-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BZ5ReUCO6U6r0ZnimGjgos6PDm9RMMmfkJEb/sp02k4rZsccVqTGCAiOAJK52upW yDpX663X/Ja41SyLivvjlQ== 0000914317-03-003765.txt : 20031222 0000914317-03-003765.hdr.sgml : 20031222 20031222110011 ACCESSION NUMBER: 0000914317-03-003765 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 14 CONFORMED PERIOD OF REPORT: 20031215 FILED AS OF DATE: 20031222 FILER: COMPANY DATA: COMPANY CONFORMED NAME: COASTAL FINANCIAL CORP /DE CENTRAL INDEX KEY: 0000935930 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 570925911 STATE OF INCORPORATION: DE FISCAL YEAR END: 630 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 333-01274 FILM NUMBER: 031066725 BUSINESS ADDRESS: STREET 1: 2619 NORTH OAK CITY: MYRTLE BEACH STATE: SC ZIP: 29577-3129 BUSINESS PHONE: 8434485151 10-K 1 form10k55779coast.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------- FORM 10-K |X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended September 30, 2003 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-19684 COASTAL FINANCIAL CORPORATION ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 57-0925911 - --------------------------------------------- ---------------------- (State or other jurisdiction of incorporation (I.R.S. Employer I.D.) or organization) 2619 Oak Street, Myrtle Beach, South Carolina 29577-3129 - --------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (843) 205-2000 -------------- Securities registered pursuant to Section 12(b) of the Act: None ---- Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share -------------------------------------- (Title of Class) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |X| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act. YES |X| NO |_|. The aggregate market value of the voting and non-voting common equity held by non affiliates of the registrant, based upon the closing sales price of the registrant's common stock as quoted on the NASDAQ System under the symbol "CFCP" as of the last business day of the registrant's most recently completed second fiscal quarter, was $125,703,910 (12,879,499) shares at $9.76 per share. It is assumed for purposes of this calculation that none of the registrant's officers, directors and 5% stockholders are affiliates. As of December 18, 2003, there were issued and outstanding 12,960,874 shares of the registrant's Common Stock. 1 DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Annual Report to Stockholders for the Fiscal Year Ended September 30, 2003 (Parts I and II) 2. Portions of the Proxy Statement for the 2004 Annual Meeting of Stockholders. (Part III) 2 PART I Item 1. Business General Coastal Financial Corporation ("Coastal Financial" or the "Corporation") was incorporated in the State of Delaware in June 1990, for the purpose of becoming a savings and loan holding company for Coastal Federal Bank, formerly named Coastal Federal Savings Bank, ("Coastal Federal" or the "Bank"). On January 28, 1991, the stockholders of the Bank approved a plan to reorganize the Bank into the holding company form of ownership. The reorganization was completed on November 6, 1991, on which date the Bank became the wholly owned subsidiary of the Corporation, and the stockholders of the Bank became stockholders of the Corporation. Prior to completion of the reorganization, the Corporation had no material assets or liabilities and engaged in no business activities. On April 1, 1993, Coastal Federal's investment in Coastal Investor Services, Inc., formerly named Coastal Investment Services, Inc., was transferred to Coastal Financial and became a first tier subsidiary of the Corporation. The financial results contained herein relate primarily to the Corporation's principal subsidiary, Coastal Federal. Coastal Federal was organized in 1953 as a mutual savings and loan association and, since that time, its deposits have been federally insured. In March 1989, Coastal Federal converted from a federally chartered mutual savings and loan association to a federally chartered mutual savings bank. On October 4, 1990, Coastal Federal converted to the stock form of ownership ("Conversion") through the sale and issuance of 492,541 shares of common stock at a price of $10.00 per share, which resulted in gross proceeds to Coastal Federal of $4,925,410. Coastal Federal conducts its business from its main office in Myrtle Beach, South Carolina, thirteen branch offices located in South Carolina, one branch office located in Sunset Beach, North Carolina, one branch office in Southport, North Carolina, one branch office in Shallotte, North Carolina and two branch offices located in Wilmington, North Carolina. At September 30, 2003 Coastal Financial had total assets of $1.2 billion, total deposits of $697.0 million and stockholders' equity of $73.7 million. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation ("FDIC") under the Savings Association Insurance Fund ("SAIF"). The corporate offices of the Bank are located at 2619 Oak Street, Myrtle Beach, South Carolina and the telephone number is (843) 205-2000. Twelve of Coastal Federal's nineteen offices are in Horry County, South Carolina and one office is in Georgetown County, South Carolina. The economy of the Horry County area depends primarily on tourism. To the extent Horry County area businesses rely heavily on tourism for business, decreased tourism would have a significant adverse effect on Coastal Federal's primary deposit base and lending area. Moreover, Coastal Federal would likely experience a higher degree of loan delinquencies should the local economy be materially and adversely affected. 3 Coastal Federal's principal business currently consists of attracting deposits from the general public and using these funds to originate consumer, commercial business loans, commercial real estate loans and residential mortgage loans. Commercial real estate loans were 36.2% of total loans at September 30, 2003. As part of its lending strategy, subject to market conditions, management intends to continue emphasizing the origination of consumer and commercial business loans in addition to residential mortgage loans. At September 30, 2003, 3.4% and 6.9% respectively, of the Bank's total loan portfolio consisted of commercial business and consumer loans. The Company maintains an Internet website at http://www.coastalfederal.com. ------------------------------ The Company makes available its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended, and other information related to the Company, free of charge, on this site as soon as reasonably practicable after it electronically files those documents with, or otherwise furnish them to, the SEC. The Company's Internet website and the information contained therein or connected thereto are not intended to be incorporated into this annual report on Form 10-K. 4 Rate/Volume Analysis The following table sets forth certain information regarding changes to interest income and interest expense of the Corporation for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributed to (i) changes in rate (changes in rate multiplied by old volume); (ii) changes in volume (changes in volume multiplied by old rate), (iii) changes in rate-volume (change in rate multiplied by change in volume), and (iv) the net change (the sum of the prior columns). Non-accrual loans are included in the average volume calculations.
Year Ended September 30, -------------------------------------------------------------------------------------- 2001 Compared to 2000 2002 Compared to 2001 Increase (Decrease) Increase (Decrease) Due to Due to ----------------------------------------- ----------------------------------------- Rate Volume Rate/ Net Rate Volume Rate/ Net ---- ------ ----- --- ---- ------ ----- --- Volume Volume -------- -------- -------- -------- -------- -------- -------- -------- (Dollars in thousands) Interest-Earning Assets: Loans ................. $ 286 $ 1,597 $ 10 $ 1,893 $ (6,372) $ 852 $ (118) $ (5,638) Mortgage-backed Securities/Investments (691) 1,024 (50) 283 (1,943) 1,386 (187) (744) -------- -------- -------- -------- -------- -------- -------- -------- Total net change in income on interest- earning assets ........ (405) 2,621 (40) 2,176 (8,315) 2,238 (305) (6,382) -------- -------- -------- -------- -------- -------- -------- -------- Interest-Bearing Liabilities: Deposits .............. 135 3,435 40 3,610 (7,799) 3,629 (1,460) (5,630) FHLB advances ......... (380) 662 (23) 259 (1,486) (2,268) 303 (3,451) Repurchase Agreements .......... (766) (3,837) 420 (4,183) (1,811) (1,645) 1,060 (2,396) -------- -------- -------- -------- -------- -------- -------- -------- Total net change in expense on interest- bearing liabilities ... (1,011) 260 437 (314) (11,096) (284) (97) (11,477) -------- -------- -------- -------- -------- -------- -------- -------- Net change in net Interest income ....... $ 606 $ 2,361 $ (477) $ 2,490 $ 2,781 $ 2,522 $ (208) $ 5,095 ======== ======== ======== ======== ======== ======== ======== ======== Year Ended September 30, ---------------------------------------- 2003 Compared to 2002 Increase (Decrease) Due to ---------------------------------------- Rate Volume Rate/ Net ---- ------ ----- --- Volume -------- -------- -------- -------- (Dollars in thousands) Interest-Earning Assets: Loans ................. $ (4,869) $ 7,469 $ (903) $ 1,697 Mortgage-backed Securities/Investments (2,695) 7,903 (1,564) 3,644 -------- -------- -------- -------- Total net change in income on interest- earning assets ........ (7,564) 15,372 (2,467) 5,341 -------- -------- -------- -------- Interest-Bearing Liabilities: Deposits .............. (3,487) 2,333 (597) (1,751) FHLB advances ......... (1,271) 3,184 (527) 1,386 Repurchase Agreements .......... (4) 1,534 (13) 1,517 -------- -------- -------- -------- Total net change in expense on interest- bearing liabilities ... (4,762) 7,051 (1,137) 1,152 -------- -------- -------- -------- Net change in net Interest income ....... $ (2,802) $ 8,321 $ (1,330) $ 4,189 ======== ======== ======== ========
5 Average Balance Sheet The following table sets forth certain information relating to the Corporation's average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are derived from month-end balances. Management does not believe that the use of month-end balances instead of daily average balances has caused any material difference in the information presented. Non-accrual loans are included in average balance calculations.
Year Ended September 30, ------------------------------------------------------------------------------------------ 2001 2002 2003 -------- -------- -------- -------- -------- -------- -------- -------- -------- Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate ------- -------- ---- ------- -------- ---- ------- -------- ---- (Dollars in thousands) ASSETS Loans ........................ $521,575 $ 45,899 8.80% $531,257 $ 40,261 7.58% $629,817 $ 41,958 6.67% Mortgage-backed Securities/Investments(1) .. 206,367 14,356 6.95 226,295 13,612 6.02 357,680 17,256 4.81 -------- -------- -------- -------- -------- -------- -------- -------- -------- Total interest-earning assets ....................... $727,942 $ 60,255 8.26% $757,552 $ 53,873 7.11% $987,497 $ 59,214 6.00% ======== ======== ======== ======== ======== ======== ======== ======== ======== LIABILITIES Transaction accounts ......... 250,784 7,404 2.95 309,624 4,524 1.46 369,871 3,925 1.06 Passbook accounts ............ 34,071 741 2.17 36,870 459 1.24 40,913 427 1.04 Certificate accounts ......... 194,575 11,235 5.77 222,723 8,767 3.94 258,355 7,647 2.96 FHLB advances ................ 188,666 11,133 5.90 150,239 7,682 5.11 212,501 9,068 4.27 Securities sold under repurchase agreements ...... 49,891 2,810 5.63 20,676 414 2.00 97,288 1,931 1.98 -------- -------- -------- -------- -------- -------- -------- -------- -------- Total interest-bearing liabilities .................. $717,987 $ 33,323 4.64% $740,132 $ 21,846 2.95% $978,928 $ 22,998 2.35% ======== ======== ======== ======== ======== ======== ======== ======== ======== Net interest income/ interest rate spread ......... $ 26,932 3.62% $ 32,027 4.16% $ 36,216 3.65% Net yield on interest earning assets ....................... 3.70% 4.23% 3.67% Ratio of interest earning assets to interest-bearing liabilities .................. 1.01x 1.02x 1.01x
- ----------------- (1) Includes short-term interest-bearing deposits and Federal funds sold. 6 Lending Activities General. The principal lending activities of Coastal Federal are the origination of consumer loans, commercial business loans, commercial real estate loans and residential mortgage loans. The Bank originates construction and permanent loans on single family and multi-unit dwellings, as well as on commercial structures. The Bank emphasizes the origination of adjustable rate residential and commercial real estate mortgages. The Bank's loan portfolio totaled approximately $701.8 million at September 30, 2003, representing approximately 59.4% of its total assets. On that date, approximately 42.4% of Coastal Federal's total loan portfolio was secured by mortgages on one-to-four family residential properties. In an effort to ensure that the yields on its loan portfolio and investments are interest-rate sensitive, the Bank has implemented a number of measures, including: (i) emphasis on origination of adjustable rate mortgages on residential and commercial properties; (ii) origination of construction loans secured by residential properties, generally with terms for a one-year period or less; and (iii) origination of commercial and consumer loans having either adjustable rates or relatively short maturities. At September 30, 2003, adjustable rate loans constituted approximately $506.7 million (or 72.2%) of the Bank's total loan portfolio. Therefore, at such date, fixed rate loans comprised only 27.8% of the total loan portfolio. These lending practices were adopted to shorten the term of the Bank's assets and make the loan portfolio more responsive to interest rate volatility. 7 Loan Portfolio Analysis The following table set forth the composition of the Corporation's loan portfolio by type of loan as of the dates indicated.
At September 30, ------------------------------------------------------------------------------------ 1999 2000 2001 2002 ------------------ ------------------ ------------------ ------------------ Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- (Dollars in thousands) Mortgage loans: Construction ................ $ 46,766 9.48% $ 54,905 10.13% $ 60,765 11.56% $ 45,544 7.99% Single family to 4 family units .................... . 265,069 53.73 283,851 52.39 268,670 51.10 261,296 45.88 Income property (Commercial). 114,931 23.29 133,569 24.65 137,282 26.11 202,117 35.49 Commercial business loans ..... 22,818 4.62 23,357 4.31 18,886 3.59 18,377 3.23 Consumer loans: Mobile home ................. 1,166 0.24 1,374 0.25 2,056 0.39 3,446 0.61 Automobiles ................. 6,809 1.38 7,789 1.44 6,599 1.26 7,117 1.25 Equity lines of credit ...... 21,081 4.27 23,009 4.25 22,379 4.26 24,273 4.26 Other ....................... 14,738 2.99 13,915 2.58 9,161 1.73 7,378 1.29 --------- ------ --------- ------ --------- ------ --------- ------ Total loans and loans held for sale .............. $ 493,378 100.00% $ 541,769 100.00% $ 525,798 100.00% $ 569,548 100.00% ====== ====== ====== ====== Less: Loans in process ............ (15,315) (13,329) (13,983) (6,365) Deferred loan costs, net .... 354 519 372 245 Allowance for loan losses ... (6,430) (7,064) (7,159) (7,883) --------- --------- --------- --------- Total loans and loans held for sale, net ............. $ 471,987 $ 521,895 $ 505,028 $ 555,545 ========= ========= ========= ========= 2003 --------------------- Amount Percent ------ ------- (Dollars in thousands) Mortgage loans: Construction ................ $ 81,227 11.16% Single family to 4 family units ..................... 308,293 42.37 Income property (Commercial) 263,688 36.24 Commercial business loans ..... 24,475 3.36 Consumer loans: Mobile home ................. 4,607 .63 Automobiles ................. 8,516 1.17 Equity lines of credit ...... 26,639 3.66 Other ....................... 10,234 1.41 --------- ------ Total loans and loans held for sale ............. $ 727,679 100.00% ====== Less: Loans in process ............ (16,570) Deferred loan costs, net .... 556 Allowance for loan losses ... (9,832) --------- Total loans and loans held for sale, net ............ $ 701,833 =========
8 Commercial Business Loans. The Bank is permitted under OTS regulations to make secured or unsecured loans for commercial, corporate, business or agricultural purposes, including the issuance of letters of credit secured by real estate, business equipment, inventories, accounts receivable and cash equivalents. The aggregate amount of such loans outstanding may not exceed 20% of such institution's assets. Coastal Federal has been making commercial business loans since 1983 on both a secured and unsecured basis with terms that generally do not exceed one year. The majority of these loans have interest rates that adjust with changes in the prime rate as published in The Wall Street Journal. The Bank's non-real ----------------------- estate commercial loans primarily consist of short-term loans for working capital purposes, seasonal loans and lines of credit. The Bank customarily requires a personal guaranty of payment by the principals of any borrowing entity and reviews the financial statements and income tax returns of the guarantors. At September 30, 2003, the Bank had $24.5 million outstanding in commercial business loans, which represented approximately 3.4% of its loan portfolio. Commercial business lending is inherently riskier than secured mortgage lending and involves risks that are different from those associated with residential and commercial real estate lending. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of such collateral in the event of a borrower default is often not a sufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete, of limited use, or have limited marketability, among other things. Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and potentially insufficient source of repayment. Commercial Real Estate Loans. The Bank may invest, by OTS regulation, in non-residential real estate loans up to 400% of its capital as computed under GAAP plus general loan loss reserves. At September 30, 2003, this limited Coastal Federal's aggregate non-residential real estate loans to approximately $361.2 million. At such date, the Bank had non-residential real estate loans outstanding of $263.7 million compared to $202.1 million at September 30, 2002. During fiscal 2000 through 2003, the Bank opened eight offices. The Bank hired commercial lending officers to lead many of these offices and intends to have commercial lending officers leading a majority of its banking offices. As a result of this focus, the Bank has approximately doubled the number of its commercial lending officers over the last two years. The Bank expects to continue to focus significant origination efforts in commercial real estate and commercial lending. It is expected that the Bank's commercial real estate loans will continue to comprise the most significant portion of the Bank's loan growth in future years. 9 The commercial real estate loans originated by the Bank are primarily secured by shopping centers, office buildings, warehouse facilities, retail outlets, hotels, motels and multi-family apartment buildings. The interest rate of the commercial real estate loans presently offered by the Bank generally adjusts every one, three or five years and is indexed to U.S. Treasury securities or adjusts monthly indexed to the prime interest rate. Such loans generally have a fifteen to twenty year term, with the payments based on a similar amortization schedule. In many cases, the Bank may require the loan to include a call option at the Bank's option in three to ten years. The Bank generally requires that such loans have a minimum debt service coverage of 120% of projected net operating income together with other generally accepted underwriting criteria. Commercial real estate lending entails significant additional risks compared to residential lending. Commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. The payment experience of such loans is typically dependent upon the successful operation of the real estate project. These risks can be significantly affected by supply and demand conditions in the market for office and retail space and for apartments and, as such, may be subject, to a greater extent, to adverse conditions in the economy. In dealing with these risk factors, Coastal Federal generally limits itself to a real estate market or to borrowers with which it has experience. The Bank concentrates on originating commercial real estate loans secured by properties located within its market areas of Horry and Georgetown Counties, South Carolina and Brunswick and New Hanover Counties, North Carolina. Additionally, the Bank has, on a limited basis, originated commercial real estate loans secured by properties located in other parts of North and South Carolina. Consumer Loans. The Bank is permitted by OTS regulations to invest up to 35% of its assets in consumer loans. The Bank currently offers a wide variety of consumer loans on a secured and unsecured basis including home improvement loans, loans secured by savings accounts and automobile, truck and boat loans. The Bank also offers a revolving line of credit secured by owner-occupied real estate. Total consumer loans, including equity lines of credit generally secured by one-to-four family residences, amounted to $50.0 million, or 6.9% of the total loan portfolio, at September 30, 2003. Coastal Federal offers consumer loans in order to provide a wider range of financial services to its customers. These loans also have a shorter term and normally higher interest rates than residential real estate loans. 10 Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by assets which may depreciate rapidly, such as automobiles, boats and other moving vehicles. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower's continuing financial stability and, thus, are more likely to be adversely affected by job loss, a change in family status such as divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount recoverable on such loans. Such loans may also give rise to claims and defenses by the borrower against Coastal Federal as the holder of the loan, and a borrower may be able to assert claims and defenses which it has against the seller of the underlying collateral. Residential Mortgage Loans. The Bank originates loans to enable borrowers to purchase existing homes or residential lots, refinance existing mortgage loans or construct new homes. Residential mortgage loans originated by the Bank are generally long-term loans, amortized on a monthly basis, with principal and interest due each month. The contractual loan payment period for residential mortgage loans typically ranges from 10 to 30 years. The Bank's experience indicates that real estate loans remain outstanding for significantly shorter periods than their contractual terms. Borrowers may refinance or prepay loans at their option, subject to any prepayment penalty provisions included in the note. The Bank generally requires mortgage title insurance on all single family first mortgage and residential mortgage loans. The Bank offers adjustable rate residential mortgage loans ("ARMs"), the interest rates of which generally adjust based upon either the prime rate or treasury securities indices. Although Coastal Federal's ARMs are beneficial in helping Coastal Federal improve the interest rate sensitivity of its assets, such loans may pose potential additional risks to Coastal Federal. A precipitous increase in interest rates could be expected to result in an increase in delinquencies or defaults on such loans. Whereas a significant decrease in rates could cause repayments to increase significantly. Coastal Federal also offers residential mortgage loans with fixed rates of interest. These loans generally can be sold in the secondary market or are portfolio loans where the Bank offers such loans at rates somewhat above conforming loan rates. Loans sold to correspondents amounted to $1.6 million and $1.5 million, respectively, in fiscal 2002 and 2003. Coastal Federal sold approximately $12.3 million and $43.9 million, respectively, of mortgages in 2002 and 2003 to FHLMC. In addition, Coastal Federal securitized loans into FHLMC mortgage-backed securities of $84.0 million and $95.6 million in 2002 and 2003, respectively. The securitized mortgage-backed securities were generally sold in the secondary market within a few days of securitization. 11 At September 30, 2003, approximately $308.3 million or 42.4% of the Bank's loan portfolio consisted of one-to-four family residential loans. Construction Loans. The Bank originates residential construction loans that generally have a term of six to twelve months for individuals or one year for builders. The individual's loans are generally tied to a commitment by the Bank to provide permanent financing upon completion of construction. The interest rate charged on construction loans is indexed to the prime rate as published in The Wall Street Journal or the current permanent loan rate and varies depending on the terms of the loan and the loan amount. The Bank customarily requires personal guaranties of payment from the principals of the borrowing entities. The interest rate on commercial real estate construction loans presently offered by the Bank is generally indexed to the prime rate as published in The --- Wall Street Journal. Both residential and commercial real estate construction - ------------------- financing generally expose the Bank to a greater risk of loss than long-term financing on improved, occupied real estate, due in part to the fact that the loans are underwritten on projected, rather than historical, income and rental results. The Bank's risk of loss on such loans generally depends largely upon the accuracy of the initial appraisal of the property's value at completion of construction and the estimated cost (including interest) of completion. If either estimate proves to have been inaccurate and the borrower is unable to provide additional funds pursuant to his guaranty, the lender either may be required to advance funds beyond the amount originally committed to permit completion of the development and/or be confronted at the maturity of the loan with a project whose value is insufficient to assure full repayment. Coastal Federal generally provides a permanent financing commitment on residential and commercial properties at the time the Bank provides the construction financing. The Bank's underwriting criteria are designed to evaluate and to minimize the risks of each residential and commercial real estate construction loan. The Bank considers evidence of the financial stability and reputation of both the borrower and the contractor, the amount of the borrower's cash equity in the project, independent evaluation and review of the building costs, local market conditions, pre-construction sale and leasing information based upon evaluation of similar projects and the borrower's cash flow projections upon completion. The Bank generally requires personal guaranties of payment by the principals of any borrowing entity. 12 At September 30, 2003, approximately $81.2 million or 11.2% of the Bank's gross loan portfolio consisted of construction loans on both residential ($27.5 million) and commercial properties ($53.7 million). Undisbursed proceeds on these loans amounted to $16.6 million at September 30, 2003. 13 Loan Maturity The following table sets forth certain information at September 30, 2003 regarding the dollar amount of loans maturing in the Company's loan portfolio based on their contractual terms to maturity including scheduled payments and potential prepayments. Prepayment estimates used are based on the OTS NPV Model prepayment functions. Specific prepayment speeds applied to loans are a function of their underlying coupons, lifetime rate caps and maturities. Demand loans (without a stated maturity), loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less. More than One Year One Year Through More than or Less Five Years Five Years Totals ------- ---------- ---------- ------ (In thousands) First mortgage loans ....... $ 230,573 $ 165,875 $ 79,293 $ 475,741 Other residential and non-residential ......... 48,054 91,878 22,957 162,889 Equity lines of credit ..... 24,123 1,987 633 26,743 Consumer loans ............. 9,012 13,968 107 23,087 Commercial loans ........... 6,629 16,020 -- 22,649 ---------- ---------- ---------- ---------- Total loans ........... $ 318,391 $ 289,728 $ 102,990 $ 711,109 ========== ========== ========== Less: Deferred loan costs, net .. 556 Allowance for loan losses . (9,832) ---------- Total loans, net ...... $ 701,833 ========== The following table sets forth the dollar amount of all loans expected to be repaid after one year at September 30, 2003 which have fixed interest rates and those which have floating or adjustable interest rates. Fixed Floating or Rates Adjustable Rates Totals ----- ---------------- ------ (In thousands) First mortgage loans ........ $ 81,268 $163,900 $245,168 Other residential and non-residential ........... 21,239 93,596 114,835 Equity lines of credit ...... 341 2,279 2,620 Consumer loans .............. 9,218 4,857 14,075 Commercial loans ............ 8,416 7,604 16,020 -------- -------- -------- Total loans ................ $120,482 $272,236 $392,718 ======== ======== ======== 14 Loan Solicitation and Processing. The Bank actively solicits mortgage loan applications from the Communities it serves. Detailed loan applications are obtained to determine the borrower's ability to repay, and the more significant items on these applications are verified through the use of credit reports, financial statements and confirmations through verification forms. After analysis of the loan application and property or collateral involved, including an appraisal of the property by independent appraisers approved by the Bank's Board of Directors and reviewed by the Bank's underwriter, or Credit Administration Group, a lending decision is made by the Bank. With respect to commercial loans, the Bank also reviews the capital adequacy of the business, the ability of the borrower to repay the loan and honor its other obligations and general economic and industry conditions. All loan applications over $1 million require the approval by a member or members, depending on loan size, of the Bank's Internal Loan Committee, Director Gerald and Executive Vice Presidents Rexroad and Stalvey. All loan applications greater than $2.5 million require the approval of the Bank's Loan Committee that consists of Directors Clemmons, Gerald, Thompson and Executive Vice Presidents Rexroad and Stalvey. All residential mortgage loan applications in excess of 80% of the lesser of appraised value or purchase price of the property, unless the borrowers have private mortgage insurance, generally must be approved by a member of the Bank's Internal Loan Committee. The Bank's general policy is to obtain a title insurance policy insuring that the Bank has a valid lien on the mortgaged real estate and that the property is free of encumbrances. Borrowers must also obtain paid hazard insurance policies prior to closing and, when the property is in a flood plain as designated by the Federal Emergency Management Agency, obtain paid flood insurance policies. It is the policy of Coastal Federal to require flood insurance for the full insurable value of the improvements for any such loan located in a designated flood hazard area. Borrowers on residential mortgage loans which exceed 80% of the value of the security property are also required to advance funds on a monthly basis, with each payment of principal and interest, to a mortgage escrow account from which the Bank makes disbursements for items such as real estate taxes, hazard insurance premiums and private mortgage insurance premiums. In cases of flood insurance, it is the Bank's policy to generally require escrow on these premiums regardless of the loan-to-value ratio. Residential Mortgage Loan Originations, Purchases and Sales. The Bank is qualified to service loans for FHLMC and FNMA. Depending upon interest rates and economic conditions, the Bank has sold loans in order to provide additional funds for lending, to generate servicing fee income, and to decrease the amount of its long-term, fixed rate loans in order to minimize the gap between the maturities of its interest-earning assets and interest-bearing liabilities. The Bank generally continues to collect payments on the loans, to supervise foreclosure proceedings, if necessary, and to otherwise service the loans. The Bank retains a portion of the interest paid by the borrower on the loans as consideration for its servicing activities. At September 30, 2003, the Bank was servicing loans sold to others with a principal balance of approximately $219.8 million. Sales of whole loans and participation interests by the Bank are made without right of recourse to the Bank by the buyer of the loans in the event of default by the borrower. At September 30, 2003, the Bank's consolidated loan portfolio included purchased loans of approximately $5.8 million, which have been primarily secured by single family residences and which have been written as adjustable rate mortgage loan instruments. These loans are generally secured by properties located in the Southeast and were purchased according to the Bank's non-conforming mortgage loan underwriting standards. 15 Loans Originated, Purchased and Sold The following table shows total loans originated, purchased, sold and repaid during the periods indicated.
Year Ended September 30, --------------------------------------------- 2001 2002 2003 --------- --------- --------- (In thousands) Loans receivable, net, at the beginning of the period ........................ $ 521,895 $ 505,028 $ 555,545 --------- --------- --------- Loans originated: Construction .......................... 66,769 100,717 134,036 Residential ........................... 106,043 192,095 483,352 Nonresidential & commercial business .. 83,463 67,951 74,472 Land .................................. 23,665 43,819 62,011 Consumer .............................. 16,134 13,626 15,705 --------- --------- --------- Total loans originated .......... 296,074 418,208 769,576 --------- --------- --------- Loans purchased, primarily single family residential mortgages .............. 20 233 0 --------- --------- --------- Loans sold ................................ (28,541) (13,907) (45,367) --------- --------- --------- Loan principal repayment and other ........ (233,653) (268,120) (477,676) --------- --------- --------- Securitization of mortgage loans .......... (47,157) (83,982) (95,635) Other ..................................... (3,610) (1,915) (4,610) --------- --------- --------- Loans receivable, net, at end of period ... $ 505,028 $ 555,545 $ 701,833 ========= ========= =========
17 Loan Commitments. The Bank, upon the submission of a loan application, generally provides a 45-day written commitment as to the interest rate applicable to such loan. If the loan has not been closed within 45 days, the rate may be adjusted to reflect current market conditions at the Bank's option. Loans which require closing time in excess of 45 days from the date of application are issued a written commitment, with a term ranging from three to six months. For fixed rate loans, the Bank either charges a higher interest rate on the loan or may charge up to one point to lock in the rate for 180 days. At September 30, 2003, the Company had residential loan origination commitments of approximately $39.3 million, home equity loans and consumer lines of credit of $42.0 million, commercial lines of credit of $11.0 million, standby letters of credit of $2.9 million and unused business and personal credit card lines of $12.9 million. Loan Origination and Other Fees. Coastal Federal may receive loan origination fees and discount "points." Loan fees and points are a percentage of the principal amount of the loan which are charged to the borrower for funding the loan. In certain circumstances, Coastal Federal allows the purchaser to reduce the rate of interest by the payment of points at the Customers' options. Fees on long-term commercial mortgage and residential construction loans vary with loan type. Delinquencies. Coastal Federal's collection procedures provide for a series of contacts with delinquent borrowers. If the delinquency continues, more formal efforts are made to contact the delinquent borrower. If a residential mortgage loan continues in a delinquent status for 90 days or more, Coastal Federal generally initiates foreclosure proceedings. Coastal Federal generally initiates foreclosure proceedings on a commercial mortgage loan if the loan continues in a delinquent status for 60 days or more. In certain limited instances, however, Coastal Federal may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his financial affairs. Problem Assets and Asset Classification. Loans are reviewed on a regular basis and a reserve for uncollectible interest is established on loans where collection of interest is questionable, generally when such loans become 90 days delinquent. Loan balances that relate to interest amounts reserved are considered to be on a nonaccrual basis. Typically, payments received on a nonaccrual loan are applied to the outstanding principal and interest as determined at the time of collection of the loan. 18 The following table sets forth information with respect to the Bank's non-performing assets at the dates indicated.
At September 30, --------------------------------------------------------------------- 1999 2000 2001 2002 2003 ---- ---- ---- ---- ---- (Dollars in thousands) Loans accounted for on a nonaccrual basis: Real estate - Residential ......................... $ 1,097 $2,080 $1,554 $ 785 $3,538 Commercial .......................... 267 2,478 1,185 18 2,816 Commercial business .................... -- -- 322 2,423 793 Consumer ............................... 67 224 193 288 302 --------- ------ ------ ------ ------ Total ....................... 1,431 4,782 3,254 3,514 7,449 --------- ------ ------ ------ ------ Accruing loans which are contractually past due 90 days or more: Real estate - Residential ......................... -- -- -- -- -- Commercial .......................... -- -- -- -- -- Commercial business .................... -- -- -- -- -- Consumer ............................... -- -- -- -- -- --------- ------ ------ ------ ------ Total .................... -- -- -- -- -- --------- ------ ------ ------ ------ Restructured loans ....................... 418 419 1,693 970 369 Real estate owned, net ................... 96 867 2,363 1,046 1,627 Other nonperforming assets ............... -- -- -- -- -- --------- ------ ------ ------ ------ Total nonperforming assets ............... $ 1,945 $6,068 $7,310 $5,530 $9,445 ========= ====== ====== ====== ====== Total nonaccrual loans to net loans .............................. 0.30% 0.92% 0.64% 0.63% 1.06% Total nonaccrual loans to total assets ........................... 0.20% 0.62% 0.43% 0.37% 0.63% Total nonperforming assets to total assets ........................ 0.27% 0.79% 0.96% 0.58% 0.80% Total nonperforming assets,excluding restructured loans which are generally performing under the restructured terms, to total assets ................... 0.21% 0.73% 0.74% 0.48% .77%
In fiscal years 2001, 2002 and 2003, interest income which would have been recorded was approximately $377,000, $301,000 and $623,000, respectively, had nonaccruing loans been current in accordance with their original terms. At September 30, 2002, impaired loans totaled $3.2 million. There were $4.9 million in impaired loans at September 30, 2003. Included in the allowance for loan losses at September 30, 2002 was $194,000 related to impaired loans compared to $263,000 at September 30, 2003. The average recorded investment in impaired loans for the year ended September 30, 2002 was $3.1 million compared to $4.0 million for the year ended September 30, 2003. Interest income recognized on impaired loans in fiscal 2002 was $36,000. Interest income recognized on impaired loans in fiscal 2003 was $134,000. 19 The allowance for uncollectible interest which is netted against accrued interest receivable totaled $349,000 and $691,000 at September 30, 2002 and 2003, respectively. The OTS has adopted various changes in its regulations regarding problem assets. OTS regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, OTS examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are four classifications for problem assets: special mention, substandard, doubtful and loss. Substandard assets must have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. The regulations also have a special mention category, described as assets which do not currently expose an insured institution to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving management's close attention. Assets classified as substandard or doubtful require the institution to establish general allowances for loan losses. If an asset or portion thereof is classified loss, the insured institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss or charge off such amount. A portion of general loss allowances established to cover possible losses related to assets classified substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital. Coastal Federal had four individually classified assets in excess of $1.2 million as of September 30, 2003. At that date, classified assets amounted to $27.3 million ($9.3 million substandard; $529,000 doubtful; and $17.4 million special mention). Substandard assets consist primarily of twenty-nine loans with aggregate balances of approximately $7.7 million at September 30, 2003. The largest amount to any one borrower was $1.2 million. Special mention assets consist primarily of twenty-six loans with aggregate balances of approximately $16.0 million at September 30, 2003. Allowance for Loan Losses. The adequacy of the allowance is analyzed on a quarterly basis. For purposes of this analysis, adequacy is defined as a level of reserves sufficient to absorb probable losses inherent in the loan portfolio. The methodology employed for this analysis considers historical loan loss experience, the results of loan reviews, current economic conditions, and other qualitative and quantitative factors that warrant current consideration in determining an adequate allowance. 20 The evaluation of the allowance is segregated into general allocations and specific allocations. For general allocations, the portfolio is segregated into risk-similar segments for which historical loss ratios are calculated and adjusted for identified trends or changes in current portfolio characteristics. Historical loss ratios are calculated by product type for consumer loans (installment and revolving), mortgage loans, and commercial loans. To allow for modeling error, a range of probable loss ratios is then derived for each segment. The resulting percentages are then applied to the dollar amounts of the loans in each segment to arrive at each segment's range of probable loss levels. Certain nonperforming loans are individually assessed for impairment under SFAS 114 and assigned specific allocations. Other identified high-risk loans or credit relationships based on internal risk ratings are also individually assessed and assigned specific allocations. The general allocation also includes a component for probable losses inherent in the portfolio, based on management's analysis, that are not fully captured elsewhere in the allowance. This component serves to address the inherent estimation and imprecision risk in the methodology as well as address management's evaluation of various factors or conditions not otherwise directly measured in the evaluation of the general and specific allocations. Such factors or conditions may include evaluation of current general economic and business conditions; geographic, collateral, or other concentrations; system, procedural, policy, or underwriting changes; experience of lending staff; entry into new markets or new product offerings; and results from internal and external portfolio examinations. The allocation of the allowance to the respective loan segments is an approximation and not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses occurring in the overall loan portfolio. Assessing the adequacy of the allowance is a process that requires considerable judgment. Management's methodology and judgments are based on the information currently available and includes numerous assumptions about current events, which are believed to be reasonable, but which may or may not be valid. Thus, there can be no assurance that loan losses in future periods will not exceed the current allowance amount or that future increases in the allowance will not be required. No assurance can be given that management's ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to 21 the allowance, thus adversely affecting the operating results of the Company. Management believes that the current level of the allowance for loan losses is presently adequate considering the composition of the loan portfolio, the portfolio's loss experience, delinquency trends, current regional and local economic conditions and other factors. The allowance is also subject to examination and adequacy testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other adequacy tests. In addition, such regulatory agencies could require us to adjust our allowance based on information available to them at the time of their examination. The Company established provisions for loan losses for the year ended September 30, 2001, 2002 and 2003, of $955,000, $1.2 million and $2.7 million, respectively. For the years ended September 30, 2001, 2002 and 2003, the Company had net charge-offs of $860,000, $511,000 and $706,000, respectively. Net charge-offs as a percentage of average outstanding loans were .17%, .10%, and ..11% for fiscal years ended 2001, 2002, and 2003. At September 30, 2003, the Company had an allowance for loan losses of $9.8 million, which was 1.40% of net loans. See "Management's Discussion and Analysis - Non-Performing Assets" in the 2003 Annual Report to Stockholders attached hereto and incorporated by reference. 22 Loan Loss Allowance Analysis The following table sets forth analysis of the Company's allowance for loan losses for the periods indicated. Where specific loan loss reserves have been established, any difference between the loss reserve and the amount of the loss realized has been charged or credited to the loan loss allowance as a charge-off or recovery.
Year Ended September 30, -------------------------------------------------------------------- 1999 2000 2001 2002 2003 ---- ---- ---- ---- ---- (Dollars in thousands) Allowance at beginning of period $5,668 $ 6,430 $7,064 $7,159 $7,883 Allowance recorded on acquired loans 112 50 -- -- -- Sale of Florence office loans -- (75) -- -- -- Provision for loan losses 750 978 955 1,235 2,655 ------ ------- ------ ------ ------ Recoveries: Residential loans 184 12 3 4 -- Commercial loans 13 -- -- -- 92 Construction loans -- -- -- -- -- Consumer loans 55 65 57 62 44 ------ ------- ------ ------ ------ Total recoveries 252 77 60 66 136 ------ ------- ------ ------ ------ Charge-offs: Residential loans 15 28 167 -- 46 Construction loans 8 -- 226 90 388 Construction Loans -- -- -- -- -- Consumer loans 329 368 527 487 408 ------ ------- ------ ------ ------ Total charge-offs 352 396 920 577 842 ------ ------- ------ ------ ------ Net charge-offs 100 319 860 511 706 ------ ------- ------ ------ ------ Allowance at end of period $6,430 $ 7,064 $7,159 $7,883 $9,832 ====== ======= ====== ====== ====== Ratio of allowance to net loans outstanding at the end of the period 1.36% 1.35% 1.42% 1.42% 1.40% Ratio of net charge-offs to average loans outstanding during the period .02% .06% .17% .10% .11%
23 Loan Loss Allowance by Category The following table sets forth the breakdown of the allowance for loan losses by loan category for the periods indicated.
September 30, ------------------------------------------------------------------------------------------------------ 1999 2000 2001 -------------------------------- -------------------------------- -------------------------------- As a % Loan Type As a % Loan Type As a % Loan Type of out- As a % of out- As a % of out- As a % standing of out- standing of out- standing of out- loans in standing loans in standing loans in standing Amount category loans Amount category loans Amount category loans ------ -------- ----- ------ -------- ----- ------ -------- ----- (Dollars in thousands) Residential $ 1,747 0.56% 66.01% $ 2,081 0.60% 66.53% $ 2,148 0.65% 65.55% Commercial 4,191 3.04 29.18 4,719 3.01 30.07 4,893 3.13 30.92 Consumer 492 2.17 4.81 264 1.49 3.40 118 0.66 3.53 ------- ------- ------- ------- ------- ------- Total Allowance for loan losses $ 6,430 1.36% 100.00% $ 7,064 1.35% 100.00% $ 7,159 1.42% 100.00% ======= ======= ======= ======= ======= ======= September 30, ------------------------------------------------------------------- 2002 2003 -------------------------------- -------------------------------- As a % Loan Type As a % Loan Type of out- As a % of out- As a % standing of out- standing of out- loans in standing loans in standing Amount category loans Amount category loans ------ -------- ----- ------ -------- ----- (Dollars in thousands) Residential $ 2,272 0.72% 57.08% $ 1,992 0.51% 55.61% Commercial 5,273 2.39 39.69 7,229 2.51 41.06 Consumer 338 1.88 3.23 611 2.62 3.33 ------- ------- ------- ------- Total Allowance for loan losses $ 7,883 1.42% 100.00% $ 9,832 1.40% 100.00% ======= ======= ======= =======
24 Investment Activities Under OTS regulations, the Bank has authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and of state and municipal governments, deposits at the FHLB of Atlanta, certificates of deposit of federally insured institutions, certain bankers' acceptances and federal funds. Subject to various restrictions, such savings institutions may also invest a portion of their assets in commercial paper, corporate debt securities and mutual funds, the assets of which conform to the investments that federally chartered savings institutions are otherwise authorized to make directly. These institutions are also required to maintain minimum levels of liquid assets which vary from time to time. See "Regulation and Supervision - Federal Home Loan Bank System." The Bank may decide to increase its liquidity above the required levels depending upon the availability of funds and comparative yields on investments in relation to return on loans. Coastal Federal is required under federal regulations to maintain a minimum amount of liquid assets and is also permitted to make certain other securities investments. See "Regulation and Supervision" herein and "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" in the Annual Report. The balance of the Bank's investments in short-term securities in excess of regulatory requirements reflects management's response to the significantly increasing percentage of deposits with short maturities. Investment decisions are made by the Investment Officer who reports quarterly to the Asset/Liability Committee ("ALCO Committee"). The ALCO Committee meets quarterly and consists of Directors Creel, Bishop, Thompson, Clemmons and Gerald, and Executive Vice Presidents Graham, Rexroad, Douglas, Sherry and Stalvey and Vice President Loehr. The ALCO Committee acts within policies established by the Board of Directors. At September 30, 2003, the Bank's investment portfolio had a market value of approximately $399.2 million. The investment securities portfolio consisted primarily of mortgage-backed securities. For further information concerning the Bank's securities portfolio, see Notes 2 and 3 of the Notes to Consolidated Financial Statements attached hereto and incorporated by reference. At September 30, 2003, Coastal Federal did not own any securities, other than those disclosed in the following table, that had an aggregate book value in excess of 10% of its retained earnings at that date. 25 Securities Analysis The following table sets forth Coastal Federal's investment securities portfolio at amortized cost at the dates indicated.
September 30, ------------- 2001 2002 2003 ---- ---- ---- Amortized Percent of Amortized Percent of Amortized Percent of Cost(1) Portfolio Cost(1) Portfolio Cost(1) Portfolio ------- --------- ------- --------- ------- --------- (Dollars in thousands) U.S. Government agency Securities: FHLMC ......................... $ 1,893 100.00% -- -- -- -- FHLB .......................... -- -- $ 1,998 100.00% $ 1,998 12.38% State and municipal Obligations ................... -- -- -- -- 14,141 87.62 ---------- ---------- ---------- ---------- ---------- ---------- Total ................... $ 1,893 100.00% $ 1,998 100.00% $ 16,139 100.00% ========== ========== ========== ========== ========== ==========
(1) The market value of the Bank's investment securities portfolio amounted to $2.0 million, $2.0 million and $15.9 million at September 30, 2001, 2002 and 2003, respectively. The following table sets forth the final maturities and weighted average yields of the securities at amortized cost at September 30, 2003.
One Year More than One More than Five More than or Less to Five Years to Ten Years Ten Years ------- ------------- ------------ --------- Amount Yield Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- ------ ----- (Dollars in thousands) U.S. Government agency securities: FHLB .......................... $ -- --% $ -- --% $1,998 5.30% $ -- --% State and municipal Obligations ................... -- -- -- -- -- -- 14,141 4.16% --------- ------ --------- ------ ------ ------ --------- ------ Total ................... $ -- --% $ -- --% $1,998 5.30% $ 14,141 4.16% ========= ====== ========= ====== ====== ====== ========= ======
The yield on state and municipal obligations is not computed on a tax equivalent basis. 26 The following table sets forth Coastal Federal's mortgage-backed securities portfolio, at amortized cost, at the dates indicated.
September 30, -------------------------------------------------------------------------------- 2001 2002 2003 ------------------------ ------------------------ ------------------------ Amortized Percent of Amortized Percent of Amortized Percent of Cost(1) Portfolio Cost(1) Portfolio Cost(1) Portfolio -------- -------- -------- -------- -------- -------- (Dollars in thousands) Mortgage-backed Securities: FHLMC .............. $ 12,223 6.61% $ 57,628 17.87% $133,674 35.44% FNMA ............... 123,271 66.64 206,448 64.01 205,200 54.41 GNMA ............... 20,630 11.15 22,139 6.86 26,659 7.07 CMO ................ 28,856 15.60 36,320 11.26 11,617 3.08 -------- -------- -------- -------- -------- -------- Total ........ $184,980 100.00% $322,535 100.00% $377,150 100.00% ======== ======== ======== ======== ======== ========
(1) The market value of the Bank's mortgage-backed securities portfolio amounted to $190.6 million, $331.8 million and $383.3 million at September 30, 2001, 2002 and 2003, respectively. The following table sets forth the maturities and weighted average yields of the securities, at amortized cost, at September 30, 2003.
