedings 30
1A. Risk Factors 30-34
1B. Unresolved Staff Comments 34
2. Unregistered Sales of Equity Securities and Use of Proceeds 34
3. Defaults Upon Senior Securities 34
4. Submission of Matters to a Vote of Securities Holders 34
5. Other Information 34
6. Exhibits 35
Signatures 36
Exhibits
3(c) Certificate of Amendment of Certificate of Incorporation 37
31(a) Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer) 38
(b) Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer) 39
32(a) Section 1350 Certification (Chief Executive Officer) 40
(b) Section 1350 Certification (Chief Financial Officer) 41
2
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, March 31,
2005 2006
---- ----
(Unaudited)
(In thousands)
ASSETS:
Cash and amounts due from banks $ 52,592 $ 39,204
Short-term interest-bearing deposits 33,742 59,926
Federal funds sold 5,191 486
Investment securities available for sale 25,616 21,501
Mortgage-backed securities available for sale 399,655 421,781
Investment securities held to maturity (market
value $10,049 at September 30, 2005 and
$10,000 at March 31, 2006) 10,000 10,000
Loans receivable (net of allowance for loan
losses of $11,748 at September 30, 2005 and
$12,208 at March 31, 2006) 924,260 1,004,385
Loans receivable held for sale 18,121 3,783
Real estate acquired through foreclosure, net 818 1,120
Office property and equipment, net 22,758 26,657
Federal Home Loan Bank (FHLB) stock, at cost 15,775 18,365
Accrued interest receivable on loans 3,807 4,647
Accrued interest receivable on securities 2,351 2,698
Bank-owned life insurance 22,574 23,050
Other assets 6,199 6,388
----------- -----------
$ 1,543,459 $ 1,643,991
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
LIABILITIES:
Deposits $ 1,070,918 $ 1,080,440
Securities sold under agreements to repurchase 41,937 96,706
Advances from FHLB 289,007 337,765
Junior subordinated debt 15,464 15,464
Drafts outstanding 12,890 3,001
Advances by borrowers for property taxes and insurance 1,221 621
Accrued interest payable 3,415 4,367
Other liabilities 11,386 5,418
----------- -----------
Total Liabilities 1,446,238 1,543,782
----------- -----------
STOCKHOLDERS' EQUITY:
Serial preferred stock, 1,000,000 shares authorized
and unissued -- --
Common stock, $.01 par value, 50,000,000 shares
authorized; 19,457,492 shares at September 30, 2005
and 19,583,163 shares at March 31, 2006 issued
and outstanding 195 196
Additional paid-in capital 11,410 11,941
Retained earnings, restricted 86,723 93,857
Accumulated other comprehensive loss, net of tax (1,107) (5,785)
----------- -----------
Total stockholders' equity 97,221 100,209
----------- -----------
$ 1,543,459 $ 1,643,991
=========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2006
2005 2006
---- ----
(Unaudited)
(In thousands,
Except per share)
Interest income:
Loans receivable $ 13,364 $ 18,182
Investment securities 1,231 1,672
Mortgage-backed securities 4,250 4,077
Other 67 207
------------ ------------
Total interest income 18,912 24,138
------------ ------------
Interest expense:
Deposits 2,939 6,519
Securities sold under agreements to repurchase 746 539
Advances from FHLB 3,128 3,623
Other borrowings 203 289
------------ ------------
Total interest expense 7,016 10,970
------------ ------------
Net interest income 11,896 13,168
Provision for loan losses 625 330
------------ ------------
Net interest income after provision for loan losses 11,271 12,838
------------ ------------
Other income:
Fees and service charges on loan and deposit accounts 1,423 2,246
Gain on sales of loans held for sale 244 202
Gain on sales of investment securities, net 28 30
Gain on sales of mortgage-backed securities, net 60 --
Gain on investment security held to maturity called by
issuer 160 --
Loss from real estate acquired through foreclosure, net (6) (62)
Income from sales of non-depository products 470 505
FHLB stock dividends 213 256
Income from ATM and debit card transactions 328 538
Bank-owned life insurance 233 237
Other income 183 250
------------ ------------
Total other income 3,336 4,202
------------ ------------
General and administrative expenses:
Salaries and employee benefits 4,496 5,474
Net occupancy, furniture and fixtures and data
processing expenses 1,186 1,568
Depreciation 673 844
FDIC insurance premium 26 34
Marketing expenses 482 520
Expense from ATM and debit card transactions 236 348
Other expense 1,220 1,138
------------ ------------
Total general and administrative expense 8,319 9,926
------------ ------------
Income before income taxes 6,288 7,114
Income taxes 2,153 2,469
------------ ------------
Net income $ 4,135 $ 4,645
============ ============
Net income per common share:
Basic $ 0.21 $ 0.24
============ ============
Diluted $ 0.20 $ 0.23
============ ============
Dividends declared per common share $ 0.04 $ 0.05
============ ============
Weighted average common shares outstanding:
Basic 19,362,000 19,547,000
============ ============
Diluted 20,524,000 20,440,000
============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED MARCH 31, 2005 AND 2006
2005 2006
---- ----
(Unaudited)
(In thousands,
Except per share)
Interest income:
Loans receivable $ 26,104 $ 35,329
Investment securities 2,375 3,287
Mortgage-backed securities 8,257 8,186
Other 122 374
------------ ------------
Total interest income 36,858 47,176
------------ ------------
Interest expense:
Deposits 5,435 12,389
Securities sold under agreements to repurchase 1,312 917
Advances from FHLB 6,296 6,868
Other borrowings 403 558
------------ ------------
Total interest expense 13,446 20,732
------------ ------------
Net interest income 23,412 26,444
Provision for loan losses 975 730
------------ ------------
Net interest income after provision for loan losses 22,437 25,714
------------ ------------
Other income:
Fees and service charges on loan and deposit accounts 2,513 4,335
Gain on sales of loans held for sale 554 294
Gain on sales of investment securities, net 17 18
Gain (loss) on sales of mortgage-backed securities, net 229 (33)
Gain on investment security held to maturity called by
issuer 160 --
Loss from real estate acquired through foreclosure, net (45) (95)
Income from sales of non-depository products 930 910
FHLB stock dividends 350 456
Income from ATM and debit card transactions 624 1,039
Bank-owned life insurance 474 476
Other income 296 390
------------ ------------
Total other income 6,102 7,790
------------ ------------
General and administrative expenses:
Salaries and employee benefits 8,920 10,852
Net occupancy, furniture and fixtures and data
processing expenses 2,328 3,019
Depreciation 1,271 1,646
FDIC insurance premium 53 67
Marketing expenses 993 957
Expense from ATM and debit card transactions 465 677
Other expense 2,070 2,388
------------ ------------
Total general and administrative expense 16,100 19,606
------------ ------------
Income before income taxes 12,439 13,898
Income taxes 4,260 4,810
------------ ------------
Net income $ 8,179 $ 9,088
============ ============
Net income per common share:
Basic $ 0.42 $ 0.47
============ ============
Diluted $ 0.40 $ 0.45
============ ============
Dividends declared per common share $ 0.08 $ 0.10
============ ============
Weighted average common shares outstanding:
Basic 19,278,000 19,488,000
============ ============
Diluted 20,367,000 20,380,000
============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE SIX MONTHS ENDED MARCH 31, 2005 AND 2006
Accumulated
Other
Compre-
Additional hensive Total
Common Paid-In Retained Treasury Income Stockholders'
Stock Capital Earnings Stock (Loss) Equity
------------ ------------ ------------ ------------ ------------ ------------
(Unaudited)
(In thousands)
Balance at September
30, 2004 $ 192 $ 10,607 $ 73,533 $ (1,182) $ 2,198 $ 85,348
Net income -- -- 8,179 -- -- 8,179
Other comprehensive
income:
Unrealized losses arising
during period, net of
taxes of $2,139 -- -- -- -- (3,490) --
Less: reclassification
adjustment for gains
included in net income,
net of taxes of $93 -- -- -- -- 153 --
------------
Other comprehensive loss -- -- -- -- (3,337) (3,337)
------------
Comprehensive income -- -- -- -- -- 4,842
------------
Exercise of stock options
including tax benefit of $262 1 347 (602) 1,182 -- 928
Cash dividends -- -- (1,584) -- -- (1,584)
------------ ------------ ------------ ------------ ------------ ------------
Balance at March
31, 2005 $ 193 $ 10,954 $ 79,526 $ -- $ (1,139) $ 89,534
============ ============ ============ ============ ============ ============
Balance at September
30, 2005 $ 195 $ 11,410 $ 86,723 $ -- $ (1,107) $ 97,221
Net income -- -- 9,088 -- -- 9,088
Other comprehensive
income:
Unrealized losses arising
during period, net of
tax benefit of $2,873 -- -- -- -- (4,687) --
Less: reclassification
adjustment for losses
included in net income,
net of taxes of $6 -- -- -- -- 9 --
------------
Other comprehensive loss -- -- -- -- (4,678) (4,678)
------------ ------------
Comprehensive income -- -- -- -- -- 4,410
------------
Exercise of stock options
including tax benefit of $185 1 484 -- -- -- 485
Stock compensation expense,
net of tax -- 47 -- -- -- 47
Cash dividends -- -- (1,954) -- -- (1,954)
------------ ------------ ------------ ------------ ------------ ------------
Balance at March
31, 2006 $ 196 $ 11,941 $ 93,857 $ -- $ (5,785) $ 100,209
============ ============ ============ ============ ============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 2005 AND 2006
2005 2006
---- ----
(Unaudited)
(In thousands)
Cash flows from operating activities:
Net income $ 8,179 $ 9,088
Adjustments to reconcile net income to net cash
Provided by operating activities:
Depreciation 1,271 1,646
Provision for loan losses 975 730
Gain on sale of investment securities
available for sale, net (17) (18)
(Gain) loss on sale of mortgage-backed securities
available for sale, net (229) 33
Gain on call of investment security called by issuer (160) --
Stock option compensation expense -- 75
Loss on disposal of office properties and equipment 124 --
Origination of loans receivable held for sale (26,623) (15,597)
Proceeds from sale of loans receivable held for sale, net 8,371 7,960
Recovery from write-down of mortgage servicing rights (155) --
Proceeds from securitization and sales of loans receivable
held for sale 20,080 12,874
Tax benefit from exercise of stock options (262) (185)
(Increase) decrease in:
Cash value of life insurance (474) (476)
Accrued interest receivable (296) (1,187)
Other assets 1,793 (189)
Increase (decrease) in:
Accrued interest payable 492 952
Other liabilities 364 (2,945)
--------- ---------
Net cash provided by operating activities 13,433 12,761
--------- ---------
Cash flows from investing activities:
Proceeds from sales of investment securities available for sale 3,371 7,175
Proceeds from sales of mortgage-backed securities
available for sale 95,200 41,474
Proceeds from issuer call of investment securities held
to maturity 8,000 --
Proceeds from issuer call of investment securities
available for sale 1,950 --
Purchases of investment securities available for sale (3,659) (3,691)
Purchases of investment securities held to maturity (10,000) --
Purchases of mortgage-backed securities available for sale (206,648) (111,622)
Principal collected on mortgage-backed securities
available for sale 42,678 41,094
Origination of loans receivable, net (349,851) (358,349)
Purchase of loans receivable -- (8,656)
Proceeds from sales of commercial loan participations 13,251 2,100
Principal collected on loans receivable, net 267,904 292,251
Proceeds from sales of real estate acquired through
foreclosure, net 714 598
Purchases of office properties and equipment (2,866) (5,545)
Change in FHLB stock, net 533 (2,590)
--------- ---------
Net cash used in investing activities (139,423) (105,761)
--------- ---------
(CONTINUED)
7
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 2005 AND 2006 (CONTINUED)
2005 2006
---- ----
(Unaudited)
(In thousands)
Cash flows from financing activities:
Increase in deposits, net $ 136,902 $ 9,522
Increase in securities sold under agreements to repurchase, net 28,827 54,769
Proceeds from FHLB advances 372,850 568,300
Repayment of FHLB advances (399,200) (519,542)
Decrease in advance payments by borrowers for
property taxes and insurance, net (681) (600)
Increase(decrease) in drafts outstanding, net 1,487 (9,889)
Cash dividends to stockholders (1,584) (1,954)
Proceeds from exercise of stock options 666 300
Tax benefit from exercise of stock options 262 185
--------- ---------
Net cash provided by financing activities 139,529 101,091
--------- ---------
Net decrease in cash and cash equivalents 13,539 8,091
Cash and cash equivalents at beginning of period 29,652 91,525
--------- ---------
Cash and cash equivalents at end of period $ 43,191 $ 99,616
========= =========
Supplemental information:
Interest paid $ 12,954 $ 19,780
========= =========
Income taxes paid $ 3,492 $ 5,077
========= =========
Supplemental schedule of non-cash investing and financing transactions:
Securitization of mortgage loans into mortgage-backed
securities $ 20,080 $ 12,874
========= =========
Transfer of mortgage loans to real estate acquired
through foreclosure $ 463 $ 900
========= =========
Change in unrealized loss in investment securities
and mortgage-backed securities available for sale,
net of tax $ (3,337) $ (4,678)
========= =========
Transfer of loans held for sale to loans receivable $ -- $ 9,100
========= =========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements were prepared in
accordance with instructions for Form 10-Q and, therefore, do not include all
disclosures necessary for a complete presentation of financial condition,
results of operations, cash flows and changes in stockholders' equity and
comprehensive income in conformity with accounting principles generally accepted
in the United States of America. All adjustments, consisting only of normal
recurring accruals, which in the opinion of management are necessary for fair
presentation of the interim financial statements, have been included. The
results of operations for the three and six-month periods ended March 31, 2006
are not necessarily indicative of the results that may be expected for the
entire fiscal year. These unaudited consolidated financial statements should be
read in conjunction with Coastal Financial Corporation and Subsidiaries' (the
"Company") audited consolidated financial statements and related notes for the
year ended September 30, 2005, included in the Company's 2005 Annual Report to
Stockholders. The principal business of the Company is conducted by its
wholly-owned subsidiary, Coastal Federal Bank (the "Bank"). The information
presented herein, therefore, relates primarily to the Bank.
