EX-13 2 exhibit13.txt COASTAL FINANCIAL CORPORATION 2004 ANNUAL REPORT A QUEST FOR EXCELLENCE Dedication Exceptional Progress Toward Transforming A Very Good Organization Into An Exceptional Organization All of us at Coastal Financial Corporation would probably agree that the best word we could use to describe our 2004 performance is WOW! Thanks to the most incredible group of Associates imaginable, we made significant progress this year in beginning our quest for Transforming A Very Good Organization Into An Exceptional Organization. The journey began by refocusing on our QUEST FOR EXCELLENCE Business Model and developed into a renewed understanding of and commitment to the Mission Statement, Business Purpose, Principles and Values which are the essence of that Guiding Vision. In fact, the progress we made during this past year has dramatically reshaped our approach to the execution of our Business Model. Going into this transformational year, we understood clearly that it would be much more difficult to Transform A Very Good Organization Into An Exceptional Organization than it had been to transform an Average Organization Into A Very Good Organization. And, during the course of this year, we learned that progress in such an ambitious endeavor could only be accomplished by creating a much more in-depth understanding of our Business Purpose and Mission Statement throughout our organization. The progress which resulted has lead us to significantly alter our paradigms about our business and create totally new strategies which have simplified our approach and enabled a much more aligned and consistent execution of our Business Model. These new strategies, which will define and differentiate our organization in the future, are reflected in two tactical initiatives which were created during 2004. They are The Experience of FANtastic! Customer Service and Totally Free Checking With A Gift! Through the continued implementation of these strategies over the next several months, we will begin to significantly change the rules which have generally applied to banking throughout our market areas by making it an Experience which is more convenient than ever before, fun, memorable and even exhilarating for our Customers. Over the fourteen years since becoming a publicly owned company, we have viewed change and constant improvement, such as these powerful new strategies, as essential to the accomplishment 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. And 2004 was certainly a testimony to that philosophy. Thanks to our exceptional Associates and their ever-increasing understanding of and commitment to our QUEST FOR EXCELLENCE Business Model and Vision 2005 Plan, we made very good progress toward The Transformation Of Our Very Good Organization Into An Exceptional Organization and produced outstanding results for our Shareholders. Going forward, we remain absolutely convinced that this approach will help to ensure that our best days are yet to come. Share Price Performance [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] $10.00 $10.00 $27.20 $68.31 $85.56 $85.92 $134.94 $217.16 $215.52 $177.72 $113.80 $217.36 $299.07 $374.19 $467.90 ------------------------------------------------------------------------------------------------------------------------------------ Initial Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Sept. Public 30, 30, 30, 30, 30, 30, 30, 30, 30, 30, 30, 30, 30, 30, Offering 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 October 4, 1990
The market price of Coastal Financial Corporation's common stock increased 25.0% from $11.56 at September 30, 2003 compared to $14.45 at September 30, 2004, and has grown at a compound annual rate of over 31% since 1990 as indicated in the above graph. 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, ----------------------------------------------------------------- 2000 2001 2002 2003 2004 --------- --------- --------- ----------- ----------- (Dollars in thousands, except per share data) Financial Condition Data: Total assets .................................................. $ 768,838 $ 763,214 $ 950,796 $ 1,181,209 $ 1,305,485 Loans receivable, net ......................................... 511,701 488,754 536,851 682,737 790,730 Mortgage-backed securities .................................... 189,239 190,553 331,808 383,324 374,283 Cash, interest-bearing deposits and investment securities ..... 25,715 36,320 27,816 37,484 60,941 Deposits ...................................................... 406,217 530,364 637,081 697,012 753,379 Borrowings .................................................... 303,151 160,808 228,622 392,797 451,144 Stockholders' equity .......................................... 46,945 57,248 66,386 73,707 85,348 Operating Data: Interest income ............................................... $ 58,079 $ 60,255 $ 53,873 $ 59,214 $ 65,805 Interest expense .............................................. 33,636 33,323 21,846 22,998 23,524 --------- --------- --------- ----------- ----------- Net interest income ........................................... 24,443 26,932 32,027 36,216 42,281 Provision for loan losses ..................................... 978 955 1,235 2,655 1,750 --------- --------- --------- ----------- ----------- Net interest income after provision for loan losses ........... 23,465 25,977 30,792 33,561 40,531 --------- --------- --------- ----------- ----------- Other Income: Fees and service charges on loan and deposit accounts ......... 2,126 2,634 3,148 3,489 3,771 Gain on sales of loans held for sale .......................... 631 1,295 1,462 2,985 1,523 Gain (loss) on sales of investment securities, net ............ (17) (56) 102 -- (100) Gain (loss) on sales of mortgage-backed securities, net ....... (1,554) 727 238 469 (997) Gain (loss) from real estate operations ....................... (64) (453) (137) (18) 3 Other income .................................................. 4,759 3,755 3,326 3,983 4,971 --------- --------- --------- ----------- ----------- Total other income ............................................ 5,881 7,902 8,139 10,908 9,171 Total general and administrative expense ...................... 16,191 19,292 22,824 27,156 27,269 --------- --------- --------- ----------- ----------- Income before income taxes .................................... 13,155 14,587 16,107 17,313 22,433 Income taxes .................................................. 4,698 5,287 5,901 6,141 7,627 --------- --------- --------- ----------- ----------- Net income .................................................... $ 8,457 $ 9,300 $ 10,206 $ 11,172 $ 14,806 ========= ========= ========= =========== =========== Net income per common diluted share ........................... $ .52 $ .58 $ .64 $ .69 $ .89 ========= ========= ========= =========== =========== Cash dividends per common share ............................... $ .12 $ .13 $ .14 $ .17 $ .18 ========= ========= ========= =========== =========== Weighted average shares outstanding diluted ................... 16,421 16,098 16,017 16,264 16,625 ========= ========= ========= =========== ===========
All share and per share data have been restated as applicable 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 10% stock dividends declared on May 27, 2003, August 28, 2003, February 18, 2004 and July 30, 2004. 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, -------------------------------------------------- 2000 2001 2002 2003 2004 ------ ------- ------- ------- ------- Other Data: Return on assets (net income divided by average assets) .................... 1.13% 1.20% 1.23% 1.04% 1.18% Return on average equity (net income divided by average equity) ............ 19.52% 17.75% 16.92% 15.84% 18.77% Average equity to average assets ........................................... 5.80% 6.59% 7.29% 6.59% 6.31% Book value per share ....................................................... $ 2.93 $ 3.64 $ 4.28 $ 4.71 $ 5.37 Dividend payout ratio ...................................................... 22.61% 21.58% 21.77% 23.20% 19.91% Interest rate spread (difference between average yield on interest- earning assets and average cost of interest-bearing liabilities) ......... 3.50% 3.64% 4.14% 3.65% 3.64% Net interest margin (net interest income as a percentage of average interest-earning assets) ................................................. 3.57% 3.77% 4.24% 3.67% 3.64% Allowance for loan losses to total net loans at end of period .............. 1.35% 1.42% 1.42% 1.40% 1.39% Ratio of non-performing assets to total assets (1) ......................... 0.73% 0.74% 0.48% 0.77% 0.51% Tangible capital ratio ..................................................... 6.56% 7.28% 6.57% 7.14% 7.44% Core capital ratio ......................................................... 6.56% 7.28% 6.57% 7.14% 7.44% Risk-based capital ratio ................................................... 12.45% 13.30% 12.74% 13.17% 13.55%
(1) Nonperforming assets consist of nonaccrual loans 90 days or more past due and real estate acquired through foreclosure. 3 Dear Friends 2004 really was a very good year! In addition to achieving record levels in Core Deposits, Core Earnings and Share Price, we witnessed an encouraging demonstration of the tremendous personal growth and development of many of our key Leaders in undertaking significant roles of responsibility as we began the most important transformation we have undertaken since our conversion to public ownership in 1990. In the 2003 Annual Report, we reviewed and discussed our level of readiness to undertake the ambitious challenge of Transforming Coastal Financial Corporation From A Very Good Organization Into An Exceptional Organization and concluded that, while it would indeed be challenging, it could only be accomplished by working toward developing an even deeper understanding of and focus on our QUEST FOR EXCELLENCE Business Model. Accordingly, during this past year, in addition to celebrating our first fifty years of operation, we spent considerable time examining our strengths, weaknesses and opportunities, and in planning and organizing our efforts in preparation for that journey. Through that discovery-based process, we learned two very important things this year. First, we further confirmed our belief that we are an organization comprised of truly exceptional Associates who possess a strong sense of appreciation for the Principles, Values and direction in which our organization is moving. And, second, as Alexander Graham Bell learned long ago that "the sun's rays do not burn until brought to a focus," we learned this year through our discovery initiatives that we must simplify and bring into crystal clear focus those very few critical things which each of us must do on a daily basis in order to achieve 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. In addition to undertaking the discovery, planning and organizational initiatives in support of this transformational journey, our ever-increasing focus on and commitment to our QUEST FOR EXCELLENCE Business Model and Vision 2005 Plan continued to guide our operations during 2004 and has produced another year of exceptional financial results and some notable accomplishments: o Coastal Financial Corporation's net income for 2004 totaled $14.8 million, compared to $11.2 million in 2003. On a fully diluted basis, these results equated to a 29.0% increase, from $0.69 per share in 2003 to $0.89 per share in 2004. Major contributors to this growth in net income were continued strong Core Deposit and loan growth and effective expense control. o Deposits increased by approximately $56.4 million, or 8.1% to $753.4 million. Over the past three years, our average rate of deposit growth has been 14% per year. o Net loans receivable grew by 15.8%, primarily reflecting our continued strong focus on our Business Banking operations. o Coastal Investor Services, our Investment Services Division, had another banner year with assets under management through Raymond James Services, increasing by 23.0% to $261.4 million. Total revenues from this area of our operations continued to increase, resulting in Raymond James Financial Services ranking Coastal Investor Services Branch #4, out of over 260 Financial Institution Division offices. o Our branch distribution system continued to expand to serve more of the Communities of coastal North and South Carolina. Since October of 1998, Coastal Federal has added 9 new branches to our rapidly growing network - 50 percent of our existing branches. During 2004, we completed construction of new branch facilities in Shallotte, North Carolina and Loris, South Carolina and are currently nearing completion of our newest branch office which is located on 17th Street in the heart of the growing Wilmington, North Carolina marketplace. o In support of our primary focus on the significant growth of Checking Account based relationships, during 2004, our Finance Group developed and implemented a totally new financial management and reporting system. This new system, based upon simple, straightforward and enduring principles which are an outgrowth of the well-grounded philosophies of our QUEST FOR EXCELLENCE Business Model, will allow our organization to focus with much better clarity on key result areas in a more aligned and consistent manner. 4 Dear Friends 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 enhanced array and number of curriculum offerings designed to enable each of our Associates to achieve their full personal and professional potential, during 2004, the Dean of Coastal Federal University, together with our exceptional faculty and the members of the FANtastic! Customer Service Experience Team and the Totally Free Checking Team helped to facilitate our progress in a significant way. Through their work in developing, teaching and reinforcing the principles which we use to maintain a laser-like focus on what our Customers want and need, our new strategies have gained immediate traction throughout our organization. Another key achievement in support of our Transformation To An Exceptional Organization was evidenced by the significant expansion of our Leadership Development College. This initiative is crucial to our philosophy of promoting our own Associates into the Leadership positions which are created as a result of our growth. In addition to the excellent operating results and Transformational progress achieved this past year, the market price of Coastal Financial's common stock, at September 30, 2004, was 25.0% higher than the market price at September 30, 2003. Equally as impressive is the fact that, since 1990, our operating earnings have increased at a compound annualized rate in excess of 17%. 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 $229.7 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 $467,900 at September 30, 2004. One of the best indicators of performance is Return On Shareholders' Equity, and this measure for 2004 was, again, outstanding. Our Return On Average Shareholders' Equity of 18.8% ranks us among the top performing financial services companies in America. Our own sense of satisfaction with these financial results during 2004 was augmented with continued 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 5th consecutive year, was ranked the #1 Community Bank in the Carolinas by U.S. BANKER ------------ MAGAZINE, in its August 2004 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 $5 billion, based upon a 3-year average measure of Return On Average Equity. Coastal Financial Corporation was ranked 1st in the Carolinas and 30th nationally in this listing. o Coastal Federal Bank, for the seventh 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 2004. -------- 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 2004. o Coastal Investor Services/Raymond James 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 2004. -------- o The FDIC SUMMARY OF DEPOSITS REPORT ranked Coastal Federal Bank the -------------------------------- leader in deposit market share for Horry County for the twelve months ended June 30, 2004. Examples like these offer strong evidence of the caliber of our organization and the results which are possible through our ever-increasing focus on our QUEST FOR EXCELLENCE Business Model and our Vision 2005 Plan. 5 2004 Our Best Year Yet Considering the multitude of discovery-based, planning and organizational initiatives undertaken during 2004, our very good operating results continue to affirm what can be achieved through the aligned effort of an organization which is anchored to our never-changing Business Purpose, Mission Statement, Principles and Values. The consciously-held commitment our Associates have for following our QUEST FOR EXCELLENCE Business Model in executing the strategies established in our Vision 2005 Plan has enabled the financial performance during fiscal 2004 which, again met our high expectations and which will serve to further fuel our Transformation From A Very Good Organization To An Exceptional Organization. Noteworthy Financial Results for Fiscal 2004 DILUTED EARNINGS PER SHARE o Net income for 2004 totaled $14.8 million, compared to $11.2 million in 2003. On a fully diluted basis, these results equated to a 29.0% increase, from $0.69 per share in 2003 to $0.89 per share in 2004. [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] $0.52 $0.58 $0.64 $0.69 $0.89 -------------------------------------------------------------------------------- 2000 2001 2002 2003 2004 BOOK VALUE PER SHARE o Book value per share grew 14.0% to $5.37. o Shareholders' equity advanced 15.8% to $85.3 million. [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] $2.93 $3.64 $4.28 $4.71 $5.37 -------------------------------------------------------------------------------- 2000 2001 2002 2003 2004 6 2004 Our Best Year Yet ASSETS o Total assets increased 10.5%, from $1.2 billion to $1.3 billion. o Deposits derived from the residents and businesses of the Communities we serve increased 8.1%, from $697.0 million to $753.4 million, the highest level in the Company's history. o Loans receivable increased 15.8%, from $682.7 million to $790.7 million. [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] (IN MILLIONS) $769 $763 $951 $1,181 $1,305 -------------------------------------------------------------------------------- 2000 2001 2002 2003 2004 NON-PERFORMING ASSETS TO TOTAL ASSETS o Non-performing Assets to Total Assets decreased from 0.77% to 0.51%. [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] 0.73% 0.74% 0.48% 0.77% 0.51% -------------------------------------------------------------------------------- 2000 2001 2002 2003 2004 ALLOWANCE FOR LOAN LOSSES TO NET LOANS o Allowance for Loan Losses to Net Loans was 1.39%. o The Company had net loan charge-offs as a percentage of Average Loans of 0.07% in 2004. [THE FOLLOWING TABLE WAS REPRESENTED BY A BAR CHART IN THE PRINTED MATERIAL.] 1.35% 1.42% 1.42% 1.40% 1.39% -------------------------------------------------------------------------------- 2000 2001 2002 2003 2004 Our success in these key measures of performance is the result of the commitment, dedication and aligned effort of a truly outstanding group of Associates who share a passion for our QUEST FOR EXCELLENCE Business Model and Vision 2005 Plan. This continuing trend of exceptional performance has been rewarded in the financial markets by a 4,466% increase in the price of our shares since becoming a public company in October of 1990, vs. 267% for the Standard & Poors 500 Index over the same period. 7 2004 Our Best Year Yet The momentum we have achieved and sustained since our conversion to public ownership has resulted from the methodic focus of 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. Over the past fourteen years, our compounded Shareholder return of 31% has, indeed, been impressive. In evaluating our progress toward the attainment of Our Basic Corporate Objective since becoming publicly owned, 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 shown 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. 14 Year Peer Group Price Performance [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE CHART IN THE PRINTED MATERIAL.]