One Year More than One More than Five More than or Less to Five Years to Ten Years Ten Years ------------------- ------------------- ------------------- ------------------- Amount Yield Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- ------ ----- (Dollars in thousands) Mortgage-backed Securities: FHLMC ......... $ -- --% $ -- --% $ -- --% $133,674 5.52% FNMA .......... -- -- -- -- 3,302 3.62 201,898 5.85 GNMA .......... -- -- -- -- -- -- 26,659 6.39 CMO ........... -- -- -- -- -- -- 11,617 5.17 -------- -------- -------- -------- -------- -------- -------- -------- Total ... $ -- --% $ -- --% $ 3,302 3.62% $373,848 5.75% ======== ======== ======== ======== ======== ======== ======== ========
27 Service Corporation Activities The Company has two wholly-owned subsidiaries, Coastal Federal and Coastal Financial Capital Trust I. Coastal Federal has one wholly-owned service corporation: Coastal Mortgage Bankers and Realty Co., Inc. "Coastal Mortgage Bankers," which was incorporated in 1970 under the laws of South Carolina, and a subsidiary Coastal Federal Holding Corporation, which was incorporated in 1998 under the laws of Delaware. Coastal Mortgage Bankers is not active in any real estate operations. ------------------- COASTAL FEDERAL ------------------- | | | | ------------------- | | | | COASTAL FEDERAL(1) | | HOLDING | -------- CORPORATION | | ------------------- | | | ------------------- ------------------- COASTAL REAL COASTAL MORTGAGE ESTATE INVESTMENT BANKERS* CORPORATION ------------------- ------------------- | | ------------------------------------------------------------------------ | | | | | - ------------------ ------------- ------------ ------------- ---------------- Shady Forest Sherwood Ridge North Beach Development Development Development 501 Development Investments, Inc.* Corporation* Corporation* Corporation* Corporation* - ------------------ ------------- ------------ ------------- ---------------- * Inactive (1) First tier operating subsidiary of Coastal Federal Bank consolidated with Coastal Federal Bank for regulatory reporting. 28 On February 20, 1998, Coastal Real Estate Investment Corporation ("CREIC") was incorporated in North Carolina. CREIC is a wholly owned operating subsidiary of Coastal Federal Holding Corporation ("CFHC") and is a real estate investment trust ("REIT"). CREIC engages in the investment and management of real estate related assets, primarily mortgage loans. On September 1, 1998, CREIC was capitalized with approximately $131.8 million of mortgage loans from Coastal Federal. On December 10, 1998, CREIC became a wholly owned subsidiary of CFHC through an exchange of stock transaction. On January 10, 2002, January 10, 2003 and January 24, 2003, CREIC received capital contributions from CFHC of $35.0 million, $50.0 million and $50.0 million, respectively, to purchase loans. On June 25, 1998, Coastal Federal Holding Corporation was incorporated in the state of Delaware. CFHC is a wholly owned subsidiary of Coastal Federal Bank and is a passive investment company. All of CFHC's consolidated operating activities are consolidated into Coastal Federal Bank. CFHC engages in the management of its investment in CREIC and the management of the related dividends received on that investment. Deposit Activities and Other Sources of Funds General. Deposits and loan repayments are the major source of Coastal Federal's funds for lending and other investment purposes. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions. Borrowings may be used to compensate for reductions in the availability of funds from other sources. They may also be used for general business purposes. Deposit Accounts. Deposits are attracted from within Coastal Federal's primary market area through the offering of a broad selection of deposit instruments, including checking accounts, money market accounts, savings accounts, certificates of deposit and retirement accounts. Deposit account terms vary, according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, Coastal Federal considers the rates offered by its competition, profitability to Coastal Federal, matching deposit and loan products and its customer preferences and concerns. Coastal Federal generally reviews its deposit mix and pricing at least monthly. 29 Deposit Flow The following table sets forth the balances of deposits in the various types of deposit accounts offered by the Bank at the dates indicated.
At September 30, ------------------------------------------------------------------------------------------------- 2001 2002 2003 ----------------------------- ------------------------------- -------------------------------- Percent Increase Percent Increase Percent Increase Amount of Total (Decrease) Amount of Total (Decrease) Amount of Total (Decrease) ------ --------- ---------- ------ -------- ---------- ------ -------- ---------- (Dollars in thousands) Transaction accounts: NOW checking ........... $ 55,926 10.54% $ 6,981 $ 67,381 10.58% $ 11,455 $ 98,171 14.08% $30,790 Noninterest-bearing checking ............... 49,098 9.26 13,884 63,003 9.89 13,905 86,258 12.38 23,255 --------- ------ --------- --------- ------ --------- --------- ------ --------- Total transaction accounts . 105,024 19.80 20,865 130,384 20.47 25,360 184,429 26.46 54,045 --------- ------ --------- --------- ------ --------- --------- ------ --------- Money market demand accounts 193,631 36.51 73,498 212,924 33.42 19,293 206,010 29.56 (6,914) Savings accounts ........... 33,317 6.28 (2,888) 39,092 6.13 5,775 46,236 6.63 7,144 Fixed-rate certificates (original maturity): 3 months ................ 3,689 0.70 (6) 4,968 0.78 1,279 3,477 .50 (1,491) 6 months ................ 47,126 8.89 (15,251) 90,177 14.15 43,051 82,349 11.81 (7,828) 9 months ................ 30,180 5.69 26,969 17,613 2.76 (12,567) 6,702 .96 (10,911) 12 months ............... 44,866 8.46 12,216 57,206 8.98 12,340 57,777 8.29 571 18 months ............... 31,638 5.97 7,118 30,994 4.87 (644) 46,044 6.61 15,050 24 months ............... 25,120 4.74 7,047 27,939 4.39 2,819 36,313 5.21 8,374 30 months ............... 2,751 0.52 (5,869) 3,041 0.48 290 2,923 .42 (118) 36 months ............... 2,294 0.43 (981) 11,580 1.82 9,286 11,649 1.67 69 48 months ............... 6,586 1.24 1,765 7,936 1.25 1,350 10,108 1.45 2,172 96 months ............... 18 0.00 (15) 19 0.00 1 20 0.00 1 --------- ------ --------- --------- ------ --------- --------- ------ --------- 194,268 36.64 32,993 251,473 39.48 57,205 257,362 36.92 5,889 --------- ------ --------- --------- ------ --------- --------- ------ --------- Variable rate certificates: (original maturity) -- 0.00 -- 163 0.02 163 130 .02 (33) 18 months .............. 2,146 0.40 (141) 1,471 0.23 (675) 1,311 .19 (160) 30 months .............. 1,978 0.37 -- 1,574 0.25 (404) 1,534 .22 (40) --------- ------ --------- --------- ------ --------- --------- ------ --------- Total variable ............. 4,124 0.77 (321) 3,208 0.50 (916) 2,975 .43 (233) --------- ------ --------- --------- ------ --------- --------- ------ --------- Total certificates ......... 198,392 37.41 32,672 254,681 39.98 56,289 260,337 37.35 5,656 --------- ------ --------- --------- ------ --------- --------- ------ --------- Total deposits ............. $ 530,364 100.00% $ 124,147 $ 637,081 100.00% $ 106,717 $ 697,012 100% $ 59,931 ========= ====== ========= ========= ====== ========= ========= ====== =========
30 Time Deposits by Maturity and Rate The following table sets forth the amount and maturities of time deposits at September 30, 2003. Amount Due ---------- Less Than One 1-2 2-3 3-4 After Rate Year Years Years Years 4 Years Total ---- ---- ----- ----- ----- ------- ----- (In thousands) 0.00 - 1.99% ... $ 83,956 $ 3,151 $ 286 $ 3 $ -- $ 87,396 2.00 - 3.99% ... 109,864 34,396 2,414 2,904 100 149,678 4.00 - 5.99% ... 3,029 11,256 4,754 231 299 19,569 6.00 - 7.99% ... 1,387 1,747 7 -- 20 3,161 8.00 - 10.00% . 487 46 -- -- -- 533 -------- -------- -------- -------- -------- -------- Total ...... $198,723 $ 50,596 $ 7,461 $ 3,138 $ 419 $260,337 ======== ======== ======== ======== ======== ======== The following table sets forth the amount and maturities of time deposits with balances of $100,000 or more at September 30, 2003. Amount Due - -------------------------------------------------------------------------------- Within Over 3 Over 6 Over 12 3 Months through 6 months through 12 months Months Total - -------------------------------------------------------------------------------- (In thousands) $26,558 $ 31,506 $19,759 $19,102 $ 96,925 ======= ======== ======= ======= ======== In the unlikely event Coastal Federal is liquidated, depositors will be entitled to full payment of their deposit accounts prior to any payment being made to the Corporation as the sole stockholder of Coastal Federal. Borrowings. Demand and time deposits are the primary source of funds for Coastal Federal's lending and investment activities and for its general business purposes. The Bank has in the past, however, relied upon advances from the FHLB of Atlanta to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB of Atlanta has served as one of the Bank's primary borrowing sources. Advances from the FHLB of Atlanta are typically secured by the Bank's first mortgage loans and certain of the Bank's mortgage-backed securities portfolio. At September 30, 2003, Coastal Federal had advances totaling $244.1 million from the FHLB of Atlanta due on various dates through 2012 with a weighted average interest rate of 3.89%. Certain of these advances are subject to call provisions. Call provisions are more likely to be exercised by the FHLB when rates rise. 31 The FHLB of Atlanta functions as a central reserve bank providing credit for financial institutions and certain other member financial institutions. As a member, Coastal Federal is required to own capital stock in the FHLB of Atlanta and is authorized to apply for advances on the security of such stock and certain of its mortgage loans, certain commercial real estate loans, and other assets (principally securities which are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution's net worth or on the FHLB's assessment of the institution's creditworthiness. The FHLB of Atlanta determines specific lines of credit for each member institution. In addition to the borrowing described above, the Bank, from time to time, has borrowed funds under reverse repurchase agreements pursuant to which it sells securities (generally secured by government securities and mortgage-backed securities) under an agreement to buy them back at a specified price at a later date. These agreements to repurchase are deemed to be borrowings collateralized by the securities sold. At September 30, 2003, the Bank had $125.9 million in broker repurchase agreements. The Bank has also offered repurchase agreements to its customers that are borrowings collateralized by underlying government securities. At September 30, 2003, the Bank had $7.7 million outstanding in customer repurchase agreements. 32 The following tables set forth certain information regarding short-term borrowings by the Bank at the end of and during the periods indicated: At September 30, ------------------------------ 2001 2002 2003 -------- -------- -------- (Dollars in thousands) Outstanding balance: Securities sold under agreements to repurchase: Customer ........................... $ 3,703 $ 4,070 $ 7,703 Broker ............................. 15,000 30,000 125,899 Short-term FHLB advances (1) .......... 46,400 110,350 91,435 Weighted average rate paid on: Securities sold under agreements to repurchase: Customer ........................... 3.36% 1.37% 0.81% Broker ............................. 2.97 1.84 1.64 Short-term FHLB advances (1) .......... 5.13 4.52 3.81 Maximum amount of borrowings outstanding At any month end: Securities sold under agreements to repurchase: Customer ........................... $ 3,726 $ 5,625 $ 7,703 Broker ............................. 67,099 30,000 125,899 Short-term FHLB advances (1) .......... 138,946 110,350 121,582 Approximate average short-term borrowings outstanding with respect to: Securities sold under agreements to repurchase: Customer ........................... $ 2,361 $ 3,600 $ 4,812 Broker ............................. 45,461 15,007 92,476 Short-term FHLB advances (1) .......... 50,884 59,243 86,191 Weighted average rate paid on: Securities sold under agreements to repurchase: Customer ........................... 3.73% 1.58% 1.02% Broker ............................. 5.65 2.39 2.04 Short-term FHLB advances (1) .......... 5.90 4.52 3.81 (1) Short-term FHLB advances include various advances which are subject to call by FHLB, within one year. 33 Competition As of June 30, 2003, Coastal Federal held the largest share of deposits, a 16.4% share, in Horry County, S.C. according to the Federal Deposit Insurance Corporation. Coastal Federal also held an 10.4% share in Brunswick County, N.C. and a 0.4% share in Wilmington, N.C. The Bank faces strong competition in the attraction of deposits (its primary source of lendable funds) and in the origination of loans. Its most direct competition for deposits and loans has historically come from other financial institutions located in its primary market area. The Bank estimates that there are over 89 offices of other financial institutions in Horry County, 29 offices in Brunswick County and 57 offices in Wilmington. Particularly in times of high interest rates, the Bank has faced additional significant competition for investors' funds from short-term money market securities and other corporate and government securities. The Bank's competition for loans comes principally from other financial institutions, mortgage banking companies and mortgage brokers. Personnel As of September 30, 2003, the Company had 303 full-time Associates and 24 part-time Associates. The Associates are not represented by a collective bargaining unit. The Bank believes its relationship with its Associates is excellent. REGULATION AND SUPERVISION General As a savings and loan holding company, the Company is required by federal law to file reports with, and otherwise comply with, the rules and regulations of the Office of Thrift Supervision. The Bank is subject to extensive regulation, examination and supervision by the Office of Thrift Supervision, as its primary federal regulator, and the Federal Deposit Insurance Corporation, as the deposit insurer. The Bank is a member of the Federal Home Loan Bank System and, with respect to deposit insurance, of the Savings Association Insurance Fund managed by the Federal Deposit Insurance Corporation. The Bank must file reports with the Office of Thrift Supervision and the Federal Deposit Insurance Corporation concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The Office of Thrift Supervision and/or the Federal Deposit Insurance Corporation conduct periodic 34 examinations to test the Bank's safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Office of Thrift Supervision, the Federal Deposit Insurance Corporation or the Congress, could have a material adverse impact on the Company, the Bank and their operations. Certain of the regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the Company. Holding Company Regulation The Company is a nondiversified unitary savings and loan holding company within the meaning of federal law. Under prior law, a unitary savings and loan holding company, such as the Company, was not generally restricted as to the types of business activities in which it may engage, provided that the Bank continued to be a qualified thrift lender. See "Federal Savings Institution Regulation - QTL Test." The Gramm-Leach-Bliley Act of 1999 provides that no company may acquire control of a savings association after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies as described below. Further, the Gramm-Leach-Bliley Act specifies that existing savings and loan holding companies may only engage in such activities. The Gramm-Leach-Bliley Act, however, grandfathered the unrestricted authority for activities with respect to unitary savings and loan holding companies existing prior to May 4, 1999, so long as the Bank continues to comply with the QTL Test. The Company does qualify for the grandfathering. Upon any non-supervisory acquisition by the Company of another savings institution or savings bank that meets the qualified thrift lender test and is deemed to be a savings institution by the Office of Thrift Supervision, the Company would become a multiple savings and loan holding company (if the 35 acquired institution is held as a separate subsidiary) and would generally be limited to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, subject to the prior approval of the Office of Thrift Supervision, and certain activities authorized by Office of Thrift Supervision regulation. A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company, without prior written approval of the Office of Thrift Supervision and from acquiring or retaining control of a depository institution that is not insured by the Federal Deposit Insurance Corporation. In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision considers the financial and managerial resources and future prospects of the Company and institution involved, the effect of the acquisition on the risk to the deposit insurance funds, the convenience and needs of the community and competitive factors. The Office of Thrift Supervision may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions. Although savings and loan holding companies are not currently subject to specific capital requirements or specific restrictions on the payment of dividends or other capital distributions, federal regulations do prescribe such restrictions on subsidiary savings institutions as described below. The Bank must notify the Office of Thrift Supervision 30 days before declaring any dividend to the Company. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the Office of Thrift Supervision and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution. Acquisition of the Company. Under the Federal Change in Bank Control Act ("CIBCA"), a notice must be submitted to the Office 36 of Thrift Supervision if any person (including a company), or group acting in concert, seeks to acquire 10% or more of the Company's outstanding voting stock, unless the Office of Thrift Supervision has found that the acquisition will not result in a change of control of the Company. Under the CIBCA, the Office of Thrift Supervision has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that so acquires control would then be subject to regulation as a savings and loan holding company. Federal Savings Institution Regulation Business Activities. The activities of federal savings banks are governed by federal law and regulations. These laws and regulations delineate the nature and extent of the activities in which federal savings banks may engage. In particular, certain lending authority for federal savings banks, e.g., commercial, non-residential real property loans and consumer loans, is limited to a specified percentage of the institution's capital or assets. Capital Requirements. The Office of Thrift Supervision capital regulations require savings institutions to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS examination rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system), and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The Office of Thrift Supervision regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank. The risk-based capital standard for savings institutions requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a 37 risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation based on the risks believed inherent in the type of asset. Core (Tier 1) capital is defined as common stockholders' equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. The OTS has authority to establish higher capital requirements where it determines that the circumstances of a particular association require it. At September 30, 2003, the Bank met each of its capital requirements. See Note 14 of the Notes to Consolidated Financial Statements for further information. Prompt Corrective Regulatory Action. The Office of Thrift Supervision is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, a savings institution that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." A savings institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and a savings institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the Office of Thrift Supervision is required to appoint a receiver or conservator for an institution that is "critically undercapitalized." The regulation also provides that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance 38 with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The Office of Thrift Supervision could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Insurance of Deposit Accounts. The Bank is a member of the Savings Association Insurance Fund. The Federal Deposit Insurance Corporation maintains a risk-based assessment system by which institutions are assigned to one of three categories based on their capitalization and one of three subcategories based on examination ratings and other supervisory information. An institution's assessment rate depends upon the categories to which it is assigned. Assessment rates for Savings Association Insurance Fund member institutions are determined semi-annually by the Federal Deposit Insurance Corporation and currently range from zero basis points for the healthiest institutions to 27 basis points of assessable deposits for the riskiest. The Federal Deposit Insurance Corporation has authority to increase insurance assessments. A significant increase in Savings Association Insurance Fund insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future. Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the Federal Deposit Insurance Corporation or the Office of Thrift Supervision. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance. Loans to One Borrower. Federal law provides that savings institutions are generally subject to the limits on loans to one borrower applicable to national banks. A savings institution may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable 39 collateral. At September 30, 2003, the Bank's limit on loans to one borrower was $13.9 million, and the Bank's largest aggregate outstanding balance of loans to one borrower was $12.5 million. QTL Test. The HOLA requires savings institutions to meet a qualified thrift lender test. Under the test, a savings association is required to either qualify as a "domestic building and loan association" under the Internal Revenue Code or maintain at least 65% of its "portfolio assets" (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period. A savings institution that fails the qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a bank charter. As of September 30, 2003, the Bank met the qualified thrift lender test. Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered "qualified thrift investments." Limitation on Capital Distributions. Office of Thrift Supervision regulations impose limitations upon all capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, an application to and the prior approval of the Office of Thrift Supervision is required prior to any capital distribution if the institution does not meet the criteria for "expedited treatment" of applications under Office of Thrift Supervision regulations (i.e., generally, examination ratings in the two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with Office of Thrift Supervision. If an application is not required, the institution must still provide prior notice to Office of Thrift Supervision of the capital distribution if, like the Bank, it is a subsidiary of a holding company. In the event the Bank's capital fell below its regulatory requirements or the Office of Thrift Supervision notified it that it was in need of more than normal supervision, the Bank's ability to make capital distributions could be restricted. In addition, the Office of 40 Thrift Supervision could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the Office of Thrift Supervision determines that such distribution would constitute an unsafe or unsound practice. Assessments. Savings institutions are required to pay assessments to the Office of Thrift Supervision to fund the agency's operations. The general assessments, paid on a semi-annual basis, are computed upon the savings institution's total assets, including consolidated subsidiaries, as reported in the Bank's latest quarterly thrift financial report. The assessments paid by the Bank for the fiscal year ended September 30, 2003 totaled $185,000. Transactions with Related Parties. The Bank's authority to engage in transactions with "affiliates" (e.g., any company that controls or is under common control with an institution, including the Company and its non-savings institution subsidiaries) is limited by federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution's capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in federal law. The purchase of low quality assets from affiliates is generally prohibited. The transactions with affiliates must be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary. The Bank's authority to extend credit to executive officers, directors and 10% shareholders ("insiders"), as well as entities such persons control, is also governed by federal law. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. Recent legislation created an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. The law limits both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank's capital position and requires certain board approval 41 procedures to be followed. Enforcement. The Office of Thrift Supervision has primary enforcement responsibility over savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The Federal Deposit Insurance Corporation has the authority to recommend to the Director of the Office of Thrift Supervision that enforcement action to be taken with respect to a particular savings institution. If action is not taken by the Director, the Federal Deposit Insurance Corporation has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations. Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the Office of Thrift Supervision determines that a savings institution fails to meet any standard prescribed by the guidelines, the Office of Thrift Supervision may require the institution to submit an acceptable plan to achieve compliance with the standard. Federal Home Loan Bank System The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. The Bank, as a member of the Federal Home Loan Bank, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank in an amount at least equal to $500,1.0% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the Federal Home Loan Bank, whichever is greater. The Bank was 42 in compliance with this requirement with an investment in Federal Home Loan Bank stock at September 30, 2003 of $14.0 million. The Federal Home Loan Banks are required to provide funds for the resolution of insolvent thrifts in the late 1980s and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, the Bank's net interest income would likely also be reduced. Recent legislation has changed the structure of the Federal Home Loan Banks funding obligations for insolvent thrifts, revised the capital structure of the Federal Home Loan Banks and implemented entirely voluntary membership for Federal Home Loan Banks. Management cannot predict the effect that these changes may have with respect to its Federal Home Loan Bank membership. Federal Reserve System The Federal Reserve Board regulations require savings institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts up to and including $45.4 million; a 10% reserve ratio is applied above $45.4 million. The first $6.6 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The amounts are adjusted annually. The Bank complies with the foregoing requirements. TAXATION Federal Taxation General. The Corporation and the Bank report their income via a consolidated return on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Corporation. 43 Tax Bad Debt Reserves. For discussion related to the Bank's Tax Bad Debt Reserves, please refer to Note 12 of the Company's Annual Report to Stockholders for the fiscal year ended September 30, 2003. Distributions. To the extent that the Bank makes "nondividend distributions" to the Corporation that are considered as made: (i) from the reserve for losses on qualifying real property loans, to the extent the reserve for such losses exceeds the amount that would have been allowed under the experience method; or (ii) from the supplemental reserve for losses on loans ("Excess Distributions"), then an amount based on the amount distributed will be included in the Bank's taxable income. Nondividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, distributions in redemption of stock, and distributions in partial or complete liquidation. However, dividends paid out of the Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Bank's bad debt reserve. Thus, any dividends to the Corporation that would reduce amounts appropriated to the Bank's bad debt reserve and deducted for federal income tax purposes would create a tax liability for the Bank. The amount of additional taxable income attributable to an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if, the Bank makes a "nondividend distribution," then approximately one and one-half times the amount so used would be includable in gross income for federal income tax purposes, assuming a 35% corporate income tax rate (exclusive of state and local taxes). See "Regulation" for limits on the payment of dividends by the Bank. The Bank does not intend to pay dividends that would result in a recapture of any portion of its tax bad debt reserve. Corporate Alternative Minimum Tax. The Code imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. Generally, only 90% of AMTI can be offset by net operating loss carryovers. AMTI is increased by an amount equal to 75% of the amount by which the Bank's adjusted current earnings exceeds its AMTI (prior to reduction for net operating losses). Dividends-Received Deduction and Other Matters. The Corporation may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends-received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Corporation and the Bank will not file a consolidated tax return, except that if the Corporation or the Bank owns more than 20% of the stock of a corporation distributing a dividend, then 80% of any dividends received may be deducted. 44 Audits. There have not been any audits of the Corporation's federal or state income tax returns during the past five years. State Income Taxation. South Carolina has adopted the Code as it relates to savings and loan associations, effective for taxable years beginning after December 31, 1985. Coastal Federal is subject to South Carolina income tax at the rate of 6% and North Carolina income tax at a rate of 6.9%. This rate of tax is imposed on savings associations in lieu of the general state business corporation income tax. For information regarding income taxes payable by Coastal Federal, see Note 12 of the Notes to Consolidated Financial Statements. 45 Item 2. Properties The following table sets forth the location of the offices of Coastal Financial's subsidiaries, as well as certain additional information relating to these offices, as of September 30, 2003.
Total Investment Including Land, Net Book Approximate Year Building, Furni- Value as Square Owned/ Location Opened ture and Fixtures Of 9/30/03 Footage Leased - -------- ------ ----------------- ---------- ------- ------ (Dollars in thousands) Main Office 1980 $ 11,611 $ 4,529 25,000 Owned 2619 Oak St Myrtle Beach, SC (1) Dunes Office 1971 836 239 2,000 Owned 7500 North Kings Hwy Myrtle Beach, SC North Myrtle Beach Office 1973 2,026 1,317 4,100 Owned 521 Main Street North Myrtle Beach, SC Surfside Office 112 Highway 17 South 1975 1,515 581 3,300 Owned & Glenns Bay Road Surfside Beach, SC Conway Office 1976 1,177 451 2,882 Owned 310 Wright Boulevard Conway, SC Socastee Office 1981 1,046 271 2,275 Owned 4801 Socastee Boulevard Myrtle Beach, SC Murrells Inlet Office 3348 Highway 17 South & Inlet 1986 1,175 606 3,450 Owned Crossing Murrells Inlet, SC Waccamaw Medical Pk Office 1986 693 301 1,450 Owned 112 Waccamaw Medical Pk Drive Conway, SC Sunset Beach Office 1998 1,134 817 3,000 Owned 1625 Seaside Road S.W Sunset Beach, NC Coastal Federal University Center 1997 1,701 747 17,500 Owned 504 27th Avenue North Myrtle Beach, SC Conway Annex Property 1999 2,013 743 10,000 Owned 1515 4th Avenue Conway, SC
46 Little River Office 1999 $1,203 $ 965 2,300 Owned 1602 Highway 17 Little River, SC Bi-Lo 38th Avenue 2000 333 186 600 Leased 1245 38th Avenue North Myrtle Beach, SC Wilmington Office 1999 194 87 1,400 Lease 5710 Oleander Drive, Suite 209 Wilmington, NC Carolina Forest Office 2000 1,253 1,016 3,500 Owned 3894 Renee Drive Myrtle Beach, SC Southport Office 2001 280 176 1,600 Leased 4956-1 Long Beach Road SE Southport, NC Central Business District Office 2001 196 122 1,800 Leased 109 Market Street Wilmington, NC Bi-Lo Socastee Office 2001 286 160 486 Leased 5020 Dick Pond Road Myrtle Beach, SC Loris Office 2002 378 282 1,040 Leased 4262 Main Street Loris, SC Pawleys Island Office Coastal Federal Town Center 2002 1,058 994 3,150 Owned 11403 Ocean Highway Pawleys Island, SC Coastal Mortgage Bankers 1970 2 0 N/A N/A and Realty Co., Inc. 2619 Oak Street Myrtle Beach, SC Coastal Investor Services, a division of Coastal Federal Bank 1987 136 13 N/A N/A 2619 Oak Street Myrtle Beach, SC Shallotte Office 2003 614 609 2,000 Owned 200 Smith Avenue Shallotte, NC N/A Land only Wilmington-Main 2003 576 575 for Owned 4320 17th Street Extension Wilmington, NC future Banking Center
47 Residential Lending Admin. 2003 $492 $301 4,100 Owned 604 27th Avenue North Myrtle Beach, SC
(1) The original main office was located at 816 North Kings Highway and opened in January 1954. The main office was moved to its new location in 1980. The net book value of the Company's investment in office, properties and equipment totaled $16.1 million at September 30, 2003. See Note 6 of the Notes to the Consolidated Financial Statements. Coastal Federal uses the services of an independent data processing service to process customer records and monetary transactions, post deposit and general ledger entries and record activity in installment lending, loan servicing and loan originations. Item 3. Legal Proceedings The Company is not a defendant in any lawsuits. The subsidiaries are defendants in lawsuits arising out of the normal course of business. Based upon current information received from counsel representing the subsidiaries in these matters, the Company believes none of the lawsuits would have a material impact on the Company's financial status. Item 4. Submission of Matters to a Vote of Security Holders Not Applicable. PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters The information contained under the section captioned "Market for the Corporation's Common Stock and Related Stockholder Matters" in the Corporation's Annual Report to Stockholders for the Fiscal Year Ended September 30, 2003 ("Annual Report") is incorporated herein by reference. Item 6. Selected Financial Data The information contained in the section captioned "Financial Highlights" in the Annual Report is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The information contained in the section captioned 48 "Management's Discussion and Analysis" in the Annual Report is incorporated herein by reference. Item 7A. Quantitative and Qualitative Disclosures about Market Risk The information contained in the section captioned "Interest Rate Risk Disclosure" in the Annual Report is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data The consolidated financial statements contained in the Annual Report which are listed under Item 14 herein are incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The registrant has not, within the 24 months before the date of the most recent financial statements, changed its accountants, nor have there been any disagreements on accounting and financial disclosure. Item 9A. Evaluation of Disclosure Controls and Procedures and Changes in Internal Controls 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) promulgated 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 year ended September 30, 2003 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 49 PART III Item 10. Directors and Executive Officers of the Registrant The information contained under the sections captioned "Proposal I -- Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive proxy statement for the Bank's 2003 Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by reference. Certain executive officers of the Bank also serve as executive officers of the Corporation. The day-to-day management duties of the executive officers of the Corporation and the Bank relate primarily to their duties as to the Bank. The executive officers of the Company and the Bank are elected annually by the respective Boards of Directors and hold office until their successors have been elected and qualified or until they are removed from office. 50 Executive Officers of the Registrant Name, Age and Position Business Experience - ---------------------- ------------------- Michael C. Gerald, 54 Mr. Gerald has been associated with Coastal President, Chief Executive Federal since 1974 and serves as Director, Officer and a Director President and Chief Executive Officer of the Corporation and Bank. Mr. Gerald also serves as Director and President of Coastal Mortgage Bankers & Realty Company, Inc., as Director and President of Coastal Real Estate Investment Corporation, and as a Director of Coastal Retirement, Estate and Tax Planners, Inc. He currently serves on the Board of Visitors of Coastal Carolina University's Wall School of Business, the Board of Directors of the Waccamaw Community Foundation, the Board of Directors of the Coastal Education Foundation, the Board of Directors of the South Carolina Bankers Association, the Board of Directors of SC BancPAC and the Board of Trustees of the USC Business Partnership Foundation. Jimmy R. Graham, 55, Mr. Graham serves as Executive Vice President Executive Vice President and and Chief Information Officer of Coastal Chief Information Officer Federal. Mr. Graham serves as Executive Vice President of Coastal Financial Corporation. He has been associated with the bank since 1977. 51 Jerry L. Rexroad, CPA, 43, Mr. Rexroad joined the Company in April 1995 Executive Vice President and and is Executive Vice President and Chief Chief Financial Officer Financial Officer of Coastal Federal and Coastal Financial Corporation. Mr. Rexroad also serves as the Chief Financial Officer and a Director for Coastal Mortgage Bankers & Realty Company, Inc., Coastal Investor Services, Inc., Coastal Planners Holding Corporation, Coastal Retirement Estate and Tax Planners, Coastal Federal Mortgage, Coastal Real Estate Investment Corporation and President of Coastal Federal Holdings Corporation. He currently serves on the Junior Achievement Board of Directors of Horry County. He is a Past Chairman of the Board of Directors for Junior Achievement of Horry County as well as Past Chairman of the Board of Directors for Junior Achievement of Greenville. Mr. Rexroad is a Director of PowerHouse Ministries, Inc. and Chairman of the Board of Deacons at Grand Strand Baptist Church. He is a certified public accountant, and is a member of the AICPA and SCACPA. Prior to joining the Company, Mr. Rexroad was a partner with KPMG LLP where he was partner in charge of the Financial Institutions practice in South Carolina. Phillip G. Stalvey, 47, Mr. Stalvey is Executive Vice President and Executive Vice President Banking Group Leader for the Bank. He also and Banking Group Leader serves as an Executive Vice President of the Corporation and is a director of Coastal Federal Mortgage and Coastal Investor Services, Inc. He has been associated with Coastal Federal for the past 22 years. In addition, Mr. Stalvey is a member of the Florence Stake Presidency with his Church and a member of the Myrtle Beach Air Force Base Redevelopment Authority. Steven J. Sherry, 52 Mr. Sherry joined the Company in May 1998 and Executive Vice President and is Executive Vice President and Director of Director of Marketing Marketing for the Bank. He also serves as Executive Vice President and Chief Marketing Officer for Coastal Financial Corporation. Mr. Sherry is a member of the Bank Marketing Association and the ABA Marketing Network. He is active with Horry County United Way and serves on the Executive Board of the Franklin G. Burroughs-Simeon B. Chapin Art Museum. Mr. Sherry holds numerous achievement awards for marketing and advertising. 52 Susan J. Cooke, 53 Ms. Cooke is Senior Vice President and Senior Vice President and Corporate Secretary for Coastal Federal and Corporate Secretary for Coastal Financial Corporation, Corporate Secretary for Coastal Mortgage Bankers & Realty Company, Inc., and Coastal Investor Services, Inc. Ms. Cooke has been employed with Coastal Federal for sixteen years. She is a member of the American Society of Corporate Secretaries, Inc. and the National Association for Female Executives. Robert D. Douglas, 44 Mr. Douglas joined the corporation in June Executive Vice President 1994 and serves as Executive Vice President Human Resources/Coastal of the Bank and Coastal Financial Federal University Group Corporation. He previously served as Chairman of the Human Resources Committee of the South Carolina Community Bankers Association. He has served on various advisory committees for the Horry County Drug and Alcohol Commission, and the South Carolina Employment Security Commission, Coastal Carolina and Horry Georgetown Technical College, and Grand Strand Area Chamber of Commerce. The Company has adopted a Code of Ethics, a copy of which is filed as Exhibit 14 to the report. The Company intends to disclose any changes or waivers from the Code of Ethics in a report on Form 8-K. 53 Item 11. Executive Compensation The information contained under the section captioned "Proposal I -- Election of Directors -- Executive Compensation" in the Proxy Statement is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management (a) Security Ownership of Certain Beneficial Owners Information required by this item is incorporated herein by reference to the section captioned "Stock Ownership" of the Proxy Statement. (b) Security Ownership of Management Information required by this item is incorporated herein by reference to the section captioned "Stock Ownership" of the Proxy Statement. (c) Management of the Corporation knows of no arrangements, including any pledge by any person of securities of the Corporation, the operation of which may at a subsequent date result in a change in control of the registrant. (d) Equity Compensation Plan Information as of September 30, 2003:
- ----------------------------------------------------------------------------------------------- Number of securities remaining available for future issuance Number of securities under equity to be issued upon Weighted-average compensation plans exercise of price of outstanding (excluding outstanding options, options, warrants securities reflected Plan Category warrants and rights and rights in column (a)) (a) (b) (c) (d) - ----------------------------------------------------------------------------------------------- Equity compensation plans approved by 1,580,011 $7.64 303,184 security holders - ----------------------------------------------------------------------------------------------- Equity compensation plans not approved N/A N/A N/A by security holders - ----------------------------------------------------------------------------------------------- Total 1,580,011 $7.64 303,184 - -----------------------------------------------------------------------------------------------
Item 13. Certain Relationships and Related Transactions The information required by this item is incorporated herein by reference to the section captioned "Proposal I - Election of Directors" and "Voting Securities and Principal Holders Thereof" in the Proxy Statement. 54 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 1. Independent Auditors' Report(1) 2. All Financial Statements(1) (a) Consolidated Statements of Financial Condition as of September 30, 2002 and 2003. (b) Consolidated Statements of Operations for the Years Ended September 30, 2001, 2002, 2003. (c) Consolidated Statements of Stockholders' Equity and Comprehensive Income for the Years Ended September 30, 2001, 2002, 2003. (d) Consolidated Statements of Cash Flows for the Years Ended September 30, 2001, 2002, 2003. (e) Notes to Consolidated Financial Statements. 3. All Schedules have been omitted, as the required information is either inapplicable or included in the Notes to consolidated Financial Statements. 4. Exhibits 3 (a) Certificate of Incorporation of Coastal Financial Corporation(2) 3 (b) Certificate of Amendment to Certificate of Incorporation of Coastal Financial Corporation(7) 3 (c) Bylaws of Coastal Financial Corporation(1) 10 (a) Employment Agreement with Michael C. Gerald (b) Employment Agreement with Jerry L. Rexroad (c) Employment Agreement with Phillip G. Stalvey (d) Employment Agreement with Steven J. Sherry (e) Employment Agreement with Jimmy R. Graham (f) 1990 Stock Option Plan (2) 55 (g) Directors Performance Plan(3) (h) 2000 Stock Option Plan(6) (i) Loan Agreement with Bankers Bank(8) 13 Annual Report to Stockholders for the Fiscal Year Ended September 30, 2003 14 Code of Ethics 21 Subsidiaries of the Registrant 23 Consent of Independent Auditors 31 (a) Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer 31 (b) Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer 32 (a) Section 1350 Certification of Chief Executive Officer 32 (b) Section 1350 Certification of 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 proxy statement for the 1996 Annual Meeting of Stockholders. (4) Incorporated by reference to 1997 Form 10-K filed with the Securities and Exchange Commission on January 2, 1998. (5) Incorporated by reference to 1998 Form 10-K filed with the Securities and Exchange Commission on December 29, 1998. (6) Incorporated by reference to the proxy statement for the 2000 Annual Meeting of Stockholders. (7) Incorporated by reference to the March 31, 1998 Form 10-Q filed with the Securities and Exchange Commission on May 15, 1998. 56 (8) Incorporated by reference to the December 31, 1997 Form 10-Q filed with the Securities and Exchange Commission on February 13, 1998. 57 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. COASTAL FINANCIAL CORPORATION Date: December 19, 2003 By: /s/ Michael C. Gerald ----------------------------------- Michael C. Gerald President/Chief Executive Officer (Duly Authorized Representative) Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/Michael C. Gerald By: /s/Jerry L. Rexroad -------------------- ------------------- Michael C. Gerald Jerry L. Rexroad President/Chief Executive Executive Vice President Officer And a Director And Chief Financial Officer (Principal Executive (Principal Financial and Officer) Accounting Officer) Date: December 19, 2003 December 19, 2003 By: /s/James T. Clemmons By: /s/Frank A. Thompson, II -------------------- ------------------------ James T. Clemmons Frank A. Thompson, II Chairman of the Board Director Date: December 19, 2003 Date: December 19, 2003 By: /s/James C. Benton By: /s/James P. Creel ------------------ ----------------- James C. Benton James P. Creel Director Director Date: December 19, 2003 Date: December 19, 2003 By: /s/G. David Bishop By: /s/James H. Dusenbury ------------------ --------------------- G. David Bishop James H. Dusenbury Director Director Date: December 19, 2003 Date: December 19, 2003 58 EX-10 3 ex10a.txt Exhibit 10(a) FORM OF EMPLOYMENT AGREEMENT THIS AGREEMENT (the "Agreement"), made this 24th day of November 2003, by and among COASTAL FINANCIAL CORPORATION, a Delaware corporation ("the Company"), COASTAL FEDERAL BANK, a wholly owned subsidiary of the Company (the "Bank"), and Michael C. Gerald (the "Executive"). WITNESSETH WHEREAS, the Company and the Bank desire to retain the services of the Executive as President and Chief Executive Officer of the Company and the Bank; WHEREAS, the Company and the Bank have previously entered into an employment agreement with the Executive; WHEREAS, the Executive and the respective Boards of Directors of the Bank and the Company desire to enter into an updated and revised agreement setting forth the terms and conditions of the continuing employment of the Executive and the related rights and obligations of each of the parties; NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, it is agreed as follows: 1. Employment. The Executive is employed as the President & Chief Executive Officer of the Company and the Bank, reporting directly to their respective Boards. The Executive shall have responsibility for the general management and control of the business and affairs of the Company, the Bank, and their respective subsidiaries, and shall perform all duties and shall have all powers which are commonly incident to the offices of President and Chief Executive Officer or which, consistent with those offices, are delegated to him by the respective Boards. 2. Location and Facilities. The Executive will be furnished with the working facilities and staff customary for executive officers with the title and duties set forth in Section 1 and as are necessary for him to perform his duties. The location of such facilities and staff shall be at the principal administrative offices of the Company and the Bank, or at such other site or sites customary for such offices. 3. Term. a. The term of this Agreement shall be (i) the initial term, consisting of the period commencing on the date of this Agreement (the "Effective Date") and ending on the third anniversary of the Effective Date, plus (ii) any and all extensions of the initial term made pursuant to this Section 3. b. Commencing on the Effective Date and on each day thereafter, the term under this Agreement shall be renewed automatically for an additional one (1) day period beyond the then effective expiration date without action by any party, provided that neither the Company, on the one hand, nor Executive, on the other, shall have given at least sixty (60) days written notice of its or his desire that the term not be renewed. In the case such notice is given by one party to the other, the term of this Agreement shall become fixed and shall end on the third anniversary of the date of written notice. 4. Base Salary. a. The Bank agrees to pay the Executive during the term of this Agreement a base salary at the rate of $248,000.00 per annum, payable in accordance with the Bank's customary payroll practices. b. The Board of the Bank shall review annually the rate of the Executive's base salary based upon factors they deem relevant, and may maintain or increase his salary, provided that no such action shall reduce the rate of salary below the rate in effect on the Effective Date. c. In the absence of action by the Board of the Bank, the Executive shall continue to receive salary at the per annum rate specified on the Effective Date or, if another rate has been established under the provisions of this Section 4, the rate last properly established by action of the Board of the Bank under the provisions of this Section 4. 5. Bonuses. The Executive shall be entitled to participate in any discretionary bonus or other incentive compensation programs that the Board of the Company or the Bank may establish from time to time for the benefit of the officers or employees of the Company or the Bank. 6. Benefit Plans. The Executive shall be entitled to participate in such life insurance, medical, dental, pension, profit sharing, and retirement plans, stock compensation plans and other programs and arrangements as may be approved from time to time by the Company or the Bank for the benefit of their respective employees. 7. Vacation and Leave. a. The Executive shall be entitled to vacations and other leave in accordance with Bank policy for senior executives, or otherwise as approved by the Board, but in any event, not less than four (4) weeks vacation per calendar year. b. In addition to paid vacations and other leave, the Executive shall be entitled, without loss of pay, to absent himself voluntarily from the performance of his employment for such additional periods of time and for such valid and legitimate reasons as the Board of the Company and the 2 Bank may in their discretion determine. Further, the Board of the Company or the Bank may grant to the Executive a leave or leaves of absence, with or without pay, at such time or times and upon such terms and conditions as such Boards in their discretion may determine. 