COASTAL FINANCIAL CORP - Quarter Report: 2022 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark one)


x			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2022


o			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______________ to _______________

Commission file number: 001-38589

COASTAL FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)


Washington			56-2392007
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification No.)

5415 Evergreen Way, Everett, Washington			98203
(Address of principal executive offices)			(Zip Code)


(425) 257-9000
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

_________________________________________________________________________________________________

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading symbol(s)	Name of each exchange on which registered
Common Stock, no par value per share	CCB	NASDAQ Global Select Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and emerging growth company in Rule 12b-2 of the Exchange Act.


Large Accelerated Filer	o	Accelerated Filer	o
Non-Accelerated Filer	x	Smaller Reporting Company	x
		Emerging Growth Company	x

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of November 2, 2022, there were 12,962,028 shares of the issuer’s common stock outstanding.

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COASTAL FINANCIAL CORPORATION

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		Page No.
Part I. Financial Information

Item 1.	Condensed Consolidated Financial Statements (unaudited)	4

	Condensed Consolidated Balance Sheets as of September 30, 2022 and December 31, 2021 (unaudited)	5

	Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2022 and 2021 (unaudited)	6

	Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2022 and 2021 (unaudited)	8

	Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three and Nine Months Ended September 30, 2022 and 2021 (unaudited)	9

	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2022 and 2021 (unaudited)	10

	Notes to Condensed Consolidated Financial Statements (unaudited)	12

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	36

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	88

Item 4.	Controls and Procedures	90

Part II. Other Information

Item 1.	Legal Proceedings	91

Item 1A.	Risk Factors	91

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	91

Item 3.	Defaults Upon Senior Securities	91

Item 4.	Mine Safety Disclosures	91

Item 5.	Other Information	91

Item 6.	Exhibits	91

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Forward-Looking Statements

This report may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect our current views with respect to, among other things, future events and our financial performance. Any statements about our management’s expectations, beliefs, plans, predictions, forecasts, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “believes,” “can,” “could,” “may,” “predicts,” “potential,” “should,” “will,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,” “expects,” “intends” and similar words or phrases. All forward-looking statements, expressed or implied, included herewith are expressly qualified in their entirety by the cautionary statements contained or referred to herein. The inclusion of forward-looking information in this report should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs.

Factors that may affect our results are disclosed in “Item 1A. Risk Factors” in Part II of this report and in the section titled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2021 (“Form 10-K”). Some of the risks and uncertainties that may cause our actual results, performance or achievements to differ materially from those expressed include, but are not limited to, the following: the difficult market conditions and unfavorable economic conditions and uncertainties associated with the coronavirus, and variants thereof (“COVID-19”) pandemic, including the emergence of variant strains of the virus, particularly in the markets in which we operate and in which our loans are concentrated, including declines in housing markets, an increase in unemployment levels and slowdowns in economic growth; our expected future financial results; the overall health of the local and national real estate market; the credit risk associated with our loan portfolio, such as possible additional loan losses and impairment of collectability of loans as a result of the COVID-19 pandemic and policies and programs implemented by the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), including its automatic loan forbearance provisions and the effects on our loan portfolio from our Paycheck Protection Program (“PPP”) lending activities, specifically with our commercial real estate loans; our level of nonperforming assets and the costs associated with resolving problem loans; business and economic conditions generally and in the financial services industry, nationally and within our market area, including as a result of the COVID-19 pandemic, particularly in the markets in which we operate and in which our loans are concentrated; our ability to maintain an adequate level of allowance for loan losses; our ability to successfully manage liquidity risk; our ability to implement our growth strategy and manage costs effectively; the composition of our senior leadership team and our ability to attract and retain key personnel; our ability to raise additional capital to implement our business plan; changes in market interest rates and impacts of such changes on our profits and business; the occurrence of fraudulent activity, breaches or failures of our information security controls or cybersecurity-related incidents; interruptions involving our information technology and telecommunications systems or third-party servicers; our ability to maintain our reputation; increased competition in the financial services industry; regulatory guidance on commercial lending concentrations; our relationship with broker-dealers and digital financial service providers; the effectiveness of our risk management framework; the costs and obligations associated with being a publicly traded company; the commencement and outcome of litigation and other legal proceedings and regulatory actions against us or to which we may become subject; the extensive regulatory framework that applies to us; the impact of recent and future legislative and regulatory changes and economic stimulus programs; and other changes in banking, securities and tax laws and regulations, and their application by our regulators; the impact on our operations due to epidemic illnesses, natural or man-made disasters, such as wildfires, the effects of regional or national civil unrest, and political developments that may disrupt or increase volatility in securities or otherwise affect economic conditions; the impact of benchmark interest rate reform in the U.S. and implementation of alternative reference rates, such as the Secured Overnight Financing Rate (“SOFR”), to the London Interbank Offered Rate (“LIBOR”); fluctuations in the value of the securities held in our securities portfolio; governmental monetary and fiscal policies; material weaknesses in our internal control over financial reporting; and our success at managing the risks involved in the foregoing items.

The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this report. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. You are cautioned not to place undue reliance on forward-looking statements. Further, any forward-looking statement speaks only as of the date on which it is made and we undertake no obligation to update or revise any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events, except as required by law.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(dollars in thousands)


ASSETS
	September 30, 2022		December 31, 2021
Cash and due from banks	$	37,482	$	14,496
Interest earning deposits with other banks (restricted cash of $0 at September 30, 2022 and December 31, 2021)	373,246		798,665
Investment securities, available for sale, at fair value	97,621		35,327
Investment securities, held to maturity, at amortized cost	1,250		1,296
Other investments	10,581		8,478
Loans held for sale	43,314		—
Loans receivable	2,507,889		1,742,735
Allowance for loan losses	(59,282)		(28,632)
Total loans receivable, net	2,448,607		1,714,103
CCBX receivable	54,373		9,978
Premises and equipment, net	18,467		17,219
Operating lease right-of-use assets	5,293		6,105
Accrued interest receivable	13,114		8,105
Bank-owned life insurance, net	12,576		12,254
Deferred tax asset, net	13,997		6,818
Other assets	3,820		2,673
Total assets	$	3,133,741	$	2,635,517

LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES
Deposits	$	2,837,066	$	2,363,787
Federal Home Loan Bank ("FHLB") advances	—		24,999
Subordinated debt
Principal amount $25,000 (less unamortized debt issuance costs of $657 and $712 ) at September 30, 2022 and December 31, 2021, respectively	24,343		24,288
Junior subordinated debentures
Principal amount $3,609 (less unamortized debt issuance costs of $21 and $23 at September 30, 2022 and December 31, 2021, respectively)	3,588		3,586
Deferred compensation	648		744
Accrued interest payable	153		357
Operating lease liabilities	5,514		6,320
Other liabilities	33,696		10,214
Total liabilities	2,905,008		2,434,295
SHAREHOLDERS’ EQUITY
Preferred stock, no par value:
Authorized: 25,000,000 shares at September 30, 2022 and December 31, 2021; issued and outstanding: zero shares at September 30, 2022 and December 31, 2021	—		—
Common stock, no par value:
Authorized: 300,000,000 shares at September 30, 2022 and December 31, 2021; 12,954,573 shares at September 30, 2022 issued and outstanding and 12,875,315 shares at December 31, 2021 issued and outstanding	123,944		121,845
Retained earnings	106,880		79,373
Accumulated other comprehensive (loss) income, net of tax	(2,091)		4
Total shareholders’ equity	228,733		201,222
Total liabilities and shareholders’ equity	$	3,133,741	$	2,635,517

See accompanying Notes to Condensed Consolidated Financial Statements.

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(dollars in thousands, except for per share data)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
INTEREST AND DIVIDEND INCOME
Interest and fees on loans	$	52,328	$	19,383	$	122,126	$	56,978
Interest on interest earning deposits with other banks	2,273		170		3,631		314
Interest on investment securities	554		24		1,188		76
Dividends on other investments	24		31		195		169
Total interest income	55,179		19,608		127,140		57,537
INTEREST EXPENSE
Interest on deposits	5,717		523		7,943		1,811
Interest on borrowed funds	273		278		854		992
Total interest expense	5,990		801		8,797		2,803
Net interest income	49,189		18,807		118,343		54,734
PROVISION FOR LOAN LOSSES	18,428		255		45,464		973
Net interest income after provision for loan losses	30,761		18,552		72,879		53,761
NONINTEREST INCOME
Deposit service charges and fees	986		956		2,858		2,768
Loan referral fees	—		723		810		2,126
Gain on sales of loans, net	—		206		—		367
Mortgage broker fees	24		187		232		702
Unrealized (loss) gain on equity securities, net	(133)		1,472		(135)		1,472
Gain on sale of bank branch including deposits and loans, net	—		—		—		1,263
Other income	236		302		814		542
Noninterest income, excluding BaaS program income and BaaS indemnification income	1,113		3,846		4,579		9,240
Servicing and other BaaS fees	1,079		1,313		3,407		3,046
Transaction fees	940		146		2,247		264
Interchange fees	738		188		1,798		333
Reimbursement of expenses	885		333		1,875		709
BaaS program income	3,642		1,980		9,327		4,352
BaaS credit enhancements	17,928		10		45,210		10
BaaS fraud enhancements	11,708		296		22,753		296
BaaS indemnification income	29,636		306		67,963		306
Total noninterest income	34,391		6,132		81,869		13,898
NONINTEREST EXPENSE
Salaries and employee benefits	14,506		9,961		37,829		26,560
Occupancy	1,147		1,037		3,366		3,085
Data processing and software licenses	1,670		1,333		4,719		3,457
Legal and professional fees	2,251		796		3,961		2,182
Point of sale expense	742		212		1,399		475
Excise taxes	588		407		1,501		1,154
Federal Deposit Insurance Corporation ("FDIC") assessments	850		400		2,309		820
Director and staff expenses	475		274		1,196		812
Marketing	69		130		242		344
Other expense	1,522		865		4,318		2,419
Noninterest expense, excluding BaaS loan and BaaS fraud expense	23,820		15,415		60,840		41,308
BaaS loan expense	15,560		419		36,079		609
BaaS fraud expense	11,707		296		22,752		296
BaaS loan and fraud expense	27,267		715		58,831		905
Total noninterest expense	51,087		16,130		119,671		42,213

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Income before provision for income taxes	14,065		8,554		35,077		25,446
PROVISION FOR INCOME TAXES	2,964		1,870		7,570		5,731
NET INCOME	$	11,101	$	6,684	$	27,507	$	19,715
Basic earnings per common share	$	0.86	$	0.56	$	2.13	$	1.65
Diluted earnings per common share	$	0.82	$	0.54	$	2.04	$	1.58
Weighted average number of common shares outstanding:
Basic	12,938,200		11,999,899		12,921,814		11,982,009
Diluted	13,536,823		12,456,674		13,484,950		12,465,346

See accompanying Notes to Condensed Consolidated Financial Statements.

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(dollars in thousands)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2022		2021		2022		2021
NET INCOME	$	11,101	$	6,684	$	27,507	$	19,715
OTHER COMPREHENSIVE LOSS, before tax
Securities available-for-sale
Unrealized holding (loss) income during the period	(946)		5		(2,652)		(35)
Income tax benefit related to unrealized holding loss	199		(1)		557		7
OTHER COMPREHENSIVE LOSS, net of tax	(747)		4		(2,095)		(28)
COMPREHENSIVE INCOME	$	10,354	$	6,688	$	25,412	$	19,687

See accompanying Notes to Condensed Consolidated Financial Statements.

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)
(dollars in thousands)


	Shares of Common Stock	Amount of Common Stock		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Total
BALANCE, June 30, 2021	12,007,669	$	88,699	$	65,399	$	2	$	154,100
Net income	—	—		6,684		—		6,684



Exercise of stock options	4,438	30		—		—		30
Stock-based compensation	—	268		—		—		268
Other comprehensive income, net of tax	—	—		—		4		4
BALANCE, September 30, 2021	12,012,107	$	88,997	$	72,083	$	6	$	161,086

BALANCE, December 31, 2020	11,954,327	$	87,815	$	52,368	$	34	$	140,217
Net income	—	—		19,715		—		19,715
Issuance of restricted stock awards	10,714	—		—		—		—
Vesting of restricted stock units	7,851	—		—		—		—
Exercise of stock options	39,215	280		—		—		280
Stock-based compensation	—	902		—		—		902
Other comprehensive loss, net of tax	—	—		—		(28)		(28)
BALANCE, September 30, 2021	12,012,107	$	88,997	$	72,083	$	6	$	161,086

BALANCE, June 30, 2022	12,948,623	$	123,226	$	95,779	$	(1,344)	$	217,661
Net income	—	—		11,101		—		11,101

Vesting of restricted stock units	500	—		—		—		—
Exercise of stock options	5,450	34		—		—		34
Stock-based compensation	—	684		—		—		684
Other comprehensive loss, net of tax	—	—		—		(747)		(747)
BALANCE, September 30, 2022	12,954,573	$	123,944	$	106,880	$	(2,091)	$	228,733

BALANCE, December 31, 2021	12,875,315	$	121,845	$	79,373	$	4	$	201,222
Net income	—	—		27,507		—		27,507
Issuance of restricted stock awards	10,396	—		—		—		—
Vesting of restricted stock units	27,137	—		—		—		—
Exercise of stock options	41,725	311		—		—		311
Stock-based compensation	—	1,788		—		—		1,788
Other comprehensive loss, net of tax	—	—		—		(2,095)		(2,095)
BALANCE, September 30, 2022	12,954,573	$	123,944	$	106,880	$	(2,091)	$	228,733

See accompanying Notes to Condensed Consolidated Financial Statements.

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(dollars in thousands)


	Nine Months Ended September 30,
	2022		2021
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	27,507	$	19,715
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses	45,464		973
Depreciation and amortization	1,338		1,170
Loss on disposition of fixed assets	35		—
Decrease in operating lease right-of-use assets	812		789
Decrease in operating lease liabilities	(806)		(781)
Gain on sales of loans	—		(367)
Proceeds from sale of loans related to sale of bank branch	—		4,092
Net (premium amortization)/discount accretion on investment securities	(45)		21
Unrealized holding loss (gain) on equity investment	135		(1,472)
Stock-based compensation	1,788		902
Gain on sale of bank branch, including deposits and loans	—		(1,263)
Increase in bank-owned life insurance value	(269)		(212)
Deferred tax benefit	(6,623)		(1)
Net change in CCBX receivable	(44,395)		(472)
Net change in other assets and liabilities	17,082		189
Total adjustments	14,517		3,568
Net cash provided by operating activities	42,024		23,283
CASH FLOWS FROM INVESTING ACTIVITIES
Net change in interest earning deposits with other banks	425,419		(493,851)
Purchase of investment securities available for sale	(134,912)		(57,495)
Change in other investments, net	(2,238)		(818)
Principal paydowns of investment securities available-for-sale	14		25
Principal paydowns of investment securities held-to-maturity	44		737
Maturities and calls of investment securities available-for-sale	70,000		45,000
Purchase of bank owned life insurance	(53)		(4,872)
Proceeds from sales of loans held for sale	84,878		—
Proceeds from sales of loan participations	10,300		915
Purchase of loans	(165,790)		—
Increase in loans receivable, net	(752,670)		(165,122)
Net cash transfer for branch sale	—		(19,980)
Purchases of premises and equipment, net	(2,621)		(2,188)
Net cash used by investing activities	(467,629)		(697,649)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in demand deposits, NOW and money market, and savings	482,863		837,277
Net decrease in time deposits	(9,584)		(10,981)
Net repayment from long term FHLB borrowing	(24,999)		—
Increase from subordinated debt proceeds	—		24,263
Decrease from subordinated debt repayment	—		(10,000)
Net advances from Paycheck Protection Program Liquidity Facility	—		(153,716)
Proceeds from exercise of stock options	311		280
Net cash provided by financing activities	448,591		687,123
NET CHANGE IN CASH, DUE FROM BANKS AND RESTRICTED CASH	22,986		12,757
CASH, DUE FROM BANKS AND RESTRICTED CASH, beginning of year	14,496		18,965
CASH, DUE FROM BANKS AND RESTRICTED CASH, end of quarter	$	37,482	$	31,722
SUPPLEMENTAL SCHEDULE OF OPERATING AND INVESTING ACTIVITIES

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Interest paid	$	9,001	$	3,187
Income taxes paid	11,430		6,809
SUPPLEMENTAL SCHEDULE OF NONCASH TRANSACTIONS
Fair value adjustment of securities available-for-sale, gross	$	(2,095)	$	(35)
In conjunction with ASU 2016-02 as detailed in Note 6 to the Unaudited Consolidated Financial Statements, the following assets and liabilities were recognized:
Operating lease right-of-use assets	$	—	$	41
Operating lease liabilities	$	—	$	(41)
Non-cash investing and financing activities:
Transfer from loans to loans held for sale	$	128,193	$	—

See accompanying Notes to Condensed Consolidated Financial Statements.

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 - Description of Business and Summary of Significant Accounting Policies

Nature of operations - Coastal Financial Corporation (“Corporation” or “Company”) is a registered bank holding company whose wholly owned subsidiaries are Coastal Community Bank (“Bank”) and Arlington Olympic LLC (“LLC”). The Company is a Washington state corporation that was organized in 2003. The Bank was incorporated and commenced operations in 1997 and is a Washington state-chartered commercial bank that is a member bank of the Federal Reserve system. Arlington Olympic LLC was formed in 2019 and owns the Company’s Arlington branch site, which the Bank leases from the LLC.

We are headquartered in Everett, Washington, which by population is the largest city in, and the county seat of, Snohomish County. The Company’s business is conducted through two reportable segments: the community bank and CCBX. The primary focus of the community bank is on providing a wide range of banking products and services to consumers and small to medium-sized businesses, professionals, and individuals in the broader Puget Sound region in the state of Washington through its 14 branches in Snohomish, Island and King Counties, and through the Internet and its mobile banking application. The CCBX segment provides Banking as a Service (“BaaS”) that allows our broker dealers and digital financial service partners to offer their customers banking services. Through CCBX’s partners the Company is able to offer banking services and products across the nation.

The Bank’s deposits are insured in whole or in part by the Federal Deposit Insurance Corporation (“FDIC”). The community bank’s loans and deposits are primarily within the greater Puget Sound area, while CCBX loans and deposits are dependent upon the partner’s market. The Bank’s primary funding source is deposits from customers. The Bank is subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and the Washington State Department of Financial Institutions Division of Banks. The Federal Reserve also has regulatory and supervisory authority over the Company.

Financial statement presentation - The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim reporting requirements and with instructions to Form 10-Q and Article 10 of Regulation S-X, and therefore do not include all the information and notes included in the annual consolidated financial statements in conformity with GAAP. These interim condensed consolidated financial statements and accompanying notes should be read in conjunction with the Company’s audited consolidated financial statements and accompanying notes included in the Company’s Annual report on Form 10-K as filed with the U.S. Securities and Exchange Commission (“SEC”) on March 14, 2022. Operating results for the three months and nine months ended September 30, 2022 are not necessarily indicative of the results that may be expected for the entire year.

Amounts presented in the consolidated financial statements and footnote tables are rounded and presented in thousands of dollars except per-share amounts, which are presented in dollars. In the narrative footnote discussion, amounts are rounded to thousands and presented in dollars.

In management’s opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations on the accompanying consolidated financial statements have been made. These adjustments include normal and recurring accruals considered necessary for a fair and accurate presentation.

Principles of consolidation - The consolidated financial statements include the accounts of the Company, the Bank and the LLC. All significant intercompany accounts have been eliminated in consolidation.

Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management believes that its critical accounting policies include determining the allowance for loan losses, the valuation of the Company’s deferred tax assets, and fair value of financial instruments. Actual results could differ significantly from those estimates.

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Accounting policy update– During the nine months ended September 30, 2022, the Company transferred $128.2 million in CCBX loans receivable to loans held for sale. These CCBX loans held for sale consist of the portion of CCBX partner loans that the Company intends to sell back to the originating CCBX partner at par. As of September 30, 2022 there were $43.3 million in CCBX partner loans held for sale recorded at par, compared to zero at December 31, 2021.

Community bank loans held-for-sale consist of the guaranteed portion of SBA loans and United States Department of Agriculture (“USDA”) loans the Company intends to sell after origination and are reflected at the lower of aggregate cost or fair value. Loans are generally sold with servicing of the sold portion retained by the Company when the sale of the loan occurs, the premium received is combined with the estimated present value of future cash flows on the related servicing asset and recorded as a gain on sale of loans in noninterest income. There were no community bank loans held for sale at September 30, 2022 or December 31, 2021.

Subsequent Events - The Company has evaluated events and transactions subsequent to September 30, 2022 for potential recognition or disclosure.

On November 1, 2022 the Company completed its private placement of $20.0 million in fixed-to-floating rate subordinated notes due November 1, 2032 (the “Notes”). The Notes will bear interest at a fixed annual rate of 7.00% for the first five years and will reset quarterly thereafter to the then-current three-month Secured Overnight Financing Rate ("SOFR") plus 290 basis points. The Company intends to use the net proceeds from the offering for general corporate purposes. The Company is entitled to redeem the Notes, in whole or in part, on any interest payment date on or after November 1, 2027, or at any time, in whole but not in part, upon certain other specified events prior to the Notes’ maturity on November 1, 2032.

Reclassifications - Certain amounts reported in prior quarters' consolidated financial statements may have been reclassified to conform to the current presentation with no effect on stockholders’ equity or net income.

Note 2 - Recent accounting standards

Recent Accounting Guidance Not Yet Effective

In September 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendment is effective for annual periods beginning after December 15, 2019 and interim period within those annual periods. The Company’s implementation of ASU 2016-13 will be effective January 1, 2023. The Company is actively assessing the data and the model needs and is evaluating the impact of adopting the amendment. The Company expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses as of the beginning of the first reporting period, January 2023, in which the new standard is effective, but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements. The actual magnitude of the change will be impacted by the growth, composition and performance of the loan portfolio and economic conditions at January 1, 2023.

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls reference rate reform, if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. The amendments in this ASU are effective for all entities upon issuance through December 31, 2022. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

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In March 2022, the FASB issued ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. The ASU eliminates the accounting guidance for TDR loans by creditors while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. Additionally, the ASU requires public business entities to disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases. This ASU is effective upon adoption of ASU 2016-13. The Company is evaluating the impact this ASU will have on its financial position or results of operations.

Note 3 - Investment Securities

The amortized cost and fair values of investments in debt securities at the date indicated are as follows:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(dollars in thousands; unaudited)
September 30, 2022
Available-for-sale
U.S. Treasury securities	$	99,960	$	—	$	(2,644)	$	97,316
U.S. Agency collateralized mortgage obligations	57		—		(3)		54
U.S. Agency residential mortgage-backed securities	1		—		—		1
Municipal bonds	250		—		—		250
Total available-for-sale securities	100,268		—		(2,647)		97,621
Held-to-maturity
U.S. Agency residential mortgage-backed securities	1,250		—		(118)		1,132
Total investment securities	$	101,518	$	—	$	(2,765)	$	98,753


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(dollars in thousands; unaudited)
December 31, 2021
Available-for-sale
U.S. Treasury securities	$	34,999	$	—	$	(1)	$	34,998
U.S. Agency collateralized mortgage obligations	68		2		—		70
U.S. Agency residential mortgage-backed securities	3		—		—		3
Municipal bonds	252		4		—		256
Total available-for-sale securities	35,322		6		(1)		35,327
Held-to-maturity
U.S. Agency residential mortgage-backed securities	1,296		52		—		1,348
Total investment securities	$	36,618	$	58	$	(1)	$	36,675

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The amortized cost and fair value of debt securities at September 30, 2022, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers or the underlying borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities and collateralized mortgage obligations are shown separately, since they are not due at a single maturity date.


	Available-for-Sale				Held-to-Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
	(dollars in thousands; unaudited)
September 30, 2022
Amounts maturing in
One year or less	$	—	$	—	$	—	$	—
After one year through five years	100,211		97,567		—		—
	100,211		97,567		—		—
U.S. Agency residential mortgage-backed securities and collateralized mortgage obligations	57		54		1,250		1,132
	$	100,268	$	97,621	$	1,250	$	1,132

Investments in debt securities with an amortized cost of $38.0 million and $36.0 million at September 30, 2022 and December 31, 2021, respectively, were pledged to secure public deposits and for other purposes as required or permitted by law. During the three months ended September 30, 2022, $10.0 million in U.S. Treasury securities matured. During the nine months ended September 30, 2022, five U.S. Treasury securities were purchased for $135.0 million for their higher yielding return compared to cash on deposit with other banks, and $70.0 million in U.S. Treasury securities matured during the nine months ended September 30, 2022.

There were no sales of securities during the three or nine months ended September 30, 2022 or 2021.

There were eight securities with a $2.8 million unrealized loss as of September 30, 2022. There were four securities in an unrealized loss position as of December 31, 2021. The following table shows the investments’ gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:


	Less Than 12 Months				12 Months or Greater				Total
	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
	(dollars in thousands; unaudited)
September 30, 2022
Available-for-sale
U.S. Treasury securities	$	97,316	$	2,644	$	—	$	—	$	97,316	$	2,644
U.S. Agency collateralized mortgage obligations	1		—		—		—		1		—
Municipals	250		—		—		—		250		—
U.S. Agency residential mortgage-backed securities	54		3		—		—		54		3
Total available-for-sale securities	97,621		2,647		—		—		97,621		2,647
Held-to-maturity
U.S. Agency residential mortgage-backed securities	1,132		118		—		—		1,132		118
Total investment securities	$	98,753	$	2,765	$	—	$	—	$	98,753	$	2,765

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Management has evaluated the above securities and does not believe that any individual unrealized loss as of September 30, 2022, represents an other-than-temporary impairment (“OTTI”). Unrealized losses have not been recognized into income because management does not intend to sell and does not expect it will be required to sell the investments. The decline is largely due to changes in market conditions and interest rates, rather than credit quality. The fair value is expected to recover as the underlying securities in the portfolio approach maturity date and market conditions improve. Management believes there is a high probability of collecting all contractual amounts due, because the majority of the securities in the portfolio are backed by government agencies or government sponsored enterprises. However, a recovery in value may not occur for some time, if at all, and may be delayed for greater than the one year time horizon or perhaps even until maturity.

Note 4 - Loans and Allowance for Loan Losses

During the quarter ended September 30, 2022, $48.1 million in CCBX loans were transferred to loans held for sale, with $64.8 million in loans sold, at par; $43.3 million remains in loans held for sale as of September 30, 2022. At December 31, 2021, there were no loans held for sale. The loans held for sale are residential real estate secured lines of credit.

The composition of the loan portfolio is as follows as of the periods indicated:


	September 30,		December 31,
	2022		2021
	(dollars in thousands; unaudited)
Commercial and industrial loans	$	339,928	$	419,060
Real estate loans:
Construction, land, and land development	224,188		183,594
Residential real estate	402,781		204,389
Commercial real estate	1,024,067		835,587
Consumer and other loans	523,536		108,871
Gross loans receivable	2,514,500		1,751,501
Net deferred origination fees and premiums	(6,611)		(8,766)
Loans receivable	$	2,507,889	$	1,742,735

Included in commercial and industrial loans are PPP loans of $5.8 million at September 30, 2022 and $111.8 million at December 31, 2021. PPP loans are 100% guaranteed by the Small Business Administration (“SBA”). PPP loans had net deferred origination fees of $111,000 as of September 30, 2022, and $3.6 million as of December 31, 2021. Also included in commercial and industrial loans as of September 30, 2022 and December 31, 2021, is $174.3 million and $202.9 million, respectively in capital call lines, provided to venture capital firms through one of our BaaS clients. These loans are secured by the capital call rights and are individually underwritten to the Bank’s credit standards by our BaaS client and the underwriting is reviewed and approved by the Bank on every line.

