omersukrugoksu
Moderate loan growth will likely boost the earnings of Coastal Financial Corporation (NASDAQ:CCB) this year. Further, the margin will likely continue to expand despite the recent deposit mix deterioration. As a result, I’m expecting Coastal Financial’s earnings to grow by a hefty 37% year-over-year to $4.11 per share. Compared to my last report on the company, I haven’t changed my earnings estimate much. The year-end target price suggests a moderate downside from the current market price. Therefore, I’m downgrading Coastal Financial Corporation to a Hold rating.
Regional Economic Factors to Support Loan Growth
Coastal Financial’s loan growth continued to remain at a remarkable level during the first quarter. The portfolio grew by 7.6% in the quarter, or 30.5% annualized, which is at par with the last five-year compounded annual growth rate of 32%. Going forward, loan growth will likely slow down because of higher interest rates which should discourage borrowing.
Further, the outlook for the Banking-as-a-Service (BaaS) division doesn’t seem too bright. I was positive about BaaS in my last report, but the first quarter’s performance has shown that I had overestimated the business’ potential. Deposits from BaaS shrank to $0.0 million by the end of March 2023 from $101.5 million at the end of December 2022, as mentioned in the 10-Q filing.
On the plus side, strength in the regional economy will likely keep loan growth from decelerating too much. Coastal Financial operates in the Puget Sound area of the state of Washington. The state’s labor market had been recovering nicely since the pandemic, but it slipped in the latter part of 2022. However, the last couple of months have seen a significant improvement.
Last year’s faltering is also visible in the state’s economic activity index. Similar to the unemployment rate trend, the regional economy has improved in the first three months of this year.
The Federal Reserve Bank of Philadelphia
Considering these factors, I’m expecting the loan portfolio to grow by 15.9% in 2023. The following table shows my balance sheet estimates.
| Financial Position | FY18 | FY19 | FY20 | FY21 | FY22 | FY23E |
| Net Loans | 758 | 928 | 1,528 | 1,714 | 2,553 | 2,959 |
| Growth of Net Loans | 16.9% | 22.3% | 64.7% | 12.2% | 49.0% | 15.9% |
| Other Earning Assets | 151 | 148 | 173 | 844 | 418 | 508 |
| Deposits | 804 | 968 | 1,421 | 2,364 | 2,818 | 3,333 |
| Borrowings and Sub-Debt | 34 | 32 | 200 | 59 | 53 | 54 |
| Common equity | 109 | 124 | 140 | 201 | 243 | 422 |
| Book Value Per Share ($) | 10.3 | 10.2 | 11.5 | 16.1 | 18.0 | 31.0 |
| Tangible BVPS ($) | 10.3 | 10.2 | 11.5 | 16.1 | 18.0 | 31.0 |
| Source: SEC Filings, Author’s Estimates (In USD million unless otherwise specified) | ||||||
Deposit Mix Deterioration to Slow Down the Margin’s Rate of Expansion
Coastal Financial’s net interest margin expanded by 19 basis points during the first quarter of 2023. This is quite an achievement given the deposit mix actually worsened during the quarter. Non-interest-bearing deposits fell to 24.6% of total deposits by the end of March 2023 from 27.5% at the end of December 2022. The full-quarter impact of the shift in the deposit mix will be felt in the second quarter of 2023.
Fortunately, the asset side is better positioned. Around 58% of Coastal Financial’s assets reprice within three months as of March 31, 2023, according to details given in the earnings presentation. Further, the results of the management’s rate sensitivity analysis show that a 200-basis points hike in rates could increase the net interest income by 7.3% over twelve months.
1Q 2023 10-Q Filing
Considering these factors, I’m expecting the pace of margin growth to slow down compared to the first quarter. I’m expecting the net interest margin to increase by a total of 15 basis points in the last nine months of this year.
