EDGAR 10-K Filing

Company CIK: 1437958
Filing Year: 2021
Filename: 1437958_10-K_2021_0001564590-21-012709.json

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ITEM 1. BUSINESS
Item 1.
Business
Our Company
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 and Federal Reserve System (Federal Reserve) state member bank. Arlington Olympic LLC was formed in 2019 and owns the Company’s Arlington branch, which the Bank leases from the LLC. Our executive offices are located at 5415 Evergreen Way, Everett, Washington 98203 and our telephone number is (425) 257-9000. Our website address is www.coastalbank.com. Information on our website should not be considered a part of this Report on Form 10-K.
The Company provides a full range of banking services to small and medium-sized businesses, professionals, and individuals throughout the greater Puget Sound area through its 15 branches in Snohomish, Island, and King Counties, the Internet, and its mobile banking application. The Company opened its 15th branch in Arlington, Washington during the second quarter 2020. The Bank announced the sale of its Freeland Branch (Island County) in February 2021. The Bank’s main branch and the headquarters of the Bank and Company are located in Everett, Washington. The Bank’s deposits are insured in whole or in part by the Federal Deposit Insurance Corporation (the FDIC). The Bank’s loans and deposits are primarily within the greater Puget Sound area, and the Bank’s primary funding source is deposits from customers. Through its CCBX division, the Bank also provides banking as a service (BaaS), which enables broker dealers and digital financial service providers to offer their customers banking services, through their agreements and in collaboration with the Bank. In 2021 or early 2022, the Bank expects to introduce a digital bank offering, through its CCDB division, in collaboration with Google. 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 December 31, 2020, we had total assets of $1.77 billion, total loans receivable of $1.55 billion, total deposits of $1.42 billion and total shareholders’ equity of $140.2 million.
Throughout this Report on Form 10-K, references to “we,” “us” or “our” refer to the Company or the Bank, or both, as the context indicates.
Our Markets
We define our market broadly as the Puget Sound region in the state of Washington, which encompasses King, Kitsap, Pierce, Snohomish, Skagit, Thurston and Island Counties. The Puget Sound region, which comprises over 62% of the population of the state of Washington, and over 65% of the number of businesses located therein, with a population of approximately 4.8 million, over 125,000 businesses and $147.9 billion of deposits.
We are the largest locally headquartered bank by deposit market share in Snohomish County, according to data from the FDIC as of June 30, 2020, at which date we had a 7.6% deposit market share in Snohomish County, up from 6.2% in 2019. We aim to continuously enhance our customer base, increase loans and deposits and expand our overall market share in Snohomish County. In light of our market position and our business strategy, we do not regularly compete for commercial or retail deposits in the city of Seattle, and we believe this strategic decision has enabled us to generate low cost core deposits to fund our loan growth.
Our Banking Services
Lending Activities
We focus primarily on commercial lending, with an emphasis on commercial real estate. We offer a variety of loans to business owners, including commercial and industrial loans and commercial real estate loans secured by
owner-occupied commercial properties. We also offer non-owner occupied commercial real estate loans, multi-family loans, and construction and development loans to investors and developers. We also offer residential real estate loans and to a lesser extent, consumer loans.
Commercial and Industrial Loans. As of December 31, 2020, we had $539.2 million of commercial and industrial loans, representing 34.6% of total loans. These loans had a weighted average maturity of approximately 1.9 years. We make commercial and industrial loans, including term loans, Small Business Administration (SBA) loans, commercial lines of credit, working capital loans, equipment financing, borrowing base loans, and other loan products, that are underwritten on the basis of the borrower’s ability to service the debt from income. We take as collateral a lien on general business assets including, among other things, available real estate, accounts receivable, inventory and equipment and generally obtain a personal guaranty from the borrower or principal. Our commercial lines of credit typically have a term of one year and have variable interest rates that adjust monthly based on the prime rate. Other commercial and industrial loans generally have fixed interest rates and terms that typically range from one to five years depending on factors such as the type and size of the loan, the financial strength of the borrower/guarantor and the age, type and value of the collateral. Terms greater than five years may be appropriate in some circumstances, based upon the useful life of the underlying asset being financed or if some form of credit enhancement, such as an SBA guarantee, is obtained.
Commercial and industrial loans are often larger and involve greater risks than other types of lending. Because payments on commercial and industrial loans are often dependent on the operating cash flows of the borrower’s business, repayment of these loans is often more sensitive to adverse conditions in the general economy, which in turn increases repayment risk. We also face the risk that losses incurred on a small number of commercial loans could have an adverse impact on our financial condition and results of operations due to (a) the larger average size of commercial loans as compared with other loans, such as residential loans, as well as (b) collateral that is generally less readily marketable than collateral for consumer loans, such as residential real estate and automobiles.
As of December 31, 2020, our commercial and industrial loans included $365.8 million in PPP loans. These are SBA loans that allow small business owners to apply for financial assistance via the PPP as prescribed in the CARES Act. These loans have a contractual rate of 1.0%, with maturity terms of two to five years, are unsecured, 100% guaranteed and loan proceeds may be forgiven by the SBA if used for certain purposes. To bolster the effectiveness of the SBA’s PPP loan program, the Federal Reserve is supplying liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. The Paycheck Protection Program Liquidity Facility (PPPLF) extends credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. The interest rate is 0.35% and as PPP loans are paid down, the borrowing line must also be paid down.
As of December 31, 2020, we held $65.6 million 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 and the underwriting is reviewed by the Bank on every line. Capital call lines represent 37.8% of commercial and industrial loans, excluding PPP loans, or 12.2%, including PPP loans.
As of December 31, 2020, our total commercial SBA portfolio, excluding PPP loans, was $11.6 million, net of $8.5 million sold, of which $1.5 million was guaranteed by the SBA. We participate in the SBA 7(a) program in order to meet the needs of our small business community. As an approved participant in the SBA Preferred Lender’s Program, we enable our clients to obtain SBA loans without being subject to the potentially lengthy SBA approval process necessary for lenders that are not SBA Preferred Lenders. The SBA’s 7(a) program provides up to a 75% guaranty for loans greater than $150,000. For loans $150,000 or less, the program provides up to an 85% guaranty. The maximum 7(a) loan amount is $5 million. The guaranty is conditional and covers a portion of the risk of payment default by the borrower, but not the risk of improper closing and servicing by the lender. As such, prudent underwriting and closing processes are essential to effective utilization of the 7(a) program. We typically sell in the secondary market the SBA-guaranteed portion (generally 75% of the principal balance) of the SBA loans we originate.
The Consolidated Appropriations Act, 2021 makes the following modifications to the 7(a) program:
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Increases to 90% the loan guarantee on 7(a) loans, including for Community Advantage loans, through September 30, 2021.
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Extends the CARES Act’s increase to the Express Loan amount from $350,000 to $1 million through September 30, 2021, with that amount reverting, on a permanent basis to $500,000 beginning October 1, 2021.
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From the date of enactment of the Consolidated Appropriations Act, 2021 through September 30, 2021, temporarily increases from 50% to 75% the Express Loan guaranty percentage for loans of $350,000 and less. The guarantee percentage remains at 50% for SBA Express loans over $350,000. On October 1, 2021, the guarantee reverts to 50% for all Express Loans.
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Waives lender and borrower fees, including the up-front guaranty fee and the ongoing fee, through September 30, 2021.
In addition, the Consolidated Appropriations Act, 2021 extends section 1112 of the CARES Act, which requires the SBA to pay principal, interest, and fees on certain existing SBA loans, through the following modifications:
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Provides $3.5 billion in funding for extension of Section 1112 payments, with appropriations available through September 30, 2021.
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Resumes the payment of principal and interest (P&I) on small business loans guaranteed by the SBA under the 7(a), 504 and Microloan programs, as established under Section 1112 of the CARES Act.
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Provides that all borrowers with qualifying loans approved by the SBA prior to the CARES Act will receive an additional three months of P&I, starting in February 2021. Going forward, those payments will be capped at $9,000 per loan per month.
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Provides that, after the three-month period described above, borrowers considered to be underserved (i.e., the smallest and hardest-hit by the pandemic) will receive an additional five months of P&I payments, also capped at $9,000 per loan per month. These include borrowers with SBA microloans or 7(a) Community Advantage loans.
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Borrowers with any 7(a) or 504 loan in the hardest-hit sectors, as measured by the severity of sector-wide job losses since the start of the pandemic. Provides SBA payments of P&I on the first 6 months of newly approved loans will resume for all loans approved between February 1 and September 30, 2021, also capped at $9,000 per month.
As of December 31, 2020, we held a total of $953,000, net of $3.1 million sold, of United States Department of Agriculture (USDA) loans, which includes $850,000, classified as commercial and industrial loans. We participate in the USDA Business and Industry and Community Facilities programs. Both loan programs provide up to a 90% guarantee. The guarantee is conditional and covers a portion of the risk of payment default by the borrower but not the risk of improper servicing by the lender. Unlike the SBA 7(a) program, the USDA guarantee is not issued until after the loan closes. USDA issues a conditional commitment prior to loan closing and prudent closing processes are essential to effective utilization of the USDA loan programs. The USDA guaranteed portion of the USDA loans are typically sold in the secondary market.
Commercial Real Estate. As of December 31, 2020, we had $774.9 million of commercial real estate loans, representing 49.8% of total loans; excluding PPP loans, commercial real estate loans would represent 65.1% of total loans. We make commercial mortgage loans collateralized by owner- and non-owner-occupied real estate, as well as multi-family residential loans. Loans secured by owner-occupied real estate totaled $266.4 million and comprised 34.4% of our commercial real estate portfolio at December 31, 2020. 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 and gas stations, 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 a final maturity and balloon payment 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 Federal Home Loan Bank rates. At December 31, 2020, approximately 41.4% of the commercial real estate loan portfolio consisted of fixed rate loans. Loan amounts generally do not exceed 75% of the lesser of the appraised value or the purchase price.
As of December 31, 2020, we had a total of $3.5 million, net of $7.9 million sold, in commercial real estate SBA loans. Also included in commercial real estate loans was $49.4 million, or 3.2% of total loans, in loans under the SBA 504 program. Under the SBA 504 program we make loans to small businesses to provide funding for the purchase of real estate. Under this program, we provide up to 90% financing of the total purchase cost, represented by two loans to the borrower. The first lien loan is generally a long-term, fully amortizing, fixed-rate loan made in
the amount of 50% of the total purchase cost. The second lien loan is a short-term, interest only, adjustable rate loan made in the amount of 40% of the total purchase cost, which is generally paid off within three to six months after full receipt of loan proceeds from a certified development corporation that provides long-term financing directly to the borrower.
Our multi-family residential loan portfolio is comprised of loans secured by apartment buildings, residential mixed-use buildings and, to a lesser extent, senior living centers. As of December 31, 2020, we had $129.7 million on multi-family residential loans, representing 16.7% of our commercial real estate loans, and 8.3% of total loans.
Commercial real estate lending with respect to non-owner occupied properties typically involves higher loan principal amounts and the repayment is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. We require that our commercial real estate loans to investors be secured by well-managed properties with adequate margins and generally obtain a guaranty from responsible parties. As of December 31, 2020, we held $362.2 million in other non-owner occupied loans, excluding multifamily loans, representing 46.7% of our commercial real estate loans and 23.3% of total loans.
Construction, Land and Land Development Loans. As of December 31, 2020, we had $94.4 million in construction, land and land development loans, representing 6.1% of total loans. We make loans to established builders to construct residential properties, to developers of commercial real estate investment properties and to residential developments and, to a lesser extent, loans to individual clients for construction of single family homes in our market areas. We also make loans for the acquisition of undeveloped land. Construction loans are typically disbursed as construction progresses and carry either fixed or variable interest rates. Our construction and development loans typically have terms that range from six months to two years depending on factors such as the type and size of the development and the financial strength of the borrower/guarantor. Loans are typically structured with an interest only construction period and mature at the completion of construction.
Construction and land development loans typically involve more risk than other types of lending products because repayment of these loans is dependent, in part, on the sale or refinance of the ultimate project rather than the ability of the borrower or guarantor to repay principal and interest. Moreover, these loans are typically based on future estimates of value and economic circumstances, which may differ from actual results or be affected by unforeseen events. If the actual circumstances differ from the estimates made at the time of approval of these loans, we face the risk of having inadequate security for the repayment of the loan. Further, if we foreclose on the loan, we may be required to fund additional amounts to complete the project and may have to hold the property for an unspecified period of time until the foreclosed property is sold.
Residential Real Estate. As of December 31, 2020, we had $143.9 million in residential real estate loans, representing 9.2% of total loans. We primarily originate one-to-four 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 December 31, 2020, the balance of ARM portfolio loans was $20.5 million. 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 originate home equity lines of credit and home equity term loans for our portfolio. Home equity lines of credit have variable interest rates, while home equity term loans are fixed for up to 5-1/2 years but can be amortized up to a maximum of 180 months with a balloon payment at maturity.
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. As of December 31, 2020, we held $16.8 million, representing 1.1% of our total loans, in purchased residential real estate mortgage loans. Our last purchase of residential mortgages was in 2018. 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 December 31, 2020, residential real estate loans made to investors and business owners totaled $84.3 million.
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.
Consumer and Other Loans. As of December 31, 2020, we had $3.9 million in total consumer loans, representing 0.3% of total loans. We make a variety of consumer loans to individuals, mainly business owners and family of business owners, for personal and household purposes, including automobile, boat and recreational vehicle loans and secured term loans. We also offer personal lines of credit including overdraft protection. Consumer loans are underwritten based on the individual borrower’s income, current debt level, past credit history and the value of any available collateral. The terms of consumer loans vary considerably based upon the loan type, nature of collateral and size of the loan.
Consumer loans typically have shorter terms, lower balances, higher yields and higher risks of default than residential real estate mortgage loans. Consumer loan collections are dependent on the borrower’s continuing financial stability and are therefore more likely to be affected by adverse personal circumstances, such as a loss of employment, divorce, or unexpected medical costs. Through our CCBX division we have begun making loans directly to consumers through automated offerings and anticipate that our consumer loan portfolio will grow through these offerings.
Credit Administration and Loan Review
We control credit risk both through disciplined underwriting of each transaction, as well as active credit management processes and procedures to manage risk and minimize loss throughout the life of a loan. We seek to maintain a broadly diversified loan portfolio in terms of type of customer, type of loan product, geographic area and industries in which our business customers are engaged. We have developed tailored underwriting criteria and credit management processes and procedures for each of the various loan product types we offer our customers.
Underwriting. In evaluating each potential loan relationship, we adhere to a disciplined underwriting evaluation process that includes the following:
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understanding the customer’s financial condition and ability to repay the loan;
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verifying that the primary and secondary sources of repayment are adequate in relation to the amount and structure of the loan;
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observing appropriate loan-to-value guidelines for collateral secured loans;
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maintaining our targeted levels of diversification for the loan portfolio, both as to type of borrower and type of collateral; and
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ensuring that each loan is properly documented with perfected liens on collateral.
Loan Approval Authority. Our lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by our board of directors and management. We have established several levels of lending authority that have been delegated by the board of directors to our management credit committee, Chief Executive Officer, Chief Credit Officer and other personnel in accordance with our loan policy. Authority limits are based on the total exposure of the borrower and are conditioned on the loan conforming to the policies contained in the loan policy. Any loan policy exceptions are fully disclosed to the approving authority.
Ongoing Credit Risk Management. In addition to the tailored underwriting process described above, we perform ongoing risk monitoring and review processes for credit exposures. Although we grade and classify our loans internally, we engage an independent third-party professional firm to perform regular loan reviews and confirm loan classifications. We strive to identify potential problem loans early in an effort to actively seek resolution of these situations before they create a loss. We record any necessary charge-offs promptly and maintain adequate allowance levels for probable loan losses incurred in the loan portfolio.
In general, whenever a particular loan or overall borrower relationship is downgraded from a pass grade to a watch or substandard grade based on one or more standard loan grading factors, our relationship manager (who is typically the loan officer) and credit team members engage in active evaluation of the asset to determine the appropriate resolution strategy. Management regularly reviews the status of the watch list and classified assets portfolio as well as the larger credits in the portfolio.
Concentrations of Credit Risk
Most of our lending activity is conducted with businesses and individuals in our market area. As of December 31, 2020, approximately 87% of the real estate loans in our loan portfolio (measured by dollar amount) were secured by real estate, or made to borrowers who live or conduct business, in the Puget Sound region. A substantial portion of our loan portfolio consists of commercial and industrial loans and real estate loans secured by commercial real estate properties located in the Puget Sound region, and is dependent upon the economic environment of the Puget Sound region. We have a limited number of loans secured by properties located outside of the Puget Sound region, most of which are made to borrowers who are well-known to us.
Our total non-owner-occupied commercial real estate loans, including loans secured by apartment buildings, investor commercial real estate, and construction and land loans totaled $594.6 million and represented 357.0% of the Bank’s total risk-based capital at December 31, 2020. Interagency guidance on commercial real estate concentrations describe sound risk management practices, which include board and management oversight, portfolio management, management information systems, market analysis, portfolio stress testing and sensitivity analysis, credit underwriting standards, and credit risk review functions. We believe that we have adequately implemented these practices in order to monitor concentrations in commercial real estate in our loan portfolio.
Lending Limits
Our lending activities are subject to a variety of lending limits imposed by state law. In general, the Bank is subject to a legal lending limit on loans to a single borrower based on the amount of the Bank’s capital and surplus. The dollar amounts of the Bank’s lending limit increases or decreases as the Bank’s capital and surplus increases or decreases. The Bank is able to sell participations in its larger loans to other financial institutions, which allows the Bank to better manage the risk and exposure involved with larger loans and to meet the lending needs of its customers requiring extensions of credit in excess of Bank or regulatory limits.
The Bank’s legal lending limit as of December 31, 2020 on loans to a single borrower was 20% of capital and the allowance for loan losses, or $33.3 million.
Our loan policies provide general guidelines for loan-to-value ratios that restrict the size of loans to a maximum percentage of the value of the collateral securing the loans, which percentage varies by the type of collateral. Our internal loan-to-value limitations also follow all limits established by applicable law.
Deposit Products
Our deposits serve as the primary funding source for lending, investing and other general banking purposes. We provide a full range of deposit products that have a wide range of interest rates and terms, including a variety of
demand and savings accounts, time deposits, and money market accounts. We also provide a wide range of deposit services, including debit cards, remote deposit capture, online banking, mobile banking, and direct deposit services. We also offer business accounts and cash management services, including business checking and savings accounts, and treasury services. We also offer reciprocal deposits which enables us to extend FDIC insurance to customers that have balances in excess of the FDIC insurance limit. This service trades our customer’s funds in increments under the FDIC insured amount to other participating financial institutions and in exchange we receive customer deposits from participating financial institutions in a reciprocal agreement. We solicit deposits through our relationship-driven team of dedicated and accessible bankers and through community-focused marketing. We emphasize obtaining deposit relationships at loan origination. Our focus on relationship banking combined with our robust business banking services has led to approximately 71.5% of our loan customers having deposit relationships with us as of December 31, 2020.
CCBX Division
Our CCBX Division provides BaaS enabling broker dealers and digital financial service providers to offer their clients banking services. The “X” is indicative of the technology services that our partners provide. We currently have a total of 15 relationships, which includes six active relationships, two in friends and family trials, three in implementation and onboarding, and four signed letters of intent, and we continue to maintain a robust pipeline. CCBX is supported by staff that we began hiring in late 2019 and throughout 2020 to build the infrastructure, and to work with our CCBX relationships and to execute new contracts.
CCDB Division
CCDB is our new digital banking division. We expect to introduce our digital bank accounts in connection with our previously announced collaboration with Google Pay later this year or early next year, and currently provide a mobile wallet product which provides our customers with more ways to pay.
Investments
As of December 31, 2020, the fair value of our investment portfolio, which represented 1.3% of assets, totaled $23.4 million and had an average effective yield of 0.61% and an estimated duration of approximately 0.6 years. The primary objectives of the investment portfolio are to provide a source of liquidity and provide collateral that can be readily sold or pledged for public deposits or other business purposes. At December 31, 2020, 85.8% of our investment portfolio consisted of U.S. Treasury securities. The remainder of our securities portfolio is invested in municipal bonds, U.S. Agency collateralized mortgage and U.S. Agency residential mortgage-backed securities obligations. We regularly evaluate the composition of our investment portfolio as the interest rate yield curve changes and may sell or pledge investment securities from time to time to adjust our exposure to interest rates or to provide liquidity to meet loan demand. Due to the low interest rate environment, we are primarily holding the majority of our on-balance sheet liquidity in interest bearing bank deposits to limit our exposure to interest rate and price risk and to provide readily available funds for loan growth.
Competition
We operate in a highly competitive industry and in a highly competitive market. Commercial real estate lending in the Puget Sound region attracts keen competition from large banking institutions with national operations, as well as mid-sized regional banking institutions. We compete with other community banks, savings and loan associations, credit unions, mortgage companies, insurance companies, finance companies and other financial intermediaries. The primary factors driving competition for deposits are customer service, interest rates, fees charged, branch locations and hours, online and mobile banking functionality, and the range of products offered. The primary factors driving competition for our lending products are customer service, range of products offered, price, reputation, and quality of execution. We believe the Bank is a strong competitor in our markets, however other competitors have certain advantages over us. Among them, many large institutions have the ability to finance extensive advertising campaigns, maintain extensive branch networks and make larger technology investments, and to offer services which we do not offer. The higher capitalization of the larger banking institutions permits them to have higher lending limits than those of the Bank. Some of our competitors have other advantages, such as tax
exemption in the case of credit unions, and to some extent, lesser regulation in the case of mortgage companies and finance companies.
Information Technology Systems
We have made and continue to make significant investments in our information technology systems and staff for our banking and lending operations, treasury management activities, CCBX and CCDB. We believe this investment will support our continued growth and enable us to enhance our capabilities to offer new products and overall customer experience, and to provide scale for future growth and acquisitions. We utilize a nationally recognized software vendor, and their support allows us to outsource our data processing.
The majority of our other systems including our electronic funds transfer, transaction processing and our online banking services are hosted by third-party service providers. The scalability of this infrastructure will support our growth strategy. In addition, the tested capability of these vendors to automatically switch over to standby systems should allow us to recover our systems and provide business continuity quickly in case of a disaster.
Our internal network and e-mail systems are outsourced to a third party and we have a back-up site in Phoenix, Arizona. This back-up site provides for redundancy and disaster recovery capabilities.
Emerging Growth Company Status
We are an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012, (the JOBS Act). An emerging growth company may take advantage of reduced reporting requirements and is relieved of certain other significant requirements that are otherwise generally applicable to public companies. As an emerging growth company:
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we may present as few as two years of audited financial statements and as few as two years of related management’s discussion and analysis of financial condition and results of operations;
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we are exempt from the requirement to obtain an attestation report from our auditors on management’s assessment of the effectiveness of our internal control over financial reporting under the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act;
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we are not required to comply with any requirements adopted by the Public Company Accounting Oversight Board requiring mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and our financial statements;
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we are permitted to provide reduced disclosure regarding our executive compensation arrangements pursuant to the rules applicable to smaller reporting companies, which means we do not have to include a compensation discussion and analysis and certain other disclosures regarding our executive compensation; and
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we are not required to give our shareholders non-binding advisory votes on executive compensation or golden parachute arrangements.
We will cease to be an “emerging growth company” upon the earliest of:
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the last day of the fiscal year in which we have total annual gross revenues of $1.07 billion or more;
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the date on which we become a “large accelerated filer” (the fiscal year end on which the total market value of our common equity securities held by non-affiliates is $700 million or more as of June 30);
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the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; and
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the last day of the fiscal year following the fifth anniversary of the completion of our initial public offering in 2018.
We have elected to adopt certain of the reduced disclosure requirements above with respect to the periodic reports we will file with the Securities and Exchange Commission (the SEC), and proxy statements that we use to solicit proxies from our shareholders.
In addition, Section 107 of the JOBS Act permits us to take advantage of an extended transition period for complying with new or revised accounting standards affecting public companies. However, we have irrevocably opted out of the extended transition period and, as a result, we will adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies.
Human Capital
As of December 31, 2020, we had 250 full-time equivalent employees, all were located in the United States. None of our employees are parties to a collective bargaining agreement. We consider our relationship with our employees to be good and have not experienced interruptions of operations due to labor disagreements.
Culture
We have always led with people, building our Bank on the diverse perspectives, knowledge, and experiences of our employees. We strive to create an inclusive workplace where people can bring their authentic selves to work.
We seek out talent that will be a cultural fit to our core values and have backgrounds that are as diverse as the clients we serve in each of our business units.
Pay Equity
We believe our staff should be paid for the roles they fulfill, their experience, and how they do their jobs, and our goal is to attract, retain and develop quality talent. To deliver on that commitment, we benchmark and set pay ranges based on banking market data and consider factors such as an employee’s role and experience, the location of their job, and their performance. We also regularly review our compensation practices, both in terms of our overall workforce and individual employees, to ensure our pay is fair and equitable.
Diversity, Equity and Inclusion (DEI)
We believe that DEI needs to start at the top of an organization, and the Company began this process at the Board level in 2017 when our board of directors began discussing strategic planning and board recruitment. As the Company entered more complex arenas including BaaS, we strive to seek out diverse and qualified director candidates who bring a background and expertise in the fintech and digital banking sectors regardless of their gender, race, or other personal characteristics. Additionally, those board members would need to be representative of
the diversity found in the fintech’s themselves. Since beginning this effort the board has added two female and one minority representation.
Health, Safety and Wellness
Since the onset of the COVID-19 pandemic, we have taken a people-first approach to help our employees manage their work and personal responsibilities, with a strong focus on employee wellbeing, health and safety. Our human resource team engages the staff in an evolving wellness program designed to enhance physical, financial, and mental wellbeing for all our employees. We encourage healthy lifestyle behaviors through regular communications, educational sessions, voluntary progress tracking of beneficial health changes, and wellness challenges.
We value the contributions of our employees, particularly in the face of the challenges posed by the COVID-19 pandemic. Where possible, employees have been working from home to help maintain their health and safety as well as business continuity. The Bank has accommodated staff who are unable to work on site due to health or family issues, and our human resources department works one-on-one to find solutions that are workable for both staff and the Company.
During the pandemic, many of our employees remain on the front line, keeping our branches open through drive-ups and allowing our customers to continue to do their banking transactions. This has allowed us to provide financial services while ensuring staff and customers are safe. Additional staff have been identified as having key roles in providing critical banking services that cannot be managed from home so protocol and safety measures were put in place in early 2020 to ensure their safety.
We endeavor to follow all Washington State guidance in all offices and the branches to maintain a safe environment for both staff and customers.
Community Engagement
We are committed to supporting the communities we serve through donations, sponsorships, employee volunteerism and the Employee Giving Fund, and was recognized as a Corporate Philanthropist by the Puget Sound Business Journal in 2020. In 2020, the Bank supported 112 organizations through donations and event sponsorships.
The Employee Giving Fund is supported entirely by donations contributed by employees, enabling staff to pool their donations for the greatest impact in each community we serve. Employees direct the grants from the fund by serving on Bank’s grant advisory committee. Since its inception in 2001, the Employee Giving Fund has awarded 409 grants totaling more than $600,000 (through the end of 2020).
In 2020 employees continued to volunteer in a variety of capacities, surpassing 5,700 hours given to more than 119 local organizations.
Available Information
The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q, proxy statements, current reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the Exchange Act), and other filings with the SEC are available free of charge at http://ir.coastalbank.com/ under the heading “News - Documents”, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC. These reports are also available for free on the SEC's website at http://www.sec.gov. The information contained on the Company's website as referenced in this Report on Form 10-K should not be considered a part of this report.
Regulation and Supervision
General
Insured banks, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, our growth and earnings performance may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory agencies, including the Washington Department of Financial Institutions (Washington DFI), the Board of Governors of the Federal Reserve (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC) and the Consumer Financial Protection Bureau (CFPB). Furthermore, tax laws administered by the Internal Revenue Service (IRS), and state taxing authorities, accounting rules developed by the Financial Accounting Standards Board (FASB), securities laws administered by the SEC and state securities authorities, anti-money laundering laws enforced by the U.S. Department of the Treasury (Treasury Department) and mortgage related rules, including with respect to loan securitization and servicing by the U.S. Department of Housing and Urban Development and entities such as Ginnie Mae and Freddie Mac, and SBA regulations with respect to small business loans, have an impact on our business. The effect of these statutes, regulations, regulatory policies and rules are significant to our operations and results, and the nature and extent of future legislative, regulatory or other changes affecting financial institutions are impossible to predict with any certainty.
Federal and state banking laws impose a comprehensive system of supervision, regulation and enforcement on the operations of insured banks, their holding companies and affiliates that is intended primarily for the protection of the FDIC-insured deposits and depositors of banks, rather than their shareholders. These federal and state laws, and the regulations of the bank regulatory agencies issued under them, affect, among other things, the scope of business, the kinds and amounts of investments banks may make, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, the ability to merge, consolidate and acquire, dealings with insiders and affiliates and the payment of dividends.
This supervisory and regulatory framework subjects banks and bank holding companies to regular examination by their respective regulatory agencies, which results in examination reports and ratings that, while not publicly available, can impact the conduct and growth of their businesses. These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance, earnings, liquidity, sensitivity to market risk and various other factors. The regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated entity where the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies.
The following is a summary of the material elements of the supervisory and regulatory framework applicable to us and the Bank. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. The descriptions are qualified in their entirety by reference to the particular statutory and regulatory provision.
Bank Holding Company Regulation
Since we own all of the capital stock of the Bank, we are a bank holding company under the Bank Holding Company Act of 1956, as amended (the BHC Act). As a result, we are primarily subject to the supervision, examination and reporting requirements of the BHC Act and the regulations of the Federal Reserve.
Acquisition of Banks
The BHC Act requires every bank holding company to obtain the Federal Reserve’s prior approval before:
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acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will, directly or indirectly, own or control 5% or more of the bank’s voting shares;
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acquiring all or substantially all of the assets of any bank; or
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merging or consolidating with any other bank holding company.
Additionally, the BHC Act provides that the Federal Reserve may not approve any of the above transactions if such transaction would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources includes a focus on capital adequacy, which is discussed in the section entitled “-Bank Regulation and Supervision-Capital Adequacy.” The Federal Reserve also considers the effectiveness of the institutions in combating money laundering, including a review of the anti-money laundering programs and compliance records of the parties. Finally, the Federal Reserve takes into consideration the extent to which the proposed transaction would result in greater or more concentrated risks to the stability of the U.S. banking or financial system.
Under the BHC Act, if well-capitalized and well-managed, we or any other bank holding company located in Washington may purchase a bank located outside of Washington without regard to whether such transaction is prohibited under state law. Conversely, a well-capitalized and well-managed bank holding company located outside of Washington may purchase a bank located inside Washington without regard to whether such transaction is prohibited under state law. In each case, however, restrictions may be placed under state law on the acquisition of a bank that has only been in existence for a limited amount of time or will result in concentrations of deposits exceeding limits specified by statute. For example, Washington law currently prohibits a bank holding company from acquiring control of a Washington-based financial institution until the target financial institution has been in operation for at least five years.
Change in Bank Control
Subject to various exceptions, the BHC Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person’s or company’s acquiring “control” of a bank holding company. Under a rebuttable presumption established by the Federal Reserve pursuant to the Change in Bank Control Act, the acquisition of 10% or more of a class of voting stock of a bank holding company would constitute acquisition of control of the bank holding company if no other person will own, control, or hold the power to vote a greater percentage of that class of voting stock immediately after the transaction or the bank holding company has registered securities under the Exchange Act, as we have. In addition, any person or group of persons acting in concert must obtain the approval of the Federal Reserve under the BHC Act before acquiring 25% or more (more than 5% in the case of an acquirer that is already a bank holding company) of the outstanding voting stock of a bank holding company, the right to control in any manner the election of a majority of the company’s directors, or otherwise obtaining control or a “controlling influence” over the bank holding company. Approval of the Washington DFI may also be required under state law before a person can acquire control over us.
Permitted Activities
Under the BHC Act, a bank holding company is generally permitted to engage in or acquire direct or indirect control of the voting shares of any company engaged in the following activities:
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banking or managing or controlling banks; and
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any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.
Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:
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factoring accounts receivable;
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making, acquiring, brokering or servicing loans and usual related activities in connection with the foregoing;
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leasing personal or real property under certain conditions;
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operating a non-bank depository institution, such as a savings association;
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engaging in trust company functions in a manner authorized by state law;
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financial and investment advisory activities;
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discount securities brokerage activities;
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underwriting and dealing in government obligations and money market instruments;
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providing specified management consulting and counseling activities;
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performing selected data processing services and support services;
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acting as an agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and
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performing selected insurance underwriting activities.
The Federal Reserve may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness, or stability of it or any of its bank subsidiaries.
In addition to the permissible bank holding company activities listed above, a bank holding company may qualify and elect to become a financial holding company, thereby permitting the bank holding company to engage in activities that are financial in nature or incidental or complementary to financial activity. The BHC Act expressly lists the following activities as financial in nature:
