COASTAL FINANCIAL CORP 10-K

Item 8. Financial Statements and Supplementary Data The information required by this item follows. 101 Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and the Board of Directors of Coastal Financial Corporation Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Coastal Financial Corporation and Subsidiary (the “Company”) as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2022 and 2021, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting in accordance with the standards of the PCAOB. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting in accordance with the standards of the PCAOB. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ Moss Adams LLP Everett, Washington, March 15, 2023 We have served as the Company’s auditor since 2016. 102 Table of Contents COASTAL FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (dollars in thousands) ASSETS December 31, 2022 December 31, 2021 Cash and due from banks $ 32,722 $ 14,496 Interest earning deposits with other banks 309,417 798,665 Investment securities, available for sale, at fair value 97,317 35,327 Investment securities, held to maturity, at amortized cost 1,036 1,296 Other investments 10,555 8,478 Loans receivable 2,627,256 1,742,735 Allowance for loan losses ( 74,029 ) ( 28,632 ) Total loans receivable, net 2,553,227 1,714,103 CCBX credit enhancement asset 53,377 8,712 CCBX receivable 10,416 1,266 Premises and equipment, net 18,213 17,219 Operating lease right-of-use assets 5,018 6,105 Accrued interest receivable 17,815 8,105 Bank-owned life insurance, net 12,667 12,254 Deferred tax asset, net 18,458 6,818 Other assets 4,229 2,673 Total assets $ 3,144,467 $ 2,635,517 LIABILITIES AND SHAREHOLDERS’ EQUITY LIABILITIES Deposits $ 2,817,521 $ 2,363,787 Federal Home Loan Bank ("FHLB") advances — 24,999 Subordinated debt, net Principal amount $ 45,000 and $ 25,000 (less unamortized debt issuance costs of $ 1,001 and $ 712 ) at December 31, 2022 and December 31, 2021, respectively 43,999 24,288 Junior subordinated debentures, net Principal amount $ 3,609 (less unamortized debt issuance costs of $ 21 and $ 23 at December 31, 2022 and December 31, 2021, respectively) 3,588 3,586 Deferred compensation 616 744 Accrued interest payable 684 357 Operating lease liabilities 5,234 6,320 CCBX payable 20,419 1,841 Other liabilities 8,912 8,373 Total liabilities 2,900,973 2,434,295 SHAREHOLDERS’ EQUITY Preferred stock, no par value: Authorized: 25,000,000 shares at December 31, 2022 and December 31, 2021; issued and outstanding: zero shares at December 31, 2022 and December 31, 2021 — — Common stock, no par value: Authorized: 300,000,000 shares at December 31, 2022 and December 31, 2021; 13,161,147 shares at December 31, 2022 issued and outstanding and 12,875,315 shares at December 31, 2021 issued and outstanding 125,830 121,845 Retained earnings 119,998 79,373 Accumulated other comprehensive (loss) income, net of tax ( 2,334 ) 4 Total shareholders’ equity 243,494 201,222 Total liabilities and shareholders’ equity $ 3,144,467 $ 2,635,517 See accompanying Notes to Consolidated Financial Statements. 103 Table of Contents COASTAL FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME (dollars in thousands, except for per share data) Year Ended December 31, 2022 2021 INTEREST AND DIVIDEND INCOME Interest and fees on loans $ 183,352 $ 82,112 Interest on interest earning deposits with other banks 6,728 608 Interest on investment securities 1,745 79 Dividends on other investments 345 284 Total interest income 192,170 83,083 INTEREST EXPENSE Interest on deposits 19,004 2,327 Interest on borrowed funds 1,391 1,319 Total interest expense 20,395 3,646 Net interest income 171,775 79,437 PROVISION FOR LOAN LOSSES 79,064 9,915 Net interest income after provision for loan losses 92,711 69,522 NONINTEREST INCOME Deposit service charges and fees 3,804 3,698 Loan referral fees 810 2,126 Gain on sales of loans, net — 396 Mortgage broker fees 257 920 Unrealized (loss) gain on equity securities, net ( 153 ) 1,469 Gain on sale of bank branch including deposits and loans, net — 1,263 Other income 1,087 939 Noninterest income, excluding BaaS program income and BaaS indemnification income 5,805 10,811 Servicing and other BaaS fees 4,408 4,467 Transaction fees 3,211 544 Interchange fees 2,583 701 Reimbursement of expenses 2,732 1,004 BaaS program income 12,934 6,716 BaaS credit enhancements 76,374 9,086 BaaS fraud enhancements 29,571 1,505 BaaS indemnification income 105,945 10,591 Total noninterest income 124,684 28,118 NONINTEREST EXPENSE Salaries and employee benefits 52,228 37,101 Occupancy 4,548 4,128 Data processing and software licenses 6,487 4,951 Legal and professional expenses 6,760 3,133 Point of sale expense 2,109 671 Excise taxes 2,204 1,589 Federal Deposit Insurance Corporation ("FDIC") assessments 2,859 1,632 Director and staff expenses 1,711 1,205 Marketing 351 451 Other expense 4,652 3,921 Noninterest expense, excluding BaaS loan and BaaS fraud expense 83,909 58,782 BaaS loan expense 53,294 2,976 BaaS fraud expense 29,571 1,505 BaaS loan and fraud expense 82,865 4,481 Total noninterest expense 166,774 63,263 Income before provision for income taxes 50,621 34,377 PROVISION FOR INCOME TAXES 9,996 7,372 104 Table of Contents NET INCOME $ 40,625 $ 27,005 Basic earnings per common share $ 3.14 $ 2.25 Diluted earnings per common share $ 3.01 $ 2.16 Weighted average number of common shares outstanding: Basic 12,949,266 12,022,954 Diluted 13,514,952 12,521,426 See accompanying Notes to Consolidated Financial Statements. 105 Table of Contents COASTAL FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (dollars in thousands) Year Ended December 31, 2022 2021 NET INCOME $ 40,625 $ 27,005 OTHER COMPREHENSIVE LOSS, before tax Securities available-for-sale Unrealized holding (loss) income during the period ( 2,959 ) ( 38 ) Income tax benefit related to unrealized holding loss 621 8 OTHER COMPREHENSIVE LOSS, net of tax ( 2,338 ) ( 30 ) COMPREHENSIVE INCOME $ 38,287 $ 26,975 See accompanying Notes to Consolidated Financial Statements. 106 Table of Contents COASTAL FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (dollars in thousands) Shares of Common Stock Amount of Common Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Total BALANCE, December 31, 2020 11,954,327 $ 87,815 $ 52,368 $ 34 $ 140,217 Net income — — 27,005 — 27,005 Issuance of restricted stock awards 10,714 — — — — Vesting of restricted stock units 7,851 — — — — Exercise of stock options 50,570 359 — — 359 Stock-based compensation — 1,284 — — 1,284 Stock issuance and net proceeds from public offering 851,853 32,387 — — 32,387 Other comprehensive loss, net of tax — — — ( 30 ) ( 30 ) BALANCE, December 31, 2021 12,875,315 $ 121,845 $ 79,373 $ 4 $ 201,222 BALANCE, December 31, 2021 12,875,315 $ 121,845 $ 79,373 $ 4 $ 201,222 Net income — — 40,625 — 40,625 Issuance of restricted stock awards 10,396 — — — — Vesting of restricted stock units 28,215 — — — — Exercise of stock options 247,221 1,468 — — 1,468 Stock-based compensation — 2,517 — — 2,517 Other comprehensive loss, net of tax — — — ( 2,338 ) ( 2,338 ) BALANCE, December 31, 2022 13,161,147 $ 125,830 $ 119,998 $ ( 2,334 ) $ 243,494 See accompanying Notes to Consolidated Financial Statements. 107 Table of Contents COASTAL FINANCIAL CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (dollars in thousands) Year Ended December 31, 2022 2021 CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 40,625 $ 27,005 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 79,064 9,915 Depreciation and amortization 1,809 1,587 Loss on disposition of fixed assets 35 — Decrease in operating lease right-of-use assets 1,087 1,056 Decrease in operating lease liabilities ( 1,086 ) ( 1,044 ) Gain on sales of loans — ( 396 ) Net (discount accretion)/premium amortization on investment securities ( 50 ) 32 Unrealized holding loss (gain) on equity investment 153 ( 1,469 ) Stock-based compensation 2,517 1,284 Gain on sale of bank branch, including deposits and loans — ( 1,263 ) Increase in bank-owned life insurance value ( 360 ) ( 172 ) Deferred tax benefit ( 11,018 ) ( 3,011 ) Net change in CCBX receivable ( 9,150 ) ( 1,096 ) Net change in CCBX credit enhancement asset ( 44,665 ) ( 8,712 ) Net change in CCBX payable 18,578 1,841 Net change in other assets and liabilities ( 10,441 ) 4,290 Total adjustments 26,473 2,842 Net cash provided by operating activities 67,098 29,847 CASH FLOWS FROM INVESTING ACTIVITIES Purchase of investment securities available for sale ( 134,912 ) ( 117,493 ) Change in other investments, net ( 2,230 ) ( 950 ) Principal paydowns of investment securities available-for-sale 17 33 Principal paydowns of investment securities held-to-maturity 256 1,515 Maturities and calls of investment securities available-for-sale 70,000 102,500 Purchase of bank owned life insurance ( 53 ) ( 5,000 ) Proceeds from sales of loans held for sale 152,546 — Proceeds from sales of loan participations 10,300 — Purchase of loans ( 168,464 ) ( 60,260 ) Purchase of loan participations ( 52 ) — Proceeds from sale of loans related to sale of bank branch — 4,092 Increase in loans receivable, net ( 912,518 ) ( 141,503 ) Net cash transfer for branch sale — ( 19,980 ) Purchases of premises and equipment, net ( 2,838 ) ( 2,593 ) Net cash used by investing activities ( 987,948 ) ( 239,639 ) CASH FLOWS FROM FINANCING ACTIVITIES Net increase in demand deposits, NOW and money market, and savings 467,744 980,766 Net decrease in time deposits ( 14,010 ) ( 14,223 ) Net repayment from long term FHLB borrowing ( 24,999 ) — Increase from subordinated debt proceeds 19,625 24,263 Decrease from subordinated debt repayment — ( 10,000 ) Net advances from Paycheck Protection Program Liquidity Facility — ( 153,716 ) Proceeds from exercise of stock options 1,468 359 Proceeds from public offering — 32,387 Net cash provided by financing activities 449,828 859,836 NET CHANGE IN CASH, DUE FROM BANKS AND RESTRICTED CASH ( 471,022 ) 650,044 CASH, DUE FROM BANKS AND RESTRICTED CASH, beginning of year 813,161 163,117 CASH, DUE FROM BANKS AND RESTRICTED CASH, end of year $ 342,139 $ 813,161 SUPPLEMENTAL SCHEDULE OF OPERATING AND INVESTING ACTIVITIES Interest paid $ 20,068 $ 3,820 Income taxes paid $ 23,498 $ 8,759 SUPPLEMENTAL SCHEDULE OF NONCASH TRANSACTIONS Fair value adjustment of securities available-for-sale, gross $ ( 2,959 ) $ ( 37 ) In conjunction with ASU 2016-02 as detailed in Note 6 to the Unaudited Consolidated Financial Statements, the following assets and liabilities were recognized: Operating lease right-of-use assets $ — $ 41 Operating lease liabilities $ — $ ( 41 ) Transfer from loans to loans held for sale $ 152,546 $ — See accompanying Notes to Consolidated Financial Statements. 108 Table of Contents COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Description of Business and Summary of Significant Accounting Policies Nature of operations - Coastal Financial Corporation (“Corporation” or “Company”) is a registered bank holding company whose wholly owned subsidiaries are Coastal Community Bank (“Bank”) and Arlington Olympic LLC. 