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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended December 31, 2003
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to __________
Commission File Number: 0-19684
COASTAL FINANCIAL CORPORATION
-----------------------------
(Exact name of registrant as specified in its charter)
State of Delaware 57-0925911
----------------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2619 OAK STREET, MYRTLE BEACH, S. C. 29577
------------------------------------ -----
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (843) 205-2000
--------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES |X| NO |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
YES |X| NO |_|
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of December 31, 2003.
Common Stock $.01 Par Value Per Share 12,963,502 Shares
- ------------------------------------- -----------------
(Class) (Outstanding)
1
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2003
TABLE OF CONTENTS PAGE
- ----------------- ----
PART I- Consolidated Financial Information
Item
1. Consolidated Financial Statements (unaudited):
Consolidated Statements of Financial Condition
as of September 30, 2003 and December 31, 2003 3
Consolidated Statements of Operations for the three
months ended December 31, 2002 and 2003 4
Consolidated Statements of Stockholders' Equity
and Comprehensive Income for the three months ended
December 31, 2002 and 2003 5
Consolidated Statements of Cash Flows for the three
months ended December 31, 2002 and 2003 6-7
Notes to Consolidated Financial Statements 8-12
2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12-21
3. Quantitative and Qualitative Disclosures About 21
Market Risk
4. Controls and Procedures 21
Part II - Other Information
Item
1. Legal Proceedings 22
2. Changes in Securities and Use of Proceeds 22
3. Defaults Upon Senior Securities 22
4. Submission of Matters to a Vote of Securities Holders 22
5. Other Information 22
6. Exhibits and Reports on Form 8-K 22-23
Signatures 24
Exhibits
31(a) Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer) 25
(b) Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer) 26
32(a) Section 1350 Certification (Chief Executive Officer) 27
(b) Section 1350 Certification (Chief Financial Officer) 28
2
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, December 31,
2003 2003
---- ----
(Unaudited)
(In thousands,
except share data)
ASSETS:
Cash and amounts due from banks $ 18,605 $ 24,343
Short-term interest-bearing deposits 2,970 1,120
Investment securities available for sale 15,909 16,553
Mortgage-backed securities available for sale 383,324 394,441
Loans receivable (net of allowance for
loan losses of $9,832 at September 30,
2003 and $10,317 at December 31, 2003) 682,737 706,631
Loans receivable held for sale 19,096 14,946
Real estate acquired through foreclosure 1,627 1,335
Office property and equipment, net 16,088 16,250
Federal Home Loan Bank stock, at cost 13,991 15,996
Accrued interest receivable on loans 2,258 2,452
Accrued interest receivable on securities 2,074 2,171
Cash value of life insurance 16,165 20,904
Other assets 6,365 8,196
----------- -----------
$ 1,181,209 $ 1,225,338
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
LIABILITIES:
Deposits $ 697,012 $ 682,242
Securities sold under agreements to repurchase 133,602 114,431
Advances from Federal Home Loan Bank 244,114 319,914
Debt associated with trust preferred securities 15,000 15,000
Other borrowings 81 81
Drafts outstanding 2,644 2,285
Advances by borrowers for property taxes
and insurance 1,795 790
Accrued interest payable 1,263 1,255
Other liabilities 11,991 13,051
----------- -----------
Total liabilities 1,107,502 1,149,049
----------- -----------
STOCKHOLDERS' EQUITY:
Serial preferred stock, 1,000,000 shares
authorized and unissued -- --
Common stock, $.01 par value, 15,000,000
shares authorized; 12,921,298 shares at
September 30, 2003 and 12,963,502 shares
at December 31, 2003 issued and outstanding 129 130
Additional paid-in capital 10,235 10,379
Retained earnings 63,030 65,443
Treasury stock, at cost (334,508 shares at
September 30, 2003 and 292,304 shares at December 31, 2003) (3,375) (2,914)
Accumulated other comprehensive income, net of tax 3,688 3,251
----------- -----------
Total stockholders' equity 73,707 76,289
----------- -----------
$ 1,181,209 $ 1,225,338
=========== ===========
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 DECEMBER 31, 2002 AND 2003
2002 2003
---- ----
(Unaudited)
(In thousands,
except share data)
Interest income:
Loans receivable $ 10,112 $ 11,077
Investment securities 506 479
Mortgage-backed securities 4,087 3,959
Other 35 20
------------ ------------
Total interest income 14,740 15,535
------------ ------------
Interest expense:
Deposits 3,355 2,594
Securities sold under agreements to
repurchase 304 566
Advances from Federal Home Loan Bank 2,148 2,404
Other -- 161
------------ ------------
Total interest expense 5,807 5,725
------------ ------------
Net interest income 8,933 9,810
Provision for loan losses 435 550
------------ ------------
Net interest income after provision
for loan losses 8,498 9,260
------------ ------------
Other income:
Fees and service charges 886 902
Loss from real estate owned (52) (39)
Gain on sales of loans held for sale 776 441
Gain (loss) on sales of investment securities
available for sale and mortgage-backed
securities available for sale 214 (200)
Other income 843 1,222
------------ ------------
2,667 2,326
------------ ------------
General and administrative expenses:
Salaries and employee benefits 3,192 3,994
Net occupancy, furniture and fixtures
and data processing expense 1,477 1,530
FDIC insurance premium 26 27
Prepayment penalties on FHLB advances 1,114 9
Other expenses 1,055 1,054
------------ ------------
6,864 6,614
------------ ------------
Income before income taxes 4,301 4,972
Income taxes 1,551 1,653
------------ ------------
Net income $ 2,750 $ 3,319
============ ============
Earnings per common share
Basic $ .21 $ .26
============ ============
Diluted $ .20 $ .24
============ ============
Weighted average common shares outstanding
Basic 12,830,000 12,936,000
============ ============
Diluted 13,433,000 13,760,000
============ ============
Dividends per share $ .045 $ .055
============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND 2003
Accumulated
Other
Additional Compre- Total
Common Paid-In Retained Treasury hensive Stockholders'
Stock Capital Earnings Stock Income Equity
----- ------- -------- ----- ------ ------
(Unaudited)
(In thousands)
Balance at September 30, 2002 $ 128 $ 9,922 $ 54,954 $ (4,376) $ 5,758 $ 66,386
Net income -- -- 2,750 -- -- 2,750
Other comprehensive income:
Unrealized gains arising
during period, net of
taxes of $704 -- -- -- -- 1,152 --
Less: reclassification
adjustment for gains
included in net income,
net of taxes of $81 -- -- -- -- (133) --
--------
Other comprehensive income -- -- -- -- 1,019 1,019
-------- --------
Comprehensive income -- -- -- -- -- 3,769
--------
Exercise of stock options -- -- (138) 332 -- 194
Cash dividends -- -- (584) -- -- (584)
-------- -------- -------- -------- -------- --------
