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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 quarterly period ended December 31, 2004
|_| 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, 2004.
Common Stock $.01 Par Value Per Share 15,941,459 Shares
- ---------------------------------------------------------------------
(Class) (Outstanding)*
*On December 15, 2004, the Company declared a 10% stock dividend. The stock
dividend was January 20, 2005 to Shareholders of record on January 6, 2005.
1
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2004
TABLE OF CONTENTS PAGE
- ----------------- ----
PART I- Financial Information
Item
1. Consolidated Financial Statements (unaudited):
Consolidated Statements of Financial Condition
as of September 30, 2004 and December 31, 2004 3
Consolidated Statements of Operations for the three
months ended December 31, 2003 and 2004 4
Consolidated Statements of Stockholders' Equity
and Comprehensive Income for the three months ended
December 31, 2003 and 2004 5
Consolidated Statements of Cash Flows for the three
months ended December 31, 2003 and 2004 6-7
Notes to Consolidated Financial Statements 8-13
2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 13-23
3. Quantitative and Qualitative Disclosures About 23
Market Risk
4. Controls and Procedures 24
Part II - Other Information
Item
1. Legal Proceedings 24
2. Unregistered Sales of Equity Securities and Use of Proceeds 24
3. Defaults Upon Senior Securities 24
4. Submission of Matters to a Vote of Securities Holders 24
5. Other Information 24
6. Exhibits 25
Signatures 26
Exhibits
31(a) Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer) 27
(b) Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer) 28
32(a) Section 1350 Certification (Chief Executive Officer) 29
(b) Section 1350 Certification (Chief Financial Officer) 30
2
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
September 30, December 31,
2004 2004
---- ----
(Unaudited)
(In thousands,
except share data)
ASSETS:
Cash and amounts due from banks $ 28,401 $ 16,647
Short-term interest-bearing deposits 1,251 2,085
Investment securities available for sale 23,449 23,311
Mortgage-backed securities available for sale 374,283 438,112
Investment securities held to maturity 7,840 10,000
Loans receivable (net of allowance for
loan losses of $11,077 at September 30,
2004 and $11,412 at December 31, 2004) 790,730 804,574
Loans receivable held for sale 8,246 12,937
Real estate acquired through foreclosure 785 674
Office property and equipment, net 18,844 19,718
Federal Home Loan Bank stock, at cost 16,900 20,328
Accrued interest receivable on loans 2,877 3,137
Accrued interest receivable on securities 2,473 2,378
Cash value of life insurance 21,627 21,867
Other assets 7,779 7,832
----------- -----------
$ 1,305,485 $ 1,383,600
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
LIABILITIES:
Deposits $ 753,379 $ 746,966
Securities sold under agreements to repurchase 107,173 120,910
Advances from Federal Home Loan Bank 328,507 397,207
Junior subordinated debt 15,464 15,464
Drafts outstanding 2,792 1,199
Advances by borrowers for property taxes
and insurance 1,750 538
Accrued interest payable 1,502 1,628
Other liabilities 9,570 10,437
----------- -----------
Total liabilities 1,220,137 1,294,349
----------- -----------
STOCKHOLDERS' EQUITY:
Serial preferred stock, 1,000,000 shares
authorized and unissued -- --
Common stock, $.01 par value, 25,000,000
shares authorized; 15,897,076 shares at
September 30, 2004 and 15,941,459 shares
at December 31, 2004 issued and outstanding 159 159
Additional paid-in capital 10,640 10,769
Retained earnings 73,533 76,547
Treasury stock, at cost (108,557 shares at
September 30, 2004 and 64,174 shares at
December 31, 2004) (1,182) (753)
Accumulated other comprehensive income,
net of tax 2,198 2,529
----------- -----------
Total stockholders' equity 85,348 89,251
----------- -----------
$ 1,305,485 $ 1,383,600
=========== ===========
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, 2003 AND 2004
2003 2004
---- ----
(Unaudited)
(In thousands,
except share data)
Interest income:
Loans receivable $ 11,077 $ 12,740
Investment securities 479 1,144
Mortgage-backed securities 3,959 4,006
Other 20 67
------------ ------------
Total interest income 15,535 17,957
------------ ------------
Interest expense:
Deposits 2,594 2,507
Securities sold under agreements to
repurchase 566 567
Advances from Federal Home Loan Bank 2,404 3,168
Other borrowings 161 200
------------ ------------
Total interest expense 5,725 6,442
------------ ------------
Net interest income 9,810 11,515
Provision for loan losses 550 350
------------ ------------
Net interest income after provision
for loan losses 9,260 11,165
------------ ------------
Other income:
Fees and service charges on loan and deposit accounts 902 1,090
Gain on sales of loans held for sale 441 310
Gain (loss) on sales of investment securities
available for sale and mortgage-backed
securities available for sale (200) 158
Loss from real estate owned (39) (39)
Income from sales of non-depository products 553 460
Federal Home Loan Bank stock dividends 109 137
Other income 560 651
------------ ------------
2,326 2,767
------------ ------------
General and administrative expenses:
Salaries and employee benefits 3,994 4,423
Net occupancy, furniture and fixtures
and data processing expense 1,530 1,756
FDIC insurance premium 27 27
FHLB prepayment penalties 9 --
Marketing expense 181 511
Other expense 873 1,063
------------ ------------
6,614 7,780
------------ ------------
Income before income taxes 4,972 6,152
Income taxes 1,653 2,107
------------ ------------
Net income $ 3,319 $ 4,045
============ ============
Net income per common share
Basic $ .19 $ .23
============ ============
Diluted $ .18 $ .22
============ ============
Weighted average common shares outstanding
Basic 17,218,000 17,510,000
============ ============
Diluted 18,315,000 18,513,000
============ ============
Dividends per share $ .04 $ .045
============ ============
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, 2003 AND 2004
Accumulated
Other
Compre-
Additional hensive Total
Common Paid-In Retained Treasury Income Stockholders'
Stock Capital Earnings Stock (Loss) Equity
-------- --------- -------- -------- -------- --------
(Unaudited)
(In thousands)
Balance at September
30, 2003 $ 156 $ 10,208 $ 63,030 $ (3,375) $ 3,688 $ 73,707
Net income -- -- 3,319 -- -- 3,319
Other comprehensive
income:
Unrealized gains arising
during period, net of
taxes of $704 -- -- -- -- (561) --
Less: reclassification
adjustment for gains
included in net income,
net of taxes of $81 -- -- -- -- 124 --
--------
Other comprehensive income -- -- -- -- (437) (437)
-------- --------
Comprehensive income -- -- -- -- -- 2,882
--------
Exercise of stock
options 1 144 (193) 461 -- 413
Cash dividends -- -- (713) -- -- (713)
-------- -------- -------- -------- -------- --------
Balance at December
31, 2003 $ 157 $ 10,352 $ 65,443 $ (2,914) $ 3,251 $ 76,289
======== ======== ======== ======== ======== ========
Balance at September
30, 2004 $ 159 $ 10,640 $ 73,533 $ (1,182) $ 2,198 $ 85,348
Net income -- -- 4,045 -- -- 4,045
Other comprehensive
income:
Unrealized gains arising
during period, net of
taxes of $266 -- -- -- -- 429 --