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 2020 and owns the Arlington branch, which the Bank leases from the LLC. The Company operates through the Bank and is headquartered in Everett, Washington, which by population is the largest city in, and the county seat of, Snohomish County. The Company’s business is conducted through two reportable segments: The community bank and CCBX. The community bank offers a full range of banking services to small and medium-sized businesses, professionals, and individuals throughout the greater Puget Sound region through its 14 branches in Snohomish, Island and King Counties, the Internet, and its mobile banking application. The Company also has a CCBX segment which provides Banking as a Service (“BaaS”) enabling broker dealers and digital financial service providers to offer their clients banking services. Through CCBX’s partners the Company is able to offer banking services and products across the nation. The Bank’s deposits are insured in whole or in part by the Federal Deposit Insurance Corporation (“FDIC”). The community bank’s loans and deposits are primarily within the greater Puget Sound region, while CCBX loans and deposits are dependent upon the partner’s market. The Bank’s primary funding source is deposits from customers. The Bank is subject to regulation and supervision by the Board of Governors of the Federal Reserve System and the Washington State Department of Financial Institutions Division of Banks. The Federal Reserve also has regulatory and supervisory authority over the Company. Financial statement presentation - The accompanying audited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for reporting requirements and practices within the banking industry. Amounts presented in the consolidated financial statements and footnote tables are rounded and presented in thousands of dollars except per-share amounts, which are presented in dollars. In the narrative footnote discussion, amounts are rounded to thousands and presented in dollars. In management’s opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations on the accompanying consolidated financial statements have been made. These adjustments include normal and recurring accruals considered necessary for a fair and accurate presentation. Principles of consolidation - The consolidated financial statements include the accounts of the Company, the Bank and the LLC. All significant intercompany accounts have been eliminated in consolidation. Estimates - The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management believes that its critical accounting estimates include determining the allowance for loan losses, the fair value of the Company’s financial instruments, and the valuation of deferred tax assets, financial instruments, and other fair value measurements. Actual results could differ significantly from those estimates. Subsequent Events - The Company has evaluated events and transactions subsequent to December 31, 2022 for potential recognition or disclosure. On January 31, 2023 the Company extended its lease agreement for the Everett location. This renewal was for less square footage, at reduced monthly expense and was extended for an additional ten years. As discussed in Note 6, this facility is leased from a group of investors, one of which is a director. Cash equivalents and cash flows - For purposes of reporting cash flows, cash and cash equivalents include cash on hand and in banks and interest-bearing deposits. All have original maturities of three months or less. CDs with other financial institutions, federal funds sold and cash flows from loans and deposits are reported as net increases or decreases under cash flows from investing activities or from financing activities. 109 Table of Contents The Company maintains its cash in depository institution accounts, which, at times, may exceed federally insured limits. The Company monitors these institutions and has not experienced any losses in such accounts. Investment securities - Debt securities that management has the ability and intent to hold to maturity are classified as held-to-maturity and carried at amortized cost. The amortization of premiums and accretion of discounts are recognized in interest income using the interest method or methods approximating the interest method over the period to maturity. Debt securities not classified as held-to-maturity are classified as available-for-sale. Such securities may be sold to facilitate the Company’s asset/liability management strategies and in response to changes in interest rates and similar forces. Securities available-for-sale are carried at fair value with unrealized gains and losses reported in other comprehensive income. Realized gains (losses) on securities available-for-sale are included in noninterest income and, when applicable, are reported as a reclassification adjustment in other comprehensive income. Gains and losses on sales of securities are recorded on the trade date and are determined on the specific-identification method. Declines in the fair value of individual held-to-maturity and available-for-sale securities below their amortized cost that are other than temporary result in write-downs of the individual securities to their fair value. The related write-downs are included in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Other investments - Other investments on the balance sheet consists of direct equity investments in stock of the Federal Home Loan Bank of Des Moines (“FHLB”), the Federal Reserve Bank of San Francisco (“FRB”), Pacific Coast Banker’s Bancshares, as well as investments in bank technology funds. As a Federal Reserve member bank, the Bank is required to own stock in the FRB in an amount based on the Bank’s capital. The recorded amount of the FRB stock equals its fair value because the shares can only be redeemed by the FRB at their par value. The Bank’s investment in FRB stock was $ 4.3 million and $ 2.8 million at December 31, 2022 and 2021, respectively. The Bank, as a member of the FHLB, is required to maintain an investment in capital stock of FHLB in an amount equal to 4 % of advances outstanding, plus 0.12 % of total assets from the prior fiscal year end. The recorded amount of FHLB stock equals its fair value because the shares can only be redeemed by FHLB at the $ 1 per share par value. The investment in FHLB stock was $ 3.2 million and $ 3.1 million at December 31, 2022 and 2021, respectively. The investment in Pacific Coast Banker’s Bancshares (“PCBB”) stock consists of an equity security. This investment is carried at its cost of $ 100,000 at December 31, 2022 and 2021, which approximates its fair value. The Company has the following equity investments which do not have a readily determinable fair value and are held at cost minus impairment if any, plus or minus observable price changes in orderly transactions for an identical or similar investment of the same issuer. This method will be applied until the investments do 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 investments without a readily determinable fair value qualifies to be measured at cost minus impairment. These equity investments without a readily determined fair value include: • As of December 31, 2022 and December 31, 2021 the Company has a $ 2.2 million equity interest in a specialized bank technology company. During the year ended December 31, 2021, the Company reassessed the value and recognized a $ 1.5 million unrealized holding gain as a result of an observable price change. • During the year ended December 31, 2022 the Company re-evaluated the value and recorded an impairment of $ 100,000 on a $ 500,000 equity investment in a technology company that was valued at $ 100,000 on December 31, 2021, bringing the carrying value to zero as of December 31, 2022. This investment has been written off and is no longer carried on the Company’s books. • The Company contributed $ 350,000 in a technology company during the year ended December 31, 2022. There was no equity ownership in this company as of December 31, 2021. 110 Table of Contents The following table shows the activity in equity investments without a readily determinable fair value for the dates shown: For the Twelve Months Ended December 31, (dollars in thousands) 2022 2021 Carrying value, beginning of period $ 2,322 $ 850 Purchases 350 — Observable price change ( 100 ) 1,472 Carrying value, end of period $ 2,572 $ 2,322 The Company has invested in funds that are accelerating technology for adoption by banks. These equity investments are held at fair value, as reported by the funds. During the year ended December 31, 2022, the Company contributed $ 349,000 with investment funds designed to help accelerate technology adoption at banks, and recognized net losses of $ 53,000 , resulting in an equity interest of $ 456,000 at December 31, 2022. The Company has committed up to $ 988,000 in capital for these equity funds. The following table shows the activity in equity fund investments held at fair value for the dates shown: For the Twelve Months Ended December 31, (dollars in thousands) 2022 2021 Carrying value, beginning of period $ 160 $ — Purchases/capital calls, net 349 163 Net change recognized in earnings ( 53 ) ( 3 ) Carrying value, end of period $ 456 $ 160 Loans and allowance for loan losses – Loans are stated at the principal amount outstanding less the allowance for loan losses and net of any deferred fees or costs on originated loans, and unamortized premiums or discounts on purchased loans. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the level yield methodology and a method that approximates the level yield methodology. Interest income on loans is recognized based upon the principal amounts outstanding. The accrual of interest on community bank loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due or when they are 90 days past due as to either principal or interest, unless they are well secured and in the process of collection. When interest accrual is discontinued, all unpaid accrued interest is reversed against current income. If management determines that the ultimate collectability of principal or interest is in doubt, cash receipts on nonaccrual loans are applied to reduce the principal balance on a cash-basis method, until the loans qualify for return to accrual status or principal is paid in full. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current, borrower has demonstrated ability to make regular payments, generally a period of at least six months, and future payments are reasonably assured. For installment/closed-end, and revolving/open-end consumer loans originated through CCBX lending partners loans will accrue interest until 120 and 180 days past due, respectively, which is consistent with regulatory guidelines for consumer loans of this nature, and an allowance is recorded through provision expense for these probable incurred losses. For installment/closed-end and revolving/open-end consumer loans originated through CCBX lending partners with balances outstanding beyond 120 days and 180 days, respectively, principal and capitalized interest outstanding is charged off against the allowance and accrued interest outstanding is reversed against interest income. The allowance for loan losses is comprised of amounts charged against income in the form of the provision for loan losses, less charged-off loans, net of recoveries. When available information confirms that specific loans or portions thereof are uncollectible, identified amounts are charged against the allowance for loan losses. The existence of some or all of the following criteria will generally confirm that a loss has been incurred: (1) the loan is significantly delinquent and the borrower has not demonstrated the ability or intent to bring the loan current; (2) the Company has no recourse to the borrower or if it does, the borrower has insufficient assets to pay the debt; (3) the estimated fair value of the loan collateral 111 Table of Contents is significantly below the current loan balance; and (4) there is little or no near-term prospect for improvement. Subsequent recoveries, if any, are credited to the allowance for loan losses. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance consists of specific and general components. The specific component relates to loans that are determined to be impaired. For such loans (including troubled debt restructurings), an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers various loans and is based on the probability of default and loss given default, type of loan, peer information, risk rating and adjusted for 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. Community bank and CCBX loans are assessed at either the individual loan level or pooled, depending on loan type and characteristics of the loan. Consumer loans and smaller balance loans are typically assessed as homogeneous loan pools. Based on management’s analysis, the Company records a provision for loan losses to maintain the allowance at appropriate levels. CCBX lending partners originate various loan types, and as of December 31, 2022, include consumer, commercial and home equity loans. CCBX consumer loans typically have a higher level of expected losses than community bank loans which is reflected in the higher loss factors for the allowance for loan losses. Estimated loss rates for CCBX loans vary by partner, and might be based on actual partner experience, realized losses or losses for comparable products, industry averages, or the Company’s loss rate for similar loans. Many of the agreements with our CCBX partners provide for a credit enhancement which helps protect the Bank by absorbing incurred losses. CCBX credit enhancements are free-standing and are accounted separately from the allowance for loan loss. In accordance with accounting guidance, we estimate and record a provision for probable losses for these CCBX loans, without regard to the credit enhancement. When the provision for loan losses is recorded, a free-standing credit enhancement asset is recorded on the balance sheet through noninterest income (BaaS fees -credit enhancement). Charge-offs of CCBX partner loans are recorded against the allowance for loan losses. When collected from the credit enhancement cash reserve account or the CCBX partner, the credit enhancement asset is relieved. If a CCBX lending partner is unable to fulfill its contractual obligations under the credit enhancement, then the Bank would be exposed to additional loan losses as a result of this counterparty risk and would have to absorb any loan losses associated with the CCBX partner that cannot fulfill its contractual obligations. Management believes the balance would be recoverable in the event of bankruptcy of the partner, but there are no guarantees that bankruptcy court will rule in the Company’s favor. Additionally, CCBX partners are required to maintain and/or regularly replenish funding in their cash reserve accounts. Credit-worthiness of CCBX partners are evaluated as part of initial due diligence and quarterly thereafter. The Company has not incurred any counterparty losses to date. A community bank loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral-dependent. CCBX loans are treated as homogenous pools and are not subject to individual impairment analysis. A troubled debt restructuring (“TDR”) is a loan for which the Company, for reasons related to the borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider. TDRs are individually evaluated for impairment and included in the separately identified impairment disclosures. TDRs are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a TDR is considered to be a collateral-dependent loan, the loan is reported, net, at the fair value of the collateral. For TDRs that subsequently default, 112 Table of Contents the Company determines the amount of allowance on that loan in accordance with the accounting policy for the allowance for loan losses on loans individually identified as impaired. The Company incorporates recent historical experience with TDRs including the performance of TDRs that subsequently default into the calculation of the allowance by loan portfolio segment. Loans held-for-sale - During the year ended December 31, 2022, the Company transferred $ 152.5 million in CCBX loans receivable to loans held for sale. These CCBX loans held for sale consist of the portion of loans originated by CCBX partners that the Company intends to sell back to the CCBX partner or affiliated entity generally at par. The loans sold to the originating partners are in accordance with partner agreements and are sold for credit risk and concentration management and other purposes. As of December 31, 2022 and 2021 there were no loans held for sale. Community bank loans held-for-sale consist of the guaranteed portion of SBA loans and USDA loans the Company intends to sell after origination and are reflected at the lower of aggregate cost or fair value. Loans are generally sold with servicing of the sold portion retained by the Company when the sale of the loan occurs, the premium received is combined with the estimated present value of future cash flows on the related servicing asset and recorded as a gain on sale of loans in noninterest income. There were no loans held for sale at December 31, 2022 and 2021. Loan sales recognition - The Company recognizes a sale on loans if the transferred portion (or portions) and any portion that continues to be held by the transferor are participating interests. Participating interest is defined as a portion of a financial asset that (a) conveys proportionate ownership rights with equal priority to each participating interest holder, (b) involves no recourse (other than standard representations and warranties), and (c) does not entitle any participating interest holder to receive cash before any other participating interest holder. The transfer of the participating interest (or participating interests) must also meet the conditions for surrender of control. To determine the gain or loss on sale of loans, the Company’s investment in the loan is allocated among the retained portion of the loan, the servicing retained, and the sold portion of the loan, based on the relative fair market value of each portion. The gain or loss on the sold portion of the loan is based on the difference between the sale proceeds and the allocated investment in the sold portion of the loan. A discount is recorded against the carrying value of the retained portion of the loan to offset the fair value allocation of said retained portion. The Company retains the servicing on the sold guaranteed portion of SBA and USDA loans. The Company receives a fee for servicing the loan. The Company also retains the servicing on the sold guaranteed portion of MSLP loans. The net deferred fee on the sold portion of the loan is recognized when sold. The Company does not retain the servicing on sold CCBX loans. SBA and USDA servicing - The Company accounts for SBA and USDA servicing rights as separately recognized servicing rights and initially measures them at fair value. Fair value is based on market prices for comparable servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The Company subsequently measures each SBA and USDA servicing asset using the amortization method. Under the amortization method, servicing assets are amortized into noninterest income in proportion to, and over the period of, estimated net servicing income. The amortized assets are assessed for impairment or increased obligations, at the loan level, based on the fair value of each reporting date. As of December 31, 2022 and 2021, SBA and USDA servicing assets totaled $ 183,000 and $ 269,000 , respectively, and are included in other assets on the consolidated balance sheets, and SBA and USDA loans serviced totaled $ 14.3 million and $ 19.3 million, as of December 31, 2022 and 2021 respectively. Reserve for unfunded commitments - A reserve for unfunded commitments is maintained at a level that, in the opinion of management, is adequate to absorb probable losses associated with the Company’s commitment to lend funds under existing agreements, such as letters or lines of credit. Management determines the adequacy of the reserve for unfunded commitments based on review of individual credit facilities, current economic conditions, and risk characteristics of the various categories of commitments and other relevant factors. The reserve is based on estimates, and ultimate losses may vary from the current estimates. These estimates are evaluated on a regular basis and adjustments are reported in earnings in the periods in which they become known. Draws on unfunded commitments that are considered uncollectible at the time funds are advanced are charged to the allowance for loan losses. Provision for unfunded commitments losses are added to the reserve for unfunded commitments, which is included in the other liabilities section of the consolidated balance sheets. The reserve for unfunded commitments was $ 974,000 and $ 1.3 million as of December 31, 2022 and 2021, respectively, and includes a reserve for community bank loans and CCBX loans. The Company has determined that no allowance is necessary for the portion of the unfunded commitment of the loan portfolio that is unconditionally cancelable. 113 Table of Contents Additionally, agreements with our CCBX partners provide for a credit enhancement against losses. When the provision for unfunded commitments is recorded, a credit enhancement asset is also recorded on the consolidated balance sheet through noninterest income (BaaS fees -credit enhancement). Any incurred losses would be recorded in the allowance for loan losses, and as the credit enhancement recoveries are received from the CCBX partner, the credit enhancement asset on the balance sheet is relieved. Premises and equipment - Premises and equipment are stated at cost less accumulated depreciation. Depreciation expense is computed using the straight-line method based upon the estimated useful lives of the assets. Asset lives range from three to thirty-nine years . Leasehold improvements are amortized over the expected term of the lease or the estimated useful life of the improvement, whichever is less. Maintenance and repairs are charged to operating expenses. Renewals and betterments are added to the asset accounts and depreciated over the periods benefited. Depreciable assets sold or retired are removed from the asset and related accumulated depreciation accounts and any gain or loss is reflected in the income statement. These assets are reviewed for impairment when events indicate their carrying value may not be recoverable. If management determines impairment exists, the asset is reduced with an offsetting charge to the income statement. Transfers of financial assets - Transfers of an entire financial asset are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) a group of financial assets or a participating interest in an entire financial asset has been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Other real estate owned and repossessed assets - Other real estate owned and repossessed assets are foreclosed property held pending disposition and are initially recorded at fair value less estimated selling costs when acquired, establishing a new cost basis. At