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lending, exchanging, transferring, investing for others, or safeguarding money or securities;
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insuring, guaranteeing, or indemnifying against loss or harm, or providing and issuing annuities, and acting as principal, agent, or broker for these purposes, in any state;
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providing financial, investment, or economic advisory services;
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issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly;
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underwriting, dealing in or making a market in securities;
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engaging in other activities that the Federal Reserve may determine to be so closely related to banking or managing or controlling banks as to be a proper incident to managing or controlling banks;
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engaging in the United States in activities permitted outside of the United States if the Federal Reserve has determined them to be usual in connection with banking or other financial operations abroad;
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merchant banking through securities or insurance affiliates; and
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insurance company portfolio investments.
For us to qualify to become a financial holding company, we must be well-capitalized and well-managed. In addition, the Bank and any other depository institution subsidiary we control must be well-capitalized and well-managed and must have a CRA rating of at least “satisfactory.” Additionally, we must file an election with the Federal Reserve to become a financial holding company and must provide the Federal Reserve with 30 days written notice prior to engaging in a permitted financial activity. We have not elected to become a financial holding company at this time.
Dividends
The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve’s view that a bank holding company should pay cash dividends only to the extent that the holding company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. The Federal Reserve also has indicated that it would be inappropriate for a holding company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the prompt corrective action regulations adopted by the Federal Reserve, the Federal Reserve may prohibit a bank holding company from paying any dividends if one or more of the holding company’s bank subsidiaries is classified as undercapitalized.
Support of Subsidiary Institutions
The Federal Deposit Insurance Act (FDIA) and a Federal Reserve regulation require a bank holding company to serve as a source of financial and managerial strength to its bank subsidiaries. In addition, where a bank holding company has more than one FDIC-insured bank or thrift subsidiary, each of the bank holding company’s subsidiary FDIC-insured depository institutions is responsible for any losses to the FDIC as a result of an affiliated depository institution’s failure. As a result of a bank holding company’s source of strength obligation, a bank holding company may be required to provide funds to a bank subsidiary in the form of subordinate capital or other instruments which qualify as capital under bank regulatory rules and at a time when the bank holding company would not otherwise be inclined to do so.
Repurchase or Redemption of Securities
A bank holding company that is not well capitalized or well managed, or that is subject to any unresolved supervisory issues, is required to give the Federal Reserve prior written notice of any purchase or redemption of its own then-outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve order or directive, or any condition imposed by, or written agreement with, the Federal Reserve. Additionally, under Federal Reserve guidance, a bank holding company is generally expected to consult with Federal Reserve supervisory staff prior to repurchasing or redeeming stock in a number of circumstances, including when the company is considering expansion.
Bank Regulation and Supervision
The Bank is subject to extensive federal and state banking laws and regulations that impose restrictions on and provide for general regulatory oversight of the operations of the Bank. These laws and regulations are generally intended to protect the safety and soundness of the Bank and the Bank’s depositors, rather than our shareholders. The following discussion describes the material elements of the regulatory framework that applies to the Bank.
Since the Bank is a commercial bank chartered under the laws of the state of Washington and is a member of the Federal Reserve System, it is primarily subject to the supervision, examination and reporting requirements of the Federal Reserve and the Washington DFI. The Federal Reserve and the Washington DFI regularly examine the Bank’s operations and have the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. Both regulatory agencies have the power to take enforcement action to prevent the development or continuance of unsafe or unsound banking practices or other violations of law. The Bank’s deposits
are insured by the FDIC to the maximum extent provided by law. The Bank is also subject to numerous federal and state statutes and regulations that affect its business, activities and operations.
Branching
Under current Washington law, the Bank may open branch offices throughout Washington with the prior approval of the Washington DFI. In addition, with prior regulatory approval, the Bank may acquire branches of existing banks located in Washington. Under federal law, the Bank may establish branch offices with the prior approval of the Federal Reserve. Federal law allows a bank to branch into a new state by setting up a new branch if, under the laws of the state in which the branch is to be located, a state bank chartered by that state would be permitted to establish the branch, and if the bank meets certain supervisory and financial criteria.
FDIC Insurance and Other Assessments
The Bank’s deposits are insured by the FDIC to the full extent provided in the FDIA (currently $250,000 per deposit account), and the Bank pays assessments to the FDIC for that coverage. Under the FDIC’s risk-based deposit insurance assessment system, an insured institution’s deposit insurance premium is computed by multiplying the institution’s assessment base by the institution’s assessment rate. An institution’s assessment base equals the institution’s average consolidated total assets during a particular assessment period, minus the institution’s average tangible equity capital (that is, Tier 1 capital) during such period. For banks with less than $10.0 billion in total consolidated assets, the assessment rate is calculated using a financial ratios method based on a statistical model estimating the bank’s probability of failure over three years utilizing seven financial ratios (leverage ratio; net income before taxes/total assets; nonperforming loans and leases/gross assets; other real estate owned/gross assets; brokered deposit ratio; one year asset growth; and loan mix index) and a weighted average of supervisory ratings components. The current rule fixes the range of assessment rates from 1.5 basis points for an institution posing the least risk, to 30 basis points for an institution posing the most risk; and will further lower the range of assessment rates if the reserve ratio of the Deposit Insurance Fund increases to 2% or more. As of September 30, 2020, which is the most recent information available, the Deposit Insurance Fund was at 1.30%. Banks with over $10.0 billion in total consolidated assets are required to pay a surcharge of 4.5 basis points on their assessment basis, subject to certain adjustments. The FDIC may also impose special assessments from time to time.
Termination of Deposit Insurance
The FDIC may terminate its insurance of deposits of a bank if it finds that the bank has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Community Reinvestment Act
The Community Reinvestment Act (CRA) requires that, in connection with examinations of insured depository institutions within their respective jurisdictions, the federal banking agencies will evaluate the record of each financial institution in meeting the credit needs of its local community, including low- and moderate-income neighborhoods. The Federal Reserve periodically evaluates the Bank’s record of performance under the CRA, and these evaluations are publicly available. A bank’s CRA performance is considered in evaluating applications seeking approval for mergers, acquisitions, and new offices or facilities. Failure to adequately meet these criteria could result in additional requirements and limitations being imposed on the bank. Certain regulatory advantages, such as expedited processing of applications, are available only to banks with CRA ratings of Satisfactory or Outstanding. Additionally, we must publicly disclose the terms of certain CRA-related agreements. The Bank received a Satisfactory rating at its most recent evaluation dated September 25, 2017.
Interest Rate Limitations
Interest and other charges collected or contracted for by the Bank are subject to applicable state usury laws and federal laws concerning interest rates.
Reserves
Pursuant to regulations of the Federal Reserve, an insured depository institution must maintain reserves against its transaction accounts. Because required reserves generally must be maintained in the form of vault cash, with a pass-through correspondent bank, or in the institution’s account at a Federal Reserve Bank, the effect of the reserve requirement may be to reduce the amount of an institution’s assets available for lending or investment. During 2020, in response to the COVID-19 pandemic, the Federal Reserve reduced all reserve requirement ratios to zero. The Federal Reserve indicated that it may adjust reserve requirement ratios in the future if conditions warrant.
Federal Laws Applicable to Consumer Credit and Deposit Transactions
The Bank’s loan and deposit operations are subject to a number of federal consumer protection laws, including:
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the Federal Truth in Lending Act, governing disclosures of credit terms to consumer borrowers;
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the Real Estate Settlement Procedures Act, imposing requirements on the settlement and servicing of residential mortgage loans;
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the Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the communities it serves;
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the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, color, religion, national origin, sex, marital status or certain other prohibited factors in all aspects of credit transactions;
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the Fair Credit Reporting Act (FCRA), governing the use and provision of information to credit reporting agencies;
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the Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by debt collectors;
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the Service Members Civil Relief Act, governing the repayment terms of, and property rights underlying, secured obligations of persons in military service;
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the Gramm-Leach-Bliley Act, governing the disclosure and safeguarding of sensitive non-public personal information of our clients;
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the Right to Financial Privacy Act, imposing a duty to maintain confidentiality of consumer financial records and prescribing procedures for complying with administrative subpoenas of financial records;
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the Electronic Funds Transfer Act governing automatic deposits to and withdrawals from deposit accounts and clients’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and
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the rules and regulations of the CFPB and various federal agencies charged with the responsibility of implementing these federal laws.
Capital Adequacy
The Federal Reserve has adopted risk-based and leverage capital adequacy requirements, pursuant to which they assess the adequacy of capital in examinations and in analyzing bank regulatory applications. Risk-based capital requirements determine the adequacy of capital based on the credit and certain other risks inherent in various classes of assets and off-balance sheet items. The federal banking regulators have adopted regulations implementing the Basel Capital Adequacy Accord (Basel III), which had been approved by the Basel member central bank governors in 2010 as an agreement among the countries’ central banks and bank regulators on the amount of capital banks and their holding companies must maintain as a cushion against losses and insolvency. The U.S. Basel III
rule’s minimum capital to risk-weighted assets requirements are a common equity Tier 1 capital ratio of 4.5%, a Tier 1 capital ratio of 6.0%, and a total capital ratio of 8.0%. The minimum leverage ratio (Tier 1 capital to total assets) is 4.0%. Bank holding companies with assets of less than $3.0 billion that are not engaged in significant nonbanking activities, do not conduct significant off-balance sheet activities and that do not have a material amount of debt or equity securities registered with the SEC, such as the Company, are exempt from the Federal Reserve’s risk-based-capital and leverage rules.
In order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must maintain a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements. The buffer is measured relative to risk-weighted assets. A banking organization with a buffer greater than 2.5% is not subject to limits on capital distributions or discretionary bonus payments; however, a banking organization with a buffer of less than 2.5% would be subject to increasingly stringent limitations as the buffer approaches zero. A banking organization also would be prohibited from making distributions or discretionary bonus payments during any quarter if its eligible retained income is zero or negative in that quarter and its capital conservation buffer ratio was less than 2.5% at the beginning of the quarter. Effectively, the Basel III framework, including the capital conservation buffer, requires the Bank meet minimum risk-based capital ratios of (i) 7% for common equity Tier 1 capital, (ii) 8.5% Tier 1 capital, and (iii) 10.5% total capital. The eligible retained income of a banking organization is defined as the greater of (1) its net income for the four calendar quarters preceding the current calendar quarter, based on the organization’s quarterly regulatory reports, net of any distributions and associated tax effects not already reflected in net income, and (2) the average of its net income over the preceding four quarters. The minimum capital requirements plus the capital conservation buffer will exceed the prompt corrective action (PCA), well-capitalized thresholds, which are described below under “-Prompt Corrective Action.”
The U.S. Basel III rule includes stringent criteria for capital instruments to qualify as Tier 1 or Tier 2 capital. For instance, the rule effectively disallows newly-issued trust preferred securities as a component of a holding company’s Tier 1 capital. However, depository institution holding companies with less than $15 billion in total assets may permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 in Additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature. At December 31, 2020, the Company had $3.5 million of non-qualifying instruments includable in Tier 1 capital that were issued prior to May 19, 2010.
In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms, which standards are commonly referred to as Basel IV. Among other things, these standards revise the Basel Committee’s standardized approach for credit risk (including the recalibration of the risk weights and the introduction of new capital requirements for certain “unconditionally cancellable commitments,” such as unused credit card lines of credit) and provides a new standardized approach for operational risk capital. Under the Basel framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing in through January 1, 2027. Under the current U.S. capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and are not applicable to the Bank. The impact of Basel IV on us will depend on how it is implemented by the federal bank regulators.
The Economic Growth, Regulatory Relief and Consumer Protection Act (the EGRRCPA) requires the federal banking agencies to develop a community bank leverage ratio (the CBLR) (defined as the ratio of tangible equity capital to average total consolidated assets) for certain banks and holding companies with total consolidated assets of less than $10 billion. Qualifying banks that exceed the minimum CBLR are deemed to be in compliance with all other capital and leverage requirements. In 2019, the federal banking agencies fixed the CBLR at 9.0%, and the CARES Act temporarily reduced the CBLR to 8% until the earlier of December 31, 2020 or the expiration of the national emergency declaration. Rules issued by the federal banking agencies provide a graduated transition back to the 9% threshold by January 1, 2022. The Company and Bank have not adopted the CBLR.
Failure to meet statutorily mandated capital guidelines or more restrictive ratios separately established for a banking institution could subject the institution to a variety of enforcement remedies available to federal regulatory authorities, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting or renewing brokered deposits, limitations on the rates of interest that the institution may pay on its deposits, and other restrictions on its business.
Prompt Corrective Action
The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of “prompt corrective action” to resolve the problems of undercapitalized insured depository institutions. Under this system, the federal banking regulators have established five capital categories (well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized); all insured depository institutions fall into one of these categories. The federal banking agencies have specified by regulation the relevant capital thresholds and other qualitative requirements for each of the categories. For an insured depository institution to be “well-capitalized” under the PCA framework, it must have a common equity Tier 1 capital ratio of 6.5%, Tier 1 capital ratio of 8.0%, a total capital ratio of 10.0%, and a leverage ratio of 5.0%, and must not be subject to any written agreement, order or capital directive, or prompt corrective action directive issued by its primary federal regulator to meet and maintain a specific capital level for any capital measure. At December 31, 2020, the Bank qualified for the well-capitalized category.
Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. An undercapitalized institution has a capital ratio below any one of four thresholds: a common equity Tier 1 risk-based capital ratio of 4.5%, a Tier 1 risk-based capital ratio of 6.0%, a total risk-based capital ratio of 8.0%, or a leverage ratio of 4.0%. The severity of the action depends upon the capital category in which the institution is placed. For example, institutions in all three undercapitalized categories are automatically restricted from paying distributions and management fees, whereas only an institution that is significantly undercapitalized or critically undercapitalized is restricted in its compensation paid to senior executive officers. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.
An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. Such a plan must include a guarantee from the institution’s bank holding company that the institution will comply with the plan until the institution has been adequately capitalized on average during each of the four consecutive calendar quarters. The holding company’s obligation to fund a capital restoration plan is limited to the lesser of (i) 5% of an undercapitalized subsidiary institution’s assets at the time it became undercapitalized and (ii) the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with Federal Reserve approval. A critically undercapitalized bank, one with a ratio of tangible equity to total assets of 2% or less, is presumptively subject to a supervisory acquisition or the appointment of a conservator or receiver.
The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital.
Liquidity
Financial institutions are subject to significant regulatory scrutiny regarding their liquidity positions. This scrutiny has increased during recent years, as the economic downturn that began in the late 2000s negatively affected the liquidity of many financial institutions. Various bank regulatory publications, including Federal Reserve SR 10-6 (Funding and Liquidity Risk Management), address the identification, measurement, monitoring and control of funding and liquidity risk by financial institutions.
The U.S. federal banking regulators have introduced two new liquidity metrics for large banking organizations. The first metric is the “liquidity coverage ratio,” and it aims to require a financial institution to maintain sufficient high-quality liquid resources to survive an acute stress scenario that lasts for one month. The second metric is the “net stable funding ratio,” and its objective is to require a financial institution to maintain a minimum amount of stable sources relative to the liquidity profiles of the institution’s assets, as well as the potential for contingent liquidity needs arising from off-balance sheet commitments, over a one-year horizon.
The federal banking regulators finalized the liquidity coverage ratio in September 2014, and finalized the net stable funding ratio in October 2020. While the liquidity coverage ratio and the net stable funding ratio only apply to the largest banking organizations in the country, certain elements may filter down and become applicable to or expected of all insured depository institutions.
Payment of Dividends
We are a legal entity separate and distinct from the Bank. Our principal source of cash flow, including cash flow to pay dividends to our shareholders, is from capital raises and dividends the Bank pays to us as the Bank’s sole shareholder. Statutory and regulatory limitations apply to the Bank’s payment of dividends to us as well as to our payment of dividends to our shareholders. A corollary to the requirement that a bank holding company serve as a source of strength to its subsidiary banks is the Federal Reserve policy that a bank holding company should not maintain a level of cash dividends to its shareholders that places undue pressure on the capital of its bank subsidiaries or that can be funded only through additional borrowings or other arrangements that may undermine the bank holding company’s ability to serve as such a source of strength. Our ability to pay dividends is also subject to the provisions of Washington corporate law that prevent distributions to shareholders if, after giving effect to the distribution, we would not be able to pay our liabilities as they become due in the usual course of business or our total assets would be less than the sum of our total liabilities plus the amount that would be needed, if we were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. In addition, in deciding whether or not to declare a dividend of any particular size, our board of directors must consider our and the Bank’s current and prospective capital, liquidity, and other needs.
The Washington DFI and the Federal Reserve also regulate the Bank’s dividend payments. Under Washington law, a state-chartered bank may not pay a dividend in an amount greater than its retained earnings without approval of the Washington DFI. Under Federal Reserve regulations, the Bank may not declare or pay a dividend if the total of all dividends declared during the calendar year, including the proposed dividend, exceeds the sum of the Bank’s net income during the current calendar year and the retained net income of the prior two calendar years, unless the dividend has been approved by the Federal Reserve.
The Bank’s payment of dividends may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository institution may not pay any dividends if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal agencies have issued policy statements providing that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.
Restrictions on Transactions with Affiliates and Insiders
The Bank is subject to Section 23A of the Federal Reserve Act, which places limits on the amount of:
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a bank’s loans or extensions of credit to affiliates;
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a bank’s investment in securities issued by affiliates;
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a bank’s purchase of assets from affiliates;
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loans or extensions of credit made by a bank to third parties collateralized by the securities or obligations of affiliates;
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a bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate;
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a bank’s transactions with an affiliate involving the borrowing or lending of securities to the extent they create credit exposure to the affiliate; and
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a bank’s derivative transactions with an affiliate to the extent they create credit exposure to the affiliate.
Subject to various exceptions, the total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, the above transactions also must meet specified collateral requirements and safety and soundness requirements. Under no circumstances may a bank purchase a low-quality asset from an affiliate.
The Bank is also subject to Section 23B of the Federal Reserve Act, which, among other things, prohibits a bank from engaging in the above transactions with affiliates, as well as other types of transactions set forth in Section 23B, unless the transactions are on terms substantially the same, or at least as favorable to the bank, as those prevailing at the time for comparable transactions with nonaffiliated companies.
The Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions between the bank and third parties, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. There are also individual and aggregate limitations on loans to insiders and their related interests. The aggregate amount of insider loans generally cannot exceed the institution’s total unimpaired capital and surplus. Insiders and banks are subject to enforcement actions for knowingly entering into insider loans in violation of applicable restrictions.
Brokered Deposits
The FDIA prohibits insured banks from accepting brokered deposits or offering interest rates on any deposits significantly higher than the prevailing rate in the bank’s normal market area or nationally (depending upon where the deposits are solicited) unless it is “well-capitalized,” or it is “adequately capitalized” and receives a waiver from the FDIC. A bank that is “adequately capitalized” and that accepts brokered deposits under a waiver from the FDIC may not pay an interest rate on any deposit in excess of 75 basis points over certain prevailing market rates. There are no such restrictions under the FDIA on a bank that is “well-capitalized.” Further, “undercapitalized” institutions are subject to growth limitations.
On December 15, 2020, the FDIC issued a final rule to revise and clarify its framework for classifying deposits as brokered deposits, including the standards for determining whether a person is a “deposit broker” and satisfies the “primary purpose” exemption from that definition. Among other things, the final rule provides that a person can generally only be a deposit broker if the person places deposits at more than one insured depository institution.
Single Borrower Credit Limits
Under Washington law, total loans and extensions of credit to a borrower may not exceed 20% of the Bank’s capital and surplus.
Commercial Real Estate Concentration Limits
In December 2006, the federal banking regulators issued guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” to address increased concentrations in commercial real estate (CRE), loans. In addition, in December 2015, the federal bank agencies issued additional guidance entitled “Statement on Prudent Risk Management for Commercial Real Estate Lending.” Together, these guidelines describe the criteria the agencies will use as indicators to identify institutions potentially exposed to CRE concentration risk. An institution that has (i) experienced rapid growth in CRE lending, (ii) notable exposure to a specific type of CRE, (iii) total reported loans for construction, land development, and other land representing 100% or more of the institution’s capital, or (iv) total CRE loans representing 300% or more of the institution’s capital, and the outstanding balance of the institutions CRE portfolio has increased by 50% or more in the prior 36 months, may be identified for further supervisory analysis of the level and nature of its CRE concentration risk. As of December 31, 2020, the Bank’s total non-owner-occupied commercial real estate loans, including loans secured by apartment buildings, investor commercial real estate, and construction and land loans, represented 357.0% and 347.9% of its capital, at December 31, 2020 and 2019, respectively. The outstanding balance of the Bank’s CRE portfolio has
increased by 26.3% and 18.9%, for the years ended December 31, 2020 and 2019, respectively. Because both the level of CRE and growth rate exceed regulatory guidelines, the Bank maintains enhanced underwriting and monitoring processes and procedures.
Privacy
Financial institutions are required to disclose their policies for collecting and protecting nonpublic personal information of their clients. Clients generally may prevent financial institutions from sharing non-public personal information with nonaffiliated third parties except under certain circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly offering a product or service with a nonaffiliated financial institution. Additionally, financial institutions generally are prohibited from disclosing consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.
Cybersecurity
Federal banking agencies pay close attention to the cybersecurity practices of banks and their holding companies and affiliates. The interagency council of the agencies, the Federal Financial Institutions Examination Council (FFIEC), has issued several policy statements and other guidance for banks as new cybersecurity threats arise. FFIEC has recently focused on such matters as compromised customer credentials and business continuity planning. Examinations by the banking agencies now include review of an institution’s information technology and its ability to thwart cyberattacks.
Additionally, on December 18, 2020, the federal banking agencies released a notice of proposed rulemaking that would require a banking organization to notify its primary federal regulator within 36 hours of a significant cybersecurity incident.
Consumer Credit Reporting
The FCRA imposes, among other things:
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requirements for financial institutions to develop policies and procedures to identify potential identity theft and, upon the request of a consumer, to place a fraud alert in the consumer’s credit file stating that the consumer may be the victim of identity theft or other fraud;
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requirements for entities that furnish information to consumer reporting agencies to implement procedures and policies regarding the accuracy and integrity of the furnished information and regarding the correction of previously furnished information that is later determined to be inaccurate;
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requirements for mortgage lenders to disclose credit scores to consumers in certain circumstances; and
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limitations on the ability of a business that receives consumer information from an affiliate to use that information for marketing purposes.
Anti-Terrorism, Money Laundering Legislation and OFAC
The Bank is subject to the Bank Secrecy Act and the USA Patriot Act. These statutes and related rules and regulations impose requirements and limitations on specified financial transactions and accounts and other relationships intended to guard against money laundering and terrorism financing. The principal requirements for an insured depository institution include (i) establishment of an anti-money laundering program that includes training and audit components, (ii) establishment of a “know your customer” program involving due diligence to confirm the identities of persons seeking to open accounts and to deny accounts to those persons unable to demonstrate their identities, (iii) the filing of currency transaction reports for deposits and withdrawals of large amounts of cash, (iv) additional precautions for accounts sought and managed for non-U.S. persons and (v) verification and certification of money laundering risk with respect to private banking and foreign correspondent banking relationships. For many of these tasks a bank must keep records to be made available to its primary federal regulator.
Anti-money laundering rules and policies are developed by a bureau within the Treasury Department, the Financial Crimes Enforcement Network, but compliance by individual institutions is overseen by its primary federal regulator.
The Bank has established appropriate anti-money laundering and customer identification programs. The Bank also maintains records of cash purchases of negotiable instruments, files reports of certain cash transactions exceeding $10,000 (daily aggregate amount), and reports suspicious activity that might signify money laundering, tax evasion, or other criminal activities pursuant to the Bank Secrecy Act. The Bank otherwise has implemented policies and procedures to comply with the foregoing requirements.
The Treasury Department’s Office of Foreign Assets Control (OFAC), is responsible for helping to ensure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC publishes lists of persons, organizations and countries suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If the Company or the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, the Company or the Bank must freeze or block such account or transaction, file a suspicious activity report, and notify the appropriate authorities.
Sarbanes-Oxley Act
The Sarbanes-Oxley Act represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. The Sarbanes-Oxley Act is applicable to all companies with equity securities registered, or that file reports, under the Exchange Act. In particular, the act established (i) requirements for audit committees, including independence, expertise and responsibilities; (ii) responsibilities regarding financial statements for the chief executive officer and chief financial officer of the reporting company and new requirements for them to certify the accuracy of periodic reports; (iii) standards for auditors and regulation of audits; (iv) disclosure and reporting obligations for the reporting company and its directors and executive officers; and (v) civil and criminal penalties for violations of the federal securities laws. The legislation also established a new accounting oversight board to enforce auditing standards and restrict the scope of services that accounting firms may provide to their publicly traded company audit clients.
Overdraft Fees
Federal Reserve Regulation E restricts banks’ abilities to charge overdraft fees. The rule prohibits financial institutions from charging fees for paying overdrafts on ATM and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions.
The Dodd-Frank Act and the EGRRCPA
As final rules and regulations implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) have been adopted, this law has significantly changed and is significantly changing the bank regulatory framework and affected the lending, deposit, investment, trading and operating activities of banks and their holding companies.
A number of the effects of the Dodd-Frank Act are described or otherwise accounted for in various parts of this “-Regulation and Supervision” section. The following items provide a brief description of certain other provisions of the Dodd-Frank Act that may be relevant to us and the Bank.
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The Dodd-Frank Act imposed new requirements regarding the origination and servicing of residential mortgage loans. The law created a variety of new consumer protections, including limitations, subject to exceptions, on the manner by which loan originators may be compensated and an obligation on the part of lenders to verify a borrower’s “ability to repay” a residential mortgage loan. Final rules implementing these latter statutory requirements became effective in 2014.
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The Dodd-Frank Act addresses many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies. The Dodd-Frank Act (i) requires publicly traded companies to give shareholders a non-binding vote on executive compensation and golden parachute payments; (ii) enhances independence requirements for compensation committee members; (iii) requires national securities exchanges to require listed companies to adopt incentive-based compensation clawback policies for executive officers;
(iv) authorizes the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials; and (v) directs the federal banking regulators to issue rules prohibiting incentive compensation that encourages inappropriate risks.
The EGRRCPA made changes to a variety of rules and regulations, including revisions to the Dodd-Frank Act. For example, the EGRRCPA exempts certain lenders from the “ability to repay” requirements. Other EGRRCPA changes are described elsewhere in this section.
Consumer Financial Protection Bureau
The Dodd-Frank Act created the CFPB, an independent federal bureau within the Federal Reserve System having broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Practices Act, the consumer financial privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with more than $10.0 billion in assets. Smaller institutions, including the Bank, are subject to rules promulgated by the CFPB but continue to be examined and supervised by federal banking agencies for compliance with federal consumer protection laws and regulations. The CFPB also has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations. The EGRRCPA requires amendments generally intended to narrow the scope of certain of these rules, but we are not currently able to determine how these changes may affect the Bank’s business.
The CFPB has proposed or issued a number of important rules affecting a wide range of consumer financial products. The changes resulting from the Dodd-Frank Act and CFPB rulemakings and enforcement policies may impact the profitability of our business activities, limit our ability to make, or the desirability of making, certain types of loans, require us to change our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business or profitability. The changes may also require us to dedicate significant management attention and resources to evaluate and make necessary changes to comply with the new statutory and regulatory requirements.
The CFPB has concentrated much of its rulemaking efforts on reforms related to residential mortgage transactions. The CFPB has issued rules related to a borrower’s ability to repay and qualified mortgage standards, mortgage servicing standards, loan originator compensation standards, requirements for high cost mortgages, appraisal and escrow standards and requirements for higher-priced mortgages. The CFPB has also issued rules establishing integrated disclosure requirements for lenders and settlement agents in connection with most closed end, real estate secured consumer loans; and rules which, among other things, expand the scope of information lenders must report in connection with mortgage and other housing-related loan applications under the Home Mortgage Disclosure Act. These rules, which became effective on a rolling basis through January 1, 2019, include significant regulatory and compliance changes and are expected to have a broad impact on the financial services industry.
The CFPB’s rulemaking and enforcement activities and strategic priorities have shifted as its leadership has changed, and in the future, the CFPB may take a different approach to its implementation of consumer financial protection laws than it has taken in the recent past.
The Volcker Rule
On December 10, 2013, five U.S. financial regulators, including the Federal Reserve, adopted a final rule implementing the “Volcker Rule.” The Volcker Rule was created by Section 619 of the Dodd-Frank Act and generally prohibits “banking entities,” including insured depository institutions and their affiliates, from engaging in “proprietary trading” and from sponsoring or investing in private equity or hedge funds, or extending credit to or engaging in other covered transactions with private equity or hedge funds that they sponsor or advise. The EGRRCPA amended Section 619 to exempt from the Volcker Rule any insured depository institution that has
$10.0 billion or less in total consolidated assets and whose total trading assets and trading liabilities are 5% or less of total consolidated assets. We are among the exempt institutions.
Limitations on Incentive Compensation
In April 2016, the Federal Reserve and other federal financial agencies re-proposed restrictions on incentive-based compensation pursuant to Section 956 of the Dodd-Frank Act for financial institutions with $1 billion or more in total consolidated assets. For institutions with at least $1 billion but less than $50 billion in total consolidated assets, the proposal would impose principles-based restrictions that are broadly consistent with existing interagency guidance on incentive-based compensation. Such institutions would be prohibited from entering into incentive compensation arrangements that encourage inappropriate risks by the institution (1) by providing an executive officer, employee, director, or principal shareholder with excessive compensation, fees, or benefits, or (2) that could lead to material financial loss to the institution. The proposal would also impose certain governance and recordkeeping requirements on institutions covered by the rule. Whether or when the agencies will finalize the proposal is uncertain.
Information About Our Executive Officers
The table below provides information about our executive officers. Ages are as of December 31, 2020.
Name
Age
Position
Eric M. Sprink
President, Chief Executive Officer and Director
Joel G. Edwards
Chief Financial Officer, Corporate Secretary
Russ A. Keithley
Chief Banking Officer
John J. Dickson
Chief Operating Officer
Laura L. Byers
Chief Digital Banking Officer
The following is a brief discussion of the business and banking background and experience of our executive officers, including their business experience during the last five years.
Eric M. Sprink serves as our President and Chief Executive Officer. Mr. Sprink joined the Company in late 2006 as President and Chief Operating Officer and became Chief Executive Officer in 2010. Mr. Sprink began his banking career working for Security Pacific Bank while enrolled at Arizona State University. He assumed increasing levels of responsibility in the areas of retail operations, consumer and commercial lending and wealth management with Security Pacific Bank and its successor, Bank of America. He then moved to Centura Bank, where he held management positions in retail operations and corporate finance. After Centura Bank was acquired, he held senior management positions at Washington Trust Bank and Global Credit Union. Mr. Sprink is active in industry trade groups and is a director and past chairman of the Community Bankers of Washington. Mr. Sprink received a bachelor’s degree from Arizona State University and an M.B.A. from the University of North Carolina. Mr. Sprink brings to our board of directors leadership experience, significant experience in many facets of the financial services business, and familiarity with our market area. Mr. Sprink has been a member of our board of directors since 2006.
Joel G. Edwards has served as Executive Vice President and Chief Financial Officer of the Company since 2012. Mr. Edwards is also the Executive Vice President and Chief Financial Officer of the Bank. Prior to joining the Company and Bank, Mr. Edwards was a Senior Vice President and Administration Officer at AmericanWest Bank. Prior to that experience, he was Executive Vice President and Chief Financial Officer at Viking Bank, Vice President and Chief Financial Officer at Rainier Pacific Bank, and President of the Washington Credit Union Share Guaranty Association. He also was employed in the Farm Credit System for eight years including positions as vice president responsible for administration, budget and policy. Mr. Edwards graduated magna cum laude with a bachelor’s degree in business and concentration in economics from, and completed post-graduate studies in accounting at, Eastern Washington University. He also received an M.B.A. from Eastern Washington University.
Russ A. Keithley serves as Executive Vice President and Chief Banking Officer of the Bank. From 2015 to 2020 Mr. Keithley held the position of Executive Vice President and Chief Lending Officer. He joined the Bank in
2012 and became Senior Vice President and Chief Credit Officer in 2014. Prior to joining the Bank, he served as Senior Vice President and Chief Lending Officer of North County Bank and Manager Team Lead at InterWest Bank. Mr. Keithley graduated from the University of Washington with a bachelor’s degree in political science. He is an honors graduate of the Pacific Coast Banking School at the University of Washington.
John J. Dickson joined the Bank in 2010 and currently serves as Executive Vice President and Chief Operating Officer of the Bank. Prior to joining the Bank, he served in various roles for Frontier Financial Corporation and Frontier Bank from 1985 to 2010, most recently serving as President of Frontier Bank from 2008 to 2010. In 2010, Frontier Bank was closed by the Washington DFI, and the FDIC was named receiver. Mr. Dickson received a bachelor’s degree in economics from the University of Puget Sound and graduated with honors from the Graduate School of Banking at the University of Wisconsin-Madison. Mr. Dickson practiced accounting as a CPA for three years in the audit division of a large accounting firm. Mr. Dickson is past Chairman of the Washington Bankers Association.
Laura L. Byers serves as Executive Vice President and Chief Digital Banking Officer of the Bank. Byers joined the Bank in 2004 and previously held the position of Executive Vice President, Chief Retail and Marketing Officer. Before joining the Bank she was Vice President and District Manager for EverTrust Bank, and served as Vice President and District Manager at Great American Bank NA and at US Bank where she opened the first in-store branches for the company. Byers attended Northern Arizona University and University of Arizona and is an honors graduate of Pacific Coast Banking School at the University of Washington.