8. Expense Payments and Reimbursements. The Executive shall be reimbursed for all reasonable out-of-pocket business expenses that he shall incur in connection with his services under this Agreement upon substantiation of such expenses in accordance with applicable policies of the Company or the Bank. 9. Loyalty. a. During the term of this Agreement the Executive: (i) shall devote all his time, attention, skill, and efforts to the faithful performance of his duties hereunder; provided, however, that from time to time, the Executive may serve on the boards of directors of, and hold any other offices or positions in, companies or organizations which will not present any conflicts of interest with the Company or the Bank or any of their subsidiaries or affiliates, unfavorably affect the performance of Executive's duties pursuant to this Agreement, or violate any applicable statute or regulation and (ii) shall not engage in any business or activity contrary to the business affairs or interests of the Company or the Bank. b. Nothing contained in this Agreement shall prevent or limit the Executive's right to invest in the capital stock or other securities of any business dissimilar from that of the Company and the Bank, or, solely as a passive, minority investor, in any business. c. The Executive agrees to maintain the confidentiality of any and all information concerning the operation or financial status of the Company and the Bank; the names or addresses of any of its borrowers, depositors and other customers; any information concerning or obtained from such customers; and any other information concerning the Company and the Bank to which he may be exposed during the course of his employment. The Executive further agrees that, unless required by law or specifically permitted by the Board in writing, he will not disclose to any person or entity, either during or subsequent to his employment, any of the above-mentioned information which is not generally known to the public, nor shall he employ such information in any way other than for the benefit of the Company and the Bank. 10. Termination and Termination Pay. Subject to Section 11 of this Agreement, the Executive's employment under this Agreement may be terminated in the following circumstances: 3 a. Death. The Executive's employment under this Agreement shall terminate upon his death during the term of this Agreement, in which event the Executive's estate shall be entitled to receive the compensation due to the Executive through the last day of the calendar month in which his death occurred. b. Retirement. This Agreement shall be terminated upon the retirement of the Executive under the retirement benefit plan or plans in which he participates pursuant to Section 6 of this Agreement or otherwise. For all other purposes, the Executive's termination of employment at retirement shall be treated in the same manner as if he voluntarily terminated employment pursuant to Section 10(f). c. Disability. i. The Company, the Bank, or the Executive may terminate the Executive's employment after having established the Executive's Disability. For purposes of this Agreement, "Disability" means a physical or mental infirmity that impairs the Executive's ability to substantially perform his duties under this Agreement and that results in the Executive's becoming eligible for long-term disability benefits under the Company's or the Bank's long-term disability plan (or, if the Company or the Bank has no such plan in effect, that impairs the Executive's ability to substantially perform his duties under this Agreement for a period of one hundred eighty (180) consecutive days). The Boards of the Company and the Bank shall determine whether or not the Executive is and continues to be permanently disabled for purposes of this Agreement in good faith, based upon competent medical advice and other factors that they reasonably believe to be relevant. As a condition to any benefits, such Board may require the Executive to submit to such physical or mental evaluations and tests as it deems reasonably appropriate. ii. In the event of such Disability, the Executive's obligation to perform services under this Agreement will terminate. In the event of such termination, the Executive shall continue to receive seventy-five (75) percent of his monthly base salary (at the annual rate in effect on his date of termination) through the earlier of the date of the Executive's death, the date he attains age 65 or the date which is three (3) years after the Executive's termination date. Such payments shall be reduced by the amount of any short- or long-term disability benefits payable to the Executive under any other disability program sponsored by the Company or the Bank. In addition, during any period of the Executive's Disability in which he is receiving payments under this paragraph, the Executive and his dependents shall, to the greatest extent possible, 4 continue to be covered under all benefit plans (including, without limitation, retirement plans and medical, dental and life insurance plans) of the Company and the Bank in which Executive participated prior to his Disability on the same terms as if Executive were actively employed by the Company and the Bank. d. Just Cause. i. The Board of the Company or the Bank may, by written notice to the Executive in the form and manner specified in this paragraph, immediately terminate his employment with the Company or the Bank, respectively, at any time, for Just Cause. The Executive shall have no right to receive compensation or other benefits for any period after termination for Just Cause except for vested benefits. Termination for "Just Cause" shall mean termination because of, in the good faith determination of the Company's or the Bank's Board, the Executive's: (1) Personal dishonesty; (2) Incompetence; (3) Willful misconduct; (4) Breach of fiduciary duty involving personal profit; (5) Intentional failure to perform duties under this Agreement; (6) Willful violation of any law, rule or regulation (other than traffic violations or similar offenses) that reflects adversely on the reputation of the Bank, any felony conviction, any violation of law involving moral turpitude, or any violation of a final cease-and-desist order; or (7) Material breach by the Executive of any provision of this Agreement. ii Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated for Just Cause by the Company or the Bank unless there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths (3/4) of the entire membership of the Board of the Company or the Bank at a meeting of such Board called and held for the purpose (after reasonable notice to the Executive and an opportunity for the Executive to be heard before the Board with counsel), finding that in the good faith opinion of such Board the 5 Executive was guilty of conduct described above and specifying the particulars thereof. e. Certain Regulatory Events. i. If the Executive is removed and/or permanently prohibited from participating in the conduct of the Bank's affairs by an order issued under Sections 8(e)(4) or 8(g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. ss.ss. 1818(e)(4) and (g)(1)), all obligations of the Bank under this Agreement shall terminate as of the effective date of the order, but vested rights of the parties shall not be affected. ii. If the Bank is in default (as defined in Section 3(x)(1) of FDIA), all obligations of the Bank under this Agreement shall terminate as of the date of default, but vested rights of the parties shall not be affected. iii. If a notice served under Sections 8(e)(3) or (g)(1) of the FDIA (12 U.S.C. Sections 1818(e)(3) and (g)(1)) suspends and/or temporarily prohibits the Executive from participating in the conduct of the Bank's affairs, the Bank's obligations under this Agreement shall be suspended as of the date of such service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Bank shall, (x) pay the Executive all or part of the compensation withheld while its contract obligations were suspended, and (y) reinstate (in whole or in part) any of its obligations which were suspended. f. Voluntary Termination by Executive. In addition to his other rights to terminate under this Agreement, the Executive may voluntarily terminate employment with the Bank and the Company during the term of this Agreement upon at least sixty (60) days prior written notice to each Board, in which case the Executive shall receive only his compensation, vested rights and employee benefits up to the date of his termination. g. Without Just Cause or With Good Reason. i. In addition to termination pursuant to Sections 10(a) through 10(f), (x) the Board of the Company or the Bank, respectively, may, by written notice to the Executive, immediately terminate his employment with the Company or the Bank, respectively, at any time for a reason other than Just Cause (a termination "Without Just Cause") and (y) the Executive may, by written notice to the Boards of the Company and the Bank, immediately terminate this Agreement at any time within ninety (90) days following an event 6 constituting "Good Reason" as defined below (a termination "With Good Reason"). ii. Subject to Section 11 hereof, in the event of termination under this Section 10(g), the Executive shall be entitled to receive his base salary for the remaining term of the Agreement, including any renewals or extensions thereof (determined at the highest annual rate of base salary in effect pursuant to Section 4 of this Agreement for any of the twelve (12) months immediately preceding the date of such termination), plus annual cash bonuses for each year (prorated in the event of partial years) remaining under such term (determined by reference to the highest annual cash bonus received by the Executive in any of the three (3) calendar years preceding the termination. The sum due under this Section 10(g) shall be paid in one lump sum within ten (10) calendar days of such termination. Also, in such event, the Executive shall, for the remaining term of the Agreement, receive the benefits he would have received during the remaining term of the Agreement under any tax-qualified or non-tax-qualified retirement programs in which the Executive participated prior to his termination (with the amount of the benefits determined by reference to the benefits received by the Executive under such programs during the twelve (12) months preceding his termination or, if applicable, the accruals made on the Executive's behalf under such programs) and continue to participate in any benefit plans of the Company and the Bank that provide health (including medical and dental), life or disability insurance, or similar coverage upon terms no less favorable than the most favorable terms provided to senior executives of the Bank during such period. In the event that the Company or the Bank is unable to provide such coverage by reason of the Executive no longer being an employee, the Company and the Bank shall provide the Executive with comparable coverage on an individual policy basis or, if individual coverage is not available, provide a cash payment equivalent to the value of such coverage. iii. "Good Reason" shall exist if, without Executive's express written consent, the Company or the Bank materially breach any of their respective obligations under this Agreement. Without limitation, such a material breach shall be deemed to occur upon any of the following: (1) A material reduction in the Executive's responsibilities or authority, or a requirement that the Executive report to any person or group other than the Boards of the Company and the Bank (or any other effective reduction in reporting 7 responsibilities) in connection with his employment with the Company or the Bank; (2) Assignment to the Executive of duties of a non-executive nature or duties for which he is not reasonably equipped by his skills and experience; (3) A reduction in salary or benefits contrary to the terms of this Agreement, or, following a Change in Control as defined in Section 11 of this Agreement, any reduction in salary or material reduction in benefits below the amounts to which he was entitled prior to the Change in Control; (4) Termination of incentive and benefit plans, programs or arrangements, or reduction of the Executive's participation to such an extent as to materially reduce their aggregate value below their aggregate value as of the Effective Date; or (5) A requirement that the Executive relocate his principal business office or his principal place of residence outside of the area consisting of a thirty five (35) mile radius from the current main office and any branch of the Bank, or the assignment to the Executive of duties that would reasonably require such a relocation. iv. Notwithstanding the foregoing, a reduction or elimination of the Executive's participation or benefits under one or more benefit plans maintained by the Company or the Bank as part of a good faith, overall reduction or elimination of such plan or plans or benefits thereunder applicable to all participants in a manner that does not discriminate against the Executive (except as such discrimination may be necessary to comply with law) shall not constitute an event of Good Reason or a material breach of this Agreement, provided that benefits of the type or to the general extent as those offered under such plans prior to such reduction or elimination are not available to other officers of the Company or the Bank or any company that controls either of them under a plan or plans in or under which the Executive is not entitled to participate. v. Notwithstanding anything in this Agreement to the contrary, during the period beginning three (3) months prior to the announcement by the Bank or the Company of an event constituting a Change in Control (as defined in Section 11(a)) and ending twelve (12) months following the effective date of a 8 Change in Control, the Executive may voluntarily terminate his employment under this Agreement for any reason and such termination shall constitute termination With Good Reason. h. Continuing Covenant Not to Compete or Interfere with Relationships. Regardless of anything herein to the contrary, following a termination by the Company, the Bank or the Executive pursuant to Section 10(g) and continuing until the first anniversary of the effective date of such termination, the Executive shall not serve as an officer, director or employee of any bank holding company, bank, savings association, savings and loan holding company, or mortgage company which offers products or services competing with those offered by the Company or the Bank from any office in any city, town or county where Bank maintains an office as of the date of the Executive's termination and shall not interfere with the relationship of the Company or the Bank and any of its employees, agents, or representatives. 11. Termination in Connection with a Change in Control. a. For purposes of this Agreement, a "Change in Control" shall be deemed to occur on the earliest of i. The acquisition by any entity, person or group (other than the acquisition by a tax-qualified retirement plan sponsored by the Company or the Bank) of beneficial ownership, as that term is defined in Rule 13d-3 under the Securities Exchange Act of 1934, of more than 25% of the outstanding capital stock of the Company or the Bank entitled to vote for the election of directors ("Voting Stock"); ii. The commencement by any entity, person, or group (other than the Company or the Bank, a subsidiary of the Company or the Bank, or a tax-qualified retirement plan sponsored by the Company or the Bank) of a tender offer or an exchange offer for more than 25% of the outstanding Voting Stock of the Company or the Bank; iii. The effective time of (x) a merger or consolidation of the Company or the Bank with one or more other corporations as a result of which the holders of the outstanding Voting Stock of the Company or the Bank immediately prior to such merger exercise voting control over less than 51 % of the Voting Stock of the surviving or resulting corporation, or (y) a transfer of substantially all of the property of the Company or the Bank other than to an entity of which the Company or the Bank owns at least 51% of the Voting Stock; and 9 iv. At such time that, during any period of two (2) consecutive years, individuals who at the beginning of such period constitute the Board of the Company or the Bank (the "Continuing Directors") cease for any reason to constitute at least two-thirds thereof, provided that any individual whose election or nomination for election as a member of the Board was approved by a vote of at least two-thirds (_) of the Continuing Directors then in office shall be considered a Continuing Director. b. If within the period beginning three (3) months prior to the announcement by the Bank or the Company of an event constituting a Change in Control and ending twelve (12) months following the effective date of a Change in Control, (i) the Company or the Bank shall terminate the Executive's employment Without Just Cause, or (ii) the Executive shall voluntarily terminate his employment With Good Reason, the Company or the Bank shall, within ten (10) calendar days of the termination of the Executive's employment, make a lump-sum cash payment to him equal to three (3) times the sum of the Executive's (x) current base salary (determined at the highest annual rate of base salary in effect pursuant to Section 4 of this Agreement for any of the twelve (12) months immediately preceding the effective date of the Change in Control or, if higher, the rate in effect on the Executive's termination date) and (y) the highest cash bonus paid to the Executive or accrued on the Executive's behalf with respect to any of the three (3) most recently completed fiscal years of the Bank preceding the effective date of the Change in Control. This cash payment shall be made in lieu of any payment also required under Section 10(g) of this Agreement because of a termination in such period. The Executive's rights under Section 10(g) are not otherwise affected by this Section 11. Also, in such event, the Executive shall, for a thirty-six (36) month period following his termination of employment, receive the benefits he would have received over such period under any tax-qualified or non-tax-qualified retirement programs in which the Executive participated prior to his termination (with the amount of the benefits determined by reference to the benefits received by the Executive under such programs during the twelve (12) months preceding the Change in Control or, if applicable, the accruals made on the Executive's behalf during such period) and continue to participate in any benefit plans of the Company and the Bank that provide health (including medical and dental), life or disability insurance, or similar coverage upon terms no less favorable than the most favorable terms provided to senior executives of the Bank during such period. In the event that the Company or the Bank is unable to provide such coverage by reason of the Executive no longer being an employee, the Company and the Bank shall provide the Executive with comparable coverage on an individual policy or, if individual coverage is not available, provide a cash payment equivalent to the value of such coverage. 10 12. Indemnification and Liability Insurance. a. Indemnification. The Company and the Bank agree to indemnify the Executive (and his heirs, executors, and administrators), and to advance expenses related thereto, to the fullest extent permitted under applicable law and regulations against any and all expenses and liabilities reasonably incurred by him in connection with or arising out of any action, suit, or proceeding in which he may be involved by reason of his having been a director or Executive of the Company or the Bank or any of their subsidiaries (whether or not he continues to be a director or Executive at the time of incurring any such expenses or liabilities) such expenses and liabilities to include, but not be limited to, judgments, court costs, and attorney's fees and the cost of reasonable settlements, such settlements to be approved by the Board of the Company or the Bank, if such action is brought against the Executive in his capacity as an Executive or director of the Company or the Bank or any of their subsidiaries. Indemnification for expense shall not extend to matters for which the Executive has been terminated for Just Cause. Nothing contained herein shall be deemed to provide indemnification prohibited by applicable law or regulation. Notwithstanding anything herein to the contrary, the obligations of this Section 12 shall survive the term of this Agreement by a period of six (6) years. b. Insurance. During the period in which indemnification of the Executive is required under this Section, the Company or the Bank shall provide the Executive (and his heirs, executors, and administrators) with coverage under a directors' and Executives' liability policy at the expense of the Company or the Bank, at least equivalent to such coverage provided to directors and senior Executives of the Company or the Bank, whichever is more favorable to the Executive. 13. Reimbursement of Executive's Expenses to Enforce this Agreement. The Company or the Bank shall reimburse the Executive for all out-of-pocket expenses, including, without limitation, reasonable attorney's fees, incurred by the Executive in connection with successful enforcement by the Executive of the obligations of the Company or the Bank to the Executive under this Agreement. Successful enforcement shall mean the grant of an award of money or the requirement that the Company or the Bank take some action specified by this Agreement (i) as a result of court order; or (ii) otherwise by the Company or the Bank following an initial failure of the Company or the Bank to pay such money or take such action promptly after written demand therefor from the Executive stating the reason that such money or action was due under this Agreement at or prior to the time of such demand. 14. Adjustment of Certain Payments and Benefits. a. Tax Indemnification. Anything in this Agreement to the contrary notwithstanding and except as set forth below, in the event it shall be 11 determined that any payment, benefit or distribution made or provided by the Company or the Bank to or for the benefit of the Executive (whether made or provided pursuant to the terms of this Agreement or otherwise) (each referred to herein as a "Payment"), would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code") or any interest or penalties are incurred by the Executive with respect to such excise tax (the excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), the Executive shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. b. Determination of Gross-Up Payment. Subject to the provisions of Section 14(c), all determinations required to be made under this Section 14, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payments and the assumptions to be utilized in arriving at such determination, shall be made by a certified public accounting firm reasonably acceptable to the Company as may be designated by the Executive (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company, the Bank and the Executive within fifteen (15) business days of the receipt of notice from the Executive that there have been Payments, or such earlier time as is requested by the Company and the Bank. All fees and expenses of the Accounting Firm shall be borne solely by the Company and the Bank. Any Gross-Up Payment, as determined pursuant to this Section 14, shall be paid by the Company to the Executive within five days of (i) the later of the due date for the payments of any Excise Tax, and (ii) the receipt of the Accounting Firm's determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code, at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company and the Bank should have been made ("Underpayment"), consistent with the calculations required to be made hereunder. In the event that the Company and the Bank exhaust their remedies pursuant to Section 14(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. 12 c. Treatment of Claims. The Executive shall notify the Company and the Bank in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company and the Bank of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten (10) business days after the Executive is informed in writing of such claim and shall apprise the Company and the Bank of the nature of such claims and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the thirty (30) day period following the date on which it gives such notice to the Company and the Bank (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company and the Bank notify the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall: i. give the Company and the Bank any information reasonably request by the Company and the Bank relating such claim, ii. take such action in connection with contesting such claim as the Company and the Bank shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company and the Bank, iii. cooperate with the Company and the Bank in good faith in order effectively to contest such claim, and iv. permit the Company and the Bank to participate in any proceedings relating to such claim; provided, however, that the Company and the Bank shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and indemnity and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 14(c), the Company and the Bank shall control all proceedings taken in connection with such contest and, at their sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at their sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company and the Bank shall determine; 13 provided, however, that if the Company and the Bank direct the Executive to pay such claim and sue for a refund, the Company and the Bank shall advance the amount of such payment to the Executive, on an interest-free basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance. Furthermore, the Company's and the Bank's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issues raised by the Internal Revenue Service or any other taxing authority. d. Adjustments to the Gross-Up Payment. If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 14(c), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of Section 14(c)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after applicable taxes). If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 14(c), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and such denial of refund occurs prior to the expiration of thirty (30) days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of the Gross-Up Payment. 15. Injunctive Relief. If there is a breach or threatened breach of Section 10(h) of his Agreement or the prohibitions upon disclosure contained in Section 9(c) of this Agreement, the Company or the Bank and the Executive agree that there is no adequate remedy at law for such breach, and that the Company and the Bank each shall be entitled to injunctive relief restraining the Executive from such breach or threatened breach, but such relief shall not be the exclusive remedy hereunder for such breach. The parties hereto likewise agree that the Executive, without limitation, shall be entitled to injunctive relief to enforce the obligations of the Company and the Bank under Section 11 of this Agreement. 16. Successors and Assigns. a. This Agreement shall inure to the benefit of and be binding upon any corporate or other successor of the Company or the Bank which shall acquire, directly or indirectly, by merger, consolidation, purchase or otherwise, all or substantially all of the assets or stock of the Company or the Bank. 14 b. Since the Bank and the Company are contracting for the unique and personal skills of the Executive, the Executive shall be precluded from assigning or delegating his rights or duties hereunder without first obtaining the written consent of the Bank and the Company. 17. No Mitigation. The Executive shall not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise and no such payment shall be offset or reduced by the amount of any compensation or benefits provided to the Executive as a result of any subsequent employment. 18. Notices. All notices, requests, demands and other communications in connection with this Agreement shall be made in writing and shall be deemed to have been given when delivered by hand or 48 hours after mailing at any general or branch United States Post Office, by registered or certified mail, postage prepaid, addressed as follows, or to such other address as shall have been designated in writing by the addressee: a. If to the Company or the Bank: Copy to: Corporate Secretary Coastal Financial Corporation 2619 Oak Street Myrtle Beach, S.C. 29577 b. If to the Executive: Michael C. Gerald 211 Lake Drive Myrtle Beach, S.C. 29572 19. Joint and Several Liability; Payments by the Company and the Bank. To the extent permitted by law, except as otherwise provided herein, the Company and the Bank shall be jointly and severally liable for the payment of all amounts due under this Agreement. The Company hereby agrees that it shall be jointly and severally liable with the Bank for the payment of all amounts due under this Agreement and shall guarantee the performance of the Bank's obligations thereunder, provided that the Company shall not be required by this Agreement to pay to the Executive a salary or any bonuses or any other cash payments, except in the event that the Bank does not fulfill the obligations to the Executive hereunder for such payments. 20. No Plan Created by this Agreement. The Executive, the Company and the Bank expressly declare and agree that this Agreement was negotiated among them and that no provision or provisions of this Agreement are intended to, or shall be deemed to, create any plan for purposes of the Employee Retirement Income Security Act or any other law or regulation, and the Company, the Bank and the Executive each expressly waives any right to assert the contrary. Any assertion in any judicial or administrative filing, hearing, or process by or on behalf of the Executive or the Company or the Bank that such a plan was so created by this Agreement shall be deemed a material breach of this Agreement by the party making such an assertion. 15 21. Amendments. No amendments or additions to this Agreement shall be binding unless made in writing and signed by all of the parties, except as herein otherwise specifically provided. 22. Applicable Law. Except to the extent preempted by Federal law, the laws of the State of Delaware shall govern this Agreement in all respects, whether as to its validity, construction, capacity, performance or otherwise. 23. Severability. The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof. 24. Headings. Headings contained herein are for convenience of reference only. 25. Entire Agreement. This Agreement, together with any understandings or modifications thereof as agreed to in writing by the parties, shall constitute the entire agreement among the parties hereto with respect to the subject matter hereof, other than written agreements with respect to specific plans, programs or arrangements described in Sections 5 and 6. This Agreement supercedes and replaces in its entirety the Agreement dated September 26,1990, as amended, between the Company, the Bank and the Executive. 16 IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first set forth above. Attest: COASTAL FINANCIAL CORPORATION /s/ Susan J. Cooke By:/s/ J.T. Clemmons - ---------------------------- ------------------------------------ Susan J. Cooke J.T. Clemmons Title: Chairman /s/ Rebecca Belcher - ---------------------------- Rebecca Belcher Attest: COASTAL FEDERAL BANK /s/ Susan J. Cooke By: /s/ J.T. Clemmons - ---------------------------- ------------------------------------ Susan J. Cooke J.T. Clemmons Title: Chairman /s/ Rebecca Belcher - ---------------------------- Rebecca Belcher Witness: /s/ Susan J. Cooke /s/ Michael C. Gerald - ---------------------------- --------------------------------------- Susan J. Cooke EXECUTIVE: Michael C. Gerald 17 EX-10 4 ex10b.txt Exhibit 10(b) FORM OF EMPLOYMENT AGREEMENT THIS AGREEMENT (the "Agreement"), made this 24TH day of November 2003, by and among COASTAL FINANCIAL CORPORATION, a Delaware corporation ("the Company"), COASTAL FEDERAL BANK, a wholly owned subsidiary of the Company (the "Bank"), and Jerry L. Rexroad (the "Executive"). WITNESSETH WHEREAS, the Company and the Bank desire to retain the services of the Executive as Executive Vice President and Chief Financial Officer of the Company and the Bank; WHEREAS, the Company and the Bank have previously entered into an employment agreement with the Executive; WHEREAS, the Executive and the respective Boards of Directors of the Bank and the Company desire to enter into an updated and revised agreement setting forth the terms and conditions of the continuing employment of the Executive and the related rights and obligations of each of the parties; NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, it is agreed as follows: 1. Employment. The Executive is employed as the Executive Vice President and Chief Financial Officer of the Company and the Bank, reporting directly to their respective Boards. The Executive shall have responsibility for the general management and control of the business and affairs of the Company, the Bank, and their respective subsidiaries, and shall perform all duties and shall have all powers which are commonly incident to the offices of Executive Vice President and Chief Financial Officer, or which, consistent with those offices, are delegated to him by the respective Boards. 2. Location and Facilities. The Executive will be furnished with the working facilities and staff customary for executive officers with the title and duties set forth in Section 1 and as are necessary for him to perform his duties. The location of such facilities and staff shall be at the principal administrative offices of the Company and the Bank, or at such other site or sites customary for such offices. 3. Term. a. The term of this Agreement shall be (i) the initial term, consisting of the period commencing on the date of this Agreement (the "Effective Date") and ending on the third anniversary of the Effective Date, plus (ii) any and all extensions of the initial term made pursuant to this Section 3. b. Commencing on the Effective Date and on each day thereafter, the term under this Agreement shall be renewed automatically for an additional one (1) day period beyond the then effective expiration date without action by any party, provided that neither the Company, on the one hand, nor Executive, on the other, shall have given at least sixty (60) days written notice of its or his desire that the term not be renewed. In the case such notice is given by one party to the other, the term of this Agreement shall become fixed and shall end on the third anniversary of the date of written notice. 4. Base Salary. a. The Bank agrees to pay the Executive during the term of this Agreement a base salary at the rate of $195,000.00 per annum, payable in accordance with the Bank's customary payroll practices. b. The Board of the Bank shall review annually the rate of the Executive's base salary based upon factors they deem relevant, and may maintain or increase his salary, provided that no such action shall reduce the rate of salary below the rate in effect on the Effective Date. c. In the absence of action by the Board of the Bank, the Executive shall continue to receive salary at the per annum rate specified on the Effective Date or, if another rate has been established under the provisions of this Section 4, the rate last properly established by action of the Board of the Bank under the provisions of this Section 4. 5. Bonuses. The Executive shall be entitled to participate in any discretionary bonus or other incentive compensation programs that the Board of the Company or the Bank may establish from time to time for the benefit of the officers or employees of the Company or the Bank. 6. Benefit Plans. The Executive shall be entitled to participate in such life insurance, medical, dental, pension, profit sharing, and retirement plans, stock compensation plans and other programs and arrangements as may be approved from time to time by the Company or the Bank for the benefit of their respective employees. 7. Vacation and Leave. a. The Executive shall be entitled to vacations and other leave in accordance with Bank policy for senior executives, or otherwise as approved by the Board, but in any event, not less than four (4) weeks vacation per calendar year. b. In addition to paid vacations and other leave, the Executive shall be entitled, without loss of pay, to absent himself voluntarily from the performance of his employment for such additional periods of time and for such valid and legitimate reasons as the Board of the Company and the 2 Bank may in their discretion determine. Further, the Board of the Company or the Bank may grant to the Executive a leave or leaves of absence, with or without pay, at such time or times and upon such terms and conditions as such Boards in their discretion may determine. 8. Expense Payments and Reimbursements. The Executive shall be reimbursed for all reasonable out-of-pocket business expenses that he shall incur in connection with his services under this Agreement upon substantiation of such expenses in accordance with applicable policies of the Company or the Bank. 9. Loyalty. a. During the term of this Agreement the Executive: (i) shall devote all his time, attention, skill, and efforts to the faithful performance of his duties hereunder; provided, however, that from time to time, the Executive may serve on the boards of directors of, and hold any other offices or positions in, companies or organizations which will not present any conflicts of interest with the Company or the Bank or any of their subsidiaries or affiliates, unfavorably affect the performance of Executive's duties pursuant to this Agreement, or violate any applicable statute or regulation and (ii) shall not engage in any business or activity contrary to the business affairs or interests of the Company or the Bank. b. Nothing contained in this Agreement shall prevent or limit the Executive's right to invest in the capital stock or other securities of any business dissimilar from that of the Company and the Bank, or, solely as a passive, minority investor, in any business. c. The Executive agrees to maintain the confidentiality of any and all information concerning the operation or financial status of the Company and the Bank; the names or addresses of any of its borrowers, depositors and other customers; any information concerning or obtained from such customers; and any other information concerning the Company and the Bank to which he may be exposed during the course of his employment. The Executive further agrees that, unless required by law or specifically permitted by the Board in writing, he will not disclose to any person or entity, either during or subsequent to his employment, any of the above-mentioned information which is not generally known to the public, nor shall he employ such information in any way other than for the benefit of the Company and the Bank. 10. Termination and Termination Pay. Subject to Section 11 of this Agreement, the Executive's employment under this Agreement may be terminated in the following circumstances: 3 a. Death. The Executive's employment under this Agreement shall terminate upon his death during the term of this Agreement, in which event the Executive's estate shall be entitled to receive the compensation due to the Executive through the last day of the calendar month in which his death occurred. b. Retirement. This Agreement shall be terminated upon the retirement of the Executive under the retirement benefit plan or plans in which he participates pursuant to Section 6 of this Agreement or otherwise. For all other purposes, the Executive's termination of employment at retirement shall be treated in the same manner as if he voluntarily terminated employment pursuant to Section 10(f). c. Disability. i. The Company, the Bank, or the Executive may terminate the Executive's employment after having established the Executive's Disability. For purposes of this Agreement, "Disability" means a physical or mental infirmity that impairs the Executive's ability to substantially perform his duties under this Agreement and that results in the Executive's becoming eligible for long-term disability benefits under the Company's or the Bank's long-term disability plan (or, if the Company or the Bank has no such plan in effect, that impairs the Executive's ability to substantially perform his duties under this Agreement for a period of one hundred eighty (180) consecutive days). The Boards of the Company and the Bank shall determine whether or not the Executive is and continues to be permanently disabled for purposes of this Agreement in good faith, based upon competent medical advice and other factors that they reasonably believe to be relevant. As a condition to any benefits, such Board may require the Executive to submit to such physical or mental evaluations and tests as it deems reasonably appropriate. ii. In the event of such Disability, the Executive's obligation to perform services under this Agreement will terminate. In the event of such termination, the Executive shall continue to receive seventy-five (75) percent of his monthly base salary (at the annual rate in effect on his date of termination) through the earlier of the date of the Executive's death, the date he attains age 65 or the date which is three (3) years after the Executive's termination date. Such payments shall be reduced by the amount of any short- or long-term disability benefits payable to the Executive under any other disability program sponsored by the Company or the Bank. In addition, during any period of the Executive's Disability in which he is receiving payments under this paragraph, the Executive and his dependents shall, to the greatest extent possible, 4 continue to be covered under all benefit plans (including, without limitation, retirement plans and medical, dental and life insurance plans) of the Company and the Bank in which Executive participated prior to his Disability on the same terms as if Executive were actively employed by the Company and the Bank. d. Just Cause. i. The Board of the Company or the Bank may, by written notice to the Executive in the form and manner specified in this paragraph, immediately terminate his employment with the Company or the Bank, respectively, at any time, for Just Cause. The Executive shall have no right to receive compensation or other benefits for any period after termination for Just Cause except for vested benefits. Termination for "Just Cause" shall mean termination because of, in the good faith determination of the Company's or the Bank's Board, the Executive's: (1) Personal dishonesty; (2) Incompetence; (3) Willful misconduct; (4) Breach of fiduciary duty involving personal profit; (5) Intentional failure to perform duties under this Agreement; (6) Willful violation of any law, rule or regulation (other than traffic violations or similar offenses) that reflects adversely on the reputation of the Bank, any felony conviction, any violation of law involving moral turpitude, or any violation of a final cease-and-desist order; or (7) Material breach by the Executive of any provision of this Agreement. ii Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated for Just Cause by the Company or the Bank unless there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths (3/4) of the entire membership of the Board of the Company or the Bank at a meeting of such Board called and held for the purpose (after reasonable notice to the Executive and an opportunity for the Executive to be heard before the Board with counsel), finding that in the good faith opinion of such Board the 5 Executive was guilty of conduct described above and specifying the particulars thereof. e. Certain Regulatory Events. i. If the Executive is removed and/or permanently prohibited from participating in the conduct of the Bank's affairs by an order issued under Sections 8(e)(4) or 8(g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. ss.ss. 1818(e)(4) and (g)(1)), all obligations of the Bank under this Agreement shall terminate as of the effective date of the order, but vested rights of the parties shall not be affected. ii. If the Bank is in default (as defined in Section 3(x)(1) of FDIA), all obligations of the Bank under this Agreement shall terminate as of the date of default, but vested rights of the parties shall not be affected. iii. If a notice served under Sections 8(e)(3) or (g)(1) of the FDIA (12 U.S.C. Sections 1818(e)(3) and (g)(1)) suspends and/or temporarily prohibits the Executive from participating in the conduct of the Bank's affairs, the Bank's obligations under this Agreement shall be suspended as of the date of such service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Bank shall, (x) pay the Executive all or part of the compensation withheld while its contract obligations were suspended, and (y) reinstate (in whole or in part) any of its obligations which were suspended. f. Voluntary Termination by Executive. In addition to his other rights to terminate under this Agreement, the Executive may voluntarily terminate employment with the Bank and the Company during the term of this Agreement upon at least sixty (60) days prior written notice to each Board, in which case the Executive shall receive only his compensation, vested rights and employee benefits up to the date of his termination. g. Without Just Cause or With Good Reason. i. In addition to termination pursuant to Sections 10(a) through 10(f), (x) the Board of the Company or the Bank, respectively, may, by written notice to the Executive, immediately terminate his employment with the Company or the Bank, respectively, at any time for a reason other than Just Cause (a termination "Without Just Cause") and (y) the Executive may, by written notice to the Boards of the Company and the Bank, immediately terminate this Agreement at any time within ninety (90) days following an event 6 constituting "Good Reason" as defined below (a termination "With Good Reason"). ii. Subject to Section 11 hereof, in the event of termination under this Section 10(g), the Executive shall be entitled to receive his base salary for the remaining term of the Agreement, including any renewals or extensions thereof (determined at the highest annual rate of base salary in effect pursuant to Section 4 of this Agreement for any of the twelve (12) months immediately preceding the date of such termination), plus annual cash bonuses for each year (prorated in the event of partial years) remaining under such term (determined by reference to the highest annual cash bonus received by the Executive in any of the three (3) calendar years preceding the termination). The sum due under this Section 10(g) shall be paid in one lump sum within ten (10) calendar days of such termination. Also, in such event, the Executive shall, for the remaining term of the Agreement, receive the benefits he would have received during the remaining term of the Agreement under any tax-qualified or non-tax-qualified retirement programs in which the Executive participated prior to his termination (with the amount of the benefits determined by reference to the benefits received by the Executive under such programs during the twelve (12) months preceding his termination or, if applicable, the accruals made on the Executive's behalf under such programs) and continue to participate in any benefit plans of the Company and the Bank that provide health (including medical and dental), life or disability insurance, or similar coverage upon terms no less favorable than the most favorable terms provided to senior executives of the Bank during such period. In the event that the Company or the Bank is unable to provide such coverage by reason of the Executive no longer being an employee, the Company and the Bank shall provide the Executive with comparable coverage on an individual policy basis or, if individual coverage is not available, provide a cash payment equivalent to the value of such coverage. iii. "Good Reason" shall exist if, without Executive's express written consent, the Company or the Bank materially breach any of their respective obligations under this Agreement. Without limitation, such a material breach shall be deemed to occur upon any of the following: (1) A material reduction in the Executive's responsibilities or authority, or a requirement that the Executive report to any person or group other than the Boards of the Company and the Bank (or any other effective reduction in reporting 7 responsibilities) in connection with his employment with the Company or the Bank; (2) Assignment to the Executive of duties of a non-executive nature or duties for which he is not reasonably equipped by his skills and experience; (3) A reduction in salary or benefits contrary to the terms of this Agreement, or, following a Change in Control as defined in Section 11 of this Agreement, any reduction in salary or material reduction in benefits below the amounts to which he was entitled prior to the Change in Control; (4) Termination of incentive and benefit plans, programs or arrangements, or reduction of the Executive's participation to such an extent as to materially reduce their aggregate value below their aggregate value as of the Effective Date; or (5) A requirement that the Executive relocate his principal business office or his principal place of residence outside of the area consisting of a thirty five (35) mile radius from the current main office and any branch of the Bank, or the assignment to the Executive of duties that would reasonably require such a relocation. iv. Notwithstanding the foregoing, a reduction or elimination of the Executive's participation or benefits under one or more benefit plans maintained by the Company or the Bank as part of a good faith, overall reduction or elimination of such plan or plans or benefits thereunder applicable to all participants in a manner that does not discriminate against the Executive (except as such discrimination may be necessary to comply with law) shall not constitute an event of Good Reason or a material breach of this Agreement, provided that benefits of the type or to the general extent as those offered under such plans prior to such reduction or elimination are not available to other officers of the Company or the Bank or any company that controls either of them under a plan or plans in or under which the Executive is not entitled to participate. v. Notwithstanding anything in this Agreement to the contrary, during the period beginning three (3) months prior to the announcement by the Bank or the Company of an event constituting a Change in Control (as defined in Section 11(a)) and ending twelve (12) months following the effective date of a 8 Change in Control, the Executive may voluntarily terminate his employment under this Agreement for any reason and such termination shall constitute termination With Good Reason. h. Continuing Covenant Not to Compete or Interfere with Relationships. Regardless of anything herein to the contrary, following a termination by the Company, the Bank or the Executive pursuant to Section 10(g) and continuing until the first anniversary of the effective date of such termination, the Executive shall not serve as an officer, director or employee of any bank holding company, bank, savings association, savings and loan holding company, or mortgage company which offers products or services competing with those offered by the Company or the Bank from any office in any city, town or county where Bank maintains an office as of the date of the Executive's termination and shall not interfere with the relationship of the Company or the Bank and any of its employees, agents, or representatives. 11. Termination in Connection with a Change in Control. a. For purposes of this Agreement, a "Change in Control" shall be deemed to occur on the earliest of i. The acquisition by any entity, person or group (other than the acquisition by a tax-qualified retirement plan sponsored by the Company or the Bank) of beneficial ownership, as that term is defined in Rule 13d-3 under the Securities Exchange Act of 1934, of more than 25% of the outstanding capital stock of the Company or the Bank entitled to vote for the election of directors ("Voting Stock"); ii. The commencement by any entity, person, or group (other than the Company or the Bank, a subsidiary of the Company or the Bank, or a tax-qualified retirement plan sponsored by the Company or the Bank) of a tender offer or an exchange offer for more than 25% of the outstanding Voting Stock of the Company or the Bank; iii. The effective time of (x) a merger or consolidation of the Company or the Bank with one or more other corporations as a result of which the holders of the outstanding Voting Stock of the Company or the Bank immediately prior to such merger exercise voting control over less than 51 % of the Voting Stock of the surviving or resulting corporation, or (y) a transfer of substantially all of the property of the Company or the Bank other than to an entity of which the Company or the Bank owns at least 51% of the Voting Stock; and 9 iv. At such time that, during any period of two (2) consecutive years, individuals who at the beginning of such period constitute the Board of the Company or the Bank (the "Continuing Directors") cease for any reason to constitute at least two-thirds thereof, provided that any individual whose election or nomination for election as a member of the Board was approved by a vote of at least two-thirds (_) of the Continuing Directors then in office shall be considered a Continuing Director. b. If within the period beginning three (3) months prior to the announcement by the Bank or the Company of an event constituting a Change in Control and ending twelve (12) months following the effective date of a Change in Control, (i) the Company or the Bank shall terminate the Executive's employment Without Just Cause, or (ii) the Executive shall voluntarily terminate his employment With Good Reason, the Company or the Bank shall, within ten (10) calendar days of the termination of the Executive's employment, make a lump-sum cash payment to him equal to three (3) times the sum of the Executive's (x) current base salary (determined at the highest annual rate of base salary in effect pursuant to Section 4 of this Agreement for any of the twelve (12) months immediately preceding the effective date of the Change in Control or, if higher, the rate in effect on the Executive's termination date) and (y) the highest cash bonus paid to the Executive or accrued on the Executive's behalf with respect to any of the three (3) most recently completed fiscal years of the Bank preceding the effective date of the Change in Control. This cash payment shall be made in lieu of any payment also required under Section 10(g) of this Agreement because of a termination in such period. The Executive's rights under Section 10(g) are not otherwise affected by this Section 11. Also, in such event, the Executive shall, for a thirty-six (36) month period following his termination of employment, receive the benefits he would have received over such period under any tax-qualified or non-tax-qualified retirement programs in which the Executive participated prior to his termination (with the amount of the benefits determined by reference to the benefits received by the Executive under such programs during the twelve (12) months preceding the Change in Control or, if applicable, the accruals made on the Executive's behalf during such period) and continue to participate in any benefit plans of the Company and the Bank that provide health (including medical and dental), life or disability insurance, or similar coverage upon terms no less favorable than the most favorable terms provided to senior executives of the Bank during such period. In the event that the Company or the Bank is unable to provide such coverage by reason of the Executive no longer being an employee, the Company and the Bank shall provide the Executive with comparable coverage on an individual policy or, if individual coverage is not available, provide a cash payment equivalent to the value of such coverage. 10 12. Indemnification and Liability Insurance. a. Indemnification. The Company and the Bank agree to indemnify the Executive (and his heirs, executors, and administrators), and to advance expenses related thereto, to the fullest extent permitted under applicable law and regulations against any and all expenses and liabilities reasonably incurred by him in connection with or arising out of any action, suit, or proceeding in which he may be involved by reason of his having been a director or Executive of the Company or the Bank or any of their subsidiaries (whether or not he continues to be a director or Executive at the time of incurring any such expenses or liabilities) such expenses and liabilities to include, but not be limited to, judgments, court costs, and attorney's fees and the cost of reasonable settlements, such settlements to be approved by the Board of the Company or the Bank, if such action is brought against the Executive in his capacity as an Executive or director of the Company or the Bank or any of their subsidiaries. Indemnification for expense shall not extend to matters for which the Executive has been terminated for Just Cause. Nothing contained herein shall be deemed to provide indemnification prohibited by applicable law or regulation. Notwithstanding anything herein to the contrary, the obligations of this Section 12 shall survive the term of this Agreement by a period of six (6) years. b. Insurance. During the period in which indemnification of the Executive is required under this Section, the Company or the Bank shall provide the Executive (and his heirs, executors, and administrators) with coverage under a directors' and Executives' liability policy at the expense of the Company or the Bank, at least equivalent to such coverage provided to directors and senior Executives of the Company or the Bank, whichever is more favorable to the Executive. 13. Reimbursement of Executive's Expenses to Enforce this Agreement. The Company or the Bank shall reimburse the Executive for all out-of-pocket expenses, including, without limitation, reasonable attorney's fees, incurred by the Executive in connection with successful enforcement by the Executive of the bligations of the Company or the Bank to the Executive under this Agreement. Successful enforcement shall mean the grant of an award of money or the requirement that the Company or the Bank take some action specified by this Agreement (i) as a result of court order; or (ii) otherwise by the Company or the Bank following an initial failure of the Company or the Bank to pay such money or take such action promptly after written demand therefor from the Executive stating the reason that such money or action was due under this Agreement at or prior to the time of such demand. 14. Adjustment of Certain Payments and Benefits. a. Tax Indemnification. Anything in this Agreement to the contrary notwithstanding and except as set forth below, in the event it shall be 11 determined that any payment, benefit or distribution made or provided by the Company or the Bank to or for the benefit of the Executive (whether made or provided pursuant to the terms of this Agreement or otherwise) (each referred to herein as a "Payment"), would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code") or any interest or penalties are incurred by the Executive with respect to such excise tax (the excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), the Executive shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. b. Determination of Gross-Up Payment. Subject to the provisions of Section 14(c), all determinations required to be made under this Section 14, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payments and the assumptions to be utilized in arriving at such determination, shall be made by a certified public accounting firm reasonably acceptable to the Company as may be designated by the Executive (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company, the Bank and the Executive within fifteen (15) business days of the receipt of notice from the Executive that there have been Payments, or such earlier time as is requested by the Company and the Bank. All fees and expenses of the Accounting Firm shall be borne solely by the Company and the Bank. Any Gross-Up Payment, as determined pursuant to this Section 14, shall be paid by the Company to the Executive within five days of (i) the later of the due date for the payments of any Excise Tax, and (ii) the receipt of the Accounting Firm's determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code, at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company and the Bank should have been made ("Underpayment"), consistent with the calculations required to be made hereunder. In the event that the Company and the Bank exhaust their remedies pursuant to Section 14(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. 12 c. Treatment of Claims. The Executive shall notify the Company and the Bank in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company and the Bank of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten (10) business days after the Executive is informed in writing of such claim and shall apprise the Company and the Bank of the nature of such claims and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the thirty (30) day period following the date on which it gives such notice to the Company and the Bank (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company and the Bank notify the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall: i. give the Company and the Bank any information reasonably request by the Company and the Bank relating such claim, ii. take such action in connection with contesting such claim as the Company and the Bank shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company and the Bank, iii. cooperate with the Company and the Bank in good faith in order effectively to contest such claim, and iv. permit the Company and the Bank to participate in any proceedings relating to such claim; provided, however, that the Company and the Bank shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and indemnity and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 14(c), the Company and the Bank shall control all proceedings taken in connection with such contest and, at their sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at their sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company and the Bank shall determine; 13 provided, however, that if the Company and the Bank direct the Executive to pay such claim and sue for a refund, the Company and the Bank shall advance the amount of such payment to the Executive, on an interest-free basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance. Furthermore, the Company's and the Bank's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issues raised by the Internal Revenue Service or any other taxing authority. d. Adjustments to the Gross-Up Payment. If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 14(c), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of Section 14(c)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after applicable taxes). If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 14(c), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and such denial of refund occurs prior to the expiration of thirty (30) days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of the Gross-Up Payment. 15. Injunctive Relief. If there is a breach or threatened breach of Section 10(h) of his Agreement or the prohibitions upon disclosure contained in Section 9(c) of this Agreement, the Company or the Bank and the Executive agree that there is no adequate remedy at law for such breach, and that the Company and the Bank each shall be entitled to injunctive relief restraining the Executive from such breach or threatened breach, but such relief shall not be the exclusive remedy hereunder for such breach. The parties hereto likewise agree that the Executive, without limitation, shall be entitled to injunctive relief to enforce the obligations of the Company and the Bank under Section 11 of this Agreement. 16. Successors and Assigns. a. This Agreement shall inure to the benefit of and be binding upon any corporate or other successor of the Company or the Bank which shall acquire, directly or indirectly, by merger, consolidation, purchase or otherwise, all or substantially all of the assets or stock of the Company or the Bank. 14 b. Since the Bank and the Company are contracting for the unique and personal skills of the Executive, the Executive shall be precluded from assigning or delegating his rights or duties hereunder without first obtaining the written consent of the Bank and the Company. 17. No Mitigation. The Executive shall not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise and no such payment shall be offset or reduced by the amount of any compensation or benefits provided to the Executive as a result of any subsequent employment. 18. Notices. All notices, requests, demands and other communications in connection with this Agreement shall be made in writing and shall be deemed to have been given when delivered by hand or 48 hours after mailing at any general or branch United States Post Office, by registered or certified mail, postage prepaid, addressed as follows, or to such other address as shall have been designated in writing by the addressee: a. If to the Company or the Bank: Copy to: Corporate Secretary Coastal Financial Corporation 2619 Oak Street Myrtle Beach, S.C. 29577 b. If to the Executive: Mr. Jerry L. Rexroad 3706 Kinloch Drive Myrtle Beach, S.C. 29577 19. Joint and Several Liability; Payments by the Company and the Bank. To the extent permitted by law, except as otherwise provided herein, the Company and the Bank shall be jointly and severally liable for the payment of all amounts due under this Agreement. The Company hereby agrees that it shall be jointly and severally liable with the Bank for the payment of all amounts due under this Agreement and shall guarantee the performance of the Bank's obligations thereunder, provided that the Company shall not be required by this Agreement to pay to the Executive a salary or any bonuses or any other cash payments, except in the event that the Bank does not fulfill the obligations to the Executive hereunder for such payments. 