Coastal Financial Corporation (CFCP) BB&T Corporation (BBT) South Financial Group, Inc. (TSFG) Monthly prices Monthly prices Monthly prices DATE DATE DATE Oct-90 100 Oct-90 100.00 Oct-90 100.00 Oct-91 100 Oct-91 151.39 Oct-91 104.96 Oct-92 305.6051 Oct-92 191.67 Oct-92 149.62 Oct-93 792.2464 Oct-93 231.94 Oct-93 177.10 Oct-94 896.8847 Oct-94 229.17 Oct-94 180.15 Oct-95 874.4613 Oct-95 286.11 Oct-95 180.15 Oct-96 1471.45 Oct-96 384.72 Oct-96 213.74 Oct-97 2195.444 Oct-97 604.86 Oct-97 333.97 Oct-98 2366.66 Oct-98 794.44 Oct-98 352.10 Oct-99 1743.855 Oct-99 808.33 Oct-99 315.84 Oct-00 1510.613 Oct-00 708.33 Oct-00 155.53 Oct-01 2006.961 Oct-01 713.33 Oct-01 243.51 Oct-02 3088.126 Oct-02 805.56 Oct-02 330.53 Oct-03 4240.6 Oct-03 859.33 Oct-03 399.08 Oct-04 4565.561 Oct-04 882.00 Oct-04 430.53 Cooperative Bankshares, Inc. (COOP) First Financial Holdings, Inc. (FFCH) Bank of America Corporation (BAC) Monthly prices Monthly prices Monthly prices DATE DATE DATE Oct-90 100.00 Oct-90 100.00 Oct-90 100.00 Oct-91 100 Oct-91 148.48 Oct-91 216.67 Oct-92 293.7499 Oct-92 234.85 Oct-92 268.12 Oct-93 421.875 Oct-93 363.64 Oct-93 270.29 Oct-94 513.2813 Oct-94 363.64 Oct-94 286.96 Oct-95 618.75 Oct-95 448.48 Oct-95 381.16 Oct-96 527.3438 Oct-96 484.85 Oct-96 546.38 Oct-97 942.1875 Oct-97 936.36 Oct-97 693.48 Oct-98 731.25 Oct-98 933.33 Oct-98 666.67 Oct-99 590.625 Oct-99 906.06 Oct-99 747.10 Oct-00 541.4063 Oct-00 818.18 Oct-00 557.25 Oct-01 646.875 Oct-01 1204.36 Oct-01 683.94 Oct-02 787.5 Oct-02 1239.27 Oct-02 809.28 Oct-03 1316.25 Oct-03 1461.33 Oct-03 878.03 Oct-04 1355.625 Oct-04 1515.64 Oct-04 1004.75 Synovus Financial Corp. (SNV) Wachovia Corporation (WB) Monthly prices Monthly prices DATE DATE Oct-90 100.00 Oct-90 100.00 Oct-91 140.38 Oct-91 206.19 Oct-92 173.08 Oct-92 267.26 Oct-93 216.35 Oct-93 287.61 Oct-94 220.67 Oct-94 318.58 Oct-95 292.79 Oct-95 351.33 Oct-96 517.07 Oct-96 515.04 Oct-97 564.66 Oct-97 694.69 Oct-98 902.98 Oct-98 821.24 Oct-99 834.83 Oct-99 605.31 Oct-00 839.69 Oct-00 429.20 Oct-01 896.45 Oct-01 404.96 Oct-02 797.93 Oct-02 492.60 Oct-03 1074.81 Oct-03 649.49 Oct-04 1018.34 Oct-04 664.78
The financial results depicted above indicate that our business has continued to grow and prosper over the years. And our 2004 operating and share price performance clearly puts Coastal Financial among the top performing financial services companies in the nation. 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 Business Model and the goals established in our Vision 2005 Plan. CFCP Relative Price Performance [THE FOLLOWING TABLE WAS REPRESENTED BY A LINE CHART IN THE PRINTED MATERIAL.] Monthly prices Indexes
S&P 500 DOW JONES DOW JONES DATE INDEX (SPX) NASDAQ INDUSTRIAL DATE S&P 500 NASDAQ INDUSTRIAL CFCP ---- ----------- ------ ---------- ---- ------- ------ ---------- ---- Oct-90 304.0 329.8 2442.3 Oct-90 100 100 100 100 Oct-91 392.5 543.0 3069.1 Oct-91 129.0953947 164.6391753 125.6627892 100 Oct-92 418.7 605.2 3226.3 Oct-92 137.7236842 183.4960582 132.098447 305.7667387 Oct-93 467.8 779.3 3680.6 Oct-93 153.8914474 236.2825955 150.6999464 755.1197084 Oct-94 472.4 777.5 3908.1 Oct-94 155.3782895 235.7459066 160.0160502 854.8521944 Oct-95 581.5 1036.1 4755.5 Oct-95 191.2828947 314.1479685 194.7107885 875.1548445 Oct-96 705.3 1221.5 6029.4 Oct-96 231.9967105 370.3790176 246.8699971 1472.616518 Oct-97 914.6 1593.6 7442.1 Oct-97 300.8618421 483.2049727 304.7123034 2197.231944 Oct-98 1098.7 1771.4 8592.1 Oct-98 361.4046053 537.1103699 351.7993064 2368.641903 Oct-99 1362.9 2966.4 10729.9 Oct-99 448.3322368 899.4633111 439.3304754 1745.314976 Oct-00 1429.4 3369.6 10971.1 Oct-00 470.1973684 1021.719224 449.2062907 1511.879058 Oct-01 1059.8 1690.2 9075.1 Oct-01 348.6118421 512.4924196 371.5771415 2008.639201 Oct-02 885.76 1329.75 8397.03 Oct-02 291.3684211 403.1989084 343.8122612 3090.712408 Oct-03 1050.71 1932.21 9801.12 Oct-03 345.6283 585.8733 401.302 3656.133909 Oct-04 1114.58 1896.84 10080.27 Oct-04 366.6382 575.1486 412.7317 4565.561
8 A Look Back Oliver Wendell Holmes once said, "The great thing in this world is not so much where we are, but in what direction we are moving." The Dedication Page of our 2003 Annual Report began the discussion about Transforming Our Very Good Organization Into An Exceptional Organization. This was not just a caption chosen for the purpose of that presentation, but, rather, was intended as an outward expression of our Corporate Philosophy of viewing change and constant improvement as essential to the achievement of our long-term objectives. And during 2004, we began our quest for Transforming Coastal Financial Corporation From A Very Good Organization Into An Exceptional One in a powerful way. It started with internal survey results which confirmed that our Associates truly understood, owned and were energized by our QUEST FOR EXCELLENCE Business Model and which lead us to clarify our understanding of desired business results by creating a laser-like focus on those very few goals which could best enable the attainment of our most important objectives. Upon having fine-tuned our focus through this process, we next identified several organizations which we believed could aid us in developing the best practices necessary in creating the world-class Customer Service Experiences which would radically differentiate Coastal Financial from our competition. We then developed relationships with those organizations as we endeavored to benchmark and adopt certain of their best practices in restructuring our approach to the execution of our Business Model. Through the many projects which were undertaken in preparation for The Transformation Of Coastal Financial Corporation From A Very Good Organization Into An Exceptional Organization, two significant outcomes resulted. The first was The Experience of FANtastic! Customer Service. And the second was Totally Free Checking With A Gift. Both of these initiatives, which were introduced in the latter part of the fourth quarter of 2004, have been extremely well received by our Associates and our Customers. These approaches were intended from the outset to serve as the primary catalysts in Transforming our organization into an exciting retail environment by offering and promoting a truly exceptional Checking Account product with a gift and by ensuring that our Customers would look forward to enjoyable and memorable experiences on every visit. The Experience of FANtastic! Customer Service Totally Free Checking With A Gift 9 Looking Ahead The tremendous progress we made during 2004 toward The Transformation Of Coastal Financial From A Very Good Organization Into An Exceptional Organization has enabled us to begin our journey with a very good start. But, it is just that ... a starting point. From here, as envisioned in the first drafts of our Vision 2010 Plan, there is much to be done and many waypoints to pass in this journey which will never end, as we strive to fully develop our new Customer Service and Convenience strategies and continuously create and systemically improve upon our offerings of products and services. What must we do next? We must work diligently to sustain and enhance our focus on improving those attributes which will clearly set Coastal Federal Bank apart from our crowded marketplace by "inculturating" our organization with two primary goals. First, we must excel at marketing and selling Totally Free Checking With A Gift by mastering and then improving upon our skills to execute our sales processes exceptionally well. And, second, we must remain totally focused on providing every Customer, on every visit, on every transaction, The Experience of FANtastic! Customer Service by executing our Customer Service and Convenience strategies with precision and alignment. In so doing, we will continuously advance to the next waypoint in our never-ending journey toward Transforming Our Organization From A Very Good One Into An Exceptional Organization by building an exceptional retail model which can be replicated with a high degree of certainty in both contiguous and non-contiguous market areas. The progress and success we have enjoyed over the past fourteen years as a public company has well positioned us for this ambitious quest. 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 2004 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 2003 and 2004, both revenue and earnings reached record levels. In fact, in these two years alone, our net income has grown over 45%, and in the last five years, our net income has increased by more than 92%. Since becoming a publicly owned Company in 1990, we have roughly doubled our earnings every five years. While we are very pleased with our past achievements, in continuing the journey we began during 2004, we look forward to even greater accomplishments in the years ahead. With the advantages of our exceptional Associates, who believe in our Principles, Values and the direction in which we are moving, our great markets, our excellent new Checking Account products, our new Customer Service and Convenience strategies and our ever-increasing ability to work together, as a team, toward building even stronger relationships with our Customers and our Communities, we have great confidence that our quest for Transforming Our Very Good Organization Into An Exceptional Organization will continue to progress and that, as a result, we will be better enabled 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 [LOGO] [LOGO] CFU FEDERAL INVESTOR COASTAL COASTAL FEDERAL BANK SERVICES RETIREMENT o ESTATE o TAX UNIVERSITY The right bank for you. PLANNERS 10 Report of Independent Registered Public Accounting Firm 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, 2003 and 2004, 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, 2004. 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 the standards of the Public Company Accounting Oversight Board (United States). 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, 2003 and 2004, and the results of its operations and its cash flows for each of the years in the three-year period ended September 30, 2004, in conformity with U.S. generally accepted accounting principles. Greenville, South Carolina November 12, 2004 /s/ KPMG LLP 11 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Financial Condition September 30, 2003 and 2004
2003 2004 ----------- ---------- (Dollars in thousands) ASSETS Cash and amounts due from banks ........................................ $ 18,605 28,401 Short-term interest-bearing deposits ................................... 2,970 1,251 Investment securities available for sale ............................... 15,909 23,449 Mortgage-backed securities available for sale .......................... 383,324 374,283 Investment securities held to maturity ................................. -- 7,840 Loans receivable (net of allowance for loan losses of $9,832 at September 30, 2003 and $11,077 at September 30, 2004) ............ 682,737 790,730 Loans receivable held for sale ......................................... 19,096 8,246 Real estate acquired through foreclosure, net .......................... 1,627 785 Office property and equipment, net ..................................... 16,088 18,844 Federal Home Loan Bank (FHLB) stock, at cost ........................... 13,991 16,900 Accrued interest receivable on loans ................................... 2,258 2,877 Accrued interest receivable on securities .............................. 2,074 2,473 Bank-owned life insurance .............................................. 16,165 21,627 Other assets ........................................................... 6,365 7,779 ----------- ---------- $ 1,181,209 1,305,485 =========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Deposits ............................................................. 697,012 753,379 Securities sold under agreements to repurchase ....................... 133,602 107,173 Advances from FHLB ................................................... 244,114 328,507 Junior subordinated debt ............................................. -- 15,464 Debt associated with trust preferred securities ...................... 15,000 -- Other borrowings ..................................................... 81 -- Drafts outstanding ................................................... 2,644 2,792 Advances by borrowers for property taxes and insurance ............... 1,795 1,750 Accrued interest payable ............................................. 1,263 1,502 Other liabilities .................................................... 11,991 9,570 ----------- ---------- Total liabilities ................................................ 1,107,502 1,220,137 ----------- ---------- Stockholders' equity: Serial preferred stock, 1,000,000 shares authorized and unissued ..... -- -- Common stock $.01 par value, 25,000,000 shares authorized; 15,634,771 shares at September 30, 2003 and 15,897,076 shares at September 30, 2004 issued and outstanding .......... 156 159 Additional paid-in capital ........................................... 10,208 10,640 Retained earnings, restricted ........................................ 63,030 73,533 Treasury stock, at cost (334,508 shares at September 30, 2003 and 108,557 shares at September 30, 2004) ................... (3,375) (1,182) Accumulated other comprehensive income, net of tax ................... 3,688 2,198 ----------- ---------- Total stockholders' equity ....................................... 73,707 85,348 ----------- ---------- $ 1,181,209 1,305,485 =========== ==========
See accompanying notes to consolidated financial statements. 12 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations Years ended September 30, 2002, 2003 and 2004