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ITEM 1A. RISK FACTORS
Item 1A.
Risk Factors
As a financial services organization, we are subject to a number of risks inherent in our transactions and present in the business decisions we make. Described below are the material risks and uncertainties that if realized could have an adverse effect on our business, financial condition, results of operations or cash flows, and our access to liquidity. Consideration should also be given to the other information in this Annual Report on Form 10-K, as well as in the documents incorporated by reference into this Form 10-K. However, other factors not discussed below or elsewhere in this Annual Report on Form 10-K could adversely affect our business, financial condition, results of operations or cash flows and our access to liquidity. Therefore, the risk factors below should not be considered a complete list of potential risks we may face.
Risk Factors Summary
Our business is subject to numerous material risks and uncertainties, including those described in Part I Item 1A. “Risk Factors” in this Report on Form 10-K. You should carefully consider these material risks and uncertainties when investing in our common stock. The principal risks and uncertainties affecting our business include the following:
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We are subject to risks associated with the COVID-19 pandemic, which could have an adverse effect on our business, financial condition and results of operations.
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Our business and operations are concentrated in the Puget Sound area and we are sensitive to adverse changes in the local economy.
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If our allowance for loan losses is insufficient to absorb actual loan losses, our results of operations would be negatively affected.
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We operate in a highly competitive market and face increasing competition from traditional and new financial services providers.
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We are subject to the various risks associated with our banking business and operations, including, among others, credit, market, liquidity, interest rate and compliance risks, which may have an adverse effect on our business, financial condition and results of operations if we are unable to manage such risks.
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We may be unable to effectively manage our growth, which could have an adverse effect on our business, financial condition and results of operations.
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The success of our relationship with broker dealers, digital financial service providers and other partners to provide banking as a service (BaaS) is subject to risks associated with managing such relationships.
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We operate in a highly regulated industry, and the current regulatory framework and any future legislative and regulatory changes, may have an adverse effect on our business, financial condition and results of operations.
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We are subject to regulatory requirements, including stringent capital requirements, consumer protection laws, and anti-money laundering laws, and failure to comply with these requirements could have an adverse effect on our business, financial condition and results of operations.
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We are subject to laws regarding privacy, information security and protection of personal information and any violation of these laws or incidents involving personal, confidential or proprietary information of individuals, including, among others, system failures or cybersecurity breaches of our network security, could damage our reputation and otherwise adversely affect our business, financial condition and results of operation.
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Our charter documents contain certain provisions, including anti-takeover provision, that limit the ability of our shareholders to take certain actions and could delay or discourage takeover attempts that shareholders may consider favorable.
Risks Related to the COVID-19 Pandemic
The effects of COVID-19, and the impact of actions to mitigate it, could adversely affect our business, financial condition and results of operations.
The economic effects of the COVID-19 pandemic have had a destabilizing effect on financial markets, key market indices and overall economic activity. The uncertainty regarding the duration of the pandemic and the resulting economic disruption has caused increased market volatility and may lead to an economic recession and/or a significant decrease in consumer confidence and business generally. The continuation of these conditions caused by the COVID-19 pandemic, including the impacts of the CARES Act and other federal and state measures, specifically with respect to loan forbearances, can be expected to adversely impact our business and results of operations and the operations of our borrowers, customers and business partners. In particular, these events can be expected to, among other things:
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impair the ability of borrowers to repay outstanding loans or other obligations, resulting in increases in delinquencies;
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impair the value of collateral securing loans (particularly with respect to real estate);
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adversely affect our level of charge-offs and require an additional increase in our allowance for loan losses;
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adversely affect the stability of our deposit base, or otherwise impair our liquidity;
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create stress on our operations and systems associated with our participation in the PPP as a result of high demand and volume of applications;
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result in increased compliance risk as we become subject to new regulatory and other requirements associated with the PPP and other new programs in which we participate;
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impair the ability of loan guarantors to honor commitments;
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negatively impact our regulatory capital ratios;
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negatively impact the productivity and availability of key personnel and other employees necessary to conduct our business, and of third-party service providers who perform critical services for us, or otherwise cause operational failures due to changes in our normal business practices necessitated by the outbreak and related governmental actions;
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increase cyber and payment fraud risk, given increased online and remote activity; and
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broadly result in lost revenue and income.
Prolonged measures by health or other governmental authorities encouraging or requiring significant restrictions on travel, assembly or other core business practices could further harm our business and those of our customers, in particular our small to medium sized business customers. Although we have business continuity plans and other safeguards in place, there is no assurance that they will be effective.
COVID-19 has led to federal, state and local governments enacting various restrictions in an attempt to limit the spread of the virus, including the declaration of a federal National Emergency; multiple cities’ and states’ declarations of states of emergency; school and business closings; limitations on social or public gatherings and other social distancing measures, such as working remotely, travel restrictions, quarantines and shelter in place orders. Such measures have significantly contributed to rising unemployment and reductions in consumer and business spending. In response to the economic and financial effects of COVID-19, the Federal Reserve has sharply reduced interest rates and instituted quantitative easing measures as well as domestic and global capital market support programs, including a number of lending facilities designed to provide emergency liquidity to various segments of the U.S. economy and financial markets. Many of these facilities expired December 31, 2020, or were extended for brief periods into 2021. The expiration of these facilities could have adverse effect on U.S. economy and ultimately on our business, financial condition and results of operations.
In addition, the Biden and Trump Administrations, Congress, various federal agencies and state governments have taken measures to address the economic and social consequences of the pandemic, including the passage of the CARES Act. The CARES Act, among other things, provides certain measures to support individuals and businesses in maintaining solvency through monetary relief, including in the form of financing, loan forgiveness and automatic forbearance, and provides relief to financial institutions to avoid classifying certain COVID-19 related loan modifications as troubled debt restructurings (TDRs).
We processed loan applications under the PPP created under the CARES Act in rounds one and two, and continue to process applications in round three which opened on January 19, 2021. We also participated in the
Federal Reserve’s Main Street Lending Program (MSLP) and funded $59.2 million in MSLP loans as of December 31, 2020. Our participation in these programs could subject us to increased governmental and regulatory scrutiny, negative publicity or increased exposure to litigation, which could increase our operational, legal and compliance costs and damage our reputation. Moreover, if the federal stimulus measures are not effective in mitigating the effect of the COVID-19 pandemic, credit issues for our loan customers may be severe and adversely affect our business, financial condition and results of operations more substantially over a longer period of time.
The CARES Act and related guidance from the federal banking agencies provide financial institutions the option to temporarily suspend requirements under GAAP related to classification of certain loan modifications as TDRs, to account for the current and anticipated effects of COVID-19. The CARES Act, as amended by the Consolidated Appropriations Act, 2021, specifies that COVID-19 related loan modifications executed between March 1, 2020 and the earlier of (i) 60 days after the date of termination of the national emergency declared by the President and (ii) January 1, 2022, on loans that were current as of December 31, 2019 are not TDRs. Additionally, under guidance from the federal banking agencies, other short-term modifications made on a good faith basis in response to COVID-19 to borrowers that were current prior to any relief are not TDRs under ASC Subtopic 310-40, “Troubled Debt Restructuring by Creditors.” These modifications include short-term (e.g., up to six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. As of December 31, 2020, $9.3 million, or 3 loans, remain on deferral status as a result of the CARES Act and interagency guidance.
Banking regulatory agencies have encouraged lenders to extend additional loans, and the federal government is considering additional stimulus and support legislation focused on providing aid to various sectors, including small businesses. The full impact on our business activities as a result of new government and regulatory policies, programs and guidelines, as well as regulators’ reactions to such activities, remains uncertain.
Risks Related to Credit Matters
Our commercial real estate lending activities expose us to increased lending risks and related loan losses.
At December 31, 2020, our commercial real estate loan portfolio totaled $774.9 million, or 49.8% of our total loan portfolio, or 65.1%, excluding PPP loans. Our current business strategy is to continue our originations of commercial real estate loans. Commercial real estate loans generally expose a lender to greater risk of non-payment or late payment and loss than one-to-four family residential mortgage loans because repayment of the loans often depends on the successful operation of the properties and the income stream of the borrowers. These loans involve larger loan balances to single borrowers or groups of related borrowers compared to one-to-four family residential mortgage loans. To the extent that borrowers have more than one commercial real estate loan outstanding, an adverse development with respect to one loan or one credit relationship could expose us to a significantly greater risk of loss compared to an adverse development with respect to a one-to-four family residential real estate loan. Moreover, if loans that are collateralized by commercial real estate become troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses and would adversely affect our business, financial condition and results of operations.
We may be subject to environmental liabilities in connection with the real properties we own and the foreclosure on real estate assets securing our loan portfolio.
In the course of our business, we may purchase real estate in connection with our acquisition and expansion efforts, or we may foreclose on and take title to real estate or otherwise be deemed to be in control of property that serves as collateral on loans we make. As a result, we could be subject to environmental liabilities with respect to those properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or we may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property.
The cost of removal or abatement may substantially exceed the value of the affected properties or the loans secured by those properties, we may not have adequate remedies against the prior owners or other responsible parties and we may not be able to resell the affected properties either before or after completion of any such removal or abatement procedures. If material environmental problems are discovered before foreclosure, we generally will not foreclose on the related collateral or will transfer ownership of the loan to a subsidiary. It should be noted, however, that the transfer of the property or loans to a subsidiary may not protect us from environmental liability. Furthermore, despite these actions on our part, the value of the property as collateral will generally be substantially reduced or we may elect not to foreclose on the property and, as a result, we may suffer a loss upon collection of the loan. Any significant environmental liabilities could adversely affect our business, financial condition and results of operations.
Our commercial business lending activities expose us to additional lending risks.
As of December 31, 2020, commercial and industrial loans totaled $539.2 million and represented 34.6% of total loans. Included in commercial and industrial loans are $365.8 million in PPP loans, which are 100% guaranteed by the by the U.S. Government. Excluding PPP loans, which are 100% guaranteed, commercial and industrial loans represented 11.1% of total loans. We make commercial business loans in our market area to a variety of professionals, sole proprietorships, partnerships and corporations. As compared to commercial real estate loans, which are secured by real property, the value of which tends to be more easily ascertainable, commercial business loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans may depend substantially on the success of the business itself and the conditions in the general economy. Further, any losses incurred on a small number of commercial loans could have an adverse impact on our financial condition and results of operations due to the larger average size of commercial loans as compared with other loans and the risk that collateral securing such loans may depreciate over time, may be difficult to appraise, may fluctuate in value and may depend on the borrower’s ability to collect receivables. We have increased our focus on commercial business lending in recent years and intend to continue to focus on this type of lending in the future.
Our concentration of residential mortgage loans exposes us to increased lending risks.
At December 31, 2020, $143.9 million, or 9.3%, of our loan portfolio was secured by one-to-four family real estate, 95.0% is secured by property in Washington State, and a significant majority of that is located in the Puget Sound region. One-to-four family residential mortgage lending is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. A decline in residential real estate values as a result of a downturn in the Puget Sound housing market could reduce the value of the real estate collateral securing these types of loans. Declines in real estate values could cause some of our residential mortgages to be inadequately collateralized, which would expose us to a greater risk of loss if we seek to recover on defaulted loans by selling the real estate collateral.
Our origination of construction loans exposes us to increased lending risks.
At December 31, 2020 $94.4 million, or 6.1% of our total loans was construction, land and land development loans. We originate commercial construction loans primarily to professional builders for the construction of one-to-four family residences, apartment buildings, and commercial real estate properties. To a lesser degree, we also originate land acquisition loans for the purpose of facilitating the ultimate construction of a home or commercial building. Our construction loans present a greater level of risk than loans secured by improved, occupied real estate due to: (1) the increased difficulty at the time the loan is made of estimating the building costs and the selling price of the property to be built; (2) the increased difficulty and costs of monitoring the loan; (3) the higher degree of sensitivity to increases in market rates of interest; and (4) the increased difficulty of working out loan problems. In addition, construction costs may exceed original estimates as a result of increased materials, labor or other costs. Construction loans also often involve the disbursement of funds with repayment dependent, in part, on the success of the project and the ability of the borrower to sell or lease the property or refinance the indebtedness.
Our focus on lending to the small to medium-sized businesses may adversely affect our business, financial condition and results of operations.
We focus our business development and marketing strategy primarily on small to medium-sized businesses. Small to medium-sized businesses frequently have smaller market shares than larger firms, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial volatility in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small and medium-sized business often depends on the management skills, talents and efforts of a small group of people, and the death, disability or resignation of one or more of these people could have an adverse effect on the business and its ability to repay its loan. If our borrowers are unable to repay their loans, our business, financial condition and earnings could be adversely affected.
We may not be able to adequately measure and limit our credit risk, which could lead to unexpected losses.
The business of lending is inherently risky, including risks that the principal of or interest on any loan will not be repaid timely or at all or that the value of any collateral supporting the loan will be insufficient to cover our outstanding exposure. These risks may be affected by the strength of the borrower’s business sector and local, regional and national market and economic conditions. Many of our loans are made to small to medium-sized businesses that may be less able to withstand competitive, economic and financial pressures than larger borrowers. Our risk management practices, such as monitoring the concentration of our loans within specific industries and our credit approval practices, may not adequately reduce credit risk, and our credit administration personnel, policies and procedures may not adequately adapt to changes in economic or any other conditions affecting customers and the quality of the loan portfolio. A failure to effectively measure and limit the credit risk associated with our loan portfolio could lead to unexpected losses and adversely affect our business, financial condition and results of operations.
If our allowance for loan losses is insufficient to absorb actual loan losses, our results of operations would be negatively affected.
In determining the amount of the allowance for loan losses, we analyze our loss and delinquency experience by loan categories and we consider the effect of existing economic conditions. In addition, we make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. If the actual results are different from our estimates, or our analyses are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, which would require additions to our allowance and would decrease our net income. Our emphasis on loan growth and on increasing our portfolio, as well as any future credit deterioration, will require us to increase our allowance further in the future. While we believe that our allowance for loan losses was adequate at December 31, 2020, there is no assurance that it will be sufficient to cover future loan losses, especially if there is a significant deterioration in economic conditions.
In addition, our banking regulators periodically review our allowance for loan losses and could require us to increase our provision for loan losses. Any increase in our allowance for loan losses or loan charge-offs as required by regulatory authorities may adversely affect our business, financial condition and results of operations.
The current economic condition in the market areas we serve may adversely impact our earnings and could increase the credit risk associated with our loan portfolio.
While there is not a single employer or industry in our market area on which a significant number of our customers are dependent, a substantial portion of our loan portfolio is comprised of loans secured by property located in the Puget Sound area and substantially all of our loan and deposit customers are businesses and individuals in greater Puget Sound area. Therefore, weak economies in our market area could adversely affect our business, financial condition and results of operations. A deterioration in the market areas we serve could result in the following consequences, any of which would have an adverse impact, which could be material, on our business, financial condition, and results of operations:
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loan delinquencies may increase;
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problem assets and foreclosures may increase;
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collateral for loans made may decline in value, in turn reducing customers’ borrowing power, reducing the value of assets and collateral associated with existing loans;
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certain securities within our investment portfolio could become other than temporarily impaired, requiring a write-down through earnings to fair value, thereby reducing equity;
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low cost or noninterest bearing deposits may decrease; and
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demand for our loan and other products and services may decrease.
A decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loans are geographically diverse. Many of the loans in our portfolio are secured by real estate. Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively affect the borrower’s ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by various other factors, including changes in general or regional economic conditions, governmental rules or policies and natural disasters such as earthquakes and flooding. Further, deterioration in local economic conditions could drive the level of loan losses beyond the level we have provided for in our allowance for loan losses, which in turn could necessitate an increase in our provision for loan losses and a resulting reduction to our earnings and capital.
In addition, weakening in regional and general economic conditions such as inflation, recession, business closings, restrictions on business activity, unemployment, natural disasters, epidemic illness, or other factors beyond our control could reduce our growth rate and negatively affect demand for loans, the ability of our borrowers to repay their loans and our financial condition and results of operations.
Our SBA lending program is dependent upon the U.S. federal government, and we face specific risks associated with originating SBA loans.
As of December 31, 2020, the balance of owned SBA loans and SBA loans net of the sold portion was $382.8 million, which includes $365.8 million in PPP loans that are 100% guaranteed, and an additional $2.7 million in non-PPP SBA loans was also guaranteed. As of December 31, 2020, the balance of SBA loans sold and serviced was $17.5 million, resulting in $123,000 in servicing income for the year ended December 31, 2020. We also recognized $82,000 in income for the year ended December 31, 2020 for the gain on sale of our SBA loans. Our SBA lending program is dependent upon the U.S. federal government. As an approved participant in the SBA Preferred Lender’s Program, referred to herein as an SBA Preferred Lender, we enable our clients to obtain SBA loans without being subject to the potentially lengthy SBA approval process necessary for lenders that are not SBA Preferred Lenders. The SBA periodically reviews the lending operations of participating lenders to assess, among other things, whether the lender exhibits prudent risk management. When weaknesses are identified, the SBA may request corrective actions or impose enforcement actions, including revocation of the lender’s SBA Preferred Lender status. If we lose our status as an SBA Preferred Lender, we may lose some or all of our customers to lenders who are SBA Preferred Lenders, and as a result we could experience an adverse effect to our financial results. Any changes to the SBA program, including but not limited to changes to the level of guarantee provided by the federal government on SBA loans, changes to program specific rules impacting volume eligibility under the guaranty program, as well as changes to the program amounts authorized by Congress or exhaustion of the available funding for SBA programs may also have an adverse effect on our business, financial condition and results of operation. In addition, any default by the U.S. government on its obligations or any prolonged government shutdown could, among other things, impede our ability to originate SBA loans or sell such loans in the secondary market, which could adversely affect our business, financial condition and results of operations.
Included in this category are PPP loans, which have a contractual rate of 1.0%, with maturity terms of two to five years, are unsecured, 100% guaranteed and the loan proceeds of which may be forgiven by the U.S. Government / SBA if used for certain purposes. To bolster the effectiveness of the SBA’s PPP loan program, the Federal Reserve is supplying liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. The PPPLF extends credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. The interest rate is 0.35% and as PPP loans are paid down, the borrowing line must also be paid down.
Outside of the PPP, the SBA’s 7(a) Loan Program is the SBA’s primary program for helping start-up and existing small businesses, with financing guaranteed for a variety of general business purposes,. Generally, we sell the guaranteed portion of our non-PPP SBA 7(a) loans in the secondary market. These sales result in premium income for us at the time of sale and create a stream of future servicing income, as we retain the servicing rights to these loans. For the reasons described above, we may not be able to continue originating these loans or sell them in the secondary market. Furthermore, even if we are able to continue to originate and sell SBA 7(a) loans in the secondary market, we might not continue to realize premiums upon the sale of the guaranteed portion of these loans or the premiums may decline due to economic and competitive factors. When we originate SBA loans, we incur credit risk on the non-guaranteed portion of the loans, and if a customer defaults on a loan, we share any loss and recovery related to the loan pro-rata with the SBA. If the SBA establishes that a loss on an SBA guaranteed loan is attributable to significant technical deficiencies in the manner in which the loan was originated, funded or serviced by us, the SBA may seek recovery of the principal loss related to the deficiency from us. Generally, we do not maintain reserves or loss allowances for such potential claims and any such claims could adversely affect our business, financial condition and results of operations.
The laws, regulations and standard operating procedures that are applicable to SBA loan products may change in the future. We cannot predict the effects of these changes on our business, financial condition and results of operation. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies and especially our organization, changes in the laws, regulations and procedures applicable to SBA loans could adversely affect our ability to operate profitably.
Economic conditions could result in increases in our level of nonperforming loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.
Prolonged deteriorating economic conditions could significantly affect the markets in which we do business, the value of our loans and investment securities, and our ongoing operations, costs and profitability. Further, declines in real estate values and sales volumes and elevated unemployment levels may result in higher loan delinquencies, increases in our nonperforming and classified assets and a decline in demand for our products and services. These events may cause us to incur losses and may adversely affect our financial condition and earnings. Reduction in problem assets can be slow, and the process can be exacerbated by the condition of the properties securing nonperforming loans and the lengthy foreclosure process in Washington. To the extent that we must work through the resolution of assets, economic problems may cause us to incur losses and adversely affect our capital, business, financial condition, results of operations or cash flows and our access to liquidity.
Nonperforming assets take significant time and resources to resolve and adversely affect our business, financial condition and results of operations.
Nonperforming assets adversely affect our net income in various ways. We generally do not record interest income on other real estate owned (OREO), or on nonperforming loans, thereby adversely affecting our income and increasing loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may ultimately result in a loss. An increase in our level of nonperforming assets increases our risk profile and may impact the capital levels regulators believe are appropriate in light of the ensuing risk profile. While we seek to reduce problem assets through loan workouts, restructurings and otherwise, decreases in the value of the underlying collateral, or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect our business, financial condition and results of operations. In addition, the resolution
of nonperforming assets requires significant commitments of time from management, which may adversely impact their ability to perform their other responsibilities. We may not experience future increases in the value of nonperforming assets.
Risks Related to Compliance and Operational Matters
Imposition of limits by the bank regulators on commercial real estate lending activities could curtail our growth and adversely affect our earnings.
In 2006, the federal banking regulators issued joint guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices,” or the CRE Guidance. Although the CRE Guidance did not establish specific lending limits, it provides that a bank’s commercial real estate lending exposure could receive increased supervisory scrutiny where total non-owner-occupied commercial real estate loans, including loans secured by apartment buildings, investor commercial real estate, and construction and land loans, represent 300% or more of an institution’s total risk-based capital, and the outstanding balance of the commercial real estate loan portfolio has increased by 50% or more during the preceding 36 months. Our total non-owner-occupied commercial real estate loans, including loans secured by apartment buildings, investor commercial real estate, and construction and land loans, totaled $594.6 million and represented 357.0% of its total risk-based capital at December 31, 2020. The ratio was 347.9% at December 31, 2019. The outstanding balance of the Bank’s CRE portfolio has increased by 26.3% and 18.9% for the years ended December 31, 2020 and 2019, respectively.
In December 2015, the federal banking regulators released a new statement on prudent risk management for commercial real estate lending, referred to herein as the 2015 Statement. In the 2015 Statement, the federal banking regulators, among other things, indicate the intent to continue “to pay special attention” to commercial real estate lending activities and concentrations going forward. If the Federal Reserve, our primary federal regulator, were to impose restrictions on the amount of commercial real estate loans we can hold in our portfolio, for reasons noted above or otherwise, our earnings would be adversely affected.
Our business is subject to the risks of epidemic illnesses, earthquakes, tsunamis, floods, fires and other natural catastrophic events.
A major catastrophe, such as an epidemic illness, earthquake, tsunami, flood, fire or other natural disaster could result in a prolonged interruption of our business. For example, our headquarters are located in Everett, Washington and we serve the broader Puget Sound region, a geographical region that has been or may be affected by earthquake, tsunami and flooding activity. Because we primarily serve individuals and businesses in the Northwest, a natural disaster or epidemic illness likely would have a greater impact on our business, financial condition and results of operation than if our business were more geographically diverse. The occurrence of any of these natural disasters or epidemic illnesses could negatively impact our performance by disrupting our operations or the operations of our customers, which could adversely affect our business, financial condition, results of operations.
Appraisals and other valuation techniques we use in evaluating and monitoring loans secured by real property, OREO and repossessed personal property may not accurately reflect the net value of the asset.
In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and, as real estate values may change significantly in relatively short periods of time (especially in periods of heightened economic uncertainty), this estimate may not accurately describe the net value of the real property collateral after the loan is made. As a result, we may not be able to realize the full amount of any remaining indebtedness when we foreclose on and sell the relevant property. In addition, we rely on appraisals and other valuation techniques to establish the value of our OREO, and personal property that we acquire through foreclosure proceedings and to determine certain loan impairments. If any of these valuations are inaccurate, our financial statements may not reflect the correct value of our OREO, and our allowance for loan losses may not reflect accurate loan impairments. This could adversely affect our business, financial condition and results of operations. As of December 31, 2020, we did not hold any OREO or repossessed property and equipment.
We derive a percentage of our deposits, total assets and income from deposit accounts generated through our BaaS relationships. ﻿
Deposit accounts acquired through these relationships totaled $68.7 million, or 4.8% of total deposits at December 31, 2020. We provide oversight over these relationships, which must meet all internal and regulatory requirements. We may exit relationships where such requirements are not met or be required by our regulators to exit such relationships. Also, our partner(s) could terminate a relationship with us for many reasons, including being able to obtain better terms from another provider or dissatisfaction with the level or quality of our services. If a relationship were to be terminated, it could materially reduce our deposits, assets and income. We cannot assure you that we could replace such relationship. If we cannot replace such relationship, we may be required to seek higher rate funding sources as compared to the existing relationship and interest expense might increase. We may also be required to sell securities or other assets to meet funding needs which would reduce revenues or potentially generate losses.
Our strategy of partnering with broker dealers and digital financial service providers to offer BaaS has been adopted by other institutions with which we compete.
Several online banking operations as well as the online banking programs of conventional banks have instituted BaaS strategies similar to ours. As a consequence, we have encountered competition in this area and anticipate that we will continue to do so in the future. This competition may increase our costs, reduce our revenues or revenue growth or, because we are a relatively small banking operation without the name recognition of other, more established banking operations, make it difficult for us to compete effectively in obtaining these relationships.
Our agreements with BaaS partners may produce limited revenue and may expose us to liability for compliance violations by BaaS partners.
We have entered into agreements with BaaS partners, which includes broker dealers and digital financial service providers, pursuant to which we will provide certain banking services for the BaaS partner customers, including serving as the issuing bank for debit cards issued to their customers and establishing one or more settlement accounts for the purpose of settling customer transactions in the cash management account program. The agreements have varying terms and may be terminated by the parties under certain circumstances. If our BaaS partners are not successful in achieving customer acceptance of their programs or terminate the agreement before the end of its term, our revenue under the agreement may be limited or may cease altogether. In addition, because we will provide banking services with respect to the cash features of our BaaS partner account programs, our bank regulators may hold us responsible for their activities with respect to the marketing or administration of their programs, which may result in increased compliance costs for us or potentially compliance violations as a result of BaaS partner activities.
We are subject to interest rate risk and fluctuations in interest rates may adversely affect our earnings.
The majority of our banking assets and liabilities are monetary in nature and subject to risk from changes in interest rates. Like most financial institutions, our earnings are significantly dependent on our net interest income, the principal component of our earnings, which is the difference between interest earned by us from our interest-earning assets, such as loans and investment securities, and interest paid by us on our interest-bearing liabilities, such as deposits and borrowings. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this “gap” will negatively impact our earnings. The impact on earnings is more adverse when the slope of the yield curve flattens, that is, when short-term interest rates increase more than long-term interest rates or when long-term interest rates decrease more than short-term interest rates. Many factors impact interest rates, including governmental monetary policies, inflation, recession, changes in unemployment, the money supply and international economic weakness and disorder and instability in domestic and foreign financial markets. Our interest rate sensitivity profile was asset sensitive as of December 31, 2020, meaning that we estimate our net interest income would increase more from rising interest rates than from falling interest rates.
Interest rate increases often result in larger payment requirements for our borrowers, which increases the potential for default and could result in a decrease in the demand for loans. At the same time, the marketability of the property securing a loan may be adversely affected by any reduced demand resulting from higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on loans as borrowers refinance their loans at lower rates. In addition, in a low interest rate environment, loan customers often pursue long-term fixed rate credits, which could adversely affect our earnings and net interest margin if rates increase. Changes in interest rates also can affect the value of loans, securities and other assets. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to an increase in nonperforming assets and a reduction of income recognized, which could have an adverse effect on our results of operations and cash flows. Further, when we place a loan on nonaccrual status, we reverse any accrued but unpaid interest receivable, which decreases interest income. At the same time, we continue to have a cost to fund the loan, which is reflected as interest expense, without any interest income to offset the associated funding expense. Thus, an increase in the amount of nonperforming assets would have an adverse impact on net interest income. If short-term interest rates continue to remain at their historically low levels for a prolonged period, and assuming longer-term interest rates fall further, we could experience net interest margin compression as our interest-earning assets would continue to reprice downward while our interest-bearing liability rates could fail to decline in tandem. Such an occurrence would have an adverse effect on our net interest income and could have an adverse effect on our business, financial condition and results of operations.
Uncertainty relating to the LIBOR calculation process and phasing out of LIBOR may adversely affect our results of operations.
On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021. In November 2020, the ICE Benchmark Administration, which administers LIBOR, announced its intention to extend the publication of most tenors of LIBOR through June 30, 2023. The U.S. federal banking agencies have continued to encourage banks to transition away from LIBOR as soon as practicable.
Several domestic and international groups, including the Alternative Reference Rate Committee and the International Swaps and Derivatives Association, have begun to develop LIBOR replacements, and a consensus appears to have emerged that the SOFR as observed by the Federal Reserve Bank of New York should be the successor rate. Nevertheless, uncertainty surrounding the transition away from LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and debt instruments. If and when LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers or our existing borrowings, we may incur additional expenses in effecting the transition, and may be subject to disputes or litigation with customers and creditors over the appropriateness or comparability to LIBOR of the substitute indices, which could have an adverse effect on our business, financial condition and results
of operations. As of December 31, 2020, we had $160.0 million in loans that are tied to LIBOR, and $110.6 million of those are SWAPs. 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 may be adversely affected by recent changes in U.S. tax laws and regulations.
From time to time, the U.S. government may introduce new tax laws and regulations, or interpretations of existing income tax laws could change, causing an adverse effect on our business, financial condition and results of operations. For example, changes in tax laws contained in the Tax Cuts and Jobs Act of 2017 (the Tax Cuts and Jobs Act), which was enacted in December 2017, include a number of provisions that will have an impact on the banking industry, borrowers and the market for residential real estate. Included in this legislation was a reduction of the corporate income tax rate from 35% to 21%. In addition, other changes included: (i) a lower limit on the deductibility of mortgage interest on single-family residential mortgage loans, (ii) the elimination of interest deductions for home equity loans, (iii) a limitation on the deductibility of business interest expense and (iv) a limitation on the deductibility of property taxes and state and local income taxes.
We expect that the implementation of a new accounting standard could require us to increase our allowance for loan losses and may have an adverse effect on our business, financial condition and results of operations.
The FASB, has adopted a new accounting standard, referred to as Current Expected Credit Loss (CECL), will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and provide for the expected credit losses as allowances for loan losses. As a smaller reporting company, we will be required to implement CECL beginning as of January 1, 2023. CECL will change the current method of providing allowances for loan losses that are probable, which we expect could require us to increase our allowance for loan losses, and will likely greatly increase the data we would need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in our allowance for loan losses, or expenses incurred to determine the appropriate level of the allowance for loan losses, may have an adverse effect on our financial condition and results of operations. In addition, new accounting standards are issued or existing standards are revised periodically, changing the methods for preparing our financial statements. These changes are not within our control and may significantly impact our business, financial condition and results of operations.
Because the nature of the financial services business involves a high volume of transactions, we face significant operational risks, including, but not limited to, customer, employee or third-party fraud and data processing system failures and errors.
We rely on the ability of our employees and systems to process a high number of transactions. Operational risk is the risk of loss resulting from our operations, including but not limited to, the risk of fraud by employees or outside persons, the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of our internal control system and compliance requirements, high volume of transactions processed for our strategic partners, and business continuation and disaster recovery. Insurance coverage may not be available for such losses, or where available, such losses may exceed insurance limits. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulations, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. We maintain a system of internal controls to mitigate operational risks, including data processing system failures and errors and customer or employee fraud, as well as insurance coverage designed to protect us from material losses associated with these risks, including losses resulting from any associated business interruption. Although our control testing has not identified any significant deficiencies in our internal control system, a breakdown in our internal control system, improper operation of our systems or improper employee actions could result in material financial loss to us, the imposition of regulatory action, and damage to our reputation.
We are dependent on the use of data and modeling in our management’s decision-making, and faulty data or modeling approaches could negatively impact our decision-making ability or possibly subject us to regulatory scrutiny in the future.
The use of statistical and quantitative models and other quantitative analyses is widespread in bank decision-making, and the employment of such analyses is becoming increasingly widespread in our operations. Liquidity stress testing, interest rate sensitivity analysis, and the identification of possible violations of anti-money laundering regulations are all examples of areas in which we are dependent on models and the data that underlies them. The use of statistical and quantitative models is also becoming more prevalent in regulatory compliance. While we are not currently subject to stress testing under the Dodd-Frank Act, we anticipate that model-derived testing may become more extensively implemented by regulators in the future.
We anticipate data-based modeling will penetrate further into bank decision-making, particularly risk management efforts, as the capacities developed to meet rigorous stress testing requirements are able to be employed more widely and in differing applications. While we believe these quantitative techniques and approaches improve our decision-making, they also create the possibility that faulty data or flawed quantitative approaches could negatively impact our decision-making ability or, if we become subject to regulatory stress testing in the future, adverse regulatory scrutiny. Further, because of the complexity inherent in these approaches, misunderstanding or misuse of their outputs could similarly result in suboptimal decision-making.
We depend on the accuracy and completeness of information provided to us by our borrowers and counterparties and any misrepresented information could adversely affect our business, financial condition and results of operations.
In deciding whether to approve loans or to enter into other transactions with borrowers and counterparties, we rely on information furnished to us by, or on behalf of, borrowers and counterparties, including financial statements, credit reports and other financial information. We also rely on representations of borrowers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. If any of this information is intentionally or negligently misrepresented and such misrepresentation is not detected prior to loan funding, the value of the loan may be significantly lower than expected and we may be subject to regulatory action. Whether a misrepresentation is made by the loan applicant, another third party, or one of our employees, we generally bear the risk of loss associated with the misrepresentation. Our controls and processes may not have detected, or may not detect all, misrepresented information in our loan originations or from our business clients. Any such misrepresented information could adversely affect our business, financial condition and results of operations.
We are subject to certain operational risks, including, but not limited to, customer, employee or third-party fraud and data processing system failures and errors.
Because we are a financial institution, employee errors and employee or customer misconduct could subject us in particular to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information, each of which can be particularly damaging for financial institutions. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence.
We maintain a system of internal controls to mitigate operational risks, including data processing system failures and errors and customer or employee fraud, as well as insurance coverage designed to protect us from material losses associated with these risks, including losses resulting from any associated business interruption. If our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could adversely affect our business, financial condition and results of operations.
We could recognize losses on investment securities held in our securities portfolio, particularly if interest rates increase or economic and market conditions deteriorate.
While we attempt to invest a significant majority of our total assets in loans (our loan-to-asset ratio was 87.6% as of December 31, 2020), we invest a percentage of our total assets (1.3% as of December 31, 2020) in investment securities with the primary objectives of providing a source of liquidity and meeting pledging requirements. As of December 31, 2020, the fair value of our available for sale investment securities portfolio was $20.4 million, which included a net unrealized gain of $42,000, and the fair value of our held to maturity investment securities was $3.0 million, which included a net unrealized gain of $109,000. Factors beyond our control can significantly and adversely influence the fair value of securities in our portfolio. For example, fixed-rate securities are generally subject to decreases in market value when interest rates rise. Additional factors include, but are not limited to, rating agency downgrades of the securities, defaults by the issuer or individual borrowers with respect to the underlying securities, and instability in the credit markets. Any of the foregoing factors could cause other-than-temporary impairment in future periods and result in realized losses. The process for determining whether impairment is other-than-temporary usually requires difficult, subjective judgments about the future financial performance of the issuer and any collateral underlying the security in order to assess the probability of receiving all contractual principal and interest payments on the security. Although we have not recognized other-than-temporary impairment related to our investment portfolio as of December 31, 2020, changing economic and market conditions affecting interest rates, the financial condition of issuers of the securities and the performance of the underlying collateral, among other factors, may cause us to recognize losses in future periods, which could have an adverse effect on our business, financial condition and results of operations.
The accuracy of our financial statements and related disclosures could be affected if the judgments, assumptions or estimates used in our critical accounting policies are inaccurate.
The preparation of financial statements and related disclosures in conformity with U.S. Generally Accepted Accounting Principles (GAAP) requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and related notes to those financial statements. Our critical accounting policies, which are included in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Report on Form 10-K, describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that we consider “critical” because they require judgments, assumptions and estimates that materially affect our consolidated financial statements and related disclosures. As a result, if future events or regulatory views concerning such analysis differ significantly from the judgments, assumptions and estimates in our critical accounting policies, those events or assumptions could have a material impact on our consolidated financial statements and related disclosures, in each case resulting in our needing to revise or restate prior period financial statements, cause damage to our reputation and the price of our common stock, and adversely affect our business, financial condition and results of operations.
Dependency on external security systems expose us to greater operational risk.
External security systems with which we are connected, whether directly or indirectly, through the Bank, CCBX, or CCDB, can be sources of risk to us. We may be exposed not only to a systems failure with which we are directly connected, but also to a systems breakdown of a party to CCBX, CCDB or other relationship to which we are connected. This is particularly the case where activities of customers or those parties are beyond our security and control systems, including through the use of the internet, cloud computing services and personal smart phones and other mobile devices or services.
If that party experiences a breach of its own systems or misappropriates that data, this could result in a variety of negative outcomes for us and our customers, including:
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losses from fraudulent transactions, as well as potential liability for losses that exceed thresholds established in consumer protection laws and regulations,
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increased operational costs to remediate the consequences of the external party’s security breach,
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negative impact on future revenues; and
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harm to reputation arising from the perception that our systems may not be secure.
We are highly dependent on the accuracy and effectiveness of its operational processes and systems and the operational processes and systems of external parties related to the Bank, CCBX and CCDB.
We rely comprehensively on financial, accounting, transaction execution, data processing and other operational systems to process, record, monitor and report a large number of transactions on a continuous basis, and to do so accurately, quickly and securely. In addition to the proper design, installation, maintenance and training of our own operational systems, we rely on the effective functioning of operational systems of external parties related to the Bank, CCBX and CCDB. Breakdowns in these operational systems could result in:
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the inability to accurately and timely settle transactions,
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the possibility that funds transfers or other transactions are executed erroneously, or with unintended consequences,
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financial losses incurred, or possible restitution to customers, resulting from contractual agreements with external parties related to the Bank, CCBX and CCDB,
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regulatory issues,
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higher operational costs, associated with replacing or recovering systems that are inoperable or unavailable,
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loss of confidence in our ability to protect against and withstand operational disruptions, thus impacting our ability to market and establish new relationships in the CCBX and CCDB divisions, and
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harm to our reputation.
As the speed, frequency, volume, interconnectivity and complexity of transactions within our CCBX and CCDB divisions continue to increase, it becomes more challenging to effectively maintain systems and mitigate risks such as:
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errors made by us or external parties doing business with the Bank, CCBX and CCDB, whether inadvertent or malicious; and
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isolated or seemingly insignificant errors or losses, which migrate to other systems or grow in number, to become larger issues or losses.
We may be subject to potential business risk from actions by our regulators related to CCBX relationships.
Our regulators could impose restrictions on the businesses served in our CCBX division or restrict the number of different relationships the Company can hold. Regulatory restrictions placed on the parties served in the Company’s CCBX division could result in reduced demand for services, reduced future revenue in the CCBX division, or loss of current relationships. Regulatory restrictions that limit the number of relationships the Company can hold in its CCBX division would result in reduced future revenue and limit the potential for growth in that division.
Risks Related to Strategic and Reputational Matters
Our business strategy includes growth, and our business, financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively. Growing our operations could also cause our expenses to increase faster than our revenues.
Our business strategy includes growth in assets, deposits and the scale of our operations. Achieving such growth will require us to attract customers that currently bank at other financial institutions in our market area. Our ability to successfully grow will depend on a variety of factors, including our ability to attract and retain experienced bankers, the continued availability of desirable business opportunities, competition from other financial institutions in our market area and our ability to manage our growth. Growth opportunities may not be available or we may not be able to manage our growth successfully. If we do not manage our growth effectively, our financial condition and operating results could be negatively affected. Furthermore, there can be considerable costs involved in expanding deposit and lending capacity that generally require a period of time to generate the necessary revenues to offset their costs, especially in areas in which we do not have an established presence and that require alternative delivery methods. Accordingly, any such business expansion can be expected to negatively impact our earnings for some period of time until certain economies of scale are reached. Our expenses could be further increased if we encounter delays in modernizing existing facilities, opening new branches or deploying new services.
Our expansion strategy focuses on organic growth, expansion of our CCBX division, development of our CCDB division, and expansion of the Bank’s banking location network, or de novo branching. We may not be able to execute on aspects of our expansion strategy, which may impair our ability to sustain our historical rate of growth
or prevent us from growing at all. More specifically, we may not be able to generate sufficient new loans and deposits within acceptable risk and expense tolerances, obtain the personnel or funding necessary for additional growth or find suitable acquisition candidates. The success of our strategy also depends on our ability to effectively manage growth, which is dependent upon a number of factors, including our ability to adapt our credit, operational, technology and governance infrastructure to accommodate expanded operations. If we fail to implement one or more aspects of our strategy, we may be unable to maintain our historical earnings trends, which could have an adverse effect on our business, financial condition and results of operations.
Strong competition within our market area could hurt our profits and slow growth.
Our profitability depends upon our continued ability to compete successfully in our market area. We face intense competition both in making loans and attracting deposits. Our competitors for commercial real estate loans include other community banks and commercial lenders, some of which are larger than us and have greater resources and lending limits than we have and offer services that we do not provide. We face stiff competition for one-to-four family residential loans from other financial service providers, including large national residential lenders and local community banks. Other competitors for one-to-four family residential loans include credit unions and mortgage brokers which keep overhead costs and mortgage rates down by selling loans and not holding or servicing them. Price competition for loans and deposits might result in us earning less on our loans and paying more on our deposits, which reduces net interest income. We expect competition to remain strong in the future.
The Washington DFI has entered into a multi-state agreement with six other states that is intended to streamline the licensing process for money service businesses, which include money transmitters and payment service providers. Increasing the relative ease of obtaining a license to operate a money service business within the state of Washington may encourage financial technology, or fintech, companies to offer services in the state, thereby increasing competition for such services.
We rely heavily on our executive management team and other key employees, and we could be adversely affected by the unexpected loss of their services.
Our success depends in large part on the performance of our executive management team and other key personnel, as well as on our ability to attract, motivate and retain highly qualified senior and middle management and other skilled employees. Competition for qualified employees is intense, and the process of locating key personnel with the combination of skills, attributes and business relationships required to execute our business plan may be lengthy. We may not be successful in retaining our key employees, and the unexpected loss of services of one or more of our key personnel could have an adverse effect on our business because of their skills, knowledge of and business relationships within our primary markets, years of industry experience and the difficulty of promptly finding qualified replacement personnel. If the services of any of our key personnel should become unavailable for any reason, we may not be able to identify and hire qualified persons on terms acceptable to us, or at all, which could have an adverse effect on our business, financial condition and results of operations.
Anti-takeover provisions in our corporate organizational documents and provisions of federal and state law may make an attempted acquisition or replacement of our board of directors or management more difficult.
Our second amended and restated articles of incorporation and our amended and restated bylaws, (bylaws), may have an anti-takeover effect and may delay, discourage or prevent an attempted acquisition or change of control or a replacement of our incumbent board of directors or management. Our governing documents include provisions that:
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empower our board of directors, without shareholder approval, to issue preferred stock, the terms of which, including voting power, are to be set by our board of directors;
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establish a classified board of directors, with directors of each class serving a three-year term;
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provide that directors may be removed from office without cause only by vote of 80% of the outstanding shares then entitled to vote;
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eliminate cumulative voting in elections of directors;
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permit our board of directors to alter, amend or repeal our bylaws or to adopt new bylaws;
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require the request of holders of at least one-third of the outstanding shares of our capital stock entitled to vote at a meeting to call a special shareholders’ meeting;
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require shareholders that wish to bring business before annual meetings of shareholders, or to nominate candidates for election as directors at our annual meeting of shareholders, to provide timely notice of their intent in writing;
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require that certain business combination transactions with a significant shareholder be approved by holders of two-thirds of the shares held by persons other than the significant shareholder; and
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enable our board of directors to increase, between annual meetings, the number of persons serving as directors and to fill the vacancies created as a result of the increase by a majority vote of the directors present at a meeting of directors.
In addition, certain provisions of Washington law, including a provision which restricts certain business combinations between a Washington corporation and certain affiliated shareholders, may delay, discourage or prevent an attempted acquisition or change in control. Furthermore, banking laws impose notice, approval, and ongoing regulatory requirements on any shareholder or other party that seeks to acquire direct or indirect “control” of an FDIC-insured depository institution or its holding company. These laws include the BHC Act, the Change in Bank Control Act, and comparable banking laws in the State of Washington. These laws could delay or prevent an acquisition.
We are subject to laws regarding the privacy, information security and protection of personal information and any violation of these laws or another incident involving personal, confidential or proprietary information of individuals could damage our reputation and otherwise adversely affect our business, financial condition and earnings.
Our business requires the collection and retention of large volumes of customer data, including personally identifiable information in various information systems that we maintain and in those maintained by third parties with whom we contract to provide data services. We also maintain important internal company data such as personally identifiable information about our employees and information relating to our operations. We are subject to complex and increasingly demanding laws and regulations governing the privacy and protection of personal information of individuals (including customers, employees, suppliers and other third parties). For example, our business is subject to the Gramm-Leach-Bliley Act which, among other things: (i) imposes certain limitations on our ability to share nonpublic personal information about our customers with nonaffiliated third parties; (ii) requires that we provide certain disclosures to customers about our information collection, sharing and security practices and afford customers the right to “opt out” of any information sharing by us with nonaffiliated third parties (with certain exceptions); and (iii) requires that we develop, implement and maintain a written comprehensive information security program containing appropriate safeguards based on our size and complexity, the nature and scope of our activities, and the sensitivity of customer information we process, as well as plans for responding to data security breaches. Various state and federal laws and regulations impose data security breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification in certain circumstances in the event of a security breach. Ensuring that our collection, use, transfer and storage of personal information complies with all applicable laws and regulations can increase our costs.
Furthermore, we may not be able to ensure that all of our clients, suppliers, counterparties, broker dealers and financial providers in CCBX, and other third parties have appropriate controls in place to protect the
confidentiality of the information that they exchange with us, particularly where such information is transmitted by electronic means. If personal, confidential or proprietary information of customers or others were to be mishandled or misused (in situations where, for example, such information was erroneously provided to parties who are not permitted to have the information, or where such information was intercepted or otherwise compromised by third parties), we could be exposed to litigation or regulatory sanctions under personal information laws and regulations. Concerns regarding the effectiveness of our measures to safeguard personal information, or even the perception that such measures are inadequate, could cause us to lose customers or potential customers for our products and services and thereby reduce our revenues. Accordingly, any failure or perceived failure to comply with applicable privacy or data protection laws and regulations may subject us to inquiries, examinations and investigations that could result in requirements to modify or cease certain operations or practices or in significant liabilities, fines or penalties, and could damage our reputation and otherwise adversely affect our business, financial condition and earnings.
We are dependent on our information technology and telecommunications systems and third-party service providers; systems failures, interruptions, security breaches and cybersecurity threats could have an adverse effect on our business, financial condition and results of operations.
Our business is dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party service providers. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If significant, sustained or repeated, a system failure or service denial could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could have an adverse effect on our business, financial condition and results of operations.
In the ordinary course of our business, we collect and store sensitive data, including our proprietary business information and that of our customers, suppliers and business partners, as well as personally identifiable information about our customers and employees. The processing that takes place with our strategic partners could potentially have an adverse impact on us in the event of a security breach of their systems. The secure processing, maintenance and transmission of this information is critical to our operations and business strategy. We, our customers, and other financial institutions with which we interact, are subject to increasingly frequent, continuous attempts, including ransomware and malware attacks, to penetrate key systems by individual hackers, organized criminals, and in some cases, state-sponsored organizations.
We have a cybersecurity program that includes internal/external penetration testing, regular vulnerability assessments, detailed vulnerability management, data loss prevention controls, file access and integrity monitoring and reporting and threat intelligence. While we have established policies and procedures to prevent or limit the impact of cyber-attacks, there can be no assurance that such events will not occur or will be adequately addressed if they do. In addition, we also outsource certain cybersecurity functions, such as penetration testing, to third-party service providers, and the failure of these service providers to adequately perform such functions could increase our exposure to security breaches and cybersecurity threats. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other malicious code and cyber-attacks that could have an impact on information security. Any such breach or attacks could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such unauthorized access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, and regulatory penalties; disrupt our operations and the services we provide to customers; damage our reputation; and cause a loss of confidence in our products and services, all of which could adversely affect our business, financial condition and results of operations. Further, to the extent that the activities of our third-party service providers or the activities of our customers involve the storage and transmission of confidential information, security breaches and viruses could expose us to claims, regulatory scrutiny, litigation costs and other possible liabilities.
Risks Related to Our Capital and Liquidity
Ineffective liquidity management could adversely affect our business, financial condition and results of operations.
Effective liquidity management is essential for the operation of our business. We require sufficient liquidity to meet customer loan requests, customer deposit maturities/withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances causing industry or general financial market stress. Our access to funding sources in amounts adequate to finance our activities on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy generally. Factors that could detrimentally impact our access to liquidity sources include a downturn in the geographic markets in which our loans and operations are concentrated or difficult credit markets. Our access to deposits may also be affected by the liquidity needs of our depositors. In particular, a majority of our liabilities are checking accounts and other liquid deposits, which are payable on demand or upon several days’ notice, while by comparison, a substantial majority of our assets are loans, which cannot be called or sold in the same time frame. Although we have historically been able to replace maturing deposits and advances as necessary, we might not be able to replace such funds in the future, especially if a large number of our depositors seek to withdraw their accounts, regardless of the reason. A failure to maintain adequate liquidity could adversely affect our business, financial condition and results of operations.
We may need to raise additional capital in the future, and such capital may not be available when needed or at all.
We may need to raise additional capital, in the form of additional debt or equity, in the future to have sufficient capital resources and liquidity to meet our commitments and fund our business needs and future growth, particularly if the quality of our assets or earnings were to deteriorate significantly. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial condition. Economic conditions and a loss of confidence in financial institutions may increase our cost of funding and limit access to certain customary sources of capital or make such capital only available on unfavorable terms, including interbank borrowings, repurchase agreements and borrowings from the discount window of the Federal Reserve. We may not be able to obtain capital on acceptable terms or at all. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of debt purchasers, depositors of our bank or counterparties participating in the capital markets or other disruption in capital markets, may adversely affect our capital costs and our ability to raise capital and, in turn, our liquidity. Further, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would then have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have an adverse effect on our business, financial condition and results of operations.
Risks Related to Our Industry
Regulation of the financial services industry is intense, and we may be adversely affected by changes in laws and regulations.
We are subject to extensive government regulation, supervision and examination. Such regulation, supervision and examination govern the activities in which we may engage, and are intended primarily for the protection of the deposit insurance fund and the Bank’s depositors, rather than for shareholders.
In 2010 and 2011, in response to the financial crisis and recession that began in 2008, significant regulatory and legislative changes resulted in broad reform and increased regulation affecting financial institutions. The Dodd-Frank Act created a significant shift in the way financial institutions operate. The Dodd-Frank Act also created the CFPB to implement consumer protection and fair lending laws, a function that was formerly performed by the depository institution regulators. The Dodd-Frank Act contains various provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as that which occurred in 2008 and 2009. The Dodd-Frank Act has had and may continue to have a material impact on our operations, particularly through increased regulatory burden and compliance costs. On May 24, 2018, the EGRRCPA became law. Among other things, the EGRRCPA changed certain of the regulatory requirements of the Dodd-Frank Act and
includes provisions intended to relieve the regulatory burden on community banks. Any future legislative changes could have a material impact on our profitability, the value of assets held for investment or the value of collateral for loans. Future legislative changes could also require changes to business practices and potentially expose us to additional costs, liabilities, enforcement action and reputational risk.
Federal regulatory agencies have the ability to take strong supervisory actions against financial institutions that have experienced increased loan production and losses and other underwriting weaknesses or have compliance weaknesses. These actions include entering into formal or informal written agreements and cease and desist orders that place certain limitations on their operations. If we were to become subject to a regulatory action, such action could negatively impact our ability to execute our business plan, and result in operational restrictions, as well as our ability to grow, pay dividends, repurchase stock or engage in mergers and acquisitions. See “Item 1. Business-Regulation and Supervision-Bank Regulation and Supervision-Capital Adequacy” for a discussion of regulatory capital requirements.
Increases in Federal Deposit Insurance Corporation insurance premiums could adversely affect our earnings and results of operations.
The deposits of the Bank are insured by the FDIC up to legal limits and, accordingly, subject it to the payment of FDIC deposit insurance assessments. The Bank's regular assessments are determined by the level of its assessment base and its risk classification, which is based on its regulatory capital levels and the level of supervisory concern that it poses, as well as by its usage of brokered deposits. Moreover, the FDIC has the unilateral power to change deposit insurance assessment rates and the manner in which deposit insurance is calculated and also to charge special assessments to FDIC-insured institutions. The FDIC utilized all of these powers during the financial crisis for the purpose of restoring the reserve ratios of the Deposit Insurance Fund. Any future special assessments, increases in assessment rates or premiums, or required prepayments in FDIC insurance premiums could reduce our profitability or limit our ability to pursue certain business opportunities, which could adversely affect our business, financial condition, and results of operations.
Federal banking agencies periodically conduct examinations of our business, including compliance with laws and regulations, and our failure to comply with any supervisory actions to which we are or become subject as a result of such examinations could adversely affect us.
As part of the bank regulatory process, the Federal Reserve and the Washington DFI periodically conduct comprehensive examinations of our business, including compliance with laws and regulations. If, as a result of an examination, either of these banking agencies were to determine that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity, asset sensitivity, risk management or other aspects of any of our operations had become unsatisfactory, or that our Company, the Bank or their respective management were in violation of any law or regulation, it may take a number of different remedial actions as it deems appropriate. The Federal Reserve may enjoin “unsafe or unsound” practices or violations of law, require affirmative actions to correct any conditions resulting from any violation or practice, issue an administrative order that can be judicially enforced, direct an increase in our capital levels, restrict our growth, assess civil monetary penalties against us, the Bank or their respective officers or directors, and remove officers and directors. The FDIC also has authority to review our financial condition, and, if the FDIC were to conclude that the Bank or its directors were engaged in unsafe or unsound practices, that the Bank was in an unsafe or unsound condition to continue operations, or the Bank or the directors violated applicable law, the FDIC could move to terminate the Bank’s deposit insurance. If we become subject to such regulatory actions, our business, financial condition, and results of operations as well as our reputation could be adversely affected.
Many of our new activities and expansion plans require regulatory approvals, and failure to obtain these approvals may restrict our growth.
We intend to complement and expand our business by growing our BaaS division, expanding the Bank’s banking location network, or de novo branching, and pursuing strategic acquisitions of financial institutions and other complementary businesses. Generally, we must receive federal and state regulatory approval before we can acquire a depository institution or related business insured by the FDIC or before we open a de novo branch. In determining whether to approve a proposed acquisition, federal banking regulators will consider, among other factors, the effect of the acquisition on competition, our financial condition, our future prospects, and the impact of the proposal on U.S. financial stability. The regulators also review current and projected capital ratios and levels, the
competence, experience and integrity of management and its record of compliance with laws and regulations, the convenience and needs of the communities to be served (including the acquiring institution’s record of compliance under the CRA) and the effectiveness of the acquiring institution in combating money laundering activities. Such regulatory approvals may not be granted on terms that are acceptable to us, or at all.
Financial institutions, such as the Bank, face a risk of noncompliance with and enforcement action under the Bank Secrecy Act and other anti-money laundering statutes and regulations.
The Bank Secrecy Act, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act), and other laws and regulations require financial institutions, among other duties, to institute and maintain an effective anti-money laundering program and file suspicious activity and currency transaction reports as appropriate. The Financial Crimes Enforcement Network, established by the Treasury Department to administer the Bank Secrecy Act, has authority to impose significant civil money penalties for violations of these requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and the Internal Revenue Service. There is also increased scrutiny of compliance with the sanctions programs and rules administered and enforced by the Treasury Department’s Office of Foreign Assets Control.
In order to comply with regulations, guidelines and examination procedures in this area, we have dedicated significant resources to our anti-money laundering program. If our policies, procedures and systems are deemed deficient, we could be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the inability to obtain regulatory approvals to proceed with certain aspects of our business plans, including acquisitions and de novo branching.
We are subject to numerous laws designed to promote community reinvestment or protect consumers, including the CRA and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.
The CRA requires the Federal Reserve to assess the Bank’s performance in meeting the credit needs of the communities it serves, including low- and moderate-income neighborhoods, and if the Bank performs unsatisfactorily, various adverse regulatory consequences may ensue, including an inability to secure regulatory approval of expansionary transactions or new branches.
In addition, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose nondiscriminatory lending requirements on financial institutions. The federal banking agencies, the CFPB, the U.S. Department of Justice and other federal agencies are responsible for enforcing these laws and regulations. The CFPB was created under the Dodd-Frank Act to centralize responsibility for consumer financial protection with broad rulemaking authority to administer and carry out the purposes and objectives of federal consumer financial laws with respect to all financial institutions that offer financial products and services to consumers. The CFPB is also authorized to prescribe rules applicable to any covered person or service provider, identifying and prohibiting acts or practices that are “unfair, deceptive, or abusive” in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service. The ongoing broad rulemaking powers of the CFPB have potential to have a significant impact on the operations of financial institutions offering consumer financial products or services.
A successful regulatory challenge to an institution’s performance under fair lending laws or regulations, or other consumer lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have an adverse effect on our business, financial condition and results of operations.
Federal, state and local consumer lending laws may restrict our ability to originate certain mortgage loans or increase our risk of liability with respect to such loans and could increase our cost of doing business.
Federal, state and local laws have been adopted that are intended to eliminate certain lending practices considered “predatory.” These laws prohibit practices such as steering borrowers away from more affordable
products, selling unnecessary insurance to borrowers, repeatedly refinancing loans and making loans without a reasonable expectation that the borrowers will be able to repay the loans irrespective of the value of the underlying property. It is our policy not to make predatory loans, but these laws create the potential for liability with respect to our lending activities. They increase our cost of doing business and, ultimately, may prevent us from making certain loans and cause us to reduce the average percentage rate or the points and fees on loans that we do make.
The expanding body of federal, state and local regulations and/or the licensing of loan servicing, collections or other aspects of our business and our sales of loans to third parties may increase the cost of compliance and the risks of noncompliance and subject us to litigation.
We service most of our own loans, and loan servicing is subject to extensive regulation by federal, state and local governmental authorities, as well as various laws and judicial and administrative decisions imposing requirements and restrictions on those activities. The volume of new or modified laws and regulations has increased in recent years and, in addition, some individual municipalities have begun to enact laws that restrict loan servicing activities, including delaying or temporarily preventing foreclosures or forcing the modification of certain mortgages. If regulators impose new or more restrictive requirements, we may incur additional significant costs to comply with such requirements, which may further adversely affect us. In addition, were we to be subject to regulatory investigation or regulatory action regarding our loan modification and foreclosure practices, our business, financial condition and results of operations could be adversely affected.
Our failure to comply with applicable laws and regulations could possibly lead to: civil and criminal liability; loss of licensure; damage to our reputation in the industry; fines and penalties and litigation, including class action lawsuits; and administrative enforcement actions. Any of these outcomes could adversely affect us.
The Federal Reserve may require us to commit capital resources to support the Bank.
The Federal Reserve requires a bank holding company to act as a source of financial and managerial strength to its subsidiary banks and to commit resources to support its subsidiary banks. Under the “source of strength” doctrine that was codified by the Dodd-Frank Act, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank at times when the bank holding company may not otherwise be inclined to do so and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. Under the prompt corrective action regime, if the Bank were to become undercapitalized, we would be required to guarantee the Bank’s plan to restore its capital subject to certain limits. See “Item 1. Business-Regulation and Supervision-Bank Regulation and Supervision-Prompt Corrective Action.” Accordingly, we could be required to provide financial assistance to the Bank if it experiences financial distress.
A capital injection may be required at a time when our resources are limited, and we may be required to borrow the funds or raise capital to make the required capital injection. Any loan by a bank holding company to its subsidiary bank is subordinate in right of payment to deposits and certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the holding company’s general unsecured creditors, including the holders of any note obligations. Thus, any borrowing by a bank holding company for the purpose of making a capital injection to a subsidiary bank often becomes more difficult and expensive relative to other corporate borrowings.
We could be adversely affected by the soundness of other financial institutions.
Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when our collateral cannot be foreclosed upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due. Any such losses could adversely affect our business, financial condition and results of operations.
General Risk Factors
We could be adversely affected by the recent election and change in administration.
There is uncertainty surrounding the results of the recent election and change in administration, and how it may impact the economy, interest rates, trade, taxes, consumer spending and regulations. The uncertainty surrounding the impact of the change in administration could significantly affect the markets in which we do business. The impact to costs, profitability, loan delinquencies and value of our investments could all be impacted.
National and global economic and other conditions could adversely affect our future results of operations or market price of our stock.
Our business is directly impacted by factors such as economic, political and market conditions, broad trends in industry and finance, changes in government monetary and fiscal policies and inflation, foreign policy, and financial market volatility, all of which are beyond our control. Global economies continue to face significant challenges to achieving normalized economic growth rates and there are continuing concerns related to the level of U.S. government debt and fiscal actions that may be taken to address that debt. There can be no assurance that economic conditions will continue to improve, and these conditions could worsen. Any deterioration in the economies of the nation as a whole or in our markets would have an adverse effect, which could be material, on our business, financial condition, results of operations and could also cause the market price of our stock to decline. While it is impossible to predict how long challenging economic conditions may exist, a slow or fragile recovery could continue to present risks into the future for the industry and our company. Uncertainties regarding the potential for a renegotiation of international trade agreements under the newly elected administration, and the impact such actions and other policies of the current administration may have on economic and market conditions. In addition, concerns about the performance of international economies, especially in Europe and emerging markets, and economic conditions in Asia, particularly the economies of China, South Korea and Japan, can impact the economy and financial markets here in the United States. If the national, regional and local economies experience worsening economic conditions, including high levels of unemployment, our growth and profitability could be constrained. Weak economic conditions are characterized by, among other indicators, deflation, elevated levels of unemployment, fluctuations in debt and equity capital markets, increased delinquencies on mortgage, commercial and consumer loans, residential and commercial real estate price declines, and lower home sales and commercial activity. Further, our business could be adversely affected by the effects of a widespread outbreak of epidemic illness in the human population. All of these factors are generally detrimental to our business. Our business is significantly affected by monetary and other regulatory policies of the U.S. federal government, its agencies and government-sponsored entities. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our control, are difficult to predict and could have an adverse effect on our business, financial condition and results of operations.
We are subject to certain risks in connection with growing through mergers and acquisitions.
It is possible that we could acquire other banking institutions, other financial services companies or branches of banks in the future. Acquisitions typically involve the payment of a premium over book and trading values and, therefore, may result in the dilution of our tangible book value per share and/or our earnings per share. Our ability to engage in future mergers and acquisitions depends on various factors, including: (1) our ability to identify suitable merger partners and acquisition opportunities; (2) our ability to finance and complete transactions on acceptable terms and at acceptable prices; and (3) our ability to receive the necessary regulatory and, when required, shareholder approvals. Our inability to engage in an acquisition or merger for any of these reasons could have an adverse impact on the implementation of our business strategies. Furthermore, mergers and acquisitions involve a number of risks and challenges, including our ability to achieve planned synergies and to integrate the branches and operations we acquire, and the internal controls and regulatory functions into our current operations, as well as the diversion of management’s attention from existing operations, which may adversely affect our ability to successfully conduct our business and negatively impact our financial condition and results of operations.
We must keep pace with technological change to remain competitive.
Financial products and services have become increasingly technology-driven. Our ability to meet the needs of our customers competitively, and in a cost-efficient manner, is dependent on the ability to keep pace with
technological advances and to invest in new technology as it becomes available, as well as related essential personnel. In addition, technology has lowered barriers to entry into the financial services market and made it possible for financial technology companies and other non-bank entities to offer financial products and services traditionally provided by banks. The ability to keep pace with technological change is important, and the failure to do so, due to cost, proficiency or otherwise, could have an adverse impact on our business, financial condition and results of operations.
Negative public opinion regarding our company or failure to maintain our reputation in the communities we serve could adversely affect our business, financial condition and results of operations and prevent us from growing our business.
As a community bank, our reputation within the communities we serve is critical to our success. We believe we have set ourselves apart from our competitors by building strong personal and professional relationships with our customers and being active members of the communities we serve. As such, we strive to enhance our reputation by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve and delivering superior service to our customers. If our reputation is negatively affected by the actions of our employees or otherwise, we may be less successful in attracting new talent and customers or may lose existing customers, and our business, financial condition and results of operations could be adversely affected. Further, negative public opinion can expose us to litigation and regulatory action and delay and impede our efforts to implement our expansion strategy, which could further adversely affect our business, financial condition and results of operations.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
Item 1B. Unresolved Staff Comments
None.