Balance at December 31, 2002 $ 128 $ 9,922 $ 56,982 $ (4,044) $ 6,777 $ 69,765
======== ======== ======== ======== ======== ========
Balance at September 30, 2003 $ 129 $ 10,235 $ 63,030 $ (3,375) $ 3,688 $ 73,707
Net income -- -- 3,319 -- -- 3,319
Other comprehensive loss:
Unrealized losses arising
during period, net of
tax benefit of $213 -- -- -- -- (561) --
Less: reclassification
adjustment for losses
included in net income,
net of tax benefit of $76 -- -- -- -- 124 --
--------
Other comprehensive loss -- -- -- -- (437) (437)
-------- --------
Comprehensive income -- -- -- -- -- 2,882
--------
Exercise of stock options 1 144 (193) 461 -- 413
Cash dividends -- -- (713) -- -- (713)
-------- -------- -------- -------- -------- --------
Balance at December 31, 2003 $ 130 $ 10,379 $ 65,443 $ (2,914) $ 3,251 $ 76,289
======== ======== ======== ======== ======== ========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND 2003
2002 2003
---- ----
(Unaudited)
(In thousands)
Cash flows from operating activities:
Net income $ 2,750 $ 3,319
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 587 552
Provision for loan losses 435 550
(Gain) loss on sale of investment securities
available for sale and mortgage-backed
securities available for sale (214) 200
Loss on sale of real estate acquired through foreclosure 52 39
Prepayment penalties on FHLB advances 1,114 9
Origination of loans receivable held for sale (34,141) (13,544)
Proceeds from sales of loans receivable held for sale 38,109 3,640
Impairment loss (gain) from write-down of mortgage
servicing rights 45 (39)
(Increase) decrease in:
Cash value of life insurance (8) (239)
Accrued interest receivable 29 (291)
Other assets (1,035) (1,792)
Increase (decrease) in:
Accrued interest payable (233) (8)
Other liabilities 800 1,328
--------- ---------
Net cash provided by (used in) operating activities 8,290 (6,276)
--------- ---------
Cash flows from investing activities:
Issuer exercise of call of investment
securities available for sale 2,000 --
Purchases of investment securities available for sale -- (314)
Origination of loans receivable (158,590) (105,891)
Principal collected on loans receivable 122,795 81,365
Purchases of mortgage-backed securities
available for sale (84,609) (124,608)
Proceeds from sales of mortgage-backed
securities available for sale 23,932 94,017
Principal collected on mortgage-backed
securities, net 39,833 32,293
Proceeds from sale of real estate
acquired through foreclosure, net -- 335
Purchases of office properties and equipment (1,059) (714)
Purchases of FHLB stock, net (335) (2,005)
Purchase of bank-owned life insurance (15,500) (4,500)
--------- ---------
Net cash used in investing activities (71,533) (30,022)
--------- ---------
(CONTINUED)
6
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 AND 2003 (CONTINUED)
2002 2003
---- ----
(Unaudited)
(In thousands)
Cash flows from financing activities:
Decrease in deposits, net $ (857) $ (14,770)
Increase (decrease) in securities sold under
agreement to repurchase, net 62,730 (19,171)
Proceeds from FHLB advances 169,869 213,300
Repayment of FHLB advances (160,670) (137,500)
Prepayment penalties on FHLB advances (1,114) (9)
Decrease in advance payments by borrowers
for property taxes and insurance, net (1,285) (1,005)
Decrease in drafts outstanding, net (764) (359)
Dividends to stockholders (584) (713)
Exercise of stock options 194 413
--------- ---------
Net cash provided by financing activities 67,519 40,186
--------- ---------
Net increase in cash and cash equivalents 4,276 3,888
--------- ---------
Cash and cash equivalents at beginning
of the period 25,802 21,575
--------- ---------
Cash and cash equivalents at end
of the period $ 30,078 $ 25,463
========= =========
Supplemental information:
Interest paid $ 6,040 $ 5,733
========= =========
Income taxes paid $ 23 $ 30
========= =========
Supplemental schedule of non-cash investing
and financing transactions:
Transfer of mortgage loans to real estate
acquired through foreclosure $ 171 $ 82
========= =========
Securitization of mortgage loans into
mortgage-backed securities $ 28,106 $ 14,054
========= =========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements were prepared in
accordance with instructions for Form 10-Q and, therefore, do not include all
disclosures necessary for a complete presentation of financial condition,
results of operations, cash flows and changes in stockholders' equity in
conformity with accounting principles generally accepted in the United States of
America. All adjustments, consisting only of normal recurring accruals, which in
the opinion of management are necessary for fair presentation of the interim
financial statements, have been included. The results of operations for the
three-month period ended December 31, 2003 are not necessarily indicative of the
results which 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, 2003,
included in the Company's 2003 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) LOANS RECEIVABLE, NET
Loans receivable, net consists of the following:
September 30, December 31,
2003 2003
------------- ------------
(Unaudited)
(In thousands)
First mortgage loans:
Single family to 4 family units $ 289,197 $ 299,541
Lot loans 100,448 118,863
Other, primarily commercial real estate 163,240 165,584
Residential construction loans 27,480 30,207
Commercial construction loans 53,747 44,777
Consumer and commercial loans:
Installment consumer loans 16,571 17,248
Mobile home loans 4,607 4,739
Savings account loans 2,179 2,539
Equity lines of credit 26,639 27,455
Commercial and other loans 24,475 25,926
--------- ---------
708,583 736,879
Less:
Allowance for loan losses 9,832 10,317
Deferred loan costs, net (556) (631)
Undisbursed portion of loans in process 16,570 20,562
--------- ---------
$ 682,737 $ 706,631
========= =========
8
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
The changes in the allowance for loan losses consist of the following for the
three months ended:
Three Months Ended December 31,
-------------------------------
2002 2003
---- ----
(Unaudited)
(Dollars in thousands)
Allowance at beginning of period $ 7,883 $ 9,832
Provision for loan losses 435 550
------- -------
Recoveries:
Residential loans -- --
Commercial loans 1 67
Consumer loans 9 17
------- -------
Total recoveries 10 84
------- -------
Charge-offs:
Residential loans -- --
Commercial loans -- 40
Consumer loans 46 109
------- -------
Total charge-offs 46 149
------- -------
Net charge-offs 36 65
------- -------
Allowance at end of period $ 8,282 $10,317
======= =======
Ratio of allowance to total net loans
outstanding at the end of the period 1.41% 1.43%
======= =======
Ratio of net charge-offs to average
total loans outstanding during the period (annualized) .02% .04%
======= =======
Non-accrual loans, which are primarily loans over ninety days delinquent,
totaled approximately $4.7 million and $7.0 million at December 31, 2002 and
2003, respectively. For the three months ended December 31, 2003 and 2002,
interest income, which would have been recorded, would have been approximately
$70,000 and $172,000, respectively, had non-accruing loans been current in
accordance with their original terms.