foreclosure, if the fair value of the asset acquired less estimated selling costs is less than the Company’s recorded investment in the related loan, a write-down is recognized through a charge to the allowance for loan losses. Costs of significant property improvements that increase the value of the property are capitalized, whereas costs relating to holding the property are expensed. Valuations are periodically performed by management, and a valuation allowance is established for subsequent declines, which are recorded as a charge to income, if necessary, to reduce the carrying value of the property to its fair value less estimated selling costs. Leases - The Company accounts for its leases in accordance with ASC 842 - Leases . Most leases are recognized on the balance sheet by recording a right-of-use asset and lease liability for each lease. The right-of-use asset represents the right to use the asset under lease for the lease term, and the lease liability represents the contractual obligation to make lease payments. The right-of-use asset is tested for impairment whenever events or changes in circumstances indicate the carrying amount may not be recoverable. As a lessee, the Company enters into operating leases for certain Bank branches. The right-of-use assets and lease liabilities are initially recognized based on the net present value of the remaining lease payments which include renewal options where the Company is reasonably certain they will be exercised. The net present value is determined using the incremental collateralized borrowing rate at commencement date. The right-of-use asset is measured at the amount of the lease liability adjusted for any prepaid rent, lease incentives and initial direct costs incurred. The right-of-use asset and lease liability is amortized over the individual lease terms. Lease expense for lease payments is recognized on a straight-line basis over the lease term. For additional information regarding leases, see Note 6. Income taxes - The Company and the Bank file a consolidated federal income tax return and state tax returns as applicable. Deferred income taxes result from temporary differences between the tax basis of assets and liabilities, and their reported amounts in the financial statements. Deferred taxes are temporary differences that will be recognized in future periods. As changes in tax law or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Federal taxes are paid by the Bank to the Company based on the separate taxable income of the Bank. The Company and Bank maintain their records on the accrual basis of accounting for financial reporting and for income tax reporting purposes. As of December 31, 2022 and 2021, the Company had no unrecognized income tax benefits. The Company recognizes interest accrued and penalties related to unrecognized tax benefits in other noninterest expense. There were no interest and penalties assessed on income taxes during 2022 or 2021. 114 Table of Contents Stock-based compensation - Compensation expense is recognized for stock options and restricted stock, based on the fair value of these awards at the grant date. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the grant date is used for restricted stock awards and restricted stock units and is determined on the basis of objective criteria including trade data. Compensation cost is recognized over the requisite service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. Earnings per common share - Earnings per common share (“EPS”) is computed under the two-class method. Pursuant to the two-class method, nonvested stock based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and are included in the computation of EPS. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. Application of the two-class method resulted in the equivalent earnings per share to the treasury method. Basic earnings per common share is computed by dividing net earnings allocated to common shareholders by the weighted-average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Diluted earnings per common share is computed using the weighted-average number of shares determined for the basic earnings per common share computation plus the dilutive effect of stock using the treasury stock method. Stock options that are anti-dilutive are not included in the calculation of diluted EPS. Comprehensive income - Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale investments, are reported as a separate component of the shareholders’ equity section of the balance sheets. Accumulated other comprehensive income consists of only one component: unrealized gains or losses on investment securities available-for-sale. Business Segments – For financial reporting purposes, the Company has two segments: The community bank and CCBX. The community bank business is that of a traditional banking institution, gathering deposits and originating loans for portfolio in its market areas. The community bank offers a wide variety of deposit products to their customers. Lending activities include the origination of real estate, commercial and industrial, and consumer loans. Interest income on loans is the Company’s primary source of revenue, and is supplemented by interest income from investment securities, deposit service charges, and other service provided activities. In addition to traditional banking services the Company also has a CCBX segment which provides BaaS offerings that enable broker dealers and digital financial service providers to offer their clients banking services. The performance of the Company is reviewed and monitored by the Company’s executive management on a daily basis and the Board of Directors reviews and monitors the performance of the Company at minimum, on a monthly basis. For additional information regarding the business segments, see Note 21. Advertising costs - Advertising costs are expensed as incurred or over the period of the campaign/promotion. Advertising costs in the amount of $ 351,000 and $ 451,000 were expensed during the year ended December 31, 2022 and 2021, respectively . Reclassifications - Certain amounts reported in prior years' consolidated financial statements have been reclassified to conform to the current presentation with no effect on shareholders’ equity or net income. Note 2 - Recent accounting standards Recent Accounting Guidance Not Yet Effective In September 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments . The amendments replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendment is effective for annual periods beginning after December 15, 2020 and interim period within those annual periods. Our implementation was effective January 1, 2023 and was determined when we were a smaller reporting company. The Company is in the final steps of implementing a CECL allowance model which calculates reserves over the life of the loan and is largely driven by portfolio characteristics, economic outlook, and other key methodology assumptions versus the current accounting practice that utilizes the incurred loss model. The adoption of this ASU will result in a one-time cumulative-effect adjustment to the allowance for loan losses as of the day of adoption. The Company currently estimates a combined 115 Table of Contents increase to our allowance for credit losses and reserve for unfunded loan commitments from 3 % to 10 %. This change will decrease the opening retained earnings balance as of January 1, 2023. The above range is disclosed due to the fact that the Company is still in the process of finalizing the CECL allowance model, including the review of assumptions related to qualitative adjustments and economic forecasts; finalizing the execution of internal controls; and evaluating the impact to our financial statement disclosures. The Company does not expect a material allowance for credit losses to be recorded on its available-for-sale debt securities for losses expected over the life of the security under the newly codified available-for-sale debt security impairment model, as the majority of these securities are government agency-backed securities for which the risk of credit loss is minimal. In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting , to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls reference rate reform, if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. The amendments in this ASU are effective for all entities upon issuance through December 31, 2022. The Company expects to be able to use other expedients in this guidance to manage through the transition away from LIBOR, specifically as they relate to loans and borrowing relationships. The adoption of this accounting guidance is not expected to have a material impact on the Company’s consolidated financial statements. In March 2022, the FASB issued ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. The ASU eliminates the accounting guidance for TDR loans by creditors while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. Additionally, the ASU requires public business entities to disclose current-period gross write-offs by year of origination for financing receivables and net investments in leases. This ASU is effective upon adoption of ASU 2016-13. The Company is in the process of implementing this ASU and evaluating the impact adoption will have on the Company’s consolidated financial statement disclosures. 116 Table of Contents Note 3 - Investment Securities The amortized cost and fair values of investment securities at the date indicated are as follows: Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (dollars in thousands) December 31, 2022 Available-for-sale U.S. Treasury securities $ 99,967 $ — $ ( 2,952 ) $ 97,015 U.S. Agency collateralized mortgage obligations 54 — ( 3 ) 51 U.S. Agency residential mortgage-backed securities 1 — — 1 Municipal bonds 250 — — 250 Total available-for-sale securities 100,272 — ( 2,955 ) 97,317 Held-to-maturity U.S. Agency residential mortgage-backed securities 1,036 — ( 120 ) 916 Total investment securities $ 101,308 $ — $ ( 3,075 ) $ 98,233 Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value (dollars in thousands) December 31, 2021 Available-for-sale U.S. Treasury securities $ 34,999 $ — $ ( 1 ) $ 34,998 U.S. Agency collateralized mortgage obligations 68 2 — 70 U.S. Agency residential mortgage-backed securities 3 — — 3 Municipal bonds 252 4 — 256 Total available-for-sale securities 35,322 6 ( 1 ) 35,327 Held-to-maturity U.S. Agency residential mortgage-backed securities 1,296 52 — 1,348 Total investment securities $ 36,618 $ 58 $ ( 1 ) $ 36,675 The amortized cost and fair value of debt securities at December 31, 2022, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers in mortgage backed securities or 117 Table of Contents obligations may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities and collateralized mortgage obligations are shown separately, since they are not due at a single maturity date. Available-for-Sale Held-to-Maturity Amortized Cost Fair Value Amortized Cost Fair Value (dollars in thousands) December 31, 2022 Amounts maturing in One year or less $ 250 $ 250 $ — $ — After one year through five years 99,967 97,016 — — 100,217 97,266 — — U.S. Agency residential mortgage-backed securities and collateralized mortgage obligations 55 51 1,036 916 $ 100,272 $ 97,317 $ 1,036 $ 916 Investment securities with amortized cost of $ 37.8 million and $ 36.0 million at December 31, 2022 and December 31, 2021 respectively, were pledged to secure