Certain prior period amounts have been reclassified to conform to current year
presentation.
(2) INVESTMENT SECURITIES AVAILABLE FOR SALE
The unrealized losses on investment securities were attributable to increases in
interest rates, rather than credit quality deterioration. The unrealized losses
that had continuous losses of less than 12 months are comprised of seven
securities at September 30, 2005 totaling $18,000 and thirty securities at March
31, 2006 totaling $235,000. The unrealized losses that had continuous losses 12
months or longer are comprised of six securities at September 30, 2005 totaling
$33,000 and five securities at March 31, 2006 totaling $104,000. None of the
individual investment securities had an unrealized loss that exceeded 10% of its
amortized cost in either period. At September 30, 2005 and March 31, 2006,
substantially all investment securities were rated AAA or higher. At September
30, 2005 and March 31, 2006, none of the investment securities available for
sale were considered impaired.
(3) MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE
Gross unrealized losses on mortgage-backed securities and the length of time the
securities have been in a continuous loss position were as follows:
September 30, 2005
--------------------------------------------------------------------------
Less than 12 Months 12 Months or Longer Total
---------------------- ----------------------- ----------------------
(Dollars in thousands)
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----- ------ ----- ------ ----- ------
Collateralized Mortgage $ 55,560 (770) 19,518 (360) 75,078 (1,130)
Obligations
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)
========= ========= ========= ========= ========= =========
March 31, 2006
--------------------------------------------------------------------------
Less than 12 Months 12 Months or Longer Total
---------------------- ----------------------- ----------------------
(Dollars in thousands)
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----- ------ ----- ------ ----- ------
Collateralized Mortgage $ 66,586 (1,240) 40,292 (1,444) 106,878 (2,684)
Obligations
FNMA 100,563 (2,666) 24,510 (839) 125,073 (3,505)
GNMA 12,133 (125) 22,049 (584) 34,182 (709)
FHLMC 102,380 (2,307) 21,289 (718) 123,669 (3,025)
--------- --------- --------- --------- --------- ---------
$ 281,662 (6,338) 108,140 (3,585) 389,802 (9,923)
========= ========= ========= ========= ========= =========
9
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
(3) MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE - CONTINUED
The unrealized losses on mortgage-backed securities were attributable to
increases in interest rates, rather than credit quality deterioration. The
unrealized losses are comprised of 72 securities at September 30, 2005 and 95
securities at March 31, 2006 that have had continuous losses of less than 12
months. There were 10 securities at September 30, 2005 and 36 securities at
March 31, 2006 with continuous losses 12 months or longer. None of the
individual mortgage-backed securities had an unrealized loss that exceeded 10%
of its amortized cost at September 30, 2005. One of the mortgage-backed
securities had unrealized losses which exceeded 10% of its amortized cost by an
immaterial amount at March 31, 2006. At September 30, 2005 and March 31, 2006,
all mortgage-backed securities were rated AAA or higher. At September 30, 2005
and March 31, 2006, none of the Company's securities were considered impaired.
(4) LOANS RECEIVABLE, NET
Loans receivable, net, consists of the following:
September 30, March 31,
2005 2006
----------- -----------
(Unaudited)
(Dollars in thousands)
First mortgage loans:
Single family to four family units $ 352,893 $ 396,752
Land and land development 121,170 138,661
Residential lots 37,112 35,908
Other, primarily commercial real estate 211,432 220,951
Construction loans on residential properties 127,970 143,453
Construction loans on commercial properties 14,989 15,330
Consumer and commercial loans:
Installment consumer loans 19,115 17,977
Mobile home loans 4,308 3,821
Savings account loans 1,883 2,525
Equity lines of credit 34,019 36,528
Commercial and other loans 38,691 38,516
----------- -----------
963,582 1,050,422
Less:
Allowance for loan losses 11,748 12,208
Deferred loan costs, net (771) (236)
Undisbursed portion of loans in process 28,345 34,065
----------- -----------
$ 924,260 $ 1,004,385
=========== ===========
The changes in the allowance for loan losses consist of the following for the
six months ended:
Six Months Ended March 31,
--------------------------
2005 2006
---- ----
(Unaudited)
(Dollars in thousands)
Allowance at beginning of period $ 11,077 $ 11,748
Provision for loan losses 975 730
--------- ---------
Recoveries:
Residential loans -- --
Commercial loans 17 179
Consumer loans 56 90
--------- ---------
Total recoveries 73 269
--------- ---------
Charge-offs:
Residential loans -- --
Commercial loans 158 341
Consumer loans 199 198
--------- ---------
Total charge-offs 357 539
--------- ---------
Net charge-offs 284 270
--------- ---------
Allowance at end of period $ 11,768 $ 12,208
========= =========
10
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(4) LOANS RECEIVABLE, NET - CONTINUED
Six Months Ended March 31,
--------------------------
2005 2006
---- ----
(Unaudited)
Ratio of allowance to total net loans
outstanding at the end of the period 1.36% 1.21%
==== ====
Ratio of net charge-offs to average
total loans outstanding during the period (annualized) .07% .05%
==== ====
Non-accrual loans, which are primarily loans over ninety days delinquent,
totaled approximately $2.6 million and $3.1 million at September 30, 2005 and
March 31, 2006, respectively. For the six months ended March 31, 2005 and 2006,
interest income, which would have been recorded, would have been approximately
$243,000 and $137,000, respectively, had non-accruing loans been current in
accordance with their original terms.
At September 30, 2005 and March 31, 2006 impaired loans totaled $2.6 million and
$2.5 million, respectively. Included in the allowance for loan losses at
September 30, 2005 was $434,000 related to impaired loans compared to $258,000
at March 31, 2006. The average recorded investment in impaired loans for the
year ended September 30, 2005 was $3.7 million compared to $2.9 million for the
six months ended March 31, 2006. Interest income of $41,000 and $80,000 was
recognized on impaired loans for the quarter and six months ended March 31,
2006. Interest income of $65,000 and $98,000 was recognized on impaired loans
for the quarter and six months ended March 31, 2005, respectively.
(5) DEPOSITS
Deposits consist of the following:
September 30, 2005 March 31, 2006
--------------------- ----------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
------ ---- ------ ----
(Unaudited)
(Dollars in thousands)
Checking accounts:
Noninterest-bearing $ 219,080 -- $ 214,352 --
Interest-bearing 139,810 0.52% 124,659 0.60%
---------- ----------
Total checking accounts 358,890 0.20 339,011 0.22
Money market accounts 213,078 2.26 212,726 2.91
Statement savings accounts 71,824 1.47 75,325 1.94
Certificate accounts 427,126 3.39 453,378 4.26
---------- ----------
$1,070,918 1.97% $1,080,440 2.57%
========== ==========
Included in certificate accounts ("CDs") are $169.9 million of brokered CDs at
September 30, 2005 and $189.3 million at March 31, 2006. The average rate and
remaining term of brokered CD's at September 30, 2005 was 3.51% and
approximately four months, respectively. The average rate and remaining term of
brokered CDs at March 31, 2006 was 4.54% and approximately five months,
respectively.
(6) ADVANCES FROM FEDERAL HOME LOAN BANK
Advances from Federal Home Loan Bank ("FHLB") consist of the following:
September 30, 2005 March 31, 2006
---------------------- -----------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
(Unaudited)
(Dollars in thousands)
Fiscal Year Maturing:
Year 1 $ 4,177 2.79% $ 2,936 3.02%
Year 2 3,560 2.83 3,560 2.83
Year 3 3,977 3.18 3,977 3.18
Year 4 31,803 2.36 6,802 3.74
Year 5 63,651 5.74 63,651 5.74
After Year 5 181,839 3.64 256,839 3.84
-------- --------
$289,007 3.93% $337,765 4.17%
======== ========
11
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(6) ADVANCES FROM FEDERAL HOME LOAN BANK (continued)
At September 30, 2005, and March 31, 2006, the Bank had pledged first mortgage
loans and mortgage-backed securities with unpaid balances of approximately
$362.5 million and $459.5 million, respectively, as collateral for FHLB
advances. At March 31, 2006, the excess first mortgage loan collateral pledged
to FHLB will support additional borrowings of $94.8 million.
At March 31, 2006, included in the one, two, three, four, and after five years
maturities were advances of $241 million, with a weighted average rate of 3.91%,
subject to call provisions. Callable advances at March 31, 2006 are summarized
as follows: $59.0 million callable in fiscal 2006, with a weighted average rate
of 4.84%; $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%; $75.0 million callable in fiscal 2009 with a weighted average rate of
3.92%, and $25.0 million callable in fiscal 2011 or later, with a weighted
average rate of 4.36%. Call provisions are more likely to be exercised by the
FHLB when market interest rates rise. If called, the Bank may be required to
replace these advances with higher cost funds.