At December 31, 2003, impaired loans totaled $4.2 million. There were $3.4
million in impaired loans at December 31, 2002. Included in the allowance for
loan losses at December 31, 2003 was $362,000 related to impaired loans compared
to $238,000 at December 31, 2002. The average recorded investment in impaired
loans for the three months ended December 31, 2003 was $4.6 million compared to
$3.3 million for the three months ended December 31, 2002. Interest income of
$108,000 was recognized on impaired loans for the quarter ended December 31,
2003. Interest income of $16,000 was recognized on impaired loans for the
quarter ended December 31, 2002.
(3) DEPOSITS
Deposits consist of the following:
September 30, 2003 December 31, 2003
------------------ -----------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
------ ---- ------ ----
(Unaudited)
(Dollars in thousands)
Transaction accounts $ 390,439 0.84% $ 374,544 0.84%
Statement savings accounts 46,236 0.80 47,538 0.80
Certificate accounts 260,337 2.67 260,160 2.59
--------- ---------
$ 697,012 1.52% $ 682,242 1.50%
========= =========
9
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED) - CONTINUED
(4) ADVANCES FROM FEDERAL HOME LOAN BANK
Advances from Federal Home Loan Bank ("FHLB") consist of the following:
September 30, 2003 December 31, 2003
------------------ -----------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
------ ---- ------ ----
Maturing within: (Unaudited)
(Dollars in thousands)
1 year $ 34,435 1.32% $102,735 1.16%
2 years 13,500 5.17 13,500 5.17
3 years 5,686 2.81 3,886 2.89
4 years 5,132 3.00 6,001 3.05
5 years 4,633 3.28 3,964 3.26
After 5 years 180,728 4.35 189,828 4.31
-------- --------
$244,114 3.89% $319,914 3.28%
======== ========
At September 30, 2003, and December 31, 2003, the Bank had pledged first
mortgage loans and mortgage-backed securities with unpaid balances of
approximately $275.8 million and $340.9 million, respectively, as collateral for
FHLB advances. At December 31, 2003, included in the two, four, and after five
years maturities were $166.0 million, with a weighted average rate of 4.39%, of
advances subject to call provisions. Callable advances at December 31, 2003 are
summarized as follows: $57.0 million callable in fiscal 2004, with a weighted
average rate of 5.32%; $32.0 million callable in fiscal 2005, with a weighted
average rate of 5.96%; $2.0 million callable in fiscal 2006, with a weighted
average rate of 4.72%; $35.0 million callable in fiscal 2007, with a weighted
average rate of 3.00%; $32.0 million callable in fiscal 2008, with a weighted
average rate of 2.92%; and $8.0 million callable in fiscal 2009, with a weighted
average rate of 3.38%. Call provisions are more likely to be exercised by the
FHLB when interest rates rise.
(5) EARNINGS PER SHARE
Basic earnings per share for the three months ended December 31, 2002 and 2003,
are computed by dividing net income by the weighted average common shares
outstanding during the respective periods. Diluted earnings per share for the
three months ended December 31, 2002 and 2003, are computed by dividing net
earnings by the weighted average dilutive shares outstanding during the
respective periods.
The following is a reconciliation of average shares outstanding used to
calculate basic and fully diluted earnings per share.
For the Quarter Ended December 31,
(Unaudited)
2002 2002 2003 2003
-------------------------- --------------------------
BASIC DILUTED BASIC DILUTED
-------------------------- --------------------------
Weighted average shares outstanding 12,830,000 12,830,000 12,936,000 12,936,000
Effect of dilutive securities-
Stock options -- 603,000 -- 824,000
-------------------------- --------------------------
12,830,000 13,433,000 12,936,000 13,760,000
========================== ==========================
10
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(6) STOCK-BASED COMPENSATION
At December 31, 2003, the Company had a stock option plan that provides for
stock options to be granted primarily to directors, officers and other key
Associates. The plan is more fully described in Note 17 of the Notes to
Consolidated Financial Statements included in the Company's 10-K for the year
ended September 30, 2003. The Company accounts for the plan under the
recognition and measurement principles of APB Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations. No stock-based employee
or director compensation cost is reflected in net income, as all options granted
under the plan had an exercise price equal to the market value of the underlying
common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of FASB
Statement 123, "Accounting for Stock-Based Compensation", to stock-based
employee and non-employee compensation.
Three Months Ended December 31,
-------------------------------
2002 2003
---- ----
(Unaudited)
(Dollars in thousands)
Net income, as reported $ 2,750 $ 3,319
Deduct: Total stock-based employee and director
compensation expense determined under
fair value based method for all awards,
net of related tax effects (124) (131)
--------- ---------
Pro forma net income $ 2,626 $ 3,188
========= =========
Basic earnings per share:
As reported $ .21 $ .26
========= =========
Pro forma $ .20 $ .25
========= =========
Diluted earnings per share:
As reported $ .20 $ .24
========= =========
Pro forma $ .20 $ .23
========= =========
(7) COMMON STOCK DIVIDEND
On May 27, 2003 and August 28, 2003, the Company declared a 10% stock dividend,
aggregating approximately 1,065,000 shares and 1,174,000 shares, respectively.