Included in consumer and other loans are overdrafts of $3.8 million and $1.3 million at September 30, 2022 and December 31, 2021, respectively.

The Company has pledged loans totaling $233.0 million and $183.5 million at September 30, 2022 and December 31, 2021, respectively, for borrowing lines at the FHLB and FRB.

The balance of SBA and USDA loans and participations sold and serviced for others totaled $14.8 million and $19.3 million at September 30, 2022 and December 31, 2021, respectively.

The balance of Main Street Lending Program (“MSLP”) loans including participations to others with servicing retained totaled $58.0 million and $56.3 million at September 30, 2022 and December 31, 2021, respectively, with $3.1 million and $4.8 million in MSLP loans on the balance sheet and included in commercial and industrial loans at September 30, 2022, and December 31, 2021, respectively.

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The Company, at times, purchases individual loans through the community bank at fair value as of the acquisition date. The Company held purchased loans with remaining balances that totaled $9.7 million and $12.8 million as of September 30, 2022 and December 31, 2021, respectively. Unamortized premiums on these loans totaled $173,000 and $223,000 as of September 30, 2022 and December 31, 2021, respectively, and are amortized into interest income over the life of the loans.

The Company, at times, purchases participations of loans and held purchased participation loans with remaining balances totaling $58.9 million and $27.9 million as of September 30, 2022 and December 31, 2021, respectively.

The Company purchased loans from a CCBX partner, at par, through agreements with that CCBX partner, and those loans had a remaining balance of $183.1 million as of September 30, 2022 and $59.7 million as of December 31, 2021. As of September 30, 2022, $167.3 million is included in consumer and other loans and $15.8 million is included in commercial and industrial loans, compared to $59.4 million in consumer and other loans and $28.1 million in commercial and industrial loans as of December 31, 2021.

The following is a summary of the Company’s loan portfolio segments:

Commercial and industrial loans – Commercial and industrial loans are secured by business assets including inventory, receivables and machinery and equipment of businesses located generally in the Company’s primary market area and capital calls on venture and investment funds. Also included in commercial and industrial loans are $15.8 million in unsecured CCBX partner loans. Loan types include PPP loans, revolving lines of credit, term loans, and loans secured by liquid collateral such as cash deposits or marketable securities. Also included in commercial and industrial loans are loans to other financial institutions. Additionally, the Company issues letters of credit on behalf of its customers. Risk arises primarily due to the difference between expected and actual cash flows of the borrowers. In addition, the recoverability of the Company’s investment in these loans is also dependent on other factors primarily dictated by the type of collateral securing these loans. The fair value of the collateral securing these loans may fluctuate as market conditions change. In the case of loans secured by accounts receivable, the recovery of the Company’s investment is dependent upon the borrower’s ability to collect amounts due from its customers.

As of September 30, 2022, $174.3 million in CCBX capital call lines are included in commercial and industrial loans compared to $202.9 million at December 31, 2021. Capital call lines are provided to venture capital firms. These loans are secured by the capital call rights and are individually underwritten to the Bank’s credit standards and the underwriting is reviewed by the Bank on every line/loan. Capital call lines bear a lower rate of interest, but have less credit risk due to the way the loans are structured compared to other commercial loans.

Construction, land and land development loans – The Company originates loans for the construction of 1-4 family, multifamily, and Commercial Real Estate (“CRE”) properties in the Company’s market area. Construction loans are considered to have higher risks due to construction completion and timing risk, the ultimate repayment being sensitive to interest rate changes, government regulation of real property and the availability of long-term financing. Additionally, economic conditions may impact the Company’s ability to recover its investment in construction loans, as adverse economic conditions may negatively impact the real estate market, which could affect the borrower’s ability to complete and sell the project. Additionally, the fair value of the underlying collateral may fluctuate as market conditions change. The Company occasionally originates land loans for the purpose of facilitating the ultimate construction of a home or commercial building. The primary risks include the borrower’s ability to pay and the inability of the Company to recover its investment due to a material decline in the fair value of the underlying collateral.

Residential real estate loans – Residential real estate includes various types of loans for which the Company holds real property as collateral. Included in this segment are first and second lien single family loans, which the Company occasionally purchases to diversify its loan portfolio, and rental portfolios secured by one-to-four family homes. The primary risks of residential real estate loans include the borrower’s inability to pay, material decreases in the value of the collateral, and significant increases in interest rates which may make the loan unprofitable.

As of September 30, 2022, $203.9 million in CCBX loans are included in residential real estate loans, compared to $36.9 million at December 31, 2021. These home equity lines of credit are secured by residential real estate and are accessed by using a credit card. Home equity lines of credit are classified as residential real estate per regulatory guidelines.

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Commercial real estate (includes owner occupied and nonowner occupied) loans – Commercial real estate loans include various types of loans for which the Company holds real property as collateral. We make commercial mortgage loans collateralized by owner-occupied and non-owner-occupied real estate, as well as multi-family residential loans. The primary risks of commercial real estate loans include the borrower’s inability to pay, material decreases in the value of the collateralized real estate and significant increases in interest rates, which may make the real estate loan unprofitable. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy.

Consumer and other loans – The community bank originates a limited number of consumer loans, generally for banking customers only, which consist primarily of lines of credit, saving account secured loans, and auto loans. CCBX originates consumer loans including credit cards, consumer term loans and secured and unsecured lines of credit. This loan category also includes overdrafts. Repayment of these loans is dependent on the borrower’s ability to pay and the fair value of the underlying collateral.

As of September 30, 2022, $521.3 million in CCBX loans are included in consumer and other loans compared to $106.8 million at December 31, 2021.

The following table illustrates an age analysis of past due loans as of the dates indicated:


	30-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		Recorded Investment 90 Days or More Past Due and Still Accruing
	(dollars in thousands; unaudited)
September 30, 2022
Commercial and industrial loans	$	588	$	224	$	812	$	339,116	$	339,928	$	138
Real estate loans:
Construction, land and land development	—		66		66		224,122		224,188		—
Residential real estate	707		638		1,345		401,436		402,781		638
Commercial real estate	6,901		—		6,901		1,017,166		1,024,067		—
Consumer and other loans	27,867		15,045		42,912		480,624		523,536		15,045
	$	36,063	$	15,973	$	52,036	$	2,462,464	$	2,514,500	$	15,821
Less net deferred origination fees and premiums									(6,611)
Loans receivable									$	2,507,889

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	30-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		Recorded Investment 90 Days or More Past Due and Still Accruing
	(dollars in thousands; unaudited)
December 31, 2021
Commercial and industrial loans	$	259	$	38	$	297	$	418,763	$	419,060	$	—
Real estate loans:
Construction, land and land development	—		—		—		183,594		183,594		—
Residential real estate	809		94		903		203,486		204,389		39
Commercial real estate	—		—		—		835,587		835,587		—
Consumer and other loans	3,901		1,467		5,368		103,503		108,871		1,467
	$	4,969	$	1,599	$	6,568	$	1,744,933	$	1,751,501	$	1,506
Less net deferred origination fees and premiums									(8,766)
Loans receivable									$	1,742,735

There were $15.8 million in loans past due 90 days or more and still accruing interest as of September 30, 2022, and $1.5 million as of December 31, 2021. The increase is attributed to installment/closed-end, and revolving/open-end consumer loans originated by CCBX lending partners which continue to accrue interest until 120 and 180 days past due, respectively.

The following table is a summary of information pertaining to impaired loans as of the period indicated. Loans originated by CCBX partners are reported using pool accounting and are not subject to impairment analysis, therefore CCBX loans are not included in this table.


	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Related Allowance
	(dollars in thousands; unaudited)
September 30, 2022
Commercial and industrial loans	$	106	$	8	$	86	$	94	$	76
Real estate loans:
Construction, land and land development	67		66		—		66		—
Residential real estate	—		—		—		—		—
Commercial real estate	6,901		6,901		—		6,901		—
Total	$	7,074	$	6,975	$	86	$	7,061	$	76

December 31, 2021
Commercial and industrial loans	$	173	$	—	$	166	$	166	$	132
Real estate loans:
Residential real estate	69		55		—		55		—
Total	$	242	$	55	$	166	$	221	$	132

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The following tables summarize the Company’s average recorded investment and interest income recognized on impaired loans by loan class for the three and nine months ended September 30, 2022 and 2021:


	Three Months Ended
	September 30, 2022				September 30, 2021
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(dollars in thousands; unaudited)
Commercial and industrial loans	$	103	$	—	$	489	$	—
Real estate loans:
Construction, land and land development	67		—		—		—
Residential real estate	26		—		111		—
Commercial real estate	38		—		—		—
Total	$	234	$	—	$	600	$	—


	Nine Months Ended
	September 30, 2022				September 30, 2021
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(dollars in thousands; unaudited)
Commercial and industrial loans	$	125	$	—	$	498	$	—
Real estate loans:
Construction, land and land development	33		—		—		—
Residential real estate	41		—		143		—
Commercial real estate	19		—		—		—
Total	$	218	$	—	$	641	$	—

The Company grants restructurings in response to borrower financial difficulty, and generally provides for a temporary modification of loan repayment terms. The restructured loans on accrual status represent the only impaired loans accruing interest. In order for a restructured loan to be considered for accrual status, the loan’s collateral coverage generally will be greater than or equal to 100% of the loan balance, the loan is current on payments, and the borrower must either prefund an interest reserve or demonstrate the ability to make payments from a verified source of cash flow for an extended period of time, usually at least six months in duration.

No loans were restructured in the three and nine months ended September 30, 2022 and 2021 that qualified as TDRs. The Company has no commitments to loan additional funds to borrowers whose loans were classified as TDRs at September 30, 2022, as there were no outstanding TDRs at September 30, 2022.

Generally, the accrual of interest on community bank loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due or when they are 90 days past due as to either principal or interest, unless they are well secured and in the process of collection. Installment/closed-end, and revolving/open-end consumer loans originated by CCBX lending partners will continue to accrue interest until 120 and 180 days past due, respectively and an allowance is recorded through provision expense for these probable incurred losses. Any principal and interest outstanding on revolving/open-end loans at greater than 180 days past due is charged off against the allowance. Any accrued interest outstanding on installment/closed-end loans at 120 days past due is reversed against interest income. These consumer loans are reported as substandard, 90 days or more days past due and still accruing.

When loans are placed on nonaccrual status, all accrued interest is reversed from current period earnings. Payments received on nonaccrual loans are generally applied as a reduction to the loan principal balance. If the likelihood of further loss is removed, the Company will recognize interest on a cash basis only. Loans may be returned to accruing status if the Company believes that all remaining principal and interest is fully collectible and there has been at least six months of sustained repayment performance since the loan was placed on nonaccrual.

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An analysis of nonaccrual loans by category consisted of the following at the periods indicated:


	September 30,		December 31,
	2022		2021
	(dollars in thousands; unaudited)
Commercial and industrial loans	$	94	$	166
Real estate loans:
Construction, land and land development	66		—
Residential real estate	—		55
Commercial real estate	6,901		—
Total nonaccrual loans	$	7,061	$	221

Credit Quality and Credit Risk

Federal regulations require that the Company periodically evaluate the risks inherent in its loan portfolio. In addition, the Company’s regulatory agencies have authority to identify problem loans and, if appropriate, require them to be reclassified. The Company classifies some loans as Watch or Other Loans Especially Mentioned (“OLEM”). Loans classified as Watch are performing assets but have elements of risk that require more monitoring than other performing loans and are reported in the OLEM column in the following table. Loans classified as OLEM are assets that continue to perform but have shown deterioration in credit quality and require close monitoring. There are three classifications for problem loans: Substandard, Doubtful, and Loss. Substandard loans have one or more defined weaknesses and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Revolving (open-ended loans, such as credit cards) and installment (closed end) consumer loans originated by CCBX partners continue to accrue interest until they are charged-off at 120 days past due for installment loans (primarily unsecured loans to consumers) and 180 days past due for revolving loans (primarily credit cards) and are classified as substandard. Doubtful loans have the weaknesses of loans classified as Substandard, with additional characteristics that suggest the weaknesses make collection or recovery in full after liquidation of collateral questionable on the basis of currently existing facts, conditions, and values. There is a high possibility of loss in loans classified as Doubtful. A loan classified as Loss is considered uncollectible and of such little value that continued classification of the credit as a loan is not warranted. If a loan or a portion thereof is classified as Loss, it must be charged-off, meaning the amount of the loss is charged against the allowance for loan losses, thereby reducing that reserve.

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Loans by credit quality risk rating are as follows as of the periods indicated:


	Pass		Other Loans Especially Mentioned		Sub- Standard		Doubtful		Total
	(dollars in thousands; unaudited)
September 30, 2022
Commercial and industrial loans	$	331,384	$	8,255	$	289	$	—	$	339,928
Real estate loans:
Construction, land, and land development	224,122		—		66		—		224,188
Residential real estate	402,041		102		638		—		402,781
Commercial real estate	1,009,487		7,680		6,900		—		1,024,067
Consumer and other loans	508,492		—		15,044		—		523,536
	$	2,475,526	$	16,037	$	22,937	$	—	2,514,500
Less net deferred origination fees									(6,611)
Loans receivable									$	2,507,889
December 31, 2021
Commercial and industrial loans	$	416,642	$	2,180	$	238	$	—	$	419,060
Real estate loans:
Construction, land, and land development	183,594		—		—		—		183,594
Residential real estate	204,173		122		94		—		204,389
Commercial real estate	824,676		10,911		—		—		835,587
Consumer and other loans	107,404		—		1,467		—		108,871
	$	1,736,489	$	13,213	$	1,799	$	—	1,751,501
Less net deferred origination fees									(8,766)
Loans receivable									$	1,742,735

Allowance for Loan Losses

The Company’s ALLL covers estimated credit losses on individually evaluated loans that are determined to be impaired as well as estimated probable losses inherent in the remainder of the loan portfolio. The ALLL for the community bank is prepared using the information provided by the Company’s credit review process and our historical loss data, together with data from peer institutions and economic information gathered from published sources.

The loan portfolio is segmented into groups of loans with similar risk profiles. Each segment possesses varying degrees of risk based on the type of loan, the type of collateral, and the sensitivity of the borrower or industry to changes in external factors such as economic conditions. An estimated loss rate calculated from the community bank’s actual historical loss rates adjusted for current portfolio trends, economic conditions, and other relevant internal and external factors, is applied to each group’s aggregate loan balances.

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CCBX loans have a higher level of expected losses than our community bank loans, which is reflected in the factors for the allowance for loan losses. Agreements with our CCBX partners provide for a credit enhancement which protects the Bank by absorbing incurred losses. In accordance with accounting guidance, we estimate and record a provision for probable losses for these CCBX loans and reclassified negative deposit accounts. When the provision for CCBX loan losses and provision for unfunded commitments are recorded, a receivable is also recorded on the balance sheet through noninterest income (BaaS credit enhancements). Incurred losses are recorded in the allowance for loan losses. The receivable is relieved when credit enhancement recoveries are received from the CCBX partner. Although agreements with our CCBX partners include credit enhancements that provide protection to the Bank from credit and fraud losses, the Bank would be exposed to additional loan losses if our partner is unable to fulfill their contracted obligations. In accordance with the program agreement and for true lender purposes for a CCBX partner only, the Company is responsible for credit losses on approximately 10% of a $77.9 million loan portfolio. At September 30, 2022, 10% of this portfolio represented $7.8 million in loans. The partner is responsible for credit losses on approximately 90% of this portfolio and for fraud losses on 100% of this portfolio. The Company earns 100% of the revenue on the aforementioned $7.8 million of loans. Additionally, as of September 30, 2022, no losses have been incurred or recognized on the $7.8 million in loans for which the Company is responsible for credit losses.

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The following tables summarize the allocation of the ALLL, as well as the activity in the ALLL attributed to various segments in the loan portfolio, as of and for the three and nine months ended September 30, 2022 and 2021:


	Commercial and Industrial		Construction, Land, and Land Development		Residential Real Estate		Commercial Real Estate		Consumer and Other		Unallocated		Total
	(dollars in thousands; unaudited)
Three Months Ended September 30, 2022
ALLL balance, June 30, 2022	$	4,066	$	7,999	$	7,171	$	4,740	$	23,810	$	1,572	$	49,358
Provision for loan losses or (recapture)	298		(145)		2,260		(215)		16,402		(172)		18,428
	4,364		7,854		9,431		4,525		40,212		1,400		67,786
Loans charged-off	(360)		—		(105)		—		(8,048)		—		(8,513)
Recoveries of loans previously charged-off	2		—		—		—		7		—		9
Net (charge-offs) recoveries	(358)		—		(105)		—		(8,041)		—		(8,504)
ALLL balance, September 30, 2022	$	4,006	$	7,854	$	9,326	$	4,525	$	32,171	$	1,400	$	59,282

Nine Months Ended September 30, 2022
ALLL balance, December 31, 2021	$	3,221	$	6,984	$	4,598	$	6,590	$	7,092	$	147	$	28,632
Provision for loan losses or (recapture)	1,144		870		4,833		(2,065)		39,429		1,253		45,464
	4,365		7,854		9,431		4,525		46,521		1,400		74,096
Loans charged-off	(398)		—		(105)		—		(14,360)		—		(14,863)
Recoveries of loans previously charged-off	39		—		—		—		10		—		49
Net (charge-offs) recoveries	(359)		—		(105)		—		(14,350)		—		(14,814)
ALLL balance, September 30, 2022	$	4,006	$	7,854	$	9,326	$	4,525	$	32,171	$	1,400	$	59,282

As of September 30, 2022
ALLL amounts allocated to
Individually evaluated for impairment	$	76	$	—	$	—	$	—	$	—	$	—	$	76
Collectively evaluated for impairment	3,930		7,854		9,326		4,525		32,171		1,400		59,206
ALLL balance, September 30, 2022	$	4,006	$	7,854	$	9,326	$	4,525	$	32,171	$	1,400	$	59,282
Loans individually evaluated for impairment	$	94	$	66	$	—	$	6,901	$	—			$	7,061
Loans collectively evaluated for impairment	339,834		224,122		402,781		1,017,166		523,536				2,507,439
Loan balance, September 30, 2022	$	339,928	$	224,188	$	402,781	$	1,024,067	$	523,536			$	2,514,500

Three Months Ended September 30, 2021
ALLL balance, June 30, 2021	$	3,317	$	4,520	$	3,302	$	8,057	$	84	$	686	$	19,966
Provision for loan losses or (recapture)	8		1,410		(49)		(1,420)		11		295		255
	3,325		5,930		3,253		6,637		95		981		20,221
Loans charged-off	—		—		—		—		(31)		—		(31)
Recoveries of loans previously charged-off	16		—		—		—		16		—		32
Net (charge-offs) recoveries	16		—		—		—		(15)		—		1
Balance, September 30, 2021	$	3,341	$	5,930	$	3,253	$	6,637	$	80	$	981	$	20,222

Nine Months Ended September 30, 2021
Balance, December 31, 2020	$	3,353	$	3,545	$	3,410	$	7,810	$	127	$	1,017	$	19,262
Provision for loan losses or (recapture)	(17)		2,385		(157)		(1,173)		(29)		(36)		973
	3,336		5,930		3,253		6,637		98		981		20,235
Loans charged-off	(16)		—		—		—		(45)		—		(61)
Recoveries of loans previously charged-off	21		—		—		—		27		—		48
Net (charge-offs) recoveries	5		—		—		—		(18)		—		(13)
Balance, September 30, 2021	$	3,341	$	5,930	$	3,253	$	6,637	$	80	$	981	$	20,222

Table of Contents,

The following table summarizes the allocation of the ALLL attributed to various segments in the loan portfolio as of December 31, 2021.


	Commercial and Industrial		Construction, Land, and Land Development		Residential Real Estate		Commercial Real Estate		Consumer and Other		Unallocated		Total
	(dollars in thousands; unaudited)
As of December 31, 2021
ALLL amounts allocated to
Individually evaluated for impairment	$	132	$	—	$	—	$	—	$	—	$	—	$	132
Collectively evaluated for impairment	3,089		6,984		4,598		6,590		7,092		147		28,500
ALLL balance, December 31, 2021	$	3,221	$	6,984	$	4,598	$	6,590	$	7,092	$	147	$	28,632
Loans individually evaluated for impairment	$	166	$	—	$	55	$	—	$	—			$	221
Loans collectively evaluated for impairment	418,894		183,594		204,334		835,587		108,871				1,751,280
Loan balance, December 31, 2021	$	419,060	$	183,594	$	204,389	$	835,587	$	108,871			$	1,751,501

Note 5 - Deposits

The composition of consolidated deposits consisted of the following at the periods indicated:


	September 30, 2022		December 31, 2021
	(dollars in thousands; unaudited)
Demand, noninterest bearing	$	813,217	$	1,355,908
NOW and money market	1,807,105		789,709
Savings	107,508		103,956
Total core deposits	2,727,830		2,249,573
BaaS-brokered deposits	75,363		70,757
Time deposits less than $250,000	24,575		31,057
Time deposits $250,000 and over	9,298		12,400
Total deposits	$	2,837,066	$	2,363,787

The following table presents the maturity distribution of time deposits as of September 30, 2022:


(dollars in thousands; unaudited)
Twelve months	$	25,679
One to two years	5,460
Two to three years	1,682
Three to four years	905
Four to five years	147
	$	33,873

Our CCBX partners originate deposits and these deposits were primarily noninterest bearing prior to the rate increases in 2022 by the Federal Open Market Committee (“FOMC”). As a result of the interest rate increases, a significant portion of CCBX deposits that were not earning interest were reclassified to interest bearing deposits from noninterest bearing deposits during the first and second quarters of 2022. These CCBX deposits were reclassified because the current interest rate exceeded the minimum interest rate set in their respective program agreements, as a result of the first and second quarter 2022 interest rate increases. We do not expect additional CCBX deposits will be reclassified as a result of future rate increases.

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Note 6 - Leases

The Company has committed to rent premises used in business operations under non-cancelable operating leases and determines if an arrangement meets the definition of a lease upon inception.

Operating lease right-of-use (“ROU”) assets represent a right to use an underlying asset for the contractual lease term. Operating lease liabilities represent an obligation to make lease payments arising from the lease. An operating lease ROU asset and operating lease liability will be recognized for any new operating leases at the commencement of the new lease.

The Company’s leases do not provide an implicit interest rate, therefore the Company used its incremental collateralized borrowing rates commensurate with the underlying lease terms to determine the present value of operating lease liabilities.

The Company’s operating lease agreements contain both lease and non-lease components, which are generally accounted for separately. The Company’s lease agreements do not contain any residual value guarantees.

Operating leases with terms of 12 months or less are not included in ROU assets and operating lease liabilities recorded in the Company’s consolidated balance sheets. Operating lease terms include options to extend when it is reasonably certain that the Company will exercise such options, determined on a lease-by-lease basis. At September 30, 2022, lease expiration dates ranged from four months to 22.4 years, with additional renewal options on certain leases typically ranging from 5 to 10 years. At September 30, 2022, the weighted average remaining lease term inclusive of renewal options that the Company is reasonably certain to renew for the Company’s operating leases was 8.2 years.

Rental expense for operating leases is recognized on a straight-line basis over the lease term and amounted to $351,000 and $1.0 million, respectively, for the three and nine months ended September 30, 2022, and $343,000 and $1.0 million respectively, for the three and nine months ended September 30, 2021. Variable lease components, such as inflation adjustments, are expensed as incurred and not included in ROU assets and operating lease liabilities.

The following table presents the minimum annual lease payments under the terms of these leases, inclusive of renewal options that the Company is reasonably certain to renew, at September 30, 2022:


(dollars in thousands; unaudited)	September 30, 2022

October 1 to December 31, 2022	$	326
2023	1,272
2024	864
2025	713
2026	719
2027 and thereafter	2,490
Total lease payments	6,384
Less: amounts representing interest	870
Present value of lease liabilities	$	5,514

Table of Contents,

The following table presents the components of total lease expense and operating cash flows for the three and nine months ended September 30, 2022 and 2021:


	Three Months Ended				Nine Months Ended
	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
	(dollars in thousands; unaudited)
Lease expense:
Operating lease expense	$	320	$	321	$	961	$	962
Variable lease expense	52		37		137		108
Total lease expense (1)	$	372	$	358	$	1,098	$	1,070
Cash paid:
Cash paid reducing operating lease liabilities	$	371	$	356	$	1,090	$	1,061

(1)Included in net occupancy expense in the Condensed Consolidated Statements of Income (unaudited).

The Company entered into a five-year prepaid capital lease for ATM machines beginning October 1, 2021. The equipment is recorded as fixed assets on the Company’s balance sheet and depreciation expense is recognized on a straight-line basis over the term of the lease. Depreciation expense was $32,000 and $96,000, respectively, for the three and nine months ended September 30, 2022 and $34,000 and $100,000, respectively, for the three and nine months ended September 30, 2021, with $384,000 remaining as of September 30, 2022.

Note 7 - Stock-Based Compensation -

Stock Options and Restricted Stock

The 2018 Coastal Financial Corporation Omnibus Plan (2018 Plan) authorizes the Company to grant awards, including but not limited to, stock options, restricted stock units, and restricted stock awards, to eligible employees, directors or individuals that provide service to the Company, up to an aggregate of 500,000 shares of common stock. On May 24, 2021, the Company’s shareholders approved the First Amendment to the 2018 Plan, which increased the authorized plan shares by 600,000. The 2018 Plan replaces both the 2006 Plan and the Directors’ Stock Bonus Plan (2006 Plan). Existing awards will vest under the terms granted and no further awards will be granted under these prior plans. Shares available to be granted under the 2018 plan were 522,378 at September 30, 2022.

Stock Option Awards

The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. Expected volatilities are based on historical volatility of the Company’s stock and other factors. The Company uses the vesting term and contractual life to determine the expected life. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Compensation expense related to unvested stock option awards is reversed at date of forfeiture.

There were no new stock options granted in the three and nine months ended September 30, 2022 and 2021.

Table of Contents,

A summary of stock option activity under the 2018 Plan and 2006 Plan during the nine months ended September 30, 2022:


Options	Shares	Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
	(dollars in thousands, except per share amounts; unaudited)
Outstanding at December 31, 2021	694,519	$	7.79	4.0	$	29,744
Granted	—	—
Exercised	(41,725)	$	7.46
Forfeited or expired	(8,460)	9.92
Outstanding at September 30, 2022	644,334	$	7.79	3.2	$	20,589
Vested or expected to vest at September 30, 2022	644,334	$	7.79	3.2	$	20,589
Exercisable at September 30, 2022	397,553	$	6.77	2.2	$	13,108

The total or aggregate intrinsic value (which is the amount by which the stock price exceeds the exercise price) of options exercised during the three and nine months ended September 30, 2022 was $186,000 and $1.6 million, respectively. The total or aggregate intrinsic value of options exercised during the three and nine months ended September 30, 2021 was $101,000 and $775,000, respectively.

As of September 30, 2022, there was $1.2 million of total unrecognized compensation cost related to nonvested stock options granted under the 2018 Plan and 2006 Plan. Total unrecognized compensation costs are adjusted for unvested forfeitures. The Company expects to recognize that cost over a remaining weighted-average period of approximately 4.7 years. Compensation expense recorded related to stock options was $65,000 and $253,000 for the three and nine months ended September 30, 2022, respectively and $92,000 and $273,000 for the three and nine months ended September 30, 2021, respectively.

Restricted Stock Units

In the first quarter of 2022, the Company granted 53,721 restricted stock units under the 2018 Plan to employees, which vest ratably over 4 years and 150 restricted stock units which vest ratably over 10 years. In the second quarter of 2022, the Company granted 9,831 restricted stock units under the 2018 Plan to employees, which vest ratably over 5 years and 7,000 restricted stock units that vest ratably over 3 years. Additionally, the Company granted 53,000 performance-based restricted stock units under the 2018 Plan to an employee, that vest on June 1, 2028, the quantity of which is dependent upon achievement of specified performance goals. In the third quarter of 2022, the Company granted 20,000 restricted stock units under the 2018 Plan to employees, which vest in two blocks: 10,000 vest after 5 years and the remaining 10,000 vest after 7.5 years.