public deposits and for other purposes as required or permitted by law. During the year ended December 31, 2022, a total of five U.S. Treasury Bills were purchased for a total of $ 135.0 million, to replace maturing securities and to pledge as security for public deposits, and $ 70.0 million in U.S. Treasury securities matured during the year ended December 31, 2022. There were no sales of investments during the year ended December 31, 2022 or December 31, 2021. Information pertaining to securities with gross unrealized losses at the dates indicated, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows: Less Than 12 Months 12 Months or Greater Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses (dollars in thousands) December 31, 2022 Available-for-sale U.S. Treasury securities $ 97,015 $ 2,952 $ — $ — $ 97,015 $ 2,952 U.S. Agency collateralized mortgage obligations 50 3 — — 50 3 Total available-for-sale securities 97,065 2,955 — — 97,065 2,955 Held-to-maturity U.S. Agency residential mortgage-backed securities 916 120 — — 916 120 Total investment securities $ 97,981 $ 3,075 $ — $ — $ 97,981 $ 3,075 At December 31, 2022 and December 31, 2021, there were six and four securities, respectively, in an unrealized loss position. Unrealized losses have not been recognized into income because management does not intend to sell and does not expect it will be required to sell the investments. The decline is largely due to changes in market conditions and interest rates, rather than credit quality. The fair value is expected to recover as the underlying securities in the portfolio approach maturity date and market conditions improve. The Company does not consider these securities to be other than temporarily impaired at December 31, 2022. 118 Table of Contents Note 4 - Loans and Allowance for Loan Losses (“ALLL”) The composition of the loan portfolio is as follows as of the periods indicated: December 31, December 31, 2022 2021 (dollars in thousands) Commercial and industrial loans $ 312,628 $ 419,060 Real estate loans: Construction, land, and land development 214,055 183,594 Residential real estate 449,157 204,389 Commercial real estate 1,048,752 835,587 Consumer and other loans 608,771 108,871 Gross loans receivable 2,633,363 1,751,501 Net deferred origination fees and premiums ( 6,107 ) ( 8,766 ) Loans receivable $ 2,627,256 $ 1,742,735 Included in commercial and industrial loans is $ 146.0 million and $ 202.9 million in capital call lines, as of December 31, 2022 and December 31, 2021, respectively, 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. Also included in commercial and industrial loans are Paycheck Protection Program (“PPP”) loans of $ 4.7 million and $ 111.8 million at December 31, 2022 and December 31, 2021, respectively. PPP loans are 100 % guaranteed by the SBA. Consumer and other loans includes overdrafts of $ 2.7 million and $ 1.3 million at December 31, 2022 and December 31, 2021, respectively. Community bank overdrafts were $ 94,000 and $ 13,000 at December 31, 2022 and December 31, 2021, respectively and CCBX overdrafts were $ 2.6 million and $ 1.3 million at December 31, 2022 and December 31, 2021, respectively. The Company has pledged loans totaling $ 220.1 million and $ 183.5 million at December 31, 2022 and December 31, 2021, respectively, for borrowing lines at the FHLB and FRB. The balance of SBA and USDA loans and participations serviced for others totaled $ 14.3 million and $ 19.3 million at December 31, 2022 and December 31, 2021, respectively. The balance of Main Street Lending Program (“MSLP”) loans participated and serviced for others totaled $ 58.0 million and $ 56.3 million at December 31, 2022 and December 31, 2021, respectively, with $ 3.1 million and $ 4.8 million outstanding and included in commercial and industrial loans as of December 31, 2022 and December 31, 2021, respectively. The Company, at times, purchases individual loans through the community bank at fair value as of the acquisition date. The Company held purchased loans with remaining balances totaled $ 9.6 million and $ 12.8 million as of December 31, 2022 and December 31, 2021, respectively. Unamortized premiums totaled $ 167,000 and $ 223,000 as of December 31, 2022 and December 31, 2021, respectively, and are amortized into interest income over the life of the loans. These loans are included in the applicable loan category depending upon the collateral and purpose of the individual loan. The Company has purchased participation loans with remaining balances totaling $ 63.9 million and $ 27.9 million as of December 31, 2022 and December 31, 2021, respectively. These loans are included in the applicable loan category depending upon the collateral and purpose of the individual loan. The Company purchased loans from CCBX partners, at par, through agreements with those CCBX partners, and those loans had a remaining balance of $ 157.4 million as of December 31, 2022 and $ 59.7 million as of December 31, 2021. As of December 31, 2022, $ 146.1 million is included in consumer and other loans and $ 11.3 million is included in commercial and industrial loans, compared to $ 59.4 million in consumer and other loans and $ 281,000 in commercial and industrial loans as of December 31, 2021. 119 Table of Contents The following is a summary of the Company’s loan portfolio segments: Commercial and industrial loans - Commercial and industrial loans are secured by business assets including inventory, receivables and machinery and equipment of businesses located generally in the Company’s primary market area and capital calls on venture and investment funds. Also included in commercial and industrial loans are $ 14.9 million in unsecured loans originated through CCBX partners as of December 31, 2022, compared to zero as of December 31, 2021. Loan types include PPP loans, revolving lines of credit, term loans, and loans secured by liquid collateral such as cash deposits or marketable securities. Also included in commercial and industrial loans are loans to other financial institutions. Additionally, the Company issues letters of credit on behalf of its customers. Risk arises primarily due to the difference between expected and actual cash flows of the borrowers. In addition, the recoverability of the Company’s investment in these loans is also dependent on other factors primarily dictated by the type of collateral securing these loans. The fair value of the collateral securing these loans may fluctuate as market conditions change. In the case of loans secured by accounts receivable, the recovery of the Company’s investment is dependent upon the borrower’s ability to collect amounts due from its customers. For the year ended December 31, 2022, $ 146.0 million in CCBX capital call lines are included in commercial and industrial loans compared to $ 202.9 million at December 31, 2021. Capital call lines are provided to venture capital firms. These loans are secured by the capital call rights and are individually underwritten to the Bank’s credit standards and the underwriting is reviewed by the Bank on every line/loan. Construction, land and land development loans – The Company originates loans for the construction of 1-4 family, multifamily, and CRE properties in the Company’s market area. Construction loans are considered to have higher risks due to construction completion and timing risk, the ultimate repayment being sensitive to interest rate changes, government regulation of real property and the availability of long-term financing. Additionally, economic conditions may impact the Company’s ability to recover its investment in construction loans, as adverse economic conditions may negatively impact the real estate market, which could affect the borrower’s ability to complete and sell the project. Additionally, the fair value of the underlying collateral may fluctuate as market conditions change. The Company occasionally originates land loans for the purpose of facilitating the ultimate construction of a home or commercial building. The primary risks include the borrower’s ability to pay and the inability of the Company to recover its investment due to a material decline in the fair value of the underlying collateral. Residential real estate - Residential real estate includes various types of loans for which the Company holds real property as collateral. Included in this segment are multi-family loans, first lien single family loans, which the Company occasionally purchases to diversify its loan portfolio, home equity lines of credit and rental portfolios secured by one-to-four family homes. The primary risks of residential real estate loans include the borrower’s inability to pay, material decreases in the value of the collateral, and significant increases in interest rates which may make the loan unprofitable. As of December 31, 2022, $ 244.6 million in loans originated through CCBX partners are included in residential real estate loans, compared to $ 36.9 million at December 31, 2021. These home equity lines of credit are secured by residential real estate and are accessed by using a credit card. Home equity lines of credit are classified as residential real estate per regulatory guidelines. Commercial real estate (includes owner occupied and nonowner occupied) - Commercial real estate loans include various types of loans for which the Company holds real property as collateral. We make commercial mortgage loans collateralized by owner-occupied and non-owner-occupied real estate, as well as multi-family residential loans. The primary risks of commercial real estate loans include the borrower’s inability to pay, material decreases in the value of the collateralized real estate and significant increases in interest rates, which may make the real estate loan unprofitable. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Consumer and other loans – The community bank originates a limited number of consumer loans, generally for banking customers only, which consist primarily of lines of credit, saving account secured loans, and auto loans. CCBX originates consumer loans including credit cards, consumer term loans and secured and unsecured lines of credit. This loan category also includes overdrafts. Repayment of these loans is dependent on the borrower’s ability to pay and the fair value of the underlying collateral. As of December 31, 2022 $ 607.0 million in CCBX loans are included in consumer and other loans, compared to $ 106.8 million at December 31, 2021. 