All share and per share data have been retroactively restated for the stock
dividends.
(8) 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; however, these standby letters of credit are generally not
collateralized. Commitments under standby letters of credit are usually one year
or less. At December 31, 2003, the Company has recorded no liability for the
current carrying amount of the obligation to perform as a guarantor, as such
amounts are not considered material. The maximum potential amount of
undiscounted future payments related to standby letters of credit at December
31, 2003 was $3.0 million.
11
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(9) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITES
The Bank originates certain fixed rate residential loans with the intention of
selling these loans. Between the time that the Bank enters into an interest rate
lock or a commitment to originate a fixed rate residential loan with a potential
borrower and the time the closed loan is sold, the Company is subject to
variability in the market prices related to these commitments. The Company
believes that it is prudent to limit the variability of expected proceeds from
the sales through forward sales of "to be issued" mortgage-backed securities and
loans ("forward sales commitments"). The commitment to originate fixed rate
residential loans and forward sales commitments are freestanding derivative
instruments. When 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 $4.1 million at December 31, 2003.
The fair value of the loan commitments was an asset of approximately $41,000 at
December 31, 2003. As of December 31, 2003, the Company had sold $8.0 million in
forward commitments to deliver fixed rate mortgage-backed securities, which were
recorded as a derivative liability of $49,000.
(10) SUBSEQUENT EVENT
The Board has unanimously adopted an amendment to the Company's Certificate of
Incorporation to increase the Company's authorized common stock from 15,000,000
to 25,000,000 shares. On January 27, 2004, the Stockholders of the Company
approved this amendment.
On October 29, 2003, the Board of Directors of the Company approved an amendment
to the 2000 Stock Option and Incentive Plan which increases the number of shares
of common stock with respect to which options may be granted from 525,000 shares
to 1,050,000 shares, subject to adjustment for stock splits and stock dividends.
On January 27, 2004, the Stockholders of the Company approved this amendment.
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. Such
forward-looking statements are about matters that are inherently subject to
risks and uncertainties. Factors that could influence the matters discussed in
certain forward-looking statements include the timing and amount of revenues
that may be recognized by the Company, continuation of current revenue and
expense trends (including trends affecting charge-offs), absence of unforeseen
changes in the Company's markets, legal and regulatory changes, and general
changes in the economy (particularly in the markets served by the Company).
Except as required by applicable law and regulations, the Company disclaims any
obligation to update such forward-looking statements.
OVERVIEW
- --------
Coastal Financial Corporation is a unitary thrift holding company headquartered
in Delaware with one wholly-owned banking subsidiary, Coastal Federal Bank (the
"Bank" or "Coastal Federal"). The Company's primary business activities are
conducted by the Bank. The Bank's principal executive offices are located in
Myrtle Beach, South Carolina.
Coastal Federal Bank is a full service financial services company with 18
banking centers located in four counties throughout the coastal regions of South
Carolina and North Carolina. The Bank has twelve offices in Horry County, South
Carolina; one office in
12
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
Georgetown County, South Carolina; three offices in Brunswick County, North
Carolina; and two 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, 2003 with 16.4% of deposits. The Bank also has the third highest market
share of deposits as of June 30, 2003 in Brunswick County, North Carolina with
8.4% of deposits.
The primary business activities in Horry County are centered around the tourism
industry. To the extent that Horry County businesses rely heavily on tourism
business, decreased tourism would have a significant adverse effect on Coastal
Federal's primary deposit base and lending area. Moreover, the Bank would likely
experience a higher degree of loan delinquencies should the local economy be
materially and adversely affected.
Coastal Federal's principal business consists of attracting core deposits from
Customers in its primary market locations and using these funds to meet the
lending needs of its Customers as well as providing numerous financial products
and services to meet its Customer's needs.
Through its banking center locations, the Bank provides a wide range of banking
products, including interest-bearing and non-interest bearing checking accounts;
money market accounts; certificates of deposit; individual retirement accounts;
commercial, business, personal, real estate, residential mortgage and home
equity loans; safe deposit boxes; and electronic banking. The Bank also offers a
wide range of financial products through its division, Coastal Investor
Services, including stocks, bonds, mutual funds, annuities, insurance, and
retirement products. The Company's subsidiary, Coastal Retirement, Estate and
Tax Planners, Inc., also offers a wide range of fee-based financial planning
services.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
The Company considers its policy regarding the allowance for loan losses to be
its most critical accounting policy due to the significant degree of management
judgment. The Company has developed policies and procedures for assessing the
adequacy of the allowance, recognizing that this process requires a significant
number of assumptions and estimates with respect to its loan portfolio. The
Company assessments of future loan losses may be impacted in future periods by
changes in economic and market conditions, the impact of regulatory
examinations, weather related events such as hurricanes or major storms, and the
discovery of information with respect to certain borrowers and or guarantors,
which is not known to management at the time of the issuance of the consolidated
financial statements. Further, a significant portion of the Company's loans are
supported by collateral which is significantly affected by changes in the
tourism industry. The tourism industry is the major economic force in many of
the markets the Company serves and future changes in tourism could significantly
impact collateral values.
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, 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. At December 31, 2003 and
September 30, 2003, the Company had no interests in non-consolidated special
purpose entities.
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
13
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
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 which are unsecured or are secured by residential property. At December
31, 2003, unfunded business and personal lines of credit commitments totaled
$49.5 million. Unused business and personal credit card lines, which totaled
$12.7 million at December 31, 2003, are generally for short-term borrowings.
The Company also had commitments to originate $18.4 million in residential
mortgage loans.
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; however, these standby letters of credit are generally not
collateralized. Commitments under standby letters of credit are usually one year
or less. At December 31, 2003, the Company has recorded no liability for the
current carrying amount of the obligation to perform as a guarantor, as such
amounts are not considered material. The maximum potential amount of
undiscounted future payments related to standby letters of credit at December
31, 2003 was $3.0 million.
