Coastal Financial's BaaS Engine Fuels Strategic Expansion in a Dynamic Market (NASDAQ:CCB) - CCB Stock Research Report

## Executive Summary / Key Takeaways * Coastal Financial Corporation's core investment thesis is anchored in its rapidly expanding Banking as a Service (BaaS) segment, CCBX, which is driving significant loan and deposit growth through strategic partnerships and innovative digital offerings. * The second quarter of 2025 showcased CCBX's operational strength, with net interest income climbing 18.4% quarter-over-quarter, even as overall noninterest income saw a temporary dip due to reduced BaaS credit enhancements reflecting improved loan portfolio quality. * Management is actively optimizing the CCBX loan portfolio by prioritizing higher-quality originations and strategically selling loans to manage risk, while simultaneously securing recurring fee income from these transactions. * Coastal Financial maintains a robust liquidity profile and strong capital adequacy, reinforced by a $98 million equity raise in December 2024, providing a solid foundation for future growth and risk mitigation. * While regulatory scrutiny on BaaS partnerships and inherent counterparty risks present challenges, CCB is proactively addressing these through refined partner selection, enhanced risk management practices, and a commitment to operational excellence. ## The Dual Engine: Community Roots and Digital Frontiers Coastal Financial Corporation (NASDAQ:CCB) stands at a compelling juncture, blending its deep community banking heritage with an innovative, high-growth Banking as a Service (BaaS) platform. Established in 1997 as Coastal Community Bank in Everett, Washington, the company has steadily grown its presence in the Puget Sound region, where it holds the distinction of being the largest community bank by deposit market share in Snohomish County. This foundational community bank segment provides a full suite of traditional banking products to local consumers and small to medium-sized businesses, fostering strong, localized relationships. However, the true differentiator and growth engine for CCB is its CCBX segment, launched to enable digital financial service providers, companies, and brands to offer banking services to their customers. This strategic pivot, evolving significantly since 2020, has transformed CCB into a hybrid financial institution. The company's history reflects a deliberate evolution, from early capital raises in 2004 and 2021 to the formation of Arlington Olympic LLC in 2019, all building towards a more diversified and technologically advanced banking model. Recent strategic partnerships, such as becoming a sponsor bank for Dave Inc. (TICKER:DAVE)'s banking products and Robinhood (TICKER:HOOD) entering production testing for deposit products in Q2 2025, underscore the momentum and future potential of this BaaS strategy. The broader banking industry is currently experiencing a dynamic shift. While traditional regional banks face pressures from evolving interest rate environments and increased competition, the BaaS sector is booming, driven by the demand for embedded finance solutions. The Federal Open Market Committee (FOMC) lowered the targeted Federal Funds rate by 0.25% in December 2024, settling at 4.50% as of June 30, 2025, with future rate cuts expected to be tied to inflationary trends. This environment impacts net interest margins across the sector. CCB's dual model, particularly its BaaS segment, positions it uniquely to capitalize on digital transformation trends while maintaining a stable, relationship-driven community presence. ## Technological Edge: The CCBX BaaS Platform CCB's core technological differentiation lies in its proprietary CCBX BaaS platform. This platform is not merely a service offering; it is a strategic asset that allows CCB to embed banking functionalities into diverse digital ecosystems. As of June 30, 2025, CCBX boasts 29 partners, with 20 actively generating revenue and nine more in various stages of testing or implementation. This extensive partner network is a testament to the platform's scalability and appeal. The tangible benefits of this technology are multifaceted and quantifiable. The BaaS platform enables CCB to expand its customer base significantly with a modest increase in regulatory risk, leveraging its operational history with partners. This expansion translates directly into increased partner activity and transaction counts, which positively impacts noninterest income. For instance, the company's strategy of selling CCBX loans to originating partners, while retaining a portion of the future fee income for transaction processing, creates an ongoing, recurring revenue stream without the associated on-balance sheet risk or capital requirements. Furthermore, the CCBX segment enhances CCB's interest rate risk profile. Approximately 75% of CCBX loans and the majority of its deposits are designed to reprice immediately with market shifts. This characteristic helps to mitigate overall balance sheet variability in both rising and falling rate environments, offsetting the community bank segment's traditional asset sensitivity. The deliberate optimization of the CCBX loan portfolio, focusing on higher-quality originations, has led to lower historical loss factors and a reduced provision for credit losses, directly improving profitability. The company is also investing in automation within CCBX to reduce future expense growth and enhance operational efficiency. ## Financial Performance: Growth and Optimization Coastal Financial's financial performance in the first half of 2025 reflects the strategic emphasis on its CCBX segment and ongoing portfolio optimization. For the three months ended June 30, 2025, net income was $11.0 million, or $0.71 per diluted share, a slight decrease from $11.6 million, or $0.84 per diluted share, in the prior year's comparable quarter. This was primarily due to a $14.9 million increase in noninterest expenses, partially offset by a $10.4 million increase in interest income and a $2.0 million increase in BaaS program income, which included $504,000 in nonrecurring revenue.