120 Table of Contents The following table illustrates an age analysis of past due loans as of the dates indicated: 30-89 Days Past Due 90 Days or More Past Due Total Past Due Current Total Loans Recorded Investment 90 Days or More Past Due and Still Accruing (dollars in thousands) December 31, 2022 Commercial and industrial loans $ 393 $ 486 $ 879 $ 311,749 $ 312,628 $ 404 Real estate loans: Construction, land and land development — 66 66 213,989 214,055 — Residential real estate 1,016 876 1,892 447,265 449,157 876 Commercial real estate 95 6,901 6,996 1,041,756 1,048,752 — Consumer and other loans 37,932 24,815 62,747 546,024 608,771 24,815 $ 39,436 $ 33,144 $ 72,580 $ 2,560,783 $ 2,633,363 $ 26,095 Less net deferred origination fees and premiums ( 6,107 ) Loans receivable $ 2,627,256 30-89 Days Past Due 90 Days or More Past Due Total Past Due Current Total Loans Recorded Investment 90 Days or More Past Due and Still Accruing (dollars in thousands) December 31, 2021 Commercial and industrial loans $ 259 $ 38 $ 297 $ 418,763 $ 419,060 $ — Real estate loans: Construction, land and land development — — — 183,594 183,594 — Residential real estate 809 94 903 203,486 204,389 39 Commercial real estate — — — 835,587 835,587 — Consumer and other loans 3,901 1,467 5,368 103,503 108,871 1,467 $ 4,969 $ 1,599 $ 6,568 $ 1,744,933 $ 1,751,501 $ 1,506 Less net deferred origination fees and premiums ( 8,766 ) Loans receivable $ 1,742,735 121 Table of Contents There were $ 26.1 million in loans past due 90 days or more and still accruing interest as of December 31, 2022, and $ 1.5 million as of December 31, 2021. The increase is attributed to loans originated through CCBX lending partners which continue to accrue interest up to 180 days past due. The following table is a summary of information pertaining to impaired loans as of the period indicated. Loans originated through CCBX partners are reported using pool accounting and are not subject to individual impairment analysis, therefore CCBX loans are not included in this table. Unpaid Contractual Principal Balance Recorded Investment With No Allowance Recorded Investment With Allowance Total Recorded Investment Related Allowance (dollars in thousands) December 31, 2022 Commercial and industrial loans $ 124 $ — $ 113 $ 113 $ 95 Real estate loans: Construction, land and land development 67 66 — 66 — Residential real estate — — — — — Commercial real estate 6,901 6,901 — 6,901 — Total $ 7,092 $ 6,967 $ 113 $ 7,080 $ 95 December 31, 2021 Commercial and industrial loans $ 173 $ — $ 166 $ 166 $ 132 Real estate loans: Residential real estate 69 55 — 55 — Total $ 242 $ 55 $ 166 $ 221 $ 132 The following tables summarize the average recorded investment and interest income recognized on impaired loans by loan class for the year ended December 31, 2022 and 2021: December 31, 2022 December 31, 2021 Average Recorded Investment Interest Income Recognized Average Recorded Investment Interest Income Recognized (dollars in thousands) Commercial and industrial loans $ 121 $ — $ 498 $ — Real estate loans: Construction, land and land development 40 — — — Residential real estate 32 — 143 — Commercial real estate 1,395 — — — Total $ 1,588 $ — $ 641 $ — In some circumstances, the Company grants restructurings in response to borrower financial difficulty, and generally provides for a temporary modification of loan repayment terms. The restructured loans on accrual status represent the only impaired loans accruing interest. In order for a restructured loan to be considered for accrual status, the loan’s collateral coverage generally will be greater than or equal to 100 % of the loan balance, the loan is current on payments, and the borrower must either prefund an interest reserve or demonstrate the ability to make payments from a verified source of cash flow for an extended period of time, usually at least six months in duration. No loans were restructured in the year ended December 31, 2022 and December 31, 2021 that qualified as troubled debt restructurings. The Company has no commitments to loan additional funds to borrowers whose loans were classified as troubled debt restructurings at December 31, 2022, as there were no outstanding troubled debt restructurings at December 31, 2022 and December 31, 2021. 122 Table of Contents Pursuant to guidance from the federal bank regulatory agencies, the Company deferred or modified payments on existing loans to assist customers financially during the COVID-19 pandemic and economic shutdown. As of December 31, 2022 all deferred and modified loans during the COVID-19 pandemic have either returned to active status or paid off. In accordance with GAAP, the CARES Act, as amended by the Consolidated Appropriations Act, 2021, and interagency guidance issued on March 22, 2020 and April 7, 2020, these short-term modifications, made on a good faith basis in response to the COVID-19 pandemic to borrowers that were current prior to any relief, were not considered TDRs. The accrual of interest on community bank loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due or when they are 90 days past due as to either principal or interest, unless they are well secured and in the process of collection. Installment/closed-end, and revolving/open-end consumer loans originated through CCBX lending partners will continue to accrue interest until 120 and 180 days past due, respectively and an allowance is recorded through provision expense for these probable incurred losses. For installment/closed-end and revolving/open-end consumer loans originated through CCBX lending partners with balances outstanding beyond 120 days and 180 days past due, respectively, principal and capitalized interest outstanding is charged off against the allowance and accrued interest outstanding is reversed against interest income. These consumer loans are reported as substandard, 90 days or more days past due and still accruing. When loans are placed on nonaccrual status, all accrued interest is reversed from current period earnings. Payments received on nonaccrual loans are generally applied as a reduction to the loan principal balance. If the likelihood of further loss is removed, the Company will recognize interest on a cash basis only. Loans may be returned to accruing status if the Company believes that all remaining principal and interest is fully collectible and there has been at least six months of sustained repayment performance since the loan was placed on nonaccrual. An analysis of nonaccrual loans by category consisted of the following at the periods indicated: December 31, December 31, 2022 2021 (dollars in thousands) Commercial and industrial loans $ 113 $ 166 Real estate loans: Construction, land and land development 66 — Residential real estate — 55 Commercial real estate 6,901 — Total nonaccrual loans $ 7,080 $ 221 Credit Quality and Credit Risk Federal regulations require that the Company periodically evaluate the risks inherent in its loan portfolio. In addition, the Company’s regulatory agencies have authority to identify problem loans and, if appropriate, require them to be reclassified. The Company classifies some loans as Watch or Other Loans Especially Mentioned (“OLEM”). Loans classified as Watch are performing assets but have elements of risk that require more monitoring than other performing loans and are reported in the OLEM column in the following table. Loans classified as OLEM are assets that continue to perform but have shown deterioration in credit quality and require close monitoring. There are three classifications for problem loans: Substandard, Doubtful, and Loss. Substandard loans have one or more defined weaknesses and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Revolving (open-ended loans, such as credit cards) and installment (closed end) consumer loans originated through CCBX partners continue to accrue interest until they are charged-off at 120 days past due for installment loans (primarily unsecured loans to consumers) and 180 days past due for revolving loans (primarily credit cards) and are classified as substandard. Doubtful loans have the weaknesses of loans classified as Substandard, with additional characteristics that suggest the weaknesses make collection or recovery in full after liquidation of collateral questionable on the basis of currently existing facts, conditions, and values. There is a high possibility of loss in loans classified as Doubtful. A loan classified as Loss is considered uncollectible and of such little value that continued classification of the credit as a loan is not warranted. If a loan or a portion thereof is classified as Loss, it must be charged-off, meaning the amount of the loss is charged against the allowance for loan losses, thereby reducing that reserve. 123 Table of Contents Loans by credit quality risk rating are as follows as of the periods indicated: Pass Other Loans Especially Mentioned Sub- Standard Doubtful Total (dollars in thousands) December 31, 2022 Commercial and industrial loans $ 304,840 $ 7,219 $ 569 $ — $ 312,628 Real estate loans: Construction, land, and land development 206,304 7,685 66 — 214,055 Residential real estate 448,185 96 876 — 449,157 Commercial real estate 1,030,650 11,201 6,901 — 1,048,752 Consumer and other loans 583,956 — 24,815 — 608,771 $ 2,573,935 $ 26,201 $ 33,227 $ — 2,633,363 Less net deferred origination fees ( 6,107 ) Loans receivable $ 2,627,256 December 31, 2021 Commercial and industrial loans $ 416,642 $ 2,180 $ 238 $ — $ 419,060 Real estate loans: Construction, land, and land development 183,594 — — — 183,594 Residential real estate 204,173 122 94 — 204,389 Commercial real estate 824,676 10,911 — — 835,587 Consumer and other loans 107,404 — 1,467 — 108,871 $ 1,736,489 $ 13,213 $ 1,799 $ — 1,751,501 Less net deferred origination fees ( 8,766 ) Loans receivable $ 1,742,735 Allowance for Loan Losses The Company’s ALLL covers estimated credit losses on individually evaluated loans that are determined to be impaired as well as estimated probable losses inherent in the remainder of the loan portfolio. The ALLL for the community bank is prepared using the information provided by the Company’s credit review process and our historical loss data, together with data from peer institutions and economic information gathered from published sources. The loan portfolio is segmented into groups of loans with similar risk profiles. Each segment possesses varying degrees of risk based on the type of loan, the type of collateral, and the sensitivity of the borrower or industry to changes in external factors such as economic conditions. An estimated loss rate calculated from the community bank’s actual historical loss rates adjusted for current portfolio trends, economic conditions, and other relevant internal and external factors, is applied to each group’s aggregate loan balances. 