Derivatives and Hedging Activities. The Bank originates certain fixed rate
residential loans with the intention of selling these loans. Between the time
that the Bank enters into an interest rate lock or a commitment to originate a
fixed rate residential loan with a potential borrower and the time the closed
loan is sold, the Company is subject to variability in the market prices related
to these commitments. The Company believes that it is prudent to limit the
variability of expected proceeds from the sales through forward sales of "to be
issued" mortgage-backed securities and loans ("forward sales commitments"). The
commitment to originate fixed rate residential loans and forward sales
commitments are freestanding derivative instruments. When 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 $4.1 million at
December 31, 2003. The fair value of the loan commitments was an asset of
approximately $41,000 at December 31, 2003. As of December 31, 2003, the Company
had sold $8.0 million in forward commitments to deliver fixed rate
mortgage-backed securities, which were recorded as a derivative liability of
$49,000.
DISCUSSION OF FINANCIAL CONDITION CHANGES FROM SEPTEMBER 30, 2003 TO DECEMBER
- -----------------------------------------------------------------------------
31, 2003
- --------
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.
14
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
The Company originated loans receivable of $192.7 million for the three months
ended December 31, 2002, compared to $119.4 million for the three months ended
December 31, 2003. Originations in fiscal 2003 were significantly higher due to
increased refinancings of both residential and business loans. Loan principal
repayments amounted to $122.8 million in the first quarter of 2002 compared to
$81.4 million for the three months ended December 31, 2003. In addition, the
Company sells certain loans in the secondary market to finance future loan
originations. In the first quarter of fiscal 2003, the Company sold loans or
securitized and sold loans totaling $66.2 million that compares to $17.7 million
in the first three months ended December 31, 2003. Generally, these loans have
consisted only of mortgage loans, which have been originated within the prior
twelve months.
During the three month period ended December 31, 2003, the Company securitized
$14.1 million of mortgage loans and concurrently sold these mortgage-backed
securities to outside third parties and recognized a net gain on sale of
$482,000, which included $187,000 related to mortgage servicing rights. The gain
is included in gains on sales of loans held for sale in the consolidated
statement of operations. The proceeds from sale are included in proceeds from
sales of mortgage-backed securities available for sale in the consolidated
statement of cash flows. The Company has no retained interest in the securities
that were sold other than servicing rights.
For the three-month period ended December 31, 2002, the Company purchased $84.6
million in investment and mortgage-backed securities. For the three-month period
ended December 31, 2003, the Company purchased $124.9 million in investment and
mortgage-backed securities. These purchases during the three-month period ended
December 31, 2003 were funded primarily by repayments of $32.3 million within
the securities portfolio and sales of mortgage-backed securities of $94.0
million.
The Company experienced a decrease of $14.8 million in deposits for the
three-month period ended December 31, 2003. For the three-month period ended
December 31, 2003, transaction accounts decreased $15.9 million, statement
savings accounts increased $1.3 million, and certificate accounts decreased
$177,000.
The Company generally experiences a decline in deposits in its first and second
quarters of each fiscal year. The Company's primary market place is very
dependent upon the tourism industry, which is much slower in the winter months.
The Company is focused on growing core deposits. The Company is presently
planning to build three full service banking centers in fiscal 2004. At December
31, 2003 the Company had $202.7 million of certificates of deposits that were
due to mature within one year. The Company believes that the majority of these
certificates of deposits will renew with the Company. At December 31, 2003, the
Company had commitments to originate $18.4 million in residental mortgage loans,
$49.5 million in undisbursed business and retail lines of credit and $12.7
million in unused business and personal credit card lines, which the Company
expects to fund from normal operations. At December 31, 2003, the Company had
$21.0 million available in FHLB advances. Additionally, at December 31, 2003,
the Company had outstanding available lines for federal funds of $20.0 million.
As a result of $3.3 million in net income, less the cash dividends paid to
stockholders of approximately $713,000, proceeds of approximately $413,000 from
the exercise of stock options, and the net decrease in unrealized gain on
securities available for sale, net of income tax of $437,000, stockholders'
equity increased from $73.7 million at September 30, 2003 to $76.3 million at
December 31, 2003.
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 $87.6 million at December 31,
2003, exceeding the core capital requirement by $50.9 million. At December 31,
2003, the Bank's risk-based capital of approximately $96.5 million exceeded its
current risk-based capital requirement by $37.8 million. (For further
information see Regulatory Capital Matters).
15
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED
- -----------------------------------------------------------------------------
DECEMBER 31, 2002 AND 2003
- --------------------------
EARNINGS SUMMARY
- ----------------
Net income increased from $2.8 million, or $.20 per diluted share, for the
three months ended December 31, 2002 to $3.3 million, or $.24 per diluted share
for the three months ended December 31, 2003. This 20.7% increase in net income
resulted from increased net interest income of $877,000, or 9.8%, reduced
general and administrative expenses of $250,000, offset by increased provision
for loan losses of $115,000 and decreased other income of $341,000.
Despite the decrease in the net interest margin as a result of continued
declining interest rates, from 3.67% for the three months ended December 31,
2002 to 3.48% for the three months ended December 31, 2003, net interest income
increased 9.8%. The increase in net interest income is primarily attributable to
an increase in average earning assets of $172.7 million, or 18.1%. Loans
receivable have continued to increase significantly as the Company has
emphasized commercial real estate and business loans production. Commercial real
estate loans and business loans were $236.3 million at December 31, 2003, an
increase of 21.9%, when compared to $193.8 million at December 31, 2002. In
addition, average balances of investment securities increased approximately
$53.1 million. The investment securities were primarily funded with longer-term
advances. The Company's advances with a maturity greater than five years
increased from $140.8 million at December 31, 2002 to $189.8 million at December
31, 2003.
Provision for loan losses increased by $115,000 due to increased balances in
commercial real estate loans and two relationships aggregating $5.6 million,
which were classified during the three months ended December 31, 2003.
Other income decreased from $2.7 million for the quarter ended December 31, 2003
to $2.3 million for the quarter ended December 31, 2003. This was primarily a
result of decreased gains on sales of loans held for sale of $335,000. The
Company experienced a significant reduction in residential loan refinancings in
the first quarter of fiscal 2004 compared to fiscal 2003 due to interest rates,
which increased slightly beginning in September 2003. The Company also had
increased loss on securities available for sale of $414,000 in the first fiscal
quarter of 2004 when comparing to the first fiscal 2003 quarter. This was offset
by increased other income of $379,000. The increase in other income was
primarily due to increased income from bank owned life insurance of $239,000.