(7) EARNINGS PER SHARE
Basic earnings per share for the quarter and six months ended March 31, 2005 and
2006 are computed by dividing net income by the weighted average common shares
outstanding during the respective periods. Diluted earnings per share for the
quarter and six months ended March 31, 2005 and 2006 are computed by dividing
net earnings by the weighted average dilutive shares outstanding during the
respective periods. At March 31, 2006, the Company had antidilutive securities
of approximately 225,000 options to purchase shares by Directors and Associates.
The average exercise price was approximately $15.26 per share.
The following is a reconciliation of average shares outstanding used to
calculate basic and fully diluted earnings per share.
For the Quarter Ended March 31,
(Unaudited)
2005 2005 2006 2006
-------------------------------- --------------------------------
BASIC DILUTED BASIC DILUTED
-------------------------------- --------------------------------
Weighted average shares outstanding 19,362,000 19,362,000 19,547,000 19,547,000
Effect of dilutive securities-
stock options -- 1,162,000 -- 893,000
-------------------------------- --------------------------------
19,362,000 20,524,000 19,547,000 20,440,000
================================ ================================
For the Six Months Ended March 31,
(Unaudited)
2005 2005 2006 2006
-------------------------------- --------------------------------
BASIC DILUTED BASIC DILUTED
-------------------------------- --------------------------------
Weighted average shares outstanding 19,278,000 19,278,000 19,488,000 19,488,000
Effect of dilutive securities-
stock options -- 1,089,000 -- 892,000
-------------------------------- --------------------------------
19,278,000 20,367,000 19,488,000 20,380,000
================================ ================================
(8) STOCK BASED COMPENSATION
In December 2004, the FASB issued SFAS No. 123 (revised), "Share-Based Payment"
("SFAS 123(R)"). SFAS 123(R) replaces SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), and supersedes APB Opinion No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"). SFAS 123(R) requires compensation costs
related to share-based payment transactions to be recognized in the financial
statements over the period that an employee provides service in exchange for the
award. Public companies are required to adopt, and the Company has adopted
effective October 1, 2005, the new standard using a modified prospective method.
12
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(8) STOCK BASED COMPENSATION (continued)
Under the modified prospective method, companies are allowed to record
compensation cost for new and modified awards over the related vesting period of
such awards prospectively and record compensation cost prospectively on the
nonvested portion, at the date of adoption, of previously issued and outstanding
awards over the remaining vesting period of such awards. No change to prior
periods presented is permitted under the modified prospective method.
At March 31, 2006, the Company had one stock-based payment plan for directors,
officers and other key Associates, which is described below. Prior to October 1,
2005, the Company, as permitted under SFAS 123, applied the intrinsic value
method under APB 25, and related interpretations in accounting for its
stock-based compensation plan.
Effective October 1, 2005, the Company adopted the provisions of SFAS 123(R)
thereby expensing employee stock-based compensation using the fair value method
prospectively for all awards granted, modified, or settled on or after October
1, 2005. The fair value at date of grant of the stock option is estimated using
the Black-Scholes option-pricing model based on assumptions noted in a table
below. The dividend yield is based on estimated future dividend yields. The
risk-free rate for periods within the contractual term of the share option is
based on the U.S. Treasury yield curve in effect at the time of grant. Expected
volatilities are generally based on historical volatilities. The expected term
of share options granted is generally derived from historical experience.
Compensation expense is recognized on a straight-line basis over the stock
option vesting period. The impact of adoption of the fair value based method for
expense recognition of employee awards resulting in expense of approximately
$47,000, net of tax benefit of approximately $28,000 during the six months ended
March 31, 2006.
The Company's stock option plan ("the Plan"), which is stockholder approved,
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. Share option awards are
generally granted with an exercise price equal to, or higher than, the market
price of the Company's shares at the date of grant. Options vest ratably over a
five-year period and expire after ten years from the date of grant, except as
discussed below. Share options awards provide for accelerated vesting if there
is a change in control, as defined in the Plan. The remaining shares of stock
reserved for the stock option plan at March 31, 2006 amounted to approximately
114,000 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 the fiscal 2003, 2004 and 2005 through September
20, 2005 that would have otherwise vested at various times through fiscal 2010
was accelerated, as more fully described in note 1(p) of the 2005 Annual Report
to Stockholders. All other terms and conditions of the accelerated options
remain unchanged as a result of 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. All options expire
ten years after the date of grant.
The weighted average fair value of all of the options granted during the six
months ended March 31 have been estimated using the Black-Scholes option-pricing
model with the following assumptions (unaudited):
2005 2006
---- ----
Dividend yield 1.1% --%
Weighted average risk-free interest rate 4.21% --%
Weighted average expected volatility 35.2% --%
Weighted average expected life in years 7.5 --
No options were granted during the six months ended March 31, 2006.
13
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(8) STOCK BASED COMPENSATION (continued)
A summary of share option activity for the six months ended March 31, 2006
follows (Dollars in thousands, except share data):
Weighted
Weighted Average
Number Average Remaining Aggregate
Of Exercise Contractual Intrinsic
Shares Price Life (Years) Value
------ ----- ------------ -----
(Unaudited)
Outstanding at September 30, 2005 2,811,609 $ 8.52
Granted -- --
Exercised (150,423) $ 4.36
Forfeited or expired (7,074) $ 12.06
------------
Outstanding at March 31, 2006 2,654,112 $ 8.75 6.1 $ 13,264
============ ============
Exercisable at March 31, 2006 2,600,992 $ 8.82 6.1 $ 12,829
============ ============
The weighted average grant-date fair value of options granted during the six
months ended March 31, 2005 was $5.46 per share. The total intrinsic value of
options exercised during the six months ended March 31, 2005 and 2006 was $1.8
million and $1.4 million, respectively.
A summary of the status of the Company's nonvested options as of March 31, 2006,
and changes during the six months then ended, is presented below (unaudited):
Weighted
Average
Number Grant-Date
Of Shares Fair Value
--------- ----------
Nonvested at September 30, 2005 145,389 $ 2.09
Granted -- --
Vested (92,269) 1.77
Forfeited -- --
----------
Nonvested at March 31, 2006 53,120 $ 2.64
==========
Fair values have been retroactively restated for all stock dividends since the
date the option was granted.
As of March 31, 2006, there was approximately $82,000 of total unrecognized
compensation cost related to nonvested share-based compensation arrangements.
That cost is expected to be recognized over a weighted average period of
approximately one year.
The Company generally issues authorized but previously unissued shares to
satisfy option exercises.
14
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(8) STOCK BASED COMPENSATION (continued)
Had the compensation cost for the Company's stock-based compensation plan been
determined under the fair value-based method, the Company's net income and
earnings per share would have been adjusted to the pro forma amounts below for
the quarters ended March 31 (in thousands, except per share data)(unaudited):
2005 2006
---- ----
Information as reported in the Financial Statements:
Net income $4,135 $4,645
====== ======
Basic earnings per share $ 0.21 $ 0.24
====== ======
Diluted earnings per share $ 0.20 $ 0.23
====== ======
Share-based compensation cost, net of related tax effects $ -- $ 23
====== ======
Information calculated as if fair value method had been
applied to all awards:
Net income, as reported $4,135 $4,645
Add: Stock-based compensation expense recognized during
the period, net of related tax effects -- 23
Less: Stock-based compensation expense determined under the
fair value-based method, net of related tax effects (200) (23)
------ ------
Pro forma net income $3,935 $4,645
====== ======
Pro forma basic earnings per share $ 0.20 $ 0.24
====== ======
Pro forma diluted earnings per share $ 0.19 $ 0.23
====== ======
Had the compensation cost for the Company's stock-based compensation plan been
determined under the fair value-based method, the Company's net income and
earnings per share would have been adjusted to the pro forma amounts below for
the six months ended March 31 (in thousands, except per share data)(unaudited):
2005 2006
---- ----
Information as reported in the Financial Statements:
Net income $8,179 $9,088
====== ======
Basic earnings per share $ 0.42 $ 0.47
====== ======
Diluted earnings per share $ 0.40 $ 0.45
====== ======
Share-based compensation cost, net of related tax effects $ -- $ 47
====== ======
Information calculated as if fair value method had been
applied to all awards:
Net income, as reported $8,179 $9,088
Add: Stock-based compensation expense recognized during
the period, net of related tax effects -- 47
Less: Stock-based compensation expense determined under the
fair value-based method, net of related tax effects (375) (47)
------ ------
Pro forma net income $7,804 $9,088
====== ======
Pro forma basic earnings per share $ 0.40 $ 0.47
====== ======
Pro forma diluted earnings per share $ 0.38 $ 0.45
====== ======
15
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(9) COMMON STOCK DIVIDEND
On December 15, 2004 and October 26, 2005, the Company declared 10% stock
dividends, aggregating approximately 1,594,000 and 1,770,000 shares,
respectively. All share and per share data have been retroactively restated for
the stock dividends.
(10) GUARANTEES
Standby letters of credit obligate the Company to meet certain financial
obligations of its customers, if, under the contractual terms of the agreement,
the customers are unable to do so. Payment is only guaranteed under these
letters of credit upon the borrower's failure to perform its obligations to the
beneficiary. The Company can seek recovery of the amounts paid from the
borrower. These standby letters of credit are generally collateralized.
Commitments under standby letters of credit are usually one year or less. At
March 31, 2006, the Company has recorded no liability for the current carrying
amount of the obligation to perform as a guarantor. The maximum potential amount
of undiscounted future payments related to standby letters of credit at
September 30, 2005 and March 31, 2006 was $5.8 million and $7.3 million,
respectively.
(11) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITES
The Bank originates certain fixed rate residential loans with the intention of
selling these loans in the secondary market. Between the time that the Bank
enters into an interest rate lock or a commitment to originate a fixed rate
residential loan with a potential borrower and the time the closed loan is sold,
the Company is subject to variability in the market prices related to these
commitments due to potential changes in interest rates. The Company believes
that it is prudent to limit the variability of expected proceeds from the sales
through forward sales of "to be issued" mortgage-backed securities and loans
("forward sales commitments"). The commitment to originate fixed rate
residential loans and forward sales commitments are freestanding derivative
instruments. Since such instruments do not qualify for hedge accounting
treatment, their fair value adjustments are recorded through the income
statement in net gains on sales of loans held for sale. The commitments to
originate fixed rate conforming loans totaled $6.0 million at March 31, 2006.
The fair value of the loan commitments was an asset of approximately $15,000 at
March 31, 2006. As of March 31, 2006, the Company had sold $6.0 million in
forward commitments to deliver fixed rate mortgage-backed securities, which were
recorded as a derivative asset of $16,000.
16
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis should be read in conjunction with the
consolidated financial statements of Coastal Financial Corporation and
Subsidiaries and the notes thereto.
FORWARD LOOKING STATEMENTS
- --------------------------
This report may contain certain "forward-looking statements" within the meaning
of Section 27A of the Securities Exchange Act of 1934, as amended, that
represent the Company's expectations or beliefs concerning future events. All
forward-looking statements are based on assumptions and involve risks and
uncertainties, many of which are beyond the Company's control and which may
cause its actual results, performance or achievements to differ materially from
the results, performance or achievements contemplated by the forward-looking
statements. Forward-looking statements can be identified by the fact that they
do not relate strictly to historical or current facts. They often include words
such as "believe," "expect," "anticipate," "intend," "plan," "estimate" or words
of similar meaning, or future or conditional verbs such as "will," "would,"
"should," "could" or "may." Forward-looking statements speak only as of the date
they are made. The Company undertakes no obligation to publicly update or
otherwise revise any forward-looking statement, whether as a result of new
information, future events or otherwise. See Part II, Item 1.A., "Risk Factors"
for disclosure regarding risks and uncertainties related to the Company's
business.
OVERVIEW
- --------
Coastal Financial Corporation (the "Company") 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 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. 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.