Less: reclassification
adjustment for gains
included in net income,
net of taxes of $60 -- -- -- -- (98) --
--------
Other comprehensive income -- -- -- -- 331 331
-------- --------
Comprehensive income -- -- -- -- -- 4,376
--------
Exercise of stock
options -- 129 (242) 429 -- 316
Cash dividends -- -- (789) -- -- (789)
-------- -------- -------- -------- -------- --------
Balance at December
31, 2004 $ 159 $ 10,769 $ 76,547 $ (753) $ 2,529 $ 89,251
======== ======== ======== ======== ======== ========
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, 2003 AND 2004
2003 2004
---- ----
(Unaudited)
(In thousands)
Cash flows from operating activities:
Net income $ 3,319 $ 4,045
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 552 598
Provision for loan losses 550 350
(Gain) loss on sale of investment securities
available for sale and mortgage-backed
securities available for sale 200 (158)
Origination of loans receivable held for sale (13,544) (19,653)
Proceeds from sales of loans receivable held for sale 3,640 4,084
Loss on early extinguishment of debt 9 --
Increase in:
Cash value of life insurance (239) (240)
Other assets (1,831) (53)
Accrued interest receivable (291) (165)
Increase (decrease) in:
Accrued interest payable (8) 126
Other liabilities 1,328 660
--------- ---------
Net cash used in operating activities (6,315) (10,406)
--------- ---------
Cash flows from investing activities:
Proceeds from sales of investment of investment
securities available for sale -- 739
Proceeds from maturities of investment
securities available for sale -- 1,950
Proceeds from issuer call of investment
securities held to maturity -- 7,840
Purchases of investment securities available (314) (2,150)
for sale
Purchases of investment securities held to maturity -- (10,000)
Proceeds from sales of mortgage-backed securities
available for sale 94,017 29,662
Purchases of mortgage-backed securities
available for sale (124,608) (103,328)
Principal collected on mortgage-backed
securities available for sale 32,293 21,010
Origination of loans receivable, net (105,891) (139,522)
Proceeds from sale of loan participations -- 5,842
Principal collected on loans receivable 81,365 119,073
Purchase of bank-owned life insurance (4,500) --
Proceeds from sales of real estate
acquired through foreclosure 374 524
Purchases of office properties and equipment (714) (1,472)
Purchases of FHLB stock, net (2,005) (3,428)
--------- ---------
Net cash used in investing activities (29,983) (73,260)
--------- ---------
(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, 2003 AND 2004 (CONTINUED)
2003 2004
---- ----
(Unaudited)
(In thousands)
Cash flows from financing activities:
Decrease in deposits, net $ (14,770) $ (6,413)
Increase (decrease) in securities sold under
agreement to repurchase, net (19,171) 13,737
Proceeds from FHLB advances 213,300 195,500
Repayment of FHLB advances (137,500) (126,800)
Prepayment penalties on early extinguishment of debt (9) --
Decrease in advance payments by borrowers
for property taxes and insurance, net (1,005) (1,212)
Decrease in drafts outstanding, net (359) (1,593)
Cash dividends to stockholders (713) (789)
Exercise of stock options 413 316
--------- ---------
Net cash provided by financing activities 40,186 72,746
--------- ---------
Net increase (decrease) in cash and cash equivalents 3,888 (10,920)
--------- ---------
Cash and cash equivalents at beginning
of the period 21,575 29,652
--------- ---------
Cash and cash equivalents at end
of the period $ 25,463 $ 18,732
========= =========
Supplemental information:
Interest paid $ 5,733 $ 6,316
========= =========
Income taxes paid $ 30 $ --
========= =========
Supplemental schedule of non-cash investing
and financing transactions:
Securitization of mortgage loans into
mortgage-backed securities $ 14,054 $ 10,878
========= =========
Transfer of mortgage loans to real
estate acquired through foreclosure $ 82 $ 413
========= =========
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, 2004 are not necessarily indicative of the
results that may be expected for the entire fiscal year. These unaudited
consolidated financial statements should be read in conjunction with Coastal
Financial Corporation and Subsidiaries' the ("Company") audited consolidated
financial statements and related notes for the year ended September 30, 2004,
included in the Company's 2004 Annual Report to Stockholders. The principal
business of the Company is conducted by its wholly-owned subsidiary, Coastal
Federal Bank (the "Bank"). The information presented herein, therefore, relates
primarily to the Bank.
Certain prior period amounts have been reclassified to conform to current year
presentation.
(2) INVESTMENT SECURITIES AVAILABLE FOR SALE
The unrealized losses on investment securities were attributable to increases in
interest rates, rather than credit quality. The unrealized losses are comprised
of four securities at September 30, 2004 and December 31, 2004 that have had
continuous losses of less than 12 months. There were ten securities at September
30, 2004 and six securities at December 31, 2004, with continuous losses 12
months or longer. None of the individual investment securities had an unrealized
loss that exceeded 5% of its amortized cost in either period.
(3) MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE
Gross unrealized losses on mortgage-backed securities and the length of time the
securities have been in a continuous loss position were as follows:
September 30, 2004
-----------------------------------------------------------------------------------------------
Less than 12 Months 12 Months or Longer Total
--------------------------- --------------------------- ---------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----- ------ ----- ------ ----- ------
Collateralized Mortgage $ 29,362 (221) 2,113 (98) 31,475 (319)
Obligations
FNMA 21,027 (116) 22,117 (545) 43,144 (661)
GNMA 6,456 (5) -- -- 6,456 (5)
FHLMC 46,457 (226) 20,829 (567) 67,286 (793)
---------- ---------- ---------- ---------- ---------- ----------
$ 103,302 (568) 45,059 (1,210) 148,361 (1,778)
========== ========== ========== ========== ========== ==========
December 31, 2004
-----------------------------------------------------------------------------------------------
Less than 12 Months 12 Months or Longer Total
--------------------------- --------------------------- ---------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----- ------ ----- ------ ----- ------
Collateralized Mortgage $ 40,014 (216) 4,274 (30) 44,288 (246)
Obligations
FNMA 27,908 (454) 13,579 (192) 41,487 (646)
GNMA 976 (1) -- -- 976 (1)
FHLMC 39,364 (192) 23,792 (504) 63,156 (696)
---------- ---------- ---------- ---------- ---------- ----------
$ 108,262 (863) 41,645 (726) 149,907 (1,589)
========== ========== ========== ========== ========== ==========
8
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. The unrealized losses
are comprised of 25 securities at September 30, 2004 and December 31, 2004 that
have had continuous losses of less than 12 months. There were 8 securities at
September 30, 2004 and 10 securities at December 31, 2004, with continuous
losses 12 months or longer. None of the individual investment securities had an
unrealized loss that exceeded 5% of its amortized cost in either period.