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ITEM 2. PROPERTIES
Item 2. Properties
Our corporate headquarters is located at 5415 Evergreen Way, Everett, WA 98203. In addition to our corporate headquarters, which includes our Evergreen branch, we operated 14 other branch offices as of December 31, 2020. We own our corporate headquarters and four of our other branch offices and lease the remainder of our branch offices. The leases, excluding renewal periods, on our branch offices expire in 2021 through 2030. We believe that these facilities and additional or alternative space available to us are adequate to meet our needs for the foreseeable future.

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ITEM 3. LEGAL PROCEEDINGS
Item 3. 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.

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ITEM 4. MINE SAFETY DISCLOSURE
Item 4. Mine Safety Disclosures
Not applicable.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s common stock, no par value per share, is traded on the Nasdaq Global Select Market under the symbol “CCB.” On December 31, 2020, there were 384 holders of record of the Company’s common stock.
Holders of our common stock are only entitled to receive dividends when, as and if declared by our board of directors out of funds legally available for dividends. We have not historically declared or paid dividends on our common stock and we do not intend to declare or pay dividends on our common stock in the near-term. Instead, we anticipate that all of our future earnings will be retained to support our operations and to finance the growth and development of our business. Any future determination to pay dividends will be made by our board of directors and will depend on a number of factors, including:
•
our historic and projected financial condition, liquidity and results of operations;
•
our capital levels and needs;
•
tax considerations;
•
any acquisitions or potential acquisitions that we may pursue;
•
statutory and regulatory prohibitions and other limitations;
•
the terms of any credit agreements or other borrowing arrangements that restrict our ability to pay cash dividends;
•
general economic conditions; and
•
other factors that our board of directors may deem relevant.
We are not obligated to pay dividends on our common stock and are subject to certain restrictions on paying dividends on our common stock.
As a Washington corporation, we are subject to certain restrictions on distributions to shareholders under the Washington Business Corporation Act. Generally, a Washington corporation is prohibited from making a distribution to shareholders if, after giving effect to the distribution, the corporation would not be able to pay its liabilities as they become due in the usual course of business or the corporation’s total assets would be less than the sum of its total liabilities plus, unless its articles of incorporation provide otherwise, the amount that would be needed, if the corporation were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. In addition, if required payments on our outstanding junior subordinated debentures are not made or suspended, we may be prohibited from paying dividends on our common stock. We are also subject to certain restrictions on our right to pay dividends on our capital stock in the event we have failed to make any required payment of interest or principal under the terms of our subordinated note.
We are subject to certain restrictions on the payment of cash dividends as a result of banking laws, regulations and policies. Because we are a bank holding company and do not engage directly in business activities of a material nature, our ability to pay dividends on our common stock depends, in large part, upon our receipt of dividends from the Bank, which is also subject to numerous limitations on the payment of dividends under federal and state banking laws, regulations and policies. See “Item 1. Business-Regulation and Supervision-Bank Holding Company Regulation-Dividends.” The present and future dividend policy of the Bank is subject to the discretion of its board of directors. The Bank is not obligated to pay us dividends.
Purchases of Equity Securities
The Company did not purchase any shares of its common stock during the year ended December 31, 2020.