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.
17
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 continuing
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 extended
operating hours. The call center employs approximately 20 Associates. The Bank
experienced increased salary and benefit expenses in fiscal 2005 and in the
first six months of fiscal 2006 and anticipates these expenses will continue
thereafter associated with the hiring, training and placement of these new
Associates.
The second initiative was "Totally Free Checking with A Gift" that was
introduced in September 2004. The Bank has incurred, and will continue to incur,
significant marketing costs associated with this strategy. The Bank expects to
realize significant benefits from this strategy consisting of increased Bank
lobby traffic, increased number of personal checking accounts and higher fee
income as a result of those checking accounts. In the first six months of 2006,
checking account balances grew approximately 18% when compared to the same
period a year ago. This rate of growth necessitated the hiring of additional
Associates to open and service these accounts. The Associates hired for these
two initiatives are expected to have total compensation averaging between
$28,000 and $35,000 per Associate.
In the latter part of fiscal 2005, the Company began preparations to increase
lending production in mortgage originations. The Company has hired leadership
and support staff as well as additional mortgage lending officers. As a net
result of these plans, the Company has increased support staff by approximately
five personnel and added approximately thirteen residential lending officers and
staffing as of March 31, 2006. Increased lending volumes from these lending
personnel are not expected to increase significantly until the fourth quarter of
fiscal 2006 and the first quarter of fiscal 2007. Further, the amount of
increased revenues in relation to the increased expense cannot be accurately
predicted at this time.
During the first quarter of fiscal 2006, the Bank opened two branches; in Oak
Island, North Carolina and at Stephens Crossroads in Longs, South Carolina. The
Bank anticipates that it will open four additional branches during the remainder
of fiscal 2006. The first of these branches was opened in North Conway, South
Carolina in April 2006. The opening of these branches will increase
compensation, occupancy and other expenses as well as related marketing
expenditures. Generally, the Bank will hire personnel three to six months in
advance of a branch opening to ensure that they are properly trained. As a
result of these openings, the Bank expects its total investment in these four
offices to be approximately $6.5 million in land, buildings and equipment costs
as well as increased lease expenses of approximately $200,000.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
The Company's accounting policies are in accordance with accounting principles
generally accepted in the United States of America and with general practice
within the banking industry. In order to understand the Company's financial
condition and results of operations, it is important to understand the more
critical accounting policies and the extent to which judgment and estimates are
used in applying those policies. The Company considers its policies regarding
the allowance for loan losses and income taxes to be its most critical
accounting policies due to the significant degree of the levels of subjectivity
and management judgment necessary to account for these matters. Different
assumptions in the application of these policies could result in material
changes in the Company's consolidated financial statements. The Company's
accounting policies are set forth in Note 1 of the Notes to Consolidated
Financial Statements in the Company's 2005 Annual Report to Stockholders. For
additional discussion concerning the Company's allowance for loan losses and
related matters, see "Allowance for Loan Losses." See "Income Taxes" for
additional discussion concerning income taxes in the Company's 2005 Annual
Report to Stockholders.
OFF-BALANCE SHEET ARRANGEMENTS
- ------------------------------
In the normal course of operations, the Company engages in a variety of
financial transactions that, in accordance with generally accepted accounting
principles, are recorded in amounts that differ from the notional amounts. These
transactions involve, to varying degrees, elements of credit risk, interest
rate, and liquidity risk. Such transactions are used by the Company for general
corporate purposes or to satisfy customer needs. Corporate purpose transactions
are used to help manage customers' requests for funding. The Bank's off-balance
sheet arrangements, which principally include lending commitments and
derivatives, are described below.
18
Lending Commitments: Lending commitments include loan commitments, standby
letters of credit, unused business and personal credit card lines, and unused
business and personal lines of credit. These instruments are not recorded in the
consolidated balance sheet until funds are advanced under the commitments. The
Bank provides these lending commitments to customers in the normal course of
business. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company applies essentially the same
credit policies and standards as it does in the lending process when making
these loans. For business customers, commercial loan commitments generally take
the form of revolving credit arrangements to finance customers' working capital
requirements. For personal customers, loan commitments are generally lines of
credit that are unsecured or are secured by residential property. Standby
letters of credit obligate the Company to meet certain financial obligations of
its customers, if, under the contractual terms of the agreement, the customers
are unable to do so. Payment is only guaranteed under these letters of credit
upon the borrower's failure to perform its obligations to the beneficiary. The
Company can seek recovery of the amounts paid from the borrower. Standby letters
of credit are generally collateralized and are usually one year or less.
At March 31, 2006, the Company recorded no liability for the current carrying
amount of the obligation to perform as a guarantor, as such amounts are not
considered material. The maximum potential amount of undiscounted future
payments related to standby letters of credit at September 30, 2005 and March
31, 2006 was $5.8 million and $7.3 million, respectively.
A summary of loans receivable with undisbursed commitments to extend credit at
September 30, 2005 and March 31, 2006 follows:
September 30, March 31,
2005 2006
---- ----
(Unaudited)
(Dollars in thousands)
Residential mortgage loans in process $ 28,345 $ 34,065
Business and consumer credit card lines 14,065 14,338
Consumer home equity lines 41,117 44,521
Other consumer lines of credit 6,818 7,551
Standby letters of credit 5,777 7,301
Commercial real estate and construction
and land development 107,731 120,652
Other commercial lines of credit 10,527 9,941
--------- ---------
Total loans receivable with undisbursed commitments $ 214,380 $ 238,369
========= =========
Derivatives and Hedging Activities: The Bank originates certain fixed rate
residential loans with the intention of selling these loans. Between the time
that the Bank enters into an interest rate lock or a commitment to originate a
fixed rate residential loan with a potential borrower and the time the closed
loan is sold, the Company is subject to variability in the market prices related
to these commitments due to potential changes in interest rates. The Company
believes that it is prudent to limit the variability of expected proceeds from
the sales through forward sales of "to be issued" mortgage-backed securities and
loans ("forward sales commitments"). The commitment to originate fixed rate
residential loans and forward sales commitments are freestanding derivative
instruments. Since such instruments do not qualify for hedge accounting
treatment, their fair value adjustments are recorded through the income
statement in net gains on sale of loans. The commitments to originate fixed rate
conforming loans totaled $6.0 million at March 31, 2006. The fair value of the
loan commitments was an asset of approximately $15,000 at March 31, 2006. As of
March 31, 2006, the Company had sold $6.0 million in forward commitments to
deliver fixed rate mortgage-backed securities, which were recorded as a
derivative asset of $16,000.
19
DISCUSSION OF FINANCIAL CONDITION CHANGES FROM SEPTEMBER 30, 2005 TO MARCH 31,
- --------------------------------------------------------------------------------
2006
- ----
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Historically, the Company has maintained its liquidity at levels believed by
management to be adequate to meet the requirements of normal operations,
potential deposit out-flows and strong loan demand and still allow for optimal
investment of funds and return on assets. The principal sources of funds for the
Company are cash flows from operations, consisting mainly of loan payments,
Customer deposits, advances from the FHLB, securitization of loans and
subsequent sales, and loan sales. The principal use of cash flows is the
origination of loans receivable and purchase of investment securities. The
Company originated loans receivable of $376.5 million for the six months ended
March 31, 2005, compared to $373.9 million for the six months ended March 31,
2006. Loan principal repayments amounted to $267.9 million in the first six
months of 2005 compared to $292.3 million for the six months ended March 31,
2006. In addition, the Company sells certain loans in the secondary market to
finance future loan originations. In the first six months of fiscal 2005, the
Company sold mortgage loans or securitized and sold mortgage loans totaling
$28.5 million that compares to $20.8 million for the six months ended March 31,
2006. In addition, the Bank sold $13.3 million of commercial loan participations
in the six months ended March 31, 2005 compared to $2.1 million for the same
period in 2006.
During the six month period ended March 31, 2006, the Company securitized $12.9
million of mortgage loans and concurrently sold these mortgage-backed securities
to outside third parties and recognized a net gain on sale of $176,000. The
related mortgage servicing rights associated with the loans are $184,000. The
gain is included in gains on sales of loans held for sale in the consolidated
statement of operations. The Company has no retained interest in the securities
that were sold other than servicing rights.
For the six months ended March 31, 2006, the Company purchased $115.3 million in
investment and mortgage-backed securities. For the six months ended March 2005,
the Company purchased $220.3 million in investment and mortgage-backed
securities. These purchases during the six months ended March 31, 2006 were
primarily funded by borrowings, repayments of $41.1 million within the
securities portfolio and sales of mortgage-backed securities of $41.5 million.
Total Customer Deposits, defined as total deposits excluding certificates of
deposits obtained through brokers, decreased $9.9 million between September 30,
2005 and March 31, 2006. Money market and checking accounts decreased from
approximately $572.0 million at September 30, 2005 to $551.7 million at March
31, 2006, a decrease of $20.2 million or 3.5%. Core Deposits (defined as money
market accounts, checking accounts and statement savings accounts) decreased
from $643.8 million at September 30, 2005 to $627.1 million at March 31, 2006, a
decrease of 2.6%. The Company believes these decreases are generally seasonal as
tourism activity decreases during fall and winter months. In addition, real
estate activities slow in the fall and winter months resulting in decreased
balances in checking trust accounts when comparing the March 31, 2006 balances
to the September 30, 2005 balances related to real estate activities. Customer
Deposits at March 31, 2006 and March 31, 2005, are $891.1 million and $804.7
million, respectively, an increase of 10.7%. In addition, Core Deposits at March
31, 2006 and March 31, 2005 are $627.1 million and $575.4 million, respectively,
a 9.0% increase.
At March 31, 2006, the Company had $418.5 million of certificates of deposits
("CDs") that were due to mature within one year. Included in these CDs were
brokered CDs totaling $189.3 million. Based on past experience, the Company
believes that the majority of the non-brokered certificates of deposits will
renew with the Company. At March 31, 2006, the Company had commitments to
originate $24.5 million in residential mortgage loans, $62.0 million in
undisbursed business and retail lines of credit, $14.3 million in unused
business and personal credit card lines, and $120.7 million in commercial real
estate and construction and land development which the Company expects to fund
from normal operations. At March 31, 2006, the Company had approximately $91.5
million available in FHLB advances. In addition, the Company had unpledged
collateral that would support approximately $57.5 million in additional reverse
repurchases. At March 31, 2006, the Company also had an outstanding available
line for federal funds of $20.0 million.
As a result of $9.1 million in net income, less the cash dividends paid to
stockholders of approximately $2.0 million, proceeds of approximately $485,000
20
from the exercise of stock options, and the net increase in unrealized loss on
securities available for sale, net of income tax of $4.7 million, stockholders'
equity increased from $97.2 million at September 30, 2005 to $100.2 million at
March 31, 2006.
OTS regulations require that the Bank calculate and maintain a minimum
regulatory capital requirement on a quarterly basis and satisfy such requirement
as of the calculation date and throughout the quarter. The Bank's capital, as
calculated under OTS regulations, is approximately $120.1 million at March 31,
2006, exceeding the core capital requirement by $54.0 million. At March 31,
2006, the Bank's risk-based capital of approximately $131.4 million exceeded its
current risk-based capital requirement by $53.9 million. (For further
information see Regulatory Capital Matters.)