Restricted stock units provide for an interest in Company common stock to the recipient, the underlying stock is not issued until certain conditions are met. Vesting requirements include time-based, performance-based, or market-based conditions. Recipients of restricted stock units do not pay any cash consideration to the Company for the units and the holders of the restricted units do not have voting rights. The fair value of time-based and performance-based units is equal to the fair market value of the Company’s common stock on the grant date. The fair value of market-based units is estimated on the grant date using the Monte Carlo simulation model. Compensation expense is recognized over the vesting period that the awards are based. Restricted stock units are nonparticipating securities.

As of September 30, 2022, there was $9.4 million of total unrecognized compensation cost related to nonvested restricted stock units. The Company expects to recognize that cost over the remaining weighted-average vesting period of approximately 3.6 years. Compensation expense recorded related to restricted stock units was $518,000 and $1.3 million for the three and nine months ended September 30, 2022, respectively and $133,000 and $367,000 for the three and nine months ended September 30, 2021, respectively.

Table of Contents,

A summary of the Company’s nonvested RSUs at September 30, 2022 and changes during the nine month period is presented below:


Nonvested shares - RSUs	Shares	Weighted- Average Grant Date Fair Value		Total or Aggregate Intrinsic Value
	(dollars in thousands, except per share amounts; unaudited)
Nonvested shares at December 31, 2021	269,844	$	21.70	$	7,803
Granted	143,702	$	39.61
Forfeited	(5,716)	$	24.66
Vested	(26,137)	$	19.79
Nonvested shares at September 30, 2022	381,693	$	28.52	$	4,268

Restricted Stock Awards

Employees

There were no new restricted stock awards granted in the three or nine months ended September 30, 2022. The fair value of restricted stock awards is equal to the fair value of the Company’s stock at the date of grant. Compensation expense is recognized over the vesting period that the awards are based. Restricted stock awards are participating securities.

As of September 30, 2022, there was $48,000 of total unrecognized compensation cost related to nonvested restricted stock awards. The Company expects to recognize that cost over the remaining weighted-average vesting period of approximately 5.4 years. Compensation expense recorded related to restricted stock awards was $2,000 and $7,000 for the three and nine months ended September 30, 2022, respectively and $3,000 and $132,000 for the three and nine months ended September 30, 2021, respectively.

Director’s Stock Compensation

Under the 2018 Plan, eligible directors are granted stock with a total market value of $35,000, and the Board Chair is granted stock with a total market value of $55,000. Committee chairs will receive additional stock with a market value of $2,500 for each committee chaired. Stock is granted as of each annual meeting date and will cliff vest one day prior to the next annual meeting date. During the vesting period, the grants are considered participating securities.

There were 10,396 new shares granted during the three and nine months ended September 30, 2022. As of September 30, 2022, there was $249,000 of total unrecognized compensation expense related to director restricted stock awards which the Company expects to recognize over the remaining average vesting period of approximately 0.6 years. Director compensation expense recorded related to the 2018 Plan totaled $98,000 and $196,000 for the three and nine months ended September 30, 2022, respectively, and $43,000 and $133,000 for the three and nine months ended September 30, 2021, respectively.

Table of Contents,

A summary of the Company’s nonvested shares at September 30, 2022 and changes during the nine-month period is presented below:


Nonvested shares - RSAs	Shares	Weighted- Average Grant Date Fair Value		Total or Aggregate Intrinsic Value
	(dollars in thousands, except per share amounts; unaudited)
Nonvested shares at December 31, 2021	10,203	$	23.78	$	274
Granted	10,396	$	37.30
Forfeited	—	$	—
Vested	(7,203)	$	26.27
Nonvested shares at September 30, 2022	13,396	$	32.94	$	91

Note 8 - Fair Value Measurements

The following tables present estimated fair values of the Company’s financial instruments as of the period indicated, whether or not recognized or recorded in the consolidated balance sheets at the period indicated:


	September 30, 2022				Fair Value Measurements Using
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
	(dollars in thousands; unaudited)
Financial assets
Cash and due from banks	$	37,482	$	37,482	$	37,482	$	—	$	—
Interest earning deposits with other banks	373,246		373,246		373,246		—		—
Investment securities	98,871		98,753		97,316		1,437		—
Other investments	10,581		10,581		—		8,009		2,572
Loans held for sale	43,314		43,314		—		43,314
Loans receivable	2,507,889		2,548,820		—		—		2,548,820
Accrued interest receivable	13,114		13,114		—		13,114		—
Financial liabilities
Deposits	$	2,837,066	2,836,117		$	—	$	2,836,117	$	—
Subordinated debt	24,343		21,643		—		21,643		—
Junior subordinated debentures	3,588		3,464		—		3,464		—
Accrued interest payable	153		153		—		153		—

Table of Contents,


	December 31, 2021				Fair Value Measurements Using
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
	(dollars in thousands; unaudited)
Financial assets
Cash and due from banks	$	14,496	$	14,496	$	14,496	$	—	$	—
Interest earning deposits with other banks	798,665		798,665		798,665		—		—
Investment securities	36,623		36,675		34,998		1,677		—
Other investments	8,478		8,478		—		6,156		2,322
Loans receivable, net	1,714,103		1,686,124		—		—		1,686,124
Accrued interest receivable	8,105		8,105		—		8,105		—
Financial liabilities
Deposits	$	2,363,787	$	2,363,624	$	—	$	2,363,624	$	—
FHLB advances	24,999		24,447		—		24,447		—
Subordinated debt	24,288		21,891		—		21,891		—
Junior subordinated debentures	3,586		2,771		—		2,771		—
Accrued interest payable	357		357		—		357		—

The Company measures and discloses certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (that is, not a forced liquidation or distressed sale). GAAP establishes a consistent framework for measuring fair value and disclosure requirements about fair value measurements. Among other things, the accounting standard requires the reporting entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s estimates for market assumptions. These two types of inputs create the following fair value hierarchy:

•Level 1 – Quoted prices in active markets for identical instruments. An active market is a market in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

•Level 2 – Observable inputs other than Level 1 including quoted prices in active markets for similar instruments, quoted prices in less active markets for identical or similar instruments, or other observable inputs that can be corroborated by observable market data.

•Level 3 – Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs from nonbinding single dealer quotes not corroborated by observable market data.

The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize at a future date. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for certain financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values.

Table of Contents,

Items measured at fair value on a recurring basis – The following fair value hierarchy table presents information about the Company’s assets that are measured at fair value on a recurring basis at the dates indicated:


	Level 1		Level 2		Level 3		Total Fair Value
	(dollars in thousands; unaudited)
September 30, 2022
Available-for-sale
U.S. Treasury securities	$	97,316	$	—	$	—	$	97,316
U.S. Agency collateralized mortgage obligations	—		1		—		1
U.S. Agency residential mortgage-backed securities	—		54		—		54
Municipals	—		250		—		250
	$	97,316	$	305	$	—	$	97,621
December 31, 2021
Available-for-sale
U.S. Treasury securities	$	34,998	$	—	$	—	$	34,998
U.S. Agency collateralized mortgage obligations	—		70		—		70
U.S. Agency residential mortgage-backed securities	—		3		—		3
Municipals	—		256		—		256
	$	34,998	$	329	$	—	$	35,327

The following methods were used to estimate the fair value of the class of financial instruments above:

Investment securities - The fair value of securities is based on quoted market prices, pricing models, quoted prices of similar securities, independent pricing sources, and discounted cash flows.

Limitations: The fair value estimates presented herein are based on pertinent information available to management as of September 30, 2022 and December 31, 2021. The factors used in the fair values estimates are subject to change subsequent to the dates the fair value estimates are completed, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

Items measured at fair value on a nonrecurring basis – The following table presents financial assets and liabilities measured at fair value on a nonrecurring basis and the level within the fair value hierarchy of the fair value measurements for those assets at the dates indicated:


	Level 1		Level 2		Level 3		Total Fair Value
	(dollars in thousands; unaudited)
September 30, 2022
Impaired loans	$	—	$	—	$	7,061	$	7,061
Equity securities					2,572		2,572
Total	$	—	$	—	$	9,633	$	9,633

December 31, 2021
Impaired loans	$	—	$	—	$	221	$	221
Equity securities					2,322		2,322
Total	$	—	$	—	$	2,543	$	2,543

The amounts disclosed above represent the fair values at the time the nonrecurring fair value measurements were made, and not necessarily the fair value as of the dates reported on.

Table of Contents,

Impaired loans - A loan is considered impaired when it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. Impairment is measured based on the fair value of the underlying collateral or the discounted cash expected future cash flows. Subsequent changes in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported. Impaired loans are evaluated quarterly to determine if valuation adjustments should be recorded. The need for valuation adjustments arises when observable market prices or current appraised values of collateral indicate a shortfall in collateral value compared to current carrying values of the related loan. If the Company determines that the value of the impaired loan is less than the carrying value of the loan, the Company either establishes an impairment reserve as a specific component of the allowance for loan losses or charges off the impairment amount. These valuation adjustments are considered nonrecurring fair value adjustments.

Equity securities – The Company measures equity securities without readily determinable fair values at cost less impairment (if any), plus or minus observable price changes from an identical or similar investment of the same issuer, with price changes recognized in earnings.

Assets measured at fair value using significant unobservable inputs (Level 3)

The following table presents the carrying value of equity securities without readily determinable fair values, as of September 30, 2022, with adjustments recorded during the periods presented for those securities with observable price changes, if applicable. These equity securities are included in other investments on the balance sheet.


	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
(dollars in thousands; unaudited)	2022		2021		2022		2021
Carrying value, beginning of period	$	2,672	$	850	$	2,322	$	850
Purchases	—		—		350		—
Net change recognized in earnings	(100)		1,472		(100)		1,472
Carrying value, end of period	$	2,572	$	2,322	$	2,572	$	2,322

The following table provides a description of the valuation technique, unobservable inputs, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a nonrecurring basis at the dates indicated:

(unaudited)

Valuation Technique

Unobservable Inputs

September 30, 2022

Weighted

Average Rate

December 31, 2021

Weighted

Average Rate

Impaired loans

Collateral valuations

Discount to appraised value

8.0%

Table of Contents,

Note 9 - Earnings Per Common Share

The following is a computation of basic and diluted earnings per common share at the periods indicated:


	Three Months Ended				Nine Months Ended
	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
	(dollars in thousands, except share data; unaudited)
Net Income	$	11,101	$	6,684	$	27,507	$	19,715
Basic weighted average number common shares outstanding	12,938,200		11,999,899		12,921,814		11,982,009
Dilutive effect of equity-based awards	598,623		456,775		563,136		483,337
Diluted weighted average number common shares outstanding	13,536,823		12,456,674		13,484,950		12,465,346
Basic earnings per share	$	0.86	$	0.56	$	2.13	$	1.65
Diluted earnings per share	$	0.82	$	0.54	$	2.04	$	1.58
Antidilutive stock options and restricted stock outstanding	52,840		160,668		52,840		160,668

Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings, however the difference in the two-class method was not significant.

Note 10 – Segment Reporting

As defined in ASC 280, Segment Reporting, an operating segment is a component of an enterprise that engages in business activities from which it may earn revenues and incur expenses, whose operating results are regularly reviewed by the enterprise’s chief operating decision makers to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available. We evaluate performance based on an internal performance measurement accounting system, which provides line of business results. This system uses various techniques to assign balance sheet and income statement amounts to the business segments, including allocations of income and expense. A primary objective of this measurement system and related internal financial reporting practices are to produce consistent results that reflect the underlying financial impact of the segments on the Company and to provide a basis of support for strategic decision making. The accounting policies applicable to our segments are those that apply to our preparation of the accompanying Consolidated Financial Statements. Based on these criteria, we have identified two segments: the community bank and CCBX.

Income and expenses that are specific to CCBX are recorded to the CCBX segment. Additionally, certain indirect expenses are allocated to CCBX utilizing various metrics, such as number of employees, utilization of space, and allocations based on loan and deposit balances. Included in noninterest expense for the community bank is administrative overhead of $7.9 million and $5.2 million for the quarters ended September 30, 2022 and September 30, 2021, respectively. Included in noninterest expense for the community bank is administrative overhead of $19.8 million and $13.9 million for the nine months ended September 30, 2022 and September 30, 2021, respectively. Both the community bank and the CCBX segment benefit from this administrative overhead and services, which includes shared operational activities such as data management, compliance monitoring and other administration functions.

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Summarized financial information concerning the Company's reportable segments and the reconciliation to the consolidated financial results is shown in the following tables for the periods indicated:


	September 30, 2022						December 31, 2021
	Bank		CCBX		Total		Bank		CCBX		Total
	(dollars in thousands; unaudited)
Total assets	$	2,140,820	$	992,921	$	3,133,741	$	2,282,514	$	353,003	$	2,635,517
Loans held for sale	—		43,314		43,314		—		—		—
Total loans receivable	1,592,320		915,569		2,507,889		1,396,060		346,675		1,742,735
Allowance for loan losses	(20,139)		(39,143)		(59,282)		(20,299)		(8,333)		(28,632)
Total deposits	1,634,796		1,202,270		2,837,066		1,647,529		716,258		2,363,787


	Three months ended September 30, 2022						Three months ended September 30, 2021
	Bank		CCBX		Total		Bank		CCBX		Total
	(dollars in thousands; unaudited)
Net interest income	$	22,815	$	26,374	$	49,189	$	17,359	$	1,448	$	18,807
Provision for loan losses	(238)		18,666		18,428		192		63		255
Noninterest income (1)	1,113		33,278		34,391		3,783		2,349		6,132
Noninterest expense	17,765		33,322		51,087		13,811		2,319		16,130

(1)For the three months ended September 30, 2022, CCBX noninterest income includes credit enhancements of $17.9 million, fraud enhancements of $11.7 million, and BaaS program income of $3.6 million. For the three months ended September 30, 2021, CCBX noninterest income includes credit enhancements of $10,000, fraud enhancements of $296,000 and BaaS program income of $2.0 million.


	Nine Months Ended September 30, 2022						Nine Months Ended September 30, 2021
	Bank		CCBX		Total		Bank		CCBX		Total
	(dollars in thousands; unaudited)
Net interest income	$	60,171	$	58,172	$	118,343	$	52,038	$	2,696	$	54,734
Provision for loan losses	214		45,250		45,464		877		96		973
Noninterest income (1)	4,426		77,443		81,869		9,175		4,723		13,898
Noninterest expense	50,113		69,558		119,671		37,159		5,054		42,213

(1)For the nine months ended September 30, 2022, CCBX noninterest income includes credit enhancements of $45.2 million, fraud enhancements of $22.8 million and BaaS program income of $9.3 million. For the nine months ended September 30, 2021, CCBX noninterest income includes credit enhancements of $10,000, fraud enhancements of $296,000 and BaaS program income of $4.4 million.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are a bank holding company that operates through our wholly owned subsidiaries, Coastal Community Bank (“Bank”) and Arlington Olympic LLC. We are headquartered in Everett, Washington, which by population is the largest city in, and the county seat of, Snohomish County. Our business is conducted through two reportable segments: the community bank and CCBX. The primary focus of the community bank is on providing a wide range of banking products and services to consumers and small to medium sized businesses in the broader Puget Sound region in the state of Washington and through the Internet and our mobile banking application. We currently operate 14 full-service banking locations, 12 of which are located in Snohomish County, where we are the largest community bank by deposit market share, and two of which are located in neighboring counties (one in King County and one in Island County). The CCBX segment provides banking as a service (“BaaS”) that allows our broker-dealer and digital financial service partners to offer their customers banking services. The CCBX segment has 29 partners as of September 30, 2022. The Bank’s deposits are insured in whole or in part by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is subject to regulation by the Federal Reserve and the Washington State Department of Financial Institutions Division of Banks. The Federal Reserve also has supervisory authority over the Company.

As of September 30, 2022, we had total assets of $3.13 billion, total loans receivable of $2.51 billion, total deposits of $2.84 billion and total shareholders’ equity of $228.7 million.

The following discussion and analysis presents our financial condition and results of operations on a consolidated basis. However, because we conduct all of our material business operations through the Bank, the discussion and analysis relate to activities primarily conducted by the Bank.

We generate most of our community bank revenue from interest on loans and investments and CCBX revenue from interest on loans and BaaS income. Our primary source of funding for our loans is commercial and retail deposits from our customer relationships and from our partner deposit relationships. We place secondary reliance on wholesale funding, primarily borrowings from the Federal Home Loan Bank (“FHLB”). Less commonly used sources of funding include borrowings from the Federal Reserve System ("Federal Reserve") discount window, draws on established federal funds lines from unaffiliated commercial banks, brokered funds, which allows us to obtain deposits from sources that do not have a relationship with the Bank and can be obtained through certificate of deposit listing services, via the internet or through other advertising methods, or a one-way buy through an insured cash sweep (“ICS”) account, which allows us to obtain funds from other institutions that have deposited funds through ICS. Our largest expenses are salaries and employee benefits, provision for loan losses, interest on deposits and borrowings, legal and professional fees, occupancy and data processing. Our principal lending products are commercial real estate loans, commercial and industrial loans, consumer loans, residential real estate loans, and construction, land and land development loans.

Recent Developments

On November 1, 2022 we completed a private placement of $20.0 million in fixed-to-floating rate subordinated notes due November 1, 2032 (the “Notes”). The Notes will bear interest at a fixed annual rate of 7.00% for the first five years and will reset quarterly thereafter to the then-current three-month Secured Overnight Financing Rate ("SOFR") plus 290 basis points. We intend to use the net proceeds from the offering for general corporate purposes. We are entitled to redeem the Notes, in whole or in part, on any interest payment date on or after November 1, 2027, or at any time, in whole but not in part, upon certain other specified events prior to the Notes’ maturity on November 1, 2032.

Coronavirus Aid, Relief, and Economic Security (“CARES”) Act and PPP Overview

Our financial results for the three and nine months ended September 30, 2022 and 2021 were impacted by the coronavirus, and variants thereof (“COVID-19”), pandemic. On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was enacted, providing wide ranging economic relief for individuals and businesses impacted by the COVID-19 pandemic. Among other things, the statute created the Paycheck Protection Program (“PPP”), which was a stimulus response to the potential economic impacts of the COVID-19 pandemic. The purpose of the PPP was to provide forgivable loans to smaller businesses, sole proprietorships, independent contractors, and self-employed individuals that used the proceeds of the loans for payroll and certain other qualifying expenses.

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In total, we funded $763.9 million in PPP loans since the first round of PPP loans opened in March 2020, through the close of round three. Total net deferred fees on these loans were $26.3 million. As of September 30, 2022, there were $5.8 million in PPP loans outstanding, compared to $267.3 million as of September 30, 2021.

London Interbank Offered Rate (“LIBOR”) Transition

On March 5, 2021, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, confirmed that the publication of most LIBOR term rates will end on June 30, 2023 (excluding 1-week U.S. LIBOR and 2-month U.S. LIBOR, the publication of which ended December 31, 2021). On April 6, 2021, New York Governor Cuomo signed into law legislation that provides for the substitution of an alternative reference rate, the SOFR, in any LIBOR-based contract governed by New York state law that does not include clear fallback language, once LIBOR is discontinued but no later than December 31, 2021. The Federal Reserve and other federal banking agencies have continued to encourage banks to transition away from LIBOR as soon as practicable. On March 15, 2022, President Biden signed into law the Adjustable Interest Rate (LIBOR) Act (the “LIBOR Act”), which was included as part of a larger Consolidated Appropriations Act, 2022. The LIBOR Act provides a nationwide process for replacing LIBOR in financial contracts that mature after the cessation of the overnight, one-, three-, six- and 12-month USD LIBOR tenors on June 30, 2023 and that do not provide for an effective means to replace LIBOR upon its cessation. For contracts in which a party has the discretion to identify a replacement rate, the LIBOR Act also provides a safe harbor to parties if they choose the SOFR-based benchmark replacement rate to be identified by the Federal Reserve. The Federal Reserve published a notice of proposed rulemaking on July 28, 2022 that would implement the LIBOR Act by replacing reference to LIBOR with the applicable selected replacement rate after June 30, 2023 for certain contracts, including those that do not mature before LIBOR ends and that lack adequate fallback provisions. For more information on the Company’s approach to LIBOR transition planning, please see the risk factors discussed in the Company’s annual report on Form 10-K for the year ended December 31, 2021.

As of September 30, 2022, we had 54 loans totaling $212.3 million that are tied to LIBOR. We have $3.6 million in floating rate junior subordinated debentures to Coastal (WA) Statutory Trust I, which was formed for the issuance of trust preferred securities. These debentures are also tied to LIBOR. The move to an alternate index may impact the rates we receive on loans and rates we pay on our junior subordinated debentures. We have identified the loans and debt instruments impacted, are reviewing LIBOR replacement options and are preparing for and evaluating the impact of the transition from LIBOR. We are no longer issuing any loans or debt tied to LIBOR.

Community Reinvestment Act

On May 5, 2022 the federal banking agencies issued a proposed rule that would substantially revise how they evaluate an insured depository institution’s record of satisfying the credit needs of its entire communities, including low- and moderate-income individuals and neighborhoods, under the Community Reinvestment Act (“CRA”). The proposed rule would impose new requirements on a “large” bank (one with greater than $2 billion in average assets for two prior calendar years) including new methods of evaluating a large bank that provides retail credit on a nationwide basis. Among other things, the proposed rule would evaluate a large bank’s retail lending distribution in new retail lending assessment areas where a bank has a concentration of home mortgage or small business loans, in addition to facility-based assessment areas where the bank has branches, as well as in the broader nationwide area in which the bank does not have assessment areas. We continue to evaluate potential impacts of the proposed rule on the Bank, including as a result of the CCBX segment’s activities.

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Results of Operations

Net Income

Comparison of the quarter ended September 30, 2022 to the comparable quarter in the prior year

Net income for the three months ended September 30, 2022 was $11.1 million, or $0.82 per diluted share, compared to $6.7 million, or $0.54 per diluted share, for the three months ended September 30, 2021. The increase in net income over the comparable period in the prior year was primarily attributable to a $35.6 million increase in interest income and $28.3 million increase in noninterest income. These were partially offset by an increase in the provision for loan losses of $18.2 million, related to CCBX loan growth, and $35.0 million more in noninterest expense, also largely related to loan growth. The increase in noninterest income, provision expense and noninterest expense are all largely related to CCBX growth. In accordance with GAAP, we recognize as revenue (1) the reimbursement of non-credit fraud losses on partner’s customer loans and deposits and (2) the indemnification obligation, also known as credit enhancements, that our partners provide for expected loan losses related to loans they originate and unfunded commitments from such loans. Partner customer credit losses are recognized in the allowance for loan loss and non-credit fraud loss is recognized in BaaS noninterest expense. For more information on the accounting for BaaS allowance for loan losses, reserve for unfunded commitments, credit enhancements and fraud enhancements see the section titled “CCBX – BaaS Reporting Information.”

Comparison of the nine months ended September 30, 2022 to the comparable period in the prior year

Net income for the nine months ended September 30, 2022 was $27.5 million, or $2.04 per diluted share, compared to $19.7 million, or $1.58 per diluted share, for the nine months ended September 30, 2021. The increase in net income over the comparable period in the prior year was primarily attributable to a $69.6 million increase in interest income and $68.0 million increase in noninterest income. These were partially offset by an increase in the provision for loan losses of $44.5 million, related primarily to CCBX loan growth, and $77.5 million more in noninterest expense, also largely related to loan growth. The increase in noninterest income and noninterest expense are largely related to CCBX growth.

Net Interest Income

Comparison of the quarter ended September 30, 2022 to the comparable quarter in the prior year

Net interest income for the three months ended September 30, 2022 was $49.2 million, compared to $18.8 million for the three months ended September 30, 2021, an increase of $30.4 million, or 161.5%. Yield on loans receivable was 8.46% for the three months ended September 30, 2022, compared to 4.57% for the three months ended September 30, 2021. The increase in net interest income compared to September 30, 2021 was largely related to increased yield on loans from growth in higher yielding CCBX loans and the overall increase in interest rates resulting from the Federal Open Market Committee (“FOMC”) raising rates 3.0% during the nine months ended September 30, 2022, with the most recent increase during such period on September 21, 2022. This increase in interest rates impacts our existing variable rate loans as well as rates on new loans. The impact of these increases in interest rates will continue to be seen in future quarters. Average loans receivable for the three months ended September 30, 2022 was $2.45 billion, compared to $1.68 billion for the three months ended September 30, 2021.

Interest and fees on loans totaled $52.3 million for the three months ended September 30, 2022 compared to $19.4 million for the three months ended September 30, 2021. The $32.9 million increase in interest and fees on loans for the quarter ended September 30, 2022, compared to September 30, 2021, was largely due to increased yield on loans from growth in higher yielding CCBX loans combined with the overall increase in interest rates. Total loans receivable was $2.51 billion at September 30, 2022, compared to $1.71 billion at September 30, 2021. CCBX loan growth was strong during the quarter with average loans receivable of $893.7 million for the quarter ended September 30, 2022, compared to $160.0 million for the quarter ended September 30, 2021, an increase of $733.6 million, or 458.5%. Average CCBX yield of 13.96% was earned on CCBX loans for the quarter ended September 30, 2022, compared to 3.65% for the quarter ended September 30, 2021. CCBX yield does not include the impact of BaaS loan expense. BaaS loan expense represents the amount paid or payable to partners for credit enhancements, fraud enhancements and servicing CCBX loans. The tables later in this section illustrate the impact of BaaS loan expense on CCBX loan yield. Also impacting the increase in loan interest is the increase in interest rates on variable rate loans resulting from the FOMC raising rates 3.0% during the nine months ended September 30, 2022, with the most recent increase during such period on September 21, 2022. We continue to monitor the impact of these increases in interest rates.

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Interest income from interest earning deposits with other banks was $2.3 million for the quarter ended September 30, 2022, an increase of $2.1 million, or 1,237.1%, due to higher interest rates, compared to the quarter ended September 30, 2021. The average balance of interest earning deposits invested with other banks for the three months ended September 30, 2022 was $397.6 million, compared to $419.7 million for the three months ended September 30, 2021. This decrease was a result of increased loan demand. The yield on these interest earning deposits with other banks increased 2.11%, to 2.27% compared to 0.16% at September 30, 2021. Interest income on investment securities increased $530,000 to $554,000 at September 30, 2022, compared to $24,000 at September 30, 2021. Average investment securities increased $69.9 million from $33.8 million for the three months ended September 30, 2021, to $103.7 million for the three months ended September 30, 2022, and average yield increased to 2.12% for the three months ended September 30, 2022, compared to 0.28% for the three months ended September 30, 2021.

Interest expense was $6.0 million for the quarter ended September 30, 2022, a $5.2 million increase from the quarter ended September 30, 2021. Interest expense on deposits was $5.7 million for the quarter ended September 30, 2022, compared to $523,000 for the quarter ended September 30, 2021. The $5.2 million increase in interest expense on deposits was due to an increase of $1.03 billion in interest bearing deposits as well as a 94 basis point increase in interest rates on deposit accounts. Interest on borrowed funds was $273,000 for the quarter ended September 30, 2022, compared to $278,000 for the quarter ended September 30, 2021. The $5,000 decrease in interest expense on borrowed funds from the quarter ended September 30, 2021 is the result of a decrease in average FHLB borrowings, which were paid off in the quarter ended March 31, 2022, partially offset by an $11.9 million average balance increase in subordinated debt, which increased during the quarter ended September 30, 2021. Interest expense is expected to increase as a result of the FOMC increasing rates. In addition, as a result of the Fed Funds rate increases, CCBX deposits that were below their floor to earn interest due to the low interest rate environment and not earning interest were reclassified to interest bearing deposits from noninterest bearing deposits in the first and second quarter of 2022. We anticipate additional rate increases in 2022, which we expect will result in higher interest expense on interest bearing deposits which we expect will be offset by higher interest rates on CCBX loans and excess cash invested in the Federal Reserve Bank or other banks.