2002 2003 2004 ------------ ------------ ------------ (In thousands, except share data) Interest: Loans receivable ................................................ $ 40,261 41,958 46,765 Investment securities ........................................... 2,030 1,840 2,886 Mortgage-backed securities ...................................... 11,348 15,279 16,067 Other ........................................................... 234 137 87 ------------ ------------ ------------ Total interest income ............................................. 53,873 59,214 65,805 ------------ ------------ ------------ Interest expense: Deposits ........................................................ 13,750 11,999 10,024 Securities sold under agreements to repurchase .................. 414 1,718 2,114 Advances from FHLB .............................................. 7,682 9,068 10,724 Other borrowings ................................................ -- 213 662 ------------ ------------ ------------ Total interest expense ....................................... 21,846 22,998 23,524 ------------ ------------ ------------ Net interest income .......................................... 32,027 36,216 42,281 Provision for loan losses ......................................... 1,235 2,655 1,750 ------------ ------------ ------------ Net interest income after provision for loan losses .......... 30,792 33,561 40,531 ------------ ------------ ------------ Other income: Fees and service charges on loan and deposit accounts ........... 3,148 3,489 3,771 Gain on sales of loans held for sale ............................ 1,462 2,985 1,523 Gain (loss) on sales of investment securities, net .............. 102 -- (100) Gain (loss) on sales of mortgage-backed securities, net ......... 238 469 (997) Gain (loss) from real estate acquired through foreclosure ....... (137) (18) 3 Income from sales of non-depository products .................... 1,281 1,176 1,909 Federal Home Loan Bank stock dividends .......................... 463 453 499 Other income .................................................... 1,582 2,354 2,563 ------------ ------------ ------------ Total other income ........................................... 8,139 10,908 9,171 ------------ ------------ ------------ General and administrative expenses: Salaries and employee benefits .................................. 12,514 13,452 16,099 Net occupancy, furniture and fixtures and data processing expense ....................................... 5,044 5,917 6,176 FDIC insurance premium .......................................... 93 104 104 FHLB prepayment penalties ....................................... 1,083 2,824 77 Other expense ................................................... 4,090 4,859 4,813 ------------ ------------ ------------ Total general and administrative expense ...................... 22,824 27,156 27,269 ------------ ------------ ------------ Income before income taxes .................................... 16,107 17,313 22,433 Income taxes ...................................................... 5,901 6,141 7,627 ------------ ------------ ------------ Net income ........................................................ $ 10,206 11,172 14,806 ============ ============ ============ Net income per common share Basic ........................................................... $ 0.66 0.72 0.94 ============ ============ ============ Diluted ......................................................... $ 0.64 0.69 0.89 ============ ============ ============ Average common shares outstanding Basic ........................................................... 15,541,000 15,552,000 15,752,000 ============ ============ ============ Diluted ......................................................... 16,017,000 16,264,000 16,625,000 ============ ============ ============
See accompanying notes to consolidated financial statements. 13 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity and Comprehensive Income Years ended September 30, 2002, 2003 and 2004
Accumulated Additional Other Total Common Paid-in Retained Treasury Comprehensive Stockholders' Stock Capital Earnings Stock Income Equity ------- ---------- -------- -------- -------- -------- (In thousands) Balance at September 30, 2001 .......................... $ 156 9,695 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 .......................... 155 9,895 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 .......................... 156 10,208 63,030 (3,375) 3,688 73,707 Exercise of stock options .............................. 3 432 (1,355) 2,193 -- 1,273 Cash dividends ......................................... -- -- (2,948) -- -- (2,948) Net income ............................................. -- -- 14,806 -- -- 14,806 Other comprehensive income, net of tax: Unrealized losses arising during period, net of taxes of $1,330 ............................... -- -- -- -- (2,170) -- Less: reclassification adjustment for losses included in net income, net of tax benefit of $417 ............ -- -- -- -- 680 -- ------- -------- -------- -------- -------- -------- Other comprehensive loss ............................... -- -- -- -- (1,490) (1,490) ------- -------- -------- -------- -------- -------- Comprehensive income ................................... -- -- -- -- -- 13,316 ------- -------- -------- -------- -------- -------- Balance at September 30, 2004 .......................... $ 159 10,640 73,533 (1,182) 2,198 85,348 ======= ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements. 14 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended September 30, 2002, 2003 and 2004
2002 2003 2004 --------- --------- --------- (In thousands) Cash flows from operating activities: Net income ........................................................................ $ 10,206 11,172 14,806 Adjustments to reconcile net income to net cash used in operating activities: Depreciation ................................................................... 2,074 2,374 2,175 Provision for loan losses ...................................................... 1,235 2,655 1,750 (Gain) loss on sale of mortgage-backed securities available for sale ........... (238) (469) 997 (Gain) loss on sale of investment securities available or sale ................. (102) -- 100 Origination of loans receivable held for sale .................................. (100,309) (141,404) (63,448) Proceeds from sales of loans receivable held for sale .......................... 13,907 45,367 27,453 Loss on early extinguishment of debt ........................................... 1,083 2,824 77 Increase in: Cash value of life insurance ................................................. -- (665) (962) Other assets ................................................................. (2,006) (157) (2,290) Accrued interest receivable .................................................. (127) (81) (1,018) Increase (decrease) in: Accrued interest payable ..................................................... 289 (210) 239 Other liabilities ............................................................ 2,176 (65) (168) --------- --------- --------- Net cash used in operating activities ........................................ (71,812) (78,659) (20,289) --------- --------- --------- Cash flows from investing activities: Proceeds from sales of investment securities available for sale ................... -- -- 2,881 Proceeds from maturities of investment securities available for sale .............. 1,995 2,000 2,000 Purchases of investment securities available for sale ............................. (1,998) (16,141) (11,866) Purchases of investment securities held to maturity ............................... -- -- (7,840) Purchases of loans receivable ..................................................... (233) -- -- Proceeds from sales of mortgage-backed securities available for sale .............. 128,169 135,413 171,324 Purchases of mortgage-backed securities available for sale ........................ (254,494) (328,245) (234,672) Principal collected on mortgage-backed securities available for sale .............. 72,990 234,321 115,179 Origination of loans receivable, net .............................................. (317,899) (628,172) (513,858) Principal collected on loans receivable ........................................... 268,120 477,676 403,501 Purchase of bank-owned life insurance ............................................. -- (15,500) (4,500) Proceeds from sales of real estate acquired through foreclosure ................... 1,997 1,374 1,456 Proceeds from sale of office properties and equipment ............................. -- -- 58 Purchases of office properties and equipment ...................................... (2,637) (4,749) (4,989) Purchases of FHLB stock, net ...................................................... (2,935) (3,432) (2,909) --------- --------- --------- Net cash used in investing activities ........................................ (106,925) (145,455) (84,235) --------- --------- --------- Cash flows from financing activities: Increase in deposits .............................................................. 106,717 59,931 56,367 Increase (decrease) in securities sold under agreements to repurchase ............. 18,181 96,718 (26,429) Proceeds from FHLB advances ....................................................... 312,426 715,705 686,476 Repayment of FHLB advances ........................................................ (262,793) (661,260) (602,083) Repayments from other borrowings, net ............................................. -- (1,988) (81) Issuance of debt associated with trust preferred securities ....................... -- 15,000 -- Cash payments for debt issuance costs ............................................. -- (150) -- Prepayment penalties on early extinguishment of debt .............................. (1,083) (2,824) (77) Increase (decrease) in advance payments by borrowers for property taxes and insurance .......................................................... 136 409 (45) Increase (decrease) in drafts outstanding, net .................................... (60) 127 148 Repurchase of treasury stock, at cost ............................................. (2,286) (342) -- Cash dividends to stockholders and cash for fractional shares ..................... (2,222) (2,592) (2,948) Exercise of stock options ......................................................... 1,203 1,153 1,273 --------- --------- --------- Net cash provided by financing activities .................................... 170,219 219,887 112,601 --------- --------- --------- Net increase (decrease) in cash and cash equivalents ............................... (8,518) (4,227) 8,077 --------- --------- --------- Cash and cash equivalents at beginning of year ..................................... 34,320 25,802 21,575 --------- --------- --------- Cash and cash equivalents at end of year ........................................... $ 25,802 21,575 29,652 ========= ========= ========= Supplemental information: Interest paid ..................................................................... $ 21,557 23,208 23,285 ========= ========= ========= Income taxes paid ................................................................. $ 5,726 5,325 7,762 ========= ========= ========= Supplemental schedule of non-cash investing and financing transactions: Securitization of mortgage loans into mortgage-backed securities .................. $ 83,982 95,635 46,845 ========= ========= ========= Transfer of mortgage loans to real estate acquired through foreclosure ............ $ 680 1,955 614 ========= ========= ========= Increase in other assets and junior subordinated debt resulting from deconsolidation under FIN 46R ............................................... $ -- -- 464 ========= ========= =========
See accompanying notes to consolidated financial statements. 15 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 U.S. 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. Material estimates that are particularly susceptible to signigicant change relate to the determination of the allowance for loan losses and income tax assets or liabilities. To a lesser extent, significant estimates are also associated with the valuation of derivative instruments and valuation of mortgage servicing rights. (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 (which was deconsolidated at December 31, 2003 - See Note 11), Coastal Investor Services, Inc., Coastal Planners Holding Corporation (and Coastal Planners Holding Corporation's wholly-owned subsidiary, Coastal Retirement, Estate and Tax Planners, 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), 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.). Shady Forest Development Corporation, Ridge Development Corporation, 501 Development Corporation and North Beach Investments, Inc. were dissolved effective September 30, 2004. 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 accumulated other comprehensive income 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. Dividends and interest income are recognized when earned. 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. 16 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED (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, 2003 and 2004, the Company had approximately $19.1 million and $8.2 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 and deferred loan fees/costs. The Company recognizes interest income on loans using the simple interest method. 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 as part of the basis of loans 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. 17 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED (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, 2004, 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. The Company has identified two concentrations of credit risk that it is monitoring. One of these areas involves loans for the acquisition of land and loans for the development of land, which totaled $102.6 million at September 30, 2004 representing 120.2% of total equity and 13.0% of net loans receivable. Economic growth and low interest rate environments have created opportunities for land acquisition and development activities in the Company's market area. Adverse changes in such factors can also slow absorption of developing projects and moderate market values of land and developed lots. The other identified concentration of credit risk is permanent mortgage loans secured by condominiums, which totaled $65.6 million at September 30, 2004 representing 76.9% of total equity and 8.3% of net loans receivable. The market for condominium properties in the Company's market area has been very active during the year ended September 30, 2004, especially in new ocean front condominium properties, fueling an overall rise in market values for such properties. However, economic and social changes that affect tourism tend to influence activity in resort properties and can cause fluctuations in the market values for such condominium properties. Management continues to monitor these concentrations of credit risk at this time and has considered these concentrations in its evaluation of the allowance for loan losses. The Company experienced no loan losses in either of these identified risks during the years ending September 30, 2004 and 2003. (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. (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, primarily considering prepayments and interest rates. Impairment is measured on a disaggregated 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. 18 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED (m) Income Taxes Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the period that includes the statutory enactment date. A deferred tax asset valuation allowance is recorded when it is more likely than not that deferred tax assets will not be realized. (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. The Company enters into sales of securities under agreements to repurchase. Fixed-coupon, repurchase agreements are treated as financing, with the obligation to repurchase securities sold being reflected as a liability and the securities underlying the agreements remaining as assets. (p) Stock Based Compensation At September 30, 2004, the Company has one stock option plan which is described more fully in note 17. 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): 2002 2003 2004 -------- -------- -------- Net income As reported $ 10,206 $ 11,172 $ 14,806 Proforma 9,728 10,668 14,207 Basic earnings per share As reported $ 0.66 $ 0.72 $ 0.94 Proforma 0.63 0.69 0.90 Diluted earnings per share As reported $ 0.64 $ 0.69 $ 0.89 Proforma 0.61 0.66 0.85 The weighted average fair value per share of options granted in 2002, 2003 and 2004 amounted to $3.15, $4.53 and $7.24, 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 2002, 2003 and 2004, respectively: dividend yield of approximately 1.62%, 1.86% and 1.25%, expected volatility of approximately 51%, 47% and 40%, risk-free interest rate of 4.60%, 3.96% and 4.21%, 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. 19 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED (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 Activities 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). (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 $1.1 million of losses on the early extinguishment of debt to general and administrative expense, which were incurred in fiscal 2002 and were previously classified as extraordinary loss. (u) Reclassifications Certain amounts in the 2002 and 2003 consolidated financial statements have been reclassified to conform with the 2004 presentation. Such reclassifications did not change net income or equity as previously reported. (2) INVESTMENT SECURITIES The amortized cost and fair 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 ======== ======== ======== ========