(4) LOANS RECEIVABLE, NET
Loans receivable, net consists of the following:
September 30, December 31,
2004 2004
------------- ------------
(Unaudited)
(In thousands)
First mortgage loans:
Single family to four family units $ 329,287 $ 334,670
Land and land development 99,697 89,449
Residential lots 29,839 30,896
Other, primarily commercial real estate 182,924 195,487
Residential construction loans 82,789 88,754
Commercial construction loans 10,503 8,753
Consumer and commercial loans:
Installment consumer loans 18,024 19,562
Mobile home loans 4,618 4,641
Savings account loans 2,058 2,196
Equity lines of credit 30,906 32,305
Commercial and other loans 32,101 32,987
--------- ---------
822,746 839,700
Less:
Allowance for loan losses 11,077 11,412
Deferred loan costs, net (674) (586)
Undisbursed portion of loans in process 21,613 24,300
--------- ---------
$ 790,730 $ 804,574
========= =========
The changes in the allowance for loan losses consist of the following for the
three months ended:
Three Months Ended December 31,
-------------------------------
2003 2004
---- ----
(Unaudited)
(Dollars in thousands)
Allowance at beginning of period $ 9,832 $ 11,077
Provision for loan losses 550 350
--------- ---------
Recoveries:
Residential loans -- --
Commercial loans 67 14
Consumer loans 17 33
--------- ---------
Total recoveries 84 47
--------- ---------
Charge-offs:
Residential loans -- --
Commercial loans 40 5
Consumer loans 109 57
--------- ---------
Total charge-offs 149 62
--------- ---------
Net charge-offs 65 15
--------- ---------
Allowance at end of period $ 10,317 $ 11,412
========= =========
9
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(4) LOANS RECEIVABLE, NET - CONTINUED
Ratio of allowance to total net loans
outstanding at the end of the period 1.43% 1.40%
==== ====
Ratio of net charge-offs to average
total loans outstanding during the period (annualized) .04% .01%
==== ====
Non-accrual loans, which are primarily loans over ninety days delinquent,
totaled approximately $7.0 million and $5.6 million at December 31, 2003 and
2004, respectively. For the three months ended December 31, 2004 and 2003,
interest income, which would have been recorded, would have been approximately
$126,000 and $70,000, respectively, had non-accruing loans been current in
accordance with their original terms.
At December 31, 2004, impaired loans totaled $4.0 million. There were $4.2
million in impaired loans at December 31, 2003. Included in the allowance for
loan losses at December 31, 2004 was $409,000 related to impaired loans compared
to $362,000 at December 31, 2003. The average recorded investment in impaired
loans for the three months ended December 31, 2004 was $3.6 million compared to
$4.6 million for the three months ended December 31, 2003. Interest income of
$35,000 was recognized on impaired loans for the quarter ended December 31,
2004. Interest income of $108,000 was recognized on impaired loans for the
quarter ended December 31, 2003.
(5) DEPOSITS
Deposits consist of the following:
September 30, 2004 December 31, 2004
------------------- -------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
------ ---- ------ ----
(Unaudited)
(Dollars in thousands)
Transaction accounts $457,596 0.79% $446,636 0.82%
Statement savings accounts 55,205 0.80 65,255 0.82%
Certificate accounts 240,578 2.49 235,075 2.57%
-------- --------
$753,379 1.33% $746,966 1.37%
======== ========
(6) ADVANCES FROM FEDERAL HOME LOAN BANK
Advances from Federal Home Loan Bank ("FHLB") consist of the following:
September 30, 2004 December 31, 2004
------------------- -------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
------ ---- ------ ----
Maturing within: (Unaudited)
(Dollars in thousands)
1 year $ 64,500 2.78% $133,200 2.72%
2 years 4,177 2.79 4,377 2.79
3 years 11,560 2.23 11,860 2.27
4 years 3,977 3.18 3,477 3.15
5 years 31,803 2.36 32,303 2.39
After 5 years 212,490 4.20 211,990 4.20
-------- --------
$328,507 3.64% $397,207 3.47%
======== ========
10
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(6) ADVANCES FROM FEDERAL HOME LOAN BANK- CONTINUED
At September 30, 2004, and December 31, 2004, the Bank had pledged first
mortgage loans and mortgage-backed securities with unpaid balances of
approximately $357.3 million and $432.5 million, respectively, as collateral for
FHLB advances. At December 31, 2004, included in the one, two, three, five and
after five years maturities were $219.0 million, with a weighted average rate of
3.92%, of advances subject to call provisions. Callable advances at December 31,
2004 are summarized as follows: $93.0 million callable in fiscal 2005, with a
weighted average rate of 5.33%; $29.0 million callable in fiscal 2006, with a
weighted average rate of 2.37%; $35.0 million callable in fiscal 2007, with a
weighted average rate of 3.00%; $37.0 million callable in fiscal 2008, with a
weighted average rate of 2.98%; and $25.0 million callable in fiscal 2009, with
a weighted average rate of 3.13%. Call provisions are more likely to be
exercised by the FHLB when interest rates rise.
(7) EARNINGS PER SHARE
Basic earnings per share for the three months ended December 31, 2003 and 2004
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, 2003 and 2004 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)
2003 2003 2004 2004
-------------------------- --------------------------
BASIC DILUTED BASIC DILUTED
-------------------------- --------------------------
Weighted average shares outstanding 17,218,000 17,218,000 17,510,000 17,510,000
Effect of dilutive securities-
Stock options -- 1,097,000 -- 1,003,000
-------------------------- --------------------------
17,218,000 18,315,000 17,510,000 18,513,000
========================== ==========================
(8) STOCK BASED COMPENSATION
At December 31, 2004, the Company had a stock option plan that provides for
stock options to be granted primarily to directors, officers and other key
Associates. The plan is more fully described in Note 17 of the Notes to
Consolidated Financial Statements included in the Company's Annual Report for
the year ended September 30, 2004. The Company accounts for the plan under the
recognition and measurement principles of APB Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations. No stock-based employee
or director compensation cost is reflected in net income, as all options granted
under the plan had an exercise price equal to the market value of the underlying
common stock on the date of grant.