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ITEM 6. SELECTED FINANCIAL DATA
Item 6. Selected Financial Data
The following table sets forth selected historical consolidated financial data as of and for the years ended December 31, 2020, 2019, 2018, 2017 and 2016. The selected balance sheet data as of December 31, 2020 and 2019, and the selected statement of income data for the years ended December 31, 2020 and 2019, have been derived from our audited consolidated financial statements included elsewhere in this Report on Form 10-K. The selected balance sheet data as of December 31, 2018, 2017 and 2016 and the selected statement of income data for the years ended December 31, 2018, 2017 and 2016 have been derived from our audited consolidated financial statements that are not included in this Report on Form 10-K. Our historical results are not necessarily indicative of any future performance. The information presented in the following table has been adjusted to give effect to a one-for-five reverse stock split of our common shares completed effective May 4, 2018. The effect of the reverse stock split on outstanding shares and per share figures has been retroactively applied to all periods presented. This data should be read in conjunction with, and is qualified by reference to, "Item 7 - Management's Discussion and Analysis of Financial Condition and Operations" and our consolidated financial statements and notes thereto contained elsewhere in this Annual Report on Form 10-K.
The selected historical consolidated financial data presented below contains financial measures that are not presented in accordance with GAAP and have not been audited. See “Item 7. Management's Discussion and Analysis of Financial Condition and Operations - GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”
As of or for the Year Ended December 31,
(Dollars in thousands, except per share data)
Statement of Income Data:
Total interest income
$
63,038
$
48,587
$
38,743
$
32,113
$
28,460
Total interest expense
5,652
6,576
3,926
2,875
2,523
Provision for loan losses
8,308
2,544
1,826
1,919
Net interest income after provision for loan losses
49,078
39,467
32,991
28,368
24,018
Total noninterest income
8,182
8,258
5,467
4,154
4,977
Total noninterest expense
38,119
31,063
26,216
22,433
21,538
Provision for income taxes
3,995
3,461
2,541
4,653
2,454
Net income
15,146
13,201
9,701
5,436
5,003
Adjusted net income (1)
15,146
13,201
9,701
6,731
5,003
Balance Sheet Data:
Cash and due from banks
163,117
127,814
125,782
89,751
86,975
Investment securities
23,247
32,710
37,922
38,336
34,994
Loans
1,547,138
939,103
767,899
656,788
596,128
Allowance for loan losses
19,262
11,470
9,407
8,017
7,544
Total assets
1,766,122
1,128,526
952,110
805,753
740,611
Interest-bearing deposits
829,046
596,716
510,089
460,937
424,707
Noninterest-bearing deposits
592,261
371,243
293,525
242,358
223,955
Total deposits
1,421,307
967,959
803,614
703,295
648,662
Total borrowings
192,292
23,562
33,546
33,529
28,513
Total shareholders’ equity
140,217
124,173
109,156
65,711
59,897
Share and Per Share Data: (2)
Earnings per share-basic
1.27
1.11
0.93
0.59
0.54
Earnings per share-diluted
1.24
1.08
0.91
0.59
0.54
Adjusted earnings per share-diluted (1)
1.24
1.08
0.91
0.73
0.54
Dividends per share
-
-
-
-
-
Book value per share (3)
11.73
10.42
9.18
7.11
6.48
Tangible book value per share (4)
11.73
10.42
9.18
7.11
6.48
Weighted average common shares outstanding-basic
11,920,735
11,896,258
10,440,740
9,232,398
9,226,204
Weighted average common shares
outstanding-diluted
12,209,371
12,196,120
10,608,764
9,237,629
9,227,216
Shares outstanding at end of period
11,954,327
11,913,885
11,893,203
9,248,901
9,238,788
Performance Ratios:
Return on average assets (ROAA)
0.98
%
1.28
%
1.14
%
0.73
%
0.76
%
Pre-tax, pre-provision ROAA (1)
1.78
%
1.86
%
1.66
%
1.46
%
1.43
%
Adjusted ROAA (1)
0.98
%
1.28
%
1.14
%
0.90
%
0.76
%
Return on average shareholders’ equity
11.44
%
11.29
%
11.40
%
8.27
%
8.56
%
Adjusted return on average shareholders’ equity (1)
11.44
%
11.29
%
11.40
%
10.24
%
8.56
%
Yield on earnings assets
4.21
%
4.90
%
4.72
%
4.48
%
4.53
%
Yield on loans
4.64
%
5.38
%
5.18
%
4.98
%
5.16
%
Cost of funds
0.40
%
0.73
%
0.52
%
0.42
%
0.42
%
Cost of deposits
0.35
%
0.65
%
0.42
%
0.32
%
0.36
%
Cost of interest bearing deposits
0.59
%
1.03
%
0.66
%
0.50
%
0.55
%
Net interest margin
3.83
%
4.23
%
4.24
%
4.08
%
4.13
%
Noninterest expense to average assets
2.47
%
3.01
%
3.09
%
3.00
%
3.28
%
Efficiency ratio (5)
58.14
%
61.79
%
65.08
%
67.18
%
69.67
%
Loans receivable to deposits
108.85
%
97.02
%
95.56
%
93.40
%
91.90
%
Credit Quality Ratios:
Nonperforming assets to total assets
0.04
%
0.09
%
0.19
%
0.26
%
1.11
%
Nonperforming assets to total loans receivable
and OREO
0.05
%
0.11
%
0.24
%
0.32
%
1.38
%
Nonperforming loans to total loans
0.05
%
0.11
%
0.24
%
0.32
%
0.27
%
Allowance for loan losses to nonperforming loans
2705.34
%
1113.60
%
515.17
%
378.16
%
468.28
%
Allowance for loan losses to total loans receivable
1.25
%
1.22
%
1.23
%
1.22
%
1.27
%
Net charge-offs to average loans
0.04
%
0.06
%
0.06
%
0.06
%
0.07
%
As of or for the Year Ended
December 31,
Capital Ratios :
Total shareholders’ equity to total assets
7.94
%
11.00
%
11.46
%
8.16
%
8.09
%
Tangible equity to tangible assets (6)
7.94
%
11.00
%
11.46
%
8.16
%
8.09
%
Tier 1 leverage ratio (7)
9.29
%
11.22
%
11.35
%
9.94
%
10.11
%
Common equity Tier 1 capital ratio (7)
11.86
%
12.43
%
12.84
%
11.67
%
11.60
%
Tier 1 risk-based capital ratio (7)
11.86
%
12.43
%
12.84
%
11.67
%
11.60
%
Total risk-based capital ratio (7)
13.11
%
13.63
%
14.05
%
12.90
%
12.85
%
(1) These are non-GAAP financial measures. See our reconciliation of non-GAAP financial measures to their most directly comparable GAAP financial measures in Item 7. Management's Discussion and Analysis of Financial Condition and Operations under the caption “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”
(2) Share and per share amounts are based on total common shares outstanding, which includes common stock and nonvoting common stock. There was no nonvoting common stock at December 31, 2020, 2019 and 2018.
(3) We calculate book value per share as total shareholders’ equity at the end of the relevant period divided by the outstanding number of our common shares, which includes common stock and any nonvoting common stock, at the end of each period.
(4) Tangible book value per share is total shareholders’ equity at the end of the relevant period, less goodwill and other intangible assets, divided by the outstanding number of our common shares at the end of each period. The most directly comparable GAAP financial measure is book value per share. We had no goodwill or other intangible assets as of any of the dates indicated. As a result, tangible book value per share is the same as book value per share as of each of the dates indicated.
(5) Efficiency ratio represents noninterest expense divided by the sum of net interest income and noninterest income.
(6) Tangible equity to tangible assets is common equity less goodwill and other intangible assets, divided by total assets less goodwill and other intangible assets. The most directly comparable GAAP financial measure is total shareholders' equity to total assets. We had no goodwill or other intangible assets as of any of the dates indicated. As a result tangible equity to tangible assets is the same as total shareholders' equity to total assets.
(7) These capital ratios are for the Bank.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
Item 7. 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. We focus 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. We currently operate 15 full-service banking locations, 12 of which are located in Snohomish County, where we are the largest community bank by deposit market share, and three of which are located in neighboring counties (one in King County and two in Island County). The Bank announced the sale of its Freeland Branch (Island County) in February 2021. The Bank also provides banking as a service (BaaS), through our CCBX division, that allows broker-dealer and digital financial service providers to offer their customers banking services and we expect to introduce a digital bank offering, through our CCDB division, in collaboration with Google in 2021 or early 2022. As of December 31, 2020, we had total assets of $1.77 billion, total gross loans of $1.55 billion, total deposits of $1.42 billion and total shareholders’ equity of $140.2 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. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and the accompanying notes presented elsewhere in this Annual Report on Form 10-K.
As a bank holding company that operates through one segment, community banking, we generate most of our revenue from interest on loans and investments. Our primary source of funding for our loans is commercial and retail deposits from our customer relationships. We place secondary reliance on wholesale funding, primarily borrowings from the Federal Home Loan Bank (FHLB). We are utilizing the Paycheck Protection Program Liquidity Facility (PPPLF), which provides an additional source of low cost funding for the Paycheck Protection Program (PPP) loans, with a contractual interest rate of 0.35%. The PPPLF borrowings are collateralized by PPP loans and must be paid down as the PPP loans are forgiven or paid down by customers. 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 provision for loan losses, salaries and related employee benefits, interest on deposits and borrowings, occupancy and data processing. Our principal lending products are commercial real estate loans, commercial and industrial loans, residential real estate loans, construction, land and land development loans, and to a lesser extent consumer loans.
CARES Act
On March 27, 2020, the 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 PPP, which is a stimulus response to the potential economic impacts of COVID-19, and its purpose is to provide forgivable loans to smaller businesses that use the proceeds of the loans for payroll and certain other qualifying expenses. The Small Business Administration (SBA) manages and backs the PPP. If a loan is fully forgiven, the SBA will repay the lending bank in full. If a loan is partially forgiven or not forgiven at all, a bank must look to the borrower for repayment of unforgiven principal and interest. If the borrower defaults, the loan is guaranteed by the SBA. The PPP program closed to new loan applicants on August 8, 2020. We accepted and processed requests for existing and new customers for the duration of the program, and recently began accepting and processing applications for round three, which opened for applications on January 19, 2021. As of March 8, 2021, we have funded $259.3 million, representing 1,867 customers, in this latest round of PPP loans, consisting of $16.6 million in new PPP applications for first draws and $242.7 million in a second draw for small businesses that previously received PPP funds. Net deferred fees on these loans total $10.1 million and will be recognized in interest income in future periods. Round
three PPP loans have a maturity of five years. Loan payments will be deferred for borrowers who apply for loan forgiveness until SBA remits the borrower's loan forgiveness amount to the lender. If a borrower does not apply for loan forgiveness, payments are deferred 10 months after the end of the covered period for the borrower’s loan forgiveness (either 8 weeks or 24 weeks).
We are accepting applications from customers for loan forgiveness and as of March 8, 2021 we have received $180.8 million in forgiveness or principal paydowns. In order to obtain loan forgiveness, a PPP borrower must submit a forgiveness application to us, which we must review and forward to the SBA. We expect that the pace of forgiveness of PPP loans will increase in the first half of 2021. The initial payment deferral period on PPP loans was extended and customers with two-year loans can work with their lender to extend to a five year maturity, which we anticipate could be a popular option for customers not eligible for forgiveness.
The Company's Preparations and Responses to COVID-19 Pandemic
As part of its ongoing risk preparation and mitigation efforts, the Company had developed a detailed plan and action measures related to a possible pandemic scenario. This pandemic plan was implemented on March 12, 2020 and continued through the third quarter and into fourth quarter of 2020. The Company carefully executed the plan with limited operational disruptions, with attention to ensure continued customer support, and with the utmost care to safeguard employees, customers and vendors. Management continues to monitor and, when appropriate, make changes to our planned response. To date we have:
•
Continued to serve customers through drive throughs, call center, mobile banking, online banking and ATMs, and closed branches except for drive throughs and appointments.
•
Dispersed workforce throughout facilities in order to maximize social distancing protocols, including successful employment of remote work solutions for many employees.
•
Continued participation in the SBA PPP with funded loans outstanding of $365.8 million, as of December 31, 2020.
•
Actively engaged borrowers and other businesses in discussion to identify short-term cash flow and other financial needs, and restructured payments on existing loans to alleviate financial hardship per regulatory guidance. As of December 31, 2020, $9.3 million, or 3 loans, remain on deferred or modified payment status.
•
Pledged 703 PPP loans, or $153.7 million as of December 31, 2020, which provides an additional source of funding for the PPP loans, through the PPPLF. The borrowings must be paid down as PPP loan amounts are forgiven or when the customers pay their loans down. PPPLF is a low cost source of funding and liquidity for PPP loans, with an interest rate of 0.35%, and favorable capital treatment.
•
Enhanced credit monitoring on loan segments that have been most impacted by COVID-19, monitoring and tracking loan payment deferrals and customer liquidity.
•
As of December 31, 2020, all of Washington State was in Phase 1 of Washington State’s Healthy Washington - Roadmap to Recovery. During the first quarter of 2021, the majority of Washington State, including Snohomish County, moved to Phase 2, which provides:
o
Indoor gatherings of no more than 5 people outside one’s household, limit of two households
o
Outdoor gatherings of no more than 15 people outside one’s household, limit two households
o
Opens certain businesses with social distancing and capacity restrictions
o
Professionals services -remote work strongly encouraged, 25% capacity otherwise
•
Refreshed and analyzed the Company's liquidity, funding and capital stress forecasts and risk assumptions.
PPP Overview
Throughout 2020, significant focus was placed on helping the small businesses in our communities through the PPP. These loans have had a significant impact on our financial statements for the year ended December 31, 2020 and will continue to impact our results in the future. Throughout this discussion, we will address the impact of these loans, including borrowings received through PPPLF to help fund these loans and to aid in liquidity, increased customer deposit accounts from unused disbursements, and earnings and expenses related to these activities. Any estimated adjusted ratios that exclude the impact of this activity are non-GAAP measures. For more information about non-GAAP financial measures, see the non-GAAP disclosure “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”
Key Factors Affecting our Business
Average Balances and Interest Rates
Our operating results depend primarily on our net interest income, which is the largest contributor to our net income and is the difference between the interest and fees earned on interest-earning assets (such as loans and securities) and the interest expense incurred in connection with interest-bearing liabilities (such as deposits and borrowings). Net interest income is primarily a function of the average balances of interest-earning assets and interest-bearing liabilities and the yields and costs with respect to these assets and liabilities. Average balances are influenced by internal considerations such as the types of products we offer and the amount of risk that we are willing to assume as well as external influences such as economic conditions, competition for loans and deposits, and interest rates. The yields generated by our loans and securities are typically affected by short-term and long-term interest rates and, in the case of loans, competition for similar products in our market area. Interest rates are often impacted by the actions of the Federal Reserve. The cost of our deposits and short-term borrowings is primarily based on short-term interest rates, which are largely driven by competition and by the actions of the Federal Reserve. The level of net interest income is influenced by movements in interest rates and the pace at which such movements occur, as well as the relationship between short- and long-term interest rates.
Credit Quality
We have well established loan policies and underwriting practices that have resulted in low levels of charge-offs and nonperforming assets. Through our thorough underwriting process, we strive to originate quality loans that will maintain and enhance the overall credit quality of our loan portfolio, and through our careful monitoring of our loan portfolio and prompt attention to delinquencies, we seek to minimize the impact of problem loans. However, credit trends in the markets in which we operate are largely impacted by economic conditions beyond our control and can adversely impact our financial condition.
Operating Efficiency
The largest component of noninterest expense is salaries and employee benefits. Other significant operating expenses include occupancy expense, data processing expense, director and staff expense, marketing expense, and legal and professional fees. Our operating efficiency, as measured by our efficiency ratio, has gradually improved primarily because the growth of our deposits and loans has enabled our net interest income and noninterest income to outpace the growth of our expenses. When we make substantial investments in the infrastructure of new divisions, open new branches or make investments to increase our operating capacity, our operating efficiency decreases until we generate enough revenue growth to offset the increased costs however, prior to making such investments, we focus on how best and most expediently we can achieve the revenue growth necessary to offset the costs of these investments or new branches.
Economic Conditions
Our business and financial performance are affected by economic conditions generally in the United States and more directly in the markets in the Puget Sound region where we operate. The significant economic factors that are most relevant to our business and our financial performance include, but are not limited to, real estate values,
interest rates and unemployment rates. In recent years, the Puget Sound region has experienced significant population gain, fueled in large part by the region’s technology industry, low unemployment and rising real estate values, all of which positively impacted our business. The economic effects of the COVID-19 pandemic have had a destabilizing effect on financial markets, key market indices and overall economic activity. The uncertainty regarding the duration of the pandemic and the resulting economic disruption has caused increased market volatility and may lead to an economic recession and/or a significant decrease in consumer confidence and business generally.
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 to our consolidated financial statements included elsewhere in this Report on Form 10-K. We believe that of our accounting policies, the following accounting policies may involve a higher degree of judgment and complexity:
Securities
Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value. Unrealized gains and losses are excluded from earnings and reported in other comprehensive income. Securities within the available for sale portfolio may be used as part of our asset/liability strategy and may be pledged or sold in response to changes in interest rate risk, prepayment risk or other similar economic factors. Securities held to maturity are carried at cost, adjusted for the amortization of premiums and the accretion of discounts and may be pledged.
Interest earned on these assets is included in interest income. Interest income includes amortization of any purchase premium or discount. Premiums and discounts on securities are amortized using the level-yield method, except for mortgage backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Management evaluates debt securities for other-than-temporary impairment (OTTI), on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: (1) OTTI related to credit loss, which must be recognized in the income statement, and (2) OTTI related to other factors, which is recognized in other comprehensive income, net of applicable taxes. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the security.
Loans Held for Investment
Loans held for investment are those that management has the intent and ability to hold for the foreseeable future or until maturity or payoff at the principal and interest balance outstanding, net of deferred loan fees and costs. Loans are typically secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. Interest income is accrued on the unpaid principal balance. Loan origination fees and certain direct origination costs are deferred and recognized as adjustments to interest income using a level yield methodology or a method approximating the level yield methodology.
Allowance for Loan Losses
The allowance for loan losses represents management’s estimate of probable and reasonably estimable credit losses inherent in the loan portfolio. In determining the allowance, the Company estimates losses on individual impaired loans, or groups of loans which are not impaired, where the probable loss can be identified and reasonably estimated. On a quarterly basis, the Company assesses the risk inherent in the Company’s loan portfolio based on qualitative and quantitative trends in the portfolio, including the internal risk classification of loans, historical loss rates, changes in the nature and volume of the loan portfolio, industry or borrower concentrations, delinquency trends, detailed reviews of significant loans with identified weaknesses and the impacts of local, regional and national economic factors on the quality of the loan portfolio. Based on this analysis, the Company records a provision for loan losses to maintain the allowance at appropriate levels.
Determining the amount of the allowance is considered a critical accounting estimate, as it requires significant judgment and the use of subjective measurements, including management’s assessment of overall portfolio quality. The Company maintains the allowance at an amount the Company believes is sufficient to provide for estimated losses inherent in the Company’s loan portfolio at each balance sheet date, and fluctuations in the provision for loan losses may result from management’s assessment of the adequacy of the allowance. Changes in these estimates and assumptions are possible and may have a material impact on the Company’s allowance, and therefore the Company’s financial position, liquidity or results of operations.
Stock-based Compensation
We grant stock options and restricted stock to our employees and directors. We record the related compensation expense based on the grant date fair value calculated in accordance with the authoritative guidance issued by FASB. We recognize these compensation costs on a straight-line basis over the requisite service period of the award. We estimate the grant date fair value of stock options using the Black-Scholes valuation model. Stock-based compensation expense related to awards of restricted stock is based on the fair value at the grant date.
The determination of fair value using the Black-Scholes model is affected by the price of our common stock, as well as the input of other subjective assumptions. These assumptions include, but are not limited to, the expected term of stock options and our stock price volatility. As there has been no public market for our common stock prior to July 20, 2018, the estimated fair value of our common stock was determined by our board of directors as of the date of each option grant, with input from management, based on our board of directors’ assessment of objective and subjective factors that it believed were relevant. The factors considered by our board of directors included the prices of known transactions in our common stock, the book value per share of our common stock, and our board of directors’ understanding of pricing multiples for comparable financial institutions that were not publicly traded.
The assumptions underlying these valuations represented management’s best estimate, which involved inherent uncertainties and the application of management’s judgment. As a result, if we had used different assumptions or estimates, the fair value of our common stock and our stock-based compensation expense could have been materially different.
Emerging Growth Company
The JOBS Act permits an “emerging growth company” to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. However, we have decided not to take advantage of this provision. As a result, we will comply with new or revised accounting standards to the same extent that compliance is required for non-emerging growth companies. Our decision to opt out of the extended transition period under the JOBS Act is irrevocable.
Recent Pronouncements
For a discussion of the expected impact of accounting pronouncements recently adopted and accounting pronouncements recently issued but not yet adopted by us as of December 31, 2020, see Note 2 of our audited consolidated financial statements included elsewhere in this Report on Form 10-K.
Results of Operations
Net Income
Year Ended December 31, 2020, Compared to Year Ended December 31, 2019. Net income for the year ended December 31, 2020, was $15.1 million, or $1.24 per diluted share, compared to $13.2 million, or $1.08 per diluted share, for the year ended December 31, 2019. The increase in net income over the prior year was attributable to a $15.4 million increase in net interest income partially offset by an $7.1 million increase in noninterest expense and $5.8 million increase in provision for loan losses.
Year Ended December 31, 2019, Compared to Year Ended December 31, 2018. Net income for the year ended December 31, 2019, was $13.2 million, or $1.08 per diluted share, compared to $9.7 million, or $0.91 per diluted share, for the year ended December 31, 2018. The increase in net income over the prior year was attributable to a $7.2 million increase in net interest income and a $2.8 million increase in noninterest income, which were partially offset by an $4.8 million increase in noninterest expense, $920,000 increase in provision for income taxes and $718,000 increase in provision for loan losses.
Net Interest Income
Year Ended December 31, 2020, Compared to Year Ended December 31, 2019. Net interest income for the year ended December 31, 2020, was $57.4 million compared to $42.0 million for the year ended December 31, 2019, an increase of $15.4 million, or 36.6%. The increase in net interest income consisted of a $14.5 million, or 29.7%, increase in interest income combined with a $924,000, or 14.1%, decrease in interest expense.
The increase is largely related to increased interest income resulting from loan growth, the recognition of deferred fees on PPP loans, including forgiven and paid off loans, and the additional $398,000 in interest and fee income recognized on MSLP loans. Interest and fees on loans increased $16.6 million, or 36.5%, over the prior year period, despite a decrease in yield on loans receivable of 0.74% for the year ended December 31, 2020, compared to the year ended December 31, 2019. Non-PPP loan growth of $248.0 million, which includes CCBX loan growth of $65.3 million, for the year ended December 31, 2020 contributed to this increase. Also contributing to the increase is PPP loans, which had an average balance of $302.7 million, and contributed $3.0 million from the 1% interest rate and $7.2 million in fees recognized, for a total of $10.2 million in interest income on PPP loans for the year ended December 31, 2020. Interest and fee income of $398,000 on MSLP loans also contributed to the increase, for the year ended December 31, 2020, compared to no income on MSLP loans for the year ended December 31, 2019. Net deferred fees on PPP loans are earned over the life of the loan, as a yield adjustment in interest income. Forgiveness of principal, early paydowns and payoffs on PPP loans will increase interest income earned in those periods from the recognition of PPP net deferred fees. As of December 31, 2020, $5.8 million in net deferred fees on PPP loans remained to be recognized. Interest income from interest earning deposits with other banks decreased $1.8 million, or 72.6%, to $663,000 for the year ended December 31, 2020, compared to $2.4 million for the year ended December 31, 2019, as a result of lower interest rates.
The table below summarizes key information regarding the PPP loans as of the period indicated:
Loan Size
As of December 31, 2020
$0.00 -
$50,000.00
$50,0000.01 -
$150,000.00
$150,000.01 -
$350,000.00
$350,000.01 -
$2,000,000.00
> 2,000,000.00
Totals
(Dollars in thousands; unaudited)
Principal outstanding:
Existing customer
$
9,399
$
22,614
$
17,211
$
55,821
$
52,299
$
157,344
New customer
18,324
30,325
34,206
64,591
61,052
208,498
Total principal
outstanding
27,723
52,939
51,417
120,412
113,351
365,842
Deferred fees outstanding
(906
)
(1,580
)
(1,538
)
(2,060
)
(631
)
(6,715
)
Deferred costs outstanding
Net deferred fees
$
(419
)
$
(1,372
)
$
(1,424
)
$
(1,974
)
$
(614
)
$
(5,803
)
Total principal, net of
deferred fees
$
27,304
$
51,567
$
49,993
$
118,438
$
112,737
$
360,039
Weighted average maturity
(years)
2.02
1.53
1.42
1.42
1.38
1.47
Number of loans:
Existing customer
New customer
1,006
1,620
Total loan count
1,440
2,488
Percent of total
57.9
%
24.4
%
9.7
%
6.7
%
1.3
%
100.0
%
Forgiveness/Payoffs/Paydowns in Quarter Ended December 31, 2020, net
Dollars
$
4,139
$
9,330
$
20,948
$
52,587
$
-
$
87,004
Deferred fee recognized
1,254
2,783
Interest expense decreased $924,000, or 14.1%, to $5.7 million for the year ended December 31, 2020 compared to $6.6 million for the year ended December 31, 2019. Lower interest rates resulted in a decrease in interest expense despite a $158.6 million increase in average interest bearing deposits and $144.0 million increase in average borrowings for the year ended December 31, 2020, compared to the prior year period. Borrowings included $124.1 million in average PPPLF borrowings, which were obtained to partially fund the PPP loans.
For the year ended December 31, 2020, net interest margin and interest rate spread were 3.83% and 3.57%, respectively, compared to 4.23% and 3.76% for the year ended December 31, 2019. The net interest margin and spread declined as a result of the lower yielding PPP loans and lower interest rate environment.
Year Ended December 31, 2019, Compared to Year Ended December 31, 2018. Net interest income for the year ended December 31, 2019, was $42.0 million compared to $34.8 million for the year ended December 31, 2018, an increase of $7.2 million, or 20.7%. The increase in net interest income consisted of a $9.8 million, or 25.4%, increase in interest income offset by a $2.7 million, or 67.5%, increase in interest expense.
The growth in interest income was primarily attributable to a $138.2 million, or 19.6%, increase in average loans outstanding for the year ended December 31, 2019, compared to the prior year, combined with a 20 basis point increase in the yield on total loans. The increase in average loans outstanding was primarily due to our dual strategies of focusing on deepening relationships with existing borrowers and actively calling on new customers. Also contributing to the increase in 2019 was $8.1 million in purchased participation loans. The hiring of new lending teams and lenders in 2018 contributed to loan growth in 2019 as those lenders were able to transition more customers and increase new customer relationships overall. The increase in the yield on total loans reflects the total 1.25% interest rate increases by the Federal Open Market Committee (FOMC) between December 2017 and December 2018, resulting in higher rates on new and renewing loans during that period, the benefit of which was reflected throughout 2019.
The increase in interest expense for the year ended December 31, 2019, was primarily related to a $87.5 million, or 18.3%, increase in average interest-bearing deposits over the prior year. The majority of this increase is attributable to growth in core deposit accounts, which we define as deposits excluding all brokered and time deposits. Noninterest bearing deposits (such as demand or checking accounts) grew $77.7 million, or 26.5%, in 2019. NOW (which are interest bearing checking accounts) and money market accounts grew $88.0 million, or 25.1%, and savings accounts increased $793,000, or 1.5%, in 2019. Non-core deposits decreased $2.1 million in 2019 with time deposits decreasing $15.2 million, or 15.7%, partially offset by an increase in BaaS brokered deposits of $13.1 million, or 124.2%, in 2019. We do not regularly advertise time deposit rates or money market rates, although we occasionally advertise promotional rates in targeted portions of our market area. Market conditions for deposits are competitive and the aforementioned rate increase by the FOMC in 2018 resulted in a 23 basis point increase in cost of deposits as of December 31, 2019 as compared to December 31, 2018.
For the year ended December 31, 2019, net interest margin and net interest spread were 4.23% and 3.76%, respectively, compared to 4.24% and 3.92% for the year ended December 31, 2018.
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 $9.1 million and $1.4 million for the years ended December 31, 2020 and 2019, respectively. Of the $9.1 million fees recognized in 2020, $7.2 million were from PPP loans. For the years ended December 31, 2020 and 2019, the amount of interest income not recognized on nonaccrual loans was not material.
Average Balance Sheets
For the Year Ended December 31,
Average
Interest &
Yield /
Average
Interest &
Yield /
Average
Interest &
Yield /
(Dollars in thousands)
Balance
Dividends
Cost
Balance
Dividends
Cost
Balance
Dividends
Cost
Assets
Interest earning assets:
Interest earning
deposits
$
133,951
$
0.49
%
$
107,916
$
2,423
2.25
%
$
73,330
$
1,432
1.95
%
Investment securities,
available for sale (1)
20,386
0.86
34,386
1.58
38,322
1.53
Investment securities,
held to maturity (1)
3,734
1.45
2,982
3.02
1,318
2.43
Other investments
5,608
4.19
3,545
5.05
3,022
5.16
Loans receivable (2)
1,333,028
61,910
4.64
843,450
45,350
5.38
705,292
36,537
5.18
Total interest earning
assets
1,496,707
63,038
4.21
992,279
48,587
4.90
821,284
38,743
4.72
Noninterest earning
assets:
Allowance for loan
losses
(14,686
)
(10,304
)
(8,657
)
Other noninterest
earning assets
58,970
49,998
36,631
Total assets
$
1,540,991
$
1,031,973
$
849,258
Liabilities and Shareholders’ Equity
Interest bearing liabilities:
Interest bearing
deposits
$
724,279
$
4,288
0.59
%
$
565,713
$
5,802
1.03
%
$
478,231
$
3,141
0.66
%
PPPLF borrowings
124,068
0.35
-
-
0.00
-
-
0.00
FHLB advances and other
borrowings
20,736
1.13
2.32
2,010
2.04
Subordinated debt
9,986
5.90
9,971
5.89
9,957
5.90
Junior subordinated
debentures
3,584
2.93
3,582
4.69
3,580
4.39
Total interest bearing
liabilities
882,653
5,652
0.64
580,085
6,576
1.13
493,778
3,926
0.80
Noninterest bearing
deposits
513,550
322,064
267,227
Other liabilities
12,445
12,944
3,154
Total shareholders' equity
132,343
116,880
85,099
Total liabilities and
shareholders' equity
$
1,540,991
$
1,031,973
$
849,258
Net interest income
$
57,386
$
42,011
$
34,817
Interest rate spread
3.57
%
3.76
%
3.92
%
Net interest margin (3)
3.83
%
4.23
%
4.24
%
(1) 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.
(2) Includes nonaccrual loans.
(3) Net interest margin represents net interest income divided by the average total interest earning assets.
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. For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to volume.
Year Ended December 31, 2020
Compared to
Year Ended December 31, 2019
Compared to
Year Ended December 31, 2019
Year Ended December 31, 2018
Increase (Decrease)
Total
Increase (Decrease)
Total
Due to
Increase
Due to
Increase
(Dollars in thousands)
Volume
Rate
(Decrease)
Volume
Rate
(Decrease)
Interest income:
Interest earning deposits
$
$
(1,894
)
$
(1,760
)
$
$
$
Investment securities, available for sale
(120
)
(249
)
(369
)
(62
)
(41
)
Investment securities, held to maturity
(47
)
(36
)
Other investments
(31
)
(3
)
Loans receivable
22,754
(6,194
)
16,560
7,428
1,385
8,813
Total increase in interest income
22,866
(8,415
)
14,451
8,219
1,625
9,844
Interest expense:
Interest bearing deposits
(2,459
)
(1,514
)
1,764
2,661
PPPLF borrowings
-
-
-
-
FHLB advances and other borrowings
(10
)
(28
)
(22
)
Subordinated debt
-
(1
)
-
Junior subordinated debentures
-
(63
)
(63
)
-
Total increase in interest expense
1,606
(2,530
)
(924
)
1,780
2,650
Increase in net interest income
$
21,260
$
(5,885
)
$
15,375
$
7,349
$
(155
)
$
7,194
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 is deemed appropriate by management 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 “Item 7. Management’s Discussion and Analysis of Financial Condition and Operations-Financial Condition-Allowance for Loan Losses.”
Year Ended December 31, 2020, Compared to Year Ended December 31, 2019. The provision for loan losses for the year ended December 31, 2020, was $8.3 million compared to $2.5 million for the year ended December 31, 2019. The increase of $5.8 million was primarily related to an increase in qualitative factors related to the economic uncertainties caused by the COVID-19 pandemic and loan growth. The Company is not required to implement the provisions of the Current Expected Credit Loss accounting standard until January 1, 2023 and will continue to account for the allowance for credit losses under the incurred loss model. Gross loans totaled $1.55 billion in 2020 compared to $939.1 million in 2019 and grew $608.0 million in 2020. Included in the loan growth for 2020 is $365.8 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 1.25% at December 31, 2020, compared to 1.22% at December 31, 2019. Excluding PPP loans, which are 100% guaranteed by the SBA, the allowance for loan losses as a percentage of loans was approximately 1.62% at December 31, 2020. A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”
Net charge-offs for the year ended December 31, 2020 totaled $516,000, or 0.04% of total average loans, as compared to net charge-offs of $481,000, or 0.06% of total average loans, for the year ended December 31, 2019. Net charge-offs were down slightly in 2020 compared to 2019 based on percent of average loans.
Year Ended December 31, 2019, Compared to Year Ended December 31, 2018. The provision for loan losses for the year ended December 31, 2019, was $2.5 million compared to $1.8 million for the year ended December 31, 2018. The increase of $718,000 was primarily due to gross loan growth. Gross loans totaled $939.1 million in 2019 compared to $767.9 million in 2018 and grew $171.2 million in 2019 compared to $111.1 million in 2018. The allowance for loan losses as a percentage of loans was 1.22% at December 31, 2019, compared to 1.23% at December 31, 2018.
Net charge-offs for the year ended December 31, 2019, totaled $481,000, or 0.06% of total average loans, as compared to net charge-offs of $436,000, or 0.06% of total average loans, for the year ended December 31, 2018. Net charge-offs for both years were consistent on a percentage basis.
Noninterest Income
Our primary sources of recurring noninterest income are deposit account service charges and fees, BaaS fees, loan referral fees, and mortgage broker fees. Noninterest income does not include loan origination fees to the extent they exceed the direct loan origination costs, which are generally recognized over the life of the related loan as an adjustment to yield using the interest method.
The following table presents, for the periods indicated, the major categories of noninterest income:
Year Ended
Year Ended
December 31,
Increase
Percent
December 31,
Increase
Percent
(Dollars in thousands)
(Decrease)
Change
(Decrease)
Change
Deposit service charges and fees
$
3,091
$
3,107
(16
)
(0.5
)%
$
3,107
$
3,061
1.5
%
BaaS fees
2,365
2,060
14.8
2,060
1,351
190.6
Loan referral fees
1,726
1,438
20.0
1,438
132.7
Mortgage broker fees
46.5
107.9
Sublease and lease income
110.3
(23
)
(28.4
)
Gain on sale of loans, net
(408
)
(83.3
)
85.6
Gain on sale of securities, net
-
(171
)
(100.0
)
-
NA
Other
(346
)
(71.0
)
(32
)
(6.2
)
Total noninterest income
$
8,182
$
8,258
$
(76
)
-0.9
%
$
8,258