20 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (2) INVESTMENT SECURITIES- CONTINUED The amortized cost and fair value of investment securities available for sale at September 30, 2004 are summarized as follows:
2004 ----------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- -------- (In thousands) U.S. Government and agency obligations: Due after five years $ 2,901 12 -- 2,913 State and municipal obligations: Due after five years ...................... 20,123 497 (84) 20,536 -------- -------- -------- -------- $ 23,024 509 (84) 23,449 ======== ======== ======== ========
The amortized cost of investment securities held to maturity are summarized as follows:
2004 ----------------------------------------------- Gross Gross Amortized Unrealized Unrealized Total Cost Gains Losses --------- ---------- ---------- -------- (In thousands) U.S. Government and agency obligations: Due after five years ..................... $ 7,840 -- -- 7,840 ======== ======== ======== ========
The Company had gross realized gains of $102,000 and no gross realized losses for the year ended September 30, 2002. For the year ended September 30, 2003, there were no gross realized gains or losses. For the year ended September 30, 2004, there were no gross realized gains and gross realized losses were $100,000. The unrealized losses on investment securities were attributable to increases in interest rates, rather than credit quality. The unrealized losses are comprised of four securities that have had continuous losses of less than 12 months and ten securities that have had continuous losses 12 months or longer. None of the individual investment securities had an unrealized loss which exceeded 5% of its amortized cost. (3) MORTGAGE-BACKED SECURITIES 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 ======== ======== ======== ========
Mortgage-backed securities available for sale at September 30, 2004 consisted of the following:
2004 ----------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- -------- (In thousands) Collateralized Mortgage Obligations ...... $ 51,644 82 (319) 51,407 FNMA ..................................... 162,371 3,090 (661) 164,800 GNMA ..................................... 42,205 799 (5) 42,999 FHLMC .................................... 114,947 923 (793) 115,077 -------- -------- -------- -------- $371,167 4,894 (1,778) 374,283 ======== ======== ======== ========
21 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (3) MORTGAGE-BACKED SECURITIES - CONTINUED The Company had gross realized gains of $462,000 and gross realized losses of $224,000 for the year ended September 30, 2002. For the year ended September 30, 2003, the Company had gross realized gains of $695,000 and gross realized losses of $226,000. For the year ended September 30, 2004, the Company had gross realized gains of $772,000 and gross realized losses of $1.8 million. Gross unrealized losses on mortgage-backed securities and the length of time the securities have been in a continuous unrealized loss position, at September 30, 2004, were as follows:
2004 --------------------------------------------------------------------- Less than 12 Months 12 Months or Longer Total --------------------- --------------------- --------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses -------- ---------- -------- ---------- -------- ---------- Collateralized Mortgage Obligations ... $ 29,362 (221) 2,113 (98) 31,475 (319) FNMA .................................. 21,027 (116) 22,117 (545) 43,144 (661) GNMA .................................. 6,456 (5) -- -- 6,456 (5) FHLMC ................................. 46,457 (226) 20,829 (567) 67,286 (793) -------- -------- -------- -------- -------- -------- $103,302 (568) 45,059 (1,210) 148,361 (1,778) ======== ======== ======== ======== ======== ========
The unrealized losses on mortgage-backed securities summarized above were attributable to increases in interest rates, rather than credit quality. The unrealized losses are comprised of 25 securities that have had continuous losses of less than 12 months and eight securities that have had continuous losses 12 months or longer. None of the individual mortgage-backed securities had an unrealized loss which exceeded 5% of its amortized cost. 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, 2004 was $348.2 million with a fair value of $350.5 million. (4) LOANS RECEIVABLE, NET Loans receivable, net at September 30 consisted of the following:
2003 2004 --------- --------- (In thousands) First mortgage loans: Single family to four family units ......... $ 290,395 329,287 Land and land development .................. 62,221 99,697 Residential lots ........................... 20,327 29,839 Other, primarily commercial real estate .... 179,283 182,924 Residential construction loans ............. 56,950 82,789 Commercial construction loans .............. 24,943 10,503 Consumer and commercial loans: Installment consumer loans ................. 16,581 18,024 Mobile home loans .......................... 4,607 4,618 Savings account loans ...................... 2,179 2,058 Equity lines of credit ..................... 26,640 30,906 Commercial and other loans ................. 24,457 32,101 --------- --------- 708,583 822,746 Less: Allowance for loan losses .................. 9,832 11,077 Deferred loan cost, net .................... (556) (674) Undisbursed portion of loans in process .... 16,570 21,613 --------- --------- $ 682,737 790,730 ========= =========
The changes in the allowance for loan losses for the years ended September 30 consisted of the following: 22 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (4) LOANS RECEIVABLE, NET - CONTINUED 2002 2003 2004 -------- -------- -------- (In thousands) Beginning allowance ............. $ 7,159 7,883 9,832 Provision for loan losses ....... 1,235 2,655 1,750 Loan recoveries ................. 66 136 249 Loan charge-offs ................ (577) (842) (754) -------- -------- -------- $ 7,883 9,832 11,077 ======== ======== ======== Non-accrual loans which were over ninety days delinquent totaled approximately $7.4 million and $5.9 million at September 30, 2003 and 2004, respectively. In fiscal years 2002, 2003 and 2004, interest income which would have been recorded would have been approximately $301,000, $623,000 and $277,000, respectively, had non-accruing loans been current in accordance with their original terms. There were $4.9 million in impaired loans at September 30, 2003. At September 30, 2004, impaired loans totaled $3.3 million. Included in the allowance for loan losses at September 30, 2003 was $263,000 related to impaired loans compared to $359,000 at September 30, 2004. The average recorded investment in impaired loans for the year ended September 30, 2003 was $4.0 million compared to $3.9 million for the year ended September 30, 2004. Interest income recognized on impaired loans in fiscal 2003 was $134,000. Interest income recognized on impaired loans in fiscal 2004 was $607,000. This increase is primarily due to a commercial loan that was placed in non-accrual status in a prior fiscal year. The loan paid off in the fourth fiscal quarter of 2004. As a result, the Company recognized approximately $330,000 of interest which had been previously reserved. 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. Standby letters of credit obligate the Company to meet certain financial obligations of its Customers, if, under the contractual terms of the agreement, the Customers are unable to do so. Payment is only guaranteed under these letters of credit upon the borrower's failure to perform its obligations to the beneficiary. The Company can seek recovery of the amounts paid from the borrower and the letters of credit are generally collateralized. Commitments under standby letters of credit are usually one year or less. At September 30, 2004, the Company has recorded no liability for the current carrying amount of the obligation to perform as a guarantor, as such amounts are not considered material. The maximum potential amount of undiscounted future payments related to standby letters of credit at September 30, 2004 was $5.5 million. Unfunded loan commitments and letters of credit at September 30, 2004 were approximately $117.4 million and included the following (in thousands): Loan Commitments: Residential housing and land .............................. $ 40,033 Home equity loans and consumer lines of credit ............ 45,391 Commercial lines of credit ................................ 12,347 Standby letters of credit ................................. 5,502 Unused business and personal credit card lines ............ 14,171 23 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (4) LOANS RECEIVABLE, NET - CONTINUED Loans serviced for the benefit of others amounted to approximately $192.1 million, $219.8 million and $250.5 million at September 30, 2002, 2003 and 2004, respectively. During fiscal 2004, the Company securitized $46.8 million of mortgage loans and concurrently sold these mortgage-backed securities to outside third parties and recognized a net gain on sale of $1.4 million, which included the recognition of a $637,000 mortgage servicing right asset. 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 the recognition of a $1.3 million mortgage servicing right asset. 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. 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, 2004, 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, 2004 (in thousands): Balance at September 30, 2003 ........................... $ 1,076 New loans ............................................... 435 Repayments .............................................. (523) -------- Balance at September 30, 2004 ........................... $ 988 ======== (5) MORTGAGE SERVICING RIGHTS Mortgage servicing rights, net of the valuation allowance are included in other assets and totaled $2.8 million and $3.0 million at September 30, 2003 and 2004, respectively. Amortization expense for MSRs totaled $505,000, $811,00 and $1.0 million for the years ended September 30, 2002, 2003 and 2004, respectively. The estimated amortization expense for MSRs held as of September 30, 2004, is $1.0 million, $888,000, $577,000, $492,000 and $333,000 for fiscal 2005, 2006, 2007, 2008 and 2009 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. At September 30, 2003 and 2004, the valuation allowance for MSRs totaled $461,000 and $299,000, respectively. In 2003, the Company recorded $461,000 for impairment losses and in 2004 recorded $162,000 for impairment recoveries. 2003 2004 -------- -------- (In thousands) Balance at beginning of year ............... $ 2,203 2,843 MSRs capitalized ........................... 1,912 1,020 MSRs amortized ............................. (811) (1,020) (Impairment) recovery ...................... (461) 162 -------- -------- Balance at end of year ..................... $ 2,843 3,005 ======== ======== 24 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (6) OFFICE PROPERTY AND EQUIPMENT, NET Office property and equipment, net at September 30 consisted of the following: 2003 2004 -------- -------- (In thousands) Land ......................................... $ 5,532 5,848 Building and improvements .................... 10,532 13,058 Furniture, fixtures and equipment ............ 15,864 18,055 -------- -------- 31,928 36,961 Less accumulated depreciation ................ (15,840) (18,117) -------- -------- $ 16,088 18,844 ======== ======== The Company leases office space and various equipment. Total rental expense for the years ended September 30, 2002, 2003 and 2004 was approximately $288,000, $259,000 and $285,000 respectively. Future minimum rental payments for operating leases having remaining noncancelable lease terms in excess of one year at September 30, 2004 are as follows (in thousands): 2005 .............................. $ 119 2006 .............................. 111 2007 .............................. 57 2008 .............................. 31 2009 .............................. 25 Thereafter .............................. 237 ------ $ 580 ====== (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 $16.9 million, carried at cost, at September 30, 2004. 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:
2003 2004 ---------------------- ---------------------- Weighted Weighted Amount Rate Amount Rate --------- --------- --------- --------- (Dollars in thousands) Transaction accounts: Noninterest bearing ................. $ 86,258 --% 122,357 --% NOW ................................. 98,171 0.54 110,802 0.46 Money market checking ............... 206,010 1.34 224,437 1.37 --------- --------- --------- --------- Total transaction accounts ...... 390,439 0.84 457,596 0.79 --------- --------- --------- --------- Statement savings accounts: Regular .............................. 44,919 0.79 54,147 0.79 Money market ......................... 1,317 1.00 1,058 1.00 --------- --------- --------- --------- Total statement savings accounts 46,236 0.80 55,205 0.80 --------- --------- --------- --------- Certificate accounts: 0.00-1.99% ........................... 87,396 69,014 2.00-3.99% ........................... 149,678 148,493 4.00-5.99% ........................... 19,569 22,470 6.00-7.99% ........................... 3,161 8 8.00-10.00% .......................... 533 593 --------- --------- --------- --------- Total certificate accounts ...... 260,337 2.67 240,578 2.49 --------- --------- --------- --------- $ 697,012 1.52% 753,379 1.33% ========= ========= ========= =========
25 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 $287.9 million and $364.2 million at September 30, 2003 and 2004, respectively. The amounts and scheduled maturities of certificate accounts at September 30, are as follows: 2003 2004 --------- --------- (In thousands) Within 1 year ................................ $ 198,723 208,130 After 1 but within 2 years ................... 50,596 23,512 After 2 but within 3 years ................... 7,461 4,960 Thereafter ................................... 3,557 3,976 --------- --------- $ 260,337 240,578 ========= ========= Interest expense on deposits for the years ended September 30 consisted of the following: 2002 2003 2004 -------- -------- -------- (In thousands) Transaction accounts ............... $ 4,524 3,925 3,331 Statement savings accounts ......... 459 427 405 Certificate accounts ............... 8,767 7,647 6,288 -------- -------- -------- $ 13,750 11,999 10,024 ======== ======== ======== (9) ADVANCES FROM FHLB Advances from the FHLB at September 30 consisted of the following: 2003 2004 -------------------- -------------------- Weighted Weighted Amount Rate Amount Rate -------- -------- -------- -------- Fiscal Year Maturity (Dollars in thousands) 2004 .................. $ 34,435 1.32% $ -- --% 2005 .................. 13,500 5.17 64,500 2.78 2006 .................. 5,686 2.81 4,177 2.79 2007 .................. 5,132 3.00 11,560 2.23 2008 .................. 4,633 3.28 3,977 3.18 2009 .................. 6,400 3.77 31,803 2.36 2010 or greater ....... 174,328 4.37 212,490 4.20 -------- -------- -------- -------- $244,114 3.89% $328,507 3.64% ======== ======== ======== ======== Stock in the FHLB of Atlanta and specific first mortgage loans and mortgage-backed securities of approximately $275.8 million and $357.3 million at September 30, 2003 and 2004, 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, 2004, the excess first mortgage loan collateral pledged to the FHLB will support additional borrowings of approximately $45.9 million. At September 30, 2004, included in the one, three, five and after five year maturities were $217.0 million with a weighted average rate of 3.91% of advances subject to call provisions. Callable advances at September 30, 2004 are summarized as follows: $56.0 million callable in fiscal 2004, with a weighted average rate of 5.33%; $36.0 million callable in fiscal 2005, with a weighted average rate of 5.36%; $28.0 million callable in fiscal 2006, with a weighted average rate of 2.29%; $35.0 million callable in fiscal 2007, with a weighted average rate of 3.00%; and $25.0 million callable in fiscal 2009, with a weighted average rate of 3.13%. Call provisions are more likely to be excercised by the FHLB when interest rates rise. If exercised, the Company may have to replace called advances with borrowings at a higher interest rate. 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 from FHLB and incurred gross penalties of approximately $2.8 million. During fiscal 2004, the Company prepaid approximately $4.6 million of advances and incurred gross penalties of approximately $77,000. 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, ---------------------------------- 2002 2003 2004 -------- -------- -------- (Dollars in thousands) Outstanding balance: Securities sold under agreements to repurchase: Customer ............................................... $ 4,070 $ 7,703 $ 12,931 Broker ................................................. 30,000 125,899 94,242 Weighted average rate (at month end) paid on: Securities sold under agreements to repurchase: Customer .............................................. 1.37% 0.81% 1.42% Broker ................................................ 1.84 1.64 1.74 Maximum amount of borrowings outstanding at any month end: Securities sold under agreements to repurchase: Customer .............................................. $ 5,625 $ 7,703 $ 12,931 Broker ................................................ 30,000 125,899 184,129 Approximate average outstanding with respect to: Securities sold under agreements to repurchase: Customer .............................................. $ 3,600 $ 4,812 $ 9,033 Broker ................................................ 15,007 92,476 134,809 Weighted average rate (year to date) paid on: Securities sold under agreements to repurchase: Customer .............................................. 1.58% 1.02% 1.01% Broker ................................................ 2.39 2.04 1.50
Securities sold under agreements to repurchase represent borrowings by the Company with maturities ranging from 1 to 12 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 $118.4 million at September 30, 2004 and are included in mortgage-backed securities available for sale in the consolidated balance sheet. (11) JUNIOR SUBORDINATED DEBT The Company determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity under accounting principles generally accepted in the United States of America. Voting interest entities are entities in which the total equity investment at risk is sufficient to enable each entity to finance itself independently and provides the equity holders with the obligation to absorb losses, the right to receive residual returns and the right to make decisions about the entity's activities. The Company consolidates voting interest entities in which it has all, or at least a majority of, the voting interest. As defined in applicable accounting standards, variable interest entities ("VIEs") are entities that lack one or more of the characteristics of a voting interest entity described above. A controlling financial interest in an entity is present when an enterprise has a variable interest or a combination of variable interests that will absorb a majority of the entity's expected losses, receive a majority of the entity's expected residual returns, or both. The enterprise with a controlling financial interest, known as the primary beneficiary, consolidates the VIE. Prior to January 1, 2004, the Company consolidated its wholly-owned subsidiary, Coastal Financial Capital Trust I ("Trust"). In December 2003, the Financial Accounting Standards Board issued a revised version of Interpretation No. 46 ("FIN 46") "Consolidation of Variable Interest Entities." The revised FIN 46 clarifies some of the provisions of the original interpretation and adds new scope exceptions. As a result of the changes, the Company deconsolidated the Trust, increasing other assets by $464,000, increasing junior subordinated debt-trust preferred securities by $15.5 million and reducing debt associated with trust preferred securities ("Capital Securities") by $15.0 million. 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. 27 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (11) JUNIOR SUBORDINATED DEBT - CONTINUED 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, 2004, the distribution rate on the Capital Securities was 4.64%. 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. 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) 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 ======== ======== ======== 2004: Federal .................... $ 7,070 126 7,196 State ...................... 433 (2) 431 -------- -------- -------- $ 7,503 124 7,627 ======== ======== ======== 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, 2003 and 2004 relate to the following:
2003 2004 -------- -------- (In thousands) Deferred tax assets: Allowance for loan losses ................................................ $ 3,605 4,031 Accrued medical reserves ................................................. 91 91 Other real estate reserves and deferred gains on other real estate ....... 102 56 Net operating loss carryforwards ......................................... 21 38 Other .................................................................... 282 170 -------- -------- Total deferred tax assets .................................................... 4,101 4,386 Less valuation allowance ..................................................... (21) (38) -------- -------- Net deferred tax assets ...................................................... 4,080 4,348 -------- -------- Deferred tax liabilities: Tax bad debt reserve in excess of base year amount ....................... 97 -- Property and equipment principally due to differences in depreciation .... 527 688 FHLB stock, due to stock dividends not recognized for tax purposes ....... 67 15 Deferred loan fees ....................................................... 537 719 Book over tax basis in investment in unconsolidated subsidiary ........... 4,009 4,009 Unrealized gain on securities available for sale ......................... 2,225 1,312 Mortgage servicing rights ................................................ 1,075 1,120 Other .................................................................... 196 384 -------- -------- Total deferred tax liabilities ............................................... 8,733 8,247 -------- -------- Net deferred tax liability ................................................... $ (4,653) (3,899) ======== ========
28 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (12) INCOME TAXES - CONTINUED The valuation allowance for deferred tax assets was $21,000 and $38,000 at September 30, 2003 and 2004, respectively. The net change in the total valuation allowance for the years ended September 30, 2003 and 2004 was zero and an increase of $17,000, 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, 2004. 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 (asset) 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 $913,000 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 $124,000. 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: 2002 2003 2004 -------- -------- -------- (In thousands) Computed federal income taxes ....... $ 5,476 5,886 7,627 State tax, net of federal benefit ... 335 454 284 Bank-owned life insurance ........... -- (226) (327) Other, net .......................... 90 27 43 -------- -------- -------- Total income tax expense ............ $ 5,901 6,141 7,627 ======== ======== ======== The Bank had 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 recaptured tax bad debt reserves in excess of pre-1988 based year amounts over a six-year period ending September 30, 2004. 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, 2004 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 $384,000, $340,000 and $671,000 for fiscal years 2002, 2003 and 2004, respectively. (14) REGULATORY MATTERS The Company is subject to various capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital 29 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (14) REGULATORY MATTERS - CONTINUED guidelines that involve quantitative measures of the assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk-weighting and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the following table) of total and tier 1 capital (as defined in the regulation) to risk-weighted assets (as defined) and to average assets (as defined). At September 30, 2004, the Company's loans-to-one borrower limit was approximately $16.0 million. Management believes, as of September 30, 2004, that the Company met all capital adequacy requirements and loans-to-one-borrower limits. As of September 30, 2004, 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, 2004, 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, 2004: Total Capital: .................. $106,851 13.55% $ 63,077 8.00% $ 78,847 10.00% (To Risk Weighted Assets) Tier 1 Capital: ................. $ 97,450 12.36% N/A N/A $ 47,308 6.00% (To Risk Weighted Assets) Tier 1 Capital: ................. $ 97,450 7.44% $ 39,278 3.00% $ 65,574 5.00% (To Adjusted Total Assets) Tangible Capital: ............... $ 97,450 7.44% $ 19,672 1.50% N/A N/A (To Adjusted Total Assets) 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)
(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. 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. 30 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (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 had antidulutive securities of approximately 294,000 options to purchase shares by Directors and Associates. The average exercise price for such shares was $13.93. The following is a summary of the reconciliation of average shares outstanding for the years ended September 30:
2002 2003 2004 ----------------------- ----------------------- ----------------------- Basic Diluted Basic Diluted Basic Diluted ---------- ---------- ---------- ---------- ---------- ---------- Weighted average shares outstanding 15,541,000 15,541,000 15,552,000 15,552,000 15,752,000 15,752,000 Effective of dilutive securities: Stock options -- 476,000 -- 712,000 -- 873,000 ---------- ---------- ---------- ---------- ---------- ---------- Average shares outstanding 15,541,000 16,017,000 15,552,000 16,264,000 15,752,000 16,625,000 ========== ========== ========== ========== ========== ==========
(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, 2004 amounted to approximately 710,000 shares. All outstanding options have been retroactively restated to reflect the effects of the common stock dividends. At September 30, 2004, 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 $2.69 .................... 13,846 0.8 Years $ 2.69 13,846 $ 2.69 1997 $4.39 - $4.55 ............ 126,946 2.2 Years $ 4.45 126,946 $ 4.45 1998 $6.40 - $9.76 ............ 282,081 3.2 Years $ 7.25 282,081 $ 7.25 1999 $6.49 - $7.68 ............ 223,050 4.1 Years $ 7.16 223,050 $ 7.16 2000 $4.32 - $5.62 ............ 205,638 5.2 Years $ 5.13 164,510 $ 5.13 2001 $4.15 - $6.49 ............ 227,795 6.1 Years $ 4.24 136,677 $ 4.24 2002 $6.22 - $10.21 ........... 230,589 7.1 Years $ 6.32 92,236 $ 6.32 2003 $8.26 - $11.57 ........... 296,971 8.2 Years $ 9.91 59,394 $ 9.91 2004 $12.71 - $14.50 .......... 296,672 9.2 Years $ 13.93 -- N/A --------- --------- ------- --------- ------- $2.69 - $14.50 ........... 1,903,588 6.0 Years $ 7.77 1,098,740 $ 6.22 ========= ========= ======= ========= =======
The following is a summary of the activity of the stock option plans for the years 2002, 2003, and 2004.