20. No Plan Created by this Agreement. The Executive, the Company and the Bank expressly declare and agree that this Agreement was negotiated among them and that no provision or provisions of this Agreement are intended to, or shall be deemed to, create any plan for purposes of the Employee Retirement Income Security Act or any other law or regulation, and the Company, the Bank and the Executive each expressly waives any right to assert the contrary. Any assertion in any judicial or administrative filing, hearing, or process by or on behalf of the Executive or the Company or the Bank that such a plan was so created by this 15 Agreement shall be deemed a material breach of this Agreement by the party making such an assertion. 21. Amendments. No amendments or additions to this Agreement shall be binding unless made in writing and signed by all of the parties, except as herein otherwise specifically provided. 22. Applicable Law. Except to the extent preempted by Federal law, the laws of the State of Delaware shall govern this Agreement in all respects, whether as to its validity, construction, capacity, performance or otherwise. 23. Severability. The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof. 24. Headings. Headings contained herein are for convenience of reference only. 25. Entire Agreement. This Agreement, together with any understandings or modifications thereof as agreed to in writing by the parties, shall constitute the entire agreement among the parties hereto with respect to the subject matter hereof, other than written agreements with respect to specific plans, programs or arrangements described in Sections 5 and 6. This Agreement supercedes and replaces in its entirety the Agreement dated March 21, 1995, as amended, between the Company, the Bank and the Executive. 16 IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first set forth above. Attest: COASTAL FINANCIAL CORPORATION /s/ Susan J. Cooke By: /s/ J.T. Clemmons - --------------------------------- --------------------------------- Susan J. Cooke J.T. Clemmons /s/ Sandra R. Zanfini Title: Chairman - --------------------------------- Sandra R. Zanfini Attest: COASTAL FEDERAL BANK /s/ Susan J. Cooke By: /s/ J.T. Clemmons - --------------------------------- --------------------------------- Susan J. Cooke J.T. Clemmons Title: Chairman /s/ Sandra R. Zanfini - --------------------------------- Sandra R. Zanfini Witness: /s/ Susan J. Cooke /s/ Jerry L. Rexroad - --------------------------------- ------------------------------------ Susan J. Cooke EXECUTIVE Jerry L. Rexroad 17 EX-10 5 ex10c.txt Exhibit 10(c) FORM OF EMPLOYMENT AGREEMENT THIS AGREEMENT (the "Agreement"), made this 24TH day of November 2003, by and among COASTAL FINANCIAL CORPORATION, a Delaware corporation ("the Company"), COASTAL FEDERAL BANK, a wholly owned subsidiary of the Company (the "Bank"), and Phillip G. Stalvey (the "Executive"). WITNESSETH WHEREAS, the Company and the Bank desire to retain the services of the Executive as Executive Vice President of the Company and the Bank; WHEREAS, the Company and the Bank have previously entered into an employment agreement with the Executive; WHEREAS, the Executive and the respective Boards of Directors of the Bank and the Company desire to enter into an updated and revised agreement setting forth the terms and conditions of the continuing employment of the Executive and the related rights and obligations of each of the parties; NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, it is agreed as follows: 1. Employment. The Executive is employed as the Executive Vice President of the Company and the Bank and Banking Group Leader of the Bank, reporting directly to their respective Boards. The Executive shall have responsibility for the general management and control of the business and affairs of the Company, the Bank, and their respective subsidiaries, and shall perform all duties and shall have all powers which are commonly incident to the offices of Executive Vice President, or which, consistent with those offices, are delegated to him by the respective Boards. 2. Location and Facilities. The Executive will be furnished with the working facilities and staff customary for executive officers with the title and duties set forth in Section 1 and as are necessary for him to perform his duties. The location of such facilities and staff shall be at the principal administrative offices of the Company and the Bank, or at such other site or sites customary for such offices. 3. Term. a. The term of this Agreement shall be (i) the initial term, consisting of the period commencing on the date of this Agreement (the "Effective Date") and ending on the third anniversary of the Effective Date, plus (ii) any and all extensions of the initial term made pursuant to this Section 3. b. Commencing on the Effective Date and on each day thereafter, the term under this Agreement shall be renewed automatically for an additional one (1) day period beyond the then effective expiration date without action by any party, provided that neither the Company, on the one hand, nor Executive, on the other, shall have given at least sixty (60) days written notice of its or his desire that the term not be renewed. In the case such notice is given by one party to the other, the term of this Agreement shall become fixed and shall end on the third anniversary of the date of written notice. 4. Base Salary. a. The Bank agrees to pay the Executive during the term of this Agreement a base salary at the rate of $181,500.00 per annum, payable in accordance with the Bank's customary payroll practices. b. The Board of the Bank shall review annually the rate of the Executive's base salary based upon factors they deem relevant, and may maintain or increase his salary, provided that no such action shall reduce the rate of salary below the rate in effect on the Effective Date. c. In the absence of action by the Board of the Bank, the Executive shall continue to receive salary at the per annum rate specified on the Effective Date or, if another rate has been established under the provisions of this Section 4, the rate last properly established by action of the Board of the Bank under the provisions of this Section 4. 5. Bonuses. The Executive shall be entitled to participate in any discretionary bonus or other incentive compensation programs that the Board of the Company or the Bank may establish from time to time for the benefit of the officers or employees of the Company or the Bank. 6. Benefit Plans. The Executive shall be entitled to participate in such life insurance, medical, dental, pension, profit sharing, and retirement plans, stock compensation plans and other programs and arrangements as may be approved from time to time by the Company or the Bank for the benefit of their respective employees. 7. Vacation and Leave. a. The Executive shall be entitled to vacations and other leave in accordance with Bank policy for senior executives, or otherwise as approved by the Board, but in any event, not less than four (4) weeks vacation per calendar year. b. In addition to paid vacations and other leave, the Executive shall be entitled, without loss of pay, to absent himself voluntarily from the performance of his employment for such additional periods of time and for such valid and legitimate reasons as the Board of the Company and the 2 Bank may in their discretion determine. Further, the Board of the Company or the Bank may grant to the Executive a leave or leaves of absence, with or without pay, at such time or times and upon such terms and conditions as such Boards in their discretion may determine. 8. Expense Payments and Reimbursements. The Executive shall be reimbursed for all reasonable out-of-pocket business expenses that he shall incur in connection with his services under this Agreement upon substantiation of such expenses in accordance with applicable policies of the Company or the Bank. 9. Loyalty. a. During the term of this Agreement the Executive: (i) shall devote all his time, attention, skill, and efforts to the faithful performance of his duties hereunder; provided, however, that from time to time, the Executive may serve on the boards of directors of, and hold any other offices or positions in, companies or organizations which will not present any conflicts of interest with the Company or the Bank or any of their subsidiaries or affiliates, unfavorably affect the performance of Executive's duties pursuant to this Agreement, or violate any applicable statute or regulation and (ii) shall not engage in any business or activity contrary to the business affairs or interests of the Company or the Bank. b. Nothing contained in this Agreement shall prevent or limit the Executive's right to invest in the capital stock or other securities of any business dissimilar from that of the Company and the Bank, or, solely as a passive, minority investor, in any business. c. The Executive agrees to maintain the confidentiality of any and all information concerning the operation or financial status of the Company and the Bank; the names or addresses of any of its borrowers, depositors and other customers; any information concerning or obtained from such customers; and any other information concerning the Company and the Bank to which he may be exposed during the course of his employment. The Executive further agrees that, unless required by law or specifically permitted by the Board in writing, he will not disclose to any person or entity, either during or subsequent to his employment, any of the above-mentioned information which is not generally known to the public, nor shall he employ such information in any way other than for the benefit of the Company and the Bank. 10. Termination and Termination Pay. Subject to Section 11 of this Agreement, the Executive's employment under this Agreement may be terminated in the following circumstances: 3 a. Death. The Executive's employment under this Agreement shall terminate upon his death during the term of this Agreement, in which event the Executive's estate shall be entitled to receive the compensation due to the Executive through the last day of the calendar month in which his death occurred. b. Retirement. This Agreement shall be terminated upon the retirement of the Executive under the retirement benefit plan or plans in which he participates pursuant to Section 6 of this Agreement or otherwise. For all other purposes, the Executive's termination of employment at retirement shall be treated in the same manner as if he voluntarily terminated employment pursuant to Section 10(f). c. Disability. i. The Company, the Bank, or the Executive may terminate the Executive's employment after having established the Executive's Disability. For purposes of this Agreement, "Disability" means a physical or mental infirmity that impairs the Executive's ability to substantially perform his duties under this Agreement and that results in the Executive's becoming eligible for long-term disability benefits under the Company's or the Bank's long-term disability plan (or, if the Company or the Bank has no such plan in effect, that impairs the Executive's ability to substantially perform his duties under this Agreement for a period of one hundred eighty (180) consecutive days). The Boards of the Company and the Bank shall determine whether or not the Executive is and continues to be permanently disabled for purposes of this Agreement in good faith, based upon competent medical advice and other factors that they reasonably believe to be relevant. As a condition to any benefits, such Board may require the Executive to submit to such physical or mental evaluations and tests as it deems reasonably appropriate. ii. In the event of such Disability, the Executive's obligation to perform services under this Agreement will terminate. In the event of such termination, the Executive shall continue to receive seventy-five (75) percent of his monthly base salary (at the annual rate in effect on his date of termination) through the earlier of the date of the Executive's death, the date he attains age 65 or the date which is three (3) years after the Executive's termination date. Such payments shall be reduced by the amount of any short- or long-term disability benefits payable to the Executive under any other disability program sponsored by the Company or the Bank. In addition, during any period of the Executive's Disability in which he is receiving payments under this paragraph, the Executive and his dependents shall, to the greatest extent possible, 4 continue to be covered under all benefit plans (including, without limitation, retirement plans and medical, dental and life insurance plans) of the Company and the Bank in which Executive participated prior to his Disability on the same terms as if Executive were actively employed by the Company and the Bank. d. Just Cause. i. The Board of the Company or the Bank may, by written notice to the Executive in the form and manner specified in this paragraph, immediately terminate his employment with the Company or the Bank, respectively, at any time, for Just Cause. The Executive shall have no right to receive compensation or other benefits for any period after termination for Just Cause except for vested benefits. Termination for "Just Cause" shall mean termination because of, in the good faith determination of the Company's or the Bank's Board, the Executive's: (1) Personal dishonesty; (2) Incompetence; (3) Willful misconduct; (4) Breach of fiduciary duty involving personal profit; (5) Intentional failure to perform duties under this Agreement; (6) Willful violation of any law, rule or regulation (other than traffic violations or similar offenses) that reflects adversely on the reputation of the Bank, any felony conviction, any violation of law involving moral turpitude, or any violation of a final cease-and-desist order; or (7) Material breach by the Executive of any provision of this Agreement. ii Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated for Just Cause by the Company or the Bank unless there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths (3/4) of the entire membership of the Board of the Company or the Bank at a meeting of such Board called and held for the purpose (after reasonable notice to the Executive and an opportunity for the Executive to be heard before the Board with counsel), finding that in the good faith opinion of such Board the 5 Executive was guilty of conduct described above and specifying the particulars thereof. e. Certain Regulatory Events. i. If the Executive is removed and/or permanently prohibited from participating in the conduct of the Bank's affairs by an order issued under Sections 8(e)(4) or 8(g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. ss.ss. 1818(e)(4) and (g)(1)), all obligations of the Bank under this Agreement shall terminate as of the effective date of the order, but vested rights of the parties shall not be affected. ii. If the Bank is in default (as defined in Section 3(x)(1) of FDIA), all obligations of the Bank under this Agreement shall terminate as of the date of default, but vested rights of the parties shall not be affected. iii. If a notice served under Sections 8(e)(3) or (g)(1) of the FDIA (12 U.S.C. Sections 1818(e)(3) and (g)(1)) suspends and/or temporarily prohibits the Executive from participating in the conduct of the Bank's affairs, the Bank's obligations under this Agreement shall be suspended as of the date of such service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Bank shall, (x) pay the Executive all or part of the compensation withheld while its contract obligations were suspended, and (y) reinstate (in whole or in part) any of its obligations which were suspended. f. Voluntary Termination by Executive. In addition to his other rights to terminate under this Agreement, the Executive may voluntarily terminate employment with the Bank and the Company during the term of this Agreement upon at least sixty (60) days prior written notice to each Board, in which case the Executive shall receive only his compensation, vested rights and employee benefits up to the date of his termination. g. Without Just Cause or With Good Reason. i. In addition to termination pursuant to Sections 10(a) through 10(f), (x) the Board of the Company or the Bank, respectively, may, by written notice to the Executive, immediately terminate his employment with the Company or the Bank, respectively, at any time for a reason other than Just Cause (a termination "Without Just Cause") and (y) the Executive may, by written notice to the Boards of the Company and the Bank, immediately terminate this Agreement at any time within ninety (90) days following an event 6 constituting "Good Reason" as defined below (a termination "With Good Reason"). ii. Subject to Section 11 hereof, in the event of termination under this Section 10(g), the Executive shall be entitled to receive his base salary for the remaining term of the Agreement, including any renewals or extensions thereof (determined at the highest annual rate of base salary in effect pursuant to Section 4 of this Agreement for any of the twelve (12) months immediately preceding the date of such termination), plus annual cash bonuses for each year (prorated in the event of partial years) remaining under such term (determined by reference to the highest annual cash bonus received by the Executive in any of the three (3) calendar years preceding the termination). The sum due under this Section 10(g) shall be paid in one lump sum within ten (10) calendar days of such termination. Also, in such event, the Executive shall, for the remaining term of the Agreement, receive the benefits he would have received during the remaining term of the Agreement under any tax-qualified or non-tax-qualified retirement programs in which the Executive participated prior to his termination (with the amount of the benefits determined by reference to the benefits received by the Executive under such programs during the twelve (12) months preceding his termination or, if applicable, the accruals made on the Executive's behalf under such programs) and continue to participate in any benefit plans of the Company and the Bank that provide health (including medical and dental), life or disability insurance, or similar coverage upon terms no less favorable than the most favorable terms provided to senior executives of the Bank during such period. In the event that the Company or the Bank is unable to provide such coverage by reason of the Executive no longer being an employee, the Company and the Bank shall provide the Executive with comparable coverage on an individual policy basis or, if individual coverage is not available, provide a cash payment equivalent to the value of such coverage. iii. "Good Reason" shall exist if, without Executive's express written consent, the Company or the Bank materially breach any of their respective obligations under this Agreement. Without limitation, such a material breach shall be deemed to occur upon any of the following: (1) A material reduction in the Executive's responsibilities or authority, or a requirement that the Executive report to any person or group other than the Boards of the Company and the Bank (or any other effective reduction in reporting 7 responsibilities) in connection with his employment with the Company or the Bank; (2) Assignment to the Executive of duties of a non-executive nature or duties for which he is not reasonably equipped by his skills and experience; (3) A reduction in salary or benefits contrary to the terms of this Agreement, or, following a Change in Control as defined in Section 11 of this Agreement, any reduction in salary or material reduction in benefits below the amounts to which he was entitled prior to the Change in Control; (4) Termination of incentive and benefit plans, programs or arrangements, or reduction of the Executive's participation to such an extent as to materially reduce their aggregate value below their aggregate value as of the Effective Date; or (5) A requirement that the Executive relocate his principal business office or his principal place of residence outside of the area consisting of a thirty five (35) mile radius from the current main office and any branch of the Bank, or the assignment to the Executive of duties that would reasonably require such a relocation. iv. Notwithstanding the foregoing, a reduction or elimination of the Executive's participation or benefits under one or more benefit plans maintained by the Company or the Bank as part of a good faith, overall reduction or elimination of such plan or plans or benefits thereunder applicable to all participants in a manner that does not discriminate against the Executive (except as such discrimination may be necessary to comply with law) shall not constitute an event of Good Reason or a material breach of this Agreement, provided that benefits of the type or to the general extent as those offered under such plans prior to such reduction or elimination are not available to other officers of the Company or the Bank or any company that controls either of them under a plan or plans in or under which the Executive is not entitled to participate. v. Notwithstanding anything in this Agreement to the contrary, during the period beginning three (3) months prior to the announcement by the Bank or the Company of an event constituting a Change in Control (as defined in Section 11(a)) and ending twelve (12) months following the effective date of a 8 Change in Control, the Executive may voluntarily terminate his employment under this Agreement for any reason and such termination shall constitute termination With Good Reason. h. Continuing Covenant Not to Compete or Interfere with Relationships. Regardless of anything herein to the contrary, following a termination by the Company, the Bank or the Executive pursuant to Section 10(g) and continuing until the first anniversary of the effective date of such termination, the Executive shall not serve as an officer, director or employee of any bank holding company, bank, savings association, savings and loan holding company, or mortgage company which offers products or services competing with those offered by the Company or the Bank from any office in any city, town or county where Bank maintains an office as of the date of the Executive's termination and shall not interfere with the relationship of the Company or the Bank and any of its employees, agents, or representatives. 11. Termination in Connection with a Change in Control. a. For purposes of this Agreement, a "Change in Control" shall be deemed to occur on the earliest of i. The acquisition by any entity, person or group (other than the acquisition by a tax-qualified retirement plan sponsored by the Company or the Bank) of beneficial ownership, as that term is defined in Rule 13d-3 under the Securities Exchange Act of 1934, of more than 25% of the outstanding capital stock of the Company or the Bank entitled to vote for the election of directors ("Voting Stock"); ii. The commencement by any entity, person, or group (other than the Company or the Bank, a subsidiary of the Company or the Bank, or a tax-qualified retirement plan sponsored by the Company or the Bank) of a tender offer or an exchange offer for more than 25% of the outstanding Voting Stock of the Company or the Bank; iii. The effective time of (x) a merger or consolidation of the Company or the Bank with one or more other corporations as a result of which the holders of the outstanding Voting Stock of the Company or the Bank immediately prior to such merger exercise voting control over less than 51 % of the Voting Stock of the surviving or resulting corporation, or (y) a transfer of substantially all of the property of the Company or the Bank other than to an entity of which the Company or the Bank owns at least 51% of the Voting Stock; and 9 iv. At such time that, during any period of two (2) consecutive years, individuals who at the beginning of such period constitute the Board of the Company or the Bank (the "Continuing Directors") cease for any reason to constitute at least two-thirds thereof, provided that any individual whose election or nomination for election as a member of the Board was approved by a vote of at least two-thirds (_) of the Continuing Directors then in office shall be considered a Continuing Director. b. If within the period beginning three (3) months prior to the announcement by the Bank or the Company of an event constituting a Change in Control and ending twelve (12) months following the effective date of a Change in Control, (i) the Company or the Bank shall terminate the Executive's employment Without Just Cause, or (ii) the Executive shall voluntarily terminate his employment With Good Reason, the Company or the Bank shall, within ten (10) calendar days of the termination of the Executive's employment, make a lump-sum cash payment to him equal to three (3) times the sum of the Executive's (x) current base salary (determined at the highest annual rate of base salary in effect pursuant to Section 4 of this Agreement for any of the twelve (12) months immediately preceding the effective date of the Change in Control or, if higher, the rate in effect on the Executive's termination date) and (y) the highest cash bonus paid to the Executive or accrued on the Executive's behalf with respect to any of the three (3) most recently completed fiscal years of the Bank preceding the effective date of the Change in Control. This cash payment shall be made in lieu of any payment also required under Section 10(g) of this Agreement because of a termination in such period. The Executive's rights under Section 10(g) are not otherwise affected by this Section 11. Also, in such event, the Executive shall, for a thirty-six (36) month period following his termination of employment, receive the benefits he would have received over such period under any tax-qualified or non-tax-qualified retirement programs in which the Executive participated prior to his termination (with the amount of the benefits determined by reference to the benefits received by the Executive under such programs during the twelve (12) months preceding the Change in Control or, if applicable, the accruals made on the Executive's behalf during such period) and continue to participate in any benefit plans of the Company and the Bank that provide health (including medical and dental), life or disability insurance, or similar coverage upon terms no less favorable than the most favorable terms provided to senior executives of the Bank during such period. In the event that the Company or the Bank is unable to provide such coverage by reason of the Executive no longer being an employee, the Company and the Bank shall provide the Executive with comparable coverage on an individual policy or, if individual coverage is not available, provide a cash payment equivalent to the value of such coverage. 10 12. Indemnification and Liability Insurance. a. Indemnification. The Company and the Bank agree to indemnify the Executive (and his heirs, executors, and administrators), and to advance expenses related thereto, to the fullest extent permitted under applicable law and regulations against any and all expenses and liabilities reasonably incurred by him in connection with or arising out of any action, suit, or proceeding in which he may be involved by reason of his having been a director or Executive of the Company or the Bank or any of their subsidiaries (whether or not he continues to be a director or Executive at the time of incurring any such expenses or liabilities) such expenses and liabilities to include, but not be limited to, judgments, court costs, and attorney's fees and the cost of reasonable settlements, such settlements to be approved by the Board of the Company or the Bank, if such action is brought against the Executive in his capacity as an Executive or director of the Company or the Bank or any of their subsidiaries. Indemnification for expense shall not extend to matters for which the Executive has been terminated for Just Cause. Nothing contained herein shall be deemed to provide indemnification prohibited by applicable law or regulation. Notwithstanding anything herein to the contrary, the obligations of this Section 12 shall survive the term of this Agreement by a period of six (6) years. b. Insurance. During the period in which indemnification of the Executive is required under this Section, the Company or the Bank shall provide the Executive (and his heirs, executors, and administrators) with coverage under a directors' and Executives' liability policy at the expense of the Company or the Bank, at least equivalent to such coverage provided to directors and senior Executives of the Company or the Bank, whichever is more favorable to the Executive. 13. Reimbursement of Executive's Expenses to Enforce this Agreement. The Company or the Bank shall reimburse the Executive for all out-of-pocket expenses, including, without limitation, reasonable attorney's fees, incurred by the Executive in connection with successful enforcement by the Executive of the obligations of the Company or the Bank to the Executive under this Agreement. Successful enforcement shall mean the grant of an award of money or the requirement that the Company or the Bank take some action specified by this Agreement (i) as a result of court order; or (ii) otherwise by the Company or the Bank following an initial failure of the Company or the Bank to pay such money or take such action promptly after written demand therefor from the Executive stating the reason that such money or action was due under this Agreement at or prior to the time of such demand. 14. Adjustment of Certain Payments and Benefits. a. Tax Indemnification. Anything in this Agreement to the contrary notwithstanding and except as set forth below, in the event it shall be 11 determined that any payment, benefit or distribution made or provided by the Company or the Bank to or for the benefit of the Executive (whether made or provided pursuant to the terms of this Agreement or otherwise) (each referred to herein as a "Payment"), would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code") or any interest or penalties are incurred by the Executive with respect to such excise tax (the excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), the Executive shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. b. Determination of Gross-Up Payment. Subject to the provisions of Section 14(c), all determinations required to be made under this Section 14, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payments and the assumptions to be utilized in arriving at such determination, shall be made by a certified public accounting firm reasonably acceptable to the Company as may be designated by the Executive (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company, the Bank and the Executive within fifteen (15) business days of the receipt of notice from the Executive that there have been Payments, or such earlier time as is requested by the Company and the Bank. All fees and expenses of the Accounting Firm shall be borne solely by the Company and the Bank. Any Gross-Up Payment, as determined pursuant to this Section 14, shall be paid by the Company to the Executive within five days of (i) the later of the due date for the payments of any Excise Tax, and (ii) the receipt of the Accounting Firm's determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code, at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company and the Bank should have been made ("Underpayment"), consistent with the calculations required to be made hereunder. In the event that the Company and the Bank exhaust their remedies pursuant to Section 14(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. 12 c. Treatment of Claims. The Executive shall notify the Company and the Bank in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company and the Bank of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten (10) business days after the Executive is informed in writing of such claim and shall apprise the Company and the Bank of the nature of such claims and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the thirty (30) day period following the date on which it gives such notice to the Company and the Bank (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company and the Bank notify the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall: i. give the Company and the Bank any information reasonably request by the Company and the Bank relating such claim, ii. take such action in connection with contesting such claim as the Company and the Bank shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company and the Bank, iii. cooperate with the Company and the Bank in good faith in order effectively to contest such claim, and iv. permit the Company and the Bank to participate in any proceedings relating to such claim; provided, however, that the Company and the Bank shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and indemnity and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 14(c), the Company and the Bank shall control all proceedings taken in connection with such contest and, at their sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at their sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company and the Bank shall determine; 13 provided, however, that if the Company and the Bank direct the Executive to pay such claim and sue for a refund, the Company and the Bank shall advance the amount of such payment to the Executive, on an interest-free basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance. Furthermore, the Company's and the Bank's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issues raised by the Internal Revenue Service or any other taxing authority. d. Adjustments to the Gross-Up Payment. If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 14(c), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of Section 14(c)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after applicable taxes). If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 14(c), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and such denial of refund occurs prior to the expiration of thirty (30) days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of the Gross-Up Payment. 15. Injunctive Relief. If there is a breach or threatened breach of Section 10(h) of his Agreement or the prohibitions upon disclosure contained in Section 9(c) of this Agreement, the Company or the Bank and the Executive agree that there is no adequate remedy at law for such breach, and that the Company and the Bank each shall be entitled to injunctive relief restraining the Executive from such breach or threatened breach, but such relief shall not be the exclusive remedy hereunder for such breach. The parties hereto likewise agree that the Executive, without limitation, shall be entitled to injunctive relief to enforce the obligations of the Company and the Bank under Section 11 of this Agreement. 16. Successors and Assigns. a. This Agreement shall inure to the benefit of and be binding upon any corporate or other successor of the Company or the Bank which shall acquire, directly or indirectly, by merger, consolidation, purchase or otherwise, all or substantially all of the assets or stock of the Company or the Bank. 14 b. Since the Bank and the Company are contracting for the unique and personal skills of the Executive, the Executive shall be precluded from assigning or delegating his rights or duties hereunder without first obtaining the written consent of the Bank and the Company. 17. No Mitigation. The Executive shall not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise and no such payment shall be offset or reduced by the amount of any compensation or benefits provided to the Executive as a result of any subsequent employment. 18. Notices. All notices, requests, demands and other communications in connection with this Agreement shall be made in writing and shall be deemed to have been given when delivered by hand or 48 hours after mailing at any general or branch United States Post Office, by registered or certified mail, postage prepaid, addressed as follows, or to such other address as shall have been designated in writing by the addressee: a. If to the Company or the Bank: Copy to: Corporate Secretary Coastal Financial Corporation 2619 Oak Street Myrtle Beach, S.C. 29577 b. If to the Executive: Mr. Phillip G. Stalvey 4826 Keel Court Myrtle Beach, S.C. 29579 19. Joint and Several Liability; Payments by the Company and the Bank. To the extent permitted by law, except as otherwise provided herein, the Company and the Bank shall be jointly and severally liable for the payment of all amounts due under this Agreement. The Company hereby agrees that it shall be jointly and severally liable with the Bank for the payment of all amounts due under this Agreement and shall guarantee the performance of the Bank's obligations thereunder, provided that the Company shall not be required by this Agreement to pay to the Executive a salary or any bonuses or any other cash payments, except in the event that the Bank does not fulfill the obligations to the Executive hereunder for such payments. 20. No Plan Created by this Agreement. The Executive, the Company and the Bank expressly declare and agree that this Agreement was negotiated among them and that no provision or provisions of this Agreement are intended to, or shall be deemed to, create any plan for purposes of the Employee Retirement Income Security Act or any other law or regulation, and the Company, the Bank and the Executive each expressly waives any right to assert the contrary. Any assertion in any judicial or administrative filing, hearing, or process by or on behalf of the Executive or the Company or the Bank that such a plan was so created by this 15 Agreement shall be deemed a material breach of this Agreement by the party making such an assertion. 21. Amendments. No amendments or additions to this Agreement shall be binding unless made in writing and signed by all of the parties, except as herein otherwise specifically provided. 22. Applicable Law. Except to the extent preempted by Federal law, the laws of the State of Delaware shall govern this Agreement in all respects, whether as to its validity, construction, capacity, performance or otherwise. 23. Severability. The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof. 24. Headings. Headings contained herein are for convenience of reference only. 25. Entire Agreement. This Agreement, together with any understandings or modifications thereof as agreed to in writing by the parties, shall constitute the entire agreement among the parties hereto with respect to the subject matter hereof, other than written agreements with respect to specific plans, programs or arrangements described in Sections 5 and 6. This Agreement supercedes and replaces in its entirety the Agreement dated October 21, 1997, as amended, between the Company, the Bank and the Executive. 16 IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first set forth above. Attest: COASTAL FINANCIAL CORPORATION /s/ Susan J. Cooke By: /s/ J.T. Clemmons - -------------------------------- ----------------------------------------- Susan J. Cooke J.T. Clemmons Title: Chairman /s/ Sandra R. Zanfini - -------------------------------- Sandra R. Zanfini Attest: COASTAL FEDERAL BANK /s/ Susan J. Cooke By:/s/ J.T. Clemmons - -------------------------------- ----------------------------------------- Susan J. Cooke J.T. Clemmons Title: Chairman /s/ Sandra R. Zanfini - -------------------------------- Sandra R. Zanfini Witness: /s/ Carolyn A. Cremen /s/ Phillip G. Stalvey - -------------------------------- ----------------------------------------- Carolyn A. Cremen EXECUTIVE Phillip G. Stalvey 17 EX-10 6 ex10d.txt Exhibit 10(d) FORM OF EMPLOYMENT AGREEMENT THIS AGREEMENT (the "Agreement"), made this 24th day of November, 2003, by and among COASTAL FINANCIAL CORPORATION, a Delaware corporation ("the Company"), COASTAL FEDERAL BANK, a wholly owned subsidiary of the Company (the "Bank"), and Steven J. Sherry (the "Executive"). WITNESSETH WHEREAS, the Company and the Bank desire to retain the services of the Executive as Executive Vice President/Chief Marketing Director of the Company and the Bank; WHEREAS, the Company and the Bank have previously entered into an employment agreement with the Executive; WHEREAS, the Executive and the respective Boards of Directors of the Bank and the Company desire to enter into an updated and revised agreement setting forth the terms and conditions of the continuing employment of the Executive and the related rights and obligations of each of the parties; NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, it is agreed as follows: 1. Employment. The Executive is employed as Executive Vice President/Chief Marketing Director of the Company and the Bank. The Executive shall perform all duties which are customarily performed by persons situated in a similar executive capacity and such other duties as are delegated to him by the Chief Executive Officer from time to time. 2. Location and Facilities. The Executive will be furnished with the working facilities and staff customary for executive officers with the title and duties set forth in Section 1 and as are necessary for him to perform his duties. The location of such facilities and staff shall be at the principal administrative offices of the Company and the Bank, or at such other site or sites customary for such offices. 3. Term. a. The term of this Agreement shall be (i) the initial term, consisting of the period commencing on the date of this Agreement (the "Effective Date") and ending on the first anniversary of the Effective Date, plus (ii) any and all extensions of the initial term made pursuant to this Section 3. b. Commencing on the Effective Date and on each day thereafter, the term under this Agreement shall be renewed automatically for an additional one (1) day period beyond the then effective expiration date without action by any party, provided that neither the Company, on the one hand, nor Executive, on the other, shall have given at least sixty (60) days written notice of its or his desire that the term not be renewed. In the case such notice is given by one party to the other, the term of this Agreement shall become fixed and shall end on the first anniversary of the date of written notice. 4. Base Salary. a. The Bank agrees to pay the Executive during the term of this Agreement a base salary at the rate of $152,750.00 per annum, payable in accordance with the Bank's customary payroll practices. b. The Board of the Bank shall review annually the rate of the Executive's base salary based upon factors they deem relevant, and may maintain or increase his salary, provided that no such action shall reduce the rate of salary below the rate in effect on the Effective Date. c. In the absence of action by the Board of the Bank, the Executive shall continue to receive salary at the per annum rate specified on the Effective Date or, if another rate has been established under the provisions of this Section 4, the rate last properly established by action of the Board of the Bank under the provisions of this Section 4. 5. Bonuses. The Executive shall be entitled to participate in any discretionary bonus or other incentive compensation programs that the Board of the Company or the Bank may establish from time to time for the benefit of the officers or employees of the Company or the Bank. 6. Benefit Plans. The Executive shall be entitled to participate in such life insurance, medical, dental, pension, profit sharing, and retirement plans, stock compensation plans and other programs and arrangements as may be approved from time to time by the Company or the Bank for the benefit of their respective employees. 7. Vacation and Leave. The Executive shall be entitled to vacations and other leave in accordance with Bank policy for senior executives. 8. Expense Payments and Reimbursements. The Executive shall be reimbursed for all reasonable out-of-pocket business expenses that he shall incur in connection with his services under this Agreement upon substantiation of such expenses in accordance with applicable policies of the Company or the Bank. 9. Loyalty. a. During the term of this Agreement the Executive: (i) shall devote all his time, attention, skill, and efforts to the faithful performance of his duties hereunder; provided, however, that from time to time, the Executive may serve on the boards of directors of, and hold any other offices or positions in, companies or 2 organizations which will not present any conflicts of interest with the Company or the Bank or any of their subsidiaries or affiliates, unfavorably affect the performance of Executive's duties pursuant to this Agreement, or violate any applicable statute or regulation; and (ii) shall not engage in any business or activity contrary to the business affairs or interests of the Company or the Bank. b. Nothing contained in this Agreement shall prevent or limit the Executive's right to invest in the capital stock or other securities of any business dissimilar from that of the Company and the Bank, or, solely as a passive, minority investor, in any business. c. The Executive agrees to maintain the confidentiality of any and all information concerning the operation or financial status of the Company and the Bank; the names or addresses of any of its borrowers, depositors and other customers; any information concerning or obtained from such customers; and any other information concerning the Company and the Bank to which he may be exposed during the course of his employment. The Executive further agrees that, unless required by law or specifically permitted by the Board in writing, he will not disclose to any person or entity, either during or subsequent to his employment, any of the above-mentioned information which is not generally known to the public, nor shall he employ such information in any way other than for the benefit of the Company and the Bank. 10. Termination and Termination Pay. Subject to Section 11 of this Agreement, the Executive's employment under this Agreement may be terminated in the following circumstances: a. Death. The Executive's employment under this Agreement shall terminate upon his death during the term of this Agreement, in which event the Executive's estate shall be entitled to receive the compensation due to the Executive through the last day of the calendar month in which his death occurred. b. Retirement. This Agreement shall be terminated upon the retirement of the Executive under the retirement benefit plan or plans in which he participates pursuant to Section 6 of this Agreement or otherwise. For all other purposes, the Executive's termination of employment at retirement shall be treated in the same manner as if he voluntarily terminated employment pursuant to Section 10(f). c. Disability. i. The Company, the Bank, or the Executive may terminate the Executive's employment after having established the 3 Executive's Disability. For purposes of this Agreement, "Disability" means a physical or mental infirmity that impairs the Executive's ability to substantially perform his duties under this Agreement and that results in the Executive's becoming eligible for long-term disability benefits under the Company's or the Bank's long-term disability plan (or, if the Company or the Bank has no such plan in effect, that impairs the Executive's ability to substantially perform his duties under this Agreement for a period of one hundred eighty (180) consecutive days). The Boards of the Company and the Bank shall determine whether or not the Executive is and continues to be permanently disabled for purposes of this Agreement in good faith, based upon competent medical advice and other factors that they reasonably believe to be relevant. As a condition to any benefits, such Board may require the Executive to submit to such physical or mental evaluations and tests as it deems reasonably appropriate. ii. In the event of such Disability, the Executive's obligation to perform services under this Agreement will terminate. In the event of such termination, the Executive shall continue to receive seventy-five (75) percent of his monthly base salary (at the annual rate in effect on his date of termination) through the earlier of the date of the Executive's death, the date he attains age 65 or the date which is one (1) year after the Executive's termination date. Such payments shall be reduced by the amount of any short- or long-term disability benefits payable to the Executive under any other disability program sponsored by the Company or the Bank. In addition, during any period of the Executive's Disability in which he is receiving payments under this paragraph, the Executive and his dependents shall, to the greatest extent possible, continue to be covered under all benefit plans (including, without limitation, retirement plans and medical, dental and life insurance plans) of the Company and the Bank in which Executive participated prior to his Disability on the same terms as if Executive were actively employed by the Company and the Bank. d. Just Cause. i. The Board of the Company or the Bank may, by written notice to the Executive in the form and manner specified in this paragraph, immediately terminate his employment with the Company or the Bank, respectively, at any time, for Just Cause. The Executive shall have no right to receive compensation or other benefits for any period after termination for Just Cause except for vested benefits. Termination for "Just Cause" shall mean termination because of, in the good faith determination of the Company's or the Bank's Board, the Executive's: 4 (1) Personal dishonesty; (2) Incompetence; (3) Willful misconduct; (4) Breach of fiduciary duty involving personal profit; (5) Intentional failure to perform duties under this Agreement; (6) Willful violation of any law, rule or regulation (other than traffic violations or similar offenses) that reflects adversely on the reputation of the Bank, any felony conviction, any violation of law involving moral turpitude, or any violation of a final cease-and-desist order; or (7) Material breach by the Executive of any provision of this Agreement. ii Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated for Just Cause by the Company or the Bank unless there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths (3/4) of the entire membership of the Board of the Company or the Bank at a meeting of such Board called and held for the purpose (after reasonable notice to the Executive and an opportunity for the Executive to be heard before the Board with counsel), finding that, in the good faith opinion of such Board, the Executive was guilty of conduct described above and specifying the particulars thereof. e. Certain Regulatory Events. i. If the Executive is removed and/or permanently prohibited from participating in the conduct of the Bank's affairs by an order issued under Sections 8(e)(4) or 8(g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. ss.ss. 1818(e)(4) and (g)(1)), all obligations of the Bank under this Agreement shall terminate as of the effective date of the order, but vested rights of the parties shall not be affected. ii. If the Bank is in default (as defined in Section 3(x)(1) of FDIA), all obligations of the Bank under this Agreement shall terminate as of the date of default, but vested rights of the parties shall not be affected. 5 iii. If a notice served under Sections 8(e)(3) or (g)(1) of the FDIA (12 U.S.C. Sections 1818(e)(3) and (g)(1)) suspends and/or temporarily prohibits the Executive from participating in the conduct of the Bank's affairs, the Bank's obligations under this Agreement shall be suspended as of the date of such service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Bank shall, (x) pay the Executive all or part of the compensation withheld while its contract obligations were suspended, and (y) reinstate (in whole or in part) any of its obligations which were suspended. f. Voluntary Termination by Executive. In addition to his other rights to terminate under this Agreement, the Executive may voluntarily terminate employment with the Bank and the Company during the term of this Agreement upon at least sixty (60) days prior written notice, in which case the Executive shall receive only his compensation, vested rights and employee benefits up to the date of his termination. g. Without Just Cause or With Good Reason. i. In addition to termination pursuant to Sections 10(a) through 10(f), (x) the Boards of the Company or the Bank, respectively, may, by written notice to the Executive, immediately terminate his employment with the Company or the Bank, respectively, at any time for a reason other than Just Cause (a termination "Without Just Cause") and (y) the Executive may, by written notice to the Boards of the Company and the Bank, immediately terminate this Agreement at any time within ninety (90) days following an event constituting "Good Reason" as defined below (a termination "With Good Reason"). ii. Subject to Section 11 hereof, in the event of termination under this Section 10(g), the Executive shall be entitled to receive his continued base salary (determined at the highest annual rate of base salary in effect pursuant to Section 4 of this Agreement for any of the twelve (12) months immediately preceding the date of such termination) and prorated cash bonus for the remaining term of the Agreement (determined by reference to the highest annual cash bonus received by the Executive in any of the three (3) calendar years preceding the date of termination). The sum due under this Section 10(g) shall be paid in one lump sum within ten (10) calendar days of such termination. Also, in such event, the Executive shall, for the remaining term of the Agreement, receive the benefits he would have received during the remaining term of the Agreement under any tax-qualified or non-tax-qualified retirement programs in 6 which the Executive participated prior to his termination (with the amount of the benefits determined by reference to the benefits received by the Executive under such programs during the twelve (12) months preceding his termination or, if applicable, the accruals made on the Executive's behalf under such programs) and continue to participate in any benefit plans of the Company and the Bank that provide health (including medical and dental), life or disability insurance, or similar coverage upon terms no less favorable than the most favorable terms provided to senior executives of the Bank during such period. In the event that the Company or the Bank is unable to provide such coverage by reason of the Executive no longer being an employee, the Company and the Bank shall provide the Executive with comparable coverage on an individual policy basis or, if individual coverage is not available, provide a cash payment equivalent to the value of such coverage. iii. "Good Reason" shall exist if, without Executive's express written consent, the Company or the Bank materially breach any of their respective obligations under this Agreement. Without limitation, such a material breach shall be deemed to occur upon any of the following: (1) A material reduction in the Executive's responsibilities or authority, or a requirement that the Executive report to any person or group other than the Boards of the Company and the Bank (or any other effective reduction in reporting responsibilities) in connection with his employment with the Company or the Bank; (2) Assignment to the Executive of duties of a non-executive nature or duties for which he is not reasonably equipped by his skills and experience; (3) A reduction in salary or benefits contrary to the terms of this Agreement, or, following a Change in Control as defined in Section 11 of this Agreement, any reduction in salary or material reduction in benefits below the amounts to which he was entitled prior to the Change in Control; (4) Termination of incentive and benefit plans, programs or arrangements, or reduction of the Executive's participation to such an extent as to materially reduce their aggregate value below their aggregate value as of the Effective Date; or (5) A requirement that the Executive relocate his principal business office or his principal place of residence outside of the area consisting of a thirty five (35) mile radius from the current main office and any branch of the Bank, or the assignment to the Executive of duties that would reasonably require such a relocation. 7 iv. Notwithstanding the foregoing, a reduction or elimination of the Executive's participation or benefits under one or more benefit plans maintained by the Company or the Bank as part of a good faith, overall reduction or elimination of such plan or plans or benefits thereunder applicable to all participants in a manner that does not discriminate against the Executive (except as such discrimination may be necessary to comply with law) shall not constitute an event of Good Reason or a material breach of this Agreement, provided that benefits of the type or to the general extent as those offered under such plans prior to such reduction or elimination are not available to other officers of the Company or the Bank or any company that controls either of them under a plan or plans in or under which the Executive is not entitled to participate. v. Notwithstanding anything in this Agreement to the contrary, during the period beginning three (3) months prior to the announcement by the Bank or the Company of an event constituting a Change in Control (as defined in Section 11(a)) and ending twelve (12) months following the effective date of a Change in Control, the Executive may voluntarily terminate his employment under this Agreement for any reason and such termination shall constitute termination With Good Reason. h. Continuing Covenant Not to Compete or Interfere with Relationships. Regardless of anything herein to the contrary, following a termination by the Company, the Bank or the Executive pursuant to Section 10(g) and continuing until the first anniversary of the effective date of such termination, the Executive shall not serve as an officer, director or employee of any bank holding company, bank, savings association, savings and loan holding company, or mortgage company which offers products or services competing with those offered by the Company or the Bank from any office in any city, town or county where Bank maintains an office as of the date of the Executive's termination and shall not interfere with the relationship of the Company or the Bank and any of its employees, agents, or representatives. 