124 Table of Contents CCBX loans have a higher level of expected losses than our community bank loans, which is reflected in the factors for the allowance for loan losses. Agreements with our CCBX partners provide for a credit enhancement which protects the Bank by absorbing incurred losses. In accordance with accounting guidance, we estimate and record a provision for probable losses for these CCBX loans and reclassified negative deposit accounts. When the provision for CCBX loan losses and provision for unfunded commitments are recorded, a credit enhancement asset is also recorded on the balance sheet through noninterest income (BaaS credit enhancements). Incurred losses are recorded in the allowance for loan losses. The credit enhancement asset is relieved when credit enhancement recoveries are received from the CCBX partner. Although agreements with our CCBX partners include credit enhancements that provide protection to the Bank from credit and fraud losses, the Bank would be exposed to additional loan losses if our partner is unable to fulfill its contracted obligations. In accordance with the program agreement for one CCBX partner, the Company is responsible for credit losses on approximately 10 % of a $ 114.5 million loan portfolio. At December 31, 2022, 10 % of this portfolio represented $ 11.5 million in loans. The partner is responsible for credit losses on approximately 90 % of this portfolio and for fraud losses on 100 % of this portfolio. The Company earns 100 % of the revenue on the aforementioned $ 11.5 million of loans. For the year ended December 31, 2022, there were $ 216,000 in net charge-offs on the portion of loans for which the Company is responsible for credit losses. The following tables summarize the allocation of the allowance for loan loss, as well as the activity in the allowance for loan loss attributed to various segments in the loan portfolio, as of and for the year ended December 31, 2022. Commercial and Industrial Construction, Land, and Land Development Residential Real Estate Commercial Real Estate Consumer and Other Unallocated Total (dollars in thousands) Twelve Months Ended December 31, 2022 ALLL balance, December 31, 2021 $ 3,221 $ 6,984 $ 4,598 $ 6,590 $ 7,092 $ 147 $ 28,632 Provision for loan losses or (recapture) 2,125 441 ( 4 ) ( 1,120 ) 76,604 1,018 79,064 5,346 7,425 4,594 5,470 83,696 1,165 107,696 Loans charged-off ( 555 ) — ( 452 ) — ( 32,742 ) — ( 33,749 ) Recoveries of loans previously charged-off 40 — — — 42 — 82 Net (charge-offs) recoveries ( 515 ) — ( 452 ) — ( 32,700 ) — ( 33,667 ) ALLL balance, December 31, 2022 $ 4,831 $ 7,425 $ 4,142 $ 5,470 $ 50,996 $ 1,165 $ 74,029 As of December 31, 2022 ALLL amounts allocated to Individually evaluated for impairment $ 95 $ — $ — $ — $ — $ — $ 95 Collectively evaluated for impairment 4,736 7,425 4,142 5,470 50,996 1,165 73,934 ALLL balance, December 31, 2022 $ 4,831 $ 7,425 $ 4,142 $ 5,470 $ 50,996 $ 1,165 $ 74,029 Loans individually evaluated for impairment $ 113 $ 66 $ — $ 6,901 $ — $ 7,080 Loans collectively evaluated for impairment 312,515 213,989 449,157 1,041,851 608,771 2,626,283 Loan balance, December 31, 2022 $ 312,628 $ 214,055 $ 449,157 $ 1,048,752 $ 608,771 $ 2,633,363 As of December 31, 2021 Loan balance, December 31, 2021 $ 419,060 $ 183,594 $ 204,389 $ 835,587 $ 108,871 $ 1,751,501 125 Table of Contents The following tables summarize the allocation of the allowance for loan loss, as well as the activity in the allowance for loan loss attributed to various segments in the loan portfolio, as of and for the year ended December 31, 2021: Commercial and Industrial Construction, Land, and Land Development Residential Real Estate Commercial Real Estate Consumer and Other Unallocated Total (dollars in thousands) Twelve Months Ended December 31, 2021 Balance, December 31, 2020 $ 3,353 $ 3,545 $ 3,410 $ 7,810 $ 127 $ 1,017 $ 19,262 Provision for loan losses or (recapture) 23 3,439 1,267 ( 1,220 ) 7,276 ( 870 ) 9,915 3,376 6,984 4,677 6,590 7,403 147 29,177 Loans charged-off ( 222 ) — ( 79 ) — ( 339 ) — ( 640 ) Recoveries of loans previously charged-off 67 — — — 28 — 95 Net (charge-offs) recoveries ( 155 ) — ( 79 ) — ( 311 ) — ( 545 ) Balance, December 31, 2021 $ 3,221 $ 6,984 $ 4,598 $ 6,590 $ 7,092 $ 147 $ 28,632 As of December 31, 2021 ALLL amounts allocated to Individually evaluated for impairment $ 132 $ — $ — $ — $ — $ — $ 132 Collectively evaluated for impairment 3,089 6,984 4,598 6,590 7,092 147 28,500 ALLL balance, December 31, 2021 $ 3,221 $ 6,984 $ 4,598 $ 6,590 $ 7,092 $ 147 $ 28,632 Loans individually evaluated for impairment $ 166 $ — $ 55 $ — $ — $ 221 Loans collectively evaluated for impairment 418,894 183,594 204,334 835,587 108,871 1,751,280 Loan balance, December 31, 2021 $ 419,060 $ 183,594 $ 204,389 $ 835,587 $ 108,871 $ 1,751,501 As of December 31, 2020 Loan balance, December 31, 2020 $ 539,200 $ 94,423 $ 143,869 $ 774,925 $ 3,916 $ 1,556,333 Note 5 – Premises and Equipment The investment in premises and equipment consisted of the following at December 31: 2022 2021 (dollars in thousands) Land $ 3,599 $ 2,672 Buildings 11,745 10,086 Leasehold Improvements 4,049 4,117 Furniture 2,479 2,473 Equipment 5,691 5,234 Software 1,765 934 Projects in process 138 1,375 29,466 26,891 Less accumulated depreciation and amortization ( 11,253 ) ( 9,672 ) Premises and equipment, net $ 18,213 $ 17,219 Depreciation and amortization on premises and equipment charged to expense totaled $ 1.8 million and $ 1.6 million for the years ended December 31, 2022 and 2021, respectively. Note 6 – Leases The Company has committed to rent premises used in business operations under non-cancelable operating leases and determines if an arrangement meets the definition of a lease upon inception. 126 Table of Contents Operating lease right-of-use (“ROU”) assets represent a right to use an underlying asset for the contractual lease term. Operating lease liabilities represent an obligation to make lease payments arising from the lease. Any new operating leases entered into will be recognized as an operating lease ROU asset and operating lease liability at the commencement date of the new lease. The Company’s leases do not provide an implicit interest rate, therefore the Company used its incremental collateralized borrowing rates commensurate with the underlying lease terms to determine the present value of operating lease liabilities. The weighted average discount rate used to discount operating lease liabilities at December 31, 2022 was 3.4 %. The Company’s operating lease agreements contain both lease and non-lease components, which are generally accounted for separately. The Company’s lease agreements do not contain any residual value guarantees. Operating leases with original terms of 12 months or less are not included in ROU assets and operating lease liabilities recorded in our consolidated balance sheets. Operating lease terms include options to extend when it is reasonably certain that the Company will exercise such options, determined on a lease-by-lease basis. At December 31, 2022, lease expiration dates ranged from less than one month to 22 years, with additional renewal options on certain leases typically ranging from 5 to 10 years. At December 31, 2022, the dollar weighted average remaining lease term for the Company’s operating leases was 8.2 years. Rental expense for operating leases is recognized on a straight-line basis over the lease term and amounted to $ 1.4 million for the years ended December 31, 2022 and 2021. Variable lease components, such as fair market value adjustments, are expensed as incurred and not included in ROU assets and operating lease liabilities. The following sets forth, as of December 31, 2022, the minimum annual lease payments under the terms of these leases, inclusive of renewal options that the Company is reasonably certain to renew: (dollars in thousands) December 31, 2022 2023 $ 1,272 2024 864 2025 713 2026 719 2027 667 2028 and thereafter 1,823 Total lease payments 6,058 Less: amounts representing interest 824 Present value of lease liabilities $ 5,234 The Company leases its Downtown Everett facility from related parties (Note 12). Office space at a small number of branches is leased and sub-leased to a few tenants on month-to-month and multi-year leases. Lease and sublease income was $ 157,000 and $ 127,000 for 2022 and 2021, respectively. 127 Table of Contents The following table presents the components of total lease expense and operating cash flows for the year ended December 31, 2022: For the Year Ended (dollars in thousands) December 31, 2022 December 31, 2021 Lease expense: Operating lease expense $ 1,281 $ 1,283 Variable lease expense 193 148 Total lease expense (1) $ 1,474 $ 1,431 Cash paid: Cash paid reducing operating lease liabilities $ 1,473 $ 1,419 (1) Included in net occupancy expense in the Consolidated Statements of Income. Note 7 - Deposits The composition of consolidated deposits consisted of the following at the periods indicated: (dollars in thousands) December 31, 2022 December 31, 2021 (dollars in thousands) Demand, noninterest bearing $ 775,012 $ 1,355,908 NOW and money market 1,804,399 789,709 Savings 107,117 103,956 BaaS-brokered deposits 101,546 70,757 Time deposits less than $250,000 21,942 31,057 Time deposits $250,000 and over 7,505 12,400 Total deposits $ 2,817,521 $ 2,363,787 The following table presents the maturity distribution of time deposits as of December 31, 2022: (dollars in thousands) Twelve months $ 22,219 One to two years 4,956 Two to three years 1,401 Three to four years 828 Four to five years 43 $ 29,447 CCBX deposits are originated through CCBX partners for true depositor and FDIC insurance purposes. CCBX deposits were primarily noninterest bearing prior to the rate increases in 2022 by the Federal Open Market Committee (“FOMC”). As a result of the interest rate increases, a significant portion of CCBX deposits that were not earning interest were reclassified to interest bearing deposits from noninterest bearing deposits during the first and second quarters of 2022. These CCBX deposits were reclassified because the current interest rate exceeded the minimum interest rate set in their respective program agreements, as a result of the first and second quarter 2022 interest rate increases by the FOMC, we needed to pay interest to the CCBX partners for these deposits. We do not expect additional CCBX deposits will be reclassified as a result of future rate increases. 128 Table of Contents Note 8 – Federal Home Loan Bank Advances and Other Borrowings At December 31, 2022 the Company had no overnight or term FHLB advances. During the year ended December 31, 2022, the Company repaid a total of $ 25.0 million in FHLB advances. This includes a $ 10.0 million advance that would have matured in March 2023 and a $ 15.0 million advance that would have matured in March 2027. We have sufficient liquidity for our current loan demand, and with no prepayment penalty for early repayment, management opted to repay these term advances and save the unnecessary interest expense. At December 31, 2021 the Company had no FHLB overnight advances and $ 25.0 million in term advances. FHLB advances are secured by a blanket pledge of eligible collateral including first lien single family and multi-family mortgages with a carrying value of $ 175.1 million and $ 140.1 million at December 31, 2022 and 2021, respectively. The Company has available borrowing capacity of an additional $ 120.8 million from FHLB at December 31, 2022, subject to certain collateral requirements and with interest at then stated rate. The following table provides details on FHLB advance borrowings for the periods indicated: Year Ended December 31, (dollars in thousands) 2022 2021 Maximum amount outstanding at any month-end during period: $ 24,999 $ 24,999 Average outstanding balance during period: $ 6,029 $ 24,999 Weighted average interest rate during period: 1.13 % 1.13 % Balance outstanding at end of period: $ — $ 24,999 Weighted average interest rate at end of period: n/a 1.13 % The Company has established an $ 50.0 million unsecured line of credit with interest payable at the then-stated rate, with PCBB, which expires in June 2023. There were no borrowings on this line at December 31, 2022 or 2021. The Company has established a Borrower-in-Custody (BIC) arrangement with the FRB, which is secured by eligible loans, with interest payable at the then-stated rate. At December 31, 2022, the Company had pledged commercial real estate loans totaling $ 45.0 million, which provided available borrowing capacity of $ 26.7 million. At December 31, 2021, the Company had pledged commercial real estate loans totaling $ 43.4 million, which provided available borrowing capacity of $ 21.9 million. There were no borrowings outstanding on this line of credit at December 31, 2022 or 2021. To bolster the effectiveness of the SBA’s PPP loan program, the Federal Reserve supplied liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. The PPP provided loans to small businesses so that they could keep their employees on the payroll and pay for other allowed expenses. If the borrowers met certain