11
PART I. FINANCIAL INFORMATION
Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
(8) STOCK BASED COMPENSATION - CONTINUED
The following table illustrates the effect on net income and earnings per share
if the Company had applied the fair value recognition provisions of FASB
Statement 123, "Accounting for Stock-Based Compensation", to stock-based
employee and non-employee compensation.
Three Months Ended December 31,
-------------------------------
2003 2004
---- ----
(Unaudited)
(Dollars in thousands)
Net income, as reported $ 3,319 $ 4,045
Deduct: Total stock-based employee and director
compensation expense determined under
fair value based method for all awards,
net of related tax effects (131) (176)
---------- ----------
Pro forma net income $ 3,188 $ 3,869
========== ==========
Basic earnings per share:
As reported $ .19 $ .23
========== ==========
Pro forma $ .19 $ .22
========== ==========
Diluted earnings per share:
As reported $ .18 $ .22
========== ==========
Pro forma $ .17 $ .21
========== ==========
(9) COMMON STOCK DIVIDEND
On February 18, 2004, July 30, 2004 and December 15, 2004, the Company declared
10% stock dividends, aggregating approximately 1,308,000, 1,442,000 and
1,594,000 shares, respectively. The most recent common stock dividend was
payable January 20, 2005 to shareholders of record as of January 6, 2005. 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; 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, 2004, 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, 2004 was $7.3 million.
(11) 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. 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 $4.5 million at December 31, 2004.
The fair value of the loan commitments was an asset of approximately $39,000 at
December 31, 2004. As of December 31, 2004, the Company had sold $7.0 million in
forward commitments to deliver fixed rate mortgage-backed securities, which were
recorded as a derivative liability of $8,000.
12
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 our control and which may cause our
actual results, performance or achievements to differ materially from the
results, performance or achievements contemplated by the forward-looking
statements. Forward-looking statements can be identified by the fact that they
do not relate strictly to historical or current facts. They often include words
such as "believe," "expect," "anticipate," "intend," "plan," "estimate" or words
of similar meaning, or future or conditional verbs such as "will," "would,"
"should," "could" or "may." Forward-looking statements speak only as of the date
they are made. Such risks and uncertainties include, among other things:
o Competitive pressures among depository and other financial
institutions in our market areas may increase significantly.
o Adverse changes in the economy or business conditions, either
nationally or in our market areas, could increase credit-related
losses and expenses and/or limit growth.
o Increases in defaults by borrowers and other delinquencies could
result in increases in our provision for losses on loans and related
expenses.
o Our inability to manage growth effectively, including the successful
expansion of our Customer support, administrative infrastructure and
internal management systems, could adversely affect our results of
operations and prospects.
o Fluctuations in interest rates and market prices could reduce our
net interest margin and asset valuations and increase our expenses.
o The consequences of continued bank acquisitions and mergers in our
market areas, resulting in fewer but much larger and financially
stronger competitors, could increase competition for financial
services to our detriment.
o Our continued growth will depend in part on our ability to enter new
markets successfully and capitalize on other growth opportunities.
o Changes in legislative or regulatory requirements applicable to us
and our subsidiaries could increase costs, limit certain operations
and adversely affect results of operations.
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
FORWARD LOOKING STATEMENTS - CONTINUED
- --------------------------------------
o Changes in tax requirements, including tax rate changes, new tax
laws and revised tax law interpretations may increase our tax
expense or adversely affect our Customers' businesses.
o Company initiatives now in place or introduced in the future, not
producing results consistent with historic growth rates or results
which justify their costs.
In light of these risks, uncertainties and assumptions, you should not
place undue reliance on any forward-looking statements in this report. We
undertake no obligation to publicly update or otherwise revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
OVERVIEW
- --------
Coastal Financial Corporation is a unitary thrift holding company incorporated
in Delaware with one wholly-owned banking subsidiary, Coastal Federal Bank (the
"Bank" or "Coastal Federal"). The Company also owns Coastal Planners Holding
Corporation, whose subsidiary Coastal Retirement, Estate and Tax Planners, Inc.,
offers fee-based financial planning and tax preparation services. The Company's
primary business activities are conducted by the Bank. The Company and Bank's
principal executive offices are located in Myrtle Beach, South Carolina.
Coastal Federal Bank is a full service financial services company with 19
branches located in four counties throughout the coastal regions of South
Carolina and North Carolina. The Bank has twelve offices in Horry County, South
Carolina; one office in Georgetown County, South Carolina; three offices in
Brunswick County, North Carolina; and three offices in New Hanover County, North
Carolina.
The Bank's primary market areas are located along the coastal regions of South
Carolina and North Carolina and predominately center around the Metro regions of
Myrtle Beach, South Carolina and Wilmington, North Carolina, and their
surrounding counties. Coastal Federal's primary market is Horry County, South
Carolina where the Bank has the number one market share of deposits as of June
30, 2004 with 16.4% of deposits as reported by the FDIC Summary of Deposits
Report. The Bank also has the third highest market share of deposits as of June
30, 2004 in Brunswick County, North Carolina with 8.9% of deposits as reported
by the FDIC Summary of Deposits Report.
The primary business activities in Horry County are centered around the tourism
industry. To the extent that Horry County businesses rely heavily on tourism
business, decreased tourism would have a significant adverse effect on Coastal
Federal's primary deposit base and lending area. Moreover, the Bank would likely
experience a higher degree of loan delinquencies should the local economy be
materially and adversely affected.
Coastal Federal's principal business consists of attracting core deposits from
Customers in its primary market locations and using these funds to meet the
lending needs of its Customers as well as providing numerous financial products
and services for its Customers.
Through its branch locations, the Bank provides a wide range of banking
products, including interest-bearing and non-interest bearing checking accounts;
business sweep accounts; business cash management services; statement savings
accounts; money market accounts; certificate of deposit accounts; individual
retirement accounts; merchant services; commercial, business, personal, real
estate, residential mortgage and home equity loans; safe deposit boxes; and
electronic banking services. The Bank has six ATMs at off-site locations and an
ATM at each branch. The Bank also makes available a wide range of financial
products through its relationship with Raymond James Financial Services,
including stocks, bonds, mutual funds, annuities, insurance, and retirement
products.