Net interest margin was 6.58% for the three months ended September 30, 2022, compared to 3.48% for the three months ended September 30, 2021. The increase in net interest margin compared to the three months ended September 30, 2021 was largely a result of an increase in higher rate loans. Average loans increased $771.7 million compared to the three months ended September 30, 2021. Also contributing to the increase in net interest margin compared to the three months ended September 30, 2021 was interest earning deposits invested in other banks, which earned an average rate of 227 basis points for the quarter ended September 30, 2022, compared to an average rate of 16 basis points for the quarter ended September 30, 2021.

Cost of funds was 0.85% for the quarter ended September 30, 2022, which is an increase of 69 basis points from the quarter ended September 30, 2021. Cost of deposits for the quarter ended September 30, 2022 was 0.82%, which was an 72 basis point increase, from 0.10% for the quarter ended September 30, 2021. These increases were largely due to an increase in interest bearing deposits and a higher interest rate environment. CCBX deposit growth and the aforementioned reclassification of CCBX noninterest bearing deposits to interest bearing deposits in the first and second quarter of 2022, that resulted from the Fed Funds rate increases, also contributed to the increase in interest expense.

Total yield on loans receivable for the quarter ended September 30, 2022 was 8.46%, compared to 4.57% for the quarter ended September 30, 2021. This increase in yield on loans receivable is primarily attributed to an increase in higher rate CCBX loans. For the quarter ended September 30, 2022, average CCBX loans increased $733.6 million, or 458.5%, with an average CCBX yield of 13.96%, compared to 3.65% at the quarter ended September 30, 2021. CCBX yield does not include the impact of BaaS loan expense. BaaS loan expense represents the amount paid or payable to partners for credit enhancements, fraud enhancements and servicing CCBX loans. The tables later in this section illustrate the impact of BaaS loan expense on CCBX loan yield. Average community bank loans increased $38.1 million. This increase includes a decrease in average in PPP loans of $311.3 million, compared to the quarter ended September 30, 2021. Average yield on community bank loans for the three months ended September 30, 2022 was 5.31% compared to 4.67% for the three months ended September 30, 2021.

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The following tables show the average yield on loans and cost of deposits by segment and also illustrates the impact of BaaS loan expense on CCBX yield on loans:


	For the Three Months Ended
	September 30, 2022		September 30, 2021
(unaudited)	Yield on Loans (2)	Cost of Deposits (2)	Yield on Loans (2)	Cost of Deposits (2)
Community Bank	5.31%	0.16%	4.67%	0.13%
CCBX(1)	13.96%	1.79%	3.65%	0.02%
Consolidated	8.46%	0.82%	4.57%	0.10%

(1)CCBX yield on loans does not include the impact of BaaS loan expense. BaaS loan expense represents the amount paid or payable to partners for credit enhancements, fraud enhancements and servicing CCBX loans. To determine net BaaS loan income earned from CCBX loan relationships, the Company takes BaaS loan interest income and deducts BaaS loan expense to arrive at net BaaS loan income which can be compared to interest income on the Company’s community bank loans.

(2)Annualized calculations shown for periods presented.


	For the Three Months Ended
	September 30, 2022				September 30, 2021
(dollars in thousands, unaudited)	Income / Expense		Income / expense divided by average CCBX loans (2)		Income / Expense		Income / expense divided by average CCBX loans (2)
BaaS loan interest income	$	31,449	13.96	%	$	1,471	3.65	%
Less: BaaS loan expense	15,560		6.91	%	419		1.04	%
Net BaaS loan income (1)	$	15,889	7.05	%	$	1,052	2.61	%
Average BaaS Loans	$	893,655			$	160,022

(1)A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”

(2)Annualized calculations shown for periods presented.

For the three months ended September 30, 2022, net interest margin (net interest income divided by the average total interest earning assets) and net interest spread (average yield on total interest earning assets minus average cost of total interest bearing liabilities) were 6.58% and 6.18%, respectively, compared to 3.48% and 3.30%, respectively, for the three months ended September 30, 2021.

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The following table presents an analysis of the average balances of net interest income, net interest spread and net interest margin for the periods indicated. Loan fees included in interest income totaled $(100,000) and $3.5 million for the three months ended September 30, 2022 and 2021, respectively. For the three months ended September 30, 2022 and 2021, the amount of interest income not recognized on nonaccrual loans was not material.


	Average Balance Sheets For the Three Months Ended September 30,
	2022						2021
(dollars in thousands; unaudited)	Average Balance		Interest & Dividends		Yield / Cost (1)		Average Balance		Interest & Dividends		Yield / Cost (1)
Assets
Interest earning assets:
Interest earning deposits	$	397,621	$	2,273	2.27	%	$	419,715	$	170	0.16	%
Investment securities, available for sale (2)	102,438		545		2.11		31,693		9		0.11
Investment securities, held to maturity (2)	1,257		9		2.84		2,095		15		2.84
Other investments	10,520		24		0.91		6,859		31		1.79
Loans receivable (3)	2,452,815		52,328		8.46		1,681,069		19,383		4.57
Total interest earning assets	2,964,651		55,179		7.38		2,141,431		19,608		3.63
Noninterest earning assets:
Allowance for loan losses	(51,259)						(20,102)
Other noninterest earning assets	128,816						77,221
Total assets	$	3,042,208					$	2,198,550

Liabilities and Shareholders’ Equity
Interest bearing liabilities:
Interest bearing deposits	$	1,953,170	$	5,717	1.16	%	$	919,792	$	523	0.23	%

FHLB advances and borrowings	—		—		0.00		24,999		72		1.14
Subordinated debt	24,331		234		3.82		17,073		185		4.30
Junior subordinated debentures	3,587		39		4.31		3,586		21		2.32
Total interest bearing liabilities	1,981,088		5,990		1.20		965,450		801		0.33
Noninterest bearing deposits	807,952						1,061,311
Other liabilities	25,662						13,705
Total shareholders' equity	227,506						158,084
Total liabilities and shareholders' equity	$	3,042,208					$	2,198,550
Net interest income			$	49,189					$	18,807
Interest rate spread					6.18	%					3.30	%
Net interest margin (4)					6.58	%					3.48	%

(1)Yields and costs are annualized.

(2)For presentation in this table, average balances and the corresponding average rates for investment securities are based upon historical cost, adjusted for amortization of premiums and accretion of discounts.

(3)Includes loans held for sale and nonaccrual loans.

(4)Net interest margin represents net interest income divided by the average total interest earning assets.

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The following table presents an analysis of certain average balances, interest income and interest expense by segment:


	For the Three Months Ended
	September 30, 2022						September 30, 2021
(dollars in thousands, unaudited)	Average Balance		Interest & Dividends		Yield / Cost (1)		Average Balance		Interest & Dividends		Yield / Cost (1)
Community Bank
Assets
Loans receivable (2)	$	1,559,160	$	20,879	5.31	%	$	1,521,047	$	17,912	4.67	%
Liabilities
Interest bearing deposits	901,339		642		0.28		888,485		500		0.22
Noninterest bearing deposits	735,038						696,906
Total deposits	1,636,377		642		0.16		1,585,391		500		0.13

CCBX
Assets
Loans receivable (2)(3)	$	893,655	$	31,449	13.96	%	$	160,022	$	1,471	3.65	%
Liabilities
Interest bearing deposits	1,051,831		5,075		1.91		31,307		23		0.29
Noninterest bearing deposits	72,914						364,405
Total deposits	1,124,745		5,075		1.79		395,712		23		0.02

(1)Yields and costs are annualized.

(2)Includes loans held for sale and nonaccrual loans.

(3)CCBX yield does not include the impact of BaaS loan expense. BaaS loan expense represents the amount paid or payable to partners for credit enhancements, fraud enhancements and servicing CCBX loans.

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The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest earning assets and interest bearing liabilities and distinguishes between the changes attributable to changes in volume and changes attributable to changes in interest rates. The table illustrates the $16.5 million increase in loan interest income that is attributed to an increase in loan rates and $16.5 million increase in loan interest income that is attributed to an increase in loan volume. For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to volume.


	Three months ended September 30, 2022 Compared to Three months ended September 30, 2021
	Increase (Decrease) Due to				Total Increase (Decrease)
(dollars in thousands; unaudited)	Volume		Rate
Interest income:
Interest earning deposits	$	(126)	$	2,229	$	2,103
Investment securities, available for sale	376		160		536
Investment securities, held to maturity	(6)		—		(6)
Other Investments	9		(16)		(7)
Loans receivable	16,464		16,481		32,945
Total increase in interest income	16,717		18,854		35,571

Interest expense:
Interest bearing deposits	3,025		2,169		5,194

FHLB advances and other borrowings	(72)		—		(72)
Subordinated debt	70		(21)		49
Junior subordinated debentures	—		18		18
Total increase in interest expense	3,023		2,166		5,189
Increase in net interest income	$	13,694	$	16,688	$	30,382

Comparison of the nine months ended September 30, 2022 to the comparable period in the prior year

Net interest income for the nine months ended September 30, 2022, was $118.3 million, compared to $54.7 million for the nine months ended September 30, 2021, an increase of $63.6 million, or 116.2%. Yield on loans receivable was 7.63% for the nine months ended September 30, 2022, compared 4.51% for the nine months ended September 30, 2021. The increase in net interest income compared to the nine months ended September 30, 2021 was largely related to increased yield on loans from growth in higher yielding CCBX loans. Average loans receivable for the nine months ended September 30, 2022 was $2.14 billion, compared to $1.69 billion for the nine months ended September 30, 2021.

Interest and fees on loans totaled $122.1 million for the nine months ended September 30, 2022 compared to $57.0 million for the nine months ended September 30, 2021. The $65.1 million increase in interest and fees on loans for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021, was largely due to increased yield on loans from growth in higher yielding CCBX loans and an overall increase in interest rates. Loan growth of $802.2 million, or 47.0%, for the nine months ended September 30, 2022, compared to September 30, 2021, includes a decrease of $261.5 million in PPP loans that were forgiven or repaid. CCBX average loans receivable grew to $657.6 million for the nine months ended September 30, 2022, compared to $113.4 million for the nine months ended September 30, 2021, an increase of $544.2 million, or 480.0%. Average CCBX yield of 13.16% was earned on CCBX loans for the nine months ended September 30, 2022, compared to 3.26% for the nine months ended September 30, 2021. CCBX yield does not include the impact of BaaS loan expense. BaaS loan expense represents the amount paid or payable to partners for credit enhancements, fraud enhancements and servicing CCBX loans. The tables later in this section illustrate the impact of BaaS loan expense on CCBX loan yield. Also impacting the increase in loan interest is the increase in interest rates on variable rate loans resulting from the FOMC raising rates 3.0% during the nine months ended September 30, 2022, with the most recent increase during such period on September 21, 2022. We continue to monitor the impact of these increases in interest rates.

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Interest income from interest earning deposits with other banks was $3.6 million at September 30, 2022, an increase of $3.3 million due to an increase in balances and higher interest rates, compared to September 30, 2021. The average balance of interest earning deposits invested with other banks for the nine months ended September 30, 2022 was $578.9 million, compared to $284.2 million for the nine months ended September 30, 2021. Additionally, the yield on these interest earning deposits with other banks increased 0.69%, compared to the nine months ended September 30, 2021. Interest income on investment securities increased $1.1 million to $1.2 million, or 1.76%, at September 30, 2022, compared to $76,000, or 0.37%, at September 30, 2021. Average investment securities increased $62.8 million from $27.7 million for the nine months ended September 30, 2022 to $90.4 million for the nine months ended September 30, 2022, and average yield increased to 1.76% for the nine months ended September 30, 2022, compared to 0.37% for the nine months ended September 30, 2021.

Interest expense was $8.8 million for the nine months ended September 30, 2022, a $6.0 million increase from the nine months ended September 30, 2021. Interest expense on deposits was $7.9 million for the nine months ended September 30, 2022, compared to $1.8 million for the nine months ended September 30, 2021. The $6.1 million increase in interest expense on deposits was primarily due to an increase in average interest bearing deposits of $736.2 million. Interest on borrowed funds was $854,000 for the nine months ended September 30, 2022, compared to $992,000 for the nine months ended September 30, 2021. The $138,000 decrease in interest expense on borrowed funds from the nine months ended September 30, 2021 is the result of a decrease in average PPPLF and FHLB borrowings, which were paid off in full during the quarter ended June 30, 2021 and March 31, 2022, respectively, partially offset by a $11.9 million average balance increase in subordinated debt, which increased during the quarter ended September 30, 2021. Interest expense is expected to increase as a result of the FOMC increasing the Fed Funds rate 3.0% during the nine months ended September 30, 2022, with the most recent increase during such period on September 21, 2022. In addition, as a result of the FOMC rate increase, CCBX deposits that were below their floor to earn interest due to the low interest rate environment and were not earning interest were reclassified to interest bearing deposits from noninterest bearing deposits during the first and second quarters of 2022. We anticipate additional rate increases in 2022, which we expect will result in higher interest expense on interest bearing deposits which will be offset by higher interest rates on CCBX loans and excess cash invested in the Federal Reserve Bank or other banks.

Net interest margin was 5.61% for the nine months ended September 30, 2022, compared to 3.64% for the nine months ended September 30, 2021. The increase in net interest margin compared to the nine months ended September 30, 2021 was largely a result of an increase in higher rate loans. Average loans increased $450.3 million, compared to the nine months ended September 30, 2021; the increase includes an average decrease in PPP loans of $394.0 million. Also contributing to the increase in net interest margin compared to the nine months ended September 30, 2021 was a $294.6 million increase in average interest earning deposits invested in other banks. These interest earning deposits earned an average rate of 84 basis points for the nine months ended September 30, 2022, compared to an average rate of 15 basis points for the nine months ended September 30, 2021.

Cost of funds was 0.44% for the nine months ended September 30, 2022, compared to 0.20% for the nine months ended September 30, 2021. Cost of deposits for the nine months ended September 30, 2022 was 0.41%, which was a 27 basis point increase, from 0.14% for the nine months ended September 30, 2021. These increases were largely due to an increase in interest bearing deposits and an increase in interest rates. CCBX deposit growth and the aforementioned reclassification of CCBX noninterest bearing deposits to interest bearing deposits also contributed to the increase in interest expense.

Total yield on loans receivable for the nine months ended September 30, 2022 was 7.63%, compared to 4.51% for the nine months ended September 30, 2021. This increase in yield on loans receivable is primarily attributed to an increase in higher rate CCBX loans. As of the nine months ended September 30, 2022, average CCBX loans increased $544.2 million, or 480.0%, with an average CCBX yield of 13.16%, compared to 3.26% at September 30, 2021. CCBX yield does not include the impact of BaaS loan expense. BaaS loan expense represents the amount paid or payable to partners for credit enhancements, fraud enhancements and servicing CCBX loans. The tables later in this section illustrate the impact of BaaS loan expense on CCBX loan yield. There was a decrease in average community bank loans of $93.9 million, or 6.0%, which is attributed to an average $394.0 million decrease in PPP loans as a result of loan forgiveness and repayments, compared to the nine months ended September 30, 2021. Average yield on community bank loans for the nine months ended September 30, 2022 was 5.17%. compared to 4.60% for the nine months ended September 30, 2021.

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The following tables show the average yield on loans and cost of deposits by segment and also illustrates the impact of BaaS loan expense on CCBX yield on loans:


	For the Nine Months Ended
	September 30, 2022		September 30, 2021
(unaudited)	Yield on Loans (2)	Cost of Deposits (2)	Yield on Loans (2)	Cost of Deposits (2)
Community Bank	5.17%	0.11%	4.60%	0.15%
CCBX (1)	13.16%	0.91%	3.26%	0.04%
Consolidated	7.63%	0.41%	4.51%	0.14%

(2)Annualized calculations shown for periods presented.


	For the Nine Months Ended
	September 30, 2022				September 30, 2021
(dollars in thousands; unaudited)	Income / Expense		Income / expense divided by average CCBX loans (2)		Income / Expense		Income / expense divided by average CCBX loans (2)
BaaS loan interest income	$	64,721	13.16	%	$	2,761	3.26	%
Less: BaaS loan expense	36,079		7.34	%	609		0.72	%
Net BaaS loan income (1)	$	28,642	5.82	%	$	2,152	2.54	%
Average BaaS Loans	$	657,574			$	113,369

(1)A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”

(2)Annualized calculations shown for periods presented.

For the nine months ended September 30, 2022, net interest margin (net interest income divided by the average total interest earning assets) and net interest spread (average yield on total interest earning assets minus average cost of total interest bearing liabilities) were 5.61% and 5.32%, respectively, compared to 3.64% and 3.46%, respectively, for the nine months ended September 30, 2021.

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The following table presents an analysis of the average balances of net interest income, net interest spread and net interest margin for the periods indicated. Loan fees included in interest income totaled $3.9 million and $11.8 million for the nine months ended September 30, 2022 and 2021, respectively. For the nine months ended September 30, 2022 and 2021, the amount of interest income not recognized on nonaccrual loans was not material.


	Average Balance Sheets For the Nine Months Ended September 30,
	2022						2021
(dollars in thousands; unaudited)	Average Balance		Interest & Dividends		Yield / Cost (1)		Average Balance		Interest & Dividends		Yield / Cost (1)
Assets
Interest earning assets:
Interest earning deposits	$	578,855	$	3,631	0.84	%	$	284,225	$	314	0.15	%
Investment securities, available for sale (2)	89,173		1,160		1.74		25,344		45		0.24
Investment securities, held to maturity (2)	1,276		28		2.93		2,349		31		1.76
Other investments	9,996		195		2.61		6,594		169		3.43
Loans receivable (3)	2,141,127		122,126		7.63		1,690,817		56,978		4.51
Total interest earning assets	2,820,427		127,140		6.03		2,009,329		57,537		3.83
Noninterest earning assets:
Allowance for loan losses	(42,836)						(19,744)
Other noninterest earning assets	112,468						73,328
Total assets	$	2,890,059					$	2,062,913

Liabilities and Shareholders’ Equity
Interest bearing liabilities:
Interest bearing deposits	$	1,628,765	$	7,943	0.65	%	$	892,574	$	1,811	0.27	%
PPPLF borrowings	—		—		0.00		91,850		240		0.35
FHLB advances and borrowings	8,058		69		1.14		24,999		212		1.13
Subordinated debt	24,313		695		3.82		12,381		477		5.15
Junior subordinated debentures	3,587		90		3.35		3,585		63		2.35
Total interest bearing liabilities	1,664,723		8,797		0.71		1,025,389		2,803		0.37
Noninterest bearing deposits	987,343						873,271
Other liabilities	20,442						12,798
Total shareholders' equity	217,551						151,455
Total liabilities and shareholders' equity	$	2,890,059					$	2,062,913
Net interest income			$	118,343					$	54,734
Interest rate spread					5.32	%					3.46	%
Net interest margin (4)					5.61	%					3.64	%

(1)Yields and costs are annualized.

(3)Includes loans held for sale and nonaccrual loans.

(4)Net interest margin represents net interest income divided by the average total interest earning assets.

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The following table presents an analysis of certain average balances, interest income and interest expense by segment:


	For the Nine Months Ended
	September 30, 2022						September 30, 2021
(dollars in thousands; unaudited)	Average Balance		Interest & Dividends		Yield / Cost (1)		Average Balance		Interest & Dividends		Yield / Cost (1)
Community Bank
Assets
Loans receivable (2)	$	1,483,553	$	57,405	5.17	%	$	1,577,448	$	54,217	4.60	%
Liabilities
Interest bearing deposits	919,415		1,394		0.20		862,986		1,746		0.27
Noninterest bearing deposits	731,517						660,773
Total deposits	$	1,650,932	$	1,394	0.11		$	1,523,759	$	1,746	0.15

CCBX
Assets
Loans receivable (2)(3)	$	657,574	$	64,721	13.16	%	$	113,369	$	2,761	3.26	%
Liabilities
Interest bearing deposits	709,350		6,549		1.23		29,588		65		0.29
Noninterest bearing deposits	255,826						212,498
Total deposits	$	965,176	$	6,549	0.91		$	242,086	$	65	0.04

(1)Yields and costs are annualized.

(2)Includes loans held for sale and nonaccrual loans.

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The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest earning assets and interest bearing liabilities and distinguishes between the changes attributable to changes in volume and changes attributable to changes in interest rates. The table illustrates the $39.5 million increase in loan interest income that is attributed to an increase in loan rates and $25.7 million increase in loan interest income that is attributed to an increase in loan volume. For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to volume.


	Nine Months Ended September 30, 2022 compared to Nine Months Ended September 30, 2021
	Increase (Decrease) Due to				Total Increase (Decrease)
(dollars in thousands; unaudited)	Volume		Rate
Interest income:
Interest earning deposits	$	1,848	$	1,469	$	3,317
Investment securities, available for sale	830		285		1,115
Investment securities, held to maturity	(24)		21		(3)
Other Investments	66		(40)		26
Loans receivable	25,685		39,463		65,148
Total increase in interest income	28,405		41,198		69,603

Interest expense:
Interest bearing deposits	3,590		2,542		6,132
PPPLF borrowings	(240)		—		(240)
FHLB advances	(143)		—		(143)
Subordinated debt	341		(123)		218
Junior subordinated debentures	—		27		27
Total increase in interest expense	3,548		2,446		5,994
Increase in net interest income	$	24,857	$	38,752	$	63,609

Provision for Loan Losses

The provision for loan losses is an expense we incur to maintain an allowance for loan losses at a level that management deems appropriate to absorb inherent losses on existing loans. For a description of the factors taken into account by our management in determining the allowance for loan losses see “—Financial Condition—Allowance for Loan Losses.”

The economic environment is continuously changing, due to increased inflation, higher interest rates, global unrest, the war in Ukraine, mid-term elections and trade issues that may impact the provision and therefore the allowance. The Company is not required to implement the provisions of the Current Expected Credit Loss (“CECL”) accounting standard until January 1, 2023 and continues to account for the allowance for credit losses under the incurred loss model. Gross loans, excluding loans held for sale, totaled $2.51 billion at September 30, 2022 and included $5.8 million in PPP loans, which are 100% guaranteed, and are excluded from the provision for loan losses calculation. The allowance for loan losses as a percentage of loans was 2.36% at September 30, 2022, compared to 1.19% at September 30, 2021.

Agreements with our CCBX partners provide for an indemnification of loan losses and is also known as a credit enhancement which protects the Bank by absorbing incurred losses. In accordance with accounting guidance, we estimate and record a provision for probable losses for CCBX loans and deposit overdrafts. When the provision for loan losses and provision for unfunded commitments is recorded, a credit enhancement receivable is also recorded in other assets on the balance sheet through noninterest income (BaaS credit enhancements) in recognition of the CCBX partner legal commitment to cover the Bank’s loan losses related to loans they originate. Incurred loan losses are recorded in the allowance for loan losses, and as the credit enhancement obligations are received from the CCBX partner, the credit enhancement receivable is relieved.

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Comparison of the quarter ended September 30, 2022 to the comparable quarter in the prior year

The provision for loan losses for the three months ended September 30, 2022 was $18.4 million, compared to $255,000 for the three months ended September 30, 2021. The increase in the Company’s provision for loan losses during the quarter ended September 30, 2022, is largely related to the provision for CCBX partner loans. During the quarter ended September 30, 2022, a $18.7 million provision for loan losses was recorded for CCBX partner loans based on management’s analysis. The factors used in management’s analysis for community bank loan losses indicated that a recapture for loan loss of $238,000 was needed for the quarter ended September 30, 2022.

The $18.7 million provision on CCBX loans includes $17.9 million for partner loans with credit enhancement on them and $814,000 on CCBX partner loans that the Company is responsible for. In accordance with the program agreement and for true lender purposes for a CCBX partner only, the Company is responsible for credit losses on approximately 10% of a $77.9 million loan portfolio, or $7.8 million in partner loans at September 30, 2022.

The following table shows the provision expense by segment for the periods indicated:


	Three Months Ended
(dollars in thousands; unaudited)	September 30, 2022		September 30, 2021
Community bank	$	(238)	$	192
CCBX	18,666		63
Total provision expense	$	18,428	$	255

Net charge-offs for the quarter ended September 30, 2022 totaled $8.5 million, or 1.38% of total average loans, as compared to net recoveries of $1,000, or 0.00% of total average loans, for the quarter ended September 30, 2021. Net charge-offs were up in 2022 compared to 2021 due to loans originated by CCBX partners. In accordance with GAAP, CCBX credit loan losses are recorded as charge-offs. Agreements with CCBX partners provide for a credit enhancement that protects the Bank from incurred losses. The credit enhancement is recognized as noninterest income in the BaaS credit enhancements category and as a credit enhancement receivable on the balance sheet. When loan credit losses are recognized on CCBX loans, the Bank charges off the loan and the partner reimburses the Bank and the credit enhancement receivable is reduced. For the three months ended September 30, 2022, $8.1 million of net charge-offs were recognized for CCBX loans and $408,000 of net charge-offs were recognized on community bank loans. For the three months ended September 30, 2021, $9,000 of net charge-offs were recognized on CCBX loans and $10,000 of net recoveries were recognized for community bank loans.

The following table shows the total charge-off activity by segment for the periods indicated:


	Three Months Ended
	September 30, 2022									September 30, 2021
(dollars in thousands; unaudited)	Community Bank			CCBX			Total			Community Bank			CCBX			Total
Gross charge-offs	$	411		$	8,102		$	8,513		$	14		$	17		$	31
Gross recoveries	(3)			(6)			(9)			(24)			(8)			(32)
Net charge-offs	$	408		$	8,096		$	8,504		$	(10)		$	9		$	(1)
Net charge-offs to average loans	0.10		%	3.59		%	1.38		%	0.00		%	0.02		%	0.00		%

Comparison of the nine months ended September 30, 2022 to the comparable period in the prior year

The provision for loan losses for the nine months ended September 30, 2022 was $45.5 million, compared to $973,000 for the nine months ended September 30, 2021. The increase in the Company’s provision for loan losses during the quarter ended September 30, 2022, is largely related to the provision for CCBX partner loans. During the nine months ended September 30, 2022, a $45.3 million provision for loan losses was recorded for loans originated by CCBX partners based on management’s analysis. The factors used in management’s analysis for community bank loan losses indicated that a provision for loan loss of $214,000 was needed for the nine months ended September 30, 2022.

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The $45.3 million provision on CCBX loans includes $44.4 million for partner loans with credit enhancement on them and $814,000 on CCBX partner loans that the Company is responsible for. In accordance with the program agreement and for true lender purposes for a CCBX partner only, the Company is responsible for credit losses on approximately 10% of a $77.9 million loan portfolio, or $7.8 million in partner loans at September 30, 2022.

The following table shows the provision expense by segment for the periods indicated:


	Nine Months Ended
(dollars in thousands; unaudited)	September 30, 2022		September 30, 2021
Community bank	$	214	$	877
CCBX	45,250		96
Total provision expense	$	45,464	$	973

Net charge-offs for the nine months ended September 30, 2022 totaled $14.8 million, or 0.93% of total average loans, as compared to net charge-offs of $13,000, or 0.00% of total average loans, for the nine months ended September 30, 2021. Net charge-offs were up in 2022 compared to 2021 due to loans originated by CCBX partners. In accordance with GAAP, CCBX losses are recorded as charge-offs, but agreements with CCBX partners provide for an indemnification of credit losses, or credit enhancement that protects the Bank from incurred losses, which is recorded as noninterest income. For the nine months ended September 30, 2022, $14.4 million of net charge-offs were recognized for CCBX loans and $375,000 of net charge-offs recognized for community bank loans. For the nine months ended September 30, 2021, $10,000 of net charge-offs were recognized for CCBX and $3,000 of net charge-offs were recognized for community bank loans.