General and administrative expenses decreased slightly from $6.9 million to $6.6
million. Compensation increased from $3.2 million for the first quarter of
fiscal 2003 to $4.0 million in the first quarter of fiscal 2004, primarily due
to an increase in the number of banking Associates in business banking and
Associates in new Banking Centers. This increase was offset by reduced penalties
on early prepayment of FHLB advances, which were $1.1 million in the first
fiscal quarter of 2003 and were $9,000 in the first fiscal quarter of 2004.
INTEREST INCOME
- ---------------
Interest income for the three months ended December 31, 2003, increased to $15.5
million as compared to $14.7 million for the three months ended December 31,
2002. The earning asset yield for the three months ended December 31, 2003, was
5.58% compared to a yield of 6.24% for the three months ended December 31, 2002.
As a result of significant declining interest rates over the last two years, the
Bank's yield on assets and cost of funds has declined. At December 31, 2001,
2002 and 2003, the one-year treasury rate of interest was approximately 2.23%,
1.41% and 1.28%, respectively. At December 31, 2001, 2002 and 2003, the prime
rate of interest was approximately 4.75%, 4.25% and 4.00%, respectively.
16
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED
- -----------------------------------------------------------------------------
DECEMBER 31, 2002 AND 2003-CONTINUED
- ------------------------------------
The average yield on loans receivable for the three months ended December 31,
2003, was 6.21% compared to 6.82% for three months ended December 31, 2002. The
Company's yield on loans has continued to decline as loans in the portfolio have
refinanced at lower rates. The yield on investments decreased to 4.47% for the
three months ended December 31, 2003, from 5.34% for the three months ended
December 31, 2002. The yield on investments has declined due to payoff of higher
yielding mortgage-backed securities (MBS) resulting from significant prepayments
during fiscal 2003. These higher yielding MBS were replaced with lower yielding
MBS. Total average interest-earning assets were $1.1 billion for the quarter
ended December 31, 2003 as compared to $952.3 million for the quarter ended
December 31, 2002. The increase in average interest-earning assets is primarily
due to an increase in average loans receivable of approximately $119.6 million
and investment securities of approximately $53.1 million.
INTEREST EXPENSE
- ----------------
Interest expense on interest-bearing liabilities was $5.7 million for the three
months ended December 31, 2003, as compared to $5.8 million for the three months
ended December 31, 2002. The average cost of deposits for the three months ended
December 31, 2003, was 1.48% compared to 2.09% for the three months ended
December 31, 2002. The cost of interest-bearing liabilities was 2.10% for the
three months ended December 31, 2003, as compared to 2.58% for the three months
ended December 31, 2002. The cost of FHLB advances and reverse repurchase
agreements was 4.00% and 2.01%, respectively, for the three months ended
December 31, 2003. For the three months ended December 31, 2002, the cost of
FHLB advances and reverse repurchase agreements was 4.43% and 1.90%,
respectively. Total average interest-bearing liabilities increased from $897.4
million at December 31, 2002 to $1.1 billion at December 31, 2003. The increase
in average interest-bearing liabilities is due to an increase in average
deposits of approximately $59.1 million. This was accompanied by an increase in
reverse repurchase agreements of $84.6 million and FHLB advances of $46.7
million.
NET INTEREST INCOME
- -------------------
Net interest income was $9.8 million for the three months ended December 31,
2003, as compared to $8.9 million for the three months ended December 31, 2002.
The net interest margin was 3.48% for the three months ended December 31, 2003,
compared to 3.67% for the three months ended December 31, 2002. With the
reduction in interest rates, resulting from the Federal Reserve Board's decision
to reduce the discount rate, it is expected that the Bank's yield on interest
earning assets and cost of deposits and borrowings will decline. Consequently,
it is expected that a portion of the Bank's loan portfolio will be subject to
refinancing at lower rates. It is expected that refinancing of loans at lower
rates and repricing of loans tied to prime or treasury rates will outpace the
repricing of deposits and borrowings. Should interest rates remain at these
historically low levels, the Bank expects to experience a reduced interest
margin for the remainder of fiscal 2004.
PROVISION FOR LOAN LOSSES
- -------------------------
The adequacy of the allowance is analyzed on a quarterly basis. For purposes of
this analysis, adequacy is defined as a level of reserves sufficient to absorb
probable losses inherent in the portfolio. The methodology employed for this
analysis considers historical loan loss experience, the results of loan reviews,
current economic conditions, and other qualitative and quantitative factors that
warrant current consideration in determining an adequate allowance.
The evaluation of the allowance is segregated into general allocations and
specific allocations. For general allocations, the portfolio is segregated into
risk-similar segments for which historical loss ratios are calculated and
adjusted for identified trends or changes in current portfolio characteristics.
Historical loss ratios are calculated by product type for consumer loans
(installment and revolving), mortgage loans, and commercial loans and may be
adjusted for other risk factors. To allow for modeling error, a range of
probable loss ratios is then derived for each segment. The resulting
17
PART I.FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED
- -----------------------------------------------------------------------------
DECEMBER 31, 2002 AND 2003 - CONTINUED
- --------------------------------------
percentages are then applied to the dollar amounts of the loans in each segment
to arrive at each segment's range of probable loss levels.
Certain nonperforming loans are individually assessed for impairment under SFAS
114 and assigned specific allocations. Other identified high-risk loans or
credit relationships based on internal risk ratings are also individually
assessed and assigned specific allocations. The general allocation also includes
a component for probable losses inherent in the portfolio, based on management's
analysis, that are not fully captured elsewhere in the allowance. This component
serves to address the inherent estimation and imprecision risk in the
methodology as well as address management's evaluation of various factors or
conditions not otherwise directly measured in the evaluation of the general and
specific allocations. Such factors or conditions may include evaluation of
current general economic and business conditions; geographic, collateral, or
other concentrations; system, procedural, policy, or underwriting changes;
experience of lending staff; entry into new markets or new product offerings;
and results from internal and external portfolio examinations.
The allocation of the allowance to the respective loan segments is an
approximation and not necessarily indicative of future losses or future
allocations. The entire allowance is available to absorb losses occurring in the
overall loan portfolio.