8 11. Termination in Connection with a Change in Control. a. For purposes of this Agreement, a "Change in Control" shall be deemed to occur on the earliest of i. The acquisition by any entity, person or group (other than the acquisition by a tax-qualified retirement plan sponsored by the Company or the Bank) of beneficial ownership, as that term is defined in Rule 13d-3 under the Securities Exchange Act of 1934, of more than 25% of the outstanding capital stock of the Company or the Bank entitled to vote for the election of directors ("Voting Stock"); ii. The commencement by any entity, person, or group (other than the Company or the Bank, a subsidiary of the Company or the Bank, or a tax-qualified retirement plan sponsored by the Company or the Bank) of a tender offer or an exchange offer for more than 25% of the outstanding Voting Stock of the Company or the Bank; iii. The effective time of (x) a merger or consolidation of the Company or the Bank with one or more other corporations as a result of which the holders of the outstanding Voting Stock of the Company or the Bank immediately prior to such merger exercise voting control over less than 51 % of the Voting Stock of the surviving or resulting corporation, or (y) a transfer of substantially all of the property of the Company or the Bank other than to an entity of which the Company or the Bank owns at least 51% of the Voting Stock; and iv. At such time that, during any period of two (2) consecutive years, individuals who at the beginning of such period constitute the Board of the Company or the Bank (the "Continuing Directors") cease for any reason to constitute at least two-thirds thereof, provided that any individual whose election or nomination for election as a member of the Board was approved by a vote of at least two-thirds (2/3) of the Continuing Directors then in office shall be considered a Continuing Director. b. If within the period beginning three (3) months prior to the announcement by the Bank or the Company of an event constituting a Change in Control and ending twelve (12) months following the effective date of a Change in Control, (i) the Company or the Bank shall terminate the Executive's employment Without Just Cause, or (ii) the Executive shall voluntarily terminate his employment With Good Reason, the Company or the Bank shall, within ten (10) calendar days of 9 the termination of the Executive's employment, make a lump-sum cash payment to him equal to one (1) times the sum of the Executive's (x) current base salary (determined at the highest annual rate of base salary in effect pursuant to Section 4 of this Agreement for the twelve (12) months immediately preceding the effective date of the Change in Control or, if higher, the rate in effect on the Executive's termination date) and (y) the highest cash bonus paid to the Executive or accrued on the Executive's behalf with respect to any of the three (3) most recently completed fiscal years of the Bank preceding the effective date of the Change in Control. This cash payment shall be made in lieu of any payment also required under Section 10(g) of this Agreement because of a termination in such period. The Executive's rights under Section 10(g) are not otherwise affected by this Section 11. Also, in such event, the Executive shall, for a twelve (12) month period following his termination of employment, receive the benefits he would have received over such period under any tax-qualified or non-tax-qualified retirement programs in which the Executive participated prior to his termination (with the amount of the benefits determined by reference to the benefits received by the Executive under such programs during the twelve (12) months preceding the Change in Control or, if applicable, the accruals made on the Executive's behalf during such period) and continue to participate in any benefit plans of the Company and the Bank that provide health (including medical and dental), life or disability insurance, or similar coverage upon terms no less favorable than the most favorable terms provided to senior executives of the Bank during such period. In the event that the Company or the Bank is unable to provide such coverage by reason of the Executive no longer being an employee, the Company and the Bank shall provide the Executive with comparable coverage through an individual policy or, if individual coverage is not available, provide a cash payment equivalent to the value of such coverage. 12. Indemnification and Liability Insurance. a. Indemnification. The Company and the Bank agree to indemnify the Executive (and his heirs, executors, and administrators), and to advance expenses related thereto, to the fullest extent permitted under applicable law and regulations against any and all expenses and liabilities reasonably incurred by him in connection with or arising out of any action, suit, or proceeding in which he may be involved by reason of his having been an Executive of the Company or the Bank or any of their subsidiaries (whether or not he continues to be an Executive at the time of incurring any such expenses or liabilities) such expenses and liabilities to include, but not be limited to, judgments, court costs, and attorney's fees and the cost of reasonable settlements, such settlements to be approved by the Board of the Company or the Bank, if such action is brought against the Executive in his capacity as an Executive of the Company 10 or the Bank or any of their subsidiaries. Indemnification for expenses shall not extend to matters for which the Executive has been terminated for Just Cause. Nothing contained herein shall be deemed to provide indemnification prohibited by applicable law or regulation. b. Insurance. During the period in which indemnification of the Executive is required under this Section, the Company or the Bank shall provide the Executive (and his heirs, executors, and administrators) with coverage under a standard Executives' and directors' liability policy at the expense of the Company or the Bank, at least equivalent to such coverage provided to senior Executives of the Company or the Bank. 13. Reimbursement of Executive's Expenses to Enforce this Agreement. The Company or the Bank shall reimburse the Executive for all out-of-pocket expenses, including, without limitation, reasonable attorney's fees, incurred by the Executive in connection with successful enforcement by the Executive of the obligations of the Company or the Bank to the Executive under this Agreement. Successful enforcement shall mean the grant of an award of money or the requirement that the Company or the Bank take some action specified by this Agreement (i) as a result of court order; or (ii) otherwise by the Company or the Bank following an initial failure of the Company or the Bank to pay such money or take such action promptly after written demand therefore from the Executive stating the reason that such money or action was due under this Agreement at or prior to the time of such demand. 14. Adjustment of Certain Payments and Benefits. a. Tax Indemnification. Anything in this Agreement to the contrary notwithstanding, and except as set forth below, in the event it shall be determined that any payment, benefit or distribution made or provided by the Company or the Bank to or for the benefit of the Executive (whether made or provided pursuant to the terms of this Agreement or otherwise) (each referred to herein as a "Payment"), would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code") or any interest or penalties are incurred by the Executive with respect to such excise tax (the excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), the Executive shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. b. Determination of Gross-Up Payment. Subject to the provisions of Section 14(c), all determinations required to be made 11 under this Section 14, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payments and the assumptions to be utilized in arriving at such determination, shall be made by a certified public accounting firm reasonably acceptable to the Company as may be designated by the Executive (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company, the Bank and the Executive within fifteen (15) business days of the receipt of notice from the Executive that there have been Payments, or such earlier time as is requested by the Company and the Bank. All fees and expenses of the Accounting Firm shall be borne solely by the Company and the Bank. Any Gross-Up Payment, as determined pursuant to this Section 14, shall be paid by the Company to the Executive within five days of (i) the later of the due date for the payments of any Excise Tax, and (ii) the receipt of the Accounting Firm's determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code, at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company and the Bank should have been made ("Underpayment"), consistent with the calculations required to be made hereunder. In the event that the Company and the Bank exhaust their remedies pursuant to Section 14(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. c. Treatment of Claims. The Executive shall notify the Company and the Bank in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company and the Bank of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten (10) business days after the Executive is informed in writing of such claim and shall apprise the Company and the Bank of the nature of such claims and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the thirty (30) day period following the date on which it gives such notice to the Company and the Bank (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company and the Bank notify the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall: i. give the Company and the Bank any information reasonably request by the Company and the Bank relating such claim, ii. take such action in connection with contesting such claim as the Company and the Bank shall reasonably 12 request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company and the Bank, iii. cooperate with the Company and the Bank in good faith in order effectively to contest such claim, and iv. permit the Company and the Bank to participate in any proceedings relating to such claim; provided, however, that the Company and the Bank shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and indemnity and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 14(c), the Company and the Bank shall control all proceedings taken in connection with such contest and, at their sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at their sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company and the Bank shall determine; provided, however, that if the Company and the Bank direct the Executive to pay such claim and sue for a refund, the Company and the Bank shall advance the amount of such payment to the Executive, on an interest-free basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance. Furthermore, the Company's and the Bank's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issues raised by the Internal Revenue Service or any other taxing authority. d. Adjustments to the Gross-Up Payment. If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 14(c), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of Section 14(c)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after applicable taxes). If, after the receipt by the Executive of an amount advanced by the 13 Company pursuant to Section 14(c), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and such denial of refund occurs prior to the expiration of thirty (30) days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of the Gross-Up Payment. 15. Injunctive Relief. If there is a breach or threatened breach of Section 10(h) of his Agreement or the prohibitions upon disclosure contained in Section 9(c) of this Agreement, the Company or the Bank and the Executive agree that there is no adequate remedy at law for such breach, and that the Company and the Bank each shall be entitled to injunctive relief restraining the Executive from such breach or threatened breach, but such relief shall not be the exclusive remedy hereunder for such breach. The parties hereto likewise agree that the Executive, without limitation, shall be entitled to injunctive relief to enforce the obligations of the Company and the Bank under Section 11 of this Agreement. 16. Successors and Assigns. a. This Agreement shall inure to the benefit of and be binding upon any corporate or other successor of the Company or the Bank which shall acquire, directly or indirectly, by merger, consolidation, purchase or otherwise, all or substantially all of the assets or stock of the Company or the Bank. b. Since the Bank and the Company are contracting for the unique and personal skills of the Executive, the Executive shall be precluded from assigning or delegating his rights or duties hereunder without first obtaining the written consent of the Bank and the Company. 17. No Mitigation. The Executive shall not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise and no such payment shall be offset or reduced by the amount of any compensation or benefits provided to the Executive as a result of any subsequent employment. 18. Notices. All notices, requests, demands and other communications in connection with this Agreement shall be made in writing and shall be deemed to have been given when delivered by hand or 48 hours after mailing at any general or branch United States Post Office, by registered or certified mail, postage prepaid, addressed as follows, or to such other address as shall have been designated in writing by the addressee: a. If to the Company or the Bank: Copy to: Corporate Secretary Coastal Financial Corporation 2619 Oak Street Myrtle Beach, S.C. 29577 14 b. If to the Executive: Steven J. Sherry 1101 Links Road Myrtle Beach, S.C. 29575 19. Joint and Several Liability; Payments by the Company and the Bank. To the extent permitted by law, except as otherwise provided herein, the Company and the Bank shall be jointly and severally liable for the payment of all amounts due under this Agreement. The Company hereby agrees that it shall be jointly and severally liable with the Bank for the payment of all amounts due under this Agreement and shall guarantee the performance of the Bank's obligations thereunder, provided that the Company shall not be required by this Agreement to pay to the Executive a salary or any bonuses or any other cash payments, except in the event that the Bank does not fulfill the obligations to the Executive hereunder for such payments. 20. No Plan Created by this Agreement. The Executive, the Company and the Bank expressly declare and agree that this Agreement was negotiated among them and that no provision or provisions of this Agreement are intended to, or shall be deemed to, create any plan for purposes of the Employee Retirement Income Security Act or any other law or regulation, and the Company, the Bank and the Executive each expressly waives any right to assert the contrary. Any assertion in any judicial or administrative filing, hearing, or process by or on behalf of the Executive or the Company or the Bank that such a plan was so created by this Agreement shall be deemed a material breach of this Agreement by the party making such an assertion. 21. Amendments. No amendments or additions to this Agreement shall be binding unless made in writing and signed by all of the parties, except as herein otherwise specifically provided. 22. Applicable Law. Except to the extent preempted by Federal law, the laws of the State of Delaware shall govern this Agreement in all respects, whether as to its validity, construction, capacity, performance or otherwise. 23. Severability. The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof. 24. Headings. Headings contained herein are for convenience of reference only. 25. Entire Agreement. This Agreement, together with any understandings or modifications thereof as agreed to in writing by the parties, shall constitute the entire agreement among the parties hereto with respect to the subject matter hereof, other than written agreements with respect to specific plans, programs or arrangements described in Sections 5 and 6. This Agreement supercedes and replaces in its entirety the Agreement dated October 27, 1998, as amended, between the Company, the Bank and the Executive. 15 IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first set forth above. Attest: COASTAL FINANCIAL CORPORATION /s/ Susan J. Cooke By: /s/ J.T. Clemmons - -------------------------------- ----------------------------------------- Susan J. Cooke J.T. Clemmons Title: Chairman /s/ Sandra R. Zanfini - -------------------------------- Sandra R. Zanfini Attest: COASTAL FEDERAL BANK /s/ Susan J. Cooke By:/s/ J.T. Clemmons - -------------------------------- ----------------------------------------- Susan J. Cooke J.T. Clemmons Title: Chairman /s/ Sandra R. Zanfini - -------------------------------- Sandra R. Zanfini Witness: /s/ Rebecca L. Belcher /s/ Steven J. Sherry - -------------------------------- ----------------------------------------- Rebecca L. Belcher EXECUTIVE Steven J. Sherry EX-10 7 ex10e.txt EXHIBIT 10(e) FORM OF EMPLOYMENT AGREEMENT THIS AGREEMENT (the "Agreement"), made this 24th day of November, 2003, by and among COASTAL FINANCIAL CORPORATION, a Delaware corporation ("the Company"), COASTAL FEDERAL BANK, a wholly owned subsidiary of the Company (the "Bank"), and Jimmy R. Graham (the "Executive"). WITNESSETH WHEREAS, the Company and the Bank desire to retain the services of the Executive as Executive Vice President/Chief Information Officer of the Company and the Bank; WHEREAS, the Company and the Bank have previously entered into an employment agreement with the Executive; WHEREAS, the Executive and the respective Boards of Directors of the Bank and the Company desire to enter into an updated and revised agreement setting forth the terms and conditions of the continuing employment of the Executive and the related rights and obligations of each of the parties; NOW, THEREFORE, in consideration of the premises and mutual covenants herein contained, it is agreed as follows: 1. Employment. The Executive is employed as Executive Vice President/Chief Information Officer of the Company and the Bank. The Executive shall perform all duties which are customarily performed by persons situated in a similar executive capacity and such other duties as are delegated to him by the Chief Executive Officer from time to time. 2. Location and Facilities. The Executive will be furnished with the working facilities and staff customary for executive officers with the title and duties set forth in Section 1 and as are necessary for him to perform his duties. The location of such facilities and staff shall be at the principal administrative offices of the Company and the Bank, or at such other site or sites customary for such offices. 3. Term. a. The term of this Agreement shall be (i) the initial term, consisting of the period commencing on the date of this Agreement (the "Effective Date") and ending on the first anniversary of the Effective Date, plus (ii) any and all extensions of the initial term made pursuant to this Section 3. b. Commencing on the Effective Date and on each day thereafter, the term under this Agreement shall be renewed automatically for an additional one (1) day period beyond the then effective expiration date without action by any party, provided that neither the Company, on the one hand, nor Executive, on the other, shall have given at least sixty (60) days written notice of its or his desire that the term not be renewed. In the case such notice is given by one party to the other, the term of this Agreement shall become fixed and shall end on the first anniversary of the date of written notice. 4. Base Salary. a. The Bank agrees to pay the Executive during the term of this Agreement a base salary at the rate of $144,000.00 per annum, payable in accordance with the Bank's customary payroll practices. b. The Board of the Bank shall review annually the rate of the Executive's base salary based upon factors they deem relevant, and may maintain or increase his salary, provided that no such action shall reduce the rate of salary below the rate in effect on the Effective Date. c. In the absence of action by the Board of the Bank, the Executive shall continue to receive salary at the per annum rate specified on the Effective Date or, if another rate has been established under the provisions of this Section 4, the rate last properly established by action of the Board of the Bank under the provisions of this Section 4. 5. Bonuses. The Executive shall be entitled to participate in any discretionary bonus or other incentive compensation programs that the Board of the Company or the Bank may establish from time to time for the benefit of the officers or employees of the Company or the Bank. 6. Benefit Plans. The Executive shall be entitled to participate in such life insurance, medical, dental, pension, profit sharing, and retirement plans, stock compensation plans and other programs and arrangements as may be approved from time to time by the Company or the Bank for the benefit of their respective employees. 7. Vacation and Leave. The Executive shall be entitled to vacations and other leave in accordance with Bank policy for senior executives. 8. Expense Payments and Reimbursements. The Executive shall be reimbursed for all reasonable out-of-pocket business expenses that he shall incur in connection with his services under this Agreement upon substantiation of such expenses in accordance with applicable policies of the Company or the Bank. 9. Loyalty. a. During the term of this Agreement the Executive: (i) shall devote all his time, attention, skill, and efforts to the faithful performance of his duties hereunder; provided, however, that from time to time, the Executive may serve on the boards of directors of, and hold any other offices or positions in, companies or 2 organizations which will not present any conflicts of interest with the Company or the Bank or any of their subsidiaries or affiliates, unfavorably affect the performance of Executive's duties pursuant to this Agreement, or violate any applicable statute or regulation; and (ii) shall not engage in any business or activity contrary to the business affairs or interests of the Company or the Bank. b. Nothing contained in this Agreement shall prevent or limit the Executive's right to invest in the capital stock or other securities of any business dissimilar from that of the Company and the Bank, or, solely as a passive, minority investor, in any business. c. The Executive agrees to maintain the confidentiality of any and all information concerning the operation or financial status of the Company and the Bank; the names or addresses of any of its borrowers, depositors and other customers; any information concerning or obtained from such customers; and any other information concerning the Company and the Bank to which he may be exposed during the course of his employment. The Executive further agrees that, unless required by law or specifically permitted by the Board in writing, he will not disclose to any person or entity, either during or subsequent to his employment, any of the above-mentioned information which is not generally known to the public, nor shall he employ such information in any way other than for the benefit of the Company and the Bank. 10. Termination and Termination Pay. Subject to Section 11 of this Agreement, the Executive's employment under this Agreement may be terminated in the following circumstances: a. Death. The Executive's employment under this Agreement shall terminate upon his death during the term of this Agreement, in which event the Executive's estate shall be entitled to receive the compensation due to the Executive through the last day of the calendar month in which his death occurred. b. Retirement. This Agreement shall be terminated upon the retirement of the Executive under the retirement benefit plan or plans in which he participates pursuant to Section 6 of this Agreement or otherwise. For all other purposes, the Executive's termination of employment at retirement shall be treated in the same manner as if he voluntarily terminated employment pursuant to Section 10(f). c. Disability. i. The Company, the Bank, or the Executive may terminate the Executive's employment after having established the 3 Executive's Disability. For purposes of this Agreement, "Disability" means a physical or mental infirmity that impairs the Executive's ability to substantially perform his duties under this Agreement and that results in the Executive's becoming eligible for long-term disability benefits under the Company's or the Bank's long-term disability plan (or, if the Company or the Bank has no such plan in effect, that impairs the Executive's ability to substantially perform his duties under this Agreement for a period of one hundred eighty (180) consecutive days). The Boards of the Company and the Bank shall determine whether or not the Executive is and continues to be permanently disabled for purposes of this Agreement in good faith, based upon competent medical advice and other factors that they reasonably believe to be relevant. As a condition to any benefits, such Board may require the Executive to submit to such physical or mental evaluations and tests as it deems reasonably appropriate. ii. In the event of such Disability, the Executive's obligation to perform services under this Agreement will terminate. In the event of such termination, the Executive shall continue to receive seventy-five (75) percent of his monthly base salary (at the annual rate in effect on his date of termination) through the earlier of the date of the Executive's death, the date he attains age 65 or the date which is one (1) year after the Executive's termination date. Such payments shall be reduced by the amount of any short- or long-term disability benefits payable to the Executive under any other disability program sponsored by the Company or the Bank. In addition, during any period of the Executive's Disability in which he is receiving payments under this paragraph, the Executive and his dependents shall, to the greatest extent possible, continue to be covered under all benefit plans (including, without limitation, retirement plans and medical, dental and life insurance plans) of the Company and the Bank in which Executive participated prior to his Disability on the same terms as if Executive were actively employed by the Company and the Bank. d. Just Cause. i. The Board of the Company or the Bank may, by written notice to the Executive in the form and manner specified in this paragraph, immediately terminate his employment with the Company or the Bank, respectively, at any time, for Just Cause. The Executive shall have no right to receive compensation or other benefits for any period after termination for Just Cause except for vested benefits. Termination for "Just Cause" shall mean termination because of, in the good faith determination of the Company's or the Bank's Board, the Executive's: 4 (1) Personal dishonesty; (2) Incompetence; (3) Willful misconduct; (4) Breach of fiduciary duty involving personal profit; (5) Intentional failure to perform duties under this Agreement; (6) Willful violation of any law, rule or regulation (other than traffic violations or similar offenses) that reflects adversely on the reputation of the Bank, any felony conviction, any violation of law involving moral turpitude, or any violation of a final cease-and-desist order; or (7) Material breach by the Executive of any provision of this Agreement. ii Notwithstanding the foregoing, the Executive shall not be deemed to have been terminated for Just Cause by the Company or the Bank unless there shall have been delivered to the Executive a copy of a resolution duly adopted by the affirmative vote of not less than three-fourths (3/4) of the entire membership of the Board of the Company or the Bank at a meeting of such Board called and held for the purpose (after reasonable notice to the Executive and an opportunity for the Executive to be heard before the Board with counsel), finding that, in the good faith opinion of such Board, the Executive was guilty of conduct described above and specifying the particulars thereof. e. Certain Regulatory Events. i. If the Executive is removed and/or permanently prohibited from participating in the conduct of the Bank's affairs by an order issued under Sections 8(e)(4) or 8(g)(1) of the Federal Deposit Insurance Act ("FDIA") (12 U.S.C. ss.ss. 1818(e)(4) and (g)(1)), all obligations of the Bank under this Agreement shall terminate as of the effective date of the order, but vested rights of the parties shall not be affected. ii. If the Bank is in default (as defined in Section 3(x)(1) of FDIA), all obligations of the Bank under this Agreement shall terminate as of the date of default, but vested rights of the parties shall not be affected. 5 iii. If a notice served under Sections 8(e)(3) or (g)(1) of the FDIA (12 U.S.C. Sections 1818(e)(3) and (g)(1)) suspends and/or temporarily prohibits the Executive from participating in the conduct of the Bank's affairs, the Bank's obligations under this Agreement shall be suspended as of the date of such service, unless stayed by appropriate proceedings. If the charges in the notice are dismissed, the Bank shall, (x) pay the Executive all or part of the compensation withheld while its contract obligations were suspended, and (y) reinstate (in whole or in part) any of its obligations which were suspended. f. Voluntary Termination by Executive. In addition to his other rights to terminate under this Agreement, the Executive may voluntarily terminate employment with the Bank and the Company during the term of this Agreement upon at least sixty (60) days prior written notice, in which case the Executive shall receive only his compensation, vested rights and employee benefits up to the date of his termination. g. Without Just Cause or With Good Reason. i. In addition to termination pursuant to Sections 10(a) through 10(f), (x) the Boards of the Company or the Bank, respectively, may, by written notice to the Executive, immediately terminate his employment with the Company or the Bank, respectively, at any time for a reason other than Just Cause (a termination "Without Just Cause") and (y) the Executive may, by written notice to the Boards of the Company and the Bank, immediately terminate this Agreement at any time within ninety (90) days following an event constituting "Good Reason" as defined below (a termination "With Good Reason"). ii. Subject to Section 11 hereof, in the event of termination under this Section 10(g), the Executive shall be entitled to receive his continued base salary (determined at the highest annual rate of base salary in effect pursuant to Section 4 of this Agreement for any of the twelve (12) months immediately preceding the date of such termination) and prorated cash bonus for the remaining term of the Agreement (determined by reference to the highest annual cash bonus received by the Executive in any of the three (3) calendar years preceding the date of termination). The sum due under this Section 10(g) shall be paid in one lump sum within ten (10) calendar days of such termination. Also, in such event, the Executive shall, for the remaining term of the Agreement, receive the benefits he would have received during the remaining term of the Agreement under any tax-qualified or non-tax-qualified retirement programs in 6 which the Executive participated prior to his termination (with the amount of the benefits determined by reference to the benefits received by the Executive under such programs during the twelve (12) months preceding his termination or, if applicable, the accruals made on the Executive's behalf under such programs) and continue to participate in any benefit plans of the Company and the Bank that provide health (including medical and dental), life or disability insurance, or similar coverage upon terms no less favorable than the most favorable terms provided to senior executives of the Bank during such period. In the event that the Company or the Bank is unable to provide such coverage by reason of the Executive no longer being an employee, the Company and the Bank shall provide the Executive with comparable coverage on an individual policy basis or, if individual coverage is not available, provide a cash payment equivalent to the value of such coverage. iii. "Good Reason" shall exist if, without Executive's express written consent, the Company or the Bank materially breach any of their respective obligations under this Agreement. Without limitation, such a material breach shall be deemed to occur upon any of the following: (1) A material reduction in the Executive's responsibilities or authority, or a requirement that the Executive report to any person or group other than the Boards of the Company and the Bank (or any other effective reduction in reporting responsibilities) in connection with his employment with the Company or the Bank; (2) Assignment to the Executive of duties of a non-executive nature or duties for which he is not reasonably equipped by his skills and experience; (3) A reduction in salary or benefits contrary to the terms of this Agreement, or, following a Change in Control as defined in Section 11 of this Agreement, any reduction in salary or material reduction in benefits below the amounts to which he was entitled prior to the Change in Control; (4) Termination of incentive and benefit plans, programs or arrangements, or reduction of the Executive's participation to such an extent as to materially reduce their aggregate value below their aggregate value as of the Effective Date; or (5) A requirement that the Executive relocate his principal business office or his principal place of residence outside of the area consisting of a thirty five (35) mile radius from the current main office and any branch of the Bank, or the assignment to the Executive of duties that would reasonably require such a relocation. 7 iv. Notwithstanding the foregoing, a reduction or elimination of the Executive's participation or benefits under one or more benefit plans maintained by the Company or the Bank as part of a good faith, overall reduction or elimination of such plan or plans or benefits thereunder applicable to all participants in a manner that does not discriminate against the Executive (except as such discrimination may be necessary to comply with law) shall not constitute an event of Good Reason or a material breach of this Agreement, provided that benefits of the type or to the general extent as those offered under such plans prior to such reduction or elimination are not available to other officers of the Company or the Bank or any company that controls either of them under a plan or plans in or under which the Executive is not entitled to participate. v. Notwithstanding anything in this Agreement to the contrary, during the period beginning three (3) months prior to the announcement by the Bank or the Company of an event constituting a Change in Control (as defined in Section 11(a)) and ending twelve (12) months following the effective date of a Change in Control, the Executive may voluntarily terminate his employment under this Agreement for any reason and such termination shall constitute termination With Good Reason. h. Continuing Covenant Not to Compete or Interfere with Relationships. Regardless of anything herein to the contrary, following a termination by the Company, the Bank or the Executive pursuant to Section 10(g) and continuing until the first anniversary of the effective date of such termination, the Executive shall not serve as an officer, director or employee of any bank holding company, bank, savings association, savings and loan holding company, or mortgage company which offers products or services competing with those offered by the Company or the Bank from any office in any city, town or county where Bank maintains an office as of the date of the Executive's termination and shall not interfere with the relationship of the Company or the Bank and any of its employees, agents, or representatives. 8 11. Termination in Connection with a Change in Control. a. For purposes of this Agreement, a "Change in Control" shall be deemed to occur on the earliest of i. The acquisition by any entity, person or group (other than the acquisition by a tax-qualified retirement plan sponsored by the Company or the Bank) of beneficial ownership, as that term is defined in Rule 13d-3 under the Securities Exchange Act of 1934, of more than 25% of the outstanding capital stock of the Company or the Bank entitled to vote for the election of directors ("Voting Stock"); ii. The commencement by any entity, person, or group (other than the Company or the Bank, a subsidiary of the Company or the Bank, or a tax-qualified retirement plan sponsored by the Company or the Bank) of a tender offer or an exchange offer for more than 25% of the outstanding Voting Stock of the Company or the Bank; iii. The effective time of (x) a merger or consolidation of the Company or the Bank with one or more other corporations as a result of which the holders of the outstanding Voting Stock of the Company or the Bank immediately prior to such merger exercise voting control over less than 51 % of the Voting Stock of the surviving or resulting corporation, or (y) a transfer of substantially all of the property of the Company or the Bank other than to an entity of which the Company or the Bank owns at least 51% of the Voting Stock; and iv. At such time that, during any period of two (2) consecutive years, individuals who at the beginning of such period constitute the Board of the Company or the Bank (the "Continuing Directors") cease for any reason to constitute at least two-thirds thereof, provided that any individual whose election or nomination for election as a member of the Board was approved by a vote of at least two-thirds (2/3) of the Continuing Directors then in office shall be considered a Continuing Director. b. If within the period beginning three (3) months prior to the announcement by the Bank or the Company of an event constituting a Change in Control and ending twelve (12) months following the effective date of a Change in Control, (i) the Company or the Bank shall terminate the Executive's employment Without Just Cause, or (ii) the Executive shall voluntarily terminate his employment With Good Reason, the Company or the Bank shall, within ten (10) calendar days of 9 the termination of the Executive's employment, make a lump-sum cash payment to him equal to one (1) times the sum of the Executive's (x) current base salary (determined at the highest annual rate of base salary in effect pursuant to Section 4 of this Agreement for the twelve (12) months immediately preceding the effective date of the Change in Control or, if higher, the rate in effect on the Executive's termination date) and (y) the highest cash bonus paid to the Executive or accrued on the Executive's behalf with respect to any of the three (3) most recently completed fiscal years of the Bank preceding the effective date of the Change in Control. This cash payment shall be made in lieu of any payment also required under Section 10(g) of this Agreement because of a termination in such period. The Executive's rights under Section 10(g) are not otherwise affected by this Section 11. Also, in such event, the Executive shall, for a twelve (12) month period following his termination of employment, receive the benefits he would have received over such period under any tax-qualified or non-tax-qualified retirement programs in which the Executive participated prior to his termination (with the amount of the benefits determined by reference to the benefits received by the Executive under such programs during the twelve (12) months preceding the Change in Control or, if applicable, the accruals made on the Executive's behalf during such period) and continue to participate in any benefit plans of the Company and the Bank that provide health (including medical and dental), life or disability insurance, or similar coverage upon terms no less favorable than the most favorable terms provided to senior executives of the Bank during such period. In the event that the Company or the Bank is unable to provide such coverage by reason of the Executive no longer being an employee, the Company and the Bank shall provide the Executive with comparable coverage through an individual policy or, if individual coverage is not available, provide a cash payment equivalent to the value of such coverage. 12. Indemnification and Liability Insurance. a. Indemnification. The Company and the Bank agree to indemnify the Executive (and his heirs, executors, and administrators), and to advance expenses related thereto, to the fullest extent permitted under applicable law and regulations against any and all expenses and liabilities reasonably incurred by him in connection with or arising out of any action, suit, or proceeding in which he may be involved by reason of his having been an Executive of the Company or the Bank or any of their subsidiaries (whether or not he continues to be an Executive at the time of incurring any such expenses or liabilities) such expenses and liabilities to include, but not be limited to, judgments, court costs, and attorney's fees and the cost of reasonable settlements, such settlements to be approved by the Board of the Company or the Bank, if such action is brought against the Executive in his capacity as an Executive of the Company 10 or the Bank or any of their subsidiaries. Indemnification for expenses shall not extend to matters for which the Executive has been terminated for Just Cause. Nothing contained herein shall be deemed to provide indemnification prohibited by applicable law or regulation. b. Insurance. During the period in which indemnification of the Executive is required under this Section, the Company or the Bank shall provide the Executive (and his heirs, executors, and administrators) with coverage under a standard Executives' and directors' liability policy at the expense of the Company or the Bank, at least equivalent to such coverage provided to senior Executives of the Company or the Bank. 13. Reimbursement of Executive's Expenses to Enforce this Agreement. The Company or the Bank shall reimburse the Executive for all out-of-pocket expenses, including, without limitation, reasonable attorney's fees, incurred by the Executive in connection with successful enforcement by the Executive of the obligations of the Company or the Bank to the Executive under this Agreement. Successful enforcement shall mean the grant of an award of money or the requirement that the Company or the Bank take some action specified by this Agreement (i) as a result of court order; or (ii) otherwise by the Company or the Bank following an initial failure of the Company or the Bank to pay such money or take such action promptly after written demand therefore from the Executive stating the reason that such money or action was due under this Agreement at or prior to the time of such demand. 14. Adjustment of Certain Payments and Benefits. a. Tax Indemnification. Anything in this Agreement to the contrary notwithstanding, and except as set forth below, in the event it shall be determined that any payment, benefit or distribution made or provided by the Company or the Bank to or for the benefit of the Executive (whether made or provided pursuant to the terms of this Agreement or otherwise) (each referred to herein as a "Payment"), would be subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended (the "Code") or any interest or penalties are incurred by the Executive with respect to such excise tax (the excise tax, together with any such interest and penalties, are hereinafter collectively referred to as the "Excise Tax"), the Executive shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed upon the Payments. b. Determination of Gross-Up Payment. Subject to the provisions of Section 14(c), all determinations required to be made 11 under this Section 14, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payments and the assumptions to be utilized in arriving at such determination, shall be made by a certified public accounting firm reasonably acceptable to the Company as may be designated by the Executive (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company, the Bank and the Executive within fifteen (15) business days of the receipt of notice from the Executive that there have been Payments, or such earlier time as is requested by the Company and the Bank. All fees and expenses of the Accounting Firm shall be borne solely by the Company and the Bank. Any Gross-Up Payment, as determined pursuant to this Section 14, shall be paid by the Company to the Executive within five days of (i) the later of the due date for the payments of any Excise Tax, and (ii) the receipt of the Accounting Firm's determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 4999 of the Code, at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company and the Bank should have been made ("Underpayment"), consistent with the calculations required to be made hereunder. In the event that the Company and the Bank exhaust their remedies pursuant to Section 14(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. c. Treatment of Claims. The Executive shall notify the Company and the Bank in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company and the Bank of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten (10) business days after the Executive is informed in writing of such claim and shall apprise the Company and the Bank of the nature of such claims and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the thirty (30) day period following the date on which it gives such notice to the Company and the Bank (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company and the Bank notify the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall: i. give the Company and the Bank any information reasonably request by the Company and the Bank relating such claim, ii. take such action in connection with contesting such claim as the Company and the Bank shall reasonably 12 request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company and the Bank, iii. cooperate with the Company and the Bank in good faith in order effectively to contest such claim, and iv. permit the Company and the Bank to participate in any proceedings relating to such claim; provided, however, that the Company and the Bank shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and indemnity and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 14(c), the Company and the Bank shall control all proceedings taken in connection with such contest and, at their sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at their sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company and the Bank shall determine; provided, however, that if the Company and the Bank direct the Executive to pay such claim and sue for a refund, the Company and the Bank shall advance the amount of such payment to the Executive, on an interest-free basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance. Furthermore, the Company's and the Bank's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issues raised by the Internal Revenue Service or any other taxing authority. d. Adjustments to the Gross-Up Payment. If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 14(c), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of Section 14(c)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after applicable taxes). If, after the receipt by the Executive of an amount advanced by the 13 Company pursuant to Section 14(c), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and such denial of refund occurs prior to the expiration of thirty (30) days after such determination, then such advance shall be forgiven and shall not be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of the Gross-Up Payment. 15. Injunctive Relief. If there is a breach or threatened breach of Section 10(h) of his Agreement or the prohibitions upon disclosure contained in Section 9(c) of this Agreement, the Company or the Bank and the Executive agree that there is no adequate remedy at law for such breach, and that the Company and the Bank each shall be entitled to injunctive relief restraining the Executive from such breach or threatened breach, but such relief shall not be the exclusive remedy hereunder for such breach. The parties hereto likewise agree that the Executive, without limitation, shall be entitled to injunctive relief to enforce the obligations of the Company and the Bank under Section 11 of this Agreement. 16. Successors and Assigns. a. This Agreement shall inure to the benefit of and be binding upon any corporate or other successor of the Company or the Bank which shall acquire, directly or indirectly, by merger, consolidation, purchase or otherwise, all or substantially all of the assets or stock of the Company or the Bank. b. Since the Bank and the Company are contracting for the unique and personal skills of the Executive, the Executive shall be precluded from assigning or delegating his rights or duties hereunder without first obtaining the written consent of the Bank and the Company. 17. No Mitigation. The Executive shall not be required to mitigate the amount of any payment provided for in this Agreement by seeking other employment or otherwise and no such payment shall be offset or reduced by the amount of any compensation or benefits provided to the Executive as a result of any subsequent employment. 18. Notices. All notices, requests, demands and other communications in connection with this Agreement shall be made in writing and shall be deemed to have been given when delivered by hand or 48 hours after mailing at any general or branch United States Post Office, by registered or certified mail, postage prepaid, addressed as follows, or to such other address as shall have been designated in writing by the addressee: a. If to the Company or the Bank: Copy to: Corporate Secretary Coastal Financial Corporation 2619 Oak Street Myrtle Beach, S.C. 29577 14 b. If to the Executive: Jimmy R. Graham 4585 Pee Dee Highway Conway, S.C. 29527 19. Joint and Several Liability; Payments by the Company and the Bank. To the extent permitted by law, except as otherwise provided herein, the Company and the Bank shall be jointly and severally liable for the payment of all amounts due under this Agreement. The Company hereby agrees that it shall be jointly and severally liable with the Bank for the payment of all amounts due under this Agreement and shall guarantee the performance of the Bank's obligations thereunder, provided that the Company shall not be required by this Agreement to pay to the Executive a salary or any bonuses or any other cash payments, except in the event that the Bank does not fulfill the obligations to the Executive hereunder for such payments. 20. No Plan Created by this Agreement. The Executive, the Company and the Bank expressly declare and agree that this Agreement was negotiated among them and that no provision or provisions of this Agreement are intended to, or shall be deemed to, create any plan for purposes of the Employee Retirement Income Security Act or any other law or regulation, and the Company, the Bank and the Executive each expressly waives any right to assert the contrary. Any assertion in any judicial or administrative filing, hearing, or process by or on behalf of the Executive or the Company or the Bank that such a plan was so created by this Agreement shall be deemed a material breach of this Agreement by the party making such an assertion. 21. Amendments. No amendments or additions to this Agreement shall be binding unless made in writing and signed by all of the parties, except as herein otherwise specifically provided. 22. Applicable Law. Except to the extent preempted by Federal law, the laws of the State of Delaware shall govern this Agreement in all respects, whether as to its validity, construction, capacity, performance or otherwise. 23. Severability. The provisions of this Agreement shall be deemed severable and the invalidity or unenforceability of any provision shall not affect the validity or enforceability of the other provisions hereof. 24. Headings. Headings contained herein are for convenience of reference only. 25. Entire Agreement. This Agreement, together with any understandings or modifications thereof as agreed to in writing by the parties, shall constitute the entire agreement among the parties hereto with respect to the subject matter hereof, other than written agreements with respect to specific plans, programs or arrangements described in Sections 5 and 6. This Agreement supercedes and replaces in its entirety the Agreement dated October 1, 1992, as amended, between the Company, the Bank and the Executive. 15 IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first set forth above. Attest: COASTAL FINANCIAL CORPORATION /s/ Susan J. Cooke By: /s/ J.T. Clemmons - -------------------------------- ----------------------------------------- Susan J. Cooke J.T. Clemmons Title: Chairman /s/ Sandra R. Zanfini - -------------------------------- Sandra R. Zanfini Attest: COASTAL FEDERAL BANK /s/ Susan J. Cooke By:/s/ J.T. Clemmons - -------------------------------- ----------------------------------------- Susan J. Cooke J.T. Clemmons Title: Chairman /s/ Sandra R. Zanfini - -------------------------------- Sandra R. Zanfini Witness: /s/ Rebecca L. Belcher /s/ Jimmy R. Graham - -------------------------------- ----------------------------------------- Rebecca L. Belcher EXECUTIVE Jimmy R. Graham EX-13 8 ex13.txt EXHIBIT 13 ANNUAL REPORT TO STOCKHOLDERS FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2003 COASTAL FINANCIAL CORPORATION 2003 ANNUAL REPORT COASTAL FINANCIAL CORPORATION Corporate Office: 2619 Oak Street o Myrtle Beach, South Carolina o 29577-3129 2003 ANNUAL REPORT 843.205.2000 A Quest for Excellence 1954-2004 Celebrating Our First Fifty Years Of Operation By Focusing On Moving To The Next Level The Transformation From A Very Good Organization Dedication To An Exceptional Organization Dedication On January 12, 1954, when Coastal Federal officially opened its doors for business, its future was already well-secured by the Vision and Values of its founders. These civic-minded individuals envisioned a Community based and owned banking organization which would be a catalyst for enabling the Community, its residents and businesses to reach their full potential. And, thanks to their strong belief that it was, and always would be, inextricably linked as partners with its Community, Coastal Federal's journey, through its first 50 years to what it is today, has to be one of the more interesting stories in the history of American small business. A quick trip back through time takes us from its grand opening in 1954, through a period of very slow growth, during which it remained a one-location bank until 1971. The late-seventies and the decade of the eighties brought rapid growth, but a very difficult economic environment and was followed by the conversion to public ownership in 1990. Since that point, its Transformation To A Very Good Organization, as evidenced by U.S. Banker Magazine having ranked it the #1 Community Bank in the Carolinas for each of the past four years, continues to affirm our belief that, when you have good people working together for the common goals of the Community, there is no limit to the growth and prosperity that can be achieved. Over the past 50 years, in keeping with the Vision and Values of our founders, we have been committed to Exceeding the Expectations of our Customers by delivering our only product, which is Service, in the only manner which adds value, as Trusted Financial Advisors, through our only real competitive advantage, our exceptional Associates. And over the thirteen years since becoming a publicly owned company, all of us at Coastal Financial Corporation have focused on accomplishing Our Basic Corporate Objective Of Maximizing The Value Of Our Shareholders' Investment by working diligently toward the achievement of Our Long-Term Goal Of Being The Best Financial Services Company In Our Marketplace. Our ongoing commitment to the Vision and Values of our founders, as expressed through our QUEST FOR EXCELLENCE Operating Philosophy and our Vision 2005 Plan, has again produced outstanding results for our Shareholders and we are absolutely convinced that this approach will help to ensure that our best days are yet to come and facilitate our Transformation From A Very Good Organization To An Exceptional Organization. Share Price Performance [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR GRAPH IN THE PRINTED MATERIAL.] Initial Public Offering October 4, 1990 $10.00 Sept. 30, 1991 $10.00 Sept. 30, 1992 $27.20 Sept. 30, 1993 $68.31 Sept. 30, 1994 $85.56 Sept. 30, 1995 $85.92 Sept. 30, 1996 $134.94 Sept. 30, 1997 $217.16 Sept. 30, 1998 $215.52 Sept. 30, 1999 $177.72 Sept. 30, 2000 $113.80 Sept. 30, 2001 $217.36 Sept. 30, 2002 $299.07 Sept. 30, 2003 $374.19 The price of Coastal Financial Corporation's common stock increased 25% since September 30, 2002 and has grown at a compound annual rate of over 31% since 1990. These historical results may not be indicative of future stock price performance. Share data has been restated to reflect all stock splits, stock dividends, and reinvested cash dividends. 2 Financial Highlights The following table sets forth certain information concerning the financial position of the Company (including data from operations of its subsidiaries) as of the dates and for the periods indicated. The consolidated data is derived from, and should be read in conjunction with, the Consolidated Financial Statements of the Company and its subsidiaries presented herein.
At or for Years Ended September 30, ------------------------------------------------------------------ 1999 2000 2001 2002 2003 ---------- ---------- ---------- ---------- ---------- (Dollars in thousands, except per share data) Financial Condition Data: Total assets .............................................. $ 713,013 $ 768,838 $ 763,214 $ 950,796 $1,181,209 Loans receivable, net ...................................... 455,351 511,701 488,754 536,851 682,737 Mortgage-backed securities ................................. 182,115 189,239 190,553 331,808 383,324 Cash, interest-bearing deposits and investment securities .. 30,296 25,715 36,320 27,816 37,484 Deposits ................................................... 399,673 406,217 530,364 637,081 697,012 Borrowings ................................................. 262,541 303,151 160,808 228,622 392,797 Stockholders` equity ....................................... 41,237 46,945 57,248 66,386 73,707 Operating Data: Interest income ........................................... $ 49,559 $ 58,079 $ 60,255 $ 53,873 $ 59,214 Interest expense ........................................... 26,991 33,636 33,323 21,846 22,998 ---------- ---------- ---------- ---------- ---------- Net interest income ...................................... 22,568 24,443 26,932 32,027 36,216 Provision for loan losses .................................. 750 978 955 1,235 2,655 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses ........ 21,818 23,465 25,977 30,792 33,561 ---------- ---------- ---------- ---------- ---------- Other Income: Fees and service charges on loans and deposit accounts ..... 2,025 2,126 2,634 3,148 3,489 Gain on sales of loans held for sale ....................... 979 631 1,295 1,462 2,985 Gain (loss) on sales of investment securities, net ......... 73 (17) (56) 102 -- Gain (loss) on sales of mortgage-backed securities, net .... 191 (1,554) 727 238 469 Real estate operations ..................................... (29) (64) (453) (137) (18) Other income ............................................... 2,334 4,759 3,755 3,326 3,983 ---------- ---------- ---------- ---------- ---------- Total other income ......................................... 5,573 5,881 7,902 8,139 10,908 Total general and administrative expense ................... 15,286 16,191 19,292 22,824 27,156 ---------- ---------- ---------- ---------- ---------- Earnings before income taxes ............................... 12,105 13,155 14,587 16,107 17,313 Income taxes ............................................... 4,390 4,698 5,287 5,901 6,141 ---------- ---------- ---------- ---------- ---------- Net income ................................................ $ 7,715 $ 8,457 $ 9,300 $ 10,206 $ 11,172 ========== ========== ========== ========== ========== Net earnings per common diluted share ...................... $ .56 $ .62 $ .70 $ .77 $ .83 ========== ========== ========== ========== ========== Cash dividends per common share ............................ $ .14 $ .14 $ .16 $ .17 $ .20 ========== ========== ========== ========== ========== Weighted average shares outstanding diluted ................ 13,767 13,571 13,304 13,237 13,441 ========== ========== ========== ========== ==========
All share and per share data have been restated to reflect a 5% stock dividend declared on November 10, 1999, a 10% stock dividend declared on March 14, 2000, a 3 for 2 stock dividend declared on July 31, 2001, and two 10% stock dividends declared on May 27, 2003 and August 28, 2003. Key Operating Ratios: The table below sets forth certain performance ratios of the Company at the dates or for the periods indicated.