2002 2003 2004 ---------------------- ---------------------- ---------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ---------- -------- ---------- -------- ---------- -------- Outstanding, October 1 ....... 1,778,156 $ 5.35 1,807,003 $ 5.59 1,911,813 $ 6.31 Granted ...................... 268,334 6.31 316,699 9.83 298,391 13.93 Cancelled .................... (15,912) 5.83 (14,423) 7.55 (5,045) 9.11 Exercised .................... (223,575) 4.52 (197,466) 5.26 (301,571) 4.53 ---------- -------- ---------- -------- ---------- -------- Outstanding, September 30 .... 1,807,003 $ 5.59 1,911,813 $ 6.31 1,903,588 $ 7.77 ========== ======== ========== ======== ========== ========
(18) COMMON STOCK DIVIDENDS On May 27, 2003, August 28, 2003, February 18, 2004 and July 30, 2004, the Company declared a 10% stock dividend aggregating approximately 1,065,000, 1,174,000, 1,308,000 and 1,442,000 shares respectively. All share and per share data has been retroactively restated to give effect to the common stock dividends. 31 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (19) CASH DIVIDENDS On each of December 29, 2000 and March 21, 2001 the Company declared quarterly cash dividends of $0.03 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 $0.033 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 $0.037 per share. On each of June 24, 2003, September 24, 2003, December 15, 2003, March 17, 2004 and June 16, 2004, the Company declared quarterly cash dividends of $0.045 per share. On September 29, 2004 the Company declared a quarterly cash dividend of $0.05 per share. Under Delaware law, the Company is permitted to declare and pay dividends either out of its surplus or, if there is no surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. (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 ----------- ----------- ----------- ----------- 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 ......... $ .17 .17 .17 .18 =========== =========== =========== =========== Weighted average shares outstanding-diluted ... 16,254,000 16,181,000 16,197,000 16,428,000 =========== =========== =========== =========== First Second Third Fourth Quarter Quarter Quarter Quarter ----------- ----------- ----------- ----------- 2004: Total interest income ......................... $ 15,535 16,155 16,661 17,453 Total interest expense ........................ 5,725 5,848 5,892 6,059 ----------- ----------- ----------- ----------- Net interest income ........................... 9,810 10,307 10,769 11,394 Provision for loan losses ..................... 550 500 200 500 ----------- ----------- ----------- ----------- Net interest income after provision for loan losses ................................ 9,260 9,807 10,569 10,894 Other income .................................. 2,326 2,430 2,121 2,298 General and administrative expenses ........... 6,614 6,729 6,773 7,156 ----------- ----------- ----------- ----------- Income before income taxes .................... 4,972 5,508 5,917 6,036 Income taxes .................................. 1,653 1,831 2,018 2,125 ----------- ----------- ----------- ----------- Net income .................................... $ 3,319 3,677 3,899 3,911 =========== =========== =========== =========== Net income per common share - diluted ......... $ .20 .22 .23 .23 =========== =========== =========== =========== Weighted average shares outstanding-diluted ... 16,650,000 16,657,000 16,687,000 16,703,000 =========== =========== =========== ===========
32 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (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, 2003 and 2004
2003 2004 -------- -------- Assets Cash ..................................................... $ 773 86 Investment in subsidiaries ............................... 88,088 99,754 Deferred tax asset ....................................... 441 441 Other assets ............................................. 246 1,334 -------- -------- Total assets ................................... $ 89,548 101,615 ======== ======== Liabilities and Stockholders' Equity Accounts payable (principally dividends) ................. 760 803 Note payable ............................................. 81 -- Junior subordinated debt ................................. -- 15,464 Debt associated with trust preferred securities .......... 15,000 -- Total stockholders' equity ............................... 73,707 85,348 -------- -------- Total liabilities and stockholders' equity .... $ 89,548 101,615 ======== ========
Coastal Financial Corporation Condensed Statements of Operations Years ended September 30, 2002, 2003 and 2004
2002 2003 2004 -------- -------- -------- Income: Interest income ..................................... $ 1 1 2 Management fees ..................................... 300 300 242 Dividends from subsidiary ........................... 3,470 1,221 2,230 Equity in undistributed earnings of subsidiaries .... 6,751 10,087 13,063 -------- -------- -------- Total income ................................ 10,522 11,609 15,537 -------- -------- -------- Expenses: Professional fees ................................... 79 20 72 Supplies and printing ............................... 58 12 33 Interest expense .................................... 84 213 662 Other expenses ...................................... 96 277 213 Income tax benefit .................................. (1) (85) (249) -------- -------- -------- Total expenses .............................. 316 437 731 -------- -------- -------- Net income ............................................ $ 10,206 11,172 14,806 ======== ======== ========
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 Statement of Cash Flows Years ended September 30, 2002, 2003 and 2004
2002 2003 2004 -------- -------- -------- Operating activities: Net income ...................................................... $ 10,206 11,172 14,806 Adjustments to reconcile net income to net cash provided by: Equity in undistributed net income of subsidiary ............. (6,751) (10,087) (13,063) (Increase) decrease in other assets .......................... 548 (290) (624) Increase (decrease) in other liabilities ..................... (104) 134 43 -------- -------- -------- Total cash provided by operating activities ............... 3,899 929 1,162 -------- -------- -------- Financing activities: Cash dividends to shareholders .................................. (2,222) (2,592) (2,948) Treasury stock repurchases ...................................... (2,286) (342) -- Proceeds from stock options ..................................... 1,203 1,153 1,273 Proceeds from trust preferred ................................... -- 15,000 -- Repayment on line of credit ..................................... -- (1,988) (81) Capital contribution to subsidiary .............................. -- (12,125) (100) Other financing activities, net ................................. 3 -- 7 -------- -------- -------- Total cash used by financing activities ................. (3,302) (894) (1,849) -------- -------- -------- Net increase (decrease) in cash and cash equivalents ............ 597 35 (687) Cash and cash equivalents at beginning of the year .............. 141 738 773 -------- -------- -------- Cash and cash equivalents at end of the years ................... $ 738 773 86 ======== ======== ========
(23) Carrying Amounts and Fair Value of Financial Instruments The carrying amounts and fair value of financial instruments as of September 30, 2003 and 2004 are summarized below:
2003 2004 --------------------- --------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value -------- ---------- -------- ---------- (In thousands) Financial Assets Cash and cash equivalents ........................... $ 21,575 21,575 $ 29,652 29,652 Investment securities available for sale ............ 15,909 15,909 23,449 23,449 Mortgage-backed securities available for sale ....... 383,324 383,324 374,283 374,283 Investment securities held to maturity .............. -- -- 7,840 7,840 Loans receivable held for sale ...................... 19,096 19,556 8,246 8,325 Loans receivable, net ............................... 682,737 704,171 790,730 818,274 FHLB stock .......................................... 13,991 13,991 16,900 16,900 Financial Liabilities Deposits: Demand accounts .................................. 436,675 436,675 512,801 512,801 Certificate accounts ............................. 260,337 263,743 240,578 241,133 Advances from Federal Home Loan Bank ............... 244,114 252,271 328,507 333,612 Securities sold under agreements to repurchase and reverse repurchase agreements ................ 133,602 133,602 107,173 107,173 Junior subordinated debt ........................... -- -- 15,464 15,464 Debt associated with trust preferred securities .... 15,000 15,000 -- -- Other borrowings ................................... 81 81 -- --
34 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (23) CARRYING AMOUNTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED 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 (including reverse 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 and fixed rate 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. The Company had $117.4 million of off-balance sheet financial commitments as of September 30, 2004, 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 $6.7 million at September, 30 2004. The fair value of these commitments was an asset of approximately $44,000 at September 30, 2004, and is reflected in gain on sales of loans held for sale in the consolidated statements of operations. The forward sales commitments totaled $14.0 million at September 30, 2004. The fair value of these commitments was a liability of approximately $12,000 at September 30, 2004, and is reflected in gain on sales of loans held for sale in the consolidated statements of operations. 35 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements - Continued (23) CARRYING AMOUNTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED 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 entered into various contracts to purchase equipment and software products to improve productivity, Customer service and convenience. The total price of the equipment and software is approximately $1.8 million. The annual maintenance fees are expected to be approximately $160,000. As of September 30, 2004, the Company had paid approximately $550,000 toward the commitments. The Company expects to complete the purchases in the first and second quarters of fiscal 2005. 36 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's 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. All forward-looking statements are based on assumptions and involve risks and uncertainties, many of which are beyond our control and which may cause our actual results, performance or achievements to differ materially from the results, performance or achievements contemplated by the forward-looking statements. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as "believe," "expect," "anticipate," "intend," "plan," "estimate" or words of similar meaning, or future or conditional verbs such as "will," "would," "should," "could" or "may." Forward-looking statements speak only as of the date they are made. Such risks and uncertainties include, among other things: o Competitive pressures among depository and other financial institutions in our market areas may increase significantly. o Adverse changes in the economy or business conditions, either nationally or in our market areas, could increase credit-related losses and expenses and/or limit growth. o Increases in defaults by borrowers and other delinquencies could result in increases in our provision for losses on loans and related expenses. o Our inability to manage growth effectively, including the successful expansion of our Customer support, administrative infrastructure and internal management systems, could adversely affect our results of operations and prospects. o Fluctuations in interest rates and market prices could reduce our net interest margin and asset valuations and increase our expenses. o The consequences of continued bank acquisitions and mergers in our market areas, resulting in fewer but much larger and financially stronger competitors, could increase competition for financial services to our detriment. o Our continued growth will depend in part on our ability to enter new markets successfully and capitalize on other growth opportunities. o Changes in legislative or regulatory requirements applicable to us and our subsidiaries could increase costs, limit certain operations and adversely affect results of operations. o Changes in tax requirements, including tax rate changes, new tax laws and revised tax law interpretations may increase our tax expense or adversely affect our Customers' businesses. o Company initiatives now in place or introduced in the future, not producing results consistent with historic growth rates or results which justify their costs. In light of these risks, uncertainties and assumptions, you should not place undue reliance on any forward-looking statements in this report. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise. Overview Coastal Financial Corporation is a unitary thrift holding company incorporated in Delaware with one wholly-owned banking subsidiary, Coastal Federal Bank (the "Bank" or "Coastal Federal"). The Company also owns Coastal Planners Holding Corporation, whose subsidiary Coastal Retirement, Estate and Tax Planners, Inc., offers fee-based financial planning and tax preparation services. The Company's primary business activities are conducted by the Bank. The Company and Bank's principal executive offices are located in Myrtle Beach, South Carolina. Coastal Federal Bank is a full service financial services company with 18 branches located in four counties throughout the coastal regions of South Carolina and North Carolina. The Bank has twelve offices in Horry County, South Carolina; one office in Georgetown County, South Carolina; three offices in Brunswick County, North Carolina; and two offices in New Hanover County, North Carolina. The Bank's primary market areas are located along the coastal regions of South Carolina and North Carolina and 37 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued predominately center around the Metro regions of Myrtle Beach, South Carolina and Wilmington, North Carolina, and their surrounding counties. Coastal Federal's primary market is Horry County, South Carolina where the Bank has the number one market share of deposits as of June 30, 2004 with 16.4% of deposits as reported by the FDIC Summary of Deposits Report. The Bank also has the third highest market share of deposits as of June 30, 2004 in Brunswick County, North Carolina with 8.9% of deposits as reported by the FDIC Summary of Deposits Report. The primary business activities in Horry County are centered around the tourism industry. To the extent that Horry County businesses rely heavily on tourism business, decreased tourism would have a significant adverse effect on Coastal Federal's primary deposit base and lending area. Moreover, the Bank would likely experience a higher degree of loan delinquencies should the local economy be materially and adversely affected. Coastal Federal's principal business consists of attracting core deposits from Customers in its primary market locations and using these funds to meet the lending needs of its Customers as well as providing numerous financial products and services to meet its Customer's needs. Through its branch locations, the Bank provides a wide range of banking products, including interest-bearing and non-interest bearing checking accounts; business sweep accounts; business cash management services; statement savings accounts; money market accounts; certificates of deposit accounts; individual retirement accounts; merchant services; commercial, business, personal, real estate, residential mortgage and home equity loans; safe deposit boxes; and electronic banking services. The Bank has six ATMs at off-site locations and an ATM at each branch. The Bank also makes available a wide range of financial products through Raymond James Financial Services, including stocks, bonds, mutual funds, annuities, insurance, and retirement products. In the fourth fiscal quarter of 2004, the Company began two new initiatives. The first was The Experience of FANtastic! Customer Service. This initiative focuses on Customer service and convenience. The Company intends to redesign its infrastructure and purchase software and products to improve Customer convenience and Associate productivity (See Note 24). In addition, in the second fiscal quarter of 2005, in order to improve Customer convenience the Company will introduce an expanded hours Call Center that will employ 20 to 25 Associates and extend the Bank's operating hours. The Company anticipates hiring another 15 to 20 Associates to service Customers during these additional banking hours. As a result, the Company anticipates increased salary and benefit expenses begining in the first fiscal quarter of 2005 and thereafter associated with the hiring, training and placement of these new Associates. The second initiative was Totally Free Checking With a Gift. The Company has incurred, and will continue to incur, significant marketing costs associated with this campaign. In the fourth fiscal quarter of 2004, marketing expenses were $270,000 compared to $140,000 in the comparable 2003 period. The Bank expects to realize significant benefits from this strategy consisting of more Bank lobby traffic, increased number of personal checking accounts and higher fee income as a result of those checking accounts. In the first week of the campaign, which began on September 27, 2004, approximately 400 accounts had been opened. This rate of growth could necessitate the hiring of additional Associates to open and service these accounts. The Associates being hired for these two initiatives are expected to have total compensation averaging between $28,000 and $35,000 per Associate. Critical Accounting Policies The Company's significant accounting policies are set forth in Note 1 of the Notes to Consolidated Financial Statements. Of these policies, the Company considers the allowance for loan losses and the income taxes to be the most critical accounting policies, because they require many of management's most subjective and complex judgments. For additional discussion concerning the Company's allowance for loan losses and related matters, see "Allowance for Loan Losses" and see "Income Taxes" for additional discussion concerning income taxes. General The Company reported $14.8 million in net income for the year ended September 30, 2004, compared to $11.2 million for the year ended September 30, 2003. Net interest income increased $6.1 million as a result of increased interest income of $6.6 million offset by an increase of $526,000 in interest expense. Provision for loan losses decreased from $2.7 million for the year ended September 30, 2003, to $1.8 million for the year ended September 30, 2004. Other income decreased from $10.9 million in fiscal 2003, to $9.2 million in 2004. General and administrative expenses increased $113,000 for fiscal 2004 as compared to fiscal 2003. 38 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued Total assets increased from $1.2 billion at September 30, 2003 to $1.3 billion at September 30, 2004, or 10.5%. Liquid assets, consisting of cash, interest-bearing deposits, and securities, increased from $420.8 million at September 30, 2003, to $435.2 million at September 30, 2004. Loans receivable increased 15.8% from $682.7 million at September 30, 2003, to $790.7 million at September 30, 2004. Total loan originations for fiscal 2004 were $577.3 million as compared to $769.6 million for fiscal 2003. The growth in liquid assets was funded by increased deposits of $56.4 million and increased advances from the Federal Home Loan Bank ("FHLB") of Atlanta of $84.4 million. As a result of increased Branches and a strong emphasis on growing local deposits during fiscal 2004, deposits increased 8.1% from $697.0 million at September 30, 2003, to $753.4 million at September 30, 2004. During this same period, noninterest bearing checking accounts and NOW accounts increased $48.7 million, money market checking accounts increased $18.4 million, statement savings accounts increased $9.0 million and certificate accounts decreased $19.8 million. As a result of $14.8 million in net earnings, proceeds from the exercise of stock options of approximately $1.3 million, less the cash dividends paid to shareholders of approximately $2.9 million, and the net change in unrealized gain (loss) on securities available for sale, net of income tax of $1.5 million, stockholders' equity increased from $73.7 million at September 30, 2003 to $85.3 million at September 30, 2004. 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, 2004.