The table below summarizes future contractual obligations as of March 31, 2006
(unaudited):
Payments Due by Period
--------------------------------------------------------------
1 Year and 2-3 4-5 After 5
Total Less Years Years Years
---------- ---------- ---------- ---------- ----------
Time deposits $ 453,378 $ 418,527 $ 30,891 $ 3,265 $ 695
Short-term borrowings 79,642 79,642 -- -- --
Long-term debt 370,293 -- 7,537 70,453 292,303
Construction contracts 2,881 2,881 -- -- --
Operating leases 3,625 473 457 238 2,457
---------- ---------- ---------- ---------- ----------
Total contractual cash
obligations $ 909,819 $ 501,523 $ 38,885 $ 73,956 $ 295,455
========== ========== ========== ========== ==========
Purchase commitments. The Company has signed a contract to purchase a 1.35 acre
tract of land in North Carolina. The purchase price is approximately $1.2
million. After due diligence, the Company expects the sale to close in the third
quarter of fiscal 2006.
Lease commitments. The Bank executed a lease in the first quarter of fiscal 2006
for 5.48 acres of land and a building, which includes an option to purchase
after one year of the lease for approximately $2.8 million. Rent during the year
prior to the purchase option is approximately $200,000 and is included in the
operating leases line of the above schedule of future contractual obligations.
In April 2006, the Company entered into a lease for a branch. The Company
assumed the remaining term of an existing lease that expires January 2009 and
also entered into a lease agreement for an additional 11 years ending January
2020. In addition, the Company will purchase certain leasehold improvements and
other assets from the existing tenant for $250,000. The lease expense is
approximately $84,000 per year.
EARNINGS SUMMARY
- ----------------
Net income increased from $8.2 million, or $.40 per diluted share, for the six
months ended March 31, 2005 to $9.1 million, or $.45 per diluted share for the
six months ended March 31, 2006. This 11.1% increase in net income resulted from
increased net interest income of $3.0 million, or 13.0%, an increase in other
income of $1.7 million, and a decrease in the provision for loan losses of
$245,000, which were offset by increased general and administrative expenses of
$3.5 million, and increased income taxes of $550,000.
Net interest income increased 13.0% as a result of growth in loans receivable
and investments despite a slight decrease in net interest margin from 3.67% for
the six months ended March 31, 2005 to 3.64% for the six months ended March 31,
2006. The increase in net interest income is primarily attributable to an
increase in average earning assets of $185.9 million, or 14.6%. Average loans
receivable increased $144.3 million for the six months ended March 31, 2006
compared to March 31, 2005. In addition, average balances of investment
securities increased approximately $41.6 million. The investment securities were
primarily funded with brokered CD's. The average balance of Customer Deposits
increased from $762.3 million at March 31, 2005 to $874.6 million at March 31,
2006, which exclude brokered CD average balances of $190.1 million and $30.3
million at March 31, 2006 and 2005, respectively.
21
The provision for loan losses decreased $245,000 for the six months ended March
31, 2006 when compared to the prior year primarily due to a reduction in
individually significant special mention, substandard and impaired loans that
carry specific reserve allocations when computing the allowance for loan losses.
Several of the special mention, substandard and impaired loans were either paid
off or there was a significant improvement in the Company's collateral position.
The allowance for loan losses as a percentage of loans was 1.21% at March 31,
2006 as compared to 1.36% at March 31, 2005.
Other income increased from $6.1 million for the six months ended March 31, 2005
to $7.8 million for the six months ended March 31, 2006. This was a result of an
increase in fees and service charges on loan and deposit accounts of $1.8
million primarily as a result of the Company's "FANtastic! Customer Service" and
"Totally Free Checking with a Gift" initiatives. ATM and debit card income
increased $415,000, gains on sales of loans held for sale decreased $260,000.
The Company also had loss on sales of mortgaged backed securities available for
sale of $33,000 for the six months ended March 31, 2006, compared to gains of
$229,000 for the six months ended March 31, 2005.
General and administrative expenses increased from $16.1 million for the six
months ended March 31, 2005 to $19.6 million for the six months ended March 31,
2006. Compensation and benefits increased from $8.9 million for the first two
quarters of fiscal 2005 to $10.9 million in the six months of fiscal 2006,
primarily due to an increase in the number of banking Associates in business and
residential banking, Associates in the Company's expanded hours call center,
Associates in new branches and normal salary increases. Marketing expenses were
$957,000 for the six months ended March 31, 2006, compared to $993,000 for the
six months ended March 31, 2005. In addition, other expense was $2.1 million for
the six months ended March 31, 2005, compared to $2.4 million for the six months
ended March 31, 2006.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED
- --------------------------------------------------------------------------------
MARCH 31, 2005 AND 2006
- -----------------------
INTEREST INCOME
- ---------------
Interest income for the three months ended March 31, 2006, increased to $24.1
million as compared to $18.9 million for the three months ended March 31, 2005.
The earning asset yield for the three months ended March 31, 2006, was 6.51%
compared to 5.83% for the three months ended March 31, 2005. The average yield
on loans receivable for the three months ended March 31, 2006, was 7.27%
compared to 6.34% for three months ended March 31, 2005. 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 7.75% at March 31,
2006, compared to 5.75% at March 31, 2005. The yield on investments increased to
4.95% for the three months ended March 31, 2006, from 4.88% for the three months
ended March 31, 2005. Long-term interest rates have remained relatively constant
during the last year despite rising short-term rates, resulting in a flat yield
curve. Consequently, most of the cash flows received from the investment
portfolio have been reinvested at approximately the same interest rate. Should
short-term rates continue to rise more quickly than long-term rates, it is
possible that the yield curve would become inverted. A flat yield curve or
inverted yield curve would likely cause the Bank's net interest margin to
decline and reduce opportunities for using securities to leverage capital. Total
average interest-earning assets were $1.5 billion for the quarter ended March
31, 2006 as compared to $1.3 billion for the quarter ended March 31, 2005, an
increase of 14.2%. The increase in average interest-earning assets is primarily
due to an increase in average loans receivable of approximately $157.9 million,
an increase of 18.7%, resulting primarily from growth in the commercial loan
portfolio.
22
INTEREST EXPENSE
- ----------------
Interest expense on interest-bearing liabilities was $11.0 million for the three
months ended March 31, 2006, as compared to $7.0 million for the three months
ended March 31, 2005. The average cost of Customer Deposits for the three months
ended March 31, 2006, was 2.03% compared to 1.33% for the three months ended
March 31, 2005. The cost of interest-bearing liabilities was 2.94% for the three
months ended March 31, 2006 compared to 2.16% for the three months ended March
31, 2005. The cost of brokered CD's, FHLB advances, repurchase and reverse
repurchase agreements and other borrowings was 4.37%, 4.07%, 3.64% and 7.71%,
respectively, for the three months ended March 31, 2006. For the three months
ended March 31, 2005, the cost of FHLB advances, repurchase and reverse
repurchase agreements and other borrowings was 3.69%, 2.35% and 5.41%,
respectively. The increased cost of funds on other borrowings is due to the
increased short-term interest rates. At March 31, 2006, the federal funds rate
was 5.00% compared to 2.96% at March 31, 2005.
Total average interest-bearing liabilities increased from $1.3 billion at March
31, 2005 to $1.5 billion at March 31, 2006. The increase in average
interest-bearing liabilities is due to an increase in average Customer Deposits
of approximately $107.8 million, increased average FHLB advances of $17.6
million and increased average customer repurchase agreements of $18.0 million.
This was partially offset by a decrease in average broker reverse repurchase
agreements of $85.7 million. Brokered CD's increased by $133.3 million in
average balances when comparing the two periods and were used to fund loan and
investment securities growth.
NET INTEREST INCOME
- -------------------
Net interest income was $13.2 million for the three months ended March 31, 2006,
as compared to $11.9 million for the three months ended March 31, 2005. The net
interest margin was 3.57% for the three months ended March 31, 2006, compared to
3.68% for the three months ended March 31, 2005.
The following table summarizes the average balance sheet and the related yields
on interest-earning assets and deposits and borrowings for the three months
ended March 31, 2005 and 2006:
Three Months Ended March 31,
----------------------------
2006 2005
---- ----
Average Income/ Yield/ Average Income/ Yield/
Balance (1) Expense Rate Balance (1) Expense Rate
----------- ------- ---- ----------- ------- ----
(Unaudited)
(Dollars in Thousands)
Assets
Earning assets
Loans (2) $1,000,737 $ 18,182 7.27% $ 842,846 $ 13,364 6.34%
Investment
Securities, MBS
Securities and
Other (3) 481,382 5,956 4.95% 454,434 5,548 4.88%
---------- ---------- ---------- ----------
Total earning assets $1,482,119 24,138 6.51% $1,297,280 $ 18,912 5.83%
========== ---------- ========== ----------
Liabilities
Customer Deposits 869,213 4,414 2.03% 761,534 2,536 1.33%
Brokered CD's 192,458 2,105 4.37% 59,201 403 2.72%
Borrowings 430,601 4,451 4.13% 480,771 4,077 3.39%
---------- ---------- ---------- ----------
Total interest-bearing
Liabilities $1,492,272 10,970 2.94% $1,301,506 7,016 2.16%
========== ---------- ========== ----------
Net interest income $ 13,168 $ 11,896
========== ==========
Net interest margin 3.57% 3.68%
Net yield on earning
assets 3.55% 3.67%
(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.
(4) Net interest income has not been adjusted to produce a tax-equivalent
yield.
23
PROVISION FOR LOAN LOSSES
- -------------------------
The provision for loan losses decreased from $625,000 for the three months ended
March 31,2005, to $330,000 for the three months ended March 31, 2006 primarily
due to a reduction in individually significant special mention, substandard and
impaired loans that carry specific reserve allocations when computing the
allowance for loan loss. Several of the special mention, substandard and
impaired loans were either paid off or there was a significant improvement in
the Company's collateral position at March 31, 2006. The allowance for loan
losses as a percentage of loans was 1.21% at March 31, 2006 as compared to 1.36%
at March 31, 2005. The allowance as a percentage of loans declined due to
improving economic conditions and the risk factors related to the underlying
portfolio. Loans delinquent 90 days or more were $3.1 million or .31% of total
loans at March 31, 2006, compared to $7.1 million or .82% of total loans at
March 31, 2005 and $2.6 million or .28% of total loans at September 30, 2005.
The allowance for loan losses was 389% of loans delinquent more than 90 days at
March 31, 2006, compared to 165% at March 31, 2005 and 445% at September 30,
2005. Net charge-offs for the three months ended March 31, 2006 were $117,000
compared to $269,000 for the three months ended March 31, 2005.
Management believes that the current level of the allowance for loan losses at
March 31, 2006 is adequate considering the composition of the loan portfolio,
the portfolio's loss experience, delinquency trends, current regional and local
economic conditions and other factors at that date.
OTHER INCOME
- ------------
For the three months ended March 31, 2006, other income was $4.2 million
compared to $3.3 million for the three months ended March 31, 2005. Fees and
service charges from deposit accounts increased $823,000 or 57.8% to $2.2
million for the three months ended March 31, 2006, compared to $1.4 million for
the three months ended March 31, 2005. The majority of this increase is due to
fee income from increased number of personal and business checking accounts.
Gain on sale of loans was $202,000 for the quarter ended March 31, 2006,
compared to $244,000 for the quarter ended March 31, 2005. During the quarter
ended March 31, 2006, the Company sold $9.3 million in loans held for sale
compared to $13.5 million in the comparable prior year period. Margins on sales
of conforming mortgage loans declined in fiscal 2006 due to rising interest
rates. Gains on sales of securities available for sale were $30,000 for the
quarter ended March 31, 2006, compared to gains of $88,000 for the quarter ended
March 31, 2005. Income from Federal Home Loan Bank Stock dividends increased
from $213,000 to $256,000 due to increased dividends resulting from higher
interest rates. In addition, income from ATM and debit card transactions
increased 64.0% to $538,000 during the second quarter of fiscal 2006, primarily
due to increased personal checking accounts.