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
OVERVIEW - CONTINUED
- --------------------
In the fourth fiscal quarter of 2004, the Bank began two new initiatives. The
first was The Experience of FANtastic! Customer Service. This initiative focuses
on Customer service and convenience. The Bank intends to redesign its
infrastructure and purchase software and products to improve Customer service
and convenience and Associate productivity. In addition, in the first fiscal
quarter of 2005, in order to improve Customer service and convenience the Bank
introduced an expanded hours Call Center that employs 20 to 25 Associates. In
the second fiscal quarter of 2005, the Bank plans to introduce extended
operating hours. The Bank experienced increased salary and benefit expenses in
the first fiscal quarter of 2005 and anticipates these expenses continuing
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 campaign. In the first fiscal
quarter of 2005, marketing expenses were $511,000 compared to $181,000 in the
comparable 2004 period. The Bank expects to realize significant benefits from
this strategy consisting of increased Bank lobby traffic, increased number of
personal checking accounts and higher fee income as a result of those checking
accounts. In the first fiscal quarter of 2005, approximately 3,900 new checking
accounts had been opened. This rate of growth could necessitate the hiring of
additional Associates to open and service these accounts.
The Associates being hired for these two initiatives are expected to have total
compensation averaging between $28,000 and $35,000 per Associate.
CRITICAL ACCOUNTING POLICIES
- ----------------------------
The Company's accounting policies are in accordance with accounting principles
generally accepted in the United States of America and with general practice
within the banking industry. In order to understand our financial condition and
results of operations, it is important to understand our more critical
accounting policies and the extent to which we use judgment and estimates in
applying those policies. The Company considers its policies regarding the
allowance for loan losses and income taxes to be its most critical accounting
policies due to the significant degree of the levels of subjectivity and
management judgment necessary to account for these matters. Different
assumptions in the application of these policies could result in material
changes in the Company's consolidated financial statements. The Company's
accounting policies are set forth in Note 1 of the Notes to Consolidated
Financial Statements in the Company's 2004 Annual Report to Stockholders. For
additional discussion concerning the Company's allowance for loan losses and
related matters, see "Allowance for Loan Losses" and see "Income Taxes" for
additional discussion concerning income taxes in the Company's 2004 Annual
Report to Stockholders.
OFF-BALANCE SHEET ARRANGEMENTS
- ------------------------------
In the normal course of operations, the Company engages in a variety of
financial transactions that, in accordance with generally accepted accounting
principles, are recorded in amounts that differ from the notional amounts. These
transactions involve, to varying degrees, elements of credit, 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, 2004 and September 30, 2004, 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 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.
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
OFF-BALANCE SHEET ARRANGEMENTS - CONTINUED
- ------------------------------------------
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, 2004, unfunded business and personal lines of credit commitments totaled
$57.0 million. Unused business and personal credit card lines, which totaled
$14.1 million at December 31, 2004, are generally for short-term borrowings. The
Company also had commitments to originate $17.4 million in residential mortgage
loans at December 31, 2004.
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, 2004, 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, 2004 was $7.3 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 $4.5 million at
December 31, 2004. The fair value of the loan commitments was an asset of
approximately $39,000 at December 31, 2004. As of December 31, 2004, the Company
had sold $7.0 million in forward commitments to deliver fixed rate
mortgage-backed securities, which were recorded as a derivative liability of
$8,000.
DISCUSSION OF FINANCIAL CONDITION CHANGES FROM SEPTEMBER 30, 2004 TO DECEMBER
- -----------------------------------------------------------------------------
31, 2004
- --------
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 $119.4 million for the three months ended
December 31, 2003, compared to $159.2 million for the three months ended
December 31, 2004. Loan principal repayments amounted to $81.4 million in the
first quarter of 2003 compared to $124.9 million for the three months ended
December 31, 2004. In addition, the Company sells certain loans in the secondary
market to finance future loan originations. In the first quarter of fiscal 2004,
the Company sold loans or securitized and sold loans totaling $17.7 million that
compares to $15.0 million in the first three months ended December 31, 2004.
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, 2004, the Company securitized
$10.9 million of mortgage loans and concurrently sold these mortgage-backed
securities to outside third parties and recognized a net gain on sale of
$315,000, which included
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
LIQUIDITY AND CAPITAL RESOURCES - CONTINUED
- ------------------------------------------
$212,000 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, 2003, the Company purchased $124.9
million in investment and mortgage-backed securities. For the three-month period
ended December 31, 2004, the Company purchased $115.5 million in investment and
mortgage-backed securities. These purchases during the three-month period ended
December 31, 2004 were primarily funded by borrowings, repayments of $21.0
million within the securities portfolio and sales of mortgage-backed securities
of $29.7 million.
During the three-month periods ended December 31, 2004 and 2003, the Company
sold loan participations totaling $5.8 million and $0, respectively.
The Company places significant emphasis on growth in checking accounts. Checking
accounts have increased from approximately $149 million at December 31, 2003 to
$214 million at December 31, 2004, an increase of $65 million or 43.6%. When
compared to fiscal year-end balances, checking slightly increased. Core deposits
(defined as transaction and statement savings accounts) have increased from
$422.1 million at December 31, 2003 to $511.9 million at December 31, 2004, an
increase of 21.3%. When compared to fiscal year-end balances, the Company
experienced a slight decrease in core deposits of .2%.
Total deposits decreased $6.4 million between September 30, 2004 and December
31, 2004. The Company generally experiences a decline in deposits in its first
and second quarters of each fiscal year since it is very dependent upon the
tourism industry, which is much slower in the winter months.
At December 31, 2004, the Company had $207.2 million of certificates of deposits
that were due to mature within one year. Based on past experience, the Company
believes that the majority of these certificates of deposits will renew with the
Company. At December 31, 2004, the Company had commitments to originate $17.4
million in residential mortgage loans, $57.0 million in undisbursed business and
retail lines of credit and $14.1 million in unused business and personal credit
card lines, which the Company expects to fund from normal operations. At
December 31, 2004, the Company had $52.7 million available in FHLB advances.
Additionally, at December 31, 2004, the Company had outstanding available lines
for federal funds of $20.0 million.
As a result of $4.0 million in net income, less the cash dividends paid to
stockholders of approximately $789,000, proceeds of approximately $316,000 from
the exercise of stock options, and the net increase in unrealized gain on
securities available for sale, net of income tax of $331,000, stockholders'
equity increased from $85.3 million at September 30, 2004 to $89.3 million at
December 31, 2004.