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For the six months ended June 30, 2025, net income increased to $20.8 million, or $1.36 per diluted share, up from $18.4 million, or $1.34 per diluted share, in the same period of 2024. This improvement was largely driven by a $24.4 million increase in net interest income, primarily from CCBX loan growth. Total loans receivable grew by $53.8 million (1.5%) to $3.54 billion at June 30, 2025, with gross CCBX loans expanding by $76.8 million (4.8%) to $1.68 billion, even after selling $2.04 billion in CCBX loans year-to-date. This strategic loan sale activity is crucial for managing portfolio size and credit quality. The net interest margin for Q2 2025 was 7.06%, a slight decrease from 7.12% in Q2 2024. This was influenced by a decrease in loan yield (16.22% for CCBX in Q2 2025 vs. 17.75% in Q2 2024), attributed to lower interest rates and a shift in loan mix towards lower-rate capital call lines, which increased by $90.5 million. However, the cost of deposits decreased by $178,000 in Q2 2025 despite a $515 million increase in average interest-bearing deposits, reflecting the benefit of lower overall interest rates. Noninterest income for Q2 2025 decreased by $26.4 million (38.2%) to $42.7 million. This was primarily due to a $29.6 million decrease in BaaS credit enhancement income, which directly correlates with a $30.1 million decrease in the provision for credit losses. This dynamic is a positive indicator, reflecting improved performance and higher quality in the CCBX loan portfolio, leading to lower expected losses. Net charge-offs for Q2 2025 totaled $49.3 million (5.54% of average loans), down from $53.0 million (6.54%) in Q2 2024, further supporting the narrative of improving credit quality within CCBX.

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Operating expenses saw an increase, with noninterest expenses rising $14.9 million (25.7%) in Q2 2025. This was driven by higher salaries and employee benefits, legal and professional expenses, data processing and software licenses, and BaaS loan and fraud expenses, all tied to the company's growth and ongoing investments in technology and risk management infrastructure. The effective tax rate for Q2 2025 increased to 23.3% from 22.8% in Q2 2024, primarily due to state income tax rate changes, notably in California. ## Liquidity and Capital Strength CCB maintains a robust liquidity position, essential for supporting its growth and mitigating market volatility. As of June 30, 2025, the company held $719.8 million in cash on its balance sheet and had access to $642.7 million in borrowing capacity from the Federal Home Loan Bank (FHLB) and Federal Reserve Bank (FRB) discount window. This combined liquidity of $1.36 billion represented 34.8% of total deposits and comfortably exceeded the $579.9 million in uninsured deposits. The company strategically uses IntraFi network sweep deposits, totaling $452.4 million, to provide fully FDIC-insured options for customers with large balances. An additional $478.7 million in CCBX deposits were transferred off-balance sheet for increased FDIC insurance coverage and liquidity management.

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Total deposits increased by $328.2 million (9.2%) to $3.91 billion at June 30, 2025, largely driven by a $296.1 million increase in CCBX deposits. Core deposits, excluding time and brokered deposits, reached $3.44 billion. The company's loan-to-deposit ratio stood at 92.0% at June 30, 2025, down from 97.8% at December 31, 2024, indicating a healthy funding position.