$
5,467
$
2,791
51.1
%
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. Deposit service charges and fees were $3.1 million for the year ended December 31, 2020, a decrease of $16,000, or 0.5%, over the prior year. Most accounts within the category remained fairly flat, despite an increase in the number of accounts, due to reduced activity from individuals and businesses resulting from the COVID-19 pandemic restrictions. Point-of-sale fees increased by $148,000, and check printing fees were up $16,000. These positive variances were partially offset by a decrease of $146,000 in overdraft fees. Deposit service charges and fees were $3.1 million for the year ended December 31, 2019, an increase of $46,000, or 1.5%, over the prior year. Despite increases in most accounts within this category, income remained fairly flat for the year ended December 31, 2019 as compared to the year ended December 31, 2018 in part due to a change in the accounting for certain point-of-sale fees which reduced fee income by $211,000 for that product in the current period.
BaaS Fees. Our CCBX division provides BaaS offerings that enable our broker dealer and digital financial service partners 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 contract. For the year ended December 31, 2020, we earned $2.4 million in BaaS fees, which was an increase of $305,000, or 14.8%, over the year ended December 31, 2019, where we earned $2.1 million in BaaS fees. The increase was the result of increased relationships with broker dealers and digital financial service providers. For the year ended December 31, 2019, we earned $2.1 million in BaaS fees, which is an increase of $1.3 million, or 190.6%, over the year ended December 31, 2018, where we earned $709,000 in BaaS fees. The increase is the result of increased relationships with broker dealers and digital financial service providers. At December 31, 2020 there were six active CCBX relationships, two
CCBX relationship in friends and family trials, three CCBX relationships in onboarding/implementation, four signed letters of intent and a solid pipeline of potential new relationships. As more CCBX customers move to active status, we expect that BaaS fees will increase. The following table illustrates the activity and growth in CCBX for the periods indicated:
As of
December 31, 2020
December 31, 2019
Active
Friends and family
Implementation / onboarding
Signed letters of intent
Total CCBX relationships
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 the assuming the interest rate risk. Loan referral fees were $1.7 million for the year ended December 31, 2020, an increase of $288,000, or 20.0%, over the year ended December 31, 2019. Loan referral fees were $1.4 million for the year ended December 31, 2019, compared to $618,000 in the prior year, an increase of $820,000 or 132.7%. 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 recognize more or fewer, loan referral fees in some periods.
Mortgage Broker Fees. We earn mortgage broker fees for residential mortgage loans that we broker through mortgage lenders. Mortgage broker fees increased $208,000 for the year ended December 31, 2020 compared to the year ended December 31, 2019 as a result increased demand from lower mortgage interest rates which continue to make homes more affordable and mortgage refinancing an attractive option. Mortgage broker fees increased $232,000 for the year ended December 31, 2019 compared to the year ended December 31, 2018 as a result of higher demand and lower mortgage interest rates in our key markets, which increased the demand for new and refinanced mortgages.
Gain on Sale 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 USDA loans that we originate. This activity fluctuates based on SBA and USDA loan activity. Gain on sale of loans decreased $408,000, or 83.3%, for the year ended December 31, 2020, to $82,000. In the year ended December 31, 2020, our primary focus was on SBA PPP loans, therefore fewer SBA and USDA loans were originated and sold to the secondary market. Gain on sale of loans increased to $490,000 for the year ended December 31, 2019 from $264,000 for the year ended December 31, 2018, due to an increase in loans sold.
Gain on Sale of Securities, net. No gain on sale of securities was recognized in 2020. In the quarter ended September 30, 2019 we restructured our investment portfolio to improve the rate of return and reduce the weighted average maturity, interest rate risk and price risk on the portfolio. As a result of this restructuring we were able to recognize $171,000 in net gains on the securities sold during the year ended December 31, 2019.
Other. This category includes a variety of other income-producing activities, annuity broker fees, and SBA and USDA servicing fees. Other noninterest income decreased $346,000, or 71.0%, for the year ended December 31, 2020 compared to the year ended December 31, 2019 most significantly because of a $400,000 write-down on an equity investment. Other noninterest income decreased $32,000, or 6.2%, for the year ended December 31, 2019 compared to the year ended December 31, 2018 most significantly because of lower SBA servicing fees and lower annuity fees, as compared to the prior period. Other noninterest income was $487,000 for the year ended December 31, 2019 and $519,000 for the year ended December 31, 2018.
Noninterest Expense
Generally, noninterest expense includes all employee expenses and costs associated with operating our facilities, obtaining and retaining customer relationships, and providing bank services. The largest component of noninterest expense is salaries and employee benefits. Noninterest expense also includes operational expenses, such as occupancy expense, data processing expense, and legal and professional fees.
For the year ended December 31, 2020, noninterest expense totaled $38.1 million, an increase of $7.1 million, or 22.7%, compared to $31.1 million for the year ended December 31, 2019. For the year ended December 31, 2019, noninterest expense totaled $31.1 million, an increase of $4.9 million, or 18.5%, compared to $26.2 million for the year ended December 31, 2018.
The following table presents, for the periods indicated, the major categories of noninterest expense:
Year Ended
Year Ended
December 31,
Increase
Percent
December 31,
Increase
Percent
(Dollars in thousands)
(Decrease)
Change
(Decrease)
Change
Salaries and employee
benefits
$
23,302
$
18,959
$
4,343
22.9
%
$
18,959
$
16,026
$
2,933
18.3
%
Occupancy
3,977
3,775
5.4
3,775
3,314
13.9
Data processing
2,348
2,081
12.8
2,081
1,971
5.6
Legal and professional fees
1,762
1,103
59.7
1,103
62.9
Excise taxes
1,057
47.0
28.6
Director and staff expenses
1,000
(200
)
(20.0
)
1,000
42.7
FDIC assessments
183.7
(111
)
(37.6
)
Business development
(87
)
(20.2
)
32.2
Marketing and promotion
(76
)
(19.3
)
0.5
OREO and repossessed assets
operations, net
-
-
-
N/A
-
(2
)
100.0
Other
3,690
2,418
1,272
52.6
2,418
1,958
23.5
Total noninterest expense
$
38,119
$
31,063
$
7,056
22.7
%
$
31,063
$
26,216
$
4,847
18.5
%
Salaries and Employee Benefits. Salaries and employee benefits are the largest component of noninterest expense and include payroll expense, incentive compensation costs, benefit plans, health insurance and payroll taxes. Salaries and employee benefits were $23.3 million for the year ended December 31, 2020, an increase of $4.3 million, or 22.9%, compared to $19.0 million for the year ended December 31, 2019. The increase was primarily due to continued hiring staff for our BaaS division and additional staff for our ongoing banking related growth initiatives, including hiring staff for opening our Arlington branch in June 2020, as well as employing temporary help to assist with operations related to the PPP loans. As our CCBX and CCDB divisions grow, we expect to continue to add employees to support these lines of business. Salaries and employee benefits were $19.0 million for the year ended December 31, 2019, an increase of $3.0 million, or 18.3%, compared to $16.0 million for the year ended December 31, 2018. The increase was primarily due to hiring staff for our BaaS CCBX division, additional staff for our ongoing banking related growth initiatives, a full year of doing business as a public company and operating our Edmonds branch. As of December 31, 2020, we had 250 full-time equivalent employees, compared to 195 at December 31, 2019, and 183 at December 31, 2018.
Occupancy Expenses. Occupancy expenses were $4.0 million for the year ended December 31, 2020, compared to $3.8 million for the year ended December 31, 2019, an increase of $202,000, or 5.4%. Occupancy expenses were $3.8 million for the year ended December 31, 2019, compared to $3.3 million for the year ended December 31, 2018. This category includes building, leasehold, furniture, fixtures and equipment depreciation totaling $1.4 million, $1.2 million, and $1.1 million for years ended December 31, 2020, 2019, and 2018, respectively. The increase of $202,000 in occupancy expenses for 2020 compared to 2019, was primarily the result of $119,000 in a one-time building operating expense, the opening of our Arlington branch in June 2020 and as a result of the growth in CCBX. As we continue to grow, we expect occupancy expenses to increase. The increase of $461,000, or 13.9%, in occupancy expenses for 2019 compared to 2018 was primarily due to the addition of our Edmonds branch in October 2018 and includes increases in rent expense, depreciation, property taxes and utilities as well as higher maintenance and repair costs overall.
Data Processing. Data processing costs were $2.3 million for the year ended December 31, 2020, compared to $2.1 million for the year ended December 31, 2019, an increase of $267,000, or 12.8%. Data processing costs were $2.1 million for the year ended December 31, 2019, compared to $2.0 million for the year ended December 31, 2018. Data processing costs include all of our customer processing, computer processing, and network costs. Data processing costs grow as we grow and add new products, customers and branches. Additionally, CCBX and CCDB data processing expenses are included in this category and are expected to increase incrementally as these divisions grow, and infrastructures for these divisions are put in place. The increase for the year ended December 31, 2019 as compared to the year ended December 31, 2018 was offset due to a change in accounting related to certain point-of-sale transactions that reduced expenses by $211,000 for that account in the current period.
Legal and Professional Fees. Legal and professional costs were $1.8 million for the year ended December 31, 2020 compared to $1.1 million for the year ended December 31, 2019, and increase of $659,000, or 59.7%. Legal and professional costs were $1.1 million for the year ended December 31, 2019 compared to $677,000 for the year ended December 31, 2018. Legal and professional costs fluctuate with the development of contracts for CCBX customers and are also impacted by our reporting cycle and timing of legal and professional services. The increase in legal and professional expenses is associated with BaaS activities through CCBX operations and higher costs related to legal and accounting work related to reporting.
Excise Taxes. Excise taxes were $1.1 million for the year ended December 31, 2020, compared to $719,000 for the year ended December 31, 2019, an increase of $338,000, or 47.0%. Excise tax expense increased $160,000, or 28.6%, in the year ended December 31, 2019 from $559,000 for the year ended December 31, 2018. Excise taxes are based on gross income of $71.2 million, $56.8 million and $44.2 million for the years ended December 31, 2020, 2019 and 2018, respectively. Gross income is reduced by certain allowed deductions to arrive at the taxable base; however, as gross income increases, so does the excise tax expense. In addition, the tax rate that is applied to our industry increased 25 basis points effective April 1, 2020, which contributed to the increase in excise tax for the year ended December 31, 2020.
Director and Staff Expenses. Director and staff expenses includes compensation for director service, continuing education for employees and other director and staff related expenses. Director and staff expenses were $800,000 for the year ended December 31, 2020 compared to $1.0 million for the year ended December 31, 2019, a decrease of $200,000, or 20%. Reduced employee travel as a result of restrictions related to the COVID-19 pandemic contributed to the decrease in the year ended December 31, 2020 compared to the year ended December 31, 2019. Director and staff expenses were $1.0 million for the year ended December 31, 2019 compared to $701,000 for the year ended December 31, 2018, an increase of $299,000 or 42.7%. In mid-2019 a change in the structure of director compensation as a result of increased responsibilities of becoming a publicly traded company contributed to the increase for each of the years ended December 31, 2020 and 2019.
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. FDIC assessments were $522,000 for the year ended December 31, 2020, compared to $184,000 for the year ended December 31, 2019, an increase of $338,000, or 183.7%. FDIC assessments were $184,000 for the year ended December 31, 2019, a decrease of $111,000, or 37.6%, from
$295,000 for the year ended December 31, 2018. The DIF’s reserve was in excess of the required ratio in 2019, resulting in a credit in the year ended December 31, 2019 based on past activity and payments. The DIF reserve ratio is currently below the required ratio.
Business Development. Business development costs include sponsorships and other activities to cultivate business and community development. Business development costs were $344,000 for the year ended December 31, 2020, compared to $431,000 for the year ended December 31, 2019, a decrease of $87,000, or 20.2%. As expected, these expenses were reduced as a result of restrictions on in person meetings and business related activities due to the COVID-19 pandemic. Business Development costs were $431,000 for the year ended December 31, 2019, compared to $326,000 for the year ended December 31, 2018, an increase of $105,000, or 32.2%. The increase in expenses for 2019, compared to 2018 is the result of increased business and community development expenses as a result of the Company’s growth.
Marketing and promotion. Marketing and promotion costs were $317,000 for the year ended December 31, 2020, compared to $393,000 for the year ended December 31, 2019, a decrease of $76,000, or 19.3%. Marketing and promotion costs decreased year over year due to a conscious effort to reduce general advertising costs during the COVID-19 pandemic. The Bank is using more cost-effective advertising options; however, we expect to see advertising expenses increase as we deploy more branding and targeted advertising for the Bank, CCBX and CCDB. Marketing and promotion costs were relatively flat at $393,000 and $391,000 for the years ended December 31, 2019 and 2018, respectively.
Other. This category includes maintenance and subscription expenses, 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. Other noninterest expense increased to $3.7 million for the year ended December 31, 2020, compared to $2.4 million for the year ended December 31, 2019, an increase of $1.3 million, or 52.6%. The increase was largely due to a $578,000 increase in software license, maintenance and subscription expenses, which is expected to increase as we invest more in automated processing and as we grow product lines and our CCBX division, $85,000 increase in the unfunded commitment provision, $83,000 increase in telephone costs, $73,000 increase in operational losses, $51,000 increase in service charges from banks, and overall increases resulting from growth for the year ended December 31, 2020, as compared to the same period last year. Other noninterest expense increased to $2.4 million for the year ended December 31, 2019, compared to $2.0 million for the year ended December 31, 2018. The increase was primarily due to an increase in the unfunded commitment provision, increases in software licenses and maintenance combined with standard increases throughout the accounts in this category.
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.
Year Ended December 31, 2020, Compared to Year Ended December 31, 2019. For the year ended December 31, 2020, income tax expense totaled $4.0 million, compared to $3.5 million for the year ended December 31, 2019. Our effective tax rates for the years ended December 31, 2020 and 2019, was 20.9% and 20.8%, respectively.
Year Ended December 31, 2019, Compared to Year Ended December 31, 2018. For the year ended December 31, 2019, income tax expense totaled $3.5 million, compared to $2.5 million for the year ended December 31, 2018. Our effective tax rates for each of the years ended December 31, 2019 and 2018, was 20.8%.
Financial Condition
Our total assets increased $637.6 million to $1.77 billion, or 56.5% at December 31, 2020, compared to $1.13 billion at December 31, 2019. This increase was largely the result of a $608.0 million increase in loans receivable, which includes $365.8 million in PPP loans as of December 31, 2020, combined with a $32.9 million increase in interest earning deposits with other banks. Our total assets increased $176.4 million, or 18.5%, to $1.13 billion as of December 31, 2019, from $952.1 million as of December 31, 2018. The increase was primarily the result of $169.1 million in net loans receivable growth during the year ended December 31, 2019. Additionally, the Company implemented the new lease accounting standard, which brought operating leases onto the balance sheet on January 1, 2019, and increased assets by $8.5 million as of December 31, 2019.
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 loan portfolio represents the highest yielding component of our earning assets.
As of December 31, 2020, loans receivable totaled $1.55 billion, an increase of $608.0 million, or 64.7%, compared to $939.1 million as of December 31, 2019. Total loans receivable is net of $9.2 million in net deferred origination fees, $5.8 million of which is attributed to PPP loans. Deferred fees on PPP loans are earned over the life of the loan, with a maximum maturity of five years. As of December 31, 2020, $5.8 million, or 44.9%, of the total $12.9 million in net deferred fees on the first and second rounds of PPP loans remained unearned and will be earned in future periods. The increase in loans receivable over the quarter ended December 31, 2019 was due to a $365.8 million increase in PPP loans, and $249.4 million increase in non-PPP loans consisting of $161.5 million increase in commercial real estate loans, $62.0 million in other commercial and industrial loans and $28.9 million in residential real estate loans.
As of December 31, 2019, gross loans totaled $939.1 million, an increase of $171.2 million, or 22.3%, compared to $767.9 million as of December 31, 2018. This increase was primarily due to our efforts to increase income by building a secure loan portfolio while maintaining strong credit quality.
Loans as a percentage of deposits were 108.9% as of December 31, 2020, 97.0% as of December 31, 2019, and 95.6% as of December 31, 2018. We are focused on serving our communities and markets by growing loans locally and funding those loans with customer deposits. The increase in the loan to deposit ratio for 2020 is largely due to the large volume of PPP loans.
The following table summarizes our loan portfolio by type of loan as of the dates indicated:
As of December 31,
(Dollars in thousands)
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Commercial and industrial loans:
PPP loans
$
365,842
23.5
%
-
0.0
%
-
0.0
%
-
0.0
%
-
0.0
%
All other commercial & industrial loans
173,358
11.1
111,401
11.8
%
90,390
11.8
%
88,688
13.5
%
71,397
12.0
%
Real estate loans:
Construction, land and land development
loans
94,423
6.1
97,034
10.3
64,045
8.3
41,641
6.3
55,565
9.3
Residential real estate loans
143,869
9.2
115,011
12.2
94,745
12.3
87,031
13.3
77,361
13.0
Commercial real estate loans
774,925
49.8
613,398
65.2
515,959
67.1
437,717
66.6
391,046
65.5
Consumer and other loans
3,916
0.3
4,214
0.5
3,584
0.5
2,058
0.3
1,276
0.2
Gross loans receivable
1,556,333
100.0
%
941,058
100.0
%
768,723
100.0
%
657,135
100.0
%
596,645
100.0
%
Net deferred origination fees - PPP loans
(5,803
)
-
-
-
-
Net deferred origination fees - Other loans
(3,392
)
(1,955
)
(824
)
(347
)
(517
)
Loans receivable
$
1,547,138
$
939,103
$
767,899
$
656,788
$
596,128
Commercial and Industrial Loans. Commercial and industrial loans increased $427.8 million, or 384.0%, to $539.2 million as of December 31, 2020, from $111.4 million as of December 31, 2019. The increase in commercial and industrial loans receivable over the year ended December 31, 2019 was due to a $365.8 million increase in PPP loans and $62.0 million in other commercial and industrial loans. Included in the commercial and industrial loan balance is $65.6 million in capital call lines resulting from relationships with our CCBX customers as of December 31, 2020.
Commercial and industrial loans increased $21.0 million, or 23.2%, to $111.4 million as of December 31, 2019, from $90.4 million as of December 31, 2018. The $21.0 million increase is the result of $63.1 million in new loans, net of $42.1 million in principal reductions and payoffs. The 2019 increase was due, in part, to our diversification strategy, which includes sourcing loans from strong markets with good returns and risk characteristics to supplement growth in our existing markets.
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.
In the first two rounds of the PPP loan program, our work with the SBA to help small businesses as provided in the CARES Act resulted in a total of $452.8 million in PPP loans, with a total of $12.9 million in net deferred fees. This includes over 2,800 loans, helping over 40,600 employees in our communities. We were able to provide loans to our existing customers and also provide assistance to new customers, by taking a proactive approach and reaching out to the communities we serve to offer aid through the PPP. These loans allowed small business owners to apply for financial relief under the PPP. This program allowed business owners that are impacted by the COVID-19 pandemic to apply for and receive financial relief to help pay for employee wages and certain other expenses. PPP loans have a maximum maturity of five years, bear a 1.0% interest rate and may be forgiven by the government if certain criteria are met. The deferred fees are or will be recognized in interest income over the life of the loans; however, if loans are forgiven or paid off remaining deferred fees will be recognized in the period the forgiveness or payoff occurs. These fees are recognized as interest income and will provide a source of income to the Company as we navigate through the COVID-19 pandemic and challenging economic times, as we continue to provide financial services to our customers and communities.
We accepted and processed requests through the duration of round one and two of the PPP, and recently began accepting and processing applications for round three, which opened for applications on January 19, 2021. As of March 8, 2021, we have funded $259.3 million, representing 1,867 customers, in this latest round of PPP loans, consisting of $16.6 million in new PPP applications for first draws and $242.7 million in a second draw for small businesses that previously received PPP funds. Net deferred fees on these loans total $10.1 million and will be recognized in interest income in future periods. Round three PPP loans have a maturity of five years. Loan payments will be deferred for borrowers who apply for loan forgiveness until SBA remits the borrower's loan forgiveness amount to the lender. If a borrower does not apply for loan forgiveness, payments are deferred 10 months after the end of the covered period for the borrower’s loan forgiveness (either 8 weeks or 24 weeks).
We are accepting applications from customers for loan forgiveness and as of March 8, 2021 we have received $180.8 million in forgiveness or principal paydowns. In order to obtain loan forgiveness, a PPP borrower must submit a forgiveness application to us, which we must review and forward to the SBA. We expect that the pace of forgiveness of PPP loans will increase in the first half of 2021. The initial payment deferral period on PPP loans was extended and customers with two-year loans can work with their lender to extend to a five year maturity, which we anticipate could be a popular option for customers not eligible for forgiveness.
Construction, Land and Land Development Loans. Construction, land and land development loans decreased $2.6 million, or 2.7%, to $94.4 million as of December 31, 2020, from $97.0 million as of December 31, 2019, primarily due to construction projects migrating from construction to other loan categories. Unfunded loan commitments for construction, land and land development loans were $88.4 million at December 31, 2020, which is an increase of $24.6 million, or 38.6%, compared to $63.7 million in unfunded commitments at December 31, 2019.
Although we have not seen a significant drop in our market in the Puget Sound region thus far, the full extent of the long-term effects of the COVID-19 pandemic remain to be seen. We anticipate that as business restrictions related to COVID-19 are eased, projects will begin or resume, and we will see drawdowns on the available commitments.
Construction, land and land development loans increased $33.0 million, or 51.5%, to $97.0 million as of December 31, 2019, from $64.0 million as of December 31, 2018, primarily due to continued favorable economic conditions for building in our market area. Unfunded loan commitments for construction, land and land development loans were $63.7 million at December 31, 2019, which was comparable to the $63.4 million in unfunded commitments at December 31, 2018.
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 December 31, 2020, construction, land and land development loans included $21.6 million in residential construction loans, $43.5 million in commercial construction loans and $29.3 million in other construction, land and land development loans.
Residential Real Estate Loans. Our residential real estate loans increased $28.9 million, or 25.1%, to $143.9 million as of December 31, 2020, from $115.0 million as of December 31, 2019.
Our residential loans increased $20.3 million, or 21.4%, to $115.0 million as of December 31, 2019, from $94.7 million as of December 31, 2018.
We originate one-to-four 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 December 31, 2020, the balance of our ARM portfolio loans was $20.5 million, compared to $11.7 million at December 31, 2019 and $7.5 million as of December 31, 2018. 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 December 31, 2020, we held $16.8 million in purchased residential real estate mortgage loans, compared to $28.6 million at December 31, 2019. 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 December 31, 2020, residential real estate loans made to investors and business owners totaled $84.3 million. As of December 31, 2019 and 2018, residential real estate loans made to investors and business owners totaled $59.7 million and $34.1 million, respectively.
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 $161.5 million, or 26.3%, to $774.9 million as of December 31, 2020, from $613.4 million as of December 31, 2019.
Commercial real estate loans increased $97.4 million, or 18.9%, to $613.4 million as of December 31, 2019, from $516.0 million as of December 31, 2018. These increases, which occurred across the various segments of our portfolio, were due to our commitment to grow this 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.
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 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 December 31, 2020, approximately 41.4% of the commercial real estate loan portfolio consisted of fixed rate loans. Commercial real estate loans represented 49.8% of our loan portfolio at December 31, 2020 and are historically our largest source of revenue. At December 31, 2019 and 2018, approximately 38.3% and 40.8%, respectively, of the commercial real estate loan portfolio consisted of fixed rate loans. The addition of the $365.8 million in PPP loans during the year ended December 31, 2020 as commercial and industrial loans has significantly impacted the composition of our loan portfolio; without the PPP loans, commercial real estate loans would represent approximately 65.1% of the loan portfolio, which is more in line with what it has been historically. The Bank actively seeks commercial real estate loans in our markets and our lenders are experienced in originating, competing for, and managing these loans and relationships. 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 Loans. Consumer and other loans decreased $298,000, or 7.1%, to $3.9 million as of December 31, 2020, from $4.2 million as of December 31, 2019.
Consumer and other loans increased $630,000, or 17.6%, to $4.2 million as of December 31, 2019, from $3.6 million as of December 31, 2018. Our consumer and other loans are comprised of personal lines of credit, automobile, boat, and recreational vehicle loans, and secured term loans.
Contractual Maturity Ranges. The contractual maturity ranges of loans in our loan portfolio and the amount of such loans with fixed and floating interest rates in each maturity range as of date indicated are summarized in the following tables:
As of December 31, 2020
Due after One
Due in One
Year Through
Due after
Gross
(Dollars in thousands)
Year or Less
Five Years
Five Years
Loans
Commercial and industrial loans:
PPP loans
$
-
$
365,842
$
-
$
365,842
All other commercial and industrial loans
99,136
44,161
30,061
173,358
Real estate loans:
Construction, land and land development loans
45,791
32,453
16,179
94,423
Residential real estate loans
41,956
21,004
80,909
143,869
Commercial real estate loans
68,703
226,487
479,735
774,925
Consumer and other loans
1,131
1,744
1,041
3,916
Total
$
256,717
$
691,691
$
607,925
$
1,556,333
The following table sets forth all loans at December 31, 2020, that are due after December 31, 2021, and have either fixed interest rates or floating or adjustable interest rates:
Floating or
(Dollars in thousands)
Fixed Rates
Adjustable
Rates
Total
Commercial and industrial loans:
PPP loans
$
365,842
$
-
$
365,842
All other commercial and industrial loans
46,679
27,543
74,222
Real estate loans:
Construction, land and land development loans
8,928
39,704
48,632
Residential real estate loans
28,934
72,979
101,913
Commercial real estate loans
229,306
476,916
706,222
Consumer and other loans
2,296
2,785
Total
$
681,985
$
617,631
$
1,299,616
Industry Exposure and Categories of Loans
We have a diversified loan portfolio, representing a wide variety of industries. As of December 31, 2020, three of our largest categories of our loans are commercial real estate, commercial and industrial, and construction, land and land development loans. Together they represent $1.04 billion in outstanding loan balances, or 87.6% of total gross loans outstanding, excluding PPP loans of $365.8 million as of December 31, 2020. When combined with $298.7 million in unused commitments the total of these three categories is $1.34 billion, or 88.9% of total outstanding loans and loan commitments as of December 31, 2020.
Commercial real estate loans represent the largest segment of our loans, comprising 65.1% of our total balance of outstanding loans, excluding PPP loans, as of December 31, 2020. Unused commitments to extend credit represents an additional $20.5 million, the combined total exposure in commercial real estate loans represents $795.4 million, or 52.7% of our total outstanding loans and loan commitments, excluding PPP loans.
The following table summarizes our exposure by industry for our commercial real estate portfolio as of December 31, 2020:
(Dollars in thousands, unaudited)
Outstanding Balance
Available Loan Commitments
Total Exposure
% of Total Loans
(Outstanding Balance & Available Commitment)
Average Loan Balance
Number of Loans
Hotel/Motel
$
120,018
$
$
120,246
8.0
%
$
4,445
Apartments
107,094
2,956
110,050
7.3
1,467
Office
79,712
3,008
82,720
5.5
Warehouse
78,732
1,900
80,632
5.3
1,575
Convenience Store
75,699
76,516
5.1
1,846
Retail
71,914
2,723
74,637
4.9
Mixed use
70,196
2,555
72,751
4.8
Mini Storage
38,923
39,451
2.6
2,780
Manufacturing
32,381
32,881
2.2
Groups < 2.0% of total
100,256
5,267
105,523
7.0
1,253
Total
$
774,925
$
20,482
$
795,407
52.7
%
$
1,341
Commercial and industrial loans comprise 14.6% of our total balance of outstanding loans, excluding PPP loans, as of December 31, 2020. Unused commitments to extend credit represents an additional $189.9 million,
the combined total exposure in commercial and industrial loans represents $363.2 million, or 24.1% of our total outstanding loans and loan commitments, excluding PPP loans.
The following table summarizes our exposure by industry, excluding PPP loans, for our commercial and industrial loan portfolio as of December 31, 2020:
(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
$
65,559
$
128,208
$
193,767
12.8
%
$
1,192
Construction/Contractor
Services
14,089
26,046
40,135
2.7
Manufacturing
11,787
5,607
17,394
1.2
Family and Social Services
9,894
5,466
15,360
1.0
Medical / Dental /
Other Care
12,300
2,376
14,676
1.0
Financial Institutions
13,400
-
13,400
0.9
3,350
Groups < 0.85% of total
46,329
22,181
68,510
4.5
Total
$
173,358
$
189,884
$
363,242
24.1
%
$
Construction, land and land development loans comprise 7.9% of our total balance of outstanding loans, excluding PPP loans, as of December 31, 2020. Unused commitments to extend credit represents an additional $88.4 million, the combined total exposure in construction, land and land development loans represents $182.8 million, or 12.1% of our total outstanding loans and loan commitments, excluding PPP loans.
The following table details our exposure for our construction, land and land development portfolio as of December 31, 2020:
(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
$
43,511
$
66,944
$
110,455
7.3
%
$
1,813
Residential construction
21,632
16,245
37,877
2.5
1,082
Land development
10,405
4,505
14,910
1.0
Developed land loans
12,624
13,092
0.9
Undeveloped land loans
6,251
6,444
0.4
Total
$
94,423
$
88,355
$
182,778
12.1
%
$
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. We are not required to report as nonperforming a loan for which we have allowed the borrower to defer payment on a short term basis because of financial pressure related to COVID-19. 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 $712,000 in nonperforming assets, and no troubled debt restructurings (TDRs), as of December 31, 2020, compared to $1.0 million as of December 31, 2019. All of our nonperforming assets were nonperforming loans as of December 31, 2020 and 2019. Our nonperforming loans to loans receivable ratio was 0.05% at December 31, 2020, compared to 0.11% at December 31, 2019. The decrease in nonperforming assets was the result of the $500,000 in write-downs on five nonperforming loans combined with principal paydowns on nonperforming loans, partially offset by the addition of one loan to nonperforming status.
We had $1.0 million in nonperforming assets, and no TDRs, as of December 31, 2019, compared to $1.8 million as of December 31, 2018. All of our nonperforming assets were nonperforming loans as of December 31, 2019 and 2018. Our nonperforming loans to loans receivable ratio was 0.11% at December 31, 2019, compared to 0.24% at December 31, 2018. The decrease in nonperforming assets was the result of the payoff of a TDR and nonperforming loan in 2019, partially offset by the addition of five smaller loans to nonperforming status.
To date we have not seen a significant change in our credit quality metrics, as demonstrated by the low level of charge-offs and nonperforming loans for the year ended December 31, 2020. The long-term economic impact of the COVID-19 pandemic, political changes, and trade issues is unknown; however, the Company remains diligent in its efforts to communicate and proactively work with borrowers to help mitigate potential credit deterioration. Credit administration is closely analyzing higher risk segments within the loan portfolio, monitoring and tracking loan payment deferrals and customer liquidity, and providing timely reporting to management and the board of directors.
Pursuant to federal guidance, the Company deferred and/or modified payments on loans to assist customers financially during the COVID-19 pandemic and economic shutdown. There was a total of $233.9 million, or 247 loans, granted deferred or modified payments in the quarters ended June 30, 2020, September 30, 2020 and December 31, 2020. As of December 31, 2020, $209.8 million, or 220 loans, have successfully resumed payments as scheduled, a total of $7.9 million, or 7 loans, moved to active status with a payment due in the first quarter of 2021, $6.9 million, or 17 loans, have closed and paid-in-full, leaving $9.3 million, or 3 loans, on deferral. The purpose of this program is to provide cash flow relief for small business customers as they navigate through the uncertainties of the COVID-19 pandemic and economic challenges. The Company’s deferral program has been successful as evidenced by customers’ ability to migrate from deferral to active status and resume making payments as planned.
The following table presents information regarding nonperforming assets at the dates indicated:
As of
As of
As of
As of
As of
December 31,
December 31,
December 31,
December 31,
December 31,
(Dollars in thousands)
Nonaccrual loans:
Commercial and industrial
loans
$
$
$
$
$
Real estate loans:
Construction, land and
land development loans
-
-
-
-
-
Residential real estate loans
Commercial real estate loans
-
-
1,261
1,660
1,363
Consumer and other loans
-
-
-
-
-
Total nonaccrual loans
1,030
1,826
2,120
1,489
Accruing loans past due
90 days or more:
Real estate loans:
Construction, land and land
development loans
-
-
-
-
Total accruing loans past due
90 days or more
-
-
-
-
Total nonperforming
loans
1,030
1,826
2,120
1,611
Other real estate owned
-
-
-
-
1,297
Troubled debt restructurings,
accruing
-
-
-
-
5,326
Total nonperforming assets
$
$
1,030
$
1,826
$
2,120
$
8,234
Total nonperforming loans to
loans receivable
0.05
%
0.11
%
0.24
%
0.32
%
0.27
%
Total nonperforming assets
to total assets
0.04
%
0.09
%
0.19
%
0.26
%
1.11
%
Potential Problem Loans
From a credit risk standpoint, we classify loans in one of five categories: pass, other loans especially mentioned, substandard, doubtful or loss. Within the pass category, we classify loans into one of the following five subcategories based on perceived credit risk, including repayment capacity and collateral security: minimal risk, low risk, modest risk, average risk and acceptable risk. The classifications of loans reflect a judgment about the risks of default and loss given default. We review the risk ratings of our credits on an annual basis, or more frequently if circumstances warrant. Risk ratings are adjusted to reflect the degree of risk and loss that is believed to be inherent in each credit as of each monthly reporting period. Our methodology is structured so that specific reserve allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).
•
Credits rated as other loans especially mentioned show clear signs of financial weaknesses or deterioration in creditworthiness; however, such concerns are not so pronounced that we generally expect to experience significant loss within the short-term. Such credits typically maintain the ability to perform within standard credit terms and credit exposure is not as prominent as credits with a lower rating.
•
Credits rated as substandard are those in which the normal repayment of principal and interest may be, or has been, jeopardized by reason of adverse trends or developments of a financial, managerial, economic or political nature, or important weaknesses in the collateral for the loan. A protracted
workout on these credits is a distinct possibility. Prompt corrective action is therefore required to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed.
•
Credits rated as doubtful have weaknesses of substandard assets that are sufficient to make collection or liquidation in full questionable and there is a high probability of loss based on currently existing facts, conditions and values.
•
Credits rated as loss are charged-off. We have no expectation of the recovery of any payments in respect of credits rated as loss.
The following table summarizes the internal ratings of our loans as of the dates indicated:
As of December 31, 2020
Pass
Other
Loans
Especially
Mentioned
Sub-
Standard
Doubtful
Total
(dollars in thousands)
Commercial and industrial loans
$
538,149
$
$
$
-
$
539,200
Real estate loans:
Construction, land, and land development loans
94,423
-
-
-
94,423
Residential real estate loans
143,540
-
143,869
Commercial real estate loans
763,647
11,278
-
-
774,925
Consumer and other loans
3,916
-
-
-
3,916
$
1,543,675
$
11,829
$
$
-
1,556,333