GENERAL AND ADMINISTRATIVE EXPENSES
- -----------------------------------
General and administrative expenses were $8.3 million for the quarter ended
March 31, 2005 compared to $9.9 million for the quarter ended March 31, 2006.
Salaries and employee benefits were $4.5 million for the three months ended
March 31, 2005, as compared to $5.5 million for the three months ended March 31,
2006, an increase of 21.8%. Increased compensation is due to the increased
number of Associates in the Company's expanded hours call center, in three new
branches opened since September 30, 2005 plus one new branch opened in April
2006, and in residential banking. In the latter part of fiscal 2005, the Company
began preparations to increase lending production in mortgage originations. The
Company has hired leadership and support staff as well as additional mortgage
lending officers. As a result of these plans, the Company has increased support
staff by approximately five personnel and added approximately thirteen
residential lending officers as of March 31, 2006. Increased lending volumes
from these lending personnel are not expected to increase significantly until
the fourth quarter of fiscal 2006 and the first quarter of fiscal 2007. Over the
past year, the Company also added several Associates in a Banking Group that is
focused on growing small to medium sized business banking relationships. As a
result of new branches, equipment purchased to improve Customer convenience and
increased checking activity, net occupancy, furniture and fixtures and data
processing expenses increased by $553,000, including increased depreciation of
$171,000, when comparing the two periods. Marketing expenses were $482,000 for
the three months ended March 31, 2005, compared to $520,000 for the three months
ended March 31, 2006. The decrease from the prior period results from decreased
initial startup expense for the Bank's "Totally Free Checking with A Gift"
initiative and the introduction of Penny Pavilion, the Bank's free coin counting
service. Other expenses were $1.2 million for the quarter ended March 31, 2005
compared to $1.1 million for the quarter ended March 31, 2006.
24
Other expense decreased $82,000 due to the non-recurring charge to write-off
signage of $111,000, a reduction in audit and accounting costs of $95,000 as the
initial compliance activities associated with Sarbanes-Oxley have been
completed, partially offset by increased legal expense of $40,000, increased
courier service of $41,000 resulting from the increased number of branches,
reduced recoveries of prior period mortgage servicing impairments of $74,000,
and increased other operating expenses of $37,000.
INCOME TAXES
- ------------
Income taxes were $2.5 million for the three months ended March 31, 2006
compared to $2.2 million for the three months ended March 31, 2005. The
effective income tax rate as a percentage of pretax income was 34.71% and 34.25%
for the quarters ended March 31, 2006 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. The Company's effective income tax rates
take into consideration certain assumptions and estimates made by management. No
assurance can be given that either the tax returns submitted by management or
the income tax reported on the consolidated financial statements will not be
adjusted by either adverse rulings by the U.S. Tax court, changes in the tax
code, or assessments made by the Internal Revenue Service. The Company is
subject to potential adverse adjustments, including but not limited to: an
increase in the statutory federal or state income tax rates, the permanent
non-deductibility of amounts currently considered deductible either now or in
future periods, and the dependency on the generation of the future taxable
income, in order to ultimately realize deferred income tax assets.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE SIX MONTHS ENDED
- --------------------------------------------------------------------------------
MARCH 31, 2005 AND 2006
- -----------------------
INTEREST INCOME
- ---------------
Interest income for the six months ended March 31, 2006, increased to $47.2
million as compared to $36.9 million for the six months ended March 31, 2005.
The earning asset yield for the six months ended March 31, 2006, was 6.46%
compared to a yield of 5.78% for the six months ended March 31, 2005. The
average yield on loans receivable for the six months ended March 31, 2006, was
7.21% compared to 6.25% for the six months ended March 31, 2005. 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 7.75% at March
31, 2006, compared to 5.75% at March 31, 2005. The yield on investments
increased to 4.92% for the six months ended March 31, 2006, from 4.89% for the
six months ended March 31, 2005. Total average interest-earning assets were $1.5
billion for the six months ended March 31, 2006 as compared to $1.3 billion for
the six months ended March 31, 2005. The increase in average interest-earning
assets is primarily due to an increase in average loans receivable of
approximately $144.3 million resulting primarily from growth in the commercial
loan portfolio and an increase in investment securities of approximately $41.6
million, primarily funded by brokered CD's.
INTEREST EXPENSE
- ----------------
Interest expense on interest-bearing liabilities was $20.7 million for the six
months ended March 31, 2006, as compared to $13.4 million for the six months
ended March 31, 2005. The average cost of Customer Deposits for the six months
ended March 31, 2006, was 1.93% compared to 1.32% for the six months ended March
31, 2005. The cost of interest-bearing liabilities was 2.82% for the six months
ended March 31, 2006 compared to 2.11% for the six months ended March 31, 2005.
The cost of brokered CD's, FHLB advances, reverse repurchase agreements and
other borrowings was 4.13%, 4.05%, 3.48% and 7.44%, respectively, for the six
months ended March 31, 2006. For the six months ended March 31, 2005, the cost
of brokered CD's, FHLB advances, reverse repurchase agreements and other
borrowings was 2.73%, 3.68%, 2.15% and 5.37%,respectively. The increased cost of
funds on other borrowings is due to the increased short-term interest rates. At
March 31, 2006, the federal funds rate was 5.00% compared to 2.96% at March 31,
2005. Total average interest-bearing liabilities increased from $1.3 billion at
March 31, 2005 to $1.5 billion at March 31, 2006. The increase in average
interest-bearing liabilities is due to an increase in average Customer Deposits
25
of approximately $112.3 million as a result of the Company's focus on checking
growth, increased average brokered CD's of $159.8 million and increased average
customer repurchase agreements of $10.1 million. This increase was partially
offset by a decrease in average reverse broker repurchase agreements of $82.3
million.
NET INTEREST INCOME
- -------------------
Net interest income was $26.4 million for the six months ended March 31, 2006,
as compared to $23.4 million for the six months ended March 31, 2005. The net
interest margin was 3.64% for the six months ended March 31, 2006, compared to
3.67% for the six months ended March 31, 2005.
The following table summarizes the average balance sheet and the related yields
on interest-earning assets and deposits and borrowings for the six months ended
March 31, 2006 and 2005:
Six Months Ended March 31,
--------------------------
2006 2005
---- ----
Average Income/ Yield/ Average Income/ Yield/
Balance (1) Expense Rate Balance (1) Expense Rate
----------- ------- ---- ----------- ------- ----
Assets
Earning assets
Loans (2) $ 980,118 $ 35,329 7.21% $ 835,820 $ 26,104 6.25%
Investment
Securities, MBS
Securities and
Other (3) 481,417 11,847 4.92% 439,783 10,754 4.89%
---------- ---------- ---------- ----------
Total earning assets $1,461,535 $ 47,176 6.46% $1,275,603 $ 36,858 5.78%
========== ---------- ========== ----------
Liabilities
Customer Deposits 874,557 8,461 1.93% 762,293 5,021 1.32%
Brokered CD's 190,141 3,928 4.13% 30,342 414 2.73%
Borrowings 406,098 8,343 4.11% 481,365 8,011 3.33%
Total interest-bearing
---------- ---------- ---------- ----------
Liabilities $1,470,796 20,732 2.82% $1,274,000 13,446 2.11%
========== ---------- ========== ----------
Net interest income $ 26,444 $ 23,412
========== ==========
Net interest margin 3.64% 3.67%
Net yield on earning
assets 3.62% 3.67%
(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.
(4) Net interest income has not been adjusted to produce a tax-equivalent
yield.
PROVISION FOR LOAN LOSSES
- -------------------------
The provision for loan losses decreased $245,000 from $975,000 for the six
months ended March 31, 2005, to $730,000 for the six months ended March 31, 2006
primarily due to a reduction in individually significant special mention,
substandard and impaired loans that carry specific reserve allocations when
computing the allowance for loan loss. Several of the special mention,
substandard and impaired loans were either paid off or there was a significant
improvement in the Company's collateral position. The allowance for loan losses
as a percentage of loans was 1.21% at March 31, 2006 as compared to 1.36% at
March 31, 2005. Loans delinquent 90 days or more were $3.1 million at March 31,
2006. The allowance for loan losses was 389% of loans delinquent more than 90
days at March 31, 2006, compared to 165% at March 31, 2005 and 445% at September
30, 2005. Net charge-offs for the six months ended March 31, 2006 were $270,000
compared to $284,000 for the six months ended March 31, 2005. 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.
26
OTHER INCOME
- ------------
For the six months ended March 31, 2006, other income was $7.8 million compared
to $6.1 million for the six months ended March 31, 2005. Fees and service
charges from deposit accounts increased $1.8 million or 72.5% to $4.3 million
for the six months ended March 31, 2006, compared to $2.5 million for the six
months ended March 31, 2005. The majority of this increase is due to fee income
resulting from an increase in the number of personal and business checking
accounts. During the six months ended March 31, 2006, the Company securitized
mortgage loans into mortgage-backed securities("MBS") and then sold the MBS and
sold loans aggregating $20.8 million of loans held for sale compared to $28.5
million for the six months ended March 31, 2005. Gain on sale of loans was
$294,000 for the six months ended March 31, 2006, compared to $554,000 for the
six months ended March 31, 2005. Loss on sales of securities was $15,000 for the
six months ended March 31, 2006, compared to gains of $246,000 for the six
months ended March 31, 2005. In addition, the Company had gain on investment
security held to maturity called by issuer of $160,000 for the six months ended
March 31, 2005 and none for the six months ended March 31, 2006. Other income
was $390,000 for the six months ended March 31, 2006, as compared to $296,000
for the six months ended March 31, 2005. ATM and debit card income increased
$415,000 for the six months ended March 31, 2006 to $1.0 million over the
similar period in fiscal 2005 primarily due to the increased number of personal
checking accounts.
GENERAL AND ADMINISTRATIVE EXPENSES
- -----------------------------------
General and administrative expenses were $16.1 million for the six months ended
March 31, 2005 compared to $19.6 million for the six months ended March 31,
2006. Salaries and employee benefits were $8.9 million for the six months ended
March 31, 2005, as compared to $10.9 million for the six months ended March 31,
2006, an increase of 21.7%, primarily due to an increase in the number of
Associates in the Company's expanded hours call center, in three new branches
opened since September 30, 2005 plus one branch opened in April 2006, and
increased personnel in residential banking. In the latter part of fiscal 2005,
the Company began preparations to increase production in mortgage originations.
As a result of these plans, the Company has increased support staff by
approximately five personnel and added approximately thirteen residential
lending officers as of March 31, 2006. Increased lending volumes from these
lending personnel are not expected to increase significantly until the fourth
quarter of fiscal 2006 and the first quarter of fiscal 2007. The Company also
added several Associates in a Banking Group that is focused on growing small to
medium sized business banking relationships. As a result of new branches,
equipment purchased to improve Customer convenience and increased checking
activity, net occupancy, furniture and fixtures and data processing expenses
increased $1.1 million including increased depreciation of $375,000, when
comparing the two periods. Marketing expenses were $993,000 for the six months
ended March 31, 2005, compared to $957,000 for the six months ended March 31,
2006. The decrease from the prior period results from decreased initial startup
expense for the Bank's "Totally Free Checking With A Gift" initiative and the
introduction of Penny Pavilion, the Bank's free coin counting service. ATM and
debit card expenses increased $212,000 from $465,000 for the six months ended
March 31, 2005 to $677,000 for the six months ended March 31, 2006 primarily as
a result of an increased number of personal checking accounts. Other expenses
were $2.1 million for the six months ended March 31, 2005 compared to $2.4
million for the six months ended March 31, 2006. Other expense increased due to
increased legal costs of $71,000, increased courier service costs of $36,000 due
the increased number of branches, increased charitable contributions of $62,000,
and reduced income from reduced recovery of mortgage servicing rights
impairments of $150,000. The increased costs in 2006 are partially offset by a
decrease in write-off of signage of $111,000 as the Bank changed its logo, a net
increase in the recovery of checking charge-offs of $44,000 and a reduction in
accounting and auditing fees of $37,000.