	Nine Months Ended
	September 30, 2022									September 30, 2021
(dollars in thousands; unaudited)	Community Bank			CCBX			Total			Community Bank			CCBX			Total
Gross charge-offs	$	418		$	14,445		$	14,863		$	39		$	22		$	61
Gross recoveries	(43)			(6)			(49)			(36)			(12)			(48)
Net charge-offs	$	375		$	14,439		$	14,814		$	3		$	10		$	13
Net charge-offs to average loans	0.03		%	2.94		%	0.93		%	0.00		%	0.01		%	0.00		%

Noninterest Income

Our primary sources of recurring noninterest income are BaaS indemnification income, Baas program income and deposit service charges and fees. Noninterest income does not include loan origination fees, which are generally recognized over the life of the related loan as an adjustment to yield using the interest or similar method.

Comparison of the quarter ended September 30, 2022 to the comparable quarter in the prior year

For the three months ended September 30, 2022, noninterest income totaled $34.4 million, an increase of $28.3 million, or 460.8%, compared to $6.1 million for the three months ended September 30, 2021.

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The following table presents, for the periods indicated, the major categories of noninterest income:


	Three Months Ended September 30,				Increase (Decrease)		Percent Change
(dollars in thousands; unaudited)	2022		2021
Deposit service charges and fees	$	986	$	956	$	30	3.1	%
Loan referral fees	—		723		(723)		(100.0)
Mortgage broker fees	24		187		(163)		(87.2)

Unrealized (loss) gain on equity securities, net	(133)		1,472		(1,605)		(109.0)
Gain on sales of loans, net	—		206		(206)		(100.0)
Other	236		302		(66)		(21.9)
Noninterest income, excluding BaaS program income and BaaS indemnification income	1,113		3,846		(2,733)		(71.1)
Servicing and other BaaS fees	1,079		1,313		(234)		(17.8)
Transaction fees	940		146		794		543.8
Interchange fees	738		188		550		292.6
Reimbursement of expenses	885		333		552		165.8
BaaS program income	3,642		1,980		1,662		83.9
BaaS credit enhancements	17,928		10		17,918		179,180
Baas fraud enhancements	11,708		296		11,412		3,855
BaaS indemnification income	29,636		306		29,330		9,585
Total noninterest income	$	34,391	$	6,132	$	28,259	460.8	%

Comparison of the nine months ended September 30, 2022 to the comparable period in the prior year

For the nine months ended September 30, 2022, noninterest income totaled $81.9 million, an increase of $68.0 million, or 489.1%, compared to $13.9 million for the nine months ended September 30, 2021.

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The following table presents, for the periods indicated, the major categories of noninterest income:


	Nine Months Ended September 30,				Increase (Decrease)		Percent Change
(dollars in thousands; unaudited)	2022		2021
Deposit service charges and fees	$	2,858	$	2,768	$	90	3.3	%
Loan referral fees	810		2,126		(1,316)		(61.9)
Mortgage broker fees	232		702		(470)		(67.0)
Gain on sale of bank branch including deposits and loans, net	—		1,263		(1,263)		(100.0)
Gain on sales of loans, net	—		367		(367)		(100.0)
Unrealized (loss) gain on equity securities, net	(135)		1,472		(1,607)		(109.2)
Other	814		542		272		50.2
Noninterest income, excluding BaaS program income and BaaS indemnification income	4,579		9,240		(4,661)		(50.4)
Servicing and other BaaS fees	3,407		3,046		361		11.9
Transaction fees	2,247		264		1,983		751.1
Interchange fees	1,798		333		1,465		439.9
Reimbursement of expenses	1,875		709		1,166		164.5
BaaS program income	9,327		4,352		4,975		114.3
BaaS credit enhancements	45,210		10		45,200		452,000.0
BaaS fraud enhancements	22,753		296		22,457		7,587
BaaS indemnification income	67,963		306		67,657		22,110
Total noninterest income	$	81,869	$	13,898	$	67,971	489.1	%

Summary of significant noninterest income for the three and nine months ended September 30, 2022 compared to the three and nine months ended September 30, 2021

A description of our largest noninterest income categories are below:

BaaS Income. Our CCBX segment provides BaaS offerings that enable our broker dealer and digital financial service providers to offer their customers banking services. In exchange for providing these services, we earn fixed fees, volume-based fees and reimbursement of costs depending on the program agreement. In accordance with GAAP, we recognize the reimbursement of noncredit fraud losses on loans and deposits originated by partners and credit enhancements related to the allowance for loan losses and reserve for unfunded commitments provided by the partner as revenue in BaaS income. CCBX credit losses are recognized in the allowance for loan loss and noncredit fraud losses are expensed in noninterest expense under BaaS fraud expense. Also in accordance with GAAP, we establish a credit enhancement receivable for expected future loan losses through the recognition of BaaS credit enhancement revenue at the same time we establish an allowance for those loans though a provision for loan losses. For more information on the accounting for BaaS allowance for loan losses, reserve for unfunded commitments, credit enhancements and fraud enhancements see the section titled “CCBX – BaaS Reporting Information.”

Table of Contents,

The following table presents the BaaS income for the periods indicated:


	Three Months Ended				Nine Months Ended
(dollars in thousands; unaudited)	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
Program income:
Servicing and other BaaS fees	$	1,079	$	1,313	$	3,407	$	3,046
Transaction fees	940		146		2,247		264
Interchange fees	738		188		1,798		333
Reimbursement of expenses	885		333		1,875		709
Program income	3,642		1,980		9,327		4,352
Indemnification income:
Credit enhancements	17,928		10		45,210		10
Fraud enhancements	11,708		296		22,753		296
Indemnification income	29,636		306		67,963		306
Total BaaS income	$	33,278	$	2,286	$	77,290	$	4,658

Our CCBX segment continues to evolve, and now has 29 relationships, at varying stages, as of September 30, 2022. As of September 30, 2022, we increased our active relationships to 19, compared to 16 as of September 30, 2021. We continue to refine the criteria for CCBX partnerships and are exiting relationships where it makes sense for both parties and are focusing on selecting larger and more established partners, with experienced management teams. We are winding down three partner relationships; these programs are not material in terms of income, deposits or loans.

The following table illustrates the activity and evolution in CCBX relationships for the periods presented.


	As of
(unaudited)	September 30, 2022	September 30, 2021
Active	19	16
Friends and family / testing	2	0
Implementation / onboarding	0	7
Signed letters of intent	5	3
Wind down - preparing to exit relationship	3	0
Total CCBX relationships	29	26

Deposit Service Charges and Fees. Deposit service charges and fees include service charges on accounts, point-of-sale fees, merchant services fees and overdraft fees. Together they constitute the largest component of our noninterest income, outside of BaaS income. During 2022 consumer overdraft fees were reduced and we anticipate eliminating consumer overdraft fees in 2023. For the nine months ended September 30, 2022, total consumer overdraft fee income was $78,000 compared to $139,000 for the nine month ended September 30, 2021. Consumer overdraft fees are not a significant source of income, and the reduction/elimination of these fees will not have a significant impact on income.

Loan Referral Fees. We earn loan referral fees when we originate a variable rate loan and the borrower enters into an interest rate swap agreement with a third party to fix the interest rate for an extended period, usually 20 or 25 years. We recognize the loan referral fee for arranging the interest rate swap. By facilitating interest rate swaps to our clients, we are able to provide them with a long-term, fixed interest rate without assuming the interest rate risk. Interest rate volatility, swap rates, and the timing of loan closings all impact the demand for long-term fixed rate swaps. The recognition of loan referral fees fluctuates in response to these market conditions and as a result we may recognize more or less, or may not recognize any, loan referral fees in some periods. Current market conditions are making interest rate swap agreements less attractive in the higher rate environment.

Mortgage Broker Fees. We earn mortgage broker fees for residential real estate loans that we broker through mortgage lenders. Mortgage broker fees fluctuate based on demand and changes in interest rates. Mortgage market is slowing down as a result of higher interest rates on mortgages.

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Gain on Sale of Bank Branch Including Deposits and Loans, net. The sale of our Freeland branch closed on April 30, 2021. Noninterest income included $1.3 million gain from sale of the branch in 2021, there was no similar income in 2022.

Gain on Sales of Loans, net. Gain on sales of loans occurs when we sell in the secondary market the guaranteed portion (generally 75% of the principal balance) of the SBA and U.S. Department of Agriculture (“USDA”) loans that we originate. This activity fluctuates based on SBA and USDA loan activity.

Unrealized (loss)/gain on equity securities, net. During the nine months ended September 30, 2022, we recognized an unrealized loss on equity securities of $135,000, compared to September 30, 2021, when we recognized a $1.5 million unrealized holding gain on an equity security as a result of an observable price change.

Other. This category includes a variety of other income-producing activities, credit card fee income, wire transfer fees, interest earned on bank owned life insurance (“BOLI”), and SBA and USDA servicing fees.

Noninterest Expense

Generally, noninterest expense is composed of all employee expenses and costs associated with operating our facilities, obtaining and retaining customer relationships and providing bank services. The largest components of noninterest expense are BaaS loan and fraud expense and salaries and employee benefits. Noninterest expense also includes operational expenses, such as legal and professional fees, data processing and software licenses, occupancy, FDIC assessment, points of sale expense, excise taxes, director and staff expenses, marketing and other expenses.

Comparison of the quarter ended September 30, 2022 to the comparable quarter in the prior year

For the three months ended September 30, 2022, noninterest expense totaled $51.1 million, an increase of $35.0 million, or 216.7%, compared to $16.1 million for the three months ended September 30, 2021.

The following table presents, for the periods indicated, the major categories of noninterest expense:


	Three Months Ended September 30,				Increase (Decrease)		Percent Change
(dollars in thousands; unaudited)	2022		2021
Salaries and employee benefits	$	14,506	$	9,961	$	4,545	45.6	%
Legal and professional fees	2,251		796		1,455		182.8
Data processing and software licenses	1,670		1,333		337		25.3
Occupancy	1,147		1,037		110		10.6
FDIC assessments	850		400		450		112.5
Point of sale expense	742		212		530		250.0
Excise taxes	588		407		181		44.5
Director and staff expenses	475		274		201		73.4
Marketing	69		130		(61)		(46.9)
Other	1,522		865		657		76.0
Noninterest expense, excluding BaaS loan and BaaS fraud expense	23,820		15,415		8,405		54.5
BaaS loan expense	15,560		419		15,141		3,613.6
BaaS fraud expense	11,707		296		11,411		3,855.1
BaaS loan and fraud expense	27,267		715		26,552		3,713.6
Total noninterest expense	$	51,087	$	16,130	$	34,957	216.7	%

Comparison of the nine months ended September 30, 2022 to the comparable period in the prior year

For the nine months ended September 30, 2022, noninterest expense totaled $119.7 million, an increase of $77.5 million, or 183.5%, compared to $42.2 million for the nine months ended September 30, 2021.

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The following table presents, for the periods indicated, the major categories of noninterest expense:


	Nine Months Ended September 30,				Increase (Decrease)		Percent Change
(dollars in thousands; unaudited)	2022		2021
Salaries and employee benefits	$	37,829	$	26,560	$	11,269	42.4	%
Data processing and software licenses	4,719		3,457		1,262		36.5
Legal and professional fees	3,961		2,182		1,779		81.5
Occupancy	3,366		3,085		281		9.1
FDIC assessments	2,309		820		1,489		181.6
Excise taxes	1,501		1,154		347		30.1
Point of sale expense	1,399		475		924		194.5
Director and staff expenses	1,196		812		384		47.3
Marketing	242		344		(102)		(29.7)
Other	4,318		2,419		1,899		78.5
Noninterest expense, excluding BaaS loan and BaaS fraud expense	60,840		41,308		19,532		47.3
BaaS loan expense	36,079		609		35,470		5,824.3
BaaS fraud expense	22,752		296		22,456		7,586.5
BaaS loan and fraud expense	58,831		905		57,926		6,400.7
Total noninterest expense	$	119,671	$	42,213	$	77,458	183.5	%

Summary of significant noninterest expense for the three and nine months ended September 30, 2022 compared to the three and nine months ended September 30, 2021

A description of our largest noninterest expense categories are below:

Salaries and Employee Benefits. Salaries and employee benefits are one of the largest components of noninterest expense and include payroll expense, incentive compensation costs, equity compensation, benefit plans, health insurance and payroll taxes. Salaries and employee benefits continue to increase primarily due to continued hiring staff for our CCBX segment and additional staff for our ongoing banking related growth initiatives. As our CCBX activities grow, we expect to continue to add employees to support these lines of business. As of September 30, 2022, we had 442 full-time equivalent employees, compared to 343 at September 30, 2021, a 28.9% increase.

Data Processing and Software Licenses. Data processing and software licenses includes expenses related to obtaining and maintaining software required for our various functions. Data processing costs include all of our customer transaction processing and data storage, computer processing, and network costs. Data processing costs grow as we grow and add new products, customers and branches. Additionally, CCBX data processing expenses and software that aids in the reporting of CCBX activities and monitoring of transactions that helps to automate and create other efficiencies in reporting have resulted in increased expenses in the category. These expenses are expected to increase as we invest more in automated processing and as we grow product lines and our CCBX segment.

Legal and Professional Fees. Legal and professional costs include legal, audit and accounting expenses, consulting fees, fees for recruiting and hiring employees, and IT related security expenses. These expenses fluctuate with the development of contracts for CCBX customers, audit and accounting needs, and are impacted by our reporting cycle and timing of legal and professional services. Legal expenses totaled $599,000 while professional services totaled $3.4 million for the nine months ended September 30, 2022 and were primarily focused on building infrastructure for future growth.

Occupancy. Occupancy expenses rent, utilities, janitorial and other maintenance expenses, property insurances and taxes. Also included is depreciation on building, leasehold, furniture, fixtures and equipment. Although our hybrid and remote workforce is increasing, which helps keep some occupancy expenses down, we do expect occupancy expenses to increase as we continue to grow.

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FDIC Assessments. FDIC assessments are assessed to fund the Deposit Insurance Fund (“DIF”) to insure and protect the depositors of insured banks and to resolve failed banks. The assessment rate is based on a number of factors and recalculated each quarter. As deposits increase, the FDIC assessment expense will generally increase. On October 18, 2022 the FDIC finalized an increase of 2 basis points in the initial base deposit insurance assessment rates schedules. The rise is intended to increase the reserve ratio of the Deposit Insurance Fund from 1.26% (as of June 30, 2022) to 1.35%, the statutory requirement. The increase in the base rates will remain in place until the reserve ratio reaches or exceeds 2.0%. The increase will take effect in the first quarterly assessment period of 2023 and will increase the FDIC assessment expense for the Bank.

Excise Taxes. Excise taxes are assessed on Washington state income and are based on gross income. Gross income is reduced by certain allowed deductions and income attributed to other states is also removed to arrive at the taxable base. Excise taxes increased as a result of increased income subject to excise taxes. Partially offsetting that increase is a credit we received in 2022 against excise taxes owed in the amount of $109,000 as a result of our participation in the Washington State Main Street Program, which reduced our calculated 2022 expense.

Point of Sale Expenses. Point of sale expenses are incurred as part of the process that allows businesses to accept payment for goods or services. Generally, point of sale expense increases as point of sale activity increases, as does point of sale income which is recognized in other income.

Director and Staff Expenses. Director and staff expenses includes compensation for director service, continuing education for employees and other director and staff related expenses. As conferences and other professional events have resumed we have seen increased expenses related to employee travel, and continuing education.

Marketing. Marketing costs are down from 2021, however they are expected to increase as we continue to expand our CCBX segment, offer new products and services and grow our brand.

Other. This category includes dues and memberships, office supplies, mail services, telephone, examination fees, internal loan expenses, services charges from banks, operational losses, directors and officer’s insurance, donations, provision for unfunded commitments, and miscellaneous other expenses. The provision for unfunded commitments has increased with the addition of CCBX loan partners.

BaaS loan and fraud expense. Included in BaaS loan and fraud expense is partner loan expense including overdraft balances and partner fraud expense. Partner loan expense represents the amount paid or payable to partners for credit enhancements, fraud enhancements and servicing CCBX loans. Partner fraud expense represents noncredit fraud losses on loans and deposits originated by partners. Fraud losses are recorded when incurred as losses in noninterest expense, and the reimbursement from the CCBX partner is recorded in noninterest income, resulting in a net impact of zero to the income statement. For more information on the accounting for BaaS loan and fraud expenses see the section titled “CCBX – BaaS Reporting Information.”

The following table presents, for the periods indicated, the BaaS loan and fraud expenses:


	Three Months Ended				Nine Months Ended
(dollars in thousands; unaudited)	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
BaaS loan expense	$	15,560	$	419	$	36,079	$	609
BaaS fraud expense	11,707		296		22,752		296
Total BaaS loan and fraud expense	$	27,267	$	715	$	58,831	$	905

Income Tax Expense

The amount of income tax expense we incur is impacted by the amounts of our pre-tax income, tax-exempt income and other nondeductible expenses. Deferred tax assets and liabilities are reflected at current income tax rates in effect for the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Valuation allowances are established when necessary to reduce our deferred tax assets to the amount expected to be realized. The Company is subject to various state taxes that are assessed as CCBX activities and employees expand into other states, which has increased the overall tax rate used in calculating the provision for income taxes in the current and future periods.

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Comparison of the quarter ended September 30, 2022 to the comparable quarter in the prior year

For the three months ended September 30, 2022, income tax expense totaled $3.0 million, compared to $1.9 million for the three months ended September 30, 2021. The $1.1 million increase in income tax expense is the result of higher net income, combined with the addition of various state taxes that are being assessed as CCBX activities and employees expanding into other states, which has increased the overall tax rate used in calculating the provision for income taxes in the current and future periods, however an accrual adjustment lowered our effective tax rate to 21.1% for the three months ended September 30, 2022, compared to 21.9% for the three months ended September 30, 2021.

Comparison of the nine months ended September 30, 2022 to the comparable period in the prior year

For the nine months ended September 30, 2022 income tax expense totaled $7.6 million, compared to $5.7 million for the nine months ended September 30, 2021. The $1.8 million increase in income tax expense is the result of higher net income. Our effective tax rates for the nine months ended September 30, 2022 and 2021 were 21.6% and 22.5%, respectively as a result of an accrual adjustment for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021.

Segment Information

For financial reporting purposes our Company has two reportable segments: the community bank and CCBX, which has been determined based upon the Company's relationship with the end customer. This determination also gave consideration to the structure and management of our various products. The community bank segment includes the operations of Coastal Community Bank, excluding CCBX BaaS operations. The community bank segment derives its revenue primarily from interest on loans and investments as well as noninterest income typical for the banking industry. The CCBX segment includes BaaS operations. The CCBX segment derives its revenue from fees and interest income from loans though our BaaS partnerships that allow our broker-dealer and digital financial partners to offer their customers banking services.

Reported segments and the financial information of the reported segments are not necessarily comparable with similar information reported by other financial institutions. Additionally, because of the interrelationships of the various segments, the information presented is not indicative of how the segments would perform if they operated as independent entities. Changes in management structure or allocation methodologies and procedures may result in future changes to previously reported segment financial data. The accounting policies of the segments are the same as those described in “Note 1 – Description of Business and Summary of Significant Accounting Policies” in the accompanying notes to the consolidated financial statements included elsewhere in this report.

Community bank total assets as of September 30, 2022 decreased $141.7 million, or 6.2%, to $2.14 billion, compared to $2.28 billion as of December 31, 2021. Loans receivable net of deferred fees for the community bank segment increased $196.3 million, or 14.1%, to $1.59 billion as of September 30, 2022, compared to $1.40 billion as of December 31, 2021. The increase in community bank loans receivable is the result of gross loan growth of $194.1 million, which includes $106.0 million in PPP loan forgiveness and paydowns during the nine months ended September 30, 2022. Total community bank deposits decreased $12.7 million, or 0.8%, to $1.63 billion, as of September 30, 2022, compared to $1.65 billion as of December 31, 2021.

CCBX total assets as of September 30, 2022 increased $639.9 million, or 181.3%, to $992.9 million, compared to $353.0 million as of December 31, 2021. During the nine months ended September 30, 2022, $128.2 million in CCBX loans were transferred to loans held for sale, with $84.9 million in loans sold and $43.3 million remaining in loans held for sale as of September 30, 2022; previously we did not have any loans held for sale. Total CCBX loans receivable increased $568.9 million, or 164.1%, to $915.6 million as of September 30, 2022, compared to $346.7 million as of December 31, 2021. The increase in loans receivable is the result of increased activity with CCBX partners. CCBX allowance for loan losses increased to $39.1 million as of September 30, 2022, compared to $8.3 million as of December 31, 2021 as a result of CCBX loan growth and portfolio mix. Total CCBX deposits increased $486.0 million, or 67.9%, to $1.20 billion, compared to $716.3 million as of December 31, 2021 as a result of growth within the CCBX relationships. This does not include an additional $266.7 million in CCBX deposits that are transferred off the balance sheet as of September 30, 2022.

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The following table presents summary financial information for each segment for the periods indicated:


	September 30, 2022						December 31, 2021
(dollars in thousands; unaudited)	Bank		CCBX		Total		Bank		CCBX		Total

Total assets	$	2,140,820	$	992,921	$	3,133,741	$	2,282,514	$	353,003	$	2,635,517
Loans held for sale	—		43,314		43,314		—		—		—
Total loans receivable	1,592,320		915,569		2,507,889		1,396,060		346,675		1,742,735
Allowance for loan losses	(20,139)		(39,143)		(59,282)		(20,299)		(8,333)		(28,632)
Total deposits	1,634,796		1,202,270		2,837,066		1,647,529		716,258		2,363,787

Comparison of the quarter ended September 30, 2022 to the comparable quarter in the prior year

Income and expenses that are specific to CCBX are recorded to the CCBX segment. Additionally, certain indirect expenses are allocated to CCBX utilizing various metrics, such as number of employees, utilization of space and allocations based on loan and deposit balances. Included in noninterest expense for the community bank is administrative overhead of $7.9 million and $5.2 million for the quarters ended September 30, 2022 and September 30, 2021, respectively. Both the community bank and the CCBX segment benefit from this administrative overhead and services, which includes shared operational activities such as data management, compliance monitoring and other administration functions.

Net interest income for the community bank was $22.8 million for the quarter ended September 30, 2022, an increase of $5.5 million, or 31.4%, compared to $17.4 million for the quarter ended September 30, 2021. The increase in net interest income is largely due to increased yield on loans resulting from loan growth. Recapture of loan losses for the community bank was $238,000 for the quarter ended September 30, 2022, compared to a provision of $192,000 for the quarter ended September 30, 2021. Net charge-offs to average loans for the community bank segment have remained consistently low and was 0.10% for the quarter ended September 30, 2022 and 0.00% for the quarter ended September 30, 2021. Noninterest income for the community bank was $1.1 million, for the quarter ended September 30, 2022, a decrease of $2.7 million, or 70.6%, compared to $3.8 million for the quarter ended September 30, 2021. This change was largely due to recognizing an unrealized loss on equity securities of $135,000 in the quarter ended September 30, 2022 compared to the quarter ended September 30, 2021, when we recognized a $1.5 million unrealized holding gain on an equity security as a result of an observable price change. Additionally, loan referral fees and mortgage income are down for the quarter ended September 30, 2022, compared to the quarter ended September 30, 2021 as a result of the interest rate increases in 2022. Noninterest expenses for the community bank increased $4.0 million, or 28.6%, to $17.8 million as of September 30, 2022, compared to $13.8 million as of September 30, 2021. The increase in noninterest expense is largely due to increased salaries and employee benefits as a result of growth, higher software licenses maintenance and subscription costs related to new reporting software that helps monitor and assess risk and to automate and create efficiencies in reporting, and other expense increases related to growth.

Net interest income for CCBX was $26.4 million for the quarter ended September 30, 2022, an increase of $24.9 million, or 1,721.4%, compared to $1.4 million for the quarter ended September 30, 2021. The increase in net interest income is due to loan growth from active CCBX relationships. Provision for loan losses was $18.7 million as a result of loan origination growth from CCBX partners for the quarter ended September 30, 2022, compared to $63,000 for the quarter ended September 30, 2021. The $18.7 million provision on CCBX loans includes $17.9 million for partner loans with credit enhancement on them and $814,000 on CCBX partner loans that the Company is responsible for. In accordance with the program agreement and for true lender purposes for a CCBX partner only, the Company is responsible for credit losses on approximately 10% of a $77.9 million loan portfolio, or $7.8 million in partner loans at September 30, 2022. Noninterest income for CCBX was $33.3 million for the quarter ended September 30, 2022, an increase of $30.9 million, or 1,316.7%, compared to $2.3 million for the quarter ended September 30, 2021, due to an increase of $17.9 million in BaaS credit enhancements to establish a credit enhancement receivable for future loan losses due from our CCBX partners, $11.4 million increase in BaaS fraud enhancements and $1.7 million in BaaS program income, which was the result of increased relationships with broker dealers and digital financial service providers. Noninterest expenses for CCBX increased $31.0 million, or 1,336.9%, to $33.3 million as of September 30, 2022, compared to $2.3 million as of September 30, 2021. The increase in noninterest expense is largely due to an increase in BaaS loan expense, BaaS fraud expense from increased CCBX loan originations and increased salaries and benefits, for the quarter ended September 30, 2022, compared to the quarter ended September 30, 2021. For more information on the accounting for BaaS income and expenses see the section titled “CCBX – BaaS Reporting Information.”.

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The following tables present summary financial information for each segment for the periods indicated:


	Three Months Ended September 30, 2022						Three Months Ended September 30, 2021
(dollars in thousands; unaudited)	Bank		CCBX		Total		Bank		CCBX		Total

Net interest income	$	22,815	$	26,374	$	49,189	$	17,359	$	1,448	$	18,807
Provision for loan losses	(238)		18,666		18,428		192		63		255
Noninterest income	1,113		33,278		34,391		3,783		2,349		6,132
Noninterest expense	17,765		33,322		51,087		13,811		2,319		16,130

Comparison of the nine months ended September 30, 2022 to the comparable period in the prior year

Included in noninterest expense for the community bank is administrative overhead of $19.8 million and $13.9 million for the nine months ended September 30, 2022 and September 30, 2021, respectively. Both the community bank and the CCBX segment benefit from this administrative overhead and services, which includes shared operational activities such as data management, compliance monitoring and other administration functions.

Net interest income for the community bank was $60.2 million for the nine months ended September 30, 2022, an increase of $8.1 million, or 15.6%, compared to $52.0 million for the nine months ended September 30, 2021. The increase in net interest income is largely due to increased yield on loans resulting from loan growth and a decrease in lower yielding PPP loans. Provision for loan losses for the community bank was $214,000 for the nine months ended September 30, 2022, compared to $877,000 for the nine months ended September 30, 2021. Net charge-offs to average loans for the community bank segment have remained consistently low and was 0.03% and 0.00% for the nine months ended September 30, 2022, and 2021, respectively. Noninterest income for the community bank was $4.4 million for the nine months ended September 30, 2022, a decrease of $4.7 million, or 51.8%, compared to $9.2 million for the nine months ended September 30, 2021, largely due to the sale of a bank branch, including deposits and loans, during the quarter ended September 30, 2021 which resulted in a nonrecurring net gain of $1.3 million for the nine months ended September 30, 2021. Additionally, loan referral fees decreased $1.3 million compared to the nine months ended September 30, 2021. The recognition of loan referral fees fluctuates in response to market conditions and as a result we may recognize more or less, or may not recognize any, loan referral fees in some periods. In the nine months ended September 30, 2021, there was a $1.5 million net unrealized gain on equity securities recognized as a result of an observable price change, compared to an unrealized loss of $135,000 in the nine months ended September 30, 2022. Noninterest expenses for the community bank increased $13.0 million, or 34.9%, to $50.1 million as of September 30, 2022, compared to $37.2 million as of September 30, 2021. The increase in noninterest expense is largely due to increased salaries and employee benefits as a result of growth, higher software licenses maintenance and subscription costs related to new reporting software that helps monitor and assess risk and to automate and create efficiencies in reporting, and other expense increases related to growth.