Less net deferred origination fees
(9,195
)
Loans receivable
$
1,547,138
As of December 31, 2019
Pass
Other
Loans
Especially
Mentioned
Sub-
Standard
Doubtful
Total
(dollars in thousands)
Commercial and industrial loans
$
104,911
$
4,740
$
1,750
$
-
$
111,401
Real estate loans:
Construction, land, and land development loans
97,034
-
-
-
97,034
Residential real estate loans
114,823
-
115,011
Commercial real estate loans
608,773
4,625
-
-
613,398
Consumer and other loans
4,212
-
-
4,214
$
929,753
$
9,488
$
1,817
$
-
941,058
Less net deferred origination fees
(1,955
)
Loans receivable
$
939,103
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. See “-Critical Accounting Policies-Allowance for Loan Losses.”
In connection with the review of our loan portfolio, 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 construction, land and land development loans, the perceived 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.
•
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; and
•
for residential real estate mortgage 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.
As of December 31, 2020, the allowance for loan losses totaled $19.3 million, or 1.25% of total loans. As of December 31, 2019, the allowance for loan losses totaled $11.5 million, or 1.22% of total loans. The increase in the provision for loan losses during the year ended December 31, 2020 is related to an increase in qualitative factors related to the economic uncertainties caused by the COVID-19 pandemic and loan growth. The Company is not required to implement the provisions of the Current Expected Credit Loss accounting standard until January 1, 2023 and will continue to account for the allowance for credit losses under the incurred loss model. Included in total loans is $365.8 million in PPP loans which are 100% guaranteed by the SBA. The allowance for loan losses to loans receivable, excluding the guaranteed PPP loans, is approximately 1.62% at December 31, 2020. A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.” As of December 31, 2019, the allowance for loan losses totaled $11.5 million, or 1.22% of total loans. As of December 31, 2018, the allowance for loan losses totaled $9.4 million, or 1.23% of total loans.
The following tables present, as of and for the periods indicated, an analysis of the allowance for loan losses and other related data:
As of or for the Year Ended December 31,
(Dollars in thousands)
Allowance at beginning of period
$
11,470
$
9,407
$
8,017
$
7,544
$
5,989
Provision for loan losses
8,308
2,544
1,826
1,919
Charge-offs:
Commercial and industrial loans
Real estate loans:
Construction, land and land development
loans
-
-
-
Residential real estate loans
-
-
-
-
Commercial real estate loans
-
Consumer and other loans
Total charge-offs
Recoveries:
Commercial and industrial loans
Real estate loans:
Construction, land and land development
loans
-
-
-
-
Residential real estate loans
-
-
-
-
Commercial real estate loans
-
-
-
-
-
Consumer and other loans
Total recoveries
Net (charge-offs) recoveries
(516
)
(481
)
(436
)
(397
)
(364
)
Allowance at end of period
$
19,262
$
11,470
$
9,407
$
8,017
$
7,544
Allowance for loan losses to nonperforming loans
2705.34
%
1113.60
%
515.17
%
378.16
%
468.28
%
Allowance for loan losses to total loans receivable
1.25
%
1.22
%
1.23
%
1.22
%
1.27
%
Net charge-offs to average loans
0.04
%
0.06
%
0.06
%
0.06
%
0.07
%
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. As a result of the COVID-19 pandemic and its impact to the economy, we increased our provision during the year ended December 31, 2020. If the COVID-19 pandemic worsens or continues indefinitely, preventing businesses and consumers from conducting business in the ordinary course, the Washington state and Puget Sound region may experience a continued economic downturn, and our asset quality could deteriorate, which may require material additional provisions for loan losses. We remain focused on working with the communities we serve, offering payment deferrals and other resources available under the CARES Act to provide financial assistance to businesses and consumers until they are able recover from this uncertain and trying time.
The following table shows the allocation of the allowance for loan losses among loan categories and certain other information as of the dates indicated. The allocation of the allowance for loan losses as shown in the table should neither be interpreted as an indication of future charge-offs, nor as an indication that charge-offs in future periods will necessarily occur in these amounts or in the indicated proportions. The total allowance is available to absorb losses from any loan category.
At December 31,
(Dollars in thousands)
Allowance
Allocated
to Loan
Portfolio
Loan
Category
as a % of
Total
Loans
Allowance
Allocated
to Loan
Portfolio
Loan
Category
as a % of
Total
Loans
Allowance
Allocated
to Loan
Portfolio
Loan
Category
as a % of
Total
Loans
Allowance
Allocated
to Loan
Portfolio
Loan
Category
as a % of
Total
Loans
Allowance
Allocated
to Loan
Portfolio
Loan
Category
as a % of
Total
Loans
Commercial and industrial loans
$
3,353
18.4
%
$
2,366
11.8
%
$
2,039
11.8
%
$
1,864
13.5
%
$
1,606
12.0
%
Real estate loans:
Construction, land and land development loans
3,545
19.4
2,745
10.3
1,806
8.3
1,063
6.3
1,398
9.3
Residential real estate loans
3,410
18.7
2,069
12.2
1,647
12.3
1,343
13.2
1,495
13.0
Commercial real estate loans
7,810
42.8
3,126
65.2
2,648
67.1
2,014
66.6
1,474
65.5
Consumer and other loans
0.7
0.5
0.5
0.4
0.2
Total allocated
18,245
10,410
8,217
6,327
5,999
Unallocated
1,017
1,060
1,190
1,690
1,545
Total allowance for loan losses
$
19,262
$
11,470
$
9,407
$
8,017
$
7,544
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 December 31, 2020, $20.0 million, or 86.2%, of our investment portfolio consisted 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 and had much of our excess cash in overnight bank deposits at the Federal Reserve. At December 31, 2020, our loan-to-deposit ratio was 108.9%, which is elevated as a result of the PPP loans. Our securities portfolio represented less than 2% 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 December 31, 2020, the carrying amount of our investment securities totaled $23.2 million, a decrease of $9.5 million, or 28.9%, compared to $32.7 million as of December 31, 2019. The decrease in the securities portfolio was due to maturities and principal paydowns. As of December 31, 2019, the carrying amount of our investment securities totaled $32.7 million, a decrease of $5.2 million, or 13.7%, compared to $37.9 million as of December 31, 2018. The decrease in the securities portfolio in 2019 was due to the restructuring of the investment portfolio to increase our overall rate of return, reduce weighted average maturity, and improve interest rate risk and pricing risk, which involved the sale of $30.0 million (par value) of existing available for sale securities and the purchase of $20.0 million (par value) of available for sale securities as well as an additional $10.0 million of one year certificates of deposits. Also contributing to the decrease was pay-downs on U.S. Agency residential mortgage-backed securities. Additionally, we purchased $3.2 million of a Community Reinvestment Act-qualified U.S. Agency residential mortgage-backed security. The fair value of available for sale securities improved during the year ended December 31, 2019. Investment securities represented 1.3% and 2.9%, and 4.0% of total assets as of December 31, 2020, 2019 and 2018, respectively.
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.
The following table summarizes the amortized cost and estimated fair value of our investment securities as of the dates shown:
As of December 31,
Amortized
Fair
Amortized
Fair
Amortized
Fair
(Dollars in thousands)
Cost
Value
Cost
Value
Cost
Value
Securities available-for-sale:
U.S. Treasury securities
$
19,997
$
20,028
$
24,988
$
24,945
$
34,831
$
33,241
U.S. Government securities
-
-
3,000
2,999
3,000
2,957
U.S. Agency collateralized mortgage
obligations
U.S. Agency residential mortgage-
backed securities
Municipal bonds
Total available-for-sale securities
20,357
20,399
28,401
28,360
38,301
36,660
Securities held-to-maturity:
U.S. Agency residential mortgage-
backed securities
2,848
2,957
4,350
4,329
1,262
1,205
Total held-to-maturity securities
2,848
2,957
4,350
4,329
1,262
1,205
Total investment securities
$
23,205
$
23,356
$
32,751
$
32,689
$
39,563
$
37,865
All of our U.S. Agency residential mortgage-backed securities and U.S. Agency collateralized mortgage obligations are U.S. Government agency securities. As of December 31, 2020, we did not hold any Fannie Mae or
Freddie Mac preferred stock, collateralized debt obligations, collateralized loan obligations, structured investment vehicles, private label collateralized mortgage obligations, subprime, Alt-A or second lien elements in our investment portfolio.
Our management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.
As of December 31, 2020, and December 31, 2019, we did not own securities of any one issuer, other than the U.S. Government and its agencies, for which aggregate adjusted cost exceeded 10.0% of consolidated shareholders’ equity.
Restricted equity securities totaled $5.2 million as of December 31, 2020 and $4.0 million as of December 31, 2019. The increase was attributable to net additions of Federal Reserve, FHLB stock and Pacific Coast Banker's Bank stock. Federal Reserve and FHLB stock are carried at par and do not have a readily determinable fair value. Ownership of FHLB stock is restricted to the FHLB and member institutions, and can only be purchased and redeemed at par.
As of December 31, 2020, we held $100,000 in corporate equity securities which was recorded in other investments on the balance sheet. The equity interest consists of 9,000 shares of stock and was previously carried at cost of $500,000, which approximated fair value at time of purchase. During the year ended December 31, 2020 the Company re-evaluated the value and recorded an unrealized loss on equity investment. The Company also purchased an additional and separate $750,000 equity interest during the year ended December 31, 2020, which consists of 1.6 million shares of common stock and 873,853 preferred shares. The Company elects to account for the investments under ASC 321 Investments - Equity Securities without Readily Determinable Value. The investments will be held at cost minus impairment, the measurement should be applied until the investment does not qualify for the measurement election (e.g., if the investment has a readily determinable fair value). The Company will reassess at each reporting period whether the equity investment without a readily determinable fair value qualifies to be measured at cost minus impairment.
The following table sets forth the amortized cost of held to maturity securities and the fair value of available for sale securities, maturities and approximated weighted average yield based on estimated annual income divided by the average amortized cost of our securities portfolio as of the dates indicated. The contractual maturity of a mortgage-backed security is the date at which the last underlying mortgage matures.
As of December 31, 2020
One Year or Less
More than One
Year to Five Years
More than Five
Years to Ten Years
More than Ten Years
Total
Carrying
Weighted
Average
Carrying
Weighted
Average
Carrying
Weighted
Average
Carrying
Weighted
Average
Carrying
Weighted
Average
(Dollars in thousands)
Value
Yield
Value
Yield
Value
Yield
Value
Yield
Value
Yield
Securities available-for-sale:
U.S. Treasury securities
$
20,028
0.349
%
$
-
0.000
%
$
-
0.000
%
$
-
0.000
%
$
20,028
0.349
%
U.S. government securities
-
0.000
%
-
0.000
%
-
0.000
%
-
0.000
%
-
0.000
%
U.S. Agency collateralized
mortgage obligations
-
0.000
%
-
0.000
%
-
0.000
%
1.713
%
1.713
%
U.S. Agency residential
mortgage-backed securities
-
0.000
%
3.868
%
-
0.000
%
-
0.000
%
3.868
%
Municipals
-
0.000
%
2.588
%
-
0.000
%
-
0.000
%
2.588
%
Total available-for-sale
20,028
0.349
%
2.635
%
-
0.000
%
1.713
%
20,399
0.386
%
Securities held to maturity:
U.S. Agency residential
mortgage-backed securities
-
0.000
%
-
0.000
%
-
0.000
%
2,848
2.278
%
2,848
2.278
%
Total held to maturity
-
0.000
%
-
0.000
%
-
0.000
%
2,848
2.278
%
2,848
2.278
%
Total
$
20,028
0.349
%
$
2.635
%
$
-
0.000
%
$
2,948
2.259
%
$
23,247
0.616
%
Deposits
We offer a variety of deposit products that have a wide range of interest rates and terms, including demand, savings, money market and time accounts, BaaS brokered deposits, and reciprocal deposits. Reciprocal deposits enable us to extend FDIC insurance to customers that have balances in excess of the FDIC insurance limit. This service trades our customer’s funds as CDs or, for DDA accounts, insured cash sweeps (ICS) in increments under the FDIC insured amount to other participating financial institutions and in exchange we receive 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 and retain our deposits.
Total deposits as of December 31, 2020, were $1.42 billion, an increase of $453.3 million, or 46.8%, compared to $968.0 million as of December 31, 2019. Included in total deposits is $68.7 million in deposits derived from CCBX deposit relationships, an increase of $30.2 million, or 78.3%, compared to $38.5 million as of December 31, 2019. CCBX customer deposit relationships include deposits with CCBX end customers, operating and non-operating deposit accounts. Total deposits as of December 31, 2019, were $968.0 million, an increase of $164.4 million, or 20.5%, compared to $803.6 million as of December 31, 2018. The increase in core deposits is primarily the result of expanding and growing banking relationships with new customers, including deposit relationships from PPP loans made to noncustomers moving their banking relationship to the Bank, and growth in our CCBX division. We define core deposits as all deposits except time deposits including BaaS-brokered deposits. We focus on growing core deposits and our branch managers, treasury service personnel and lenders work together to grow deposits from existing and new customers.
Noninterest-bearing demand deposits as of December 31, 2020, were $592.3 million, an increase of $221.1 million, or 59.5%, compared to $371.2 million as of December 31, 2019. Noninterest-bearing deposits as of December 31, 2019, were $371.2 million, an increase of $77.7 million, or 26.5%, compared to $293.5 million as of December 31, 2018. The increase is primarily the result of expanding and growing banking relationships with new customers, including deposit relationships from PPP loans made to noncustomers, who moved their banking relationship to the Bank. Noninterest bearing deposits represent 41.7% and 38.4% of total deposits December 31, 2020 and December 31, 2019, respectively.
Total interest-bearing account balances, excluding time deposits, as of December 31, 2020, were $769.4 million, an increase of $254.6 million, or 49.4%, from $514.9 million as of December 31, 2019. Total interest-bearing account balances, excluding time deposits, as of December 31, 2019, were $514.9 million, an increase of $101.8 million, or 24.6%, from $413.0 million as of December 31, 2018. The increases were due to our team focusing on growing core deposits, including deposit relationships from PPP loans made to noncustomers, who moved their banking relationship to the Bank. Included in interest bearing account balances is $33.5 million in BaaS-brokered deposits, an increase of $9.9 million, from $23.6 million at December 31, 2019. Also included in interest bearing deposits is $8.7 million in reciprocal deposits. In 2019 we introduced reciprocal deposits as a product available for time deposit customers and beginning in 2020 we added ICS, an interest bearing demand reciprocal deposit product.
Total time deposit balances as of December 31, 2020, were $59.6 million, a decrease of $22.3 million, or 27.2%, from $81.9 million as of December 31, 2019. Total time deposit balances as of December 31, 2019, were $81.9 million, a decrease of $15.1 million, or 15.7%, from $97.0 million as of December 31, 2018. The decrease is due to the strong increase in core deposits, and thus not requiring the replacement of time deposits 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 December 31,
Percent of
Percent of
Percent of
(Dollars in thousands)
Amount
Total Deposits
Amount
Total Deposits
Amount
Total Deposits
Demand, noninterest bearing
$
592,261
41.7
%
$
371,243
38.4
%
$
293,525
36.5
%
NOW and money market
658,323
46.3
437,908
45.2
349,952
43.6
Savings
77,611
5.4
53,365
5.5
52,572
6.5
Total core deposits
1,328,195
93.4
862,516
89.1
696,049
86.6
BaaS brokered deposits
33,482
2.4
23,586
2.4
10,521
1.3
Time deposits less than $100,000
19,315
1.4
21,108
2.3
25,851
3.2
Time deposits $100,000 and over
40,315
2.8
60,749
6.2
71,193
8.9
Total
$
1,421,307
100.0
%
$
967,959
100.0
%
$
803,614
100.0
%
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)
As of
December 31,
As of
December 31,
Maturity Period:
Three months or less
$
11,050
$
12,562
Over three through six months
7,799
20,940
Over six through twelve months
13,006
7,007
Over twelve months
8,460
20,240
Total
$
40,315
$
60,749
Average deposits for the year ended December 31, 2020, were $1.24 billion, an increase of $350.1 million, or 39.4%, compared to the year ended December 31, 2019. Average deposits for the year ended December 31, 2019, were $887.8 million, an increase of $142.3 million, or 19.1%, compared to the year ended December 31, 2018. The increase in average deposits was primarily due to an increase in core deposits, both in noninterest bearing deposits and in low rate interest bearing deposits. Included in this increase is deposit relationships gained from PPP loans made to noncustomers that moved their banking/deposit relationship to the Bank. We expect deposits to continue to increase as we see 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 our branch managers, treasury service personnel, and lenders.
The average rate paid on total interest-bearing deposits was 0.59% for the year ended December 31, 2020, compared to 1.03% for the year ended December 31, 2019. The average rate paid on total interest-bearing deposits was 1.03% for the year ended December 31, 2019, compared to 0.66% for the year ended December 31, 2018. The average rate paid on BaaS-brokered deposits decreased 1.63% for the year ended December 31, 2020, compared to December 31, 2019, and NOW and money market accounts decreased 34 basis points, for the year ended December 31, 2020. The decrease in average rate paid on deposit accounts for the year ended December 31, 2020, is the result of the decreased Fed funds rates since June 2019 and management lowering rates in response to the decrease; the impact of these rate decreases will continue to be reflected in future periods. Any further changes to the Fed funds rate and rate pressure from market competition is expected to continue to impact future cost of deposits and our pricing strategies.
The following table presents the average balances and average rates paid on deposits for the periods indicated:
For the Year Ended December 31,
(Dollars in thousands)
Average
Balance
Average
Rate
Average
Balance
Average
Rate
Demand, noninterest bearing
$
513,550
0.00
%
$
322,064
0.00
%
NOW and money market
559,582
0.57
388,646
0.91
Savings
68,172
0.05
52,631
0.06
BaaS brokered deposits
21,808
0.53
31,099
2.16
Time deposits less than $100,000
19,975
1.07
24,359
1.30
Time deposits $100,000 and over
54,742
1.38
68,978
1.81
Total deposits
$
1,237,829
0.35
%
$
887,777
0.65
%
The ratio of average noninterest-bearing deposits to average total deposits for the years ended December 31, 2020 and 2019, was 41.5% and 36.3%, respectively.
Factors affecting the cost of funding interest-bearing assets include the volume of noninterest- and interest-bearing deposits, changes in market interest rates and economic conditions in the Puget Sound region and their impact on interest paid on deposits, competition from other financial institutions, as well as the ongoing execution of our growth strategies. Cost of total interest-bearing liabilities is calculated as total interest expense divided by average total interest-bearing deposits plus average total borrowings. Our cost of total interest-bearing liabilities was 0.64%, 1.13% and 0.80% for the years ended December 31, 2020, 2019 and 2018, respectively. The decrease in our cost of deposits in 2020 was primarily due to rate decreases from the Federal Reserve since June 2019 and the subsequent lowering of rates by management in response to the decrease and overall market conditions. We actively manage our interest rates on deposits, however, rate changes from the Federal Reserve and competition can impact our deposit costs.
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 December 31, 2020, and December 31, 2019, total borrowing capacity of $21.3 million and $21.4 million, respectively, was available under this arrangement. As of December 31, 2020, and December 31, 2019, Federal Reserve borrowings against our line of credit totaled zero.
Paycheck Protection Program Liquidity Facility. To bolster the effectiveness of the SBA’s PPP loan program, the Federal Reserve is supplying liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. Financial institutions participating in the PPP have 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 extends credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. The interest rate is 0.35% and as PPP loans are paid down, the borrowing line must also be paid down. As of December 31, 2020, we had $153.7 million outstanding in PPPLF advances. This new borrowing arrangement has favorable capital treatment and is specific to the PPP loan program, and therefore there was no balance at December 31, 2019 and December 31, 2018.
The table below provides details on PPPLF borrowings for the periods indicated:
Year Ended December 31,
(Dollars in thousands)
Maximum amount outstanding at any month-end
during period:
PPPLF Advances
$
202,595
$
-
Average outstanding balance during period:
PPPLF Advances
$
124,068
$
-
Weighted average interest rate during period:
PPPLF Advances
0.35
%
0.00
%
Balance outstanding at end of period:
PPPLF Advances
$
153,716
$
-
Weighted average interest rate at end of period:
PPPLF Advances
0.35
%
0.00
%
Federal Home Loan Bank (FHLB) Advances. The FHLB allows us to borrow against our line of credit, which is collateralized by certain loans. As of December 31, 2020, 2019 and 2018, total borrowing capacity of $90.7 million, $84.9 million and $79.3 million, respectively, was available under this arrangement. As of December 31, 2020, we borrowed a total of $25.0 million in FHLB medium term advances. This includes $10.0 million for a 2.25-year remaining term and $15.0 million advance with a 4.25-year remaining term. FHLB advances totaled $25.0 million as of December 31, 2020, $10.0 million as of December 31, 2019 and $20.0 million as of December 31, 2018. Although there are no immediate plans to borrow additional funds, additional borrowing capacity of $65.7 million was available under this arrangement as of December 31, 2020.
The following table presents details on FHLB short term borrowings for the periods indicated:
As of and For the Years
Ended December 31,
(Dollars in thousands)
Maximum amount outstanding at any month-end during period:
FHLB Advances
$
2,260
$
20,000
Average outstanding balance during period:
FHLB Advances
$
$
Weighted average interest rate during period:
FHLB Advances
1.84
%
2.30
%
Balance outstanding at end of period:
FHLB Advances
$
-
$
10,000
Weighted average interest rate at end of period:
FHLB Advances
0.00
%
1.73
%
The following table presents details on FHLB medium term borrowings for the periods indicated:
Year Ended December 31,
(Dollars in thousands)
Maximum amount outstanding at any month-end
during period:
FHLB Advances
$
24,999
$
-
Average outstanding balance during period:
FHLB Advances
$
20,669
$
-
Weighted average interest rate during period:
FHLB Advances
1.13
%
0.00
%
Balance outstanding at end of period:
FHLB Advances
$
24,999
$
-
Weighted average interest rate at end of period:
FHLB Advances
1.13
%
0.00
%
Junior Subordinated Debentures. In 2004, we issued $3.6 million in junior subordinated debentures to Coastal (WA) Statutory Trust (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 December 31, 2020, 2019 and 2018, was 2.32%, 3.99% and 4.88%, 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. 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 2016, the Company issued a subordinated note to a commercial bank in the amount of $10.0 million. The note matures on August 1, 2026, and bears interest at the rate of 5.65% per year for five years and, thereafter, at a rate equal to The Wall Street Journal prime rate plus 2.50%. Principal payments of $500,000 per quarter commence November 1, 2021. We may redeem the subordinated note, in whole or in part, without premium or penalty after July 29, 2021, subject to any required regulatory approvals.
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.
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.
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 funds, a one-way buy through an ICS account, and the issuance of debt or equity securities. We are also participating in the PPPLF, which provides an additional source of low cost funding, at a 0.35% interest rate, and favorable capital treatment. We have pledged 703 of these loans, or $153.7 million, as of December 31, 2020. Under the terms of the agreement, the borrowings will be paid down as the loans are forgiven or paid down by the customer. We also added a new liquidity source, which provides an overnight, one-way purchase of funds that would be classified as brokered deposits, but do not anticipate using it very often. 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 for the next few years. The Company down-streamed $7.5 million in capital to the Bank during the first quarter of 2020, bringing the Company’s cash holding to $5.1 million at December 31, 2020. The Company uses approximately $1.3 million for debt servicing and operating purposes each year, leaving about $2.5 million for other purposes after deducting $2.6 million to cover operating purposes for the next two years. In addition, the Bank can declare and pay dividends to the Company to meet the Company’s debt and operating expenses. There are 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. For contingency purposes, the Company maintains a minimum level of cash to fund one year’s projected operating cash flow needs and the Bank targets a liquidity ratio of 5% or greater 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. PPPLF borrowings are not considered wholesale funds for the purpose of calculating the 30% of assets limit. Since the Bank uses only a small portion of its borrowing 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. The Company will become subject to regulatory capital requirements once its consolidated assets exceed a certain threshold. Federal legislation enacted in May 2018 and implemented by the Federal Reserve effective August 30, 2018, raised the threshold of the Federal Reserve’s “Small Bank Holding Company” exception to the application of consolidated capital requirements from $1 billion to $3 billion of consolidated assets. Consequently, bank holding companies of under $3 billion of consolidated assets are no longer subject to the consolidated requirements unless otherwise directed by the Federal Reserve Board. See “Item 1. Business-Regulation and Supervision-Bank Regulation and Supervision-Capital Adequacy” for additional discussion regarding the regulatory capital requirements applicable to the Bank.
As of December 31, 2020, and 2019, 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 will monitor our capital needs and manage our growth in order to remain in compliance with all regulatory capital standards applicable to us.
The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (Basel III rules) became effective for the Bank on January 1, 2015, with all of the requirements fully phased in by January 1, 2019. Under the Basel III rules, the Bank must maintain a capital conservation buffer of common equity Tier 1 capital of 2.50% above the minimum risk-based capital ratios. The Company and the Bank exceed all capital adequacy requirements to which they are subject, including the Basel III rules, as of December 31, 2020.
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
Required to be Well
Capitalized Under the
Prompt Corrective
Action Provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
(dollars in thousands)
December 31, 2020
Leverage Capital (to average assets)
Company
$
143,532
9.05
%
$
63,454
4.00
%
$
79,318
5.00
%
Bank Only
147,262
9.29
%
63,421
4.00
%
79,276
5.00
%
Common Equity Tier I risk-based capital ratio
(to risk-weighted assets)
Company
140,032
11.27
%
55,935
4.50
%
80,795
6.50
%
Bank Only
147,262
11.86
%
55,879
4.50
%
80,713
6.50
%
Tier I Capital (to risk-weighted assets)
Company
143,532
11.55
%
74,580
6.00
%
99,440
8.00
%
Bank Only
147,262
11.86
%
74,505
6.00
%
99,340
8.00
%
Total Capital (to risk-weighted assets)
Company
169,123
13.61
%
99,440
8.00
%
124,300
10.00
%
Bank Only
162,837
13.11
%
99,340
8.00
%
124,175
10.00
%
December 31, 2019
Leverage Capital (to average assets)
Company
$
127,524
11.64
%
$
43,806
4.00
%
$
54,758
5.00
%
Bank Only
122,904
11.22
%
43,801
4.00
%
54,751
5.00
%
Common Equity Tier I risk-based capital ratio
(to risk-weighted assets)
Company
124,024
12.78
%
43,659
4.50
%
63,064
6.50
%
Bank Only
122,904
12.43
%
44,504
4.50
%
64,283
6.50
%
Tier I Capital (to risk-weighted assets)
Company
127,524
13.14
%
58,213
6.00
%
77,617
8.00
%
Bank Only
122,904
12.43
%
58,338
6.00
%
79,118
8.00
%
Total Capital (to risk-weighted assets)
Company
149,416
15.40
%
77,617
8.00
%
97,021
10.00
%
Bank Only
134,796
13.63
%
79,118
8.00
%
98,897
10.00
%
Contractual Obligations
The following table summarizes contractual obligations and other commitments to make future payments (other than non-time deposit obligations), which consist of future cash payments associated with our contractual obligations, as of December 31, 2020.
Payments Due by Period
Less than
1 to 3
3 to 5
More than
(Dollars in thousands)
Total
1 Year
Years
Years
5 Years
Contractual Cash Obligations
Time Deposits
$
59,630
$
46,070
$
11,424
$
2,136
-
Paycheck Protection Program Liquidity Facility
$
153,716
-
153,716
-
-
FHLB advances
24,999
-
10,000
14,999
-
Subordinated note
10,000
4,000
4,000
1,500
Junior subordinated debentures
3,609
-
-
-
3,609
Deferred compensation plans
1,286
Operating leases
8,567
1,254
2,527
1,577
3,209
For a discussion of our borrowings, see “-Financial Condition-Borrowings.”
We believe that we will be able to meet our contractual obligations as they come due. Adequate cash levels are expected through profitability, repayments from loans and securities, deposit gathering activity, access to borrowing sources and periodic loan sales.
Off-Balance Sheet Items
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 below. 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 December 31, 2020, we held $65.6 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.
The following table presents commitments associated with outstanding commitments to extend credit and standby and commercial letters of credit as of the periods indicated:
As of December 31,
(Dollars in thousands)
Commitments to extend credit:
Commercial and industrial loans - capital call lines
$
128,208
$
13,200
Commercial and industrial loans - other
61,676
$
53,363
Construction - commercial real estate loans
69,866
42,371
Construction - residential real estate loans
18,489
21,361
Commercial real estate loans
20,482
9,888
Residential real estate loans
18,128
19,082
Other
1,101
1,181
Total commitments to extend credit
$
317,950
$
160,446
Standby letters of credit
$
2,754
$
2,250
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.
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.
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.
•
“Adjusted net income” is a non-GAAP measure defined as net income increased by the additional income tax expense that resulted from the revaluation of deferred tax assets as a result of the reduction in the corporate income tax rate under the recently enacted Tax Cuts and Jobs Act. The most directly comparable GAAP measure is net income.
•
“Adjusted earnings per share-diluted” is a non-GAAP measure defined as net income, plus additional income tax expense, divided by weighted average outstanding shares (diluted). The most directly comparable GAAP measure is earnings per share.
•
“Adjusted return on average assets” is a non-GAAP measure defined as net income, plus additional income tax expense, divided by average assets. The most directly comparable GAAP measure is return on average assets.
•
“Adjusted return on average shareholders’ equity” is a non-GAAP measure defined as net income, plus additional income tax expense, divided by average shareholders’ equity. The most directly comparable GAAP measure is return on average shareholders’ equity.
We believe that these non-GAAP financial measures provide information that is important to investors and that is useful in understanding our results of operations. Our management uses the non-GAAP financial measures set forth below in its analysis of our performance for 2017 to exclude the impact of a deferred tax asset revaluation due to the enactment of the Tax Cuts and Jobs Act. 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 measures, this presentation may not be comparable to other similarly titled measures by other companies.
Reconciliations of the GAAP and non-GAAP measures are presented below.
(Dollars in thousands, except share and per share data)
As of and for the
Year Ended
December 31, 2017
Adjusted net income:
Net income
$
5,436
Plus: additional income tax expense for deferred tax asset valuation
1,295
Adjusted net income
$
6,731
Adjusted earnings per share-diluted
Net income
$
5,436
Plus: additional income tax expense for deferred tax asset valuation
1,295
Adjusted net income
$
6,731
Weighted average common shares outstanding-diluted (1)
9,237,629
Adjusted earnings per share-diluted (1)
$
0.73
Adjusted return on average assets
Net income
$
5,436
Plus: additional income tax expense for deferred tax asset valuation
1,295
Adjusted net income
$
6,731
Average assets
748,940
Adjusted return on average assets
0.90
%
Adjusted return on average shareholders’ equity
Net income
$
5,436
Plus: additional income tax expense for deferred tax asset valuation
1,295
Adjusted net income
$
6,731
Average shareholders’ equity
65,720
Adjusted return on average shareholders’ equity
10.24
%
(1)
Share and per share information has been adjusted to give effect to a one-for-five reverse stock split of our common shares completed effective May 4, 2019.
We believe these non-GAAP measures are useful to investors in evaluating our performance and in demonstrating resources available with and without provision for loan losses and income taxes. The following non-GAAP measures are presented to illustrate the impact of provision for loan losses and provision for income taxes on net income and return on average assets.
“Pre-tax, pre-provision net income” is a non-GAAP measure that excludes the impact of provision for loan losses and provision for income taxes from net income. The most directly comparable GAAP measure is net income.
“Pre-tax, pre-provision return on average assets” is a non-GAAP measure that excludes the impact of provision for loan losses and provision for income taxes from return on average assets. The most directly comparable GAAP measure is return on average assets.
Reconciliations of the GAAP and non-GAAP measures are presented below.
As of and for the
Years Ended
(Dollars in thousands, unaudited)
December 31,
December 31,
Pre-tax, pre-provision net income and pre-tax, pre-provision return on average assets:
Total average assets
$
1,540,991
$
1,031,973
Total net income
15,146
13,201
Plus: provision for loan losses
8,308
2,544
Plus: provision for income taxes
3,995
3,461
Pre-tax, pre-provision net income
$
27,449
$
19,206
Return on average assets
0.98
%
1.28
%
Pre-tax, pre-provision return on average assets:
1.78
%
1.86
%
The following non-GAAP financial measures are presented to illustrate and identify the impact of PPP loans on loans receivable related measures. By removing these significant items and showing what the results would have been without them, we are providing investors with the information to better compare results with periods that did not have these significant items. We believe that these non-GAAP financial measures provide information that is important to investors and that is useful in understanding our results of operations. These measures include the following:
“Adjusted allowance for loan losses to loans receivable” is a non-GAAP measure that excludes the impact of PPP loans on balance sheet. The most directly comparable GAAP measure is allowance for loan losses to loans receivable.
“Adjusted yield on loans receivable” is a non-GAAP measure that excludes the impact of PPP loans on balance sheet. The most directly comparable GAAP measure is yield on loans.
“Adjusted contractual yield on loans receivable, excluding net earned fees and interest on PPP loans” is a non-GAAP measure that excludes the impact of PPP loans on balance sheet. The most directly comparable GAAP measure is contractual yield on loans, excluding fees.
Reconciliations of the GAAP and non-GAAP measures are presented in the following table.
Year Ended
(Dollars in thousands, unaudited)
December 31, 2020
Adjusted allowance for loan losses to loans receivable:
Total loans, net of deferred fees
$
1,547,138
Less: PPP loans
(365,842
)
Less: net deferred fees on PPP loans
5,803
Adjusted loans, net of deferred fees
$
1,187,099
Allowance for loan losses
$
(19,262
)
Allowance for loan losses to loans receivable
1.25
%
Adjusted allowance for loan losses to loans receivable
1.62
%
Adjusted yield on loans receivable:
Total average loans receivable
$
1,333,028
Less: average PPP loans
(302,685
)
Plus: average net deferred fees on PPP loans
6,432
Adjusted total average loans receivable
$
1,036,775
Interest income on loans
$
61,910
Less: interest and net deferred fee income
recognized on PPP loans
(10,172
)
Adjusted interest income on loans
$
51,738
Yield on loans receivable
4.64
%
Adjusted yield on loans receivable:
4.99
%
Adjusted contractual yield on loans receivable, excluding net earned fees and interest on PPP loans:
Total average loans receivable
$
1,333,028
Less: average PPP loans
(302,685
)
Plus: average net deferred fees on PPP loans
$
6,432
Adjusted total average loans receivable,
excluding net earned fees
$
1,036,775
Interest and net earned fee income on loans
$
61,910
Less: net earned fee income on all loans
$
(9,065
)
Less: interest income on PPP loans
(3,030
)
Adjusted interest income on loans
$
49,815
Contractual yield on loans receivable,
excluding net earned fees
3.96
%
Adjusted contractual yield on loans receivable,
excluding net earned fees and interest on PPP loans:
4.80
%
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 net income.
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 quarterly 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.
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:
Estimated Increase (Decrease)
in Net Interest Income
Change in Market Interest Rates
Twelve Month Projection
December 31, 2020
Twelve Month Projection
December 31, 2019
Static Balance Sheet and Rate Shifts
+400 basis points
18.2
%
14.9
%
+300 basis points
13.7
11.0
+200 basis points
9.1
7.2
+100 basis points
4.5
3.5
-100 basis points
(3.7
)
0.2
-200 basis points
(6.8
)
(3.8
)
-300 basis points
(9.8
)
(5.1
)
Dynamic Balance Sheet and Rate Shifts
+400 basis points
22.8
17.5
+300 basis points
17.1
13.0
+200 basis points
11.4
8.5
+100 basis points
5.6
4.2
-100 basis points
(4.3
)
(0.5
)
-200 basis points
(7.4
)
(5.2
)
-300 basis points
(10.5
)
(6.8
)
The results illustrate that the Bank is asset sensitive and generally performs better in an increasing interest rate environment. The results are primarily due to behavior of demand, money market and savings deposits during such rate fluctuations. We have found that, historically, interest rates on these deposits change more slowly than changes in the discount and federal funds rates. This assumption is incorporated into the simulation model. The assumptions incorporated into the model 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 strategies.
The -100, -200, and -300 basis point change in market interest rates no longer reflects viable interest rate changes as interest rates would have to go negative since the Fed Funds rate target range is set at 0.00% to 0.25%. Until rates increase, these rate shock scenarios may not reflect what may happen to net interest income if interest rates were to go negative.
Impact of Inflation
Our consolidated financial statements and related notes to those financial statements included elsewhere in this Report on Form 10-K have been prepared in accordance with GAAP. GAAP requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession.
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.