INCOME TAXES
- ------------
Income taxes were $4.3 million for the six months ended March 31, 2005 compared
to $4.8 million for the six months ended March 31, 2006. The effective income
tax rate as a percentage of pretax income was 34.25% and 34.61% for the six
months ended March 31, 2005 and 2006, 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. 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
27
Internal Revenue Service. The Company is subject to potential adverse
adjustments, including but not limited to: an increase in the statutory federal
or state income tax rates, the permanent non-deductibility of amounts currently
considered deductible either now or in future periods, and the dependency on the
generation of the future taxable income, in order to ultimately realize deferred
income tax assets.
REGULATORY CAPITAL MATTERS
- --------------------------
To be categorized as "Well Capitalized" under the prompt corrective action
regulations adopted by the Federal Banking Agencies, the Bank must maintain a
total risk-based capital ratio as set forth in the following table and not be
subject to a capital directive order.
Categorized as "Well
Capitalized" under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provision
------ ----------------- ----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars In Thousands)
As of March 31, 2006:
Total Capital: $131,406 13.56% $ 77,513 8.00% $ 96,891 10.00%
(To Risk Weighted Assets)
Tier 1 Capital: $120,076 12.39% N/A N/A $ 58,135 6.00%
(To Risk Weighted Assets)
Tier 1 Capital: $120,076 7.27% $ 49,358 3.00% $ 82,263 5.00%
(To Total Assets)
Tangible Capital: $120,076 7.27% $ 24,679 1.50% N/A N/A
(To Total Assets)
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
- -----------------------------------------
In February 2006, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard (SFAS) No. 155, "Accounting for Certain Hybrid
Financial Instruments" an amendment of FASB Statements No. 133 and 140 (FAS
155). FAS 155 permits fair value remeasurement for any hybrid financial
instrument that contains an embedded derivative that otherwise would require
bifurcation, clarifies which interest only-strips and principal-only strips are
not subject to the requirements of Statement 133, establishes a requirement to
evaluate interests in securitized financial assets to identify interests that
are freestanding derivatives or that are hybrid financial instruments that
contain an embedded derivative requiring bifurcation, clarifies that
concentrations of credit risk in the form of subordination are not embedded
derivatives, and amends Statement 140 to eliminate the prohibition on a
qualifying special purpose entity from holding a derivative financial instrument
that pertains to a beneficial interest other than another derivative financial
instrument. FAS 155 is effective for all financial instruments acquired or
issued after the beginning of an entity's first fiscal year that begins after
September 15, 2006 ( October 1, 2006 for the Company). The Company does not
expect the adoption of FAS 155 to have a material effect on the results of
operations or statement of condition.
In March 2006, FASB issued Statement of Financial Accounting Standards No. 156
"Accounting for Servicing of Financials Assets" an amendment of FASB Statement
No. 140 (FAS 140 and FAS 156). FAS 140 establishes, among other things, the
accounting for all separately recognized servicing assets and servicing
liabilities. This Statement amends FAS 140 to require that all separately
recognized servicing assets and servicing liabilities be initially measured at
fair value, if practicable. This Statement permits, but does not require, the
subsequent measurement of separately recognized servicing assets and servicing
liabilities at fair value. Under this Statement, an entity can elect subsequent
fair value measurement to account for its separately recognized servicing assets
and servicing liabilities. Adoption of this Statement is required as of the
beginning of the first fiscal year that begins after September 15, 2006. Upon
adoption, the Company will apply the requirements for recognition and initial
measurement of servicing assets and servicing liabilities prospectively to all
transactions. The Company will adopt FAS 156 for the fiscal year beginning
October 1, 2006 and currently has not determined if it will adopt FAS 156 using
the fair value election.
28
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
- ------------------------------------------
In December 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 123R, Share-Based Payment which revised SFAS
No. 123, Accounting for Stock-Based Compensation. This Statement supersedes APB
Opinion No. 25, Accounting for Stock Issued to Employees, and related
implementation guidance and amends SFAS No. 95, Statement of Cash Flows. It
requires that all stock-based compensation now be measured at fair value and
recognized as expense in the income statement. This Statement also clarifies and
expands guidance on measuring fair value of stock compensation, requires
estimation of forfeitures when determining expense, and requires that excess tax
benefits be shown as financing cash inflows versus a reduction of taxes paid in
the Statement of Cash Flows. Various other changes are also required. The
Company adopted this Statement effective beginning October 1, 2005. The Company
experienced no significant effect on its financial statements as a result of the
adoption of this Statement. See Note 8 of the accompanying unaudited
consolidated financial statements for additional discussion.
EFFECT ON INFLATION AND CHANGING PRICES
- ---------------------------------------
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles which require the
measurement of financial position and results of operations in terms of
historical dollars, without consideration of change in the relative purchasing
power over time due to inflation. Unlike most industrial companies, virtually
all of the assets and liabilities of a financial institution are monetary in
nature. As a result, interest rates have a more significant impact on a
financial institution's performance than the effects of inflation. Interest
rates do not necessarily change in the same magnitude as the price of goods and
services.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
The Bank's Asset Liability Management Committee ("ALCO") monitors and considers
methods of managing exposure to interest rate risk. The ALCO consists of members
of the Board of Directors and Senior Leadership of the Company and meets
quarterly. The Bank's exposure to interest rate risk is reviewed on at least a
quarterly basis by the ALCO. Interest rate risk exposure is measured using
interest rate sensitivity analysis to determine the Company's change in net
portfolio value in the event of hypothetical changes in interest rates. The ALCO
is charged with the responsibility to maintain the level of sensitivity of the
Bank's net portfolio value with Board approved limits.
Net portfolio value (NPV) represents the market value of portfolio equity and is
equal to the market value of assets minus the market value of liabilities, with
adjustments made for off-balance sheet items over a range of assumed changes in
market interest rates. The Bank's Board of Directors has adopted an interest
rate risk policy which establishes maximum allowable decreases in NPV in the
event of a sudden and sustained one hundred to three hundred basis point
increase or decrease in market interest rates. The following table presents the
Bank's change in NPV as computed by the OTS for various rate shock levels as of
March 31, 2006 (Dollars in thousands).
Market
Board Board Market Value
Limit Limit Value Portfolio
Minimum NPV Maximum Of Assets Equity NPV
Change in interest rates Ratio Decline in NPV 3/31/06 3/31/06 Ratio
- ------------------------------------ ---------------- -------------------- ------------- ------------- ----------
300 basis point rise 5.00% 400 BPS 1,650,299 170,659 10.34%
200 basis point rise 6.00% 300 BPS 1,670,119 180,085 10.78%
100 basis point rise 6.00% 250 BPS 1,689,060 188,178 11.14%
No change 6.00% 1,705,899 193,651 11.35%
100 basis point decline 6.00% 250 BPS 1,719,705 195,511 11.37%
200 basis point decline 6.00% 300 BPS 1,726,714 188,617 10.92%
300 basis point decline 6.00% 350 BPS N/A N/A N/A
The preceding table indicates that at March 31, 2006, in the event of a sudden
and sustained increase in prevailing market interest rates, the Bank's Net
Portfolio Value (NPV) would be expected to decrease, and that in the event of a
sudden decrease in prevailing market interest rates, the Bank's NPV would be
expected to decrease minimally. A value for the 300 basis point decline is not
indicated due to the level of interest rates at March 31, 2006. At March 31,
2006, the Bank's estimated changes in NPV were within the limits established by
the Board of Directors.
29
Computation of prospective effects of hypothetical interest rate changes are
based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit decay, and should not be relied upon as
indicative of actual results. Further, the computations do not contemplate any
actions the ALCO could undertake in response to sudden changes in interest
rates.
Item 4. CONTROLS AND PROCEDURES
- --------------------------------
The Company's management, including the Company's principal executive officer
and principal financial officer, have evaluated the effectiveness of the
Company's "disclosure controls and procedures," as such term is defined in Rule
13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). Based upon their evaluation, the principal executive officer and
principal financial officer concluded that, as of the end of the period covered
by this report, the Company's disclosure controls and procedures were effective
for the purpose of ensuring that the information required to be disclosed in the
reports that the Company files or submits under the Exchange Act with the
Securities and Exchange Commission (the "SEC") (1) is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and (2) is accumulated and communicated to the Company's management,
including its principal executive and principal financial officer, as
appropriate to allow timely decisions regarding required disclosure. In
addition, based on that evaluation, no material changes in the Company's
internal control over financial reporting occurred during the quarter ended
March 31, 2006 that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Item 1. Legal Proceedings
-----------------
The Company is a defendant in one lawsuit related to activities in the
Bank, arising out of the normal course of business. The subsidiaries are also
defendants in lawsuits arising out of the normal course of business. Based upon
current information received from counsel representing the Company and its
subsidiaries in these matters, the Company believes none of the lawsuits would
have a material impact on the Company's financial condition or results of
operations.
Item 1.A. Risk Factors
------------
Investing in our common stock involves various risks which are particular
to our Company, our industry and our market area. Several risk factors regarding
investing in our common stock are discussed below. This listing should not be
considered as all-inclusive. If any of the following risks were to occur, we may
not be able to conduct our business as currently planned and financial condition
or operating results could be negatively impacted. These matters could cause the
trading price of our common stock to decline in future periods.
o We are geographically concentrated along the coastlines of South
Carolina and North Carolina. Changes in local economic conditions and
catastrophic weather, could have a significantly adverse impact on our
profitability.
We operate primarily along the coastlines of South Carolina and North
Carolina and substantially all of our loan customers and most of our
deposits and other customers live or have operations in these areas.
Accordingly, our success significantly depends upon the growth in
population, income levels, deposits and housing starts in the region,
along with continued attraction of business ventures to the area. Our
profitability is impacted by changes in economic conditions,
particularly changes in the real estate and tourism industries.
Exposure to changes in tourism or the real estate market, whether due
to changing economic conditions or catastrophic weather, could reduce
our growth rate, affect the ability of our customers to repay their
loans to us, and generally affect our financial condition and results
of operations.
30
o If our loan customers do not pay us as they have contracted to, we may
experience losses.
Our principal revenue producing business is making loans. If our
customers do not repay the loans, we will suffer losses. Even though
we maintain an allowance for loan losses, the amount of the allowance
may not be adequate to cover the losses we experience. We attempt to
mitigate this risk by a thorough review of creditworthiness of loan
customers. Nevertheless, there is risk that our credit evaluation will
prove to be inaccurate due to changed circumstances or otherwise.
o Fluctuations in interest rates could reduce our profitability.
Changes in interest rates may affect our level of interest income, the
primary component of our gross revenue, as well as the level of our
interest expense. Interest rate fluctuations are caused by many
factors which, for the most part, are not under our direct control.
For example, national monetary policy plays a significant role in the
determination of interest rates. Additionally, competitor pricing and
the resulting negotiations that occur with customers also impact the
rates we collect on loans and the rates we pay on deposits.