Net interest income for CCBX was $58.2 million for the nine months ended September 30, 2022, an increase of $55.5 million, or 2057.7%, compared to $2.7 million for the nine months ended September 30, 2022. The increase in net interest income is due to loan growth from active CCBX relationships. Provision for loan losses was $45.3 million for the nine months ended September 30, 2022, compared to $96,000 for the nine months ended September 30, 2021, as a result of loan growth from our partners. The $45.3 million provision on CCBX loans includes $44.4 million for partner loans with credit enhancement on them and $814,000 on CCBX partner loans that the Company is responsible for. In accordance with the program agreement and for true lender purposes for a CCBX partner only, the Company is responsible for credit losses on approximately 10% of a $77.9 million loan portfolio, or $7.8 million in partner loans at September 30, 2022. Noninterest income for CCBX was $77.4 million for the nine months ended September 30, 2022, an increase of $72.7 million, or 1,539.7%, compared to $4.7 million for the nine months ended September 30, 2021, due to an increase of $45.2 million in BaaS credit enhancements related to the allowance for loan losses and reserve for unfunded commitments, $22.5 million increase in BaaS fraud enhancements and $5.0 million in total BaaS program income, which was the result of increased relationships with broker dealers and digital financial service providers. Noninterest expenses for CCBX increased $64.5 million, or 1,276.3%, to $69.6 million as of September 30, 2022, compared to $5.1 million as of September 30, 2021. The increase in noninterest expense is largely due to growth from active CCBX relationships resulting in an increase in BaaS loan expense, BaaS fraud expense and increased salaries and benefits, for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021. Legal and professional fees were higher due to contract costs and professional fees for infrastructure projects. For more information on the accounting for BaaS income and expenses see the section titled “CCBX – BaaS Reporting Information.”.

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The following tables present summary financial information for each segment for the periods indicated:


	Nine Months Ended September 30, 2022						Nine Months Ended September 30, 2021
(dollars in thousands; unaudited)	Bank		CCBX		Total		Bank		CCBX		Total

Net interest income	$	60,171	$	58,172	$	118,343	$	52,038	$	2,696	$	54,734
Provision for loan losses	214		45,250		45,464		877		96		973
Noninterest income	4,426		77,443		81,869		9,175		4,723		13,898
Noninterest expense	50,113		69,558		119,671		37,159		5,054		42,213

Financial Condition

Our total assets increased $498.2 million, or 18.9%, to $3.13 billion at September 30, 2022 from $2.64 billion at December 31, 2021. The increase is primarily the result of $765.2 million increase in loans receivable during the nine months ended September 30, 2022. As of September 30, 2022, $5.8 million in PPP loans remain on the balance sheet, a decrease of $106.0 million from $111.8 million at December 31, 2021.

Loans Held For Sale

During the nine months ended September 30, 2022 $128.2 million in CCBX loans were transferred to loans held for sale, with $84.9 million in loans sold, at par, during the nine months ended September 30, 2022 and $43.3 million remaining in loans held for sale as of September 30, 2022; previously we did not have any loans held for sale. All of the loans held for sale are from one CCBX partner and are credit card home equity secured lines of credit.

Loan Portfolio

Our primary source of income is derived through interest earned on loans. A substantial portion of our loan portfolio consists of commercial real estate loans and commercial and industrial loans in the Puget Sound region. Our consumer and other loans also represent a significant portion of our loan portfolio with the growth of our CCBX segment. Our loan portfolio represents the highest yielding component of our earning assets.

As of September 30, 2022, loans receivable totaled $2.51 billion, an increase of $765.2 million, or 43.9%, compared to December 31, 2021. Total loans receivable is net of $6.6 million in net deferred origination fees, $111,000 of which is attributed to PPP loans. The increase includes CCBX loan growth of $568.9 million, or 164.1%, and community bank loan growth of $194.1 million, or 13.8%, which includes a $106.0 million, or 94.8%, reduction in PPP loans due to forgiveness and principal paydowns. Additionally, unused loan commitments increased including unused commitments on capital call lines which increased $344.2 million to $760.2 million at September 30, 2022, compared to $416.0 million at December 31, 2021, which will likely translate into loan growth as the commitments are utilized.

Loans as a percentage of deposits were 89.9% as of September 30, 2022, compared to 73.7% as of December 31, 2021. We remain focused on serving our communities and markets by growing loans and funding those loans with customer deposits. The increase in the loan to deposit ratio was due to loan growth.

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The following table summarizes our loan portfolio by type of loan as of the dates indicated:


	As of September 30, 2022					As of December 31, 2021
(dollars in thousands; unaudited)	Amount			Percent		Amount			Percent
Commercial and industrial loans:
PPP loans	$	5,794		0.2	%	$	111,813		6.4	%
Capital call lines	174,311			6.9		202,882			11.5
All other commercial & industrial loans	159,823			6.4		104,365			6.0
Total commercial and industrial loans:	339,928			13.5		419,060			23.9
Real estate loans:
Construction, land and land development	224,188			8.9		183,594			10.5
Residential real estate	402,781			16.0		204,389			11.7
Commercial real estate	1,024,067			40.7		835,587			47.7
Consumer and other loans	523,536			20.9		108,871			6.2
Gross loans receivable	2,514,500			100.0	%	1,751,501			100.0	%
Net deferred origination fees - PPP loans	(111)					(3,633)
Net deferred origination fees - all other loans	(6,500)					(5,133)
Loans receivable	$	2,507,889				$	1,742,735
Loan Yield (1)	8.46		%			5.92		%

(1)Loan yield is annualized for the three months ended for each period presented and includes loans held for sale and nonaccrual loans.

The following tables detail the loans by segment which are included in the total loan portfolio table above:


Community Bank	As of
	September 30, 2022					December 31, 2021
(dollars in thousands; unaudited)	Balance			% to Total		Balance			% to Total
Commercial and industrial loans:
PPP loans	$	5,794		0.4	%	$	111,813		8.0	%
All other commercial & industrial loans	143,808			9.0		104,365			7.4
Real estate loans:
Construction, land and land development loans	224,188			14.0		183,594			13.1
Residential real estate loans	198,871			12.5		167,502			11.9
Commercial real estate loans	1,024,067			64.0		835,587			59.5
Consumer and other loans:
Other consumer and other loans	2,220			0.1		2,034			0.1
Gross Community Bank loans receivable	1,598,948			100.0	%	1,404,895			100.0	%
Net deferred origination fees	(6,628)					(8,835)
Loans receivable	$	1,592,320				$	1,396,060
Loan Yield(1)	5.31		%			5.89		%

(1)Loan yield is annualized for the three months ended for each period presented and includes loans held for sale and nonaccrual loans.

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CCBX	As of
	September 30, 2022					December 31, 2021
(dollars in thousands; unaudited)	Balance			% to Total		Balance			% to Total
Commercial and industrial loans:
Capital call lines	$	174,311		19.0	%	$	202,882		58.6	%
All other commercial & industrial loans	16,015			1.8		—			0.0
Real estate loans:
Residential real estate loans	203,910			22.3		36,887			10.6
Consumer and other loans:
Credit cards	216,995			23.7		11,429			3.3
Other consumer and other loans	304,321			33.2		95,408			27.5
Gross CCBX loans receivable	915,552			100.0	%	346,606			100.0	%
Net deferred origination costs	17					69
Loans receivable	$	915,569				$	346,675
Loan Yield - CCBX (1)(2)	13.96		%			6.13		%

(1)CCBX yield does not include the impact of BaaS loan expense. BaaS loan expense represents the amount paid or payable to partners for credit enhancements, fraud enhancements and servicing CCBX loans. To determine net BaaS loan income earned from CCBX loan relationships, the Company takes BaaS loan interest income and deducts BaaS loan expense to arrive at net BaaS loan income which can be compared to interest income on the Company’s community bank loans. Net BaaS loan income is a non-GAAP measure. See the reconciliation of non-GAAP measures set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures” for the impact of BaaS loan expense on CCBX yield.

(2)Loan yield is annualized for the three months ended for each period presented and includes loans held for sale and nonaccrual loans.

Commercial and Industrial Loans. Commercial and industrial loans decreased $79.1 million, or 18.9%, to $339.9 million as of September 30, 2022, from $419.1 million as of December 31, 2021. The decrease in commercial and industrial loans receivable over December 31, 2021 was due to $106.0 million in forgiven and repaid PPP loans and a decrease of $28.6 million in capital call lines, partially offset by a $55.5 million increase in other commercial and industrial loans. Included in the commercial and industrial loan balance is $174.3 million and $202.9 million in capital call lines resulting from relationships with our CCBX partners as of September 30, 2022, and December 31, 2021, respectively. As of September 30, 2022, there were $16.0 million in CCBX other commercial loans, compared to zero at December 31, 2021.

Also included in commercial and industrial loans is $5.8 million and $111.8 million in PPP loans as of September 30, 2022, and December 31, 2021, respectively.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and effectively. These loans are primarily made based on the borrower’s ability to service the debt from income. Most commercial and industrial loans are secured by the assets being financed or other business assets, such as accounts receivable, inventory or equipment, and we generally obtain personal guarantees on these loans. Commercial and industrial loans includes $35.2 million and $20.2 million in loans to financial institutions as of September 30, 2022, and December 31, 2021, respectively.

As of September 30, 2022, $5.8 million in PPP loans remained with $111,000 in net deferred fees, which will be recognized in interest income in future periods. The impact of PPP loans on the Company’s financial statements has significantly lessened as nearly all of the PPP loans have been paid off and/or forgiven.

Construction, Land and Land Development Loans. Construction, land and land development loans increased $40.6 million, or 22.1%, to $224.2 million as of September 30, 2022, from $183.6 million as of December 31, 2021. The increase is attributed to growth in community bank primarily for commercial construction and some land and land development loans.

Unfunded loan commitments for construction, land and land development loans were $163.0 million at September 30, 2022, compared to $134.3 million at December 31, 2021. Although we have seen a strong commercial and residential real estate market in the Puget Sound region thus far in 2022, the economic environment is continuously changing and is impacted by increased inflation, higher interest rates, global unrest, the war in Ukraine, mid-term elections and trade issues that have resulted in some economic uncertainty and slowing in construction lending.

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Construction, land and land development loans are comprised of loans to fund construction, land acquisition and land development construction. The properties securing these loans are primarily located in the Puget Sound region and are comprised of both residential and commercial properties, including owner occupied properties and investor properties. As of September 30, 2022, construction, land and land development loans included $109.9 million in commercial construction loans, $41.4 million in undeveloped land loans, $38.8 million in residential construction loans and $34.1 million in other construction, land and land development loans, compared to $82.8 million in commercial construction loans, $37.8 million in undeveloped land loans, $28.9 million in residential construction loans and $34.1 million in other construction, land and land development loans as of December 31, 2021.

Residential Real Estate Loans. Our one-to-four family residential real estate loans increased $198.4 million, or 97.1%, to $402.8 million as of September 30, 2022, from $204.4 million as of December 31, 2021 largely due to an increase of $167.0 million in CCBX loans.

We originate one-to-four family residential real estate adjustable-rate mortgage (“ARM”), loans for our portfolio and operate as a mortgage broker for mortgage lenders we have agreements with for customers who want a 15-year to 30-year, fixed-rate mortgage loan. As of September 30, 2022, the balance of our ARM portfolio loans was $27.9 million, compared to $22.2 million at December 31, 2021. Our ARM loans typically do not meet the guidelines for sale in the secondary market due to characteristics of the property, the loan terms or exceptions from agency underwriting guidelines, which enables us to earn a higher interest rate. We also purchase residential mortgages originated by other financial institutions to hold for investment with the intent to diversify our residential mortgage loan portfolio, meet certain regulatory requirements and increase our interest income. We last purchased residential mortgage loans in 2018. As of September 30, 2022, we held $9.5 million in purchased residential real estate mortgage loans, compared to $11.9 million at December 31, 2021. These loans purchased typically have a fixed rate with a term of 15 to 30 years and are collateralized by one-to-four family residential real estate. We have a defined set of credit guidelines that we use when evaluating these loans. Although purchased loans were originated and underwritten by another institution, our mortgage, credit, and compliance departments conduct an independent review of each underlying loan that includes re-underwriting each of these loans to our credit and compliance standards. We also make one-to-four family loans to investors to finance their rental properties and to business owners to secure their business loans. As of September 30, 2022, residential real estate loans made to investors and business owners totaled $137.2 million. As of December 31, 2021, residential real estate loans made to investors and business owners totaled $114.0 million.

As of September 30, 2022, there were $203.9 million in CCBX home equity loans included in residential real estate, compared to $36.9 million at December 31, 2021, as a result of increased activity.

Like our commercial real estate loans, our residential real estate loans are secured by real estate, the value of which may fluctuate significantly over a short period of time as a result of market conditions in the area in which the real estate is located. Adverse developments affecting real estate values in our market areas could therefore increase the credit risk associated with these loans, impair the value of property pledged as collateral on loans, and affect our ability to sell the collateral upon foreclosure without a loss or additional losses.

Commercial Real Estate Loans. Commercial real estate loans increased $188.5 million, or 22.6%, to $1.02 billion as of September 30, 2022, from $835.6 million as of December 31, 2021.

These increases, which occurred across the various segments of our portfolio, were due to our commitment to grow the portfolio in the Puget Sound region. We actively seek commercial real estate loans in our markets and our lenders are experienced in competing for these loans and managing these relationships.

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We make commercial mortgage loans collateralized by owner-occupied and non-owner-occupied real estate, as well as multi-family residential loans. The real estate securing our existing commercial real estate loans includes a wide variety of property types, such as manufacturing and processing facilities, business parks, warehouses, retail centers, convenience stores, hotels and motels, office buildings, mixed-use residential and commercial, and other properties. We originate both fixed- and adjustable-rate loans with terms up to 20 years. Fixed-rate loans typically amortize over a 10 to 25 year period with balloon payments due at the end of five to ten years. Adjustable-rate loans are generally based on the prime rate and adjust with the prime rate or are based on term equivalent FHLB rates. At September 30, 2022, approximately 31.1% of the commercial real estate loan portfolio consisted of fixed rate loans. Commercial real estate loans represented 40.7% of our loan portfolio at September 30, 2022 and are historically our largest source of revenue. As of September 30, 2022, we held $42.5 million in purchased commercial real estate loans, compared to $35.9 million at December 31, 2021. Our credit administration team has substantial experience in underwriting, managing, monitoring and working out commercial real estate loans, and remains diligent in communicating and proactively working with borrowers to help mitigate potential credit deterioration.

Consumer and Other. Consumer and other loans increased $414.7 million, or 380.9%, to $523.5 million, from $108.9 million as of December 31, 2021, as a result of growth in CCBX loans originated by our partners.

CCBX consumer loans totaled $521.3 million as of September 30, 2022, compared to $106.8 million at December 31, 2021. CCBX consumer loans include installment loans, credit cards, lines of credit and other loans. Our community bank consumer and other loans totaled $2.2 million as of September 30, 2022, compared to $2.0 million at December 31, 2021 and are comprised of personal lines of credit, automobile, boat, and recreational vehicle loans, and secured term loans.

Industry Exposure and Categories of Loans

We have a diversified loan portfolio, representing a wide variety of industries. Our major categories of loans are commercial real estate, consumer and other loans, residential real estate, commercial and industrial, and construction, land and land development loans. Together they represent $2.51 billion in outstanding loan balances. When combined with $2.32 billion in unused commitments the total of these categories is $4.83 billion.

The following table summarizes our exposure by industry for our commercial real estate portfolio as of September 30, 2022:


(dollars in thousands; unaudited)	Outstanding Balance		Available Loan Commitments		Total Exposure		% of Total Loans (Outstanding Balance & Available Commitment)		Average Loan Balance		Number of Loans
Apartments	$	208,509	$	5,658	$	214,167	4.4	%	$	2,644	81
Hotel/Motel	165,233		4,880		170,113		3.5		6,075		28
Retail	116,648		3,631		120,279		2.5		1,215		99
Office	100,224		3,522		103,746		2.1		1,048		99
Mixed use	84,255		4,681		88,936		1.8		988		90
Convenience Store	81,286		4,336		85,622		1.8		2,088		41
Warehouse	74,382		1,766		76,148		1.6		1,410		54
Mini Storage	46,989		1,810		48,799		1.0		3,050		16
Manufacturing	40,634		1,765		42,399		0.9		1,211		35
Groups < 0.70% of total	105,907		5,148		111,055		2.3		1,354		82
Total	$	1,024,067	$	37,197	$	1,061,264	22.0	%	$	1,698	625

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As illustrated in the table below, our CCBX partners originate a large number of mostly smaller dollar loans, resulting in an average consumer loan of just $1,200.

The following table summarizes our exposure by industry for our consumer and other loan portfolio as of September 30, 2022:


(dollars in thousands; unaudited)	Outstanding Balance		Available Loan Commitments		Total Exposure (1)		% of Total Loans (Outstanding Balance & Available Commitment)		Average Loan Balance		Number of Loans
CCBX consumer loans
Installment loans	$	294,907	$	—	$	294,907	6.1	%	$	1.5	196,058
Credit cards	216,995		800,914		1,017,909		21.1		1.3		162,170
Lines of credit	6,104		559		6,663		0.1		0.2		30,481
Other loans	3,310		—		3,310		0.1		0.2		16,854
Community bank consumer loans
Lines of credit	155		397		552		0.0		3.7		42
Installment loans	1,408		716		2,124		0.0		33.5		42
Other loans	657		—		657		0.0		1.9		339
Total	$	523,536	$	802,586	$	1,326,122	27.4	%	$	1.2	405,986

(1)Total exposure on CCBX loans is subject to portfolio maximum limits. See "Material Cash Requirements and Capital Resources" for maximum limits on CCBX loans by category.

The following table summarizes our exposure by industry for our residential real estate portfolio as of September 30, 2022:


(dollars in thousands; unaudited)	Outstanding Balance		Available Loan Commitments		Total Exposure (1)		% of Total Loans (Outstanding Balance & Available Commitment)		Average Loan Balance		Number of Loans
CCBX residential real estate loans
Home equity line of credit	$	203,910	$	436,346	$	640,256	13.2	%	$	23	8,836
Community bank residential real estate loans
Closed end, secured by first liens	173,890		4,389		178,279		3.7		610		285
Home equity line of credit	15,750		33,945		49,695		1.0		85		186
Closed end, second liens	9,231		1,912		11,143		0.2		330		28
Total	$	402,781	$	476,592	$	879,373	18.2	%	$	43	9,335

(1)Total exposure on CCBX loans is subject to portfolio maximum limits. See "Material Cash Requirements and Capital Resources" for maximum limits on CCBX loans by category.

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The following table summarizes our concentration by industry for our commercial and industrial loan portfolio as of September 30, 2022:


(dollars in thousands; unaudited)	Outstanding Balance		Available Loan Commitments		Total Exposure		% of Total Loans (Outstanding Balance & Available Commitment)		Average Loan Balance		Number of Loans
Capital Call Lines (1)	$	174,311	$	760,192	$	934,503	19.3	%	$	1,019	171
Construction/Contractor Services	23,737		31,764		55,501		1.1		129		184
Financial Institutions	35,150		—		35,150		0.7		3,906		9
Manufacturing	14,530		5,477		20,007		0.4		382		38
Medical / Dental / Other Care	21,408		4,833		26,241		0.5		335		64
Retail	17,054		5,792		22,846		0.5		25		676
Groups < 0.30% of total	53,738		31,660		85,398		1.8		177		303
Total	$	339,928	$	839,718	$	1,179,646	24.4	%	$	235	1,445

(1)Total exposure on CCBX loans is subject to portfolio maximum limits. See "Material Cash Requirements and Capital Resources" for maximum limits on CCBX loans by category.

The following table details our concentration for our construction, land and land development loan portfolio as of September 30, 2022:


(dollars in thousands; unaudited)	Outstanding Balance		Available Loan Commitments		Total Exposure		% of Total Loans (Outstanding Balance & Available Commitment)		Average Loan Balance		Number of Loans
Commercial construction	$	109,874	$	116,147	$	226,021	4.7	%	$	3,789	29
Residential construction	38,795		31,170		69,965		1.4		970		40
Undeveloped land loans	41,373		4,068		45,441		0.9		3,183		13
Developed land loans	19,436		6,130		25,566		0.5		607		32
Land development	14,710		5,485		20,195		0.4		774		19
Total	$	224,188	$	163,000	$	387,188	8.0	%	$	1,686	133

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Nonperforming Assets

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by applicable regulations. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. In general, we place loans on nonaccrual status when they become 90 days past due. We also place loans on nonaccrual status if they are less than 90 days past due if the collection of principal or interest is in doubt. Installment (closed end) consumer loans and revolving (open-ended loans, such as credit cards) originated by CCBX partners continue to accrue interest until they are charged-off at 120 days past due for installment loans (primarily unsecured loans to consumers) and 180 days past due for revolving loans (primarily credit cards). These consumer loans are reported out as substandard loans, 90+ days past due and still accruing. When loans are placed on nonaccrual status, all unpaid accrued interest is reversed from income and all interest accruals are stopped. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal balance. Loans are returned to accrual status if we believe that all remaining principal and interest is fully collectible and there has been at least six months of sustained repayment performance since the loan was placed on nonaccrual status. We define nonperforming loans as loans on nonaccrual status and accruing loans 90 days or more past due. Nonperforming assets also include other real estate owned and repossessed assets.

We believe our lending practices and active approach to managing nonperforming assets has resulted in sound asset quality and timely resolution of problem assets. We have procedures in place to assist us in maintaining the overall credit quality of our loan portfolio. We have established underwriting guidelines, concentration limits and we also monitor our delinquency levels for any negative or adverse trends. We actively manage problem assets to reduce our risk for loss.

We had $22.9 million in nonperforming assets as of September 30, 2022, compared to $1.7 million as of December 31, 2021. This includes $15.8 million in CCBX loans more than 90 days past due and still accruing interest as of September 30, 2022, compared to $1.5 million at December 31, 2021. All of our nonperforming assets were nonperforming loans as of September 30, 2022 and December 31, 2021. Our nonperforming loans to loans receivable ratio was 0.91% at September 30, 2022, compared to 0.10% at December 31, 2021. The increase in nonperforming assets was due to a $14.3 million increase in CCBX partner loans that are 90 days or more past due and still accruing interest. Community bank nonaccrual loans increased $6.8 million during the nine months ended September 30, 2022 due to the addition of two new nonaccrual loans partially offset by other nonaccrual principal reductions/charge-offs.

Our community bank credit quality remains strong, as demonstrated by the low level of community bank charge-offs and nonperforming loan balance for the nine months ended September 30, 2022. CCBX loans have a higher level of expected losses than our community bank loans, which is reflected in the factors for the allowance for loan losses. Agreements with our CCBX partners provide for a credit enhancement which protects the Bank by absorbing incurred losses, when accruing consumer loans originated by CCBX partners are charged-off at 120 days past due for installment loans (primarily unsecured loans to consumers) and 180 days past due for revolving loans (primarily credit cards).

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The following table presents information regarding nonperforming assets at the dates indicated:


(dollars in thousands; unaudited)	As of September 30, 2022			As of December 31, 2021
Nonaccrual loans:
Commercial and industrial loans	$	94		$	166
Real estate loans:
Construction, land and land development	66			—
Residential real estate	—			55
Commercial real estate	6,901			—
Total nonaccrual loans	7,061			221
Accruing loans past due 90 days or more:
Commercial & industrial loans	138			—
Real estate loans:
Residential real estate loans	638			39
Consumer and other loans:
Credit cards	4,777			155
Other consumer and other loans	10,268			1,312
Total accruing loans past due 90 days or more	15,821			1,506
Total nonperforming loans	22,882			1,727
Real estate owned	—			—
Repossessed assets	—			—
Troubled debt restructurings, accruing	—			—
Total nonperforming assets	$	22,882		$	1,727
Total nonaccrual loans to loans receivable	0.28		%	0.01		%
Total nonperforming loans to loans receivable	0.91		%	0.10		%
Total nonperforming assets to total assets	0.73		%	0.07		%

The following tables detail nonperforming assets by segment which are included in the total nonperforming assets table above:


Community Bank	As of
(dollars in thousands; unaudited)	September 30, 2022		December 31, 2021
Nonaccrual loans:
Commercial and industrial loans	$	94	$	166
Real estate:
Construction, land and land development	66		—
Residential real estate	—		55
Commercial real estate	6,901		—
Total nonaccrual loans	7,061		221

Accruing loans past due 90 days or more:
Total accruing loans past due 90 days or more	—		—
Total nonperforming loans	7,061		221
Other real estate owned	—		—
Repossessed assets	—		—
Total nonperforming assets	$	7,061	$	221

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CCBX	As of
(dollars in thousands; unaudited)	September 30, 2022		December 31, 2021
Nonaccrual loans	$	—	$	—
Accruing loans past due 90 days or more:
Commercial & industrial loans	138		—
Real estate loans:
Residential real estate loans	638		39
Consumer and other loans:
Credit cards	4,777		155
Other consumer and other loans	10,268		1,312
Total accruing loans past due 90 days or more	15,821		1,506
Total nonperforming loans	15,821		1,506
Other real estate owned	—		—
Repossessed assets	—		—
Total nonperforming assets	$	15,821	$	1,506

Allowance for Loan Losses

We maintain an allowance for loan losses that represents management’s best estimate of the loan losses and risks inherent in our loan portfolio. The amount of the allowance for loan losses should not be interpreted as an indication that charge-offs in future periods will necessarily occur in those amounts. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of our loan portfolio, overall portfolio quality, industry concentrations, delinquency trends, and current economic factors.

In connection with our allowance for loan loss review, we consider risk elements applicable to particular loan types or categories in assessing the quality of individual loans. Some of the risk elements we consider include:

•for commercial and industrial loans, the debt service coverage ratio (income from the business in excess of operating expenses compared to loan repayment requirements), the operating results of the commercial, professional or agricultural enterprise, the borrower’s business, professional and financial ability and expertise, the specific risks and volatility of income and operating results typical for businesses in that category and the value, nature and marketability of collateral;

•for commercial real estate loans, the debt service coverage ratio, operating results of the owner in the case of owner-occupied properties, the loan-to-value ratio, the age and condition of the collateral and the volatility of income, property value and future operating results typical of properties of that type;

•for residential real estate loans, the borrower’s ability to repay the loan, including a consideration of the debt-to-income ratio and employment and income stability, the loan-to-value ratio, and the age, condition and marketability of the collateral; and

•for construction, land and land development loans, the perceived market feasibility of the project including the ability to sell developed lots or improvements constructed for resale or the ability to lease property constructed for lease, the quality and nature of contracts for presale or prelease, if any, experience and ability of the developer and loan-to-value ratio.