At or for Years Ended September 30, ----------------------------------- 1999 2000 2001 2002 2003 ---- ---- ---- ---- ---- Other Data: Return on assets (net income divided by average assets) ..................... 1.14% 1.13% 1.20% 1.23% 1.04% Return on average equity (net income divided by average equity) ............. 19.30% 19.52% 17.75% 16.92% 15.84% Average equity to average assets ............................................ 5.93% 5.80% 6.59% 7.29% 6.59% Book value per share ........................................................ $ 3.06 $ 3.55 $ 4.41 $ 5.18 $ 5.70 Dividend payout ratio ....................................................... 23.28% 22.61% 21.58% 21.77% 23.20% Interest rate spread (difference between average yield on interest-earning assets and average cost of interest-bearing liabilities) .................. 3.55% 3.50% 3.64% 4.14% 3.65% Net interest margin (net interest income as a percentage of average interest-earning assets) .................................................. 3.67% 3.57% 3.77% 4.24% 3.67% Allowance for loan losses to total loans at end of period ................... 1.36% 1.35% 1.42% 1.42% 1.40% Ratio of non-performing assets to total assets (1) .......................... 0.21% 0.73% 0.74% 0.48% 0.77% Tangible capital ratio ...................................................... 6.29% 6.56% 7.28% 6.57% 7.14% Core capital ratio .......................................................... 6.29% 6.56% 7.28% 6.57% 7.14% Risk-based capital ratio .................................................... 12.64% 12.45% 13.30% 12.74% 13.17%
(1) Nonperforming assets consist of nonaccrual loans 90 days or more past due and real estate acquired through foreclosure. 3 Dear Friends The year 2004 marks our 50th anniversary and begins a celebration of our first fifty years of operation. It is also an appropriate opportunity for us to express appreciation to our founders, who created this organization with a strong sense of purpose and values and a clear vision of the opportunities the future would hold, and to the many talented Leaders who have, over the years, encouraged the organization to strive to reach its full potential and facilitated its progress. Unlike the histories of growth by merger and acquisition of many banks across the country, the history of Coastal Federal is all about internal growth fueled by the steady expansion of the Communities of coastal North and South Carolina. In the beginning, growth was very slow as the Grand Strand and its adjacent coastal Communities had not yet been discovered or fully appreciated for their many attributes. Once our Country was solidly back on its feet after World War II, and the members of that great generation who lived within a day's drive discovered and fell in love with this vacation paradise, our Community began to grow like wildfire. And, as the demand for business and real estate development grew, Coastal Federal was there to meet those financial needs with a full array of financial services delivered by qualified and trusted financial advisors. Over the past fifty years, while the world, and its values system has changed at a constantly increasing pace, we at Coastal Financial Corporation, in keeping with the Vision and Values of our founders, have staked our future on our QUEST FOR EXCELLENCE Operating Philosophy which allows us to conduct our operations with a view toward the long-term and a focus on doing the right things for our Associates, our Customers and our Communities. Thanks to the solid foundation established by our founders, we have maintained a strong belief that a shared sense of purpose and values is critical to the attainment of Our Basic Corporate Objective Of Maximizing The Value Of Our Shareholders' Investment and Our Long-Term Goal Of Being The Best Financial Services Company In Our Marketplace. The result of this ever-increasing focus has been the continued evolution of Coastal Financial Corporation to its present status as a Very Good Organization. Our challenge now is The Transformation From A Very Good Organization To An Exceptional Organization. While this journey is an ambitious one, thanks to the strong framework established by our founders, and sustained over the years by each of our subsequent Leaders, it is one which we are well-positioned to undertake. Further evidence of our readiness to begin this move to the next level is present in the results of this year's operations. Despite the very challenging economic conditions of this past year, our commitment to our QUEST FOR EXCELLENCE Operating Philosophy and Vision 2005 Plan has continued to guide our operations and has produced another year of exceptional financial results and some notable milestones: o Coastal Financial Corporation's net income for 2003 totaled $11.2 million, compared to $10.2 million in 2002. On a fully diluted basis, these results equated to a 7.8% increase, from $0.77 per share in 2002 to $0.83 per share in 2003. Major contributors to this growth in net income were continued strong Core Deposit and loan growth and effective expense control. From an overall operations perspective, our strategy of focusing on Core Deposits and promoting more interaction and integration among all of our operating areas has begun to pay off, as reflected in the number of cross-referrals which were recorded this year. o Deposits from the residents and businesses of the Communities we serve increased by approximately $59.9 million, or 9.4% to $697.0 million. o Loans grew by 26%, primarily reflecting a continued strong focus on our business banking line of business. The infrastructure we have developed in support of our business banking activities over the past several years has shown success, and, in order to increase our effectiveness, during 2003, we have continued this investment in infrastructure through the creation of a small business banking group which is specifically designed to embrace the specialized financial services needs of a much larger segment of our small business Community. By clearly differentiating our business banking and commercial banking offerings and approaches, we will be significantly better positioned to meet the unique needs of the businesses and business owners in the Communities we serve. o Our residential banking operations generated total originations in excess of $305 million. o Coastal Investor Services, our Investment Services Division, had another banner year. Assets under management through Raymond James increased by 23% to $212 million. Total revenues from this area of our operations continued to increase, resulting in Raymond James Financial Services ranking Coastal Investor Services fourth, out of over 240 Financial Institution Division affiliates. o The framework supporting our focus on financial planning activities was enhanced with the formation of Coastal Retirement, Estate & Tax Planners, Inc. during the fourth 4 Dear Friends quarter of 2003. Coastal Retirement, Estate and Tax Planners offers professional, objective, fee-based financial planning services and is a crucial step in our overall branding strategy which will make it easier for our Customers to do more of their financial services related business with us. o Our financial services distribution system continued to expand to serve more of the Communities of coastal North Carolina, with the opening of our newest office in Shallotte, North Carolina in September of this year, bringing our total number of full-service Banking Centers to nineteen. o In recognizing the role of technology in our Mission of working toward Exceeding the Expectations of our Customers, during 2003, we completed a long-planned Information Technology Platform system conversion which has armed us with enabling capability to both better serve our Customers and operate at optimum efficiency levels. o Coastal Federal University continued to enable Coastal Financial Corporation's superior performance through its never-ending focus on our philosophy of becoming a learning organization. In addition to delivering an ever-increasing array and number of curriculum offerings designed to enable each of our Associates to achieve their full personal and professional potential, the Dean of Coastal Federal University and our outstanding faculty members helped to facilitate the exceptionally well executed Information Technology Platform conversion by providing approximately 1,000 hours of classroom training. Other key achievements in support of our Transformation To An Exceptional Organization were evidenced by the development of a new Business Banking College curriculum and the initiation of a Leadership Development College. In addition to our excellent operating results for 2003, which again met our high expectations, the market price of Coastal Financial's common stock, at September 30, 2003, was 25.0% higher than the market price at September 30, 2002. And, equally as impressive, is the fact that, since 1990, our operating earnings have increased at a compound annualized rate in excess of 16%. Since becoming a publicly owned company in 1990, Coastal Financial Corporation's stock has grown at a compound annual rate of over 31%, taking our market capitalization from $4.6 million in October 1990, to $180.8 million at the close of this fiscal year. Put another way, an initial investment of $10,000 in October of 1990 would have grown to over $365,000 at September 30, 2003, without regard to the reinvestment of cash dividends. One of the best indicators of performance is Return On Shareholders' Equity, and this measure for 2003 was, again, outstanding. Our Return On Average Shareholders' Equity of 15.8% ranks us among the top performing financial services companies in America. Adding to our own sense of satisfaction with these financial results during 2003 was the continuation of significant public recognition of our progress toward the attainment of Our Basic Corporate Objective Of Maximizing The Value Of Our Shareholders' Investment and Our Long-Term Goal Of Being The Best Financial Services Company In Our Marketplace. Several very good examples follow: o Coastal Financial Corporation, for the 4th consecutive year, was ranked the #1 Community Bank in the Carolinas by U. S. BANKER ------------ MAGAZINE, in its August 2003 publication. In this edition, U. S. -------- BANKER MAGAZINE featured its Ranking of the Top 100 Publicly Traded --------------- Mid-Tier Banks. This ranking spotlighted banks with assets between $1 and $15 billion, based upon a 3-year average measure of Return On Average Equity. Coastal Financial Corporation was ranked 1st in the Carolinas and 39th nationally in this listing. o Coastal Federal Bank, for the sixth consecutive year, placed 1st in voting by the readers of the (Myrtle Beach) SUN NEWS in the -------- Financial Institutions category of the SUN NEWS Best Of The Beach -------- Competition for 2003. o Coastal Federal Bank placed 1st in voting by the readers of the SUN --- NEWS in the Mortgage Company category of the SUN NEWS Best Of The ---- -------- Beach Competition for 2003. o Coastal Investor Services/Raymond James Financial Services placed 1st in voting by the readers of the SUN NEWS in the Financial -------- Planning category of the SUN NEWS Best Of The Beach Competition for -------- 2003. o The 2003 SHESHUNOFF MARKET SHARE REPORT ranked Coastal Federal Bank ----------------------------------- the leader in deposit market share for Horry County for the twelve months ended June 30, 2003. All of us at Coastal Financial are pleased with these forms of recognition because each, in its own way, represents tangible evidence that our focus on the Vision and Values of our founders, as expressed in our QUEST FOR EXCELLENCE Operating Philosophy and our Vision 2005 Plan, has enabled us to continue to deliver value to all of our stakeholders. 5 2003 Our Best Year Yet Given the many and varied challenges which existed during 2003, our operating results continue to affirm what can be achieved through the aligned effort of an organization which is focused on the execution of well-conceived and articulated business strategies. The consciously-held commitment our Associates have for following the Mission, Values and Guiding Principles of our QUEST FOR EXCELLENCE Operating Philosophy in executing the strategies established in our Vision 2005 Plan has enabled the financial performance during fiscal 2003 which, again, met our high expectations and will serve to underpin and gird our Transformation From A Very Good Organization To An Exceptional Organization. Noteworthy Financial Results for Fiscal 2003 DILUTED EARNINGS PER SHARE o Net income for 2003 totaled $11.2 million, compared to $10.2 million in 2002. On a fully diluted basis, these results equated to a 7.8% increase, from $0.77 per share in 2002 to $0.83 per share in 2003. o Shareholders' equity advanced 11.0% to $73.7 million. [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR GRAPH IN THE PRINTED MATERIAL.] 1999 $0.56 2000 $0.62 2001 $0.70 2002 $0.77 2003 $0.83 BOOK VALUE PER SHARE o Book value per share grew 10.0% to $5.70. [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR GRAPH IN THE PRINTED MATERIAL.] 1999 $3.06 2000 $3.55 2001 $4.41 2002 $5.18 2003 $5.70 6 2003 Our Best Year Yet ASSETS o Total assets increased 24.2%, from $950.8 million to $1.2 billion. o Deposits derived from the residents and businesses of the Communities we serve increased 9.4%, from $637.1 million to $697.0 million, the highest level in the Company's history. o Loans receivable increased 26.3%, from $555.5 million to $701.8 million. [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR GRAPH IN THE PRINTED MATERIAL.] (IN MILLIONS) 1999 $713 2000 $769 2001 $763 2002 $951 2003 $1,181 NON-PERFORMING ASSETS TO TOTAL ASSETS o Non-performing assets to total assets increased from 0.48% to 0.77%. [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR GRAPH IN THE PRINTED MATERIAL.] 1999 0.21% 2000 0.73% 2001 0.74% 2002 0.48% 2003 0.77% ALLOWANCE FOR LOAN LOSSES TO NET LOANS o Allowance for loan losses to net loans was at 1.40%. o The Company had net loan charge-offs as a percentage of Average Loans of 0.11% in 2003. [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR GRAPH IN THE PRINTED MATERIAL.] 1999 1.36% 2000 1.35% 2001 1.42% 2002 1.42% 2003 1.40% Success in such key measures of performance are the product of the commitment, dedication and aligned effort of a truly outstanding group of Associates who share a passion for our QUEST FOR EXCELLENCE Operating Philosophy and Vision 2005 Plan. Our continuing trend of exceptional performance has been rewarded in the financial markets by a 3,556% increase in the price of our shares since becoming a public company in October of 1990, vs. 228% for the Standard & Poor's 500 Index over the same period. 7 2003 Our Best Year Yet Over these thirteen years of public ownership, we have methodically focused our individual and collective efforts on accomplishing Our Basic Corporate Objective Of Maximizing The Value Of Our Shareholders' Investment by working diligently toward the achievement of Our Long-Term Goal Of Being The Best Financial Services Company In Our Marketplace. In considering whether we have made real progress toward the attainment of Our Basic Corporate Objective during this period, it is both informative and illustrative to compare the share price performance of Coastal Financial Corporation to the share price performance of other publicly traded financial services companies operating within our marketplace, and to the financial markets as a whole. In the following graphs, we have compared the share price performance of (CFCP) Coastal Financial Corporation to the Nasdaq, S&P 500 and Dow Indices, and to (TSFG) The South Financial Group, the parent company of Carolina First Bank, (WB) Wachovia Corporation, the parent company of Wachovia Bank, (SNV) Synovus Financial Corporation, the parent company of NBSC, (BBT) BB&T Corporation, the parent company of BB&T, (BAC) Bank of America Corporation, the parent company of Bank of America, (FFCH) First Financial Holdings, Inc., the parent company of First Federal Savings and Loan Association of Charleston and (COOP) Cooperative Bankshares, Inc., the parent company of Cooperative Bank. As demonstrated by these graphic representations, which take a look back over our history as a publicly owned company, the price of Coastal Financial Corporation's shares has significantly outperformed the price of the shares of the other publicly traded financial services companies in our marketplace, as well as the Nasdaq, S&P 500 and Dow Indices. These historical results may not be indicative of future stock price performance. 8 13 Year Peer Group Price Performance
DATE CFCP BAC BBT COOP FFCH SNV TSFG WB Oct-90 100 100.00 100.00 100.00 100.00 100.00 100.00 Oct-91 100 216.67 151.40 100 148.47 140.38 104.96 206.19 Oct-92 305.7667 268.12 191.67 293.7375 234.80 173.05 149.62 267.24 Oct-93 755.1197 270.30 231.96 421.875 363.55 216.36 177.10 287.60 Oct-94 854.8522 286.96 229.18 513.2813 363.55 220.68 180.15 318.56 Oct-95 875.1548 381.16 286.11 618.75 448.38 292.80 180.15 351.31 Oct-96 1472.617 546.38 384.73 527.3438 484.73 517.06 213.74 515.01 Oct-97 2197.232 693.48 604.87 942.1875 936.16 564.64 333.97 694.65 Oct-98 2368.642 666.67 794.44 731.25 933.11 902.96 352.10 821.18 Oct-99 1745.315 747.11 808.33 590.625 905.87 834.81 315.84 605.27 Oct-00 1511.879 557.25 708.33 541.4063 817.98 839.68 155.53 429.18 Oct-01 2008.639 683.94 713.33 646.875 1204.07 896.42 243.51 404.93 Oct-02 3090.712 809.28 805.56 787.5 1238.97 797.90 330.53 492.57 Oct-03 3656.134 904.81 798.00 1434.375 1464.86 973.13 382.14 583.18
9 Our 2003 operating and share price performance results clearly put Coastal Financial among the top performing financial services companies in the nation. Thanks to our continuous focus on the Vision and Values established by our founders, we enter 2004 well positioned to continue our journey toward our Transformation From A Very Good Organization To An Exceptional Organization. As indicated by the financial results shown above, our business has continued to grow and prosper. But, as good as these results are, it's always the future that we are most interested in, and it always leads to the question we're often asked: "Can we keep it up?" We continue to believe the answer is a resounding "Yes," as long as we remain focused on our QUEST FOR EXCELLENCE Operating Philosophy and the goals established in our Vision 2005 Plan. CFCP Relative Price Performance Monthly prices (Oct 1990 to Oct 2002) DATE S&P 500 INDENASDAQ) DOW JONES INDUSTRIAL Oct-90 304.0 329.8 2442.3 Oct-91 392.5 543.0 3069.1 Oct-92 418.7 605.2 3226.3 Oct-93 467.8 779.3 3680.6 Oct-94 472.4 777.5 3908.1 Oct-95 581.5 1036.1 4755.5 Oct-96 705.3 1221.5 6029.4 Oct-97 914.6 1593.6 7442.1 Oct-98 1098.7 1771.4 8592.1 Oct-99 1362.9 2966.4 10729.9 Oct-00 1429.4 3369.6 10971.1 Oct-01 1059.8 1690.2 9075.1 Oct-02 885.76 1329.75 8397.03 Oct-03 995.97 1786.94 9275.06 10 Indexes DATE S&P 500 NASDAQ DOW JONES INCFCPRIAL Oct-90 100 100 100 100 Oct-91 129.0954 164.6392 125.6628 100 Oct-92 137.7237 183.4961 132.0984 305.7667 Oct-93 153.8914 236.2826 150.6999 755.1197 Oct-94 155.3783 235.7459 160.0161 854.8522 Oct-95 191.2829 314.148 194.7108 875.1548 Oct-96 231.9967 370.379 246.87 1472.617 Oct-97 300.8618 483.205 304.7123 2197.232 Oct-98 361.4046 537.1104 351.7993 2368.642 11 Indexes DATE S&P 500 NASDAQ DOW JONES INCFCPRIAL Oct-99 448.3322 899.4633 439.3305 1745.315 Oct-00 470.1974 1021.719 449.2063 1511.879 Oct-01 348.6118 512.4924 371.5771 2008.639 Oct-02 291.3684 403.1989 343.8123 3090.712 Oct-03 327.6217 541.8253 379.7628 3656.134 15 A Look Back In reflecting on our founders, I am reminded of the following quotation by an anonymous author: "It has been said that the most powerful thing in life is one's opportunity; it is also the most irretrievable. We must have clear vision, courage, and a quiet mind if we are to see it and seize it as it hurries past us on very quiet feet and disappears as completely as the day that has gone." How easily our founders could have missed seeing that our Community needed an organization like Coastal Federal if their minds had not been alert for this opportunity. Because they were Community-focused individuals, they were prepared when this opportunity came. And because of this Community focus, they understood well that our future success would be a function of Coastal Federal's Associates and their Relationships with their Customers and their Communities. Usually, the indications of the importance of an organization's People are found encoded in the symbolism and heritage of its past. Those symbols are often preserved, even without an organizational requirement for such, by those who see and recognize the value of those symbols, much like the way that members of a family somehow sense which parts of their heritage to pass along to the next generation. In thinking about the early symbolism and legacy of Coastal Federal, I reflect back on having dinner at a small restaurant in Myrtle Beach, on the eve of my joining the Bank as a teller, in February of 1974. Upon finishing my dinner and proceeding to the check out, the cashier inquired as to what I was doing in Myrtle Beach at that time of the year. I responded that I had moved here to begin work for Coastal Federal. Her reply has stuck with me over the years as if I had heard it only yesterday. She said, "those are the nicest people in town." That response has reverberated in my head many times over the years and I have sensed that the value expressed in that statement was that this attribute, this symbolic part of our legacy, was to be saved and passed on to future generations. Therefore, it is not at all surprising that, in our planning initiatives after our conversion to public ownership in the early nineties, we focused almost exclusively on our Associates, our internal Customers, who serve our external Customers. It was, and continues to be, our strong belief that each component part of our organization; the character and competency of our Associates, our Mission of Exceeding the Expectations of our Customers, our Guiding Principles which are Safety and Soundness #1, Profitability #2 and Growth #3, and our overriding focus on creating Shareholder value, is very important. Through our continued work toward planning for our future, the relative significance of each of these elements converged into the creation of our strategic focus which is: We accomplish Our Basic Corporate Objective of Maximizing The Value Of Our Shareholders' Investment by working diligently toward the achievement of Our Long-Term Goal of Being The Best Financial Services Company In Our Marketplace. This focus on our Associates, our Customers and our Communities ultimately lead to the development of our QUEST FOR EXCELLENCE Operating Philosophy and our Vision 2005 Plan. Those Vision and Values oriented instruments have enabled us to develop and maintain a strong focus on the execution of strategies designed to Exceed the Expectations of our Customers, by delivering our only product, which is Service, in the only manner which adds value, as Trusted Financial Advisors, through our only real competitive advantage, our exceptional Associates. [PHOTO] Coastal Federal Bank's First Financial Statement 12 A Look Back [PHOTO] Coastal Federal Bank's First Office. [PHOTO] Elinor Whitsett Coastal Federal Bank's first Associate. [PHOTO] To serve a growing Community, Coastal Federal Bank utilized its mobile office to provide added banking convenience. 13 Looking Ahead Our journey toward The Transformation From A Very Good Organization To An Exceptional Organization is a very ambitious one which will require us to develop an even sharper focus on our QUEST FOR EXCELLENCE Operating Philosophy and our Vision 2005 Plan by continually refocusing on being Totally Committed To Exceeding the Expectations of our Customers in a manner which can ensure that we add value for all of our stakeholders. What must we do to become an exceptional organization? Without question, it will be much more difficult to Transform a Very Good Organization into an Exceptional Organization than it was to Transform an Average Organization into a Very Good Organization. Moving to the next level can only be accomplished through our total focus on our Associates, the total focus of our Associates on our Customers and our working together as a team to earn all of every Customer's financial services related business by maintaining a laser-like focus on exceptionally well-conceived and articulated strategies and by executing those strategies with precision and alignment. The Vision and Values of our founders and the success we have enjoyed over the past thirteen years as a public company have well positioned us for this journey. And, while we are very fortunate to be located in one of the best markets in America, and enjoy many competitive advantages, all of the success that Coastal Financial has achieved over these years is due to our exceptional team of Associates. And we have the best team imaginable. My sincere appreciation goes to our Board Of Directors, Leadership Group and Associates for all they do for all of us on a daily basis. Our 2003 results speak volumes about their commitment to Our Basic Corporate Objective Of Maximizing The Value Of Our Shareholders' Investment by working diligently toward the achievement of Our Long-Term Goal Of Being The Best Financial Services Company In Our Marketplace. During 2002 and 2003, both revenue and earnings reached record levels. In fact, in these two years alone, our net income has increased over 20%, and in the last five years, our net income has increased by more than 63%. Since becoming a publicly owned Company in 1990, we have roughly doubled our earnings every 5 years. As we embark on our 51st year, while we are pleased with our past achievements, we look forward to even greater accomplishments in the years ahead. We have great confidence that, with the advantages of our exceptional Associates, who believe in who we are and what we are about, our great markets, our excellent products and our ever-increasing ability to work together, as a team, toward building even stronger relationships with our Customers and our Communities, The Transformation From A Very Good Organization To An Exceptional Organization will be accomplished and will enable us to continue to achieve superior returns for our Shareholders in the future. All of us at Coastal Financial Corporation appreciate your continued encouragement, loyalty and support, and look to the future with great enthusiasm and excitement. /s/ Michael C. Gerald Michael C. Gerald President and Chief Executive Officer COASTAL COASTAL CP [LOGO] CFU FEDERAL INVESTOR COASTAL COASTAL FEDERAL BANK SERVICES RETIREMENT o ESTATE o TAX UNIVERSITY The right bank for you. PLANNERS 14 Independent Auditors' Report The Board of Directors Coastal Financial Corporation Myrtle Beach, South Carolina We have audited the consolidated statements of financial condition of Coastal Financial Corporation and subsidiaries (the "Company") as of September 30, 2002 and 2003, and the related consolidated statements of operations, stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended September 30, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company at September 30, 2002 and 2003, and the results of its operations and its cash flows for each of the years in the three-year period ended September 30, 2003, in conformity with accounting principles generally accepted in the United States of America. Greenville, South Carolina October 29, 2003 KPMG LLP 15 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Financial Condition September 30, 2002 and 2003
2002 2003 ---------- ---------- (Dollars in thousands) ASSETS Cash and amounts due from banks ...................................... $ 25,802 $ 18,605 Short-term interest-bearing deposits ................................. -- 2,970 Investment securities available for sale ............................. 2,014 15,909 Mortgage-backed securities available for sale ........................ 331,808 383,324 Loans receivable (net of allowance for loan losses of $7,883 at September 30, 2002 and $9,832 at September 30, 2003) ............ 536,851 682,737 Loans receivable held for sale ....................................... 18,694 19,096 Real estate acquired through foreclosure, net ........................ 1,046 1,627 Office property and equipment, net ................................... 13,713 16,088 Federal Home Loan Bank (FHLB) stock, at cost ......................... 10,559 13,991 Accrued interest receivable on loans ................................. 2,232 2,258 Accrued interest receivable on securities ............................ 2,019 2,074 Bank-owned life insurance ............................................ -- 16,165 Other assets ......................................................... 6,058 6,365 ---------- ---------- $ 950,796 $1,181,209 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Deposits ........................................................... 637,081 697,012 Federal funds purchased and securities sold under agreements to repurchase ......................................... 36,884 133,602 Advances from FHLB ................................................. 189,669 244,114 Debt associated with trust preferred securities .................... -- 15,000 Other borrowings ................................................... 2,069 81 Drafts outstanding ................................................. 2,517 2,644 Advances by borrowers for property taxes and insurance ............. 1,386 1,795 Accrued interest payable ........................................... 1,473 1,263 Other liabilities .................................................. 13,331 11,991 ---------- ---------- Total liabilities ................................................ 884,410 1,107,502 ---------- ---------- Stockholders' equity: Serial preferred stock, 1,000,000 shares authorized and unissued ... -- -- Common stock $.01 par value, 15,000,000 shares authorized; 12,811,148 shares at September 30, 2002 and 12,921,298 shares at September 30, 2003 issued and outstanding .............. 128 129 Additional paid-in capital ......................................... 9,922 10,235 Retained earnings, restricted ...................................... 54,954 63,030 Treasury stock, at cost (430,082 shares at September 30, 2002 and 334,508 shares at September 30, 2003) ................... (4,376) (3,375) Accumulated other comprehensive income, net of tax ................. 5,758 3,688 ---------- ---------- Total stockholders' equity ....................................... 66,386 73,707 ---------- ---------- $ 950,796 $1,181,209 ========== ==========
See accompanying notes to consolidated financial statements. 16 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations Years ended September 30, 2001, 2002 and 2003
2001 2002 2003 ----------- ----------- ----------- (In thousands, except share data) Interest: Loans receivable ......................................... $ 45,899 40,261 41,958 Investment securities .................................... 2,479 2,030 1,840 Mortgage-backed securities ............................... 11,261 11,348 15,279 Other .................................................... 616 234 137 ----------- ----------- ----------- Total interest income ....................................... 60,255 53,873 59,214 ----------- ----------- ----------- Interest expense: Deposits ................................................. 19,380 13,750 11,999 Securities sold under agreements to repurchase ........... 2,810 414 1,931 Advances from FHLB ....................................... 11,133 7,682 9,068 ----------- ----------- ----------- Total interest expense ................................ 33,323 21,846 22,998 ----------- ----------- ----------- Net interest income ................................... 26,932 32,027 36,216 Provision for loan losses ................................... 955 1,235 2,655 ----------- ----------- ----------- Net interest income after provision for loan losses ...... 25,977 30,792 33,561 ----------- ----------- ----------- Other income: Fees and service charges on loans and deposit accounts ... 2,634 3,148 3,489 Gain on sales of loans held for sale ..................... 1,295 1,462 2,985 Gain (loss) on sales of investment securities, net ....... (56) 102 -- Gain on sales of mortgage-backed securities, net ......... 727 238 469 Loss from real estate acquired through foreclosure ....... (453) (137) (18) Income from sales of non-depository products ............. 1,269 1,281 1,176 Federal Home Loan Bank stock dividends ................... 750 463 453 Other income ............................................. 1,736 1,582 2,354 ----------- ----------- ----------- Total other income .................................... 7,902 8,139 10,908 ----------- ----------- ----------- General and administrative expenses: Salaries and employee benefits ........................... 10,546 12,514 13,452 Net occupancy, furniture and fixtures and data processing expense ............................... 4,029 5,044 5,917 FDIC insurance premium ................................... 84 93 104 FHLB prepayment penalties ................................ 1,113 1,083 2,824 Other expense ............................................ 3,520 4,090 4,859 ----------- ----------- ----------- Total general and administrative expense .............. 19,292 22,824 27,156 ----------- ----------- ----------- Income before income taxes ............................ 14,587 16,107 17,313 Income taxes ................................................ 5,287 5,901 6,141 ----------- ----------- ----------- Net income .................................................. $ 9,300 10,206 11,172 =========== =========== =========== Net income per common share Basic .................................................... $ 0.71 0.79 0.87 =========== =========== =========== Diluted .................................................. $ 0.70 0.77 0.83 =========== =========== =========== Average common shares outstanding Basic .................................................... 13,126,000 12,844,000 12,853,000 =========== =========== =========== Diluted .................................................. 13,304,000 13,237,000 13,441,000 =========== =========== ===========
See accompanying notes to consolidated financial statements. 17 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity and Comprehensive Income Years ended September 30, 2001, 2002 and 2003
Accumulated Other Additional Comprehensive Total Common Paid-in Retained Treasury Income Stockholders' Stock Capital Earnings Stock (Loss) Equity -------- -------- -------- -------- -------- -------- (In thousands) Balance at September 30, 2000 ..................... $ 131 $ 9,722 $ 40,319 $ (1,702) $ (1,525) $ 46,945 Exercise of stock options ......................... -- -- (108) 214 -- 106 Cash dividends .................................... -- -- (2,015) -- -- (2,015) Net income ........................................ -- -- 9,300 -- -- 9,300 Other comprehensive income, net of tax: Unrealized gains arising during period, net of taxes of $3,348 ......................... -- -- -- -- 5,462 -- Less: reclassification adjustment for gains included in net income, net of taxes of $255 ... -- -- -- -- (416) -- -------- -------- -------- -------- -------- -------- Other comprehensive income ........................ -- -- -- -- 5,046 5,046 -------- -------- -------- -------- -------- -------- Comprehensive income .............................. -- -- -- -- -- 14,346 -------- -------- -------- -------- -------- -------- Treasury stock repurchases ........................ (2) -- -- (2,132) -- (2,134) -------- -------- -------- -------- -------- -------- Balance at September 30, 2001 ..................... 129 9,722 47,496 (3,620) 3,521 57,248 Exercise of stock options ......................... -- 200 (526) 1,529 -- 1,203 Cash dividends .................................... -- -- (2,222) -- -- (2,222) Net income ........................................ -- -- 10,206 -- -- 10,206 Other comprehensive income, net of tax: Unrealized gains arising during period, net of taxes of $1,500 ......................... -- -- -- -- 2,449 -- Less: reclassification adjustment for gains included in net income, net of taxes of $128 ... -- -- -- -- (212) -- -------- -------- -------- -------- -------- -------- Other comprehensive income ........................ -- -- -- -- 2,237 2,237 -------- -------- -------- -------- -------- -------- Comprehensive income .............................. -- -- -- -- -- 12,443 -------- -------- -------- -------- -------- -------- Treasury stock repurchases ........................ (1) -- -- (2,285) -- (2,286) -------- -------- -------- -------- -------- -------- Balance at September 30, 2002 ..................... 128 9,922 54,954 (4,376) 5,758 66,386 Exercise of stock options ......................... 1 313 (504) 1,343 -- 1,153 Cash dividends .................................... -- -- (2,592) -- -- (2,592) Net income ........................................ -- -- 11,172 -- -- 11,172 Other comprehensive income, net of tax: Unrealized losses arising during period, net of taxes of $1,097 ......................... -- -- -- -- (1,779) -- Less: reclassification adjustment for gains included in net income, net of taxes of $178 ... -- -- -- -- (291) -- -------- -------- -------- -------- -------- -------- Other comprehensive loss .......................... -- -- -- -- (2,070) (2,070) -------- -------- -------- -------- -------- -------- Comprehensive income .............................. -- -- -- -- -- 9,102 -------- -------- -------- -------- -------- -------- Treasury stock repurchases ........................ -- -- -- (342) -- (342) -------- -------- -------- -------- -------- -------- Balance at September 30, 2003 ..................... $ 129 $ 10,235 $ 63,030 $ (3,375) $ 3,688 $ 73,707 ======== ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements. 18 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended September 30, 2001, 2002 and 2003
2001 2002 2003 --------- --------- --------- (In thousands) Cash flows from operating activities: Net income ............................................................... $ 9,300 10,206 11,172 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation .......................................................... 1,556 2,074 2,374 Provision for loan losses ............................................. 955 1,235 2,655 Gain on sale of mortgage-backed securities available for sale ......... (727) (238) (469) (Gain) loss on sale of investment securities available or sale ........ 56 (102) -- Origination of loans receivable held for sale ......................... (81,778) (100,309) (141,404) Proceeds from sales of loans receivable held for sale ................. 28,541 13,907 45,367 Gain on sale of real estate aquired through foreclosure ............... -- -- (165) Loss on early extinguishment of debt .................................. 1,113 1,083 2,824 (Increase) decrease in: Cash value of life insurance ....................................... -- -- (665) Other assets ....................................................... (1,019) (2,006) (157) Accrued interest receivable ........................................ 548 (127) (81) Increase (decrease) in: Accrued interest payable ........................................... (1,347) 289 (210) Other liabilities .................................................. 428 2,176 (65) --------- --------- --------- Net cash used in operating activities .............................. (42,374) (71,812) (78,824) --------- --------- --------- Cash flows from investing activities: Proceeds from sales of investment securities available for sale .......... 5,125 -- -- Proceeds from maturities of investment securities available for sale ..... 1,595 1,995 2,000 Purchases of investment securities available for sale .................... -- (1,998) (16,141) Purchases of loans receivable ............................................ (20) (233) -- Proceeds from sales of mortgage-backed securities available for sale ..... 164,919 128,169 135,413 Purchases of mortgage-backed securities available for sale ............... (158,004) (254,494) (328,245) Principal collected on mortgage-backed securities available for sale ..... 47,566 72,990 234,321 Origination of loans receivable, net ..................................... (214,296) (317,899) (628,172) Principal collected on loans receivable .................................. 233,653 268,120 477,676 Purchase of bank-owned life insurance .................................... -- -- (15,500) Proceeds from sales of real estate acquired through foreclosure .......... 1,159 1,997 1,539 Purchases of office properties and equipment ............................. (3,188) (2,637) (4,749) Sales (purchases) of FHLB stock, net ..................................... 4,275 (2,935) (3,432) --------- --------- --------- Net cash provided by (used in) investing activities ................... 82,784 (106,925) (145,290) --------- --------- --------- Cash flows from financing activities: Increase in deposits ..................................................... 124,147 106,717 59,931 Increase (decrease) in securities sold under agreements to repurchase .... (57,155) 18,181 96,718 Proceeds from FHLB advances .............................................. 358,771 312,426 715,705 Repayment of FHLB advances ............................................... (443,959) (262,793) (661,260) Proceeds (repayments) from other borrowings, net ......................... -- -- (1,988) Issuance of debt associated with trust preferred securities .............. -- -- 15,000 Cash payments for debt issuance costs .................................... -- -- (150) Prepayment penalties on early extinguishment of debt ..................... (1,113) (1,083) (2,824) Increase (decrease) in advance payments by borrowers for property taxes and insurance ................................................... (7) 136 409 Increase (decrease) in drafts outstanding, net ........................... 102 (60) 127 Repurchase of treasury stock, at cost .................................... (2,134) (2,286) (342) Cash dividends to stockholders and cash for fractional shares ............ (2,015) (2,222) (2,592) Exercise of stock options ................................................ 106 1,203 1,153 --------- --------- --------- Net cash provided by (used in) financing activities ................... (23,257) 170,219 219,887 --------- --------- --------- Net increase (decrease) in cash and cash equivalents ........................ 17,153 (8,518) (4,227) --------- --------- --------- Cash and cash equivalents at beginning of year .............................. 17,167 34,320 25,802 --------- --------- --------- Cash and cash equivalents at end of year .................................... $ 34,320 25,802 21,575 ========= ========= ========= Supplemental information: Interest paid ............................................................ $ 34,670 21,557 23,208 ========= ========= ========= Income taxes paid ........................................................ $ 5,249 5,726 5,325 ========= ========= ========= Supplemental schedule of non-cash investing and financing transactions: Securitization of mortgage loans into mortgage-backed securities ......... $ 47,157 83,982 95,635 ========= ========= ========= Transfer of mortgage loans to real estate acquired through foreclosure ... $ 2,655 680 1,955 ========= ========= =========
See accompanying notes to consolidated financial statements. 19 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The following is a summary of the more significant accounting policies used in the preparation and presentation of the accompanying consolidated financial statements. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. In addition, they affect the reported amounts of income and expenses during the reporting period. Actual results could differ from these estimates and assumptions. (a) Principles of Consolidation The accompanying consolidated financial statements include the accounts of Coastal Financial Corporation (the "Company"), and its wholly-owned subsidiaries, Coastal Financial Capital Trust I, a statutory trust, Coastal Investor Services, Inc., Coastal Federal Bank (the "Bank") (and the Bank's wholly-owned subsidiaries, Coastal Federal Holding Company (and Coastal Federal Holding Company's wholly-owned subsidiary, Coastal Real Estate Investment Corporation), Coastal Planners Holding Corporation (and Coastal Planners Holding Corporation's wholly-owned subsidiary, Coastal Retirement, Estate and Tax Planners, Inc.), and Coastal Mortgage Bankers and Realty Co., Inc. (and Coastal Mortgage Bankers and Realty Co. Inc.'s wholly-owned subsidiaries, Shady Forest Development Corporation, Sherwood Development Corporation, Ridge Development Corporation, 501 Development Corporation and North Beach Investments, Inc.). In consolidation, all significant intercompany balances and transactions have been eliminated. Coastal Financial Corporation is a unitary thrift holding company organized under the laws of the state of Delaware. (b) Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash and amounts due from banks, short-term interest-bearing deposits and federal funds sold. Cash and cash equivalents have maturities of three months or less. Accordingly, the carrying amount of such instruments is considered to be a reasonable estimate of fair value. (c) Investment and Mortgage-backed Securities Investment and mortgage-backed securities are accounted for in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities". Investments are classified into three categories as follows: (1) Held to Maturity - debt securities that the Company has the positive intent and ability to hold to maturity, which are reported at amortized cost; (2) Trading - debt and equity securities that are bought and held principally for the purpose of selling them in the near term, which are reported at fair value, with unrealized gains and losses included in earnings and (3) Available for Sale - debt and equity securities that may be sold under certain conditions, which are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity, net of income taxes. The Company determines investment and mortgage-backed securities classification at the time of purchase. Premiums and discounts on securities are accreted or amortized as an adjustment to income over the estimated life of the security using a method which approximates a level yield. Unrealized losses on securities, reflecting a decline in value judged by the Company to be other than temporary, are charged to income in the consolidated statements of operations. The cost basis of securities sold is determined by specific identification. Purchases and sales of securities are recorded on a trade date basis. The fair value of securities is based on quoted market prices or dealer quotes. (d) Loans Receivable Held for Sale Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are provided for in a valuation allowance by charges to operations. At September 30, 2002 and 2003, the Company had approximately $18.7 million and $19.1 million in mortgage loans held for sale, respectively. Gains or losses on sales of loans are recognized when control over these assets has been surrendered in accordance with SFAS No. 140, "Accounting for Transfer and Servicing of Financial Assets and Extinguishment of Liabilities" ("SFAS No. 140"). (e) Loans Receivable Loans receivable are stated at unpaid principal balances adjusted for unamortized premiums and unearned discounts. The Company recognizes interest income on loans using the simple interest method. 20 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued (e) Loans Receivable - CONTINUED The Company follows SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," for determining impairment on certain loans. SFAS No. 114 requires that nonhomogenous impaired loans and certain restructured loans be measured at the present value of expected future cash flows discounted at the loan's effective interest rate, at the loan's observable market price or at the fair value of the collateral if the loan is collateral dependent. A specific reserve is set up for each impaired loan. Accrual of interest income on impaired loans is suspended when, in management's judgment, doubt exists as to the collectibility of principal and interest. If amounts are received on loans for which the accrual of interest has been discontinued, a determination is made as to whether payments received should be recorded as a reduction of the principal balance or as interest income depending on management's judgment as to the collectibility of principal. The loan is returned to accrual status when, in management's judgment, the borrower has demonstrated the ability to make periodic interest and principal payments on a timely basis. Loans are charged-off when the amount of loss is reasonably quantifiable and the loss is likely to occur. Commercial loans are generally placed in nonaccrual status when they become 90-days delinquent or earlier if full collection of principal and interest becomes doubtful. Consumer and mortgage loans are placed in nonaccrual status when they become 90 days delinquent or earlier if full collection of principal and interest becomes doubtful. Interest payments received after a loan is placed in nonaccrual are applied as a principal reduction until such time as the loan is returned to accrual status. Generally, loans are returned to accrual status when the loan is brought current and the ultimate collectibility of principal and interest is no longer in doubt. The Company maintains an allowance for the loss of uncollected interest primarily on loans which are ninety days or more past due. This allowance is reviewed periodically and necessary adjustments, if any, are included in the determination of current interest income. (f) Loan Fees and Discounts The net of origination fees received and direct costs incurred in the origination of loans are deferred and amortized to interest income over the contractual life of the loans adjusted for actual principal repayments using a method approximating a level yield. (g) Allowance for Loan Losses The allowance for loan loss is based on management's ongoing evaluation of the loan portfolio and reflects an amount, that in management's opinion, is adequate to absorb probable losses in the existing portfolio. All loan losses are charged to the allowance and all recoveries are credited to the allowance. Additions to the allowance for loan losses are provided by charges to operations based on various factors which, in management's judgment, deserve current recognition in estimating losses. Such factors considered by management include the market value of the underlying collateral, growth and composition of credit risk within the loan portfolio, loss experience, review of problem assets, delinquency trends, and local and regional economic conditions. Management evaluates the carrying value of loans periodically and the allowance is adjusted accordingly. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. The allowance for loan losses is subject to periodic evaluation by various regulatory authorities and may be subject to adjustment upon their examination. (h) Concentration of Credit Risk The Company's primary market area includes northeastern South Carolina and southeastern North Carolina predominately along the coastal regions. At September 30, 2003, the majority of the total loan portfolio, as well as a substantial portion of the commercial and real estate loan portfolios, were to borrowers within this region. No areas of significant concentrations of credit risk have been identified. (i) Loan Securitizations The Company packages and sells loans receivable as securities to investors. These transactions are recorded as sales in accordance with SFAS No. 140 when control over these assets has been surrendered. The Company does not retain any interest in the securities sold other than the servicing rights. 21 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued (j) Real Estate Owned Real estate acquired in settlement of loans is initially recorded at the lower of cost or net fair value (less estimated costs to sell). If cost exceeds net fair value, the asset is written down to net fair value with the difference being charged against the allowance for loan losses. Subsequent to foreclosure, such assets are carried at the lower of cost or net fair value with any additional write downs being charged as real estate losses. (k) Office Properties and Equipment Office properties and equipment are carried at cost less accumulated depreciation. Depreciation is computed primarily on the straight-line method over estimated useful lives. Estimated lives range up to thirty years for buildings and improvements and up to ten years for furniture, fixtures and equipment. Maintenance and repairs are charged to expense as incurred. Improvements which extend the lives of the respective assets are capitalized. When property or equipment is sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the respective accounts and the resulting gain or loss is reflected in income. (l) Mortgage Servicing Rights SFAS No. 140 requires the recognition of originated mortgage servicing rights ("mortgage servicing rights" or "MSRs") as assets by allocating total costs incurred between the originated loan and the servicing rights retained based on their relative fair values. SFAS No. 140 also requires the recognition of purchased mortgage servicing rights at fair value, which is presumed to be the price paid for the rights. MSRs are amortized in proportion to the servicing income over the estimated life of the related mortgage loan. The amortization method is designed to approximate a level-yield method, taking into consideration the estimated prepayment of the underlying loans. For purposes of measuring impairment, MSRs are reviewed for impairment by management on a quarterly basis. The Company establishes an impairment valuation allowance to record any impairment for MSRs. Subsequent increases in value are recognized only to the extent of the impairment valuation allowance within the same tranche. (m) Income Taxes Deferred taxes are provided for differences in the financial reporting basis for assets and liabilities as compared to their tax bases. A current tax liability or asset is established for taxes presently payable or refundable and a deferred tax liability or asset is established for future taxable or deductible items. (n) Drafts Outstanding The Company invests all excess funds on deposit at other banks (including amounts on deposit for payment of outstanding disbursement checks) on a daily basis in an overnight interest-bearing account. Accordingly, outstanding checks are reported as a liability. (o) Securities Sold Under Agreement to Repurchase The Company maintains collateral for certain customers who wish to deposit amounts greater than $100,000. These agreements function similarly to a certificate of deposit in that the agreement is for a fixed length of time at a fixed interest rate. However, these deposits are not insured by the Federal Deposit Insurance Corporation (the "FDIC"), but are collateralized by an interest in the pledged securities. The Company has classified these borrowings separately from deposits. (p) Stock Based Compensation At September 30, 2003, the Company has one stock option plan which is described more fully in note 17. 22 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued (p) Stock Based Compensation- Continued The Company applies the intrinsic value method of APB Opinion No. 25, "Accounting for Stock Issued to Employees" (APB Opinion No. 25) and related interpretations in accounting for its plan. Accordingly, no compensation cost has been recognized for its fixed stock option plans as all options granted under those plans had an exercise price equal to or greater than the market value of the underlying stock at the date of grant. Had compensation cost for the Company's stock-based compensation plans been determined consistent with SFAS Statement No. 123, "Accounting for Stock-Based Compensation", the Company's net income and earnings per share would have been reduced to the proforma amounts indicated below for the years ended September 30 (in thousands except per share data): 2001 2002 2003 ------- ------- ------- Net income As reported $ 9,300 $10,206 $11,172 Proforma 8,805 9,728 10,668 Basic earnings per share As reported $ 0.71 $ 0.79 $ 0.87 Proforma 0.67 0.76 0.83 Diluted earnings per share As reported $ 0.70 $ 0.77 $ 0.83 Proforma 0.66 0.74 0.79 The weighted average fair value per share of options granted in 2001, 2002 and 2003 amounted to $2.46, $3.81 and $5.48, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 2001, 2002 and 2003, respectively: dividend yield of approximately 2.03%, 1.62% and 1.86%, expected volatility of approximately 42%, 51% and 47%, risk-free interest rate of 5.60%, 4.60% and 3.96%, expected lives of 7.5 years and a vesting period of 5 years. For purposes of the proforma calculation, compensation expense is recognized on a straight line basis over 5 years. (q) Comprehensive Income SFAS No. 130, "Reporting Comprehensive Income" establishes standards for the reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income consists of net income and net unrealized gains (losses) on securities and is presented in the statements of stockholders' equity and comprehensive income. (r) Disclosures Regarding Segments The Company reports operating segments in accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131"). Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. SFAS No. 131 requires that a public enterprise report a measure of segment profit or loss, certain specific revenue and expense items, segment assets, information about the way that the operating segments were determined and other items. The Company has one reportable operating segment, Coastal Federal Bank. (s) Derivative Instruments and Hedging Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") as amended by SFAS No. 137, 138, and 149 establishes accounting and reporting standards for derivatives and hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet, and measures those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on the purpose for which the derivative is held and whether the derivative qualifies for hedge accounting. The Company does not currently engage in any activities that qualify for hedge accounting under SFAS 133. Accordingly, changes in fair value of these derivative instruments are included in gain on sale of loans held for sale in the consolidated statements of operations. (See note 23). 23 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued (t) Reclassification of Losses on Early Extinguishment of Debt The Company adopted SFAS No. 145 "Recissions of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS No. 145") effective July 1, 2002. In connection with this adoption, the Company reclassified losses on the early extinguishment of debt, which were incurred in fiscal 2001 and 2002 and were $1.1 million in each year. (u) Reclassifications Certain amounts in the 2001 and 2002 consolidated financial statements have been reclassified to conform with the 2003 presentation. Such reclassifications did not change net income or equity as previously reported. (2) INVESTMENT SECURITIES The amortized cost and market value of investment securities available for sale at September 30, 2002 are summarized as follows:
2002 --------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- --------- --------- --------- (In thousands) U.S. Government and agency obligations: Due after one but within five years .. $ -- -- -- -- Due after five years ................. 1,998 16 -- 2,014 --------- --------- --------- --------- $ 1,998 16 -- 2,014 ========= ========= ========= =========
The amortized cost and market value of investment securities available for sale at September 30, 2003 are summarized as follows:
2003 --------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- --------- --------- --------- (In thousands) U.S. Government and agency obligations: Due after five years ................. $ 1,998 9 -- 2,007 State and municipal obligations: Due after five years ................. 14,141 136 (375) 13,902 --------- --------- --------- --------- $ 16,139 145 (375) 15,909 ========= ========= ========= =========
The Company had gross realized gains of $17,000 and gross realized losses of $73,000 for the year ended September 30, 2001. For the year ended September 30, 2002, gross realized gains were $102,000 and there were no gross realized losses. For the year ended September 30, 2003, there were no gross realized gains or losses. (3) MORTGAGE-BACKED SECURITIES Mortgage-backed securities available for sale at September 30, 2002 consisted of the following:
2002 --------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- --------- --------- --------- (In thousands) Collateralized Mortgage Obligations .... $ 36,320 398 (18) 36,700 FNMA ................................... 206,448 6,673 -- 213,121 GNMA ................................... 22,139 891 -- 23,030 FHLMC .................................. 57,628 1,332 (3) 58,957 --------- --------- --------- --------- $ 322,535 9,294 (21) 331,808 ========= ========= ========= =========
24 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (3) MORTGAGE-BACKED SECURITIES - CONTINUED Mortgage-backed securities available for sale at September 30, 2003 consisted of the following:
2003 --------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- --------- --------- --------- (In thousands) Collateralized Mortgage Obligations .... $ 11,617 12 (147) 11,482 FNMA ................................... 205,200 5,483 (730) 209,953 GNMA ................................... 26,659 827 (37) 27,449 FHLMC .................................. 133,674 1,793 (1,027) 134,440 --------- --------- --------- --------- $ 377,150 8,115 (1,941) 383,324 ========= ========= ========= =========
The Company had gross realized gains of $1.0 million and gross realized losses of $312,000 for the year ended September 30, 2001. For the year ended September 30, 2002, the Company had gross realized gains of $462,000 and gross realized losses of $224,000. For the year ended September 30, 2003, the Company had gross realized gains of $695,000 and gross realized losses of $226,000. Certain investment and mortgage-backed securities are pledged to secure other borrowed money and customer deposits in excess of FDIC insurance coverage. The carrying value of the securities pledged at September 30, 2003 was $248.5 million with a fair value of $256.4 million. (4) LOANS RECEIVABLE, NET Loans receivable, net at September 30 consisted of the following: 2002 2003 --------- --------- (In thousands) First mortgage loans: Single family to 4 family units ........... $ 242,602 289,197 Other, primarily commercial real estate ... 202,117 263,688 Residential construction loans ............ 15,105 27,480 Commercial construction loans ............. 30,439 53,747 Consumer and commercial loans: Installment consumer loans ................ 12,882 16,571 Mobile home loans ......................... 3,446 4,607 Savings account loans ..................... 1,613 2,179 Equity lines of credit .................... 24,273 26,639 Commercial and other loans ................ 18,377 24,475 --------- --------- 550,854 708,583 Less: Allowance for loan losses ................. 7,883 9,832 Deferred loan cost, net ................... (245) (556) Undisbursed portion of loans in process ... 6,365 16,570 --------- --------- $ 536,851 682,737 ========= ========= The changes in the allowance for loan losses for the years ended September 30 consisted of the following: 2001 2002 2003 ------- ------- ------- (In thousands) Beginning allowance ............... $ 7,064 7,159 7,883 Provision for loan losses ......... 955 1,235 2,655 Loan recoveries ................... 60 66 136 Loan charge-offs .................. (920) (577) (842) ------- ------- ------- $ 7,159 7,883 9,832 ======= ======= ======= 22 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (4) LOANS RECEIVABLE, NET - Continued Non-accrual loans which were over ninety days delinquent totaled approximately $3.5 million and $7.4 million at September 30, 2002 and 2003, respectively. In fiscal years 2001, 2002 and 2003, interest income which would have been recorded would have been approximately $377,000, $301,000 and $623,000, respectively, had non-accruing loans been current in accordance with their original terms. There were $3.2 million in impaired loans at September 30, 2002. At September 30, 2003, impaired loans totaled $4.9 million. Included in the allowance for loan losses at September 30, 2002 was $194,000 related to impaired loans compared to $263,000 at September 30, 2003. The average recorded investment in impaired loans for the year ended September 30, 2002 was $3.1 million compared to $4.0 million for the year ended September 30, 2003. Interest income recognized on impaired loans in fiscal 2002 was $36,000. Interest income recognized on impaired loans in fiscal 2003 was $134,000. In the normal course of business, to meet the financing needs of its Customers, the Company is a party to financial instruments with off-balance-sheet risk. These financial instruments include commitments to extend credit and stand by letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's exposure to credit loss in the event of non-performance by the other party to the financial instrument is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Commitments to extend credit are agreements to lend as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each Customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation. Unfunded loan commitments and letters of credit at September 30, 2003 were approximately $108.1 million and included the following (in thousands): Loan Commitments: Residential housing and land ............................ $ 39,314 Home equity loans and consumer lines of credit .......... 41,968 Commercial lines of credit .............................. 11,029 Standby letters of credit ............................... 2,851 Unused business and personal credit card lines .......... 12,918 Loans serviced for the benefit of others amounted to approximately $143.3 million, $192.1 million and $219.8 million at September 30, 2001, 2002 and 2003, respectively. During fiscal 2003, the Company securitized $95.6 million of mortgage loans and concurrently sold these mortgage-backed securities to outside third parties and recognized a net gain on sale of $1.7 million, which included $1.3 million 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. As disclosed in note 9, certain mortgage loans are pledged to secure advances from the Federal Home Loan Bank ("FHLB") of Atlanta. 25 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (4) LOANS RECEIVABLE, NET - Continued The Bank offers mortgage and consumer loans to its directors, and Associates for the financing of their personal residences and for other personal purposes. The Bank also offers commercial loans to companies affiliated with directors. These loans are made in the ordinary course of business and, in management's opinion, are made on substantially the same terms, including interest rates and collateral, prevailing at the time for comparable transactions with other persons and companies. Management does not believe these loans involve more than the normal risk of collectibility or present other unfavorable features. At September 30, 2003, such loans were current with respect to their payment terms. The following is a summary of the activity of loans outstanding to certain executive officers, directors and their affiliates for the year ended September 30, 2003 (in thousands): Balance at September 30, 2002 ...................... $ 1,119 New loans .......................................... 682 Repayments ......................................... (725) ------- Balance at September 30, 2003 ...................... $ 1,076 ======= (5) MORTGAGE SERVICING RIGHTS Mortgage servicing rights, net of the valuation allowance, are included in other assets and totaled $2.2 million and $2.8 million at September 30, 2002 and 2003, respectively. Amortization expense for MSRs totaled $217,000, $505,000 and $1.3 million for the years ended September 30, 2001, 2002 and 2003, respectively. The estimated amortization expense for MSRs held as of September 30, 2003, is $971,000, $859,000, $762,000, $451,000 and $262,000 for fiscal 2004, 2005, 2006, 2007 and 2008 respectively. The estimated amortization expense is based on current information regarding loan payments and prepayments. Amortization expense could change in future periods based on changes in the volume of prepayments and various economic factors. 2002 2003 ------- ------- (In thousands) Balance at beginning of year .............. $ 1,310 2,203 MSRs capitalized .......................... 1,398 1,912 MSRs amortized ............................ (505) (811) Valuation allowance ....................... -- (461) ------- ------- Balance at end of year .................... $ 2,203 2,843 ======= ======= (6) OFFICE PROPERTY AND EQUIPMENT, NET Office property and equipment, net at September 30 consisted of the following: 2002 2003 ------- ------- (In thousands) Land ...................................... $ 3,143 5,532 Building and improvements ................. 10,127 10,532 Furniture, fixtures and equipment ......... 14,297 15,864 ------- ------- 27,567 31,928 Less accumulated depreciation ............. 13,854 15,840 ------- ------- $13,713 16,088 ======= ======= The Company leases office space and various equipment. Total rental expense for the years ended September 30, 2001, 2002 and 2003 was approximately $291,000, $288,000 and $259,000 respectively. 26 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (6) OFFICE PROPERTY AND EQUIPMENT, NET - CONTINUED Future minimum rental payments for operating leases having remaining noncancelable lease terms in excess of one year at September 30, 2003 are as follows (in thousands): 2004 ............................. $ 159 2005 ............................. 157 2006 ............................. 122 2007 ............................. 42 2008 ............................. 20 Thereafter .......................... 212 ----- $ 712 ===== (7) INVESTMENT REQUIRED BY LAW The Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in the FHLB of Atlanta in an amount equal to the greater of (i) $500 (ii) 1.0% of the aggregate outstanding principal amount of home mortgage loans, home purchase contracts and similar obligations at the end of each calendar year, or (iii) 5% of its advances (borrowings) from the FHLB of Atlanta at the end of each calendar year. The Bank is in compliance with this requirement with an investment in FHLB stock of $14.0 million at September 30, 2003. No ready market exists for this stock and it has no quoted market value. However, redemption of this stock has historically been at par value. (8) DEPOSITS Deposits at September 30 consisted of the following:
2002 2003 -------------------- -------------------- Weighted Weighted Amount Rate Amount Rate -------- -------- -------- -------- (Dollars in thousands) Transaction accounts: Noninterest bearing ............... $ 63,003 --% 86,258 --% NOW ............................... 67,381 0.38 98,171 0.54 Money market checking ............. 212,924 2.16 206,010 1.34 -------- -------- -------- -------- Total transaction accounts ... 343,308 1.41 390,439 0.84 -------- -------- -------- -------- Passbook accounts: Regular passbooks ................. 37,905 1.09 44,919 0.79 Money market ...................... 1,187 1.95 1,317 1.00 -------- -------- -------- -------- Total passbook accounts ...... 39,092 1.12 46,236 0.80 -------- -------- -------- -------- Certificate accounts: 0.00-1.99% ........................ 1,489 87,396 2.00-3.99% ........................ 202,676 149,678 4.00-5.99% ........................ 50,024 19,569 6.00-7.99% ........................ 8 3,161 8.00-10.00% ....................... 484 533 -------- -------- -------- -------- Total certificate accounts ... 254,681 3.46 260,337 2.67 -------- -------- -------- -------- $637,081 2.21% 697,012 1.52% ======== ======== ======== ========
27 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (8) DEPOSITS - CONTINUED The aggregate amount of all deposit accounts with a minimum denomination of $100,000 or more was $245.4 million and $287.9 million at September 30, 2002 and 2003, respectively. Included in certificate accounts were $2.4 million at September 30, 2002 originated by brokers for a fee. The amounts and scheduled maturities of certificate accounts at September 30, are as follows: 2002 2003 -------- -------- (In thousands) Within 1 year ...................................... $201,370 198,723 After 1 but within 2 years ......................... 27,484 50,596 After 2 but within 3 years ......................... 20,358 7,461 Thereafter ......................................... 5,469 3,557 -------- -------- $254,681 260,337 ======== ======== Interest expense on deposits for the years ended September 30 consisted of the following: 2001 2002 2003 ------- ------- ------- (In thousands) Transaction accounts .................... $ 7,404 4,524 3,925 Passbook accounts ....................... 741 459 427 Certificate accounts .................... 11,235 8,767 7,647 ------- ------- ------- $19,380 13,750 11,999 ======= ======= ======= (9) ADVANCES FROM FHLB Advances from the FHLB at September 30 consisted of the following: 2002 2003 -------------------- -------------------- Weighted Weighted Amount Rate Amount Rate -------- -------- -------- -------- (Dollars in thousands) Fiscal Year Maturity 2003 ........................... $ 32,350 2.14% $ -- --% 2004 ........................... 11,235 2.34 34,435 1.32 2005 ........................... 25,500 6.24 13,500 5.17 2006 ........................... 3,270 4.98 5,686 2.81 2007 ........................... 6,223 3.39 5,132 3.00 2008 ........................... 10,000 4.92 4,633 3.28 2009 or greater ................ 101,091 5.27 180,728 4.35 -------- ------ -------- ------ $189,669 4.61% $244,114 3.89% ======== ====== ======== ====== Stock in the FHLB of Atlanta and specific first mortgage loans and mortgage-backed securities of approximately $219.8 million and $275.8 million at September 30, 2002 and 2003, respectively, are pledged as collateral for these advances. The Bank has adopted the policy of pledging excess collateral to facilitate future advances. At September 30, 2003, the excess first mortgage loan collateral pledged to the FHLB will support additional borrowings of approximately $31.6 million. At September 30, 2003, included in the one, three, four and five year maturities were $155.0 million subject to call provisions. Call provisions are more likely to be exercised by the FHLB when rates rise. During fiscal 2001, the Company prepaid approximately $37.7 million of advances from FHLB and incurred gross penalties of approximately $1.1 million. During fiscal 2002, the Company prepaid approximately $59.3 million of advances from FHLB and incurred gross penalties of approximately $1.1 million. During fiscal 2003, the Company prepaid approximately $54.6 million of advances and incurred gross penalties of approximately $2.8 million. Prepayment penalties are included in general and administrative expenses in the statement of operations. Also see note 1 (t). 26 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (10) REPURCHASE AGREEMENTS The following tables set forth certain information regarding repurchase agreements by the Bank at the end of and during the periods indicated:
At September 30, ---------------------------------------- 2001 2002 2003 ------- ------- -------- (Dollars in thousands) Outstanding balance: Securities sold under agreements to repurchase: Customer .......................................... $ 3,703 $ 4,070 $ 7,703 Broker ............................................ 15,000 30,000 125,899 Weighted average rate (at month end) paid on: Securities sold under agreements to repurchase: Customer .......................................... 3.36% 1.37% 0.81% Broker ............................................ 2.97 1.84 1.64 Maximum amount of borrowings outstanding at any month end: Securities sold under agreements to repurchase: Customer .......................................... $ 3,726 $ 5,625 $ 7,703 Broker ............................................ 67,099 30,000 125,899 Approximate average outstanding with respect to: Securities sold under agreements to repurchase: Customer .......................................... $ 2,361 $ 3,600 $ 4,812 Broker ............................................ 45,461 15,007 92,476 Weighted average rate (year to date) paid on: Securities sold under agreements to repurchase: Customer .......................................... 3.73% 1.58% 1.02% Broker ............................................ 5.65 2.39 2.04
Securities sold under agreements to repurchase represent borrowings by the Company with maturities ranging from 1 to 28 months collateralized by securities of the United States government or its agencies, which have been delivered to a third party custodian for safekeeping. Assets pledged to collateralize securities sold under agreements to repurchase had a fair value of $141.4 million at September 30, 2003 and are included in mortgage-backed securities available for sale in the consolidated balance sheet. (11) DEBT ASSOCIATED WITH TRUST PREFERRED SECURITIES On July 3, 2003, Coastal Financial Capital Trust I (the "Trust"), a statutory trust formed by the Company, issued and sold floating rate securities having an aggregate liquidation amount of $15.0 million (the "Capital Securities") to institutional buyers in a pooled trust preferred issue. The Capital Securities generated gross proceeds of $15.0 million. The Trust invested these proceeds in an equivalent amount of junior subordinated debentures of the Company and the Company used the proceeds for general corporate purposes. Issuance costs from the July 3, 2003 sale totaled $150,000. The junior subordinated debentures are unsecured obligations of the Company and are subordinate and junior in right of payment to all present and future senior indebtedness of the Company. The Company has entered into a guarantee, which together with its obligations under the junior subordinated debentures and the declaration of trust governing the Trust, provides a full and unconditional guarantee of the Capital Securities. The Capital Securities accrue and pay distributions semi-annually at a rate per annum equal to 90-day LIBOR plus 305 basis points. At September 30, 2003, the distribution rate on the Capital Securities was 4.16%. The distributions payable on the Capital Securities are cumulative and payable quarterly in arrears. The Company has the right, subject to events of default, to defer payments of interest on the Capital Securities for a period not to exceed 20 consecutive quarters. The Company has no current intention to exercise its right to defer payment of interest on the Capital Securities. 28 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (11) DEBT ASSOCIATED WITH TRUST PREFERRED SECURITIES - CONTINUED The Capital Securities are mandatorily redeemable upon maturity on July 3, 2033. The Company has the right to redeem the Capital Securities in whole or in part, on or after July 3, 2008. If the Capital Securities are redeemed on or after July 3, 2008, the redemption price will be 100% of the principal amount plus accrued and unpaid interest. In addition, the Company may redeem the Capital Securities in whole (but not in part) at any time within 90 days following the occurrence of a tax event, an investment company event, or a capital treatment event at a special redemption price (as defined in the indenture). (12) INCOME TAXES Income tax expense (benefit) for the years ended September 30 consisted of the following:
Current Deferred Total ------- -------- ----- (In thousands) 2001: Federal ............................... $ 4,792 196 4,988 State ................................. 308 (9) 299 ------- ----- ----- $ 5,100 187 5,287 ======= ===== ===== 2002: Federal ............................... $ 5,407 (13) 5,394 State ................................. 507 -- 507 ------- ----- ----- $ 5,914 (13) 5,901 ======= ===== ===== 2003: Federal ............................... $ 4,946 507 5,453 State ................................. 693 (5) 688 ------- ----- ----- $ 5,639 502 6,141 ======= ===== =====
The tax effect of the Company's temporary differences between the financial statement carrying amounts and tax basis of assets and liabilities that give rise to the net deferred tax asset (liability) at September 30, 2002 and 2003 relate to the following:
2002 2003 ------- ----- (In thousands) Deferred tax assets: Allowance for loan losses ...................................................... $ 2,900 3,605 Accrued medical reserves ....................................................... 94 91 Other real estate reserves and deferred gains on other real estate ............. 101 102 Net operating loss carryforwards ............................................... 21 21 Other .......................................................................... 276 282 ------- ------ Total deferred tax assets ........................................................... 3,392 4,101 Less valuation allowance ............................................................ (21) (21) ------- ------ Net deferred tax assets ............................................................. 3,371 4,080 ------- ------ Deferred tax liabilities: Tax bad debt reserve in excess of base year amount ............................. 193 97 Property and equipment principally due to differences in depreciation .......... 310 527 FHLB stock, due to stock dividends not recognized for tax purposes ............. 207 67 Deferred loan fees ............................................................. 565 537 Book over tax basis in investment in unconsolidated subsidiary ................. 2,953 4,009 Unrealized gain on securities available for sale ............................... 3,500 2,225 Mortgage servicing rights ...................................................... 833 1,075 Other .......................................................................... 236 196 ------- ------ Total deferred tax liabilities ...................................................... 8,797 8,733 ------- ------ Net deferred tax liability .......................................................... $(5,426) (4,653) ======= ======
29 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (12) INCOME TAXES - CONTINUED The valuation allowance for deferred tax assets as of September 30, 2002 and 2003 was $21,000. The net change in the total valuation allowance for the years ended September 30, 2002 and 2003 was a decrease of $114,000 and zero, respectively. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. In order to fully realize the deferred tax asset, the company will need to generate future taxable income prior to the expiration of the deferred tax assets governed by the tax code. Based upon the level of historical taxable income and projections for future taxable income over the periods, which the deferred tax assets are deductible, management believes it more likely than not the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at September 30, 2003. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. The net deferred tax liability is included in other liabilities in the consolidated financial statements. The valuation allowance relates to the state loss carryforwards which may not be ultimately realized to reduce taxes of the Company. A portion of the change in the net deferred tax liability relates to unrealized gains and losses on securities available for sale. A current period deferred tax benefit of $1.3 million for the unrealized gains on securities available for sale has been recorded directly to stockholders' equity. The balance of the change in the deferred tax liability results from the current period deferred tax expense of $502,000. Income taxes of the Company attributable to income before income taxes differ from the amounts computed by applying the Federal income tax rate of 34% for the years ended September 30 to earnings before income taxes as follows:
2001 2002 2003 ------ ----- ----- (In thousands) Computed federal income taxes ............ $4,960 5,476 5,886 State tax, net of federal benefit ........ 197 335 454 Bank-owned life insurance ................ -- -- (226) Other, net ............................... 130 90 27 ------ ----- ----- Total income tax expense ................. $5,287 5,901 6,141 ====== ===== =====
The Bank has been permitted under the Internal Revenue Code to deduct an annual addition to the tax reserve for bad debts in determining taxable income, subject to certain limitations. This addition may differ significantly from the bad debt expense for financial reporting purposes and was based on either 8% of taxable income (the "Percentage of Taxable Income Method") or actual loan loss experience (the "Experience Method") for the years prior to 1997. As a result of tax legislation, the Bank will be required to recapture tax bad debt reserves in excess of pre-1988 based year amounts over a period of approximately six to eight years. In addition, for the period ending September 30, 1997, the Bank was required to change its overall tax method of accounting for bad debts to the experience method. Retained earnings at September 30, 2003 includes approximately $5.2 million representing pre-1988 tax bad debt base year reserve amounts for which no deferred income tax liability has been provided since these reserves are not expected to reverse until indefinite future periods and may never reverse. Circumstances that would require an accrual of a portion or all of this unrecorded tax liability are a reduction in qualifying loan levels relative to the end of 1987, failure to meet the tax definition of a savings bank, dividend payments in excess of current year or accumulated tax earnings and profits, or other distributions in dissolution, liquidation or redemption of the Bank's stock. (13) BENEFIT PLANS The Company has a defined contribution plan covering substantially all Associates. The Company matches Associate contributions based upon the Company meeting certain return on equity operating results. Matching contribution expense was approximately $245,000, $384,000 and $340,000 for fiscal years 2001, 2002 and 2003, respectively. 30 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (14) REGULATORY MATTERS At September 30, 2003, the Bank's loans-to-one borrower limit was approximately $13.9 million. At September 30, 2003, the Bank is in compliance with the core, tangible and risk-based capital requirements and loans-to-one borrower limits. 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. As of September 30, 2003, the most recent notification from federal banking agencies categorized the Bank as "well capitalized" under the regulatory framework. To be categorized as "well capitalized," the Bank must maintain minimum total risk-based capital, tier 1 capital, and tier 1 leverage ratios as set forth in the table. Since September 30, 2003, there have been no events or conditions that management believes have changed the Bank's categories. (Dollars in thousands)
Amount to be For Capital Categorized as Actual Adequacy Purposes "Well Capitalized" ------------------- ---------------------- -------------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- As of September 30, 2003: Total Capital: .................... $92,847 13.17% $56,388 8.00% $70,485 10.00% (To Risk Weighted Assets) Tier 1 Capital: ................... $84,153 11.94% N/A N/A $42,291 6.00% (To Risk Weighted Assets) Tier 1 Capital: ................... $84,153 7.14% $35,358 3.00% $58,929 5.00% (To Adjusted Total Assets) Tangible Capital: ................. $84,153 7.14% $17,679 1.50% N/A N/A (To Adjusted Total Assets) As of September 30, 2002: Total Capital: .................... $68,417 12.74% $42,965 8.00% $53,706 10.00% (To Risk Weighted Assets) Tier 1 Capital: ................... $62,028 11.55% N/A N/A $32,223 6.00% (To Risk Weighted Assets) Tier 1 Capital: ................... $62,028 6.57% $37,785 4.00% $47,231 5.00% (To Adjusted Total Assets) Tangible Capital: ................. $62,028 6.57% $14,170 1.50% N/A N/A (To Adjusted Total Assets)
(15) LIQUIDATION ACCOUNT In conjunction with the Bank's conversion to stock form on October 4, 1990, the Bank established, as required by Office of Thrift Supervision (the "OTS") regulations, a liquidation account and maintains this account for the benefit of the remaining eligible account holders as defined under the Bank's plan of conversion. The initial balance of this liquidation account was equal to the Bank's net worth defined by OTS regulations as of the date of the latest statement of financial condition contained in the final offering circular. In the event of a complete liquidation of the Bank (and only in such event) each eligible holder shall be entitled to receive a liquidation distribution from this account in the amount of the then current adjusted balance for deposits then held, before any liquidation distribution may be made to the stockholders. The Bank is prohibited from declaring cash dividends or repurchasing its capital stock if it would cause a reduction in the Bank's net worth below either the balance of the liquidation account or the statutory net worth requirements set by the OTS. 30 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (15) LIQUIDATION ACCOUNT - CONTINUED The Company's ability to pay dividends depends primarily on the Bank's ability to pay dividends to the Company. The Bank is prohibited from declaring cash dividends on its common stock or repurchasing its common stock if the effect thereof would cause its net worth to be reduced below either the amount required for the liquidation account or the minimum regulatory capital requirement. In addition, the Bank is also prohibited from declaring cash dividends and repurchasing its own stock without prior regulatory approval if the total amount of all dividends and stock repurchases (including any proposed dividends and stock repurchases) for the applicable year exceeds its current year's net income plus its retained net income for the preceding two years. (16) EARNINGS PER SHARE Basic earnings per share are computed by dividing net income by the weighted-average number of common shares outstanding. Diluted earnings per share are computed by dividing net income by the weighted average number of common shares and potential common shares outstanding. Potential common shares consist of dilutive stock options determined using the treasury stock method and the average market price of common stock. All share and per share data have been retroactively restated for all common stock dividends. The Company has no antidilutive securities at September 30, 2003. The following is a summary of the reconciliation of average shares outstanding for the years ended September 30:
2001 2002 2003 ----------------------- ----------------------- ----------------------- Basic Diluted Basic Diluted Basic Diluted ---------- ---------- ---------- ---------- ---------- ---------- Weighted average shares outstanding 13,126,000 13,126,000 12,844,000 12,844,000 12,853,000 12,853,000 Effective of dilutive securities: Stock options -- 178,000 -- 393,000 -- 588,000 ---------- ---------- ---------- ---------- ---------- ---------- Average shares outstanding 13,126,000 13,304,000 12,844,000 13,237,000 12,853,000 13,441,000 ========== ========== ========== ========== ========== ==========
(17) STOCK OPTION PLAN The Company's stock option plan provides for stock options to be granted primarily to directors, officers and other key Associates. Options granted under the stock option plan may be incentive stock options or non-incentive stock options. Options vest ratably over a five year period and expire after ten years from the date of grant. The remaining shares of stock reserved for the stock option plan at September 30, 2003 amounted to approximately 303,000 shares. All outstanding options have been retroactively restated to reflect the effects of the common stock dividends. At September 30, 2003, the Company had the following options outstanding:
Weighted Average Weighted Weighted Number Remaining Average Number Average Fiscal Options Contractual Exercise Options Exercise Year Range of exercise prices: Outstanding Life Price Exercisable Price ------ ------------------------- ----------- ----------- -------- ----------- -------- 1995 $2.95 - $3.27 .............. 93,977 1.8 Years $ 3.15 93,977 $ 3.15 1996 $3.48 - $3.83 .............. 9,374 2.1 Years $ 3.48 9,374 $ 3.48 1997 $5.31 - $5.50 .............. 142,290 3.2 Years $ 5.39 142,290 $ 5.39 1998 $7.74 - $11.81 ............. 264,753 4.2 Years $ 8.77 264,753 $ 8.77 1999 $7.85 - $9.30 .............. 197,980 5.1 Years $ 8.66 158,384 $ 8.66 2000 $5.23 - $6.01 .............. 186,699 6.2 Years $ 6.21 112,019 $ 6.21 2001 $5.03 - $7.85 .............. 221,782 7.1 Years $ 5.14 88,713 $ 5.14 2002 $7.52 - $12.35 ............. 209,567 8.1 Years $ 7.64 41,913 $ 7.64 2003 $10.00 - $14.00 ............ 253,589 9.2 Years $11.96 -- N/A --------- --------- ------ ------- ------ $2.95 - $14.00 ............. 1,580,011 6.2 Years $ 7.64 911,423 $ 6.87 ========= ========= ====== ======= ======
31 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (17) STOCK OPTION PLAN - CONTINUED The following is a summary of the activity of the stock option plans for the years 2001, 2002, and 2003.
2001 2002 2003 ----------------------- ---------------------- ----------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price --------- ------- --------- ------ --------- ------- Outstanding, October 1 ............... 1,277,591 $ 7.81 1,469,550 $ 6.47 1,493,391 $ 6.76 Granted .............................. 258,150 5.18 221,764 7.64 261,735 11.90 Cancelled ............................ (28,865) 6.55 (13,150) 7.06 (11,920) 9.13 Exercised ............................ (37,326) 3.87 (184,773) 5.47 (163,195) 6.37 --------- ------- --------- ------ --------- ------- Outstanding, September 30 ............ 1,469,550 $ 6.47 1,493,391 $ 6.76 1,580,011 $ 7.64 ========= ======= ========= ====== ========= =======
(18) COMMON STOCK DIVIDENDS On July 31, 2001, the Company declared a 3 for 2 stock split in the form of a 50% stock dividend aggregating approximately 3,579,000 shares. On May 27, 2003, the Company declared a 10% stock dividend aggregating approximately 1,065,000 shares. On August 28, 2003, the Company declared a 10% stock dividend aggregating approximately 1,174,000 shares. All share and per share data has been retroactively restated to give effect to the common stock dividends. (19) CASH DIVIDENDS On each of December 29, 2000 and March 21, 2001 the Company declared quarterly cash dividends of $.036 per share. On each of June 27, 2001, September 26, 2001, December 19, 2001 and March 20, 2002 the Company declared quarterly cash dividends of $.041 per share. On each of June 19, 2002, September 18, 2002, December 18, 2002 and March 26, 2003, the Company declared quarterly cash dividends of $0.045 per share. On each of June 24, 2003 and September 24, 2003, the Company declared quarterly cash dividends of $0.055 per share. (20) LEGAL MATTERS The Company is not a defendant in any lawsuits. The subsidiaries are defendants in lawsuits arising out of the normal course of business. Based upon current information received from counsel representing the subsidiaries in these matters, the Company believes none of the lawsuits would have a material impact on the Company's financial status. (21) QUARTERLY FINANCIAL DATA (UNAUDITED) Quarterly operating data for the years ended September 30 is summarized as follows (in thousands, except share data):
First Second Third Fourth Quarter Quarter Quarter Quarter ----------- ---------- ---------- ---------- 2002: Total interest income ........................... $ 13,368 12,987 13,498 14,020 Total interest expense .......................... 5,662 5,153 5,278 5,753 ----------- ---------- ---------- ---------- Net interest income ............................. 7,706 7,834 8,220 8,267 Provision for loan losses ....................... 250 255 350 380 ----------- ---------- ---------- ---------- Net interest income after provision for loan losses .................................. 7,456 7,579 7,870 7,887 Other income .................................... 2,173 1,703 1,876 2,387 General and administrative expenses ............. 5,730 5,422 5,640 6,032 ----------- ---------- ---------- ---------- Income before income taxes ...................... 3,899 3,860 4,106 4,242 Income taxes .................................... 1,439 1,393 1,513 1,556 ----------- ---------- ---------- ---------- Net income ...................................... $ 2,460 2,467 2,593 2,686 =========== ========== ========== ========== Net income per common share - diluted ........... $ .19 .19 .20 .20 =========== ========== ========== ========== Weighted average shares outstanding-diluted ..... 13,222,000 13,099,000 13,139,000 13,436,000 =========== ========== ========== ==========
32 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (21) QUARTERLY FINANCIAL DATA (UNAUDITED) - CONTINUED
First Second Third Fourth Quarter Quarter Quarter Quarter ----------- ---------- ---------- ---------- 2003: Total interest income ............................ $ 14,740 14,743 14,790 14,941 Total interest expense ........................... 5,807 5,625 5,779 5,787 ----------- ---------- ---------- ---------- Net interest income .............................. 8,933 9,118 9,011 9,154 Provision for loan losses ........................ 435 870 750 600 ----------- ---------- ---------- ---------- Net interest income after provision for loan losses ................................... 8,498 8,248 8,261 8,554 Other income ..................................... 2,667 2,715 2,945 2,581 General and administrative expenses .............. 6,864 6,683 6,851 6,758 ----------- ---------- ---------- ---------- Income before income taxes ....................... 4,301 4,280 4,355 4,377 Income taxes ..................................... 1,551 1,526 1,575 1,489 ----------- ---------- ---------- ---------- Net income ....................................... $ 2,750 2,754 2,780 2,888 =========== ========== ========== ========== Net income per common share - diluted ............ $ .20 .21 .21 .21 =========== ========== ========== ========== Weighted average shares outstanding-diluted ...... 13,433,000 13,373,000 13,386,000 13,577,000 =========== ========== ========== ==========
(22) COASTAL FINANCIAL CORPORATION FINANCIAL STATEMENTS (PARENT COMPANY ONLY) The following is condensed financial information of Coastal Financial Corporation (parent company only), the primary asset of which is its investment in its bank subsidiary, for the periods indicated. (In thousands): Coastal Financial Corporation Condensed Balance Sheets September 30, 2002 and 2003
2002 2003 ------- ------ Assets Cash .................................................... $ 738 773 Investment in subsidiaries .............................. 67,946 88,088 Deferred tax asset ...................................... 326 441 Other assets ............................................ 71 246 ------- ------ Total assets ...................................... $69,081 89,548 ======= ====== Liabilities and Stockholders' Equity Accounts payable (principally dividends) ................ 626 760 Note payable ............................................ 2,069 81 Debt associated with trust preferred securities -- 15,000 Total stockholders' equity .............................. 66,386 73,707 ------- ------ Total liabilities and stockholders' equity ........ $69,081 89,548 ======= ======
33 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (22) COASTAL FINANCIAL CORPORATION FINANCIAL STATEMENTS (PARENT COMPANY ONLY) - CONTINUED Coastal Financial Corporation Condensed Statements of Operations Years ended September 30, 2001, 2002 and 2003
2001 2002 2003 ------- ------- ------- Income: Interest income ............................................ $ 3 1 1 Management fees ............................................ 300 300 300 Dividends from subsidiary .................................. 4,600 3,470 1,221 Equity in undistributed earnings of subsidiaries ........... 4,732 6,751 10,087 ------- ------- ------- Total income ......................................... 9,635 10,522 11,609 ------- ------- ------- Expenses: Professional fees .......................................... 80 79 20 Supplies and printing ...................................... 39 58 12 Interest expense ........................................... 152 84 213 Other expenses ............................................. 91 96 277 Income tax benefit ......................................... (27) (1) (85) ------- ------- ------- Total expenses ....................................... 335 316 437 ------- ------- ------- Net income ................................................. $ 9,300 10,206 11,172 ======= ======= =======
Coastal Financial Corporation Condensed Statement of Cash Flows Years ended September 30, 2001, 2002 and 2003
2001 2002 2003 ------- ------- ------- Operating activities: Net income ................................................. $ 9,300 10,206 11,172 Adjustments to reconcile net income to net cash provided by: Equity in undistributed net income of subsidiary ........ (4,732) (6,751) (10,087) (Increase) decrease in other assets ..................... (747) 548 (290) Increase (decrease) in other liabilities ................ (108) (104) 134 ------- ------- ------- Total cash provided by operating activities .......... 3,713 3,899 929 ------- ------- ------- Financing activities: Cash dividends to shareholders ............................. (2,015) (2,222) (2,592) Treasury stock repurchases ................................. (2,134) (2,286) (342) Proceeds from stock options ................................ 106 1,203 1,153 Proceeds from trust preferred .............................. -- -- 15,000 Repayment on line of credit ................................ -- -- (1,988) Capital contribution to subsidiary ......................... -- -- (12,125) Other financing activities, net ............................ (1) 3 -- ------- ------- ------- Total cash used by financing activities .............. (4,044) (3,302) (894) ------- ------- ------- Net increase (decrease) in cash and cash equivalents .......... (331) 597 35 Cash and cash equivalents at beginning of the year ............ 472 141 738 ------- ------- ------- Cash and cash equivalents at end of the years ................. $ 141 738 773 ======= ======= =======
34 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (23) CARRYING AMOUNTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts and fair value of financial instruments as of September 30, 2002 and 2003 are summarized below:
2002 2003 ------------------------ ----------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value -------- ---------- ------- ---------- (In thousands) Financial Assets Cash and cash equivalents .............................. $ 25,802 25,802 21,575 21,575 Investment securities .................................. 2,014 2,014 15,909 15,909 Mortgage-backed securities ............................. 331,808 331,808 383,324 383,324 Loans receivable held for sale ......................... 18,694 19,199 19,096 19,556 Loans receivable, net .................................. 536,851 541,697 682,737 704,171 FHLB stock ............................................. 10,559 10,559 13,991 13,991 Financial Liabilities Deposits: Demand accounts ..................................... 382,400 382,400 436,675 436,675 Certificate accounts ................................ 254,681 258,509 260,337 263,743 Advances from Federal Home Loan Bank ................... 189,669 197,918 244,114 252,271 Securities sold under agreements to repurchase ......... 36,884 36,884 133,602 133,602 Debt associated with trust preferred securities ........ -- -- 15,000 15,000 Other borrowings ....................................... 2,069 2,069 81 81
SFAS 107, "Disclosures about Fair Value of Financial Instruments," requires disclosure of fair value information, whether or not recognized in the statement of financial position, when it is practicable to estimate the fair value. SFAS 107 defines a financial instrument as cash, evidence of an ownership interest in an entity or contractual obligations, which require the exchange of cash, or other financial instruments. Certain items are specifically excluded from the disclosure requirements, including the Company's common stock, premises and equipment, accrued interest receivable and payable, and other asset and liabilities. Fair value approximates book value for the following financial instruments due to the short-term nature of the instrument: cash and due from banks, interest-bearing bank balances, federal funds sold, federal funds purchased and repurchase agreements and other short-term borrowings. Investments and mortgage-backed securities are valued using quoted market prices. Fair value for variable rate loans that reprice frequently is based on the carrying value. Fair values for mortgage loans, consumer loans and all other loans (primarily commercial) which have fixed rates of interest are based on the discounted present value of the estimated future cash flows. Discount rates used in these computations approximates the rates currently offered for similar loans of comparable terms and credit quality. Fair value for demand deposit accounts and interest-bearing accounts with no fixed maturity date is equal to the carrying value. Certificate of deposit accounts are estimated by discounting cash flows from expected maturities using current interest rates on similar instruments. Fair value for FHLB advances, reverse repurchase agreements and long-term debt is based on discounted cash flows using the Company's current incremental borrowing rate. The Company has used management's best estimate fair value based upon the above assumptions. Therefore, the fair values presented may not be the amounts which could be realized in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses, which would be incurred in an actual sale or settlement, are not taken into consideration in the fair values presented. 35 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (23) CARRYING AMOUNTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED The Company had $108.1 million of off-balance sheet financial commitments as of September 30, 2003, which are commitments to originate loans, unused consumer lines of credit and undisbursed portion of loans in process. Since these obligations are based on current market rates, the carrying amount is considered to be a reasonable estimate of fair value. The Company originates certain fixed rate residential loans with the intention of selling these loans. Between the time that the Company 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. They do not generally qualify for hedge accounting treatment so 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 $8.2 million at September, 30 2003. The fair value of these commitments was an asset of approximately $123,000 at September 30, 2003, and is reflected in gain on sales of loans held for sale in the consolidated statements of operations. The forward sales commitments totaled $17.0 million at September 30, 2003. The fair value of these commitments was a liability of approximately $257,000 at September 30, 2003, and is reflected in gain on sales of loans held for sale in the consolidated statements of operations. Fair value estimates are made at the dates indicated above, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the Company's entire holdings of a particular financial instrument. Because no active market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, current interest rates and prepayment trends, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in any of these assumptions used in calculating fair value would also significantly affect the estimates. Changes in market interest rates and prepayment assumptions could significantly change the fair value. Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Company has significant assets and liabilities that are not considered financial assets or liabilities including deposit franchise value, loan servicing portfolio, real estate, deferred tax liabilities, premises and equipment, and goodwill. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates. (24) COMMITMENTS AND CONTINGENCIES The Company has a $16.0 million outstanding line of credit with a commercial bank at a variable rate of LIBOR plus two percent. The line of credit is secured by 100% of the stock of the Bank. At September 30, 2003, the outstanding balance was approximately $81,000. 36 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Managements' Discussion and Analysis 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 Coastal Financial Corporation's (the Company) expectations or beliefs concerning future events. Such forward-looking statements are about matters that are inherently subject to risks and uncertainties. Factors that could influence the matters discussed in certain forward-looking statements include the timing and amount of revenues that may be recognized by the Company, continuation of current revenue and expense trends (including trends affecting charge-offs and provisions for loan losses), unforeseen changes in the Company's markets, legal and regulatory changes, and general changes in the economy (particularly in the markets served by the Company). Because of the risks and uncertainties inherent in forward looking statements, readers are cautioned not to place undue reliance on them, whether included in this report or made elsewhere from time to time by the Company or on its behalf. Except as may be required by applicable law or regulation, the Company assumes no obligation to update any forward looking statements. Critical Accounting Policies The Company's significant accounting policies are set forth in Note 1 of the Notes to Consolidated Financial Statements. Of these policies, the Company considers its policy regarding the allowance for loan losses to be its most critical accounting policy, because it requires many of management's most subjective and complex judgments. The Company has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Company's assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations and the discovery of information with respect to borrowers which were not known by management at the time of the issuance of the consolidated financial statements. For additional discussion concerning the Company's allowance for loan losses and related matters, see "Allowance for Loan Losses". General The Company reported $11.2 million in net income for the year ended September 30, 2003, compared to $10.2 million for the year ended September 30, 2002. Net interest income increased $4.2 million as a result of increased interest income of $5.3 million offset by an increase of $1.2 million in interest expense. Provision for loan losses increased from $1.2 million for the year ended September 30, 2002, to $2.7 million for the year ended September 30, 2003. Other income increased from $8.1 million in fiscal 2002, to $10.9 million in 2003. General and administrative expenses increased $4.3 million or 19.0%, for fiscal 2003, as compared to fiscal 2002. Total assets increased from $950.8 million at September 30, 2002 to $1.2 billion at September 30, 2003, or 24.2%. Liquid assets, consisting of cash, interest-bearing deposits, and securities, increased from $359.6 million at September 30, 2002, to $420.8 million at September 30, 2003. Loans receivable increased 27.2% from $536.9 million at September 30, 2002, to $682.7 million at September 30, 2003. Total loan originations for fiscal 2003 were $769.6 million as compared to $418.2 million for fiscal 2002. The growth in liquid assets was funded by increased deposits of $59.9 million, increased advances from the Federal Home Loan Bank ("FHLB") of Atlanta of $54.4 million and securities sold under agreements to repurchase of $96.7 million. As a result of increased Banking Centers and a strong emphasis on growing local deposits during fiscal 2003, deposits increased 9.4% from $637.1 million at September 30, 2002, to $697.0 million at September 30, 2003. During this same period, transaction deposits (defined as noninterest bearing checking accounts and NOW accounts) increased $54.0 million, money market checking accounts decreased $6.9 million, passbook accounts increased $7.1 million and certificate accounts increased $5.7 million. As a result of $11.2 million in net earnings, less the cash dividends paid to shareholders of approximately $2.6 million, treasury stock repurchases of approximately $342,000, and the net change in unrealized gain (loss) on securities available for sale, net of income tax of $2.1 million, stockholders' equity increased from $66.4 million at September 30, 2002 to $73.7 million at September 30, 2003. Liquidity and Capital Resources Historically, the Company has maintained its liquidity at levels believed by management to be adequate to meet requirements of normal operations, potential deposit outflows and strong loan demand and still allow for optimal investment of funds and return on assets. The following table summarizes future contractual obligations as of September 30, 2003. 37 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued
Payment Due by Period ----------------------------------------------------------------------- Less than 1-3 4-5 After 5 Total 1 Year Years Years Years -------- --------- -------- ------- -------- (Dollars in thousands) Contractual Obligations Time deposits ........................... $260,337 $198,723 $ 58,057 $ 3,238 $ 319 Short-term borrowings ................... 118,037 118,037 -- -- -- Long-term debt .......................... 274,760 -- 69,186 9,846 195,728 Operating leases ........................ 712 159 279 62 212 -------- -------- -------- ------- -------- Total contractual cash obligations ... $653,846 $316,919 $127,522 $13,146 $196,259 ======== ======== ======== ======= ========
The principal sources of funds for the Company are cash flows from operations, consisting mainly of mortgage, consumer and commercial loan payments, retail customer deposits, repurchase agreements securitized by mortgage-backed securities and advances from the FHLB of Atlanta. The principal use of cash flows is the origination of loans receivable. The Company originated loans receivable of $296.1 million, $418.2 million and $769.6 million for the years ended September 30, 2001, 2002 and 2003, respectively. A large portion of these loan originations were financed through loan principal repayments which amounted to $233.7 million, $268.1 million and $477.7 million for the years ended September 30, 2001, 2002 and 2003, respectively. In addition, the Company has generally sold conforming fixed rate mortgage loans to correspondent financial institutions in the secondary market to finance future loan originations. For the years ended September 30, 2001, 2002 and 2003, the Company sold loans amounting to $28.5 million, $13.9 million and $45.4 million, respectively. During fiscal 2003, the Company securitized $95.6 million of mortgage loans and concurrently sold these mortgage-backed securities to outside third parties and recognized a net gain on sale of $1.7 million, which included $1.3 million 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 the servicing rights. In fiscal 2003 deposits increased from $637.1 million at September 30, 2002, to $697.0 million at September 30, 2003. During fiscal 2003, the Company prepaid approximately $54.6 million of advances from FHLB and incurred gross penalties of approximately $2.8 million which were included in general and administrative expenses in the statement of operations. As a result of this and the repayment of other short-term advances, the weighted average rate on FHLB advances decreased to 3.89% at September 30, 2003, compared to 4.61% at September 30, 2002. At September 30, 2003, the Company had commitments to originate $39.3 million in loans and $68.8 million in unused lines of credit, which the Company expects to fund from normal operations. Traditionally, a significant portion of the unused lines of credit may never be used by the Customer. At September 30, 2003, the Company had $198.7 million of certificates of deposit which were due to mature within one year. Based upon previous experience, the Company believes that a major portion of these certificates will be redeposited. At September 30, 2003, the Company had excess collateral pledged to the FHLB which would support additional FHLB advance borrowings of $31.6 million. Additionally, at September 30, 2003, the Company had repurchase agreement lines of credit and available collateral consisting of investment securities and mortgage-backed securities of $118.9 million as well as federal funds lines available of $20.0 million. As a condition of deposit insurance, current FDIC regulations require that the Bank calculate and maintain a minimum regulatory capital requirement on a quarterly basis and satisfy such requirement at the calculation date and throughout the ensuing quarter. The Bank's tangible and core capital approximated $84.2 million at September 30, 2003, exceeding the Bank's tangible and core requirements by $66.4 million and $48.8 million, respectively. At September 30, 2003, the Bank's capital exceeded its current risk-based minimum capital requirement by $36.5 million. The risk-based capital requirement may increase in the future. Also see Note 14 of the Notes to Consolidated Financial Statements. 38 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued Results of Operations Comparison of the Years Ended September 30, 2002 and 2003 General Net earnings were $11.2 million ($0.83 per diluted share) for the year ended September 30, 2003, an increase of 9.5% compared to $10.2 million ($0.77 per diluted share) for the year ended September 30, 2002. As a result of increased net earnings, diluted earnings per share increased 7.8%. Net interest income increased $4.2 million primarily as a result of an increase in interest income of $5.3 million which was partially offset by an increase in interest expense of $1.2 million. Interest Income Interest income for the year ended September 30, 2003, increased 9.9% to $59.2 million as compared to $53.9 million for the year ended September 30, 2002. The yield on interest-earning assets for the year ended September 30, 2002 was 7.10% compared to 6.00% for the year ended September 30, 2003. The average yield on loans receivable for fiscal year 2003 was 6.67% compared to 7.58% in 2002. The yield on investments which includes Investments, Mortgage-Backed Securities, Overnight Funds and Federal Funds, decreased to 4.88% for the fiscal year 2003 from 6.15% for fiscal year 2002. Total interest-earning assets for fiscal year 2003 averaged $987.5 million compared to $765.8 million for the year ended September 30, 2002. The increase in average interest-earning assets is primarily due to an increase in average loans receivable of approximately $98.6 million and average mortgage-backed and investment securities of approximately $133.4 million. Interest Expense Interest expense on interest-bearing liabilities was $23.0 million for the year ended September 30, 2003, as compared to $21.8 million in fiscal 2002. The cost of interest-bearing liabilities was 2.35% for the year ended September 30, 2003, compared to 2.96% in fiscal year 2002. The average cost of deposits for the year ended September 30, 2003, was 1.79% compared to 2.42% for the year ended September 30, 2002. The cost of FHLB advances and reverse repurchase agreements for fiscal 2003 was 4.27% and 2.04%, respectively, compared to 5.11% and 2.39%, respectively, for fiscal 2002. Total average interest-bearing liabilities increased 32.6% from $738.1 million at September 30, 2002, to $978.9 million at September 30, 2003. The increase in average interest-bearing liabilities is due to an increase in average deposits of approximately $99.9 million, average FHLB advances of $62.3 million and average reverse repurchase agreements of $77.5 million. Net Interest Income Net interest income was $36.2 million for the year ended September 30, 2003, an increase of $4.2 million, compared to $32.0 million for the year ended September 30, 2002. The net interest margin decreased to 3.65% for fiscal 2003 compared to 4.14% for fiscal 2002. Average interest-earning assets increased $221.7 million while average interest-bearing liabilities increased $240.8 million. During fiscal 2003, interest rates have decreased. At September 30, 2002 and September 30, 2003, the prime rate of interest was 4.75% and 4.00%, respectively. With the reduction in interest rates, resulting from the Federal Reserve Board's decision to reduce the prime rate by 75 basis points throughout fiscal 2003, the Company's interest-earning assets repriced more quickly than its interest-bearing liabilities. For fiscal 2003, the Company's average balance of core deposits (checking, statement savings and money market) was $412.3 million with an average cost of 1.06%. This compares to average core deposits of $346.7 million at 1.44% in fiscal 2002. As the Federal Reserve has continued to reduce the discount rate, core deposits are not repricing at the same ratio as the Company's interest-earning assets. Should, as a result of continued rate, reductions, refinancing of loans at lower rates and repricing of loans tied to prime or treasury rates outpace the repricing of deposits and borrowings, the Company could experience a significantly reduced net interest margin in the future. Provision for Loan Losses As a result of growth in loans receivable and credit risk associated with problem loans, the Company's provision for loan losses increased from $1.2 million for fiscal 2002 to $2.7 million for fiscal 2003. The allowance for loan losses as a percentage of loans was 1.40% at September 30, 2003 compared to 1.42% at September 30, 2002. This is due to the nature and the risk of the delinquent loans at September 30, 2003 as compared to September 30, 2002. Loans delinquent 90 days or more were $7.4 million or 1.06% of total loans at September 30, 2003, compared to $3.5 million or 0.63% at September 30, 2002. The allowance for loan losses was 132% of loans delinquent more than 90 days at 39 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued September 30, 2003, compared to 224% at September 30, 2002. Although the Company experienced an increase in loans delinquent 90 days or more, there was not a corresponding increase in the required allowance for loan loss based on the Company's model. 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. Also see "Nonperforming Assets" and "Allowance for Loan Losses." Other Income In fiscal 2003, total other income increased from $8.1 million for the period ended September 30, 2002, to $10.9 million for the period ended September 30, 2003. As a result of increased transaction deposit accounts, fees and service charges on loans and deposit accounts was $3.5 million for fiscal 2003, compared to $3.1 million for fiscal 2002. Due to a decreased long-term interest rate environment which has resulted in increased fixed-rate mortgage originations, gain on sale of loans was $3.0 million for the year ended September 30, 2003, compared to $1.5 million for the year ended September 30, 2002. Gain on sale of mortgage-backed securities, net was $469,000 for fiscal 2003, compared to $238,000 for fiscal 2002. Other income increased from $1.6 million for the year ended September 30, 2002, to $2.4 million for the year ended September 30, 2003. This is primarily due to $665,000 of income on bank-owned life insurance purchased in December 2002. Other Expense General and administrative expenses were $27.2 million for fiscal 2003 as compared to $22.8 million for fiscal 2002. Salaries and employee benefits increased to $13.5 million for fiscal 2003 as compared to $12.5 million for fiscal 2002, or 7.5%, primarily due to normal increases, increased incentives as a result of increased loan production, and the costs of staffing for a new office. During fiscal 2003, Coastal Federal Bank added an office in Shallotte, North Carolina. Net occupancy, furniture and fixtures and data processing expense increased $873,000 for fiscal 2003, as compared to fiscal 2002. Other expenses increased from $4.1 million in fiscal 2002 to $4.9 million in fiscal 2003. Other expenses included $461,000 of mortgage servicing rights impairment for fiscal 2003. Income Taxes Income taxes increased from $5.9 million in fiscal 2002 to $6.1 million in fiscal 2003 as a result of increased earnings before income taxes. The effective income tax rate as a percentage of pretax income was 35.5% in fiscal 2003 and 36.6% in fiscal 2002. The effective income tax rate declined in connection with an increase in investment interest income generated by bank-owned life insurance and municipal securities that are exempt from federal and certain state taxes. The Company's effective income tax rates take into consideration certain assumptions and estimates made by management. No assurance can be given that either the tax returns submitted by management or the income tax reported on the consolidated financial statements will not be adjusted by either adverse rulings by the U.S. Tax court, changes in the tax code, or assessments made by the Internal Revenue Service. The Company is subject to potential adverse adjustments, including but not limited to: an increase in the statutory federal or state income tax rates, the permanent nondeductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, in order to ultimately realize deferred income tax assets. Income tax returns for 2000 and subsequent years are exposed to examination by taxing authorities. Results of Operations Comparison of the Years Ended September 30, 2001 and 2002 General Net earnings were $10.2 million ($0.77 per diluted share) for the year ended September 30, 2002, an increase of 9.7% compared to $9.3 million ($0.70 per diluted share) for the year ended September 30, 2001. As a result of share repurchases and the increase in net earnings, diluted earnings per share increased 10.0%. Net interest income increased $5.1 million primarily as a result of a decrease in interest income of $6.4 million which was accompanied by a decrease in interest expense of $11.5 million. 40 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued Interest Income Interest income for the year ended September 30, 2002, decreased 10.6% to $53.9 million as compared to $60.3 million for the year ended September 30, 2001. The yield on interest-earning assets for the year ended September 30, 2001 was 8.26% compared to 7.10% for the year ended September 30, 2002. The average yield on loans receivable for fiscal year 2002 was 7.58% compared to 8.80% in 2001. The yield on investments which includes Investments, Mortgage-Backed Securities, Overnight Funds and Federal Funds, decreased to 6.15% for the fiscal year 2002 from 7.00% for fiscal year 2001. Total interest-earning assets for fiscal year 2002 averaged $765.8 million compared to $738.5 million for the year ended September 30, 2001. The increase in average interest-earning assets is primarily due to an increase in average loans receivable of approximately $9.7 million and average mortgage-backed and investment securities of approximately $21.3 million. Interest Expense Interest expense on interest-bearing liabilities was $21.8 million for the year ended September 30, 2002, as compared to $33.3 million in fiscal 2001. The cost of interest-bearing liabilities was 2.96% for the year ended September 30, 2002, compared to 4.64% in fiscal year 2001. The average cost of deposits for the year ended September 30, 2002, was 2.42% compared to 4.03% for the year ended September 30, 2001. The cost of FHLB advances and reverse repurchase agreements for fiscal 2002 was 5.11% and 2.39%, respectively, compared to 5.90% and 5.99%, respectively, for fiscal 2001. Total average interest-bearing liabilities increased 2.8% from $717.9 million at September 30, 2001, to $738.1 million at September 30, 2002. The increase in average interest-bearing liabilities is due to an increase in average deposits of approximately $87.8 million. This was offset by a decrease in average FHLB advances of $38.4 million and average reverse repurchase agreements of $30.5 million. Net Interest Income Net interest income was $32.0 million for the year ended September 30, 2002, an increase of $5.1 million, compared to $26.9 million for the year ended September 30, 2001. The net interest margin increased to 4.14% for fiscal 2002 compared to 3.62% for fiscal 2001. Average interest-earning assets increased $27.3 million while average interest-bearing liabilities increased $20.2 million. During fiscal 2002, interest rates have decreased. At September 30, 2001 and September 30, 2002, the prime rate of interest was 6.0% and 4.75%, respectively. With the reduction in interest rates, resulting from the Federal Reserve Board's decision to reduce the prime rate by 125 basis points, it is expected that the Company's yield on interest earning assets and cost of deposits and borrowing will decline in fiscal 2003. Consequently, it is expected that a substantial portion of the Company's loan portfolio will be subject to refinancing at lower rates. Should, as a result of continued rate reductions by the Federal Reserve, refinancing of loans at lower rates and repricing of loans tied to prime or treasury rates outpace the repricing of deposits and borrowings, the Company could experience a significantly reduced net interest margin in the future. Provision for Loan Losses As a result of growth in loans receivable, the Company's provision for loan losses increased from $955,000 for fiscal 2001 to $1.2 million for fiscal 2002. The allowance for loan losses as a percentage of loans was 1.42% at September 30, 2002 and 2001. Loans delinquent 90 days or more were .63% of total loans at September 30, 2002, compared to .64% at September 30, 2001. The allowance for loan losses was 224% of loans delinquent more than 90 days at September 30, 2002, compared to 220% at September 30, 2001. 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. Also see "Nonperforming Assets" and "Allowance for Loan Losses." Other Income In fiscal 2001, total other income increased slightly from $7.9 million for the period ended September 30, 2001, to $8.1 million for the period ended September 30, 2002. As a result of increased transaction deposit accounts, fees and service charges on loans and deposit accounts was $3.1 million for fiscal 2002, compared to $2.6 million for fiscal 2001. Due to a decreased long-term interest rate environment which has resulted in increased fixed-rate mortgage originations, gain on sale of loans was $1.5 million for the year ended September 30, 2002, compared to $1.3 million for the year ended September 30, 2001. Gain on sale of mortgage-backed securities, net was $238,000 for fiscal 2002, compared to $727,000 for fiscal 2001. Other income decreased from $1.7 million for the year ended September 30, 2001, to $1.6 million for the year ended September 30, 2002. 41 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued Other Expense General and administrative expenses were $22.8 million for fiscal 2002 as compared to $19.3 million for fiscal 2001. Salaries and employee benefits increased to $12.5 million for fiscal 2002 as compared to $10.5 million for fiscal 2001, or 18.7%, primarily due to normal increases and the costs of staffing for new offices. During fiscal 2002, Coastal Federal Bank added offices in Loris and Pawleys Island, South Carolina. Also as a result of the office additions, net occupancy, furniture and fixtures and data processing expense increased $1.0 million for fiscal 2002, as compared to fiscal 2001. Other expenses increased from $3.5 million in fiscal 2001 to $4.1 million in fiscal 2002. The increase is primarily due to increased expenses related to the servicing of deposit accounts. Income Taxes Income taxes increased from $5.3 million in fiscal 2001 to $5.9 million in fiscal 2002 as a result of increased earnings before income taxes. Non-performing Assets Non-performing assets were $9.1 million at September 30, 2003 compared to $4.6 million at September 30, 2002. Loans past due 90 days or more increased from $3.5 million at September 30, 2002, to $7.4 million at September 30, 2003. Real estate acquired through foreclosure increased from $1.0 million at September 30, 2002, to $1.6 million at September 30, 2003. At September 30, 2002, impaired loans totaled $3.2 million. There were $4.9 million in impaired loans at September 30, 2003. Included in the allowance for loan losses at September 30, 2002 was $194,000 related to impaired loans compared to $263,000 at September 30, 2003. The average recorded investment in impaired loans for the year ended September 30, 2002 was $3.1 million compared to $4.0 million for the year ended September 30, 2003. Interest income recognized on impaired loans in fiscal 2002 was $36,000. Interest income recognized on impaired loans in fiscal 2003 was $134,000. Loans are reviewed on a regular basis and an allowance for uncollectible interest is established on loans where collection is questionable, generally when such loans become 90 days delinquent. Loan balances for which interest amounts have been reserved and all loans more than 90 days delinquent are placed on non-accrual status. Typically, payments received on a non-accrual loan are applied to the outstanding principal or recognized as interest based upon the collectability of the loan as determined by management. Allowance for Loan Losses The adequacy of the allowance is analyzed on a quarterly basis. For purposes of this analysis, adequacy is defined as a level of reserves sufficient to absorb probable losses inherent in the portfolio. The methodology employed for this analysis considers historical loan loss experience, the results of loan reviews, current economic conditions, and other qualitative and quantitative factors that warrant current consideration in determining an adequate allowance. The evaluation of the allowance is segregated into general allocations and specific allocations. For general allocations, the portfolio is segregated into risk-similar segments for which historical loss ratios are calculated and adjusted for identified trends or changes in current portfolio characteristics. Historical loss ratios are calculated by product type for consumer loans (installment and revolving), mortgage loans, and commercial loans and may be adjusted for other risk factors. To allow for modeling error, a range of probable loss ratios is then derived for each segment. The resulting percentages are then applied to the dollar amounts of the loans in each segment to arrive at each segment's range of probable loss levels. Certain nonperforming loans are individually assessed for impairment under SFAS 114 and assigned specific allocations. Other identified high-risk loans or credit relationships based on internal risk ratings are also individually assessed and assigned specific allocations. The general allocation also includes a component for probable losses inherent in the portfolio, based on management's analysis, that are not fully captured elsewhere in the allowance. This component serves to address the inherent estimation and imprecision risk in the methodology as well as address management's evaluation of various factors or conditions not otherwise directly measured in the evaluation of the general and specific allocations. Such factors or conditions may include evaluation of current general economic and business conditions; geographic, collateral, or other concentrations; system, procedural, policy, or underwriting changes; experience of lending staff; entry into new markets or new product offerings; and results from internal and external portfolio examinations. 42 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued The allocation of the allowance to the respective loan segments is an approximation and not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses occurring in the overall loan portfolio. Assessing the adequacy of the allowance is a process that requires considerable judgment. Management's methodology and judgments are based on the information currently available and includes numerous assumptions about current events, which we believe to be reasonable, but which may or may not be valid. Thus, there can be no assurance that loan losses in future periods will not exceed the current allowance amount or that future increases in the allowance will not be required. No assurance can be given that management's ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting the operating results of the Company. Management believes that the current level of the allowance for loan losses is presently adequate considering the composition of the loan portfolio, the portfolio's loss experience, delinquency trends, current regional and local economic conditions and other factors. The allowance is also subject to examination and adequacy testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other adequacy tests. In addition, such regulatory agencies could require the Company to adjust the allowance based on information available to them at the time of their examination. The Company established provisions for loan losses for the years ended September 30, 2001, 2002 and 2003, of $955,000, $1.2 million and $2.7 million, respectively. For the years ended September 30, 2001, 2002 and 2003, the Company had net charge-offs of $860,000, $511,000 and $706,000, respectively. Net charge-offs as a percentage of average outstanding loans were .17%, .10%, and ..11% for fiscal years ended 2001, 2002 and 2003, respectively. At September 30, 2003, the Company had an allowance for loan losses of $9.8 million, which was 1.40% of net loans. 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 not recorded in the financial statements, or 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 for Customer needs. Corporate purpose transactions are used to help manage credit, interest rate, and liquidity risk or to optimize capital. Customer transactions are used to manage Customers' requests for funding. The Company's off-balance sheet arrangements, which principally include lending commitments and derivatives are described below. At September 30, 2002 and 2003, the Company had no interests in non-consolidated special purpose entities. Lending Commitments. Lending commitments include loan commitments, standby letters of credit and unused business credit card lines. These instruments are not recorded in the consolidated balance sheet until funds are advanced under the commitments. The Company provides these lending commitments to Customers in the normal course of business. Loan commitments for residential housing and land totaled $39.3 million. For retail Customers, loan commitments are generally lines of credit secured by residential property. At September 30, 2003 retail loan commitments totaled $42.0 million. Standby letters of credit are conditional commitments to guarantee performance, typically contract or financial integrity, of a Customer to a third party and totaled $2.9 million at September 30, 2003. Commercial lines of credit and unused business and personal credit card lines, which totaled $23.9 million at September 30, 2003, are generally for short-term borrowings. The Company applies essentially the same credit policies and standards as it does in the lending process when making these commitments. Derivatives. In accordance with SFAS No. 133, the Company records derivatives at fair value, as either assets or liabilities, on the consolidated balance sheet. Derivative transactions are measured in terms of the notional amount, but this amount is not recorded on the balance sheet and is not, when viewed in isolation, a meaningful measure of the risk profile of the instrument. The notional amount is not exchanged, but is used only as the basis upon which interest and other payments are calculated. 43 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued At September 30, 2003, the fair value of derivative assets and liabilities totaled $123,000 and $257,000 respectively. The related notional amounts, which are not recorded on the consolidated balance sheet, totaled $8.2 million for the derivative assets and $17.0 million for the derivative liabilities. Interest Rate Risk Disclosure 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 Bank'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 within Board approved limits. Net portfolio value (NPV) represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items over a range of assumed changes in market interest rates. The Bank's Board of Directors has adopted an interest rate risk policy which establishes maximum allowable decreases in NPV in the event of a sudden and sustained one hundred to four hundred basis point increase or decrease in market interest rates. The following table presents the Bank's projected change in NPV as computed by the OTS for the various rate shock levels as of September 30, 2003.
Board Limit Board Limit Market Value Market Value Minimum NPV Maximum Of Assets Portfolio Equity NPV Change in Interest Rates Ratio Decline in NPV 9/30/03 9/30/03 Ratio - ------------------------ ----------- -------------- ------------ ---------------- ----- 300 basis point rise 5.00% 400 BPS $1,169,090 $ 100,277 8.58% 200 basis point rise 6.00% 300 BPS $1,190,866 $ 111,628 9.37% 100 basis point rise 6.00% 250 BPS $1,212,853 $ 121,364 10.01% No Change 6.00% $1,231,968 $ 126,363 10.26% 100 basis point decline 6.00% 250 BPS $1,242,347 $ 125,123 10.07% 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 September 30, 2003, 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 change minimally. Values for the 200 and 300 basis point decline are not indicated due to the current level of interest rates. At September 30, 2003, 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. The Bank also uses interest rate sensitivity gap analysis to monitor the relationship between the maturity and repricing of its interest-earning assets and interest-bearing liabilities. Interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within the same time period. A gap is considered positive when the amount of interest-rate-sensitive assets exceeds the amount of interest-rate-sensitive liabilities. Generally, during a period of rising rates, a positive gap would result in an increase in net interest income. Conversely, during a period of falling interest rates, a positive gap would result in a decrease in net interest income. It is ALCO's goal to maintain reasonable balance between exposure to interest rate fluctuations and earnings. Impact of New Accounting Pronouncements In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146 (Statement 146), "Accounting for Costs Associated with Exit or Disposal Activities," which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs 44 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued Incurred in a Restructuring)." This Statement applies to costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a disposal activity covered by FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Those costs include, but are not limited to, the following: a) termination benefits provided to current employees that are involuntarily terminated under the terms of a benefit arrangement that, in substance, is not an ongoing benefit arrangement or an individual deferred compensation contract (hereinafter referred to as one-time termination benefits), b) costs to terminate a contract that is not a capital lease and c) costs to consolidate facilities or relocate employees. This Statement does not apply to costs associated with the retirement of a long-lived asset covered by FASB Statement No. 143, "Accounting for Asset Retirement Obligations." A liability for a cost associated with an exit or disposal activity shall be recognized and measured initially at its fair value in the period in which the liability is incurred. A liability for a cost associated with an exit or disposal activity is incurred when the definition of a liability is met. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The Company adopted SFAS 146 on October 1, 2002 and its adoption did not have a material effect on the Company's consolidated financial statements. In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148 (Statement 148), "Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123". Statement 148 amends FASB Statement 123, "Accounting for Stock-Based Compensation" (Statement 123) to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, Statement 148 amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Effective January 1, 2003, the Company adopted the initial recognition and initial measurement provisions of Financial Accounting Standards Board Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). The Company adopted the disclosure requirements effective as of December 31, 2002. FIN 45 elaborates on the disclosure to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that is has issued. FIN 45 clarifies that a guarantor is required to disclose (a) the nature of the guarantee; (b) the maximum potential amount of future payments under the guarantee; (c) the carrying amount of the liability; and (d) the nature and extent of any recourse provisions or available collateral that would enable the guarantor to recover the amounts paid under the guarantee. FIN 45 also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the obligations it has undertaken in issuing the guarantee at its inception. In January 2003, the FASB issued Financial Accounting Standards Board Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"), which addresses consolidation by business enterprises of variable interest entities. Under FIN 46, an enterprise that holds significant variable interest in a variable interest entity but is not the primary beneficiary is required to disclose the nature, purpose, size and activities of the variable interest entity, its exposure to loss as a result of the variable interest holder's involvement with the entity, and the nature of its involvement with the entity and date when the involvement began. The primary beneficiary of a variable interest entity is required to disclose the nature, purpose, size, and activities of the variable interest entity, the carrying amount and classification of consolidated assets that are collateral for the variable interest entity's obligations, and any lack of recourse by creditors (or beneficial interest holders) of a consolidated variable interest entity to the general creditors (or beneficial interest holders). FIN 46 is effective for the first fiscal year or interim period beginning after June 15, 2003. On October 31, 2003, the FASB proposed a modification and interpretation of FIN 46. Evaluation of the impact of FIN 46 and SFAS No. 150, ("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity," on the treatment of debt associated with trust preferred securities is in process. The Company currently consolidates the trust, which issued the Company's trust preferred securities, in its consolidated financial statements and reports the related debt instruments, referred to as debt associated with trust preferred securities, as a liability on its consolidated balance sheet. Under one potential interpretation of FIN 46, the Company's trust, which issued the Company's trust preferred securities, would no longer be included in the Company's consolidated financial statements. Conversely, SFAS 150 requires the consolidation of these subsidiaries and the presentation of the related debt instruments as a liability. Effective July 1, 2003, the Company adopted SFAS No. 149, (Statement 149), "Amendment of Statement 133 on Derivative Instruments and Hedging Activities," which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to 45 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued as derivatives) and for hedging activities under SFAS No 133, "Accounting for Derivative Instruments and Hedging Activities." Statement 149 clarifies under what circumstances a contract with an initial net investment meets the characteristics of a derivative, clarifies when a derivative contains a financing component, amends the definition of an underlying to conform it to language used in FIN 45, and amends certain other existing pronouncements. Those changes will result in more consistent reporting of contracts as either derivatives or hybrid instruments. Management does not believe the provisions of this standard will have a material impact on the results of future operations. Effective July 1, 2003, the Company adopted SFAS 150, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 requires an issuer to classify certain financial instruments that include certain obligations, such as mandatory redemption, repurchase of the issuer's equity, or settlement by issuing equity, as liabilities or assets in some circumstances. Forward contracts to repurchase an issuer's equity shares that require physical settlement in exchange for cash are initially measured at the fair value of the shares at inception, adjusted for any consideration or unstated rights or privileges, which is the same as the amount that would be paid under the conditions specified in the contract if settlement occurred immediately. Those contracts and mandatory redeemable financial instruments are subsequently measured at the present value at the amount to be paid at settlement, if both the amount of cash and the settlement date are fixed, or otherwise, at the amount that would be paid under the conditions specified in the contract if settlement occurred at the reporting date. Other financial instrument are initially and subsequently measured at fair value, unless required by SFAS 150 or other generally accepted accounting principles to be measured differently. The Company had no impact upon adoption since it had no financial instruments, which it considers to be included within the scope of SFAS 150. Capital Standards and Regulatory Matters The Bank's capital standards include: (1) a leverage limit requiring all OTS chartered financial institutions to maintain core capital in an amount not less than 4% of the financial institution's total assets; (2) a tangible capital requirement of not less than 1.5% of total assets; and (3) a risk-based capital requirement of not less than 8.0% of risk weighted assets. For further information concerning the Bank's capital standards, refer to Note 14 of the Notes to the Consolidated Financial Statements. Effects of Inflation and Changing Prices The 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 effect of inflation. Interest rates do not necessarily change in the same magnitude as the price of goods and services. 46 Board of Directors
Coastal Financial Corporation Coastal Federal Bank Coastal Planners Holding Corporation James C. Benton James C. Benton James T. Clemmons President President Chairman C.L. Benton & Sons, Inc. C.L. Benton & Sons, Inc. Coastal Financial Corporation G. David Bishop G. David Bishop Michael C. Gerald Managing Director Managing Director President and Chief Executive Officer White Harvest Trading Co., LLC White Harvest Trading Co., LLC Coastal Financial Corporation James T. Clemmons James T. Clemmons Jerry L. Rexroad, CPA Chairman Chairman Chief Financial Officer Coastal Financial Corporation Coastal Federal Bank Coastal Planners Holding Corporation James P. Creel James P. Creel President President Creel Corporation Creel Corporation James H. Dusenbury James H. Dusenbury Retired - Attorney Retired - Attorney Dusenbury and Clarkson Law Firm Dusenbury and Clarkson Law Firm Michael C. Gerald Michael C. Gerald President and Chief Executive Officer President and Chief Executive Officer Coastal Financial Corporation Coastal Federal Bank Frank A. Thompson, II Frank A. Thompson, II President President Peoples Underwriters, Inc. Peoples Underwriters, Inc.
47 COASTAL FINANCIAL CORPORATION Leadership Group Sherri J. Adams Shonda C. Chestnut Andrew D. Gable Personal Banking Leader Assistant Vice President Assistant Vice President N. Myrtle Beach Banking Center Leader Closing and Construction Surfside Leader Ginger Allen Assistant Vice President Susan J. Cooke William A. Gehman, III, CPA Senior Underwriter Senior Vice President Senior Vice President Administrative Services Leader Corporate Controller Anthony Ambuhl Corporate Secretary Assistant Vice President Mary L. Geist Commercial Banking Officer Teresa L. Cotney Vice President Personal Banking Leader Data Services Leader Donna P. Bailey Murrells Inlet Assistant Vice President Michael C. Gerald Delivery Systems Resource Patricia A. Coveno President and Chief Executive Administrator Assistant Vice President Officer Banking Resources Leader James R. Baker, MCSE Kenan D. Godwin Assistant Vice President Jerry J. Cox, Jr. Assistant Vice President Systems Engineer Vice President Commercial Banking Officer Community Banking Leader Harry G. Bates, IV Loris Community Amy M. Gore Assistant Vice President Personal Banking Leader Banking Center Leader John L. Creamer Wilmington-Oleander Oak Street Vice President Coastal Investor Services Group Jimmy R. Graham Jeffrey A. Benjamin Executive Vice President Senior Vice President Robert D. Douglas Chief Information Officer Credit Administration Executive Vice President Leader Human Resources Leader Don C. Hamilton Vice President Jill L. Bone Trina S. Dusenbury Residential Banking Leader Personal Banking Leader Vice President Pawleys Island Residential Loan Administration E. Haden Hamilton Jr. Leader President Edna C. Bryant Coastal Investor Services Group Personal Banking Leader Michael L. Evans Bi-Lo Socastee Vice President Lauren E. Henson Loan Review Leader Vice President Cynthia L. Buffington Dean of Coastal Federal University Assistant Vice President Rita E. Fecteau Item Processing Leader Vice President John Michael Hill Accounting Leader Vice President Ronnie L. Burbank Coastal Investor Services Group Vice President J. Daniel Fogle Senior Banking Leader Vice President Debra Hinson Wilmington CBD Residential Banking Leader Assistant Vice President Carolina Forest/ Coastal Investor Services Group Glenn T. Butler, MCSE, CCNA Waccamaw/ Conway Vice President Glenn D. Humbert Network Services Leader Joel P. Foster Vice President Senior Vice President Community Banking Leader Anne R. Caldwell Area Banking Leader Sunset Beach Community Assistant Vice President Myrtle Beach Community Deposit Servicing Leader Lisa B. James Vice President Account Servicing Leader
48 COASTAL FINANCIAL CORPORATION Leadership Group - Continued Ruth S. Kearns Janice B. Metz Douglas E. Shaffer Senior Vice President Assistant Vice President Senior Vice President Customer Recognition Officer Advertising Officer Area Leader North and West Communities Kara S. Kessinger, CPA/PES Abigail E. Mishoe President Assistant Vice President Steven J. Sherry Coastal Retirement Residential Banking Officer Executive Vice President Estate & Tax Chief Marketing Officer Planners, Inc. Lynn T. Murray Senior Vice President Joseph Shumbo L. Eric Keys Customer Relationship Leader Assistant Vice President Vice President Residential Banking Leader Community Banking Leader Deborah J. Myers South Horry Community Assistant Vice President J. Marcus Smith, Jr. Electronic Banking Leader Senior Vice President James Louis LaBruce Internal Audit Outsource Vice President Ronald A. Nolan Commercial Banking Leader Assistant Vice President Carolyn A. Specht Central Horry Community Security Officer Purchasing Leader Scott W. Lander Deborah A. Orobello Phillip G. Stalvey Senior Vice President Personal Banking Leader Executive Vice President Area Leader Little River Banking Leader North Carolina Region Charles S. Page H. Delan Stevens William H. Langfitt Vice President Vice President Personal Banking Leader Banking Center Leader Community Banking Leader Dunes West Community Orit Perez Justin M. Lee Personal Banking Leader Sandra J. Szarek Personal Banking Leader 38th Avenue Bi-Lo Residential Loan Servicing Leader Socastee Derick R. Powers Theresa Z. Tierney Edward L. Loehr, Jr. Banking Center Leader Assistant Vice President Vice President Southport Commercial Banking Officer Budgeting and Treasury Jerry L. Rexroad, CPA Matthew J. Towns Kathleen M. Lutes Executive Vice President Vice President Assistant Vice President Chief Financial Officer Credit Administration Conforming Underwriter Leader David L. Roe Douglas W. Walters Richard M. Marsh Senior Vice President Vice President Personal Banking Leader Small Business Banking Leader Residential Banking Leader Loris North Myrtle Beach Stacy M. Sansbury Michael C. Mauney Personal Banking Leader Sandra R. Zanfini Assistant Vice President Conway Assistant Vice President Collections Leader Assistant Corporate Secretary Eulette W. Sauls Corporate Support Leader Amy E. McLaurin Customer Account Relationship Assistant Vice President System Leader Personal Banking Leader Sunset Beach Sherry G. Schoolfield, CRCM Assistant Vice President Brenda S. Meier Compliance Officer Office Services Leader
49 Locations
Coastal Federal Bank Coastal Planners Holding Corporation Oak Street Banking Center Socastee Banking Center Susan J. Cooke 2619 Oak Street 4801 Socastee Boulevard Corporate Secretary Myrtle Beach, SC 29577-3129 Myrtle Beach, SC 29575 843.205.2000 843.205.2000 843.205.2007 Michael C. Gerald Carolina Forest Banking Center Socastee Banking Center (BI-LO) President and Chief Executive Officer 3894 Renee Drive 5020 Dick Pond Road 843.205.2000 Myrtle Beach, SC 29579 Myrtle Beach, SC 29588 843.205.2016 843.205.2042 Jerry L. Rexroad Executive Vice President, Conway Banking Center Southport Banking Center Chief Financial Officer and Treasurer 310 Wright Boulevard 4956-1 Long Beach Road SE 843.205.2000 Conway, SC 29526 Southport, NC 28461 843.205.2005 843.205.2032 910.454.4173 Dunes Banking Center 7500 North Kings Highway Sunset Beach Banking Center Myrtle Beach, SC 29572 1625 Seaside Road S.W. 843.205.2001 Sunset Beach, NC 28468 843.205.2012 Little River Banking Center 910.579.8160 1602 Highway 17 Little River, SC 29566 Surfside Banking Center 843.205.2014 112 Highway 17 South & Glenns Bay Road Loris Banking Center Surfside Beach, SC 29575 4262 Main Street 843.205.2003 Loris, SC 29569 843.756.4455 Waccamaw Medical Park Banking Center 112 Waccamaw Medical Park Drive Murrells Inlet Banking Center Conway, SC 29526 3348 Highway 17 South 843.205.2009 & Inlet Crossing Murrells Inlet, SC 29576 38th Avenue Banking Center (BI-LO) 843.205.2008 1245 38th Avenue North Myrtle Beach, SC 29577 North Myrtle Beach Banking Center 843.205.2041 521 Main Street North Myrtle Beach, SC 29582 Wilmington Banking Center 843.205.2002 5710 Oleander Drive, Suite 209 Wilmington, NC 28403 Pawleys Island Banking Center 843.205.2031 Coastal Federal Town Center 910.313.1161 11403 Ocean Highway Pawleys Island, SC 29585 Wilmington Downtown Banking Center 843.205.2020 109 Market Street Wilmington, NC 28401 Shallotte Banking Center 843.205.2033 200 Smith Avenue 910.763.2372 Shallotte, NC 28459 910.754.6187
50 Corporate Information Common Stock and Dividend Information The common stock of Coastal Financial Corporation is quoted through the Nasdaq Stock Market under the symbol CFCP. For information contact the Shareholder Relations office. As of November 28, 2003, the Corporation had 1,042 shareholders and 12,933,355 shares of Common Stock outstanding. This does not reflect the number of persons or entities who hold stock in nominee or "street name." The Company's ability to pay dividends depends primarily on the ability of Coastal Federal Bank to pay dividends to the Company. See Notes 14 and 15 of the Notes to Consolidated Financial Statements for further information. Market Price of Common Stock The table below reflects the high and low bid stock prices published by Nasdaq for each quarter. The prices have been adjusted retroactive to reflect stock dividends. HIGH LOW CASH BID BID DIVIDEND Fiscal Year 2003: First Quarter $15.37 $12.31 $0.045 Second Quarter 14.19 11.65 0.045 Third Quarter 13.49 11.70 0.055 Fourth Quarter 15.91 12.44 0.055 Fiscal Year 2002: First Quarter $ 8.18 $ 7.36 $0.041 Second Quarter 7.94 7.65 0.041 Third Quarter 12.43 7.55 0.045 Fourth Quarter 12.77 10.74 0.045 Form 10-K A copy of Coastal Financial Corporation's Annual Report on Form 10-K, as filed with the Securities Exchange Commission for the year ended September 30, 2003, may be obtained without a charge by writing to the Shareholder Relations Officer at the Corporate Address. Annual Meeting of Shareholders The Annual Meeting of Shareholders of Coastal Financial Corporation will be held at the Ocean Reef Resort (formerly Myrtle Beach Martinique), 7100 North Ocean Boulevard, Myrtle Beach, South Carolina, on Tuesday, January 27, 2004 at 2:00 p.m., Eastern Standard Time. Additional Information If you are receiving duplicate mailing of shareholder reports due to multiple accounts, we can consolidate the mailings without affecting your account registration. To do this, or for additional information, contact the Shareholder Relations Office, at the Corporate address shown below. Corporate Offices Coastal Financial Corporation 2619 Oak Street Myrtle Beach, South Carolina 29577 843.205.2000 Transfer Agent and Registrar Registrar and Transfer Company P.O. Box 1010 Cranford, NJ 07016 1.800.866.1340 Ext. 2514 Independent Certified Public Accountants KPMG LLP 55 Beattie Place, Suite 900 Greenville, South Carolina 29601 Special Counsel Muldoon Murphy & Faucette LLP 5101 Wisconsin Avenue Washington, DC 20016 Shareholder Relations Officer Susan J. Cooke Coastal Financial Corporation 2619 Oak Street Myrtle Beach, South Carolina 29577 843.205.2000 Coastal Financial Corporation is an equal opportunity employer and pledges equal opportunities without regard to religion, citizenship, race, color, creed, sex, age, national origin, disability or status as a disabled or Vietnam-Era veteran. COASTAL [LOGO] [LOGO] * COASTAL Securities are FEDERAL EQUAL HOUSING COASTAL INVESTOR RAYMOND JAMES offered exclusively BANK LENDER RETIREMENT o ESTATE o TAX SERVICES FINANCIAL SERVICES through Raymond The right bank for you. MEMBER PLANNERS MEMBER NASD/SIPC James Financial FDIC Committed to your financial future. Services, Inc., member NASD/SIPC, an independent broker/dealer, and are not insured by the FDIC or any other bank insurance, are not deposits or obligations of the bank, are not guaranteed by the bank, and are subject to risk, including the possible loss of principal.
51 (Page left blank intentionally) 52 NOTICE CONCERNING QUARTERLY SHAREHOLDER REPORTS With the rising costs of publishing and mailing quarterly reports and concurrent timeliness of providing these via the Internet on our website at www.coastalfederal.com, we will be sending printed versions of our quarterly shareholder reports only to shareholders who request them. All shareholders will continue to receive the annual report and proxy statement in printed form. Shareholders and other interested parties can obtain quarterly reports and our President's letter from the previous year annual report through Coastal Federal Bank's home page. In addition, our revised website will enable you to learn more about our products and services. For your convenience, we are providing this business reply card, which should be completed and returned to us if you wish to be placed on our quarterly report mailing list. We urge you to help us lower our costs by using the more efficient electronic method of accessing this information. |X| I wish to continue to receive Coastal Financial Corporation's Quarterly Shareholders Reports (Please print clearly) ________________________________________________________________________________ First Name MI Last ________________________________________________________________________________ Address ________________________________________________________________________________ City State Zip Notice Concerning Quarterly Shareholder Reports PLACE STAMP HERE ATTN: SUSAN COOKE COASTAL FINANCIAL CORPORATION 2619 OAK STREET MYRTLE BEACH, SC 29577-3129 65 EX-14 9 ex14.txt EXHIBIT 14 Code Of Ethics For Senior Financial Officers COASTAL FINANCIAL CORPORATION In my role as a senior financial officer of Coastal Financial Corporation, I agree that I will adhere to and advocate the following principles and responsibilities governing my professional and ethical conduct. To the best of my knowledge and ability, I will: 1. act with honesty and integrity, avoiding actual or apparent conflicts of interest between personal and professional relationships; 2. provide constituents with information that is accurate, complete, objective, relevant, timely and understandable; 3. comply with rules and regulations of federal, state and local governments, and other appropriate private and public regulatory agencies; 4. act in good faith, responsibly, with due care, competence and diligence, without misrepresenting material facts or allowing my independent judgment to be subordinated; 5. respect the confidentiality of information acquired in the course of my work except when authorized or otherwise legally obligated to disclose; 6. share knowledge and maintain skills important and relevant to my constituents' needs; 7. proactively promote ethical behavior as a responsible partner among peers in my work environment; and 8. responsibly use and control all assets and resources employed or entrusted to me. 66 EX-21 10 ex21.txt EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT Parent Coastal Financial Corporation Subsidiary Percentage State of - ---------- ---------- -------- Owned Incorporation ----- ------------- Coastal Federal Bank 100% United States Coastal Investor Services, Inc. 100% South Carolina Coastal Financial Capital Trust I (1) 100% Delaware Coastal Planners Holding Corporation (1) 100% Delaware Coastal Retirement Estate and Tax 100% South Carolina Planners, Inc. (4) Coastal Federal Holding Corporation (1) 100% Delaware Coastal Real Estate Investment 100% North Carolina Corporation (3) Coastal Mortgage Bankers and 100% South Carolina Realty Co., Inc. (1) Shady Forest Development 100% South Carolina Corporation (2) Sherwood Development 100% South Carolina Corporation (2) Ridge Development Corporation (2) 100% South Carolina 501 Development Corporation (2) 100% South Carolina North Beach Investment, Inc. (2) 100% South Carolina - -------------------------------------------------------------------------------- (1) First tier subsidiaries of Coastal Federal. (2) Second tier subsidiaries of Coastal Federal and first tier subsidiaries of Coastal Mortgage. (3) First tier operating subsidiary of Coastal Federal Holding Corporation, consolidated with Coastal Federal for Regulatory Reporting. (4) First tier operating subsidiary of Coastal Planners Holding Corporation. 67 EX-23 11 ex23.txt EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS The Board of Directors Coastal Financial Corporation: We consent to incorporation by reference in the registration statements (No. 333-49741, 333-01274 and 333-54794) on Form S-8 of Coastal Financial Corporation of our report dated October 29, 2003, relating to the consolidated statements of financial condition of Coastal Financial Corporation and subsidiaries as of September 30, 2003 and 2002, and the related consolidated statements of operations, stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended September 30, 2003, which report is incorporated by reference in the September 30, 2003 Annual Report on Form 10-K of Coastal Financial Corporation. KPMG LLP Greenville, South Carolina December 19, 2003 69 EX-31 12 ex31a.txt EXHIBIT 31 (a) Rule 13a-14(a)/15d-14(a)Certification (Chief Executive Officer) I, Michael C. Gerald, certify that: 1. I have reviewed this annual report on Form 10-K of Coastal Financial Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of b) 59 internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and c) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: December 19, 2003 /s/ Michael C. Gerald ----------------------------------- Michael C. Gerald President/Chief Executive Officer 60 EX-31 13 ex31b.txt EXHIBIT 31 (b) Rule 13a-14(a)/15d-14(a)Certification (Chief Financial Officer) I, Jerry L. Rexroad, certify that: 1. I have reviewed this annual report on Form 10-K of Coastal Financial Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): 61 a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: December 19, 2003 /s/ Jerry L. Rexroad ------------------------------ Jerry L. Rexroad Executive Vice President/Chief Financial Officer 62 EX-32 14 ex32a.txt EXHIBIT 32(a) SECTION 1350 Certification (Chief Executive Officer) In connection with the Annual Report of Coastal Financial Corporation, Inc. (the "Company") on Form 10-K for the period ending September 30, 2003 as filed with the Securities and Exchange Commission (the "Report"), I Michael C. Gerald, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the Report. This Certification is provided as of December 19, 2003. /s/ Michael C. Gerald ------------------------ Michael C. Gerald President/Chief Executive Officer 63 EX-32 15 ex32b.txt EXHIBIT 32(b) SECTION 1350 Certification (Chief Financial Officer) In connection with the Annual Report of Coastal Financial Corporation, Inc. (the "Company") on Form 10-K for the period ending September 30, 2003 as filed with the Securities and Exchange Commission (the "Report"), I Jerry L. Rexroad, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the Report. This Certification is provided as of December 19, 2003. /s/ Jerry L. Rexroad ------------------------------ Jerry L. Rexroad Executive Vice President and Chief Financial Officer 64 -----END PRIVACY-ENHANCED MESSAGE-----