Coastal Financial Corporation (CCB) Earnings Call Transcript & Summary

Welcome to Coastal Financial Corporation's second quarter 2026 earnings conference call. At this time, all participants have been placed in listen-only mode. Following the prepared remarks portion of this morning's call, the management team will take questions. Before we begin, I would like to point all of you to the disclosure near the end of the company's earnings release for information about any forward-looking statements that may be made or discussed on this call. The earnings release is posted on Coastal's website. Please review the information along with our filings with the SEC for a disclosure of factors that may impact the subjects discussed in this morning's call. The company will also be discussing one or more non-GAAP financial measures. look at the company's investor presentation and website for all of the disclosures required by the SEC, including reconciliations to the most comparable GOP numbers. I would now like to turn the call over to Eric Spring, Chief Executive Officer. Please go ahead.

Thank you and good morning everyone. I'm joined today by Chris Adams, our newly appointed executive chairman, and Brandon Soto, our CFO. This is our first quarterly earnings call. As our company has grown, we believe it is important to provide investors and the broader community with more direct access to management and greater context around our financial performance, go-forward strategy, and key developments across both CC CBX and Coastal Community Bank. We also recognize that this quarter includes significant and unusual items that warrant a direct explanation. We're here to walk through those, detail the nuances, and answer your questions. I'm pleased to announce that effective today, the Board has appointed Chris Adams as the Executive Chair of Coastal Financial Corporation. Chris has served on the board since 2016 and is chair since 2019. As Executive Chair, he will devote additional time to long-term strategy, external engagement, leadership development, as well as a focus on operating leverage and profitability. This does not change management accountability. I will continue to serve as CEO and remain responsible for the company's day-to-day operations, financial performance, risk management, and execution. Today, rather than start with our operating results, it's important that I highlight the items that occurred during the quarter. I'll be very direct and transparent about what it is, what it means, and how we have actively addressed it. This morning we reported a gap net loss of 42.1 million, or a loss of $2.76 per share. her diluted share for the second quarter. That result was driven almost entirely by $68.8 million in pre-tax accounting adjustments associated with a defined CCBX portfolio company and its consumer loan portfolio. The $68.8 million consists of a $46 million valuation adjustment to the related credit enhancement asset and a separate $22.8 million provision for credit losses related to the partner's indemnification agreement. We also recorded a $4.4 million of capitalized software amortization due to shortened useful lives associated with technology modernization. On the partner related item, we regularly assess our relationships on the balance sheet. Portfolio performance, collection information, recovery expectations, and counterparty financial information. As part of this evaluation, we changed our assessment in the second quarter as it relates to a specific non-public company partner and its consumer loan portfolio. In accordance with our prudent framework, we appropriately recognized the exposure and took decisive action. Our focus is on being transparent with you about what directly matters to Coastal, the exposure, the impact on our financial results, and the action we have and will continue to take. We are working with the relevant parties to exercise our contractual rights under the agreement. Most importantly, this is not a read-through to the broader portfolio of partners. our view of the BAS model or our underwriting discipline. Let me be precise about how investors should reconcile the indemnification protection with the $68.8 million charge. The partner remains responsible for losses covered by the indemnification and recording evaluation adjustment does not change or waive those rights. It reflects our current assessment and provisioning. based on the facts available at quarter end. What changed is our assessment. which prompted us to recognize the economic losses today, Even as we continue to pursue the amounts we are entitled to recover, we believe we have taken the necessary steps to identify the potential exposure isolate it and recognize our estimate of the potential loss as of quarter end. We'll continue to provide updates