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As of September 30, 2022, the allowance for loan losses totaled $59.3 million, or 2.36% of total loans. As of December 31, 2021, the allowance for loan losses totaled $28.6 million, or 1.64% of total loans. The increase in the Company’s allowance for loan losses for the quarter ended September 30, 2022 compared to December 31, 2021, is largely related to the provision for CCBX partner loans. During the nine months ended September 30, 2022, a $45.3 million provision for loan losses was recorded for CCBX partner loans based on management’s analysis. The factors used in management’s analysis for community bank loan losses indicated that a provision for loan losses of $214,000 was needed for the nine months ended September 30, 2022. The economic environment is continuously changing with increased inflation, higher interest rates, global unrest, the war in Ukraine, mid-term elections and trade issues that have resulted in some economic uncertainty. As described above, CCBX loans have a higher level of expected losses than our community bank loans, which is reflected in the factors for the allowance for loan losses. Agreements with our CCBX partners provide for a credit enhancement provided by the partner which protects the Bank by absorbing incurred losses. In accordance with accounting guidance, we estimate and record a provision for probable losses for these CCBX loans and negative deposit accounts. When the provision for loan losses and provision for unfunded commitments is recorded, a receivable is also recorded on the balance sheet through noninterest income (BaaS credit enhancements) in recognition of the CCBX partner's legal commitment to cover losses. The receivable is relieved as credit enhancement recoveries are received from the CCBX partner. Agreements with our CCBX partners also provide protection to the Bank from fraud by absorbing incurred fraud losses. Fraud losses are recorded when incurred as losses in noninterest expense, and the enhancement received from the CCBX partner is recorded in noninterest income, resulting in a net impact of zero to the income statement. CCBX partners also pledge a cash reserve account at the Bank which the Bank can collect from when losses occur that is then replenished by the partner on a regular interval. Although agreements with our CCBX partners provide for credit enhancements that provide protection to the Bank from credit and fraud losses by absorbing incurred credit and fraud losses, if our partner is unable to fulfill their contracted obligations to replenish their cash reserve account then the Bank would be exposed to additional loan and deposit losses, as a result of this counterparty risk. If a CCBX partner does not replenish their cash reserve account then the Bank can declare the agreement in default, take over servicing and cease paying the partner for servicing the loan and providing credit enhancements. The Bank would write-off any remaining receivable from the CCBX partner but would retain the full yield on the loan going forward, and BaaS loan expense would decrease once default occurred and payments to the CCBX partner were stopped. The Company is not required to implement the provisions of the CECL accounting standard until January 1, 2023 and continues to account for the allowance for credit losses under the incurred loss model.

The following table presents the loans receivable and allowance for loan losses by segment for the periods indicated:


	As of September 30, 2022									As of December 31, 2021
(dollars in thousands; unaudited)	Community Bank			CCBX			Total			Community Bank			CCBX			Total
Loans receivable	$	1,592,320		$	915,569		$	2,507,889		$	1,396,060		$	346,675		$	1,742,735
Allowance for loan losses	(20,139)			(39,143)			(59,282)			(20,299)			(8,333)			(28,632)
Allowance for loan losses to total loans receivable	1.26		%	4.28		%	2.36		%	1.45		%	2.40		%	1.64		%

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The following table presents, as of and for the periods indicated, an analysis of the allowance for loan losses and other related data:


	As of or for the Three Months Ended September 30,						As of or for the Nine Months Ended September 30,
(dollars in thousands; unaudited)	2022			2021			2022			2021
Allowance at beginning of period	$	49,358		$	19,966		$	28,632		$	19,262
Provision for loan losses	18,428			255			45,464			973
Charge-offs:
Commercial and industrial loans	360			—			398			16
Residential real estate	105			—			105			—
Consumer and other	8,048			31			14,360			45
Total charge-offs	8,513			31			14,863			61
Recoveries:
Commercial and industrial loans	2			16			39			21
Consumer and other	7			16			10			27
Total recoveries	9			32			49			48
Net charge-offs	8,504			(1)			14,814			13
Allowance at end of period	$	59,282		$	20,222		$	59,282		$	20,222
Allowance for loan losses to nonaccrual loans	839.57		%	3277.47		%	839.57		%	3277.47		%
Allowance to nonperforming loans	259.08		%	2732.70		%	259.08		%	2732.70		%
Allowance to loans receivable	2.36		%	1.19		%	2.36		%	1.19		%
Net charge-offs to average loans (1)	1.38		%	0.00		%	0.93		%	0.00		%

(1)Annualized calculations shown for periods presented.

The following table presents, as of and for the periods indicated, net charge-off information by segment:


	Three Months Ended
	September 30, 2022									September 30, 2021
(dollars in thousands; unaudited)	Community Bank			CCBX			Total			Community Bank			CCBX			Total
Gross charge-offs	$	411		$	8,102		$	8,513		$	14		$	17		$	31
Gross recoveries	(3)			(6)			(9)			(24)			(8)			(32)
Net charge-offs	$	408		$	8,096		$	8,504		$	(10)		$	9		$	(1)
Net charge-offs to average loans (1)	0.10		%	3.59		%	1.38		%	0.00		%	0.02		%	0.00		%


	Nine Months Ended
	September 30, 2022									September 30, 2021
(dollars in thousands; unaudited)	Community Bank			CCBX			Total			Community Bank			CCBX			Total
Gross charge-offs	$	418		$	14,445		$	14,863		$	39		$	22		$	61
Gross recoveries	(43)			(6)			(49)			(36)			(12)			(48)
Net charge-offs	$	375		$	14,439		$	14,814		$	3		$	10		$	13
Net charge-offs to average loans (1)	0.03		%	2.94		%	0.93		%	0.00		%	0.01		%	0.00		%

(1)Annualized calculations shown for periods presented.

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The allowance for loan losses to nonaccrual loans ratio decreased as of September 30, 2022, compared to September 30, 2021 as a result of an increase of $6.4 million in nonaccrual community bank loans, combined with an increase of $39.1 million in the allowance for loan losses. The increase in the allowance for loan losses for the three and nine months ended September 30, 2022 compared to the three and nine months ended September 30, 2021, is largely related to the increase in the allowance for loans originated by our CCBX partners. CCBX partner agreements provide for, and the Company has collected in full, credit enhancements that cover the $8.1 million and $14.4 million in net-charge-offs on CCBX loans for the three and nine months ended September 30, 2022, respectively. At September 30, 2022, the allowance for loan losses for CCBX partner loans totaled $39.1 million, compared to $152,000 at September 30, 2021.

Although we believe that we have established our allowance for loan losses in accordance with GAAP and that the allowance for loan losses was adequate to provide for known and inherent losses in the portfolio at all times shown above, future provisions for loan losses will be subject to ongoing evaluations of the risks in our loan portfolio. We have not seen an increase in community bank loan losses due to COVID-19 as originally anticipated, as evidenced by the low level of charge-offs and nonperforming loans, however, the economic environment is continuously changing with increased inflation, higher interest rates, global unrest, the war in Ukraine, mid-term elections and trade issues that have resulted in some economic uncertainty. If economic conditions worsen then Washington state and Puget Sound region may experience a more severe economic downturn, and our asset quality could deteriorate, which may require material additional provisions for loan losses.

Securities

We use our securities portfolio primarily as a source of liquidity and collateral that can be readily sold or pledged for public deposits or other business purposes. At September 30, 2022, 98.5% of our investment portfolio consisted primarily of U.S. Treasury securities. The remainder of our securities portfolio was invested in municipal bonds, U.S. Agency collateralized mortgage obligations and U.S. Agency residential mortgage-backed securities. Because we target a loan-to-deposit ratio in the range of 90% to 100%, we prioritize liquidity over the earnings of our securities portfolio. At September 30, 2022, our loan-to-deposit ratio was 89.9% due to our significant growth in both loans and deposits. Our securities portfolio represented less than 5% of assets. To the extent our securities represent more than 5% of assets, absent an immediate need for liquidity, we anticipate investing excess funds to provide a higher return.

As of September 30, 2022, the amortized cost of our investment securities totaled $101.5 million, an increase of $64.9 million, or 177.2%, compared to $36.6 million as of December 31, 2021. The increase in the securities portfolio was due to the purchase of five Treasury securities for $135.0 million during the nine months ended September 30, 2022, to invest excess funds, replace maturing securities and pledge to secure public deposits and for other purposes as required or permitted by law, partially offset by $70.0 million in U.S. Treasury maturities and other principal paydowns.

Our investment portfolio consists of securities classified as available for sale and, to a lesser amount, held to maturity. The carrying values of our investment securities classified as available for sale are adjusted for unrealized gain or loss, and any gain or loss is reported on an after-tax basis as a component of other comprehensive income in shareholders’ equity. As of September 30, 2022, our available for sale portfolio has an unrealized loss of $2.6 million, compared to an unrealized gain of $5,000 as of December 31, 2021.

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The following table summarizes the amortized cost and estimated fair value of our investment securities as of the dates shown:


	As of September 30, 2022				As of December 31, 2021
(dollars in thousands; unaudited)	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Securities available-for-sale:
U.S. Treasury securities	$	99,960	$	97,316	$	34,999	$	34,998
U.S. Agency collateralized mortgage obligations	57		54		68		70
U.S. Agency residential mortgage-backed securities	1		1		3		3
Municipal bonds	250		250		252		256
Total available-for-sale securities	100,268		97,621		35,322		35,327
Securities held-to-maturity:
U.S. Agency residential mortgage-backed securities	1,250		1,132		1,296		1,348
Total held-to-maturity securities	1,250		1,132		1,296		1,348
Total investment securities	$	101,518	$	98,753	$	36,618	$	36,675

We held a $2.2 million equity interest in a financial technology company as of September 30, 2022 and December 31, 2021, which consists of common stock and preferred shares. We elected to account for the investments under ASC 321 Investments – Equity Securities without Readily Determinable Value. The investment is held at cost minus impairment if any, plus or minus observable price changes in orderly transactions for an identical or similar investment of the same issue. This method should be applied until the investment does not qualify for the measurement election (e.g., if the investment has a readily determinable fair value). We will reassess at each reporting period whether the equity investment without a readily determinable fair value qualifies to be measured at cost minus impairment; there was no change to the value or valuation technique this quarter. Additionally, during the nine months ended September 30, 2022 we wrote off our investment in a corporate equity security in another technology company; at December 31, 2021 our investment was $100,000, and it was recorded in other investments on the balance sheet. We also held equity indirectly in two other technology companies for $350,000 as of September 30, 2022 and December 31, 2021.

During the year ended December 31, 2021, we entered agreements with remaining capital commitments of $1.0 million in two separate investment funds designed to help accelerate technology adoption at banks. As of December 31, 2021, we held $160,000 in investment funds. During the nine months ended September 30, 2022 we contributed $375,000 and recognized a net market loss of $35,000 bringing our investment funds total to $500,000 as of September 30, 2022, and our outstanding capital commitment to $1.0 million.

Deposits

We offer a variety of deposit products that have a wide range of interest rates and terms, including demand, money market, savings, BaaS-brokered deposits and time accounts as well as reciprocal deposits. Reciprocal deposits enable us to provide an FDIC insured deposit option to customers that have balances in excess of the FDIC insurance limit. This service trades our customers’ funds as certificates of deposit or interest bearing demand deposits in increments under the FDIC insured amount to other participating financial institutions and in exchange we receive time deposit or interest bearing demand investments from participating financial institutions in a reciprocal agreement. We rely primarily on competitive pricing policies, convenient locations, electronic delivery channels (internet and mobile), and personalized service to attract new deposits and retain existing deposits. Additionally, we offer deposit products through our CCBX segment. Although the CCBX products are similar to the community bank offerings, the CCBX deposit products allow us to offer a broader range of partner specific products, which include products designed to reach specific under-served or under-banked populations served by our CCBX partners.

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Total deposits as of September 30, 2022 were $2.84 billion, an increase of $473.3 million, or 20.0%, compared to $2.36 billion as of December 31, 2021. The increase in deposits was largely in core deposits, which increased $478.3 million to $2.73 billion from $2.25 billion at December 31, 2021. We define core deposits as all deposits except time deposits and brokered deposits. The $478.3 million increase in core deposits is also largely from growth in the CCBX segment, which accounted for $481.4 million of the increase, partially offset by a decrease of $3.1 million in community bank deposits. Additionally, as of September 30, 2022 we have access to $266.7 million in CCBX customer deposits that are currently being transferred from the Bank’s balance sheet to other financial institutions on a daily basis. Depending on the circumstances of how the Bank would retain these deposits and its relationship with the customer, these retained deposits could be classified as brokered deposits.

Included in total deposits is $1.20 billion in CCBX deposits, an increase of $486.0 million, or 67.9%, compared to $716.3 million as of December 31, 2021. CCBX customer deposit relationships include deposits with CCBX end customers, operating and non-operating deposit accounts. The deposits from our CCBX division are generally classified as interest bearing NOW and money market accounts, and a portion of such CCBX deposits may be classified as brokered deposits as a result of the relationship agreement. During the first and second quarter of 2022, the majority of CCBX deposits were reclassified from noninterest bearing to interest bearing. This is because the current rate exceeds the minimum interest rate set in their respective program agreements, as a result of the recent increases in interest rates by the FOMC.

Total noninterest bearing deposits as of September 30, 2022 were $813.2 million, a decrease of $542.7 million, or 40.0%, compared to $1.36 billion as of December 31, 2021. The $542.7 million decrease is primarily the result of reclassifying CCBX noninterest bearing deposits to interest bearing as a result of the recent increase in interest rates by the FOMC, partially offset by growth in CCBX noninterest deposits and growth in community bank noninterest deposits. Noninterest bearing deposits represent 28.7% and 57.4% of total deposits for September 30, 2022 and December 31, 2021, respectively.

Total interest bearing account balances, excluding time deposits, as of September 30, 2022 were $1.99 billion, an increase of $1.03 billion, or 106.3%, compared to $964.4 million as of December 31, 2021. The $1.03 billion increase is the result of reclassifying CCBX noninterest bearing deposits to interest bearing as a result of the recent increases in interest rates by the FOMC, combined with CCBX growth in interest bearing deposits partially offset by community bank decrease in interest bearing deposits of $30.4 million. Included in interest bearing account balances is $75.4 million in BaaS-brokered deposits, an increase of $4.6 million from December 31, 2021. Also included in interest bearing deposits is $14.6 million in reciprocal deposits.

Total time deposit balances as of September 30, 2022 were $33.9 million, a decrease of $9.6 million, or 22.1%, from $43.5 million as of December 31, 2021. The decrease is due to the strong increase in core deposits, and our focus on core deposits and letting higher rate deposits run off as they mature. We have seen competitors increase rates on time deposits, and we have not globally matched their rates in response as we have been able to grow and retain less costly core deposits.

The following table sets forth deposit balances at the dates indicated:


	As of September 30, 2022					As of December 31, 2021
(dollars in thousands; unaudited)	Amount			Percent of Total Deposits		Amount			Percent of Total Deposits
Demand, noninterest bearing	$	813,217		28.7	%	$	1,355,908		57.4	%
NOW and money market	1,807,105			63.7		789,709			33.4
Savings	107,508			3.8		103,956			4.4
Total core deposits	2,727,830			96.2		2,249,573			95.2
BaaS-brokered deposits	75,363			2.6		70,757			3.0
Time deposits less than $100,000	13,296			0.5		14,961			0.6
Time deposits $100,000 and over	20,577			0.7		28,496			1.2
Total	$	2,837,066		100.0	%	$	2,363,787		100.0	%
Cost of Deposits (1)	0.82		%			0.09		%

(1)Cost of deposits is annualized for the three months ended for each period presented.

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The following tables detail the deposits for the segments which are included in the total deposit portfolio table above:


Community Bank	As of
	September 30, 2022					December 31, 2021
(dollars in thousands; unaudited)	Balance			% to Total		Balance			% to Total
Demand, noninterest bearing	$	746,516		45.7	%	$	719,233		43.7	%
NOW and money market	748,347			45.8		780,884			47.4
Savings	106,059			6.5		103,954			6.3
Total core deposits	1,600,922			97.9		1,604,071			97.4
Brokered deposits	1			0.0		1			0.0
Time deposits less than $100,000	13,296			0.8		14,961			0.9
Time deposits $100,000 and over	20,577			1.3		28,496			1.7
Total Community Bank deposits	$	1,634,796		100.0	%	$	1,647,529		100.0	%
Cost of deposits(1)	0.16		%			0.12		%

(1)Cost of deposits is annualized for the three months ended for each period presented.


CCBX	As of
	September 30, 2022					December 31, 2021
(dollars in thousands; unaudited)	Balance			% to Total		Balance			% to Total
Demand, noninterest bearing	$	66,701		5.5	%	$	636,675		88.9	%
NOW and money market	1,058,758			88.1		8,825			1.2
Savings	1,449			0.1		2			0.0
Total core deposits	1,126,908			93.7		645,502			90.1
BaaS-brokered deposits	75,362			6.3		70,756			9.9
Total CCBX deposits	$	1,202,270		100.0	%	$	716,258		100.0	%
Cost of deposits (1)	1.79		%			0.02		%

(1)Cost of deposits is annualized for the three months ended for each period presented.

The following table sets forth the Company’s time deposits of $100,000 or more by time remaining until maturity as of the dates indicated:


(dollars in thousands; unaudited)	As of September 30, 2022		As of December 31, 2021
Maturity Period:
Three months or less	$	7,060	$	8,106
Over three through six months	3,141		6,520
Over six through twelve months	5,759		8,925
Over twelve months	4,617		4,945
Total	$	20,577	$	28,496
Weighted average maturity (in years)	0.78		0.73

Average deposits for the three months ended September 30, 2022 were $2.76 billion, an increase of 39.4% compared to $1.98 billion for the three months ended September 30, 2021. The increase in average deposits was primarily due to an increase in core deposits, primarily in interest rate bearing deposits. We expect deposits to increase with continued growth in our primary market areas, the increase in commercial lending relationships for which we also seek deposit balances and the results of business development efforts by branch managers, treasury service personnel and lenders. Additionally, as our CCBX relationships grow, so too will our deposits.

The average rate paid on total deposits was 0.82% for the three months ended September 30, 2022, compared to 0.10% for the three months ended September 30, 2021. The average rate paid on NOW and money market accounts increased 100

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basis points for the three months ended September 30, 2022, compared to the three months ended September 30, 2021. The average rate paid on time deposits of less than $100,000 decreased 17 basis points for the three months ended September 30, 2022, compared to the three months ended September 30, 2021. The average rate paid on time deposits greater than $100,000 decreased 0.26% for the three months ended September 30, 2022 compared to the three months ended. The average rate paid on savings was fairly flat for the three months ended September 30, 2022 compared to the three months ended September 30, 2021. The average rate paid on BaaS brokered deposits increased 1.33% for the three months ended September 30, 2022 compared to the three months ended September 30, 2021. The overall higher average rate paid on interest bearing accounts in the three months ended September 30, 2022 compared to the three months ended September 30, 2021 is due to the recent interest rate increases by the FOMC. Increased Fed Funds rates along with competition are expected to continue to impact future cost of deposits and our pricing strategies.

The average rate paid on total deposits was 0.41% for the nine months ended September 30, 2022, compared to 0.14% for the nine months ended September 30, 2021. The average rate paid on NOW and money market accounts increased 41 basis points for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. The average rate paid on time deposits of less than $100,000 decreased 32 basis points for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021. The average rate paid on time deposits greater than $100,000 increased 0.30% for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021, due to the recognition of additional interest expense of $130,000 during the nine months ended September 30, 2022 to correct interest on CDs from a previous period. The average rate paid on savings was fairly flat for the nine months ended September 30, 2022, compared to the nine months ended September 30, 2021. The average rate paid on BaaS brokered deposits increased 52 basis points compared to the nine months ended September 30, 2021. The overall higher average rate paid on interest bearing accounts in the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021 is due to the recent interest rate increases by the FOMC.

The following table presents the average balances and average rates paid on deposits for the periods indicated:


	For the Three Months Ended September 30,								For the Nine Months Ended September 30,
	2022				2021				2022				2021
(dollars in thousands; unaudited)	Average Balance		Average Rate(1)		Average Balance		Average Rate(1)		Average Balance		Average Rate(1)		Average Balance		Average Rate(1)
Demand, noninterest bearing	$	807,952	0.00	%	$	1,061,311	0.00	%	$	987,343	0.00	%	$	873,271	0.00	%
NOW and money market	1,734,937		1.23		752,889		0.23		1,413,657		0.68		726,174		0.27
Savings	108,097		0.05		94,143		0.03		105,568		0.04		90,574		0.03
BaaS-brokered deposits	74,687		1.67		24,152		0.34		70,815		0.87		23,139		0.35
Time deposits less than $100,000	13,625		0.26		15,825		0.43		14,306		0.29		17,353		0.61
Time deposits $100,000 and over	21,824		0.25		32,783		0.51		24,419		1.02		35,334		0.72
Total deposits	$	2,761,122	0.82	%	$	1,981,103	0.10	%	$	2,616,108	0.41	%	$	1,765,845	0.14	%

(1)Annualized calculations shown for periods presented.

The ratio of average noninterest bearing deposits to average total deposits for the three months ended September 30, 2022 was 29.3% and compared to 53.6% for the three months ended September 30, 2021 and 37.7% for the nine months ended September 30, 2022 compared to 49.5% for the nine months ended September 30, 2021.

Uninsured Deposits

The FDIC insures our deposits up to $250,000 per depositor, per insured bank for each account ownership category. Deposits that exceed insurance limits are uninsured. At September 30, 2022, deposits totaled $2.84 billion, of which total estimated uninsured deposits were $867.7 million. At September 30, 2021, deposits totaled $2.22 billion, of which total estimated uninsured deposits were $796.2 million.

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The table below shows the estimated uninsured time deposits, by account, for the maturity periods indicated:


(dollars in thousands; unaudited)	As of September 30, 2022
Maturity Period:
Three months or less	$	1,296
Over three through six months	712
Over six through twelve months	742
Over twelve months	298
Total	$	3,048

Borrowings

We have the ability to utilize short-term to long-term borrowings to supplement deposits to fund our lending and investment activities, each of which is discussed below.

Federal Reserve Bank Line of Credit. The Federal Reserve allows us to borrow against our line of credit through a borrower in custody agreement utilizing the discount window, which is collateralized by certain loans. As of September 30, 2022 and September 30, 2021, total borrowing capacity of $28.2 million and $21.7 million, respectively, was available under this arrangement. As of September 30, 2022 and 2021, Federal Reserve advances totaled zero.

Paycheck Protection Program Liquidity Facility. To bolster the effectiveness of the SBA’s PPP loan program, the Federal Reserve supplied liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. The PPP provided loans to small businesses so that they can keep their employees on the payroll and pay for other allowed expenses. If the borrowers meet certain criteria, the loan may be forgiven. The PPPLF extended credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. The interest rate was 0.35% and as PPP loans were paid down, the borrowing line also had to be paid down. The borrowing was paid in full in June 2021 and as of September 30, 2022 and 2021, no PPPLF advances were outstanding. PPPLF advances were a new borrowing arrangement beginning in 2020 that had favorable capital treatment and was specific to the PPP loan program. The last day to take new advances on the PPPLF was July 31, 2021.

The table below provides details on PPPLF borrowings for the periods indicated:


	As of and For the Three Months Ended September 30,						As of and For the Nine Months Ended September 30,
(dollars in thousands; unaudited)	2022			2021			2022			2021
Maximum amount outstanding at any month-end during period:
PPPLF Advances	$	—		$	—		$	—		$	185,894
Average outstanding balance during period:
PPPLF Advances	$	—		$	—		$	—		$	91,850
Weighted average interest rate during period:
PPPLF Advances	0.00		%	0.00		%	0.00		%	0.35		%
Balance outstanding at end of period:
PPPLF Advances	$	—		$	—		$	—		$	—
Weighted average interest rate at end of period:
PPPLF Advances	0.00		%	0.00		%	0.00		%	0.00		%

Federal Home Loan Bank Advances. The FHLB allows us to borrow against our line of credit, which is collateralized by certain loans. As of September 30, 2022 and September 30, 2021, we had borrowing capacity of $136.6 million and $120.4 million, respectively, with the FHLB. During the nine months ended September 30, 2022, we repaid a total of $25.0 million in FHLB term advances. This included a $10.0 million advance that would have matured in March of 2023 and $15.0 million advance that would have matured in March 2025. We have sufficient liquidity for our current loan demand, and

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with no prepayment penalty for early repayment, management opted to repay these term advances and save the unnecessary interest expense.

The table below provides details on the FHLB borrowings for the periods indicated:


	As of and For the Three Months Ended September 30,						As of and For the Nine Months Ended September 30,
(dollars in thousands; unaudited)	2022			2021			2022			2021
Maximum amount outstanding at any month-end during period:
FHLB Advances	$	—		$	24,999		$	24,999		$	24,999
Average outstanding balance during period:
FHLB Advances	$	—		$	24,999		$	8,058		$	24,999
Weighted average interest rate during period:
FHLB Advances	0.00		%	1.13		%	1.13		%	1.13		%
Balance outstanding at end of period:
FHLB Advances	$	—		$	24,999		$	—		$	24,999
Weighted average interest rate at end of period:
FHLB Advances	0.00		%	1.13		%	0.00		%	1.13		%

Junior Subordinated Debentures. In 2004, we issued $3.6 million in junior subordinated debentures to Coastal (WA) Statutory Trust I (the “Trust”), of which we own all of the outstanding common securities. The Trust used the proceeds from the issuance of its underlying common securities and preferred securities to purchase the debentures issued by the Company. These debentures are the Trust’s only assets and the interest payments from the debentures finance the distributions paid on the preferred securities. The debentures bear interest at a rate per annum equal to the 3-month LIBOR plus 2.10%. The effective rate as of September 30, 2022 and December 31, 2021 was 5.39% and 2.30%, respectively. We generally have the right to defer payment of interest on the debentures at any time or from time to time for a period not exceeding five years provided that no extension period may extend beyond the stated maturity of the debentures. During any such extension period, distributions on the Trust’s preferred securities will also be deferred, and our ability to pay dividends on our common stock will be restricted. The Trust’s preferred securities are mandatorily redeemable upon maturity of the debentures, or upon earlier redemption as provided in the indenture, subject to Federal Reserve approval. If the debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued but unpaid interest. We unconditionally guarantee payment of accrued and unpaid distributions required to be paid on the Trust securities subject to certain exceptions, the redemption price with respect to any Trust securities called for redemption and amounts due if the Trust is liquidated or terminated.

Subordinated Debt. In August 2021, the Company issued a subordinated note in the amount of $25.0 million. The note matures on September 1, 2031, and bears interest at the rate of 3.375% per year for five years and, thereafter, reprices quarterly beginning September 1, 2026, at a rate equal to the three-month SOFR plus 2.76%. The five-year 3.375% interest period ends on September 1, 2026. We may redeem the subordinated note, in whole or in part, without premium or penalty, in principal redemption multiples of $1,000, after August 18, 2026, subject to any required regulatory approvals. Proceeds were used to repay $10.0 million in existing 5.65% interest subordinated debt on August 9, 2021 and $11.5 million was contributed to the Bank as capital during the quarter ended September 30, 2021.

In November 2022, the Company issued subordinated notes in the aggregate amount of $20.0 million. The notes mature on November 1, 2032, and bear interest at the rate of 7.00% per year for five years and, thereafter, reprices quarterly beginning November 1, 2027, at a rate equal to the three-month SOFR plus 2.9%. The five-year 7.00% interest period ends on November 1, 2027. We may redeem the subordinated notes, in whole or in part, without premium or penalty, in principal redemption multiples of $1,000, after November 1, 2027, subject to any required regulatory approvals. Proceeds will be used for general corporate purposes.

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Liquidity and Capital Resources

Liquidity Management

Liquidity refers to our capacity to meet our cash obligations at a reasonable cost. Our cash obligations require us to have cash flow that is adequate to fund loan growth and maintain on-balance sheet liquidity while meeting present and future obligations of deposit withdrawals, borrowing maturities and other contractual cash obligations. In managing our cash flows, management regularly confronts situations that can give rise to increased liquidity risk. These include funding mismatches, market constraints in accessing sources of funds and the ability to convert assets into cash. Changes in economic conditions or exposure to credit, market, and operational, legal and reputational risks also could affect the Bank’s liquidity risk profile and are considered in the assessment of liquidity management. Deposits obtained through our CCBX segment are a significant source of liquidity for us. If a relationship with a large CCBX partner terminates, the exit of those deposits could have an adverse impact on liquidity. Partner program agreements govern the relationship and are valid for a given period of time. Prior to exiting, the partner would need to provide us adequate notice as stipulated in the agreement that they were not going to renew the program agreement and intend to move the deposits. The movement to an alternate BaaS provider is cumbersome and would be over a period of time, which would allow us the opportunity to put alternate liquidity in place; those options are more fully discussed below. As of September 30, 2022, we have 2 partners with deposits that are in excess of 10% of total deposits and represent 32% of total deposits.