Assessing the adequacy of the allowance is a process that requires considerable
judgment. Management's methodology and judgments are based on the information
currently available and includes numerous assumptions about current events,
which we believe to be reasonable, but which may or may not be valid. Thus,
there can be no assurance that loan losses in future periods will not exceed the
current allowance amount or that future increases in the allowance will not be
required. No assurance can be given that management's ongoing evaluation of the
loan portfolio in light of changing economic conditions and other relevant
circumstances will not require significant future additions to the allowance,
thus adversely affecting the operating results of the Company. Management
believes that the current level of the allowance for loan losses is presently
adequate considering the composition of the loan portfolio, the portfolio's loss
experience, delinquency trends, current regional and local economic conditions
and other factors.
The allowance is also subject to examination and adequacy testing by regulatory
agencies, which may consider such factors as the methodology used to determine
adequacy and the size of the allowance relative to that of peer institutions,
and other adequacy tests. In addition, such regulatory agencies could require
the Company to adjust the allowance based on information available to them at
the time of their examination.
The Company established provisions for loan losses for the quarters ended
December 31, 2003 and 2002, of $550,000 and $435,000, respectively. For the
quarters ended December 31, 2003 and 2002, the Company had net charge-offs of
$65,000 and $36,000, respectively. Net charge-offs as a percentage of average
outstanding loans were .04% and .02% for the quarters ended December 31, 2003
and 2002, respectively. At December 31, 2003, the Company had an allowance for
loan losses of $10.3 million, which was 1.43% of net loans.
The allowance for loan losses as a percentage of net loans was 1.40% at
September 30, 2003. The allowance as a percentage of net loans increased due to
a greater composition of the loan portfolio in commercial real estate loans and
due to two relationships aggregating $5.6 million being classified during the
quarter. These loans are presently not considered impaired but contain certain
risk characteristics which management reflected in its allowance model.
OTHER INCOME
- ------------
For the three months ended December 31, 2003, other income was $2.3 million
compared to $2.7 million for the three months ended December 31, 2002. Fees and
service charges from deposit accounts were $902,000 for the three months ended
December 31, 2003, compared to
18
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED
- -----------------------------------------------------------------------------
DECEMBER 31, 2002 AND 2003 - CONTINUED
- --------------------------------------
$886,000 for the three months ended December 31, 2002. During the three months
ended December 31, 2002, the Company securitized loans into mortgage-backed
securities ("MBS") and then sold the MBS and sold loans aggregating $66.2
million of loans held for sale compared to $17.7 million for the three months
ended December 31, 2003. Originations of loans held for sale have declined as
interest rates began to increase around September 2003. This increase in rates
has significantly curtailed mortgage refinancing. Based upon current interest
rates, the Company expects mortgage refinancing to continue significantly below
last years levels. Gain on sale of loans was $441,000 for the quarter ended
December 31, 2003, compared to $776,000 for the quarter ended December 31, 2002.
Loss on sales of securities was $200,000 for the quarter ended December 31,
2003, compared to gains of $214,000 for the quarter ended December 31, 2002.
Other income was $1.2 million for the three months ended December 31, 2003, as
compared to $843,000 for the three months ended December 31, 2002. This increase
is primarily attributed to income from bank-owned life insurance of $239,000 for
the quarter ended December 31, 2003 compared to $8,000 for the quarter ended
December 31, 2002. The Bank purchased bank owned life insurance at the end of
December 2002.
GENERAL AND ADMINISTRATIVE EXPENSES
- -----------------------------------
General and administrative expenses were $6.9 million for the quarter ended
December 31, 2002 compared to $6.6 million for the quarter ended December 31,
2003. Salaries and employee benefits were $3.2 million for the three months
ended December 31, 2002, as compared to $4.0 million for the three months ended
December 31, 2003, an increase of 25.1%, primarily due to the addition of new
Banking Centers and additional business banking Associates. The Company has
added several Associates in a Banking Group that is focused on growing small to
medium sized business banking relationships. Also as a result of new Banking
Centers, net occupancy, furniture and fixtures and data processing expenses
increased $53,000 when comparing the two periods. General and administrative
expenses also included prepayment penalties on FHLB advances of $9,000 for the
quarter ended December 31, 2003 compared to $1.1 million for the quarter ended
December 31, 2002. In the quarter ended December 31, 2002, the Company prepaid
$20.0 million of FHLB advances with a weighted average rate of 4.27%. Also
during the quarter ended December 31, 2002, the Company borrowed new advances
with a term greater than one year from the FHLB with a weighted average rate of
3.04%. Other expenses were $1.1 million for the quarters ended December 31, 2002
and 2003.
INCOME TAXES
- ------------
Income taxes were $1.6 million for the three months ended December 31, 2002
compared to $1.7 million for the three months ended December 31, 2003. The
effective income tax rate as a percentage of pretax income was 36.06% and 33.25%
for the quarters ended December 31, 2002 and 2003, respectively. The effective
income tax rate declined in connection with an increase in income generated by
bank-owned life insurance and municipal securities that are exempt from federal
and certain state taxes.
The Company's effective income tax rates take into consideration certain
assumptions and estimates made by management. No assurance can be given that
either the tax returns submitted by management or the income tax reported on the
consolidated financial statements will not be adjusted by either adverse rulings
by the U.S. Tax court, changes in the tax code, or assessments made by the
Internal Revenue Service. The Company is subject to potential adverse
adjustments, including but not limited to: an increase in the statutory federal
or state income tax rates, the permanent nondeductibility of amounts currently
considered deductible either now or in future periods, and the dependency on the
generation of the future taxable income, in order to ultimately realize deferred
income tax assets.
19
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED
- -----------------------------------------------------------------------------
DECEMBER 31, 2002 AND 2003 - CONTINUED
- --------------------------------------
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 December 31, 2003:
Total Capital: $96,467 13.16% $58,639 8.00% $73,299 10.00%
(To Risk Weighted Assets)
Tier 1 Capital: $87,599 11.95% N/A N/A $43,980 6.00%
(To Risk Weighted Assets)
Tier 1 Capital: $87,599 7.16% $36,698 3.00% $61,325 5.00%
(To Total Assets)
Tangible Capital: $87,599 7.16% $18,398 1.50% N/A N/A
(To Total Assets)
NEW ACCOUNTING PRONOUNCEMENTS
- -----------------------------
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities, which addresses how a
business enterprise should evaluate whether it has a controlling financial
interest in an entity through means other than voting rights and accordingly
should consolidate the entity. FIN 46R replaces FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, which was issued in January 2003.