on this specific portfolio as we move forward. As part of this work, we also engaged independent third-party advisors to conduct an external assessment of the partner's loan level data. That review did not identify any evidence of impropriety on part of the partner and the customers. Three important points. First, the affected population is identified and separately monitored. It consists of the defined portfolio of approximately $500 million in underlying loans and the related reimbursement exposure. Second, we reflected our current estimate of the impact in our June 30 financial results. THE ULTIMATE OUTCOME COULD DIFFER FROM THE AMOUNT WE RECOGNIZE TODAY, FAVORABLY IF RECOVERIES AND COLLECTIONS COME IN AHEAD OF OUR CURRENT EXPECTATIONS. or of course unfavorably based on the quarterly CECL review and indemnification asset valuation. Third, we conducted a review of the remaining CCBX portfolio. That review included credit performance, delinquencies, and charge off trends, partner liquidity, cash collateral funding, reimbursement obligations, and individual and aggregate exposure amongst other things. Based on that review, we did not identify a comparable issue within the remaining CCBX portfolio. THE DATA SUPPORTS THIS CONCLUSION AS THE REMAINING CORE CCBX PORTFOLIO WAS APPROXIMATELY $1.7 BILLION AT QUARTER END WITH IMPROVEMENTS IN NET CHARGE OFFS AS WELL AS EARLY AND LATE STAGE DELINQUENCY MEASURES AND ALSO EVERY PARTNER WE REVIEWED WAS CURRENT ON ITS CONTRACTUAL cash collateral funding obligations. This data underscores the defined portfolio matter is not present in the credit and collateral funding trends of the remaining portfolio. We are actively managing the defined portfolio through servicing, collections, recovery, contractual remediations, and an evaluation of all strategic alternatives. Zooming out for a second, the reason we built this framework is so that it would do its job precisely during an event like this. This is consistent operating philosophy that informs us how we run this company. To identify issues, assess them based on the facts in front of us, and take appropriate decisive action. That's what we've done here and will continue to do moving forward. Importantly, we entered this period and remain well capitalized with substantial cash, meaningful contingent liquidity and no short-term borrowings outstanding. Let me move forward and talk about the strengths of the underlying business for a second. Apart from the defined portfolio adjustments and the accelerated software amortization charge, Several positive developments and metrics underscore the strength and momentum of the underlying business during the quarter. ACROSS THE COMMUNITY BANK AND CCBX, THE RESULTS SHOWED THIS HYBRID MODEL WE'VE DELIBERATELY BUILT OVER THE YEARS, A WELL CAPITALIZED, DISCIPLINED COMMUNITY BANK PAIRED WITH A GROWING CAPITAL EFFICIENT BANKING AS A SERVICE PLATFORM us to monetize partner relationships through growing fee income on and off the balance sheet. Supporting a digital banking ecosystem of our scale takes compliance, risk, and operating infrastructure that has been built carefully over years. When we set out to develop our banking as a service platform, we did so with a clear vision about what it would require and to establish an infrastructure like the one we run on today. Our investments and institutional knowledge with learnings over history in this space have put Coastal at the table with some of the best run programs in the country. During the quarter, some individual highlights. Net interest income reached a record 89.4 million, up 16.4% year over year on average. a net interest margin of 7.27, which is stable and slightly improving. We grew loans 9% during the quarter. our CCBX segment continued to build momentum with BAS program fee income of 12 million up approximately 10 quarter from first quarter. 10% GROWTH FROM FIRST QUARTER. OUR OFF-BALANCE SHEET CREDIT CARD PROGRAM NOW INCLUDES APPROXIMATELY 881,000 FEE EARNING ACCOUNTS, AN INCREASE OF 32% FROM FIRST QUARTER. DEBIT CARDS WERE UP 1.5 MILLION OVER THE QUARTER. quarter. Deposit sweep activity continued to expand, creating fee income growth while supporting liquidity and FDIC insurance coverage to the benefit of our consumers. Brandon will give you some updates on the amounts we have swept during the quarter and the increases. These are exactly the kinds of fee generating non-balance sheet activities central to our strategy. growing revenue with balance sheet light, growing with less risk weighted assets going forward. CHRIS WILL DISCUSS BOARD OVERSIGHT, AND I'VE ASKED HIM TO EXPAND ON HIS NEW ROLE AS EXECUTIVE CHAIR. including our go forward focus on capital allocation, operating expenses, and profitability. Brandon will then provide a more detailed review of the quarter.