We continually monitor our liquidity position to ensure that our assets and liabilities are managed in a manner to meet all reasonably foreseeable short-term, long-term and strategic liquidity demands. Management has established a comprehensive process for identifying, measuring, monitoring and controlling liquidity risk. Because of its critical importance to the viability of the Bank, liquidity risk management is fully integrated into our risk management processes. Critical elements of our liquidity risk management include: effective corporate governance consisting of oversight by the board of directors and active involvement by management; appropriate strategies, policies, procedures, and limits used to manage and mitigate liquidity risk; comprehensive liquidity risk measurement and monitoring systems that are commensurate with the complexity of our business activities; active management of intraday liquidity and collateral; an appropriately diverse mix of existing and potential future funding sources; adequate levels of readily available cash, deposits and highly liquid marketable securities free of legal, regulatory, or operational impediments, that can be used to meet liquidity needs in stressful situations; contingency funding policies and plans that sufficiently address potential adverse liquidity events and emergency cash flow requirements; and internal controls and internal audit processes sufficient to determine the adequacy of the Bank’s liquidity risk management process. Unlike many industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, other operating expenses do reflect general levels of inflation.

Our liquidity position is supported by management of our liquid assets and liabilities and access to alternative sources of funds. Our liquidity requirements are met primarily through our deposits, FHLB advances and the principal and interest payments we receive on loans and investment securities. Cash on hand, cash at third-party banks, investments available-for-sale and maturing or prepaying balances in our investment and loan portfolios are our most liquid assets. Other sources of liquidity that are routinely available to us include funds from retail, commercial, and BaaS deposits, advances from the FHLB and proceeds from the sale of loans. Less commonly used sources of funding include borrowings from the Federal Reserve discount window, draws on established federal funds lines from unaffiliated commercial banks, funds from online rate services, brokered deposits, a one-way buy through an ICS account, and the issuance of debt or equity securities. We also participated in the PPPLF, which provided an additional source of low cost funding, at a 0.35% interest rate, and favorable capital treatment for the PPP loans. In June 2021, we repaid all borrowings under the PPPLF in full, resulting in a zero balance thereafter. We believe we have ample liquidity resources to fund future growth and meet other cash needs as necessary and are closely monitoring liquidity in this uncertain economic environment.

The Company is a corporation separate and apart from our Bank and, therefore, must provide for its own liquidity, including liquidity required to meet its debt service requirements on its subordinated note and junior subordinated debentures. The Company’s main source of cash flow has been through equity and debt offerings. The Company has consistently retained a portion of the funds from equity and debt offerings so that is has sufficient funds for its operating and debt costs. During the nine months ended September 30, 2022, the Company contributed $21.0 million to the Bank. The Company currently holds $2.0 million in cash for debt servicing and operating purposes each year. In addition, the Bank can declare and pay dividends to the Company to meet the Company’s debt and operating expenses. There are

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statutory and regulatory limitations that affect the ability of the Bank to pay dividends to the Company. We believe that these limitations will not impact the ability of the Bank to pay dividends to the Company to meet ongoing operating needs.

Additionally, the Bank, as of September 30, 2022, has access to $266.7 million in CCBX customer deposits that are currently being transferred from the Bank’s balance sheet to other financial institutions on a daily basis. The Bank could retain these deposits for liquidity and funding purposes if needed. We believe that these limitations will not impact the ability of the Bank to pay dividends to the Company to meet ongoing operating needs. For contingency purposes, the Company maintains a minimum level of cash to fund one year’s projected operating cash flow needs and the Bank established a minimum liquidity ratio of 5% of assets. Both of these minimum liquidity levels are on-balance sheet sources. Per policy and the Bank’s liquidity contingency plan, in event of a liquidity emergency the Bank can utilize wholesale funds in an amount up to 30% of assets. Since the Bank uses only a small portion of its borrowing or wholesale funding capacity, the Bank has access to funds if needed in a liquidity emergency.

Capital Adequacy

Capital management consists of providing equity and other instruments that qualify as regulatory capital to support current and future operations. Banking regulators view capital levels as important indicators of an institution’s financial soundness. As a general matter, FDIC-insured depository institutions and their holding companies are required to maintain minimum capital levels relative to the amount and types of assets they hold. We are subject to regulatory capital requirements at the bank level. Because the Company’s consolidated assets exceed $3.0 billion as of September 30, 2022, the Company is no longer eligible for the Federal Reserve’s Small Bank Holding Company Policy Statement and will be evaluated relative to the capital adequacy standards established by the Federal Reserve going forward. The Company was not in excess of $3.0 billion as of June 30, 2022, and accordingly prepared and filed financial reports with the Federal Reserve as a small bank holding company. Currently, the Federal Reserve assesses the capital position of the Company based on these reports by reviewing its debt-to-equity ratio and its capacity to serve as a source of strength to the Bank.

As of September 30, 2022, and December 31, 2021, the Bank was in compliance with all applicable regulatory capital requirements, and the Bank was classified as “well capitalized” for purposes of the Federal Reserve’s prompt corrective action regulations. As we deploy our capital and continue to grow our operations, our regulatory capital levels may decrease depending on our level of earnings. However, we expect to monitor and control our growth in order to remain in compliance with all regulatory capital standards applicable to us. In addition, the Company maintains an effective registration statement on Form S-3 with the Securities and Exchange Commission that would allow the Company to raise additional capital in an amount up to $115.5 million. The Company raised $34.5 million in December 2021. The Company through private placement raised $25.0 million in subordinated debt in 2021 and repaid $10 million of subordinated debt with the proceeds and used the remainder for general corporate purposes. On November 1, 2022 the Company raised $20.0 million of subordinated debt with the proceeds to be used for general corporate purposes. Please see subsequent events for more detail on this subordinated debt capital raise.

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The following table presents the Company’s and the Bank’s regulatory capital ratios as of the dates presented, as well as the regulatory capital ratios that are required by Federal Reserve regulations to maintain “well-capitalized” status:


	Actual				Minimum Required for Capital Adequacy Purposes (1)				Required to be Well Capitalized Under the Prompt Corrective Action Provisions
(dollars in thousands; unaudited)	Amount		Ratio		Amount		Ratio		Amount		Ratio
September 30, 2022
Leverage Capital (to average assets)
Company	$	234,239	7.70	%	$	121,688	4.00	%	$	152,110	5.00	%
Bank Only	253,346		8.34	%	121,560		4.00	%	151,950		5.00	%
Common Equity Tier I Capital (to risk-weighted assets)
Company	230,739		8.49	%	122,290		4.50	%	176,641		6.50	%
Bank Only	253,346		9.34	%	122,079		4.50	%	176,336		6.50	%
Tier I Capital (to risk-weighted assets)
Company	234,239		8.62	%	163,053		6.00	%	217,404		8.00	%
Bank Only	253,346		9.34	%	162,772		6.00	%	217,030		8.00	%
Total Capital (to risk-weighted assets)
Company	293,546		10.80	%	217,404		8.00	%	271,756		10.00	%
Bank Only	287,595		10.60	%	217,030		8.00	%	271,287		10.00	%
December 31, 2021
Leverage Capital (to average assets)
Company	$	204,585	8.07	%	$	101,460	4.00	%	$	126,826	5.00	%
Bank Only	201,783		7.96	%	101,350		4.00	%	126,687		5.00	%
Common Equity Tier I Capital (to risk-weighted assets)
Company	201,085		11.06	%	81,834		4.50	%	118,205		6.50	%
Bank Only	201,783		11.12	%	81,623		4.50	%	117,900		6.50	%
Tier I Capital (to risk-weighted assets)
Company	204,585		11.25	%	109,112		6.00	%	145,483		8.00	%
Bank Only	201,783		11.12	%	108,830		6.00	%	145,107		8.00	%
Total Capital (to risk-weighted assets)
Company	252,405		13.88	%	145,483		8.00	%	181,854		10.00	%
Bank Only	224,545		12.38	%	145,107		8.00	%	181,384		10.00	%

(1)Presents the minimum capital adequacy requirements that apply to the Bank (excluding the capital conservation buffer) and the Company.

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Material Cash Requirements and Capital Resources

The following table provides the material cash requirements from known contractual and other obligations as of as of September 30, 2022:


			Payments Due by Period
(dollars in thousands; unaudited)	Total		Less than 1 Year		Over 1 year		Other (1)
Cash requirements
Time Deposits	$	33,873	$	25,679	$	8,194	$	—
Subordinated note	25,000		—		25,000		—
Junior subordinated debentures	3,609		—		3,609		—
Deferred compensation plans	979		175		804		—
Operating leases	6,384		1,280		5,104		—
Non-maturity deposits	2,803,193		—		—		2,803,193
Equity investment commitment	962		962		—		—

(1)Represents the undefined maturity of non-maturing deposits, including noninterest bearing demand deposits, interest bearing demand deposits, money market accounts, savings accounts and brokered deposits, which can generally be withdrawn on demand.

We maintain sufficient cash and cash equivalents and investment securities to meet short-term cash requirements and the levels of these assets are dependent on our operating, investing and financing activities during any given period. Cash on hand, cash at third-party banks, investments available-for-sale and maturing or prepaying balances in our investment and loan portfolios are our most liquid assets. Other sources of liquidity that are routinely available to us include funds from retail, commercial, and BaaS deposits, advances from the FHLB and proceeds from the sale of loans. Less commonly used sources of funding include borrowings from the Federal Reserve discount window, draws on established federal funds lines from unaffiliated commercial banks, funds from online rate services, brokered funds, a one-way buy through an ICS account, and the issuance of debt or equity securities.

In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby and commercial letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in our consolidated balance sheets.

Our commitments associated with outstanding commitments to extend credit and standby and commercial letters of credit are summarized in the following table. Since commitments associated with commitments to extend credit and letters of credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.

As of September 30, 2022 we held $174.3 million in capital call lines, included in commercial and industrial loans, provided to venture capital firms through one of our BaaS clients. These loans are secured by the capital call rights and are individually underwritten to the Bank’s credit standards and the underwriting is reviewed by the Bank on every line.

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As of September 30, 2022 we had $2.3 billion in commitments to extend credit, compared to $909.6 million as of December 31, 2021. The $1.41 billion increase is largely attributed to an increase of $639.1 million in consumer and other loan commitments, related to CCBX consumer loans, $344.2 million increase in commercial and industrial capital call line commitments, and $374.9 million increase in residential real estate commitments, related to CCBX loans.


(dollars in thousands; unaudited)	As of September 30, 2022		As of December 31, 2021
Commitments to extend credit:
Commercial and industrial loans	$	79,526	$	70,848
Commercial and industrial loans - capital call lines	760,192		415,956
Construction – commercial real estate loans	128,309		90,946
Construction – residential real estate loans	34,691		43,339
Residential real estate loans	476,592		101,715
Commercial real estate loans	37,197		23,248
Consumer and other loans	802,586		163,510
Total commitments to extend credit	$	2,319,093	$	909,562
Standby letters of credit	$	3,161	$	2,729
Equity investment commitment	$	962	$	1,090

Commitments to extend credit are agreements to lend to a customer 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 are expected to expire without being fully drawn upon, the total commitment amounts disclosed above do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if considered necessary by us, upon extension of credit, is based on management’s credit evaluation of the customer. As of September 30, 2022, $1.59 billion in commitments to extend credit are unconditionally cancelable, compared to $162.3 million at December 31, 2021. The increase in unconditionally cancelable commitments is attributed to growth in CCBX loans. Commitments that are unconditionally cancelable allow us to better manage loan growth, credit concentrations and liquidity. We also limit CCBX partners to a maximum aggregate customer loan balance originated and held on our balance sheet, such as $350.0 million in capital call lines.

The following table shows the CCBX maximum portfolio sizes by loan category as of September 30, 2022.


(dollars in thousands; unaudited)	Type of Lending	Maximum Portfolio Size
Commercial and industrial loans:
Capital call lines	Business - Venture Capital	$	350,000
All other commercial & industrial loans	Business - Small Business	68,320
Real estate loans:
Home equity lines of credit	Home Equity - Secured Credit Cards	250,000
Consumer and other loans:
Credit cards	Credit Cards - Primarily Consumer	565,534
Installment loans	Consumer	1,040,404
Other consumer and other loans	Consumer - Secured Credit Builder & Unsecured consumer	195,743
		$	2,470,001

Standby and commercial letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event of nonperformance by the customer, we have rights to the underlying collateral, which can include commercial real estate, physical plant and property, inventory, receivables, cash and/or marketable securities. Our credit risk associated with issuing letters of credit is essentially the same as the risk involved in extending loan facilities to our customers.

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Critical Accounting Policies

Our accounting policies are integral to understanding our results of operations. Our accounting policies are described in greater detail in “Note 1 - Description of Business and Summary of Significant Accounting Policies” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” of our Form 10-K. We have procedures and processes in place to facilitate making these judgments. Actual results in these areas could differ from management’s estimates. There have been no significant changes concerning our critical accounting policies as described in our Form 10-K.

Selected Financial Data

The following table shows the Company’s key performance ratios for the periods indicated.


	Three Months Ended										Nine Months Ended
(unaudited)	September 30, 2022		June 30, 2022		March 31, 2022		December 31, 2021		September 30, 2021		September 30, 2022		September 30, 2021

Return on average assets (1)	1.45	%	1.41	%	0.93	%	1.14	%	1.21	%	1.27	%	1.28	%
Return on average equity (1)	19.36	%	18.86	%	12.12	%	16.80	%	16.77	%	16.90	%	17.40	%
Yield on earnings assets (1)	7.38	%	5.94	%	4.58	%	4.09	%	3.63	%	6.03	%	3.83	%
Yield on loans receivable (1)	8.46	%	7.34	%	6.80	%	5.92	%	4.57	%	7.63	%	4.51	%



Cost of funds (1)	0.85	%	0.29	%	0.14	%	0.14	%	0.16	%	0.44	%	0.20	%
Cost of deposits (1)	0.82	%	0.25	%	0.09	%	0.09	%	0.10	%	0.41	%	0.14	%
Net interest margin (1)	6.58	%	5.66	%	4.45	%	3.95	%	3.48	%	5.61	%	3.64	%
Noninterest expense to average assets (1)	6.66	%	5.29	%	4.52	%	3.29	%	2.91	%	5.54	%	2.74	%
Noninterest income to average assets (1)	4.48	%	3.53	%	3.27	%	2.22	%	1.11	%	3.79	%	0.90	%
Efficiency ratio	61.12	%	58.38	%	59.34	%	54.08	%	64.68	%	59.77	%	61.51	%
Loans receivable to deposits (2)	89.92	%	86.54	%	76.24	%	73.73	%	76.71	%	89.92	%	76.71	%

(1)Annualized calculations shown for periods presented.

(2)Including loans held for sale.

CCBX – BaaS Reporting Information

During the three and nine months ended September 30, 2022, $17.9 million and $45.2 million, respectively was recognized in noninterest income BaaS credit enhancements related to the establishment of a credit enhancement receivable for future loan losses indemnified by our strategic partners and reserve for unfunded commitments for CCBX partner loans and deposits. Agreements with our CCBX partners provide for a credit enhancement provided by the partner which protects the Bank by absorbing incurred losses on accounts they originate. In accordance with accounting guidance, we estimate and record a provision for probable losses on these CCBX loans and deposit overdrafts. When the provision for loan losses and provision for unfunded commitments is recorded, a receivable is also recorded on the balance sheet through the recognition of noninterest income (BaaS credit enhancements) in recognition of the CCBX partner’s indemnification obligation and legal commitment to cover losses. Incurred credit losses are recorded in the allowance for loan losses, and as the credit enhancement payments are received from the CCBX partner, the credit enhancement receivable is relieved. Agreements with our CCBX partners also provide protection to the Bank from fraud by absorbing incurred fraud losses. Fraud losses are recorded when incurred as losses in noninterest expense, and the recovery received from the CCBX partner is recorded in noninterest income, resulting in a net impact of zero to the income statement. CCBX partners also pledge cash reserves in a restricted deposit account at the Bank which the Bank can collect from when losses occur that is then replenished by the partner on a regular interval. Although agreements with our CCBX partners provide for credit enhancements that provide protection to the Bank from credit and fraud losses by absorbing incurred credit and fraud losses, if our partner is unable to fulfill their contracted obligations beyond their cash reserve account then the Bank would be exposed to additional loan and deposit losses, as a result of this counterparty risk.

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For CCBX partner loans the Bank records contractual interest earned from the borrower on loans in interest income, adjusted for origination costs which are paid or payable to the CCBX partner. BaaS loan expense represents the amount paid or payable to partners for credit enhancements, fraud enhancements and servicing CCBX loans. To determine net BaaS loan income earned from CCBX loan relationships, the Bank takes BaaS loan interest income and deducts BaaS loan expense to arrive at net BaaS loan income which can then be compared to interest income on the Company’s community bank loans.

The following table illustrates how CCBX partner loan income and expenses are recorded in the financial statements:


Loan income and related loan expense	Three Months Ended						Nine Months Ended
(dollars in thousands; unaudited)	September 30, 2022			September 30, 2021			September 30, 2022			September 30, 2021
BaaS loan interest income	$	31,449		$	1,471		$	64,721		$	2,761
Less: BaaS loan expense	15,560			419			36,079			609
Net BaaS loan income (1)	15,889			1,052			28,642			2,152
Net BaaS loan income divided by average BaaS loans (1)	7.05		%	2.61		%	5.82		%	2.54		%
Yield on loans (2)	13.96		%	3.65		%	13.16		%	3.26		%

(1)A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”

(2)Annualized calculations shown for periods presented.

The addition of new CCBX partners has resulted in increases in direct fees, expenses and interest for the three and nine months ended September 30, 2022 compared to the three and nine months ended September 30, 2021. The following tables are a summary of the direct fees, expenses and interest components of BaaS for the periods indicated and are not inclusive of all income and expense related to BaaS.


Interest income	Three Months Ended				Nine Months Ended
(dollars in thousands; unaudited)	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
Loan interest income	$	31,449	$	1,471	$	64,721	$	2,761
Total BaaS interest income	$	31,449	$	1,471	$	64,721	$	2,761


Interest expense	Three Months Ended				Nine Months Ended
(dollars in thousands; unaudited)	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
BaaS interest expense	$	5,075	$	23	$	6,549	$	65
Total BaaS interest expense	$	5,075	$	23	$	6,549	$	65

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	Three Months Ended				Nine Months Ended
(dollars in thousands; unaudited)	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
Program income:
Servicing and other BaaS fees	$	1,079	$	1,313	$	3,407	$	3,046
Transaction fees	940		146		2,247		264
Interchange fees	738		188		1,798		333
Reimbursement of expenses	885		333		1,875		709
Program income	3,642		1,980		9,327		4,352
Indemnification income:
Credit enhancements	17,928		10		45,210		10
Fraud enhancements	11,708		296		22,753		296
Indemnification income	29,636		306		67,963		306
Total BaaS income	$	33,278	$	2,286	$	77,290	$	4,658


	Three Months Ended				Nine Months Ended
(dollars in thousands; unaudited)	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021
BaaS loan expense	$	15,560	$	419	$	36,079	$	609
BaaS fraud expense	11,707		296		22,752		296
Total BaaS loan and fraud expense	$	27,267	$	715	$	58,831	$	905

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

The Company uses certain non-GAAP financial measures to provide meaningful supplemental information regarding the Company’s operational performance and to enhance investors’ overall understanding of such financial performance. However, these non-GAAP financial measures are supplemental and are not a substitute for an analysis based on GAAP measures. As other companies may use different calculations for these adjusted measures, this presentation may not be comparable to other similarly titled adjusted measures reported by other companies.

The following non-GAAP measure is presented to illustrate the impact of BaaS loan expense on net loan income and yield on CCBX loans.

Net BaaS loan income and net BaaS loan income divided by average CCBX loans are non-GAAP measures that include the impact BaaS loan expense on net BaaS loan income and the yield on CCBX loans. The most directly comparable GAAP measures are BaaS loan interest income and yield on CCBX loans.

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Reconciliations of the GAAP and non-GAAP measures are presented in the following table.


	As of and for the Three Months Ended															As of and for the Nine Months Ended
(dollars in thousands; unaudited)	September 30, 2022			June 30, 2022			March 31, 2022			December 31, 2021			September 30, 2021			September 30, 2022			September 30, 2021
Net BaaS loan income divided by average CCBX loans:
Total average CCBX loans receivable	$	893,655		$	691,294		$	382,153		$	244,038		$	160,022		$	657,574		$	113,369
Interest and earned fee income on CCBX loans (GAAP)	31,449			21,281			11,992			3,771			1,471			64,721			2,761
Less: loan expense on CCBX loans	(15,560)			(12,229)			(8,290)			(2,368)			(419)			(36,079)			(609)
Net BaaS loan income	$	15,889		$	9,052		$	3,702		$	1,403		$	1,052		$	28,642		$	2,152
Net BaaS loan income divided by average CCBX loans (1)	7.05		%	5.25		%	3.93		%	2.28		%	2.61		%	5.82		%	2.54		%
CCBX loan yield (1) (GAAP)	13.96		%	12.35		%	12.73		%	6.13		%	3.65		%	13.16		%	3.26		%

(1) Annualized calculations for periods presented.

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Item 3. Quantitative and Qualitative Disclosure about Market Risk

Quantitative and Qualitative Disclosures about Market Risk

As a financial institution, our primary component of market risk is interest rate volatility. Our asset liability and funds management policy provides management with the guidelines for effective funds management, and we have established a measurement system for monitoring our net interest rate sensitivity position. We have historically managed our sensitivity position within our established guidelines.

Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of our assets and liabilities, and the market value of all interest earning assets and interest bearing liabilities, other than those which have a short term to maturity. Interest rate risk is the potential for economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a decrease in current fair market values. Our objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. The Federal Open Market Committee raised interest rates 0.25% in mid-March 2022, 1.25% in the second quarter of 2022 and 1.50% in the third quarter of 2022 with additional increases expected in the future. The impact of this and any future increases will impact financial results.

We manage our exposure to interest rates by structuring our balance sheet in the ordinary course of business. We do not enter into instruments such as leveraged derivatives, financial options, financial future contracts or forward delivery contracts for the purpose of reducing interest rate risk. Based upon the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets.

Our exposure to interest rate risk is managed by the Asset Liability Committee (“ALCO”), of the Bank and reviewed by the Asset Liability and Investment Committee of our board of directors in accordance with policies approved by our board of directors. ALCO formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, ALCO considers the impact on earnings and capital on the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. ALCO meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, purchase and sale activities, commitments to originate loans and the maturities of investments and borrowings. Additionally, ALCO reviews liquidity, cash flows, maturities of deposits and consumer and commercial deposit activity. Management employs various methodologies to manage interest rate risk including an analysis of relationships between interest earning assets and interest bearing liabilities and interest rate simulations using a model. The Asset Liability and Investment Committee of our board of directors meets regularly to review the Bank’s interest rate risk profile, liquidity position, including contingent liquidity, and investment portfolio.

We use interest rate risk simulation models to test interest rate sensitivity of net interest income and fair value of equity, and the impact of changes in interest rates on other financial metrics. Contractual maturities and re-pricing opportunities of loans are incorporated in the model, as are prepayment assumptions, maturity data and call options within the investment portfolio. Average life of non-maturity deposit accounts are based on historical decay rates and assumptions and are incorporated into the model. The assumptions used are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies. To help ensure the accuracy of the model, we perform a quarterly back test against our actual results.

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On a quarterly basis, we run multiple simulations under two different premises of which one is a static balance sheet and the other is a dynamic growth balance sheet. The static balance sheet approach produces results that show the interest risk currently inherent in our balance sheet at that point in time. The dynamic balance sheet includes our projected growth levels going forward and produces results that shows how net income, net interest income, and interest risk change based on our projected growth. These simulations test the impact on net interest income and fair value of equity from changes in market interest rates under various scenarios. Under the static and dynamic approaches, rates are shocked instantaneously and ramped over a 12-month horizon assuming parallel yield curve shifts. Parallel shock scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Non-parallel simulations are also conducted and involve analysis of interest income and expense under various changes in the shape of the yield curve including a forward curve, flat curve, steepening curve, and an inverted curve. Our internal policy regarding internal rate risk simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net income at risk for the subsequent one- and two-year period should not decline by more than 10% for a 100 basis point shift, 15% for a 200 basis point shift, 20% for a 300 basis point shift, and 25% for a 400 basis point shift.

The following tables summarize the simulated change in net interest income over a 12-month horizon as of the dates indicated:


(unaudited)
Change in Market Interest Rates	Twelve Month Projection As of September 30, 2022	Twelve Month Projection As of December 31, 2021
Static Balance Sheet and Rate Shifts
+400 basis points	20.4%	36.7%
+300 basis points	15.3%	27.2%
+200 basis points	10.3%	17.9%
+100 basis points	5.2%	8.5%
-100 basis points	(5.4)%	(9.7)%
-200 basis points	(12.8)%	(15.4)%
-300 basis points	(18.3)%	(19.9)%

Dynamic Balance Sheet and Rate Shifts
+400 basis points	21.8%	38.5%
+300 basis points	16.4%	28.7%
+200 basis points	11.0%	18.8%
+100 basis points	5.5%	9.1%
-100 basis points	(5.8)%	(11.8)%
-200 basis points	(13.4)%	(19.4)%
-300 basis points	(19.2)%	(23.0)%

The results illustrate that the Company is asset sensitive and generally performs better in an increasing interest rate environment. As the Company’s composition has shifted overtime due to the growth of the CCBX division to more variable/adjustable in nature, our interest rate risk profile has migrated, reducing exposure to interest rate risk. For the community bank, the drivers are primarily due to behavior of demand, money market and savings deposits during such rate fluctuations. We have found that, historically, offering rates on these community bank deposits change more slowly than changes in short-term market rates. For the CCBX segment, the offering rates on the loan portfolio are modeled using partner contractual net yields which adjust with market shifts. For this CCBX portfolio, the offering rates on both the loans and the deposits nearly fully reprice with changes in market rates. The assumptions incorporated into the simulation model are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact that fluctuations in market interest rates have on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude, and frequency of interest rate changes as well as changes in market conditions, the shape of the interest yield curve, and the application and timing of various assumptions and strategies.

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Item 4. Controls and Procedures

Disclosure Controls and Procedures. An evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on that evaluation, the Company's Chief Executive Officer and the Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the SEC (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.

Change in Internal Control over Financial Reporting. There were no changes in the Company’s internal control over financial reporting occurred during the three months ended September 30, 2022, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we are a party to various litigation matters incidental to the conduct of our business. We do not believe that any currently pending legal proceedings will have a material adverse effect on our business, financial condition or earnings.

Item 1A. Risk Factors

For information regarding the Company’s risk factors, see “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021, which are incorporated by reference herein. As of September 30, 2022, the risk factors of the Company have not changed materially from those disclosed in the Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

There were no unregistered sales of the Company’s equity securities during the three and nine months ended September 30, 2022.

The Company did not repurchase any of its equity securities during the three and nine months ended September 30, 2022 and does not have any authorized share repurchase programs.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits


31.1			Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2			Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1			Certifications of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2			Certifications of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101			The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter months ended September 30, 2022, formatted in inline XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statement of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to the Consolidated Financial Statements. Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

104			Cover Page Interactive Data (formatted as Inline XBRL and contained in Exhibit 101 filed herewith)

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


			COASTAL FINANCIAL CORPORATION

Dated:	November 8, 2022	By:	/s/ Eric M. Sprink
			Eric M. Sprink
			Chief Executive Officer
			(Principal Executive Officer)

Dated:	November 8, 2022	By:	/s/ Joel G. Edwards
			Joel G. Edwards
			Executive Vice President and
			Chief Financial Officer
			(Principal Financial Officer)