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 $100.9 million at December
31, 2004, exceeding the core capital requirement by $59.4 million. At December
31, 2004, the Bank's risk-based capital of approximately $110.3 million exceeded
its current risk-based capital requirement by $46.4 million. (For further
information see Regulatory Capital Matters).
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
LIQUIDITY AND CAPITAL RESOURCES - CONTINUED
- ------------------------------------------
The table below summarizes future contractual obligations as of December 31,
2004:
Payments Due by Period
--------------------------------------------------------------------------
Less than 1-3 4-5 After 5
Total 1 Year Years Years Years
---------- ---------- ---------- ---------- ----------
Time deposits $ 235,075 $ 207,212 $ 27,049 $ 119 $ 695
Short-term borrowings 254,110 254,110 -- -- --
Long-term debt 279,471 -- 16,237 35,780 227,454
Operating leases 559 120 183 25 231
---------- ---------- ---------- ---------- ----------
Total contractual cash
obligations $ 769,215 $ 461,442 $ 43,469 $ 35,924 $ 228,380
========== ========== ========== ========== ==========
Purchase commitments. The Company has entered into various contracts to purchase
equipment and software products to improve productivity, Customer service and
convenience. At December 31, 2004, the total original purchase commitments,
excluding recurring annual maintenance fees, totaled $1.9 million, of which
$800,000 had been spent. The Company expects to complete the purchases in the
second quarter of fiscal 2005. The annual maintenance fees are expected to be
approximately $160,000.
EARNINGS SUMMARY
- ----------------
Net income increased from $3.3 million, or $.18 per diluted share, for the three
months ended December 31, 2003 to $4.0 million, or $.22 per diluted share for
the three months ended December 31, 2004. This 21.9% increase in net income
resulted from increased net interest income of $1.7 million, or 17.4%, decreased
provision for loan losses of $200,000, increased other income of $441,000,
offset by increased general and administrative expenses of $1.5 million.
The net interest margin increased from 3.51% for the three months ended December
31, 2003 to 3.66% for the three months ended December 31, 2004. As a result of
growth in loans receivable and investments, net interest income increased 17.4%.
The increase in net interest income is primarily attributable to an increase in
average earning assets of $140.4 million, or 12.6%. Average loans receivable
increased $115.8 million for the three months ended December 31, 2004 compared
to December 31, 2003. In addition, average balances of investment securities
increased approximately $23.0 million. The investment securities were primarily
funded with FHLB advances. The Company's advances with a maturity greater than
five years increased from $189.8 million at December 31, 2003 to $212.0 million
at December 31, 2004.
Provision for loan losses decreased by $200,000 primarily due to criticized
loans and loans delinquent ninety days or more at December 31, 2004, as compared
to December 31, 2003. The allowance for loan losses as a percentage of net loans
was 1.40% at December 31, 2004 compared to 1.43% at December 31, 2003.
Other income increased from $2.3 million for the quarter ended December 31, 2003
to $2.8 million for the quarter ended December 31, 2004. This was a result of an
increase in fees and service charges on loan and deposit accounts of $188,000,
offset by a decrease in gains on sales of loans held for sale of $131,000. The
Company also had gains on sales of securities available for sale of $158,000 for
the quarter ended December 31, 2004, compared to losses of $200,000 for the
quarter ended December 31, 2003.
General and administrative expenses increased from $6.6 million for the three
months ended December 31, 2003 to $7.8 million for the three months ended
December 31, 2004. Compensation increased from $4.0 million for the first
quarter of fiscal 2004 to $4.4 million in the first quarter of fiscal 2005,
primarily due to an increase in the number of banking Associates in business
banking, Associates in the Company's expanded hours call center, and Associates
in new branches. Marketing expenses were $181,000 for the three months ended
December 31, 2003, compared to $511,000 for the three months ended December 31,
2004. This is primarily attributed to the Bank's "Totally Free Checking With a
Gift" initiative. Other expense was $873,000 for the three months ended December
31, 2003, compared to $1.1 million for the three months ended December 31, 2004.
18
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED
- -----------------------------------------------------------------------------
DECEMBER 31, 2003 AND 2004
- --------------------------
INTEREST INCOME
- ---------------
Interest income for the three months ended December 31, 2004, increased to $18.0
million as compared to $15.5 million for the three months ended December 31,
2003. The earning asset yield for the three months ended December 31, 2004, was
5.73% compared to a yield of 5.58% for the three months ended December 31, 2003.
The average yield on loans receivable for the three months ended December 31,
2004, was 6.15% compared to 6.21% for three months ended December 31, 2003. Due
to a decline in amortization of premiums on investment securities due to slower
prepayments in fiscal 2005, the yield on investments increased to 4.91% for the
three months ended December 31, 2004, from 4.45% for the three months ended
December 31, 2003. Total average interest-earning assets were $1.3 billion for
the quarter ended December 31, 2004 as compared to $1.1 billion for the quarter
ended December 31, 2003. The increase in average interest-earning assets is
primarily due to an increase in average loans receivable of approximately $115.8
million resulting from increased lending and an increase in investment
securities of approximately $24.6 million, primarily funded by borrowings.
INTEREST EXPENSE
- ----------------
Interest expense on interest-bearing liabilities was $6.4 million for the three
months ended December 31, 2004, as compared to $5.7 million for the three months
ended December 31, 2003. The average cost of deposits for the three months ended
December 31, 2004, was 1.31% compared to 1.48% for the three months ended
December 31, 2003. The cost of interest-bearing liabilities was 2.07% for the
three months ended December 31, 2004 and 2003. The cost of FHLB advances,
repurchase/reverse repurchase agreements and other borrowings was 3.67% 1.87%
and 5.33%, respectively, for the three months ended December 31, 2004. For the
three months ended December 31, 2003, the cost of FHLB advances,
repurchase/reverse repurchase agreements and other borrowings was 4.00%, 1.51%
and 4.27%, respectively. Total average interest-bearing liabilities increased
from $1.1 billion at December 31, 2003 to $1.2 billion at December 31, 2004. The
increase in average interest-bearing liabilities is due to an increase in
average deposits of approximately $63.4 million as a result of the Company's
focus on checking growth, increased average FHLB advances of $105.1 million used
to fund loan and investment securities growth and increased average Customer
repurchase agreements of $19.6 million. This increase was partially offset by a
decrease in average reverse repurchase agreements of $48.3 million.
NET INTEREST INCOME
- -------------------
Net interest income was $11.5 million for the three months ended December 31,
2004, as compared to $9.8 million for the three months ended December 31, 2003.