Chris, I hand it over to you. Thank you, Eric, and good morning. I appreciate the board's confidence in appointing the executive chair. As Eric noted, my increased role will focus on long-term strategy, external engagement, leadership development, operating leverage, and profitability. Eric remains CEO, and I look forward to working alongside him and the rest of the team as the independent directors of the board continue to provide strong and independent oversight. The board has been engaged throughout management's assessment of the defined portfolio. The management team meticulously reviews the portfolios on an ongoing basis and they bring it to the board for it to review the analysis, challenging the assumptions, and consider the accounting and capital implement implications. That's precisely what In this matter, we supported management's decision to recognize the quarter-end estimate in the period in which the assessment changed. Making a decisive action now and being transparent with our shareholders is the behavior that our management team and this board expects. I would make three points to shareholders. First, the board's review was not limited to whether June 30th accounting estimates for just the defined portfolio was supportable. We also asked whether the exposure was separately identified and monitored, and whether the remainder of the CCBX portfolio has been reviewed using the same standards. The board has required enhanced reporting regarding portfolio performance, collections, collateral, remaining exposure, and capital impact, counterparty conditions, and progress on strategic alternatives. We are not treating the June 30th accounting action as the end of the work. Coastal remains well capitalized and highly liquid. As of June 30th, the company's common equity tier one ratio was 10.86%. The tier one leverage ratio was 9.11%. And its total risk-based capital ratio was 13.30%. The quarter's adjustments reduced capital ratios by approximately one percentage point. The company retained approximately $1.01 billion of cash and more than $1.1 billion of additional contingent borrowing capacity, with no short-term borrowing outstanding. The company's capital efficient model, including ongoing loan sales and off balance sheet deposit and card programs, continues to support liquidity and internal capital generation. I've heard my focus is increasingly growing on profitability and operating leverage. COSO has made substantial investments in people, technology, compliance, data, risk management, and ongoing infrastructure. Many of those investments were necessary to support the company's growth and build a durable, regulated platform. The next phase, though, must translate that investment and revenue growth into stronger and more consistent profitability. Management has begun a review of vendor spending, contractor usage, discretionary expenses, organizational duplication, technology priorities, and partner and product level profitability. The objective is not to just cut costs. We'll continue to invest in compliance, credit, audit, cybersecurity, data, and risk management. The objective is to reduce lower value and duplication in spending and direct our people and capital and technology towards activities that are more efficient. that produce appropriate risk-adjusted returns. As we continue to grow, we'll place greater emphasis on the revenue, capital usage, liquidity, operating expenses, and risk-adjusted profitability for each product and relationship. The board continues to have confidence in the long-term value of Coastal's model. Our responsibility is to ensure to translate the company's underlying earnings power into strong operating leverage, lower volatility, and improving shareholder returns. With that, I'm going to turn it over to Brandon to talk through his part of the presentation. Brandon?.

All right, thank you, Chris. I'm going to provide a narrow overview of the quarter. As Eric discussed, Coastal reported a gap net loss of 42.1 million for the second quarter. The quarter included the 22.8 million specific provision and the 46.0 million valuation adjustment associated with the defined portfolio. The underlying quarter included several positive financial trends. Net interest income increased by 6.0 million or 7.2% from the first quarter to a record 89.4 million. Net interest margin increased to 7.27%. Net interest margin after BAS loan expense increased to 3.98% from 3.90%. in the first quarter. Total loans increased 348.9 million, or 9%, to approximately 4.21 billion. Fast program income increased 1.1 million, or 10.3% from the first quarter. We sold approximately 4.56 billion of CCBX loans during the quarter. including ongoing balances generated on previously sold credit card accounts. These sales help manage capital, liquidity, and credit concentrations while allowing Coastal to retain certain processing and transaction economics. Total deposits end of the quarter, approximately 4.86 billion. The decrease from the first quarter primarily reflected increased use of off-balance sheet sweep arrangements and did not reflect a comparable decrease in underlying partner deposit activity. We swept approximately 4.26 billion of deposits off balance sheet at quarter end and generated approximately 1.2 million of sweep income during the quarter. Community bank credit quality remained strong. Annualized community bank net charge offs as a percentage of average loans were approximately 0.01%. Reported non-interest expense was 14.1 million, which included the 46.0 million valuation adjustment and the 4.4 million. software charge. Beyond those identified items, we remain focused on managing the expense base more effectively. That includes technology spending, vendor and contractor costs, organizational efficiency, and ensuring that expenses are tied to revenue, measurable efficiencies, or appropriate risk-adjusted returns. It is also important to understand how the reserve affects future reporting. The $22.8 million provision increased the allowance available to absorb the future related credit losses. The $46.0 million valuation adjustment reduced the carrying value of the related credit enhancement asset. Finally, the company and the bank remained well capitalized after the quarter's adjustments, and our liquidity position remained strong.

