Executive Summary / Key Takeaways

• Coastal Financial Corporation ($CCB) is strategically evolving beyond traditional community banking by leveraging its Banking as a Service (BaaS) segment, CCBX, as a primary growth engine, complementing its established Puget Sound community bank operations.
• The CCBX segment, with 25 relationships and a focus on digital financial service providers, is driving significant increases in loans, deposits, net interest income, and noninterest income, albeit with higher associated credit and operational expenses compared to the community bank.
• Specific Q1 2025 results highlight this dynamic: total assets grew 5.3% to $4.34 billion, driven by CCBX loan and deposit growth (up 2.9% and 9.8% respectively), contributing to a 22.3% increase in consolidated net interest income year-over-year.
• While CCBX loans carry higher expected losses, partner credit enhancements cover the vast majority (97.8% of Q1 2025 charge-offs), mitigating direct credit risk exposure, though counterparty risk remains a key consideration.
• The Company is actively managing its balance sheet through CCBX loan sales to optimize portfolio mix and liquidity, while investing in technology and automation to enhance efficiency and manage future expense growth, alongside addressing previously identified material weaknesses in internal controls related to BaaS accounting.

The Dual Engine: Community Roots Meet Digital Ambition

Coastal Financial Corporation, through its subsidiary Coastal Community Bank, has long served the Puget Sound region, establishing itself as a leading community bank with 14 branches deeply embedded in its local markets. This foundational segment provides traditional banking services to consumers and small-to-medium businesses, characterized by stable deposits and a focus on commercial real estate and commercial & industrial lending.

However, the core of CCB's recent narrative and investment thesis lies in its strategic expansion into the Banking as a Service (BaaS) space via its CCBX segment. Launched to enable digital financial service providers and brands to offer banking products through the Bank's infrastructure, CCBX represents a deliberate evolution, positioning CCB at the intersection of traditional finance and fintech innovation. This dual-engine approach aims to capture growth opportunities beyond its geographic footprint, leveraging technology to scale operations and diversify revenue streams.

The CCBX segment is not merely an add-on; it is increasingly central to the company's balance sheet and income statement dynamics. As of March 31, 2025, CCBX accounted for a significant portion of total assets and deposits, and its loan portfolio, while carrying higher inherent risk, contributes substantially to interest income. The strategic focus is on refining partner criteria, seeking established players, expanding product offerings with existing partners, and using technology to drive efficiency and manage risk.

Technological Edge and Operational Evolution

CCB's foray into BaaS is fundamentally enabled by its technological capabilities. While specific proprietary software names or architectures are not detailed, the role of technology in the CCBX segment's operations is emphasized. The BaaS platform allows digital partners to integrate banking services, implying a robust API-driven infrastructure capable of handling high transaction volumes and diverse product types, including credit cards, consumer loans, and deposit accounts.

The tangible benefits of this technological focus are evident in the operational details. The ability to process transactions for digital partners, including on sold credit card balances, provides a recurring revenue stream without the associated balance sheet risk. Furthermore, management explicitly states a focus on "increasing our efficiency and using technology to reduce and/or slow future growth in hiring" and investing in "infrastructure enhancement projects to improve our processing, automate processes, reduce compliance costs and enhance our data management." This indicates a strategic intent to leverage technology for operational leverage, aiming for quantifiable improvements in processing speed, cost reduction, and risk management capabilities. Investments in data processing and software licenses, which saw a 46.3% increase year-over-year in Q1 2025, underscore this commitment.

For investors, the "so what" is clear: CCB's technological foundation and ongoing investments are intended to create a competitive moat in the BaaS space. By enabling partners to offer seamless digital banking experiences, CCB aims to attract and retain high-volume relationships. The focus on automation and efficiency seeks to translate top-line growth into improved profitability over time, potentially leading to better operating margins and return on equity compared to less technologically advanced peers. However, the need for continued investment and the challenges in integrating partner systems also represent ongoing costs and operational risks.