The net interest margin was 3.66% for the three months ended December 31, 2004,
compared to 3.51% for the three months ended December 31, 2003.
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, 2003 AND 2004 - CONTINUED
- --------------------------------------
NET INTEREST INCOME - CONTINUED
- -------------------------------
Three Months Ended December 31,
-------------------------------
2004 2003
---- ----
Average Income/ Yield/ Average Income/ Yield/
Balance (1) Expense Rate Balance (1) Expense Rate
---------- ---------- ------ ---------- ---------- -------
Assets
Earning assets
Loans (2) $ 828,793 $ 12,740 6.15% $ 713,003 $ 11,077 6.21%
Investment
Securities, MBS
Securities and
Other (3) 425,130 5,217 4.91% 400,540 4,458 4.45%
---------- ---------- ---------- ----------
Total earning assets $1,253,923 $ 17,957 5.73% $1,113,543 $ 15,535 5.58%
========== ---------- ========== ----------
Liabilities
Interest-bearing
deposits 764,536 2,507 1.31% 701,135 2,594 1.48%
Borrowings 481,957 3,935 3.27% 405,656 3,131 3.09%
Total interest-bearing ---------- ---------- ---------- ----------
liabilities $1,246,493 6,442 2.07% $1,106,791 5,725 2.07%
========== ---------- ========== ----------
Net interest income $ 11,515 $ 9,810
========== ==========
Net interest margin 3.66% 3.51%
Net yield on earning assets 3.67% 3.52%
(1) The average balances are derived from monthly balances.
(2) Nonaccrual loans are included in average balances for yield computations.
(3) Investment securities include taxable and tax-exempt securities. Net
interest income has not been adjusted to produce a tax-equivalent yield.
PROVISION FOR LOAN LOSSES
- -------------------------
The Company's provision for loan losses decreased from $550,000 for the three
months ended December 31, 2003, to $350,000 for the three months ended December
31, 2004 primarily due to criticized loans and loans delinquent ninety days or
more at December 31, 2004 as compared to December 31, 2003. The allowance for
loan losses as a percentage of loans was 1.40% at December 31, 2004 as compared
to 1.43% at December 31, 2003. Loans delinquent 90 days or more were $5.6
million or .69% of total loans at December 31, 2004, compared to $7.0 million or
..97% of total loans at December 31, 2003. The allowance for loan losses was 203%
of loans delinquent more than 90 days at December 31, 2004, compared to 147% at
December 31, 2003. Net charge-offs for the three months ended December 31, 2004
were $15,000 compared to $65,000 for the three months ended December 31, 2003.
Management believes that the current level of the allowance for loan losses is
adequate considering the composition of the loan portfolio, the portfolio's loss
experience, delinquency trends, current regional and local economic conditions
and other factors.
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
- -----------------------------------------------------------------------------
DECEMBER 31, 2003 AND 2004 - CONTINUED
- --------------------------------------
OTHER INCOME
- ------------
For the three months ended December 31, 2004, other income was $2.8 million
compared to $2.3 million for the three months ended December 31, 2003. Fees and
service charges from deposit accounts were $1.1 million for the three months
ended December 31, 2004, compared to $902,000 for the three months ended
December 31, 2003. During the three months ended December 31, 2003, the Company
securitized loans into mortgage-backed securities ("MBS") and then sold the MBS
and sold loans aggregating $17.7 million of loans held for sale compared to
$15.0 million for the three months ended December 31, 2004. Gain on sale of
loans was $310,000 for the quarter ended December 31, 2004, compared to $441,000
for the quarter ended December 31, 2003. Gains on sales of securities were
$158,000 for the quarter ended December 31, 2004, compared to losses of $200,000
for the quarter ended December 31, 2003. Other income was $651,000 for the three
months ended December 31, 2004, as compared to $560,000 for the three months
ended December 31, 2003.
GENERAL AND ADMINISTRATIVE EXPENSES
- -----------------------------------
General and administrative expenses were $6.6 million for the quarter ended
December 31, 2003 compared to $7.8 million for the quarter ended December 31,
2004. Salaries and employee benefits were $4.0 million for the three months
ended December 31, 2003, as compared to $4.4 million for the three months ended
December 31, 2004, an increase of 10.7%, primarily due to an increase in the
number of banking Associates in business banking, Associates in the Company's
expanded hours call center, and Associates in new branches. The Company has
added several Associates in a Banking Group that is focused on growing small to
medium sized business banking relationships. Also as a result of new branches,
net occupancy, furniture and fixtures and data processing expenses increased
$226,000 when comparing the two periods. Marketing expenses were $181,000 for
the three months ended December 31, 2003, compared to $511,000 for the three
months ended December 31, 2004. This is primarily attributed to the Bank's
"Totally Free Checking With a Gift" initiative. Other expenses were $873,000
million for the quarter ended December 31, 2003 compared to $1.1 for the quarter
ended December 31, 2004.
INCOME TAXES
- ------------
Income taxes were $1.7 million for the three months ended December 31, 2003
compared to $2.1 million for the three months ended December 31, 2004. The
effective income tax rate as a percentage of pretax income was 33.25% and 34.25%
for the quarters ended December 31, 2003 and 2004, respectively. The effective
income tax rate differs from the statutory rate primarily due to income
generated by bank-owned life insurance, municipal securities that are exempt
from federal and certain state taxes, and the increase in the current quarter
earnings over the comparable prior year earnings that are subject to higher
incremental tax rates.
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.
21
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
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, 2004:
Total Capital: $110,289 13.80% $ 63,936 8.00% $ 79,920 10.00%
(To Risk Weighted Assets)
Tier 1 Capital: $100,892 12.62% N/A N/A $ 47,952 6.00%
(To Risk Weighted Assets)
Tier 1 Capital: $100,892 7.30% $ 41,461 3.00% $ 69,237 5.00%
(To Total Assets)
Tangible Capital: $100,892 7.30% $ 20,771 1.50% N/A N/A
(To Total Assets)
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
- ------------------------------------------
In March 2004, the Financial Accounting Standards Board ("FASB") issued EITF No.
03-1 ("EITF 03-1"), "the Meaning of Other-Than-Temporary Impairment and Its
Application of Certain Investments," which provided guidance for evaluating
whether an investment is other-than-temporarily impaired and its application to
investments classified as either available for sale or held to maturity under
FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and investments accounted for under the cost or equity method of
accounting. In September 2004, the FASB issued FASB Staff Position ("FSP") EITF
No. 03-1-1, a delay of the effective date for the measurement and recognition
guidance contained in paragraphs 10-20 of EITF 03-1 until the FASB issues final
guidance, expected in the first quarter of 2005.