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 ............................ $ 240,578 $ 208,130 $ 28,472 $ 3,281 $ 695 Short-term borrowings .................... 171,673 171,673 -- -- -- Long-term debt ........................... 279,471 -- 15,737 35,780 227,954 Operating leases ......................... 580 119 168 56 237 --------- --------- --------- --------- --------- Total contractual cash obligations ..... $ 692,302 $ 379,922 $ 44,377 $ 39,117 $ 228,886 ========= ========= ========= ========= =========
The Company has entered into various contracts to purchase equipment and software products to improve productivity and Customer services. The total price of the equipment and software is approximately $1.8 million. The annual maintenance fees are expected to be approximately $160,000. As of September 30, 2004, the Company had paid approximately $550,000 toward the commitments. The Company expects to complete the purchases in the first and second quarters of fiscal 2005. 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 $418.2 million, $769.6 million and $577.3 million for the years ended September 30, 2002, 2003 and 2004, respectively. A large portion of these loan originations were financed through loan principal repayments which amounted to $268.1 million, $477.7 million and $403.5 million for the years ended September 30, 2002, 2003 and 2004, 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, 2002, 2003 and 2004, the Company sold loans amounting to $13.9 million, $45.4 million and $27.5 million, respectively. During fiscal 2004, the Company securitized $46.8 million of mortgage loans, concurrently sold these mortgage-backed securities to outside third parties and recognized a net gain on sale of $1.4 million, which included $637,000 related to mortgage servicing rights. The gain is included in gains on sales of loans held for sale in the consolidated statement of operations. The proceeds from sale are included in proceeds from sales of mortgage-backed securities 39 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued 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 2004 deposits increased from $697.0 million at September 30, 2003, to $753.4 million at September 30, 2004. During fiscal 2003 and 2004, the Company has placed significant emphasis on growth in checking accounts. As a result, Core Deposits (defined as transaction and statement savings accounts) increased $76.1 million or 17.4%. This was accompanied by a $19.8 million decrease in certificate accounts. During fiscal 2004, the Company prepaid approximately $4.6 million of advances from FHLB and incurred gross penalties of approximately $77,000 which were included in general and administrative expenses in the statement of operations. As a result of the prepayment of FHLB advances and the repayment of other short-term advances, the weighted average rate on FHLB advances decreased to 3.64% at September 30, 2004, compared to 3.89% at September 30, 2003. At September 30, 2004, the Company had commitments to originate $40.0 million in loans and $77.4 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, 2004, the Company had $208.1 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, 2004, the Company had excess collateral pledged to the FHLB which would support additional FHLB advance borrowings of $45.9 million. Additionally, at September 30, 2004, the Company had repurchase agreement lines of credit and available collateral consisting of investment securities and mortgage-backed securities of $68.4 million as well as federal funds lines available of $20.0 million. As a condition of deposit insurance, current OTS 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 $97.5 million at September 30, 2004, exceeding the Bank's tangible and core requirements by $77.8 million and $58.2 million, respectively. At September 30, 2004, the Bank's capital exceeded its current risk-based minimum capital requirement by $43.8 million. The risk-based capital requirement may increase in the future. Also see Note 14 of the Notes to Consolidated Financial Statements. Results of Operations Comparison of the Years Ended September 30, 2003 and 2004 Interest Income Despite a reduction in the average yield, the Company's growth in average interest earning assets of 17.6% resulted in an increase in interest income for the year ended September 30, 2004, of $6.6 million to $65.8 million, or 11.1% as compared to $59.2 million for the year ended September 30, 2003. The earning asset yield for the year ended September 30, 2004, was 5.67% compared to 6.00% for the year ended September 30, 2003. As a result of significant declining interest rates over much of the previous two years, the Bank's yield on assets and cost of funds has declined. Interest rates have very recently begun to increase. At September 30, 2002, 2003 and 2004, the one-year treasury rate of interest was approximately 1.68%, 1.22% and 2.14%, respectively. At September 30, 2002, 2003 and 2004, the prime rate of interest was approximately 4.75%, 4.00% and 4.75%, respectively. On July 1, 2004, the prime rate was increased to 4.25% and on September 22, 2004, the prime rate was increased to 4.75%. The average yield on loans receivable for the year ended September 30, 2004, was 6.17% compared to 6.66% for year ended September 30, 2003. The yield on investments decreased to 4.73% for the year ended September 30, 2004, from 4.88% for the year ended September 30, 2003. The yield on investments has declined due to payoff of higher yielding mortgage-backed securities (MBS) resulting from significant prepayments during fiscal 2003. These higher yielding MBS were replaced with lower yielding MBS. Total average interest-earning assets were $1.2 billion for the year ended September 30, 2004 as compared to $987.5 million for the year ended September 30, 2003. The increase in average interest-earning assets is primarily due to an increase in average loans receivable of approximately $127.8 million and investment securities of approximately $50.1 million. Interest Expense Interest expense on interest-bearing liabilities was $23.5 million for the year ended September 30, 2004, as compared to $23.0 million for the year ended September 30, 2003. The average cost of deposits for the year ended September 30, 2004, was 1.39% compared to 1.79% for the year ended September 30, 2003. The cost of interest-bearing 40 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued liabilities was 2.03% for the year ended September 30, 2004, as compared to 2.34% for the year ended September 30, 2003. The cost of FHLB advances, other borrowings and reverse repurchase agreements was 3.81%, 4.41% and 1.50%, respectively, for the year ended September 30, 2004. For the year ended September 30, 2003, the cost of FHLB advances, other borrowings and reverse repurchase agreements was 4.27%, 5.62% and 1.81%, respectively. Total average interest-bearing liabilities increased from $982.7 million at September 30, 2003 to $1.2 billion at September 30, 2004. The increase in average interest-bearing liabilities is due to an increase in average deposits of approximately $50.0 million. This was accompanied by an increase in average reverse repurchase agreements of $42.3 million, average FHLB advances of $68.9 million and average outstanding debt associated with trust preferred securities of $11.2 million. Net Interest Income Net interest income was $42.3 million for the year ended September 30, 2004, as compared to $36.2 million for the year ended September 30, 2003. With the reduction in interest rates over the last two years, the Bank continued to experience a decrease in its net interest margin through December 31, 2003. However, as rates stabilized over spring 2004, the Bank's net interest margin declined at a much slower pace and actually increased slightly in the most recent two quarters. The net interest margin for the quarters ended March 31, 2003, June 30, 2003, September 30, 2003, December 31, 2003, March 31, 2004, June 30, 2004 and September 30, 2004 was 3.87%, 3.61%, 3.65%, 3.48%, 3.58%, 3.63% and 3.81% respectively. For the year ended September 30, 2004, the net interest margin was 3.64%. Throughout the latter part of fiscal 2004, intermediate interest rates have increased. From September 30, 2003 to September 30, 2004, the two year treasury increased 116 basis points and the five year treasury increased 56 basis points. Management believes that over time this increase in intermediate term interest rates should slow the refinancing of loans at lower rates. Based upon the most recent information available, management believes that its net interest margin should remain stable and could increase slightly if short-term rates rise commensurately with long-term rates. Projection of the impact of interest rates on the Bank's net interest margin is often imprecise due to the fact that short-term and long-term interest rates often move very differently. Provision for Loan Losses The Company's provision for loan losses decreased from $2.7 million for fiscal 2003 to $1.8 million for fiscal 2004 due to the nature and the risk profile of the loans delinquent 90 days or more at September 30, 2004 as compared to September 30, 2003. The allowance for loan losses as a percentage of loans was 1.39% at September 30, 2004 compared to 1.40% at September 30, 2003. Loans delinquent 90 days or more were $5.9 million or 0.73% of total loans at September 30, 2004, compared to $7.4 million or 1.06% at September 30, 2003. The allowance for loan losses was 189% of loans delinquent more than 90 days at September 30, 2004, compared to 132% at September 30, 2003. Net charge-offs for the year ended September 30, 2004 were $505,000 compared to $706,000 for the year ended September 30, 2003. Net charge-offs were lower in 2004 due to increased loss recoveries of $249,000 in 2004 versus $136,000 in 2003. Management believes that the current level of the allowance for loan losses is adequate considering the composition of the loan portfolio, the portfolio's loss experience, delinquency trends, current regional and local economic conditions and other factors. Also see "Nonperforming Assets" and "Allowance for Loan Losses." Other Income In fiscal 2004, total other income decreased from $10.9 million for the period ended September 30, 2003, to $9.2 million for the period ended September 30, 2004. As a result of increased transaction account balances of $390.4 million at September 30, 2003 compared to $457.6 million at September 30, 2004, fees and service charges on loan and deposit accounts were $3.8 million for fiscal 2004, compared to $3.5 million for fiscal 2003. As a result of rising interest rates which decreased refinancing activity, gain on sale of loans was $1.5 million for the year ended September 30, 2004, compared to $3.0 million for the year ended September 30, 2003. Loss on sales of securities, net was $1.1 million for fiscal 2004, compared to gains of $469,000 for fiscal 2003. Other income increased from $2.4 million for the year ended September 30, 2003, to $2.6 million for the year ended September 30, 2004. This increase is primarily due to increased income of $298,000 on bank-owned life insurance when comparing the two periods. Other Expense General and administrative expenses were $27.3 million for fiscal 2004 as compared to $27.2 million for fiscal 2003. Salaries and employee benefits increased to $16.1 million for fiscal 2004 as compared to $13.5 million for fiscal 2003, or 19.7%. This is primarily due to the addition of new branches, additional business banking Associates 41 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued and increased expense related to commission from the sale of non-depository products. The Company employed 354 Associates at September 30, 2004 compared to 303 Associates at September 30, 2003. Also as a result of new branches, net occupancy, furniture and fixtures and data processing expense increased $259,000 for fiscal 2004, as compared to fiscal 2003. Prepayment penalties on FHLB advances were $77,000 for fiscal 2004, compared to $2.8 million for fiscal 2003. Other expenses decreased slightly from $4.9 million in fiscal 2003 to $4.8 million in fiscal 2004. Other expenses included $162,000 of mortgage servicing rights impairment recovery for fiscal 2004 compared to $461,000 of mortgage servicing rights impairment for fiscal 2003. Income Taxes Income taxes increased from $6.1 million in fiscal 2003 to $7.6 million in fiscal 2004 as a result of increased earnings before income taxes. The effective income tax rate as a percentage of pretax income was 34.0% in fiscal 2004 and 35.5% in fiscal 2003. 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 2001 and subsequent years are exposed to examination by taxing authorities. Results of Operations Comparison of the Years Ended September 30, 2002 and 2003 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 42 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued 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 reduced the discount rate, core deposits did not reprice at the same ratio as the Company's interest-earning assets. 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 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. 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, 43 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued 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. Non-performing Assets Non-performing assets were $6.6 million at September 30, 2004 compared to $9.1 million at September 30, 2003. Loans past due 90 days or more decreased from $7.4 million at September 30, 2003, to $5.9 million at September 30, 2004. Real estate acquired through foreclosure decreased from $1.6 million at September 30, 2003, to $785,000 at September 30, 2004. At September 30, 2003, impaired loans totaled $4.9 million. There were $3.3 million in impaired loans at September 30, 2004. Included in the allowance for loan losses at September 30, 2003 was $263,000 related to impaired loans compared to $359,000 at September 30, 2004. The average recorded investment in impaired loans for the year ended September 30, 2003 was $4.0 million compared to $3.9 million for the year ended September 30, 2004. Interest income recognized on impaired loans in fiscal 2003 was $134,000. Interest income recognized on impaired loans in fiscal 2004 was $607,000. This increase is primarily due to a commercial loan that was placed in non-accrual status in a prior fiscal year. The loan paid off in the fourth fiscal quarter of 2004. As a result, the Company recognized approximately $330,000 of interest which had been previously reserved. 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. 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 44 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued 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, 2002, 2003 and 2004, of $1.2 million, $2.7 million and $1.8 million, respectively. For the years ended September 30, 2002, 2003 and 2004, the Company had net charge-offs of $511,000, $706,000 and $505,000, respectively. Net charge-offs as a percentage of average outstanding loans were .10%, .11%, and .07% for fiscal years ended 2002, 2003 and 2004, respectively. At September 30, 2004, the Company had an allowance for loan losses of $11.1 million, which was 1.39% 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. 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 $40.0 million. For retail Customers, loan commitments are generally lines of credit secured by residential property. At September 30, 2004 retail loan commitments totaled $45.4 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 $5.5 million at September 30, 2004. Commercial lines of credit and unused business and personal credit card lines, which totaled $26.5 million at September 30, 2004, 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. At September 30, 2004, the fair value of derivative assets and liabilities totaled $44,000 and $12,000 respectively. The related notional amounts, which are not recorded on the consolidated balance sheet, totaled $6.7 million for the derivative assets and $14.0 million for the derivative liabilities. (See Note 23). 45 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued 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, 2004.