Competitive Arena: Navigating Regional and Digital Currents

CCB operates in a competitive landscape shaped by both traditional regional banks and agile fintech players. In its core Puget Sound market, CCB competes with institutions like Columbia Banking System (COLB), Banner Corporation (BANR), and HomeStreet, Inc. (HMST). CCB holds a strong position as the largest community bank by deposit market share in Snohomish County, a testament to its established local presence and customer relationships. Its community bank lenders are experienced in competing for commercial real estate loans, a key product in the region.

Against regional peers, CCB differentiates itself through its BaaS segment. While competitors like COLB and BANR have larger balance sheets and broader branch networks, CCB's CCBX platform offers a quantifiable edge in digital service delivery. The ability to process digital banking services faster and potentially at a lower per-unit cost due to technology focus allows CCB to target a different customer base – the digital financial service providers – that traditional banks may not be equipped to serve effectively. This strategic positioning helps CCB capture market share in the rapidly growing digital banking sector, complementing its stable community bank operations.

However, CCB faces challenges from both sides. Larger regional banks can leverage scale for better funding costs and broader product distribution. Fintech companies and online banks, including indirect competitors like Chime or Ally Financial (ALLY), offer low-cost, digitally native solutions that can pressure deposit pricing and attract digitally savvy customers, potentially eroding market share in certain segments. CCB's response includes using exception pricing tactics in the community bank to retain deposits and focusing on growing less costly core deposits rather than matching competitors' high time deposit rates globally. The strategy of selling CCBX loans also helps manage balance sheet risk and capital requirements, allowing CCB to participate in the high-growth digital lending market while retaining a fee-based revenue stream.

The competitive landscape analysis highlights CCB's strengths in digital innovation and regional focus but also vulnerabilities due to its smaller scale compared to major regional players and the cost pressures from highly efficient fintech models. The success of the CCBX segment in attracting and retaining partners, and the ability to translate digital activity into profitable growth, will be critical in determining CCB's long-term competitive standing.

Financial Performance: CCBX Fuels Growth Amidst Shifting Dynamics

Coastal Financial Corporation's financial performance in the first quarter of 2025 demonstrates the increasing influence of the CCBX segment on consolidated results. Net income for the three months ended March 31, 2025, rose to $9.7 million, or $0.63 per diluted share, compared to $6.8 million, or $0.50 per diluted share, in the prior-year period. This 43% increase in net income was primarily driven by strong growth in net interest income and BaaS program income.

Net interest income surged by $13.9 million, or 22.3%, to $76.1 million. This was largely attributable to a $12.3 million increase in interest and fees on loans, primarily from the growth in higher-yielding CCBX loans. Average total loans receivable grew by $364.2 million, or 28.8%, year-over-year, with average CCBX loans increasing to 46.4% of the total loan portfolio, up from 40.3%. While the average yield on CCBX loans slightly decreased to 16.88% from 17.74%, the significant volume increase more than offset this. The cost of deposits decreased by 41 basis points to 3.08%, contributing positively to the net interest margin, which expanded to 7.48% from 6.92%.

The provision for credit losses decreased significantly year-over-year, from $83.2 million to $55.8 million. This reduction is directly linked to the accounting for CCBX partner loans, where a corresponding decrease in BaaS credit enhancement income was recognized. While CCBX loans have a higher level of expected losses, the partner credit enhancements covered 97.8% of the $53.7 million in gross CCBX charge-offs in Q1 2025. Net charge-offs decreased to $48.2 million, or 5.57% of total average loans (annualized), down from $57.0 million, or 7.30%, in the prior-year quarter, reflecting efforts to improve CCBX credit quality.

Noninterest income, however, saw a decrease of $22.7 million, or 26.3%, totaling $63.5 million. This was primarily due to a $26.2 million decrease in BaaS credit enhancements, which, as noted, offsets the lower provision expense. Partially offsetting this decline was a $2.2 million increase in BaaS program income (up 55.2%), driven by increased activity with digital partners, and a $1.1 million increase in BaaS fraud enhancements.