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Capital adequacy remains strong, with the company and the Bank in compliance with all regulatory requirements. The Bank is classified as "well capitalized." A public offering in December 2024 raised $98.0 million, significantly strengthening regulatory capital levels and providing capital for future growth. The company also holds an effective registration statement on Form S-3, allowing it to raise up to $102.0 million in additional capital if needed. ## Competitive Landscape and Strategic Positioning Coastal Financial operates in a competitive banking landscape, facing both traditional regional banks and agile fintech players. In its community bank segment, CCB is a strong regional player, particularly in Snohomish County, where it is the largest community bank by deposit market share. This localized expertise and strong community focus foster customer loyalty and provide a stable deposit base. However, against larger regional competitors like Banner Corporation (TICKER:BANR) and Washington Federal, Inc. (TICKER:WAFD), CCB's geographic footprint is more limited, potentially restricting its scalability. While CCB's digital tools are efficient, it may not match the innovation speed of larger players or specialized fintechs. The CCBX segment, however, is where CCB truly differentiates itself. While traditional banks like KeyCorp (TICKER:KEY) offer comprehensive digital services, CCB's BaaS platform allows it to partner with a diverse ecosystem of digital financial service providers. This strategy offers a qualitative edge in digital innovation and faster adoption for clients, contrasting with more traditional, acquisition-driven approaches seen in some competitors like Pacific Premier Bancorp (TICKER:PPBI). CCB's model enables it to generate recurring fee income from transaction processing on sold loans, a revenue stream that larger, more traditional banks may not fully capture. CCB's competitive advantages stem from its strong community focus, which drives customer loyalty and stable deposits, and its proprietary BaaS platform, which enables capital-efficient growth through partnerships. These strengths allow CCB to carve out a niche and differentiate itself from larger, more generalized regional banks. However, its smaller scale and geographic limitations present vulnerabilities, potentially leading to higher operational costs and slower growth compared to national players. The company's strategic response involves refining CCBX partnerships, focusing on larger, more established partners, and expanding product offerings with existing clients to drive noninterest income growth. ## Risks and Forward Outlook Despite its strategic advantages, CCB faces several pertinent risks. Regulatory scrutiny on BaaS partnerships is increasing, with federal agencies focusing on third-party risk management and proposing new recordkeeping rules for custodial accounts. These developments could increase compliance costs and operational complexities for the CCBX segment. Management is actively evaluating these impacts and implementing controls to enhance risk assessment and ensure compliance. Counterparty risk within CCBX is also a consideration. While partner agreements include credit enhancements covering most credit and fraud losses (97.5% of gross CCBX charge-offs for the six months ended June 30, 2025), a partner's inability to fulfill its obligations could expose the Bank to losses. CCB mitigates this through cash reserve accounts pledged by partners and the ability to declare default and take over servicing if necessary. The macroeconomic environment, characterized by changing interest rates, inflation, and geopolitical events, continues to create uncertainty. While CCB's balance sheet is becoming more neutral to rate shifts due to the variable nature of CCBX loans and deposits, a severe economic downturn could still impact asset quality and necessitate additional provisions for credit losses. Furthermore, material weaknesses in internal control over financial reporting, previously reported and leading to financial statement restatements, are actively being remediated through enhanced risk assessment and accounting policy verification for BaaS partners. Looking ahead, CCB's outlook is centered on the continued expansion and optimization of its CCBX segment. Management expects noninterest income to grow as partner activity increases and new products are introduced. The strategic focus on originating higher-quality CCBX loans and selling them to manage portfolio limits is expected to continue, providing recurring fee income without balance sheet risk. New partnerships with significant players like Robinhood (TICKER:HOOD) and Dave (TICKER:DAVE) are anticipated to diversify and grow deposits. The company plans to manage future expense growth through automation and technology investments, even as it expects some continued hiring to support CCBX. Overall, CCB aims to control growth to maintain strong regulatory capital levels and leverage its unique dual-engine model for sustainable profitability. ## Conclusion Coastal Financial Corporation presents a compelling investment narrative, driven by the strategic evolution of its high-growth CCBX BaaS segment. By effectively blending its established community banking operations with an innovative digital platform, CCB is carving out a differentiated position in a dynamic financial services landscape. The company's recent financial performance, marked by robust CCBX loan and deposit growth, improving credit quality, and a strong liquidity position, underscores the success of its strategic initiatives. While the evolving regulatory environment and inherent counterparty risks in the BaaS model demand vigilant risk management, CCB's proactive approach and technological advantages provide a solid foundation. The continued expansion of its partner ecosystem, coupled with a disciplined focus on portfolio optimization and operational efficiency, positions Coastal Financial to capitalize on the secular trends in embedded finance. For discerning investors, CCB represents an opportunity to participate in the growth of a digitally forward-thinking regional bank that is strategically leveraging technology to drive sustainable value.