The Company will be required to apply FIN 46R to variable interests in VIEs
created after December 31, 2003. For variable interests in VIEs created before
January 1, 2004, the Interpretation will be applied beginning on January 1,
2005. For any VIEs that must be consolidated under FIN 46R that were created
before January 1, 2004, the assets, liabilities and noncontrolling interests of
the VIE initially would be measured at their carrying amounts with any
difference between the net amount added to the balance sheet and any previously
recognized interest being recognized as the cumulative effect of an accounting
change. If determining the carrying amounts is not practicable, fair value at
the date FIN 46R first applies may be used to measure the assets, liabilities
and noncontrolling interest of the VIE.
The Company currently consolidates the trust, which issued the Company's trust
preferred securities, in its consolidated financial statements and reports the
related debt instruments, referred to as debt associated with trust preferred
securities, as a liability on its consolidated balance sheet. Under the
interpretation of FIN 46R, the Company's trust, which issued the Company's trust
preferred securities, would no longer be included in the Company's consolidated
financial statements.
The Company will reflect the junior subordinated debentures as subordinated debt
in its consolidated financial statements in the second quarter of 2004. The
Federal Reserve presently considers the trust preferred securities to qualify as
Tier 1 Capital. This may change in the future based on the application and
interpretation by the Federal Reserve Board of FIN 46R.
20
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED
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DECEMBER 31, 2002 AND 2003 - CONTINUED
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FASB Statement No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity, was issued in May 2003. The
Statement establishes standards for the classification and measurement of
certain financial instruments with characteristics of both liabilities and
equity. The Statement also includes required disclosures for financial
instruments within its scope. For the Company, the Statement was effective for
instruments entered into or modified after May 31, 2003 and otherwise will be
effective as of January 1, 2004, except for mandatorily redeemable financial
instruments. For certain mandatorily redeemable financial instruments, the
Statement will be effective for the Company on January 1, 2005. The effective
date has been deferred indefinitely for certain other types of mandatorily
redeemable financial instruments. The Company currently does not have any
financial instruments that are within the scope of this Statement.
EFFECT ON INFLATION AND CHANGING PRICES
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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.
PART I. FINANCIAL INFORMATION
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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At December 31, 2003, no material changes have occurred in market risk
disclosures included in the Company's Annual Report to Stockholders for the year
ended September 30, 2003, filed as an exhibit to the Company's Annual Report on
Form 10-K.
Item 4. CONTROLS AND PROCEDURES
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The Company's management, including the Company's principal executive officer
and principal financial officer, have evaluated the effectiveness of the
Company's "disclosure controls and procedures," as such term is defined in Rule
13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). Based upon their evaluation, the principal executive officer and
principal financial officer concluded that, as of the end of the period covered
by this report, the Company's disclosure controls and procedures were effective
for the purpose of ensuring that the information required to be disclosed in the
reports that the Company files or submits under the Exchange Act with the
Securities and Exchange Commission (the "SEC") (1) is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and (2) is accumulated and communicated to the Company's management,
including its principal executive and principal financial officers, as
appropriate to allow timely decisions regarding required disclosure. In
addition, based on that evaluation, no change in the Company's internal control
over financial reporting occurred during the three months ended December 31,
2003 that has materially affected, or is reasonably likely to materially affect,
the Company's internal control over financial reporting.
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PART II. OTHER INFORMATION
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Item 1. Legal Proceedings
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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 subsidiaries in these
matters, the Company believes none of the lawsuits would have a material impact
on the Company's financial status.
Item 2. Changes In Securities and Use of Proceeds
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Not Applicable.
Item 3. Defaults Upon Senior Securities
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Not Applicable.
Item 4. Submission of Matters to a Vote of Security Holders
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Not Applicable.
Item 5. Other Information
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Not Applicable.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
3 (a) Certificate of Incorporation of Coastal Financial
Corporation (1)
(b) Certificate of Amendment to Certificate of Incorporation
of Coastal Financial Corporation (6)
(c) Bylaws of Coastal Financial Corporation (1)
10 (a) Employment Agreement with Michael C. Gerald (9)
(b) Employment Agreement with Jerry L. Rexroad (9)
(c) Employment Agreement with Phillip G. Stalvey (9)
(d) Employment Agreement with Jimmy R. Graham (9)
(e) Employment Agreement with Steven J. Sherry (9)
(f) 1990 Stock Option Plan (2)
(g) Directors Performance Plan (3)
(h) Loan Agreement with Bankers Bank (5)
(i) Coastal Financial Corporation 2000 Stock Option Plan (8)
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PART II. OTHER INFORMATION
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
31 (a) Rule 13a-14(a)/15d-14(a) Certification (Chief
Executive Officer)
(b) Rule 13a-14(a)/15d-14(a) Certification (Chief Financial
Officer)
32 (a) Section 1350 Certification (Chief Executive Officer)
(b) Section 1350 Certification (Chief Financial Officer)
(a) Report on Form 8-K
The Company filed a Form 8-K on November 4, 2003 to report the
Company's fourth quarter earnings. A copy of the Company's press
release dated October 29, 2003 was attached as an exhibit.
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(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 1997 Form 10-K filed with the Securities and
Exchange Commission on January 2, 1998.
(5) Incorporated by reference to December 31, 1997 Form 10-Q filed with
Securities and Exchange Commission on February 13, 1998.
(6) Incorporated by reference to March 31, 1998 Form 10-Q filed with
Securities and Exchange Commission on May 15, 1998.
(7) Incorporated by reference to 1998 Form 10-K filed with Securities and
Exchange Commission on December 29, 1998.
(8) Incorporated by reference to the definitive proxy statement for the 2000
Annual Meeting of Stockholders filed December 22, 1999.
(9) Incorporated by reference to 2003 Form 10-K filed with Securities and
Exchange Commission on December 22, 2003.
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SIGNATURES
Pursuant to the requirement of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
COASTAL FINANCIAL CORPORATION
February 11, 2004 /s/ Michael C. Gerald
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Date Michael C. Gerald
President and Chief Executive Officer
February 11, 2004 /s/ Jerry L. Rexroad
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Date Jerry L. Rexroad
Executive Vice President and
Chief Financial Officer
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