I'll turn it over to Eric for the conclusion. Thank you both, Chris and Brandon. Before I close, I do want to recognize Brandon, who, as we announced last week, will be departing to take on the CEO role of another financial institution that is not a competitor or current partner of ours. Brandon has brought invaluable insights since joining us last September. He deserves this opportunity, and I and our company are very excited for him. At Coastal, our long-time CFO, Joel Edwards, who has been serving as an advisor since his retirement last year, will return as interim CFO while we conduct a search for our next permanent CFO. Joel brings deep familiarity. and continuity to our team. I'll close this with where I began. We took a significant accounting impact in the quarter, and we are not minimizing it. The current estimate of the defined portfolio has been reflected in the June 30 financial results, and we are actively managing the relationship. As we mentioned, we and the board separately reviewed the remaining CCBX portfolio and did not identify a comparable issue as of quarter end. Underneath this defined portfolio matter is a strong and well-capitalized core business. Excluding the credit expense and software charge, we delivered record net interest income, stable to increasing net interest margin, continued loan growth, increased BAS program fee income, significant growth in off-balance sheet fee income generating activity, stable deposit cost, and strong community bank credit performance. We're focused on continuing to strengthen partner monitoring and partner and portfolio oversight, improving the economics of balance sheet usage. growing capital-efficient fee income, and taking a more direct approach to operating expenses and operating leverage. At this time, we're also making the announcement that we are no longer actively pursuing the acquisition of assets and deposits from Evolve Bank and Trust. Chris's appointment as executive chair adds additional time and resources and attention to strategy, profitability, and leadership. We remain all about a balanced approach to discipline and sustainable growth. We will continue thoughtfully expanding our products and investing in the risk management and technology capabilities that make this platform doable. Our operating momentum, capital, and liquidity position, increased focus on profitability, leaves us confident in our ability to execute and create long-term value for shareholders. With that said, we'll end the prepared marks and open it for question and answers from the analyst. Please proceed.

Thank you. We will now begin the question and answer session. If you have dialed in and would like to ask a question, please press star 1 on your telephone keypad to raise your hand and join the queue. If you would like to re-draw your question, simply press star 1 again. If you are called upon to ask your question and are listening via speakerphone in your device, please pick up your handset to ensure that your phone is not on mute when asking your question. Again, press star 1 to join the queue. And our first question comes from the line of Andrew Terrell with Stephens Inc. Your line is open.

Hey, good morning. Good morning, Andrew. Good morning. Maybe I could start just on the core expenses. If I back out the valuation adjustment and the amortization as well as the typical kind of fast loan. It looks like you're at around 46 million or so of core operating expenses quarter, up double digits sequentially, 22% year on year. I think the sense was this year you'd be able to maybe right-size expenses a bit or at least keep growth in check, which doesn't seem to be the case this quarter. I'm curious, when you look out to the back half of the year, what are you doing to keep expense growth contained from here? Is there potential to moderate right-size the expense space at all, just to improve profitability. Yes, we can just start there.

Yes. So I think you can tell from our prepared remarks we did highlight four or five times that expense uh... growth and making sure that we're focused on profitability is going to be a top priority of of this bank going forward and uh... You know, I'll ask Chris to intercede here a little bit. I know that's one of the directives the board has asked him to do.

You're exactly right, Eric. So to be clear, and I obviously talked about it in the remarks, but operating, leverage, profitability, huge focus of the board. That's what I'm going to come in and work on. We have – we've got great people. We spend a lot of money on technology, building out the platform that we have. We are certainly going to focus on getting the efficiency. out of what we've put into the company right now. We've got a really good, talented group of people, and we're going to be able to get a lot more out of it as we make the next steps in our growth pattern.

Okay, and then maybe while just on the topic, Chris, Can you talk about just either efficiency or profitability expectations that you're kind of working towards currently?.