Expecting Earnings to Surge by 37%
Earnings of Coastal Financial will most probably surge this year on the back of decent loan growth. Further, the anticipated margin expansion will support earnings. I’m expecting the company to report earnings of $4.11 per share for 2023, up 37% year-over-year. Compared to my last report on the company, I haven’t changed my earnings estimate much. The following table shows my income statement estimates.
| Income Statement | FY18 | FY19 | FY20 | FY21 | FY22 | FY23E |
| Net interest income | 35 | 42 | 57 | 79 | 172 | 233 |
| Provision for loan losses | 2 | 3 | 8 | 10 | 79 | 125 |
| Non-interest income | 5 | 8 | 8 | 28 | 125 | 191 |
| Non-interest expense | 26 | 31 | 38 | 63 | 167 | 228 |
| Net income – Common Sh. | 10 | 13 | 15 | 27 | 41 | 56 |
| EPS – Diluted ($) | 0.91 | 1.08 | 1.24 | 2.16 | 3.01 | 4.11 |
| Source: SEC Filings, Earnings Releases, Author’s Estimates (In USD million unless otherwise specified) | ||||||
Risk Level Appears Low-to-Moderate
Coastal Financial’s risk level doesn’t appear too high despite the problems in the banking sector. Firstly, Coastal’s deposits grew by 9.9% during the first quarter, which shows that the company isn’t at all bothered by deposit runs that have damaged other banks, namely First Republic Bank (OTCPK:FRCB) and SVB Financial (OTC:SIVBQ).
Secondly, uninsured deposits are well covered, so even if there is a deposit run, Coastal Financial will likely emerge unscathed. The company had a combined $969.0 million cash and borrowing capacity at the end of March 2023, which exceeds $768.3 million of uninsured deposits.
Moreover, unrealized mark-to-market losses on the Available-for-Sale securities portfolio were just $2.3 million, or 0.88% of shareholders’ equity as of March 31, 2023, as mentioned in the presentation.
Downgrading to a Hold Rating
Previously I was using the historical average price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Coastal Financial. I’ve now decided to value the company using peer-average multiples because of the current banking crisis. In my opinion, banks will continue to trade below their historical averages until the sector’s elevated riskiness subsides. Once I feel the risk level is closer to normal, I will switch back to using historical multiples.
Coastal Financial’s peers are trading at an average P/TB ratio of 0.88 and an average P/E ratio of 8.4, as shown below.
| CCB | NFBK | FMBH | AMAL | HTBK | LBC | Peer Average | |
| P/E (“ttm”) | 10.60 | 8.14 | 6.75 | 5.43 | 6.46 | 6.59 | 6.67 |
| P/E (“fwd”) | 8.97 | 11.07 | 8.26 | 5.43 | 6.52 | 10.69 | 8.39 |
| P/B (“ttm”) | 1.88 | 0.70 | 0.77 | 0.92 | 0.72 | 0.67 | 0.76 |
| P/TB (“ttm”) | 1.88 | 0.74 | 1.03 | 0.94 | 1.00 | 0.67 | 0.88 |
| Source: Seeking Alpha | |||||||
Multiplying the average P/TB multiple with the forecast tangible book value per share of $31.0 gives a target price of $27.2 for the end of 2023. This price target implies a 23.2% downside from the May 24 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
| P/TB Multiple | 0.68x | 0.78x | 0.88x | 0.98x | 1.08x |
| TBVPS – Dec 2023 ($) | 31.0 | 31.0 | 31.0 | 31.0 | 31.0 |
| Target Price ($) | 21.0 | 24.1 | 27.2 | 30.3 | 33.4 |
| Market Price ($) | 35.4 | 35.4 | 35.4 | 35.4 | 35.4 |
| Upside/(Downside) | (40.7)% | (32.0)% | (23.2)% | (14.4)% | (5.6)% |
| Source: Author’s Estimates |
Multiplying the average P/E multiple with the forecast earnings per share of $4.11 gives a target price of $34.5 for the end of 2023. This price target implies a 2.4% downside from the May 24 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
| P/E Multiple | 6.4x | 7.4x | 8.4x | 9.4x | 10.4x |
| EPS 2023 ($) | 4.11 | 4.11 | 4.11 | 4.11 | 4.11 |
| Target Price ($) | 26.3 | 30.4 | 34.5 | 38.6 | 42.8 |
| Market Price ($) | 35.4 | 35.4 | 35.4 | 35.4 | 35.4 |
| Upside/(Downside) | (25.7)% | (14.1)% | (2.4)% | 9.2% | 20.8% |
| Source: Author’s Estimates |
Equally weighting the target prices from the two valuation methods gives a combined target price of $30.9, which implies a 12.8% downside from the current market price. My updated target price is much below my previous target price as I’ve switched to peer multiples from historical multiples. Based on the updated expected return, I’m downgrading Coastal Financial Corporation stock to a Hold rating.