Coastal Financial (NASDAQ:CCB) reported a second-quarter GAAP net loss of $42.1 million, or $2.76 per diluted share, driven largely by $68.8 million of pre-tax accounting adjustments tied to a defined Banking-as-a-Service, or BaaS, partner and its consumer loan portfolio.
Chief Executive Officer Eric Sprink said the company recorded a $46 million valuation adjustment to a credit enhancement asset and a $22.8 million provision for credit losses related to the partner’s indemnification agreement. Coastal also recorded $4.4 million of accelerated amortization on capitalized software after shortening the useful lives of technology assets being replaced through modernization efforts.
Defined Partner Exposure Under Review
Management said it changed its assessment of the unnamed, non-public partner during the quarter after considering portfolio performance, collections, recovery expectations and the partner’s financial condition. The company has engaged independent third-party advisers to assess loan-level data, and Sprink said that review found no evidence of impropriety by the partner or its customers.
The company is pursuing its contractual rights and is managing the portfolio through servicing, collections, recoveries, contractual remediation efforts and an evaluation of strategic alternatives. Sprink said the potential timeline for resolution could range from one to two quarters to 12 to 18 months, depending on how the situation evolves.
During the question-and-answer session, Sprink said the partner remains in business and has not defaulted to Coastal. He said the company’s reserve reflects the current assessment of risk and collectibility rather than a waiver of the partner’s obligations.
Coastal said the defined portfolio’s reserve addresses the gap between cash collateral held and expected recoveries under the indemnification agreement. While many CCBX partners maintain cash reserve arrangements, Sprink said not every partner is required to do so, including programs involving consumer-level cash-secured lending and certain relationships where Coastal has determined a corporate cash collateral account is unnecessary.
Management Says Issue Is Isolated
Coastal said it reviewed the rest of its CCBX portfolio using the same monitoring standards and did not identify a comparable issue. The remaining core CCBX portfolio totaled approximately $1.7 billion at quarter-end, with improvements in net charge-offs and both early- and late-stage delinquency metrics, according to management.
Sprink said all reviewed partners were current on contractual cash collateral funding obligations. He characterized the matter as related to one of more than 25 partnerships and said it should not be extrapolated to the company’s broader BaaS model or underwriting discipline.
The company said it will continue to monitor the identified portfolio in real time. Sprink noted that provisioning expense could increase as loans grow, with counterparty-related benefits also increasing for the remaining programs, while the affected portfolio will receive ongoing, separate monitoring.
Core Business Metrics Show Growth
Excluding the partner-related credit expense and software charge, management highlighted continued growth in net interest income, loans and BaaS-related fees. Net interest income rose $6 million, or 7.2% from the first quarter, to a record $89.4 million. Net interest margin increased to 7.27%, while net interest margin after BaaS loan expense rose to 3.98% from 3.90% in the prior quarter.
- Total loans increased $348.9 million, or 9%, to approximately $4.21 billion.
- BaaS program income increased $1.1 million, or 10.3%, from the first quarter.
- The company sold approximately $4.56 billion of CCBX loans during the quarter, including ongoing balances generated from previously sold credit card accounts.
- Its off-balance-sheet credit card program reached approximately 881,000 fee-earning accounts, up 32% from the first quarter.
- Coastal swept approximately $4.26 billion of deposits off balance sheet and generated about $1.2 million of sweep income during the quarter.
Total deposits ended the quarter at approximately $4.86 billion. Chief Financial Officer Brandon Soto said the sequential decline primarily reflected greater use of off-balance-sheet deposit sweep arrangements rather than a comparable decline in underlying partner deposit activity.
Community Bank credit quality remained strong, with annualized net charge-offs equal to approximately 0.01% of average loans, according to Soto.
Capital, Expense Focus and Leadership Changes
Executive Chairman Chris Adams said Coastal remained well-capitalized and liquid following the quarter’s adjustments. At June 30, the company reported a Common Equity Tier 1 ratio of 10.86%, a Tier 1 leverage ratio of 9.11%, and a total risk-based capital ratio of 13.30%. The accounting adjustments reduced capital ratios by approximately 1 percentage point.
Coastal held approximately $1.01 billion in cash and more than $1.1 billion of additional contingent borrowing capacity, with no short-term borrowings outstanding.
Adams, who was appointed executive chairman effective immediately after serving on Coastal’s board since 2016 and as chair since 2019, said his expanded role will emphasize long-term strategy, external engagement, leadership development, operating leverage and profitability. The company is reviewing vendor spending, contractor usage, discretionary costs, organizational duplication, technology priorities, and partner- and product-level profitability.
Sprink will remain CEO and retain responsibility for daily operations, financial performance, risk management and execution. Coastal also announced that Soto will leave to become CEO of another financial institution that is neither a current partner nor competitor. Former CFO Joel Edwards will return as interim CFO while the company searches for a permanent successor.
Finally, Sprink said Coastal is no longer actively pursuing an acquisition of assets and deposits from Evolve Bank & Trust.
About Coastal Financial (NASDAQ:CCB)
Coastal Financial Corporation is a bank holding company whose principal subsidiary, Coastal Community Bank, provides a full range of community banking services to clients along North Carolina’s central and eastern coastline. The company focuses on delivering personalized relationship banking to individuals, small businesses, and local professionals in seaside and inland communities.
Through Coastal Community Bank, Coastal Financial offers deposit products including checking, savings, money market accounts and certificates of deposit.