Paragraphs 10 through 20 of EITF 03-1 provide guidance on when impairment of
debt and equity securities is considered other-than-temporary. This guidance
generally states impairment is considered other-than-temporary unless the holder
of the security has both the intent and ability to hold the security until the
fair value recovers and evidence supporting the recovery outweighs evidence to
the contrary.
The Company adopted the guidance of EITF 03-1, excluding paragraphs 10-20
effective as of September 30, 2004. As a result of this adoption, the Company
provides additional disclosures, which are found in Notes 2 and 3 of this
report. The initial adoption of this issue, which excludes paragraphs 10-20 did
not have a material impact on the financial condition or results of operations
of the Company.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
- -----------------------------------------
In December 2004, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 123 (Revised 2004), "Share-Based Payment" ("SFAS 123R"). This
standard requires expensing of stock options and other share-based payments and
supersedes SFAS No. 123 that had allowed companies to choose between expensing
stock options or showing proforma disclosure only. This standard is effective
for the Company as of July 1, 2005 and will apply to all awards granted,
modified, cancelled or repurchased after that date. The Company is currently
evaluating the expected impact that the adoption of SFAS 123R will have on its
financial condition or results of operations.
22
PART I. FINANCIAL INFORMATION
Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS - CONTINUED
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.
PART I. FINANCIAL INFORMATION
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
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, which
adjustments made for off-balance sheet items over a range of assumed changes in
market interest rates. The Bank's Board of Directors has adopted an interest
rate risk policy which establishes maximum allowable decreases in NPV in the
event of a sudden and sustained one hundred to four hundred basis point increase
or decrease in market interest rates. The following table presents the Bank's
change in NPV as computed by the OTS for various rate shock levels as of
December 31, 2004.
Board Board Market Market
Limit Limit Value Value
Minimum NPV Maximum Of Assets Portfolio NPV
Change in interest rates Ratio Decline in NPV 12/31/04 12/31/04 Ratio
- --------------------------- ------------ -------------- ----------- ----------- ---------
300 basis point rise 5.00% 400 BPS $1,373,361 $124,131 9.04%
200 basis point rise 6.00% 300 BPS $1,395,712 $136,532 9.78%
100 basis point rise 6.00% 250 BPS $1,420,882 $150,193 10.57%
No change 6.00% $1,441,031 $160,400 11.13%
100 basis point decline 6.00% 250 BPS $1,453,070 $163,428 11.25%
200 basis point decline 6.00% 300 BPS N/A N/A N/A
300 basis point decline 6.00% 350 BPS N/A N/A N/A
The preceding table indicates that at December 31, 2004, in the event of a
sudden and sustained increase in prevailing market interest rates, the Bank's
NPV would be expected to decrease, and that in the event of a sudden decrease in
prevailing market interest rates, the Bank's NPV would be expected to increase
minimally. Values for the 200 and 300 basis point decline are not indicated due
to the level of interest rates at December 31, 2004. At December 31, 2004, the
Bank's estimated changes in NPV were within the limits established by the Board
of Directors.
Computation of prospective effects of hypothetical interest rate changes are
based on numerous assumptions, including relative levels of market interest
rates, loan prepayments and deposit decay, and should not be relied upon as
indicative of actual results. Further, the computations do not contemplate any
actions the ALCO could undertake in response to sudden changes in interest
rates.
23
PART I. FINANCIAL INFORMATION
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES - CONTINUED
Item 4. CONTROLS AND PROCEDURES
- -------------------------------
The Company's management, including the Company's principal executive
officer and principal financial officer, have evaluated the effectiveness of the
Company's "disclosure controls and procedures," as such term is defined in Rule
13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). Based upon their evaluation, the principal executive officer and
principal financial officer concluded that, as of the end of the period covered
by this report, the Company's disclosure controls and procedures were effective
for the purpose of ensuring that the information required to be disclosed in the
reports that the Company files or submits under the Exchange Act with the
Securities and Exchange Commission (the "SEC") (1) is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and (2) is accumulated and communicated to the Company's management,
including its principal executive and principal financial officers, as
appropriate to allow timely decisions regarding required disclosure. In
addition, based on that evaluation, no change in the Company's internal control
over financial reporting occurred during the three months ended December 31,
2004 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 status.
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
---------------------------------------------------
Not Applicable.
Item 5. Other Information
-----------------
Not Applicable.
24
PART II. OTHER INFORMATION
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES - CONTINUED
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 (5)
(c) Bylaws of Coastal Financial Corporation (1)
10 (a) Employment Agreement with Michael C. Gerald (7)
(b) Employment Agreement with Jerry L. Rexroad (7)
(c) Employment Agreement with Phillip G. Stalvey (7)
(d) Employment Agreement with Jimmy R. Graham (7)
(e) Employment Agreement with Steven J. Sherry (7)
(f) 1990 Stock Option Plan (2)
(g) Directors Performance Plan (3)
(h) Loan Agreement with Bankers Bank (4)
(i) Coastal Financial Corporation 2000 Stock Option Plan (6)
31 (a) Rule 13a-14(a)/15d-14(a) Certification (Chief Executive
Officer)
(b) Rule 13a-14(a)/15d-14(a) Certification (Chief Financial
Officer)
32 (a) Section 1350 Certification (Chief Executive Officer)
(b) Section 1350 Certification (Chief Financial Officer)
(1) Incorporated by reference to Registration Statement on Form S-4
filed with the Securities and Exchange Commission on November 26,
1990.
(2) Incorporated by reference to 1995 Form 10-K filed with the
Securities and Exchange Commission on December 29, 1995.
(3) Incorporated by reference to the definitive proxy statement for the
1996 Annual Meeting of Stockholders.
(4) Incorporated by reference to December 31, 1997 Form 10-Q filed with
Securities and Exchange Commission on February 13, 1998.
(5) Incorporated by reference to March 31, 1998 Form 10-Q filed with
Securities and Exchange Commission on May 15, 1998.
(6) Incorporated by reference to the definitive proxy statement for the
2000 Annual Meeting of Stockholders filed December 22, 1999.
(7) Incorporated by reference to 2003 Form 10-K filed with Securities
and Exchange Commission on December 22, 2003.
25
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 9, 2005 /s/ Michael C. Gerald
----------------- ----------------------
Date Michael C. Gerald
President and Chief Executive Officer
February 9, 2005 /s/ Jerry L. Rexroad
----------------- ---------------------
Date Jerry L. Rexroad
Executive Vice President and
Chief Financial Officer
26