As interest rates change, we expect we will periodically experience
"gaps" in the interest rate sensitivities of our assets and
liabilities, meaning that either our interest-bearing liabilities will
be more sensitive to changes in market interest rates than our
interest-earning assets, or vice versa. In either event, if market
rates should move contrary to our position, this "gap" may work
against us, and our earnings may be negatively affected.
Changes in the level of interest rates also may negatively affect our
ability to originate real estate loans, the value of our assets and
our ability to realize gains from the sale of our assets, all
ultimately affect our earnings. A decline in the market value of our
assets may limit our ability to borrow additional funds. As a result,
we could be required to sell some of our loans and investments under
adverse market conditions, upon terms that are not favorable to us, in
order to maintain our liquidity. If those sales are made at prices
lower than the amortized cost of the investments, we will incur
losses.
o The banking industry is highly competitive.
The banking industry in our market area is highly competitive. We
compete with many different financial and financial services
institutions. A substantial number of the banks in our market area are
branches or subsidiaries of much larger organizations affiliated with
statewide, regional, or national banking companies, and as a result,
may have greater resources and lower costs of funds. These competitors
aggressively solicit customers within their market area by advertising
through direct mail, electronic media and other means. These
competitors may offer services, such as international banking
services, that we can offer only through correspondents, if at all.
Additionally, larger competitors have greater capital resources and,
consequently, higher lending limits.
o We are dependent on key personnel and the loss of one or more of those
key personnel may materially and adversely affect our prospects.
Competition for qualified employees and personnel in the banking
industry is intense and there are a limited number of qualified
persons with knowledge and experience in the South Carolina banking
industry. The process of recruiting personnel with a combination of
skills and attributes required to carry our strategies is often
lengthy. Our success depends, to a significant degree, upon our
ability to attract and retain qualified management, loan origination,
finance, administrative, marketing and technical personnel. We are
dependent upon a number of key executives who are integral to
implementing our business plan. The loss of the services of any one of
our senior executive management team or other key executives could
have a material adverse effect on our business, financial condition,
results of operations and cash flows.
31
o Provisions in our articles of incorporation and Delaware law may
discourage or prevent takeover attempts, and these provisions may have
the effect of reducing the market price of our stock.
Our articles of incorporation include several provisions that may have
the effect of discouraging or preventing hostile takeover attempts,
and therefore, making the removal of incumbent management difficult.
The provisions include staggered terms for our board of directors and
requirements of supermajority votes to approve certain business
transactions. In addition, Delaware law contains several provisions
that may make it more difficult for a third party to acquire control
of us without the approval of the board of directors, and may make it
more difficult or expensive for a third party to acquire a majority of
our outstanding stock. To the extent that these provisions are
effective in discouraging or preventing takeover attempts, they may
tend to reduce the market price for our stock.
o We are subject to governmental regulations which could change and
increase our cost of doing business or have an adverse effect on our
business.
We operate in a highly regulated industry and are subject to
examination, supervision and comprehensive regulation by various
federal and state agencies. Our compliance with the requirements of
these agencies is costly and may limit our growth and restrict certain
of our activities, including payment of dividends, mergers and
acquisitions, investments, loans and interest rates charged and
location of offices. We are also subject to capitalization guidelines
established by federal authorities and our failure to meet those
guidelines could result, in an extreme case, in our bank being placed
in receivership. Supervision, regulation and examination of banks and
bank holding companies by financial institution regulatory agencies
are intended for the protection of depositors and our other customers
rather than the holders of our common stock.
o Changes in accounting standards could impact reported earnings.
The accounting standard setters, including FASB, SEC and other
regulatory bodies, periodically change financial accounting and
reporting standards that govern the preparation of our consolidated
statements. These changes can be hard to predict and can materially
impact how the Company records and reports its financial condition and
results of operations. In some cases, we could be required to apply a
new or revised accounting standard retroactively, resulting in the
restatement of prior period financial statements.
o We are susceptible to changes in monetary policy and other economic
factors which may adversely affect our ability to operate profitably.
Changes in governmental, economic and monetary policies may affect the
ability of our bank to attract deposits and make loans. The rates of
interest payable on deposits and chargeable on loans are affected by
governmental regulation and fiscal policy as well as by national,
state and local economic conditions. All of these matters are outside
of our control and affect our ability to operate profitably.
o The preparation of financial statements requires the use of estimates
that may vary from actual results.
Preparation of consolidated financial statements in conformity with
accounting principles accepted in the United States of America
requires management to make significant estimates that affect the
financial statements. One of our most critical estimates is the level
of the allowance for loan losses. Due to the inherent nature of this
estimate, we cannot provide absolute assurance that we will not
significantly increase allowances for loan losses that are
significantly higher than the provided allowance.
32
o We rely on communications, information, operating and financial
control systems, and technology from third-party service providers,
and we may suffer an interruption in those systems that may result in
lost business. Further, we may not be able to substitute providers on
terms that are as favorable if our relationships with our existing
service providers are interrupted.
We rely heavily on third-party service providers for much of our
communications, information, operating and financial controls systems
technology. Any failure or interruption or breach in security of these
systems could result in failures or interruptions in our customer
relationships management, general ledger, deposit, servicing and/or
loan origination systems. We cannot assure you that such failures or
interruptions will not occur or, if they do occur, that they will be
adequately addressed by us or the third parties on which we rely. The
occurrence of any failure or interruption could have a material
adverse effect on our business, financial condition, results of
operations and cash flows. If any of our third-party service providers
experience financial, operational or technological difficulties, or if
there is any other disruption in our relationships with them, we may
be required to locate alternative sources of such services, and we
cannot assure you that we could negotiate terms that are as favorable
to us, or could obtain services with similar functionality as found in
our existing systems, without the need to expend substantial
resources, if at all. Any of these circumstances could have a material
adverse effect on our business, financial condition, results of
operations and cash flows.
o If the business continuity and disaster recovery plans that we have in
place are not adequate to continue our operations in the event of a
disaster, the business disruption can adversely impact our operations.
External events, including terrorist or military actions, or an
outbreak of disease, such as Asian Influenza, or "bird flu" and
resulting political and social turmoil could cause unforeseen damage
to our physical facilities or could cause delays or disruptions to
operational functions, including information processing and financial
market settlement functions. Additionally, our customers, vendors and
counterparties could suffer from such events. Should these events
affect us, or our customers, or vendors or counterparties with which
we conduct business, our results of operations could be adversely
affected.
o Litigation Risk.
From time to time, we are subject to claims and litigation from
customers and other individuals. Whether such claims and legal actions
are founded or unfounded, if such claims and legal actions are not
resolved in a manner favorable to us, they may result in significant
financial liability and/or adversely affect the market perception of
us and our products and services. Any financial liability or
reputation damage could have a material adverse effect on our business
and financial performance.
o Even though our common stock is currently traded on the Nasdaq Stock
Market, it has less liquidity than the average stock quoted on
national stock exchanges.
The trading volume in our common stock on the Nasdaq Stock Market has
been relatively low when compared with larger companies on the Nasdaq
National Market or national stock exchanges. As a result, it may be
more difficult for stockholders to sell a substantial number of shares
for the same price at which stockholders could sell a small number of
shares. We also cannot predict the effect, if any, that future sales
of our common stock in the market, or the availability of shares of
common stock for sale in the market, will have on the market price of
our common stock. We can give no assurance that sales of substantial
amounts of common stock in the market, or the potential for large of
amounts of sales in the market, would not cause the price of our
common stock to decline or impair our future ability to raise capital
through sales of common stock. The market price of our common stock
may fluctuate in the future, and these fluctuations may be unrelated
to our performance. General market price declines or overall stock
market volatility in the future could adversely affect the price of
our common stock. Further, the current market price of our stock may
not be indicative of future market prices.
33
o Our common stock is not insured, so you could lose your total
investment.
Our common stock is not a deposit or savings account, and will not be
insured by the Federal Deposit Insurance Corporation or any other
government agency. Should our business decline or fail, you could lose
your total investment.
Item 1.B. Unresolved Staff Comments
-------------------------
There are no comments from the staff of the SEC regarding our periodic or
current reports under the Exchange Act that remain unresolved.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
-----------------------------------------------------------
Not Applicable.
Item 3. Defaults Upon Senior Securities
-------------------------------
Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
At the Company's annual stockholders' meeting held on January 31, 2006, the
following items were ratified:
A. The election of directors of all nominees: G. David Bishop, James
T. Clemmons, William O. Marsh, Frank A. Thompson II.
At the meeting, a total of 16,792,972 votes were entitled to be
cast. Votes for G. David Bishop were 16,711,367 with 81,605
withheld; votes for James T. Clemmons were 16,596,687 with 196,285
withheld; votes for William O. Marsh were 16,622,474 with 170,498
withheld; votes for Frank A. Thompson II were 16,715,502 with
77,470 withheld. The directors whose terms continued and the years
their terms expire are as follows: J. Robert Calliham (2007),
James H. Dusenbury (2007) and Michael C. Gerald (2007), E. Lawton
Benton (2008), James P. Creel (2008), W. Cecil Worsley (2008).
B. An amendment to the Company's Certificate of Incorporation to
increase the authorized number of shares of common stock to
50,000,000.
At the meeting a total of 16,792,972 votes were entitled to be
cast. Votes for were 16,177,792; votes against were 366,334; and
votes withheld were 248,846.
Item 5. Other Information
-----------------
Not Applicable.
34
Item 6. Exhibits
--------
Exhibits
3 (a) Certificate of Incorporation of Coastal Financial
Corporation (1)
(b) Certificate of Amendment to Certificate of
Incorporation of Coastal Financial Corporation (4)
(c) Certificate of Amendment dated February 1, 2006 to
the Certificate of Incorporation of Coastal Financial
Corporation.
(d) Bylaws of Coastal Financial Corporation (1)
10 (a) Employment Agreement with Michael C. Gerald (6)
(b) Employment Agreement with Jerry L. Rexroad (6)
(c) Employment Agreement with Phillip G. Stalvey (6)
(d) Employment Agreement with Jimmy R. Graham (6)
(e) Employment Agreement with Steven J. Sherry (6)
(f) 1990 Stock Option Plan (2)
(g) Directors Performance Plan (3)
(h) Coastal Financial Corporation 2000 Stock Option
Plan (5)
31 (a) Rule 13a-14(a)/15d-14(a) Certification (Chief
Executive Officer)
(b) Rule 13a-14(a)/15d-14(a) Certification (Chief Financial
Officer)
3 (a) Section 1350 Certification (Chief Executive Officer)
(b) Section 1350 Certification (Chief Financial Officer)
- -------------------------------------------
(1) Incorporated by reference to Registration Statement on Form S-4 filed
with the Securities and Exchange Commission on November 26, 1990.
(2) Incorporated by reference to 1995 Form 10-K filed with the Securities
and Exchange Commission on December 29, 1995.
(3) Incorporated by reference to the definitive proxy statement for the
1996 Annual Meeting of Stockholders.
(4) Incorporated by reference to December 31, 1998 Form 10-Q filed with
Securities and Exchange Commission on May 15, 1998.
(5) Incorporated by reference to the definitive proxy statement for the
2000 Annual Meeting of Stockholders filed December 22, 1999.
(6) Incorporated by reference to 2003 Form 10-K filed with Securities and
Exchange Commission on December 22, 2003.
35
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
COASTAL FINANCIAL CORPORATION
May 10, 2006 /s/ Michael C. Gerald
------------ ----------------------
Date Michael C. Gerald
President and Chief Executive Officer
May 10, 2006 /s/ Jerry L. Rexroad
------------ ---------------------
Date Jerry L. Rexroad
Executive Vice President and
Chief Financial Officer
36