Board Limit Board Limit Market Value Market Value Minimum NPV Maximum Of Assets Portfolio Equity NPV Change in Interest Rates Ratio Decline in NPV 9/30/04 9/30/04 Ratio ------------------------ ----------- -------------- ------------ ---------------- ------- 300 basis point rise 5.00% 400 BPS $ 1,305,536 $ 124,568 9.54% 200 basis point rise 6.00% 300 BPS $ 1,329,250 $ 137,913 10.38% 100 basis point rise 6.00% 250 BPS $ 1,352,181 $ 148,722 11.00% No Change 6.00% $ 1,371,829 $ 157,947 11.51% 100 basis point decline 6.00% 250 BPS $ 1,383,497 $ 159,851 11.55% 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, 2004, in the event of a sudden and sustained increase in prevailing market interest rates, the Bank's NPV would be expected to decrease, and that in the event of a sudden decrease in prevailing market interest rates, the Bank's NPV would be expected to increase minimally. Values for the 200 and 300 basis point decline are not indicated due to the level of interest rates at September 30, 2004. At September 30, 2004, the Bank's estimated changes in NPV were within the limits established by the Board of Directors. Computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the ALCO could undertake in response to sudden changes in interest rates. 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 Effective January 1, 2004, the Company adopted FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities," 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 credit of the primary beneficiary. In accordance with these rules, the Company deconsolidated Coastal Financial Capital Trust I at January 1, 2004, which had been 46 COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis - Continued formed to raise capital by issuing preferred securities to an institutional investor. The deconsolidation of this wholly-owned subsidiary, increased other assets by $464,000, increased junior subordinated debt-trust preferred securities by $15.5 million, and reduced debt associated with trust preferred securities by $15.0 million. The full and unconditional guarantee by the Company for the preferred securities remains in effect. FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, was issued in May 2003. The Statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. The Statement also includes required disclosures for financial instruments within its scope. For the Company, the Statement was effective for instruments entered into or modified after May 31, 2003 and otherwise will be effective as of January 1, 2004, except for mandatorily redeemable financial instruments. For certain mandatorily redeemable financial instruments, the Statement will be effective for the Company on January 1, 2005. The effective date has been deferred indefinitely for certain other types of mandatorily redeemable financial instruments. The Company currently does not have any financial instruments that are within the scope of this Statement. On March 9, 2004, the Securities and Exchange Commission staff issued Staff Accounting Bulletin No. 105, "Application of Accounting Principles to Loan Commitments" ("SAB 105"). SAB 105 provides recognition guidance for entities that issue loan commitments that are required to be accounted for as derivative instruments. SAB 105 indicates that the expected future cash flows related to the associated servicing of the loan and any other internally-developed intangible assets should not be considered when recognizing a loan commitment at inception or through its life. SAB 105 also discusses disclosure requirements for loan commitments and is effective for loan commitments accounted for as derivatives and entered into subsequent to March 31, 2004. The Company currently does not include the associated servicing of the loan when recognizing loan commitments at inception and throughout its life. The Company adopted SAB 105 on April 1, 2004 with no material impact. In March 2004, the Financial Accounting Standards Board ("FASB") issued EITF No. 03-1 ("EITF 03-1"), "The Meaning of Other-Than-Temporary Impairment and Its Application of Certain Investments," which provided guidance for evaluating whether an investment is other-than-temporarily impaired and its application to investments classified as either available for sale or held to maturity under FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and investments accounted for under the cost or equity method of accounting. In September 2004, the FASB issued FASB Staff Position ("FSP") EITF No. 03-1-1, a delay of the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF 03-1 until the FASB issues final guidance, expected in the first quarter of 2005. Paragraphs 10 through 20 of EITF 03-1 provide guidance on when impairment of debt and equity securities is considered other-than-temporary. This guidance generally states impairment is considered other-than-temporary unless the holder of the security has both the intent and ability to hold the security until the fair value recovers and evidence supporting the recovery outweighs evidence to the contrary. We are currently evaluating the impact of the initial adoption of this guidance on the financial condition or results of operations of the Company. The Company adopted the guidance of EITF 03-1, excluding paragraphs 10-20 effective as of September 30, 2004. As a result of this adoption, the Company provides additional disclosures, which are found in Notes 2 and 3 of this report. The initial adoption of this issue, which excludes paragraphs 10-20 did not have a material impact on the financial condition or results of operations of the Company. 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. 47 Board of Directors
Coastal Financial Corporation Coastal Federal Bank Coastal Planners Holding Corporation E. Lawton Benton E. Lawton Benton James T. Clemmons President President Chairman C.L. Benton & Sons, Inc. C.L. Benton & Sons, Inc. Coastal Financial Corporation James C. Benton James C. Benton Michael C. Gerald Retired President Retired President President and Chief Executive Officer C.L. Benton & Sons, Inc. C.L. Benton & Sons, Inc. Coastal Financial Corporation G. David Bishop G. David Bishop Jerry L. Rexroad, CPA Managing Director Managing Director Chief Financial Officer White Harvest Trading Co., LLC White Harvest Trading Co., LLC Coastal Planners Holding Corporation J. Robert Calliham J. Robert Calliham President and Chief Executive Officer President and Chief Executive Officer Smith, Sapp, Bookhout, Crumpler & Smith, Sapp, Bookhout, Crumpler & Calliham, P.A. Calliham, P.A. James T. Clemmons James T. Clemmons Chairman Chairman Coastal Financial Corporation Coastal Federal Bank 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.
48 COASTAL FINANCIAL CORPORATION
Leadership Group Sherri J. Adams Anne R. Caldwell Joel P. Foster Branch Manager Assistant Vice President Senior Vice President N. Myrtle Beach Deposit Servicing Leader Area Banking Leader Myrtle Beach Community Ginger Allen Daniel R. Cameron, Jr. Assistant Vice President Assistant Vice President Andrew D. Gable Senior Underwriter Commercial Banking Officer Assistant Vice President Wilmington Residential Brokerage Anthony Ambuhl Assistant Vice President Tamra T. Cannon William A. Gehman, III, CPA Commercial Banking Assistant Vice President Senior Vice President Officer Senior Branch Manager Corporate Controller Conway Phillip G. Ammons Mary L. Geist Vice President Shonda C. Chestnut Vice President Community Banking Assistant Vice President Data Services Leader Leader Senior Banking Leader Pawleys Island & Murrells Surfside Michael C. Gerald Inlet President and Chief Executive Susan J. Cooke Officer Donna P. Bailey Senior Vice President Assistant Vice President Corporate Secretary Jimmy R. Graham Delivery Systems Resource Administrative Services Executive Vice President Administrator Leader Chief Information Officer James R. Baker, MCSE Patricia A. Coveno Don C. Hamilton Assistant Vice President Vice President Vice President Systems Engineer Retail Banking Resource Residential Banking Leader Leader Harry G. Bates, IV E. Haden Hamilton, Jr. Assistant Vice President Jerry J. Cox, Jr. President Commercial Banking Vice President Coastal Investor Services Officer Community Banking Leader Oak Street Loris Community Kathy D. Hane Assistant Vice President Jeffrey A. Benjamin John L. Creamer Senior Branch Manager Senior Vice President Vice President Pawleys Island Credit Administration Coastal Investor Services Leader Lauren E. Henson C. Renee Cummins Vice President Rick R. Bowen Branch Manager Dean of Coastal Federal Facilities Maintenance Socastee University Leader Deborah S. Dillard J. Michael Hill Steven Brockmann Branch Manager Vice President Assistant Vice President Sunset Beach Coastal Investor Services Coastal Investor Services Robert D. Douglas Debra Hinson Cynthia L. Buffington Executive Vice President Assistant Vice President Assistant Vice President Human Resources Leader Operations Leader Item Processing Leader Coastal Investor Services Trina S. Dusenbury Nancy G. Bundy Vice President Glenn D. Humbert Branch Manager Residential Loan Vice President Surfside Administration Leader Community Banking Leader Sunset Beach Community Ronnie L. Burbank Michael L. Evans Vice President Vice President Lisa B. James Senior Banking Leader Loan Review Leader Senior Vice President Wilmington CBD Operations Leader Rita E. Fecteau Glenn T. Butler, MCSE, Vice President Stephanie L. Karnap CCNA Accounting Leader Branch Manager Vice President Waccamaw Network Services Leader J. Daniel Fogle Vice President Ruth S. Kearns Senior Banking Leader Senior Vice President Carolina Forest / Community Relations Officer Waccamaw / Conway
49 COASTAL FINANCIAL CORPORATION
Leadership Group - Continued L. Eric Keys Abigail E. Mishoe Joseph Shumbo Vice President Assistant Vice President Assistant Vice President Community Banking Leader Residential Banking Officer Residential Banking Leader South Horry Community Lynn T. Murray J. Marcus Smith, Jr. Linwood E. Koonce, Jr. Senior Vice President Senior Vice President Banking Closing Leader Checking Account Product Internal Audit Leader Development & Management John L. Kosicki Officer Phillip G. Stalvey Senior Vice President Executive Vice President Residential Banking Leader Deborah J. Myers Banking Leader Assistant Vice President James Louis LaBruce Electronic Banking Leader H. Delan Stevens Vice President Vice President Senior Banking Leader Ronald A. Nolan Community Banking Leader Assistant Vice President West Community Scott W. Lander Security Officer Senior Vice President S. Annette Stroud Area Leader Deborah A. Orobello Branch Manager North Carolina Region Branch Manager Carolina Forest Little River William H. Langfitt Sandra J. Szarek Assistant Vice President Charles S. Page Assistant Vice President Branch Manager Vice President Commercial Loan Servicing Dunes Senior Banking Leader Leader Carolina Forest Justin M. Lee Andrea M. Taiani Assistant Vice President Orit Perez Customer Contact Center Senior Banking Leader Assistant Vice President Leader Socastee Senior Branch Manager Oak Street and 38th Avenue Sarah B. Thomas Pauline M. Lewis Bi-Lo Assistant Vice President Branch Manager Business Banking Loan Shallotte Ellen S. Poisson Administrator Branch Manager Edward L. Loehr, Jr. Wilmington - Oleander Terry B. Thornton Vice President Vice President Budgeting and Treasury Derick R. Powers Senior Branch Manager Senior Banking Leader Wilmington Mary M. Lundy Southport Branch Manager Matthew J. Towns Southport Jerry L. Rexroad, CPA Vice President Executive Vice President Credit Administration Kathleen M. Lutes Chief Financial Officer Assistant Vice President Douglas W. Walters Senior Underwriter David L. Roe Vice President Senior Vice President Residential Banking Leader Richard M. Marsh Small Business Banking Leader North Myrtle Beach Branch Manager Loris Eulette W. Sauls Theresa M. Whitley Assistant Vice President Closing and Construction Michael C. Mauney Information Management Leader Leader Assistant Vice President Collections Leader Sherry G. Schoolfield Sandra R. Zanfini Assistant Vice President Assistant Vice President Amy E. McLaurin Compliance Officer Assistant Corporate Secretary Assistant Vice President Corporate Support Leader Senior Banking Leader Douglas E. Shaffer Sunset Beach Senior Vice President Area Leader Janice B. Metz North and West Communities Assistant Vice President Advertising Officer Steven J. Sherry Executive Vice President Chief Marketing Officer
50 Branch Locations
Coastal Federal Bank Oak Street Branch Pawleys Island Branch 38th Avenue Branch (BI-LO) 2619 Oak Street Coastal Federal Town Center 1245 38th Avenue North Myrtle Beach, SC 29577-3129 11403 Ocean Highway Myrtle Beach, SC 29577 843.205.2000 Pawleys Island, SC 29585 843.205.2041 843.205.2020 Carolina Forest Branch Wilmington Branch 3894 Renee Drive Shallotte Branch 5710 Oleander Drive, Suite 209 Myrtle Beach, SC 29579 200 Smith Avenue Wilmington, NC 28403 843.205.2016 Shallotte, NC 28470 843.205.2031 843.205.2035 910.313.1161 Conway Branch 910.754.6186 310 Wright Boulevard Wilmington Branch Conway, SC 29526 Socastee Branch 109 Market Street 843.205.2005 4801 Socastee Boulevard Wilmington, NC 28401 Myrtle Beach, SC 29575 843.205.2033 Dunes Branch 843.205.2007 910.763.2372 7500 North Kings Highway Myrtle Beach, SC 29572 Southport Branch 843.205.2001 4956-1 Long Beach Road SE Southport, NC 28461 Little River Branch 843.205.2032 1602 Highway 17 910.454.4173 Little River, SC 29566 843.205.2014 Sunset Beach Branch 1625 Seaside Road SW Loris Branch Sunset Beach, NC 28468 3610 Broad Street 843.205.2012 Loris, SC 29569 910.579.8160 843.205.2018 Surfside Branch Murrells Inlet Branch 112 Highway 17 South 3348 Highway 17 South & Glenns Bay Road & Inlet Crossing Surfside Beach, SC 29575 Murrells Inlet, SC 29576 843.205.2003 843.205.2008 Waccamaw Medical Park Branch North Myrtle Beach Branch 112 Waccamaw Medical Park Drive 521 Main Street Conway, SC 29526 North Myrtle Beach, SC 29582 843.205.2009 843.205.2002
51 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 30, 2004, the Corporation had 1,114 shareholders and 15,935,823 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, 15, and 19 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. Such prices may reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not necessarily represent actual transactions. The prices have been adjusted retroactive to reflect stock dividends. HIGH LOW CASH BID BID DIVIDEND Fiscal Year 2004: First Quarter $15.67 $11.49 $0.045 Second Quarter 15.00 11.32 0.045 Third Quarter 14.26 10.73 0.045 Fourth Quarter 15.18 12.76 0.050 Fiscal Year 2003: First Quarter $12.70 $10.17 $0.037 Second Quarter 11.73 9.63 0.037 Third Quarter 11.15 9.67 0.045 Fourth Quarter 13.15 10.28 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, 2004, 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 25, 2005 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 Registered Public Accounting Firm KPMG LLP 55 Beattie Place, Suite 900 Greenville, South Carolina 29601 Special Counsel Muldoon Murphy Faucette & Aguggia 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.
52