Yes, and Andrew, I'll intervene here real quick. Nothing has changed in our approach to communications with outside parties. We don't give pro formas. We don't give estimates. and we're unable to give guidance. So at this time, I think what we'd like to reinforce is our comments in the opening piece and Chris's comments that this is going to be one of the top priorities of the bank going forward.

Okay, fair enough. If I could move over just to the, you know, some of the reactions this quarter. I guess just, you know, I heard all the prepared remarks. I'm hoping to get some more comfort on why this is, you know, a one-off situation. You know, I understand, you know, you've conducted what sounds like a pretty thorough review of, you know, all the other partners, but, you know, I'm assuming you've pretty actively monitored this partner as well. What's unique about this situation? What's different about the collateral underlying the $500 million loan pool here? I guess just what's different at this partner or this loan pool versus others that should give us incremental comfort that this isn't something that could happen again?.

Yes, so, you know, our assessment changed for this one partner based on a combination of factors that we monitor continuously across every partner relationship. portfolio performance, collection results, recovery experience, the partner's own financial condition For this specific relationship, that combination of signals moved such that, you know, under the current credit protection framework, we concluded we needed to recognize that exposure with actions taken today. You know, we can't disclose specific partner financial information, but What we can say to you is we reviewed the rest of the CCBX books against the same standards and did not see a comparable pattern, which tells us this isn't a read-through to the consumer credit trends broadly or the rest of the partners' standards. We do monitor this continuously. We're going to continue as we have always been to be a learning organization. And we are applying the lessons we learned from this matter across all relevant exposures to ensure we remain disciplined. And right now we don't see this as a read through to the rest of the portfolio.

Okay, thanks. And then were these credit card loans or support.

THE 500 MILLION IS A MIX OF and I want to be careful that we don't give too many specifics that it could in turn identify the partner. So I'll just leave it at that. Okay, thanks for taking the questions. I'll step back. Thank you, Andrew.

Our next question comes from the line of Joe Yanchunis with Raymond James. Your line is open.

Hey, thank you for taking my questions. Wanted to kind of piggyback off some of Andrew's questions. So you emphasized a greater focus on, you know, operating leverage and profitability. Does that change your approach to partner growth? And should we expect you to be more selective in adding new partners going forward?.

Joe, well, first off, thanks for being on the call. Good to talk to you, and thanks for asking the questions. No, let me answer the question. We are going to focus on profitability, operational efficiency, leveraging this platform that we've built. So I want to make that abundantly clear. With that said, the board is absolutely committed to this growth business and banking as a service. We think we're at a very unique inflection point in society with digital adoption, more brands getting into delivering financial services, and we think we are expertly positioned to continue to do this. So CCBX and the business strategy remains strong. This is related to one out of more than 25 partnerships and should not be extrapolated. BAS is an important part of our strategy, but we are focused on discipline, risk-adjusted growth. This event reinforces the importance of continuous monitoring and making sure our parameters are defined in advance and that we're picking the right partners. But we absolutely believe this platform still has long-term potential, and we are going to be deliberate in how we onboard and scale partnerships, but we're excited about this platform going forward.

Okay, that's helpful. And just kind of going back to this problem partner. What's the expected timeline for resolving the situation? Should we think in terms of quarters or, you know, potentially years before this portfolio is worked through?.

THE BOARD IS REVIEWING ALL ALTERNATIVES AND ALL REMEDIATIONS AND THE PARTNER IS exploring all of their options still the the partner engaged We're hopeful, but accounting-wise we can't rely on hope, but they are well-established and are exploring opportunities themselves as well as us. And so there could be a wide gap between remediation and potential outcomes that could be anywhere from one to two quarters to 12 to 18 months. based upon the continued evolution of the relationship and how everything pans out.

Okay, and has this event changed the appetite of potential buyers of your paper to purchase these loans? I mean, have you seen any change in pricing due diligence or buyer demand since identifying the issue?.

I would say we were very successful in the first quarter. working with our partners on loan sales, credit card receivable sales, and the market continues, in my opinion, to be vibrant. The capital markets in talking to some outside providers, including last week, said that the markets are still open. We will continue to look at all strategies, including the sales network, but right now, We believe that the secondary markets are performing. We have seen some tightening on pricing for risk-based spread premiums across the board. But nothing that's deterring the framework and the markets from working.