Noninterest expenses increased by $15.5 million, or 27.4%, to $72.0 million. The largest drivers were increases in BaaS loan expense (up $6.4 million, 24.5%), BaaS fraud expense (up $1.1 million, 115.9%), salaries and employee benefits (up $3.5 million, 19.7%), legal and professional expenses (up $2.8 million, 76.7%), and data processing and software licenses (up $1.3 million, 46.3%). These increases reflect the costs associated with supporting the growing CCBX segment, investing in technology and risk management infrastructure, and general company growth.

From a balance sheet perspective, total assets grew by $218.1 million, or 5.3%, from December 31, 2024, to $4.34 billion at March 31, 2025. This growth was fueled by a $164.9 million increase in interest earning deposits with other banks and a $30.8 million increase in loans receivable. Total deposits increased by $205.9 million, or 5.7%, to $3.79 billion, primarily due to growth in CCBX deposits. The loan-to-deposit ratio stood at 93.9% at quarter-end, down from 97.8% at the end of 2024. Liquidity remains strong, with cash and borrowing capacity significantly exceeding uninsured deposits.

Outlook and Key Considerations

Management's outlook centers on continuing the strategic evolution driven by the CCBX segment. Key initiatives include:

• CCBX Portfolio Optimization: Continuing to sell CCBX loans to originating partners is a core strategy to manage portfolio size, credit quality, and partner limits. This also provides ongoing fee income without balance sheet risk.
• Partner and Product Expansion: Refining partner criteria to focus on larger, established relationships while also pursuing promising smaller ones, and expanding product offerings with existing partners, are expected to drive continued growth in CCBX activity. The launch of the T-Mobile (TMUS) deposit program on April 1, 2025, is a concrete example of a new, potentially significant deposit relationship.
• Efficiency through Technology: Investments in automation and technology are aimed at managing future expense growth, particularly in salaries and data processing, as the company scales.
• Deposit Growth: Expectations for deposit growth are tied to continued expansion in primary market areas, commercial lending relationships, business development efforts, and new CCBX partnerships like T-Mobile.

While the outlook is positive for continued growth, several risks warrant investor attention:

• Regulatory Scrutiny: Increased regulatory focus on bank-fintech partnerships and potential new rules regarding custodial accounts could lead to increased compliance costs for the BaaS business.
• CCBX Counterparty Risk: Although credit enhancements cover most CCBX losses, the Bank is exposed if a partner is unable to fulfill their contractual indemnification obligations. Management has contingency plans, but partner failure could still result in losses.
• Credit Quality: While community bank credit quality remains strong, the macro economic environment and the higher inherent risk in certain CCBX loan categories necessitate diligent monitoring and could require additional provisions if conditions worsen.
• Operational Risk: The previously identified material weaknesses in internal controls related to BaaS accounting highlight the complexities of the business and the importance of successful remediation efforts.
• Interest Rate Risk: While the growing variable-rate nature of the CCBX portfolio helps mitigate interest rate sensitivity, the static balance sheet remains liability sensitive, meaning earnings could be pressured if interest rates decline rapidly.

Conclusion

Coastal Financial Corporation is executing a clear strategy to transform its business model, leveraging its established community bank foundation while aggressively pursuing growth through its CCBX BaaS segment. The first quarter of 2025 results underscore the success of this approach, with CCBX driving significant increases in assets, deposits, and net interest income. The company's technological investments are central to its ability to compete in the digital banking space and achieve operational efficiencies.

However, this growth trajectory is not without its complexities and risks. Managing the higher credit risk and counterparty exposure associated with the CCBX portfolio, navigating evolving regulatory expectations for bank-fintech partnerships, and successfully implementing internal control remediation plans are critical factors for investors to monitor. CCB's ability to sustain its growth momentum, translate it into improved profitability through operational leverage, and effectively manage the unique risks of its hybrid model will ultimately determine the long-term value creation potential for shareholders. The strategic focus on partner quality, portfolio optimization through loan sales, and continued investment in technology suggest a proactive approach to these challenges, positioning CCB as a compelling, albeit complex, opportunity in the evolving financial services landscape.