---

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
The information required by this item is incorporated herein by reference to the section captioned “Item 7. Management’s Discussion and Analysis of Financial Condition and Operations-Quantitative and Qualitative Disclosures about Market Risk.”

---

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8. Financial Statements and Supplementary Data
The information required by this item is included beginning on page of this Report on Form 10-K.

---

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.

---

ITEM 9A. CONTROLS AND PROCEDURES
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of 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 Exchange Act) as of December 31, 2020. In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well-designed and operated, can provide only a reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported as of the end of the period covered by this annual report.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the fourth quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining effective internal control over financial reporting (as defined in Rule 13a-15(f) and 15d- 15(f) of the Exchange Act). The Company’s internal control system is designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements in accordance with GAAP. Internal control over financial reporting includes self monitoring mechanisms, and actions are taken to correct deficiencies as they are identified.
There are inherent limitations in any internal control over financial reporting, no matter how well designed, misstatements due to error or fraud may occur and not be detected, including the possibility of circumvention or overriding of controls. Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of an internal control system may vary over time.
Management assessed its internal control structure over financial reporting as of December 31, 2020 using the criteria set forth in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2020.

---

ITEM 9B. OTHER INFORMATION
Item 9B. Other Information
None.
PART III

---

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Item 10. Directors, Executive Officers and Corporate Governance
Board of Directors
For information relating to the directors of the Company, the section captioned “Items to be Voted on by Shareholders-Item 1 - Election of Directors” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders is incorporated herein by reference.
Executive Officers
For information relating to officers of the Company, see Part I, Item 1, “Business-Information About Our Executive Officers” to this Annual Report on Form 10-K.
Delinquent Section 16(a) Reports
For information regarding compliance with Delinquent Section 16(a) Reports and the section captioned “Stock Information-Delinquent Section 16(a) Reports” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders are incorporated herein by reference.
Disclosure of Code of Ethics
For information concerning the Company’s Code of Ethics, the information contained under the section captioned “Corporate Governance-Code of Ethics and Business Conduct” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders is incorporated by reference. A copy of the Code of Ethics and Business Conduct is available to shareholders on the Company’s website at www.coastalbank.com.
Audit Committee
For information regarding the Audit Committee and its composition and the audit committee financial expert, the section captioned “Corporate Governance-Meetings and Committees of the Board of Directors-Audit Committee” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders is incorporated herein by reference.

---

ITEM 11. EXECUTIVE COMPENSATION
Item 11. Executive Compensation
Executive Compensation
For information regarding executive compensation, the sections captioned “Executive Compensation” and “Director Compensation” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders are incorporated herein by reference.

---

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to the section captioned “Stock Information” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference to the section captioned “Stock Information” in in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders.
(c) Changes in Control
Management of the Company knows of no arrangements, including any pledge by any person or securities of the Company the operation of which may at a subsequent date result in a change in control of the registrant.
(d) Equity Compensation Plan Information
The following table sets forth information about the Company common stock that may be issued upon the exercise of stock options, warrants and rights under all of the Company’s equity compensation plans as of December 31, 2020.
(a)
Number of
securities to be
issued upon
exercise of
outstanding
options
(b)
Weighted-
average
exercise price
of outstanding
options
(c)
Number of
securities
remaining
available
for issuance
under
equity
compensation
plans
(excluding
securities
reflected
in column (a))
Equity compensation plan approved by stockholders
749,397
$
7.75
272,442
Equity compensation plan not approved by shareholders
-
-
-
Total
749,397
$
7.75
272,442

---

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 13. Certain Relationships and Related Transactions, and Director Independence
Certain Relationships and Related Transactions
For information regarding certain relationships and related transactions, the section captioned “Other Information Relating to Directors and Executive Officers-Transactions with Related Persons” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders is incorporated herein by reference.
Director Independence
For information regarding director independence, the section captioned “Corporate Governance-Director Independence” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders is incorporated herein by reference.

---

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
Item 14. Principal Accountant Fees and Services
For information regarding the principal accountant fees and expenses, the section captioned “Item 2 - Ratification of Selection of Independent Registered Public Accounting Firm” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders is incorporated herein by reference.
PART IV

---

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Item 15. Exhibits and Financial Statement Schedules
(1)
The financial statements required in response to this item are incorporated herein by reference from Item 8 of this Annual Report on Form 10-K.
(2)
All financial statement schedules are omitted because they are not required or applicable, or the required information is shown in the consolidated financial statements or the notes thereto.
(3)
Exhibits
No.
Description
Location
3.1
Second Amended and Restated Certificate of Incorporation of Coastal Financial Corporation
Incorporated herein by reference to
Exhibit 3.1 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
3.2
Articles of Amendment to the Second Amended and Restated Articles of Incorporation of Coastal Financial Corporation
Incorporated herein by reference to
Exhibit 3.2 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
3.3
Amended and Restated Bylaws of Coastal Financial Corporation
Incorporated herein by reference to
Exhibit 3.3 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
4.1*
Form of Common Stock Certificate of Coastal Financial Corporation
Incorporated herein by reference to
Exhibit 4.1 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
4.2
Description of Securities
Incorporated herein by reference to
Exhibit 4.2 to the Company’s Annual Report on Form 10-K (File No. 001-38589), filed with the Commission on March 12, 2020.
10.1+
2006 Stock Option and Equity Compensation Plan
Incorporated herein by reference to
Exhibit 10.1 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.2+
First Amendment to the 2006 Stock Option and Equity Compensation Plan
Incorporated herein by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q (File No. 001-38589), filed with the Commission on August 7, 2020.
10.3+
Directors’ Stock Bonus Plan
Incorporated herein by reference to
Exhibit 10.2 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.4+
2018 Omnibus Incentive Plan
Incorporated herein by reference to
Exhibit 10.3 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.5+
Coastal Financial Corporation Annual Incentive Plan
Incorporated herein by reference to
Exhibit 10.4 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.6+
Amended and Restated Employment Agreement by and among Coastal Financial Corporation, Coastal Community Bank, and Eric M. Sprink
Incorporated herein by reference to
Exhibit 10.5 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.7+
Amended and Restated Change in Control Severance Agreement by and among Coastal Financial Corporation, Coastal Community Bank, and Joel Edwards
Incorporated herein by reference to
Exhibit 10.6 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.8
Commercial Real Estate Lease between JMHLS, LLC and Coastal Community Bank dated June 4, 2008
Incorporated herein by reference to
Exhibit 10.7 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.9
First Amendment of Commercial Real Estate Lease between JMHLS, LLC and Coastal Community Bank dated March 26, 2018
Incorporated herein by reference to
Exhibit 10.8 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.10
Lease dated October 21, 1996, between certain persons and Coastal Community Bank
Incorporated herein by reference to
Exhibit 10.9 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.11
Lease Amendment 1.0 dated as of August 15, 2006, between certain persons and Coastal Community Bank
Incorporated herein by reference to
Exhibit 10.10 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.12
Lease Amendment 2.0 dated as of March 31, 2008, between certain persons and Coastal Community Bank
Incorporated herein by reference to
Exhibit 10.11 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.13
Lease Amendment 3.0 dated as of June 29, 2009, between certain persons and Coastal Community Bank
Incorporated herein by reference to
Exhibit 10.12 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.14
Investment Agreement dated as of March 30, 2011, between Coastal Financial Corporation and Steven D. Hovde
Incorporated herein by reference to
Exhibit 10.13 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.15
First Amendment to Investment Agreement dated as of May 9, 2019, between Coastal Financial Corporation and Steven D. Hovde
Incorporated herein by reference to
Exhibit 10.20 to the Company’s Registration Statement on Form S-1 (File No. 333-225715), filed with the Commission on June 19, 2018
10.16#
Program Agreement dated as of September 26, 2019 by and between Coastal Community Bank and Aspiration Financial, LLC
Incorporated herein by reference to Exhibit 10.1 to Amendment No. 1 to the Company’s Current Report on Form 8-K/A (File No. 001-38589) filed on March 21, 2019.
10.17+
Form of Change in Control Severance Agreement
Incorporated herein by reference to
Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q (File No. 001-38589), filed with the Commission on May 8, 2020.
10.18+
Amended Non-Employee Director Compensation Policy
Incorporated herein by reference to
Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q (File No. 001-38589), filed with the Commission on November 6, 2020.
21.1
Subsidiaries
Incorporated herein by reference to
Exhibit 21.1 to the Company’s Annual Report on Form 10-K (File No. 001-38589), filed with the Commission on March 12, 2020.
23.1
Consent of Moss Adams LLP
Filed herewith
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
Filed herewith
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
Filed herewith
32.1
Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Filed herewith
The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, formatted in inline XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheet, (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
Filed herewith
Cover Page Interactive Data (formatted as Inline XBRL and contained in Exhibit 101 filed herewith)
+
Management contract or compensatory plan, contract or arrangement.
#
Portions of this exhibit have been omitted pursuant to a request for confidential treatment and the non-public information has been filed separately with the SEC.
*
Certain instruments defining the rights of holders of long-term debt securities of the Company and its subsidiaries are omitted pursuant to section (b)(4)(iii)(A) of Item 601 of Regulation S-K. The Company hereby agrees to furnish copies of these instruments to the SEC upon request.