criteria, the loan may be forgiven. The PPPLF extended credit to eligible financial institutions that originated PPP loans, taking the loans as collateral at face value. The interest rate was 0.35 % and as PPP loans were paid down, the borrowing line also had to be paid down. The Company paid the PPPLF borrowing line in full in June 2021, therefore there was no outstanding balance as of December 31, 2022 or 2021. The following tables provides details on PPPLF advance borrowings for the periods indicated: Year Ended December 31, (dollars in thousands) 2021 Maximum amount outstanding at any month-end during period: $ 185,894 Average outstanding balance during period: $ 68,699 Weighted average interest rate during period: 0.35 % Balance outstanding at end of period: $ — Weighted average interest rate at end of period: 0.00 % 129 Table of Contents Note 9 – Subordinated Debt At December 31, 2022 and 2021, the Company’s subordinated debt was as follows: Aggregate Principal Amount December 31, 2022 Aggregate Principal Amount December 31, 2021 (dollars in thousands) Total liability, at par $ 45,000 $ 25,000 Less: unamortized debt issuance costs ( 1,001 ) ( 712 ) Total liability, at carrying value $ 43,999 $ 24,288 On August 18, 2021, the Company entered into a $ 25.0 million subordinated note purchase agreement. The note matures on September 1, 2031 , is fixed for five years at 3.375 %, and thereafter is variable at a floating rate, calculated quarterly, based on the 3-month SOFR + 2.76 %. On November 1, 2022, the Company entered into a $ 20.0 million subordinated note purchase agreement. The note matures on November 1, 2032 , is fixed for five years at 7.000 %, and thereafter is variable at a floating rate, calculated quarterly, based on the 3-month SOFR + 2.90 %. Subordinated debt interest expense of $ 1.2 million and $ 711,000 was recognized during 2022 and 2021, respectively, and accrued interest payable on these notes totaled $ 535,000 and $ 286,000 at December 31, 2022 and 2021, respectively. Note 10 – Junior Subordinated Debentures At December 31, 2022 and 2021, the Company’s junior subordinated debentures were as follows: Coastal (WA) Statutory Trust I Aggregate Principal Amount December 31, 2022 Aggregate Principal Amount December 31, 2021 (dollars in thousands) Total liability, at par $ 3,609 $ 3,609 Less: unamortized debt issuance costs ( 21 ) ( 23 ) Total liability, at carrying value $ 3,588 $ 3,586 On December 15, 2004, the Company issued $ 3.6 million floating rate junior subordinated debentures to Coastal (WA) Statutory Trust I, which was formed for the issuance of trust preferred securities. The debentures bear interest at three-month LIBOR plus 2.10 % (fully indexed rate of 6.87 % and 2.30 % at December 31, 2022 and 2021, respectively). Interest is payable quarterly. Interest expense of $ 143,000 and $ 84,000 was recognized during 2022 and 2021, respectively, and accrued interest payable on these securities totaled $ 12,000 and $ 4,000 at December 31, 2022 and 2021, respectively. There are no principal payments due on these debentures in the next five years. The Trust is not consolidated with the Company. Accordingly, the Company reports the subordinated debentures held by the Trust as liabilities. The Company owns all of the common securities of the trust. The trust preferred securities issued by the trust rank equally with the common securities in right of payment, except that if an event of default under the indenture governing the note has occurred and is continuing, the preferred securities will rank senior to the common securities in right of payment. On December 16, 2022, the Federal Reserve Board adopted a final rule that implements the LIBOR Act by identifying benchmark rates based on SOFR (Secured Overnight Financing Rate) that will replace LIBOR formerly known as the London Interbank Offered Rate, in certain financial contracts after June 30, 2023. Congress enacted the LIBOR Act, which was signed into law in March 2022, to provide a uniform, nationwide solution for so-called tough legacy contracts that do not have clear and practicable provisions for replacing LIBOR after June 30, 2023. The LIBOR Act also establishes a litigation safe harbor for lenders that select a LIBOR replacement under certain situations, including the use of a replacement rate selected by the Federal Reserve. As required by the law, the final rule identifies replacement benchmark 130 Table of Contents rates based on SOFR to replace overnight, one-month, three-month, six-month, and 12-month LIBOR in contracts subject to the Act. These contracts include U.S. contracts that do not mature before LIBOR ends and that lack adequate "fallback" provisions that would replace LIBOR with a practicable replacement benchmark rate. We believe that we will be able to use the benchmark replacements and transition protections provided by the LIBOR Act and Federal Reserve rule to manage through the transition away from LIBOR. Note 11 – Income Taxes The components of the income tax for the Company consisted of the following at December 31: 2022 2021 (dollars in thousands) Current tax expense $ 21,014 $ 10,383 Deferred tax benefit ( 11,018 ) ( 3,011 ) Total tax expense $ 9,996 $ 7,372 At December 31, 2022 the current net income tax receivable was $ 1.3 million and at December 31, 2021 the net income tax payable was $ 1.2 million. A reconciliation of the income tax expense (benefit) and the amount computed by applying the statutory federal income tax rate to the income before income taxes is as follows for the year ended December 31: 2022 2021 (dollars in thousands) Amount Rate Amount Rate Federal income tax at statutory rate $ 10,630 21.0 % $ 7,219 21.0 % State income taxes 523 1.0 256 0.7 Effect of tax-exempt interest income ( 84 ) ( 0.2 ) ( 100 ) ( 0.3 ) Stock-based compensation ( 987 ) ( 1.9 ) ( 43 ) ( 0.1 ) Bank owned life insurance earnings ( 76 ) ( 0.2 ) ( 36 ) ( 0.1 ) Excess executive compensation 128 0.3 58 0.1 Other ( 138 ) ( 0.3 ) 18 0.1 $ 9,996 19.7 % $ 7,372 21.4 % The Company did not record or accrue any interest and penalties related to income taxes for the years ended December 31, 2022 or 2021. The Company and Bank have entered into a tax allocation agreement, which provides that income taxes shall be allocated between the parties on a monthly basis. The intent of this agreement is that each member of the consolidated group will incur no greater tax liability than it would have incurred on a stand-alone basis. 131 Table of Contents The net deferred tax asset consists of the following temporary differences and carryforward items at December 31: 2022 2021 (dollars in thousands) Deferred tax assets: Allowance for loan losses $ 17,076 $ 6,223 Lease liability 1,212 1,374 Accrued expenses 708 596 Deferred compensation 142 162 Allowance for unfunded commitments 225 277 Nonqualified stock options 108 107 Interest on nonaccrual loans — 10 Restricted stock options 522 196 Deferred income 79 58 Net unrealized loss on available-for-sale securities 621 — Other 218 37 Total deferred tax assets 20,911 9,040 Deferred tax liabilities: Right of use asset ( 1,162 ) ( 1,327 ) Depreciation and amortization ( 977 ) ( 661 ) Net unrealized gain on equity security ( 314 ) ( 233 ) Net unrealized gain on available-for-sale securities — ( 1 ) Total deferred tax liabilities ( 2,453 ) ( 2,222 ) Net deferred tax asset $ 18,458 $ 6,818 The determination of the amount of deferred income tax assets which are more likely than not to be realized is primarily dependent on projections of future earnings, which are subject to uncertainty and estimates that may change given economic conditions and other factors. The realization of deferred income tax assets is regularly assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax asset will not be realized. “More likely than not” is defined as greater than a 50% chance. All available evidence, both positive and negative is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed. Based upon its analysis of available evidence, including recent profitability, management has determined that it is “more likely than not” that the Company’s deferred income tax assets as of December 31, 2022 will be fully realized and therefore no valuation allowance was recorded. At December 31, 2022, the Company had no federal net operating loss carryforwards or tax credit carryforwards. The Company files federal and various state income tax returns. Federal tax returns for the 2019 tax year and later are open for examination. The total amount of unrecognized tax benefits, including interest and penalties, at December 31, 2022 was not material. The amount of tax benefits that would impact the effective rate, if recognized, is not expected to be material. The Company does not anticipate any significant changes with respect to unrecognized tax benefits within the next 12 months. Note 12 – Related Party Transactions During 2022 and 2021, the Company had transactions made in the ordinary course of business with certain of its executive officers and directors. All loans included in such transactions were made on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with other persons, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. 132 Table of Contents A summary of loan transactions follows: 2022 2021 (dollars in thousands) Beginning Balance January 1 $ 7,976 $ 8,342 Additions 10,296 1,018 Payments ( 4,845 ) ( 1,384 ) Ending Balance December 31 $ 13,427 $ 7,976 The Company held deposits of $ 5.5 million and $ 4.5 million from directors, principal shareholders and executive officers at December 31, 2022 and 2021, respectively. All deposits included in such transactions were made on substantially the same terms, including interest rate, as those prevailing at the time for comparable transactions with other persons. As discussed in Note 6, the Company leased one facility from a related party in 2022 and 2021. The Everett branch facility is leased from a group of investors, one of which is a director. The Everett lease originated in 1997 for ten years and has been renewed through March 2024. Monthly rent under the Everett lease is $ 46,000 for the remaining lease term. Rents paid during 2022 and 2021 for the related party Everett lease totaled $ 546,000 for each year. The Company utilizes Adams and Duncan, Inc. P.S. for legal services in which one of the Company’s directors is a partner. The services provided include general legal counsel and specialized CCBX agreement counsel. The Company also uses other law firms for legal counsel and specialties such as regulatory and SEC counsel. For fiscal year ended December 31, 2022 and 2021, total payments for legal services were $ 864,000 and $ 816,000 , respectively. Note 13 – Commitments and Contingencies In the normal course of business, there are various outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not reflected in the consolidated financial statements. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Company uses the same credit policies in making such commitments as it does for instruments that are included in the consolidated balance sheets. At December 31, 2022 and 2021, the Company had a reserve for unfunded commitments of $ 974,000 and $ 1.3 million, respectively, included in other liabilities on the consolidated balance sheet. Financial instruments whose contract amount represents credit or funding risk were as follows at December 31: (dollars in thousands; unaudited) 2022 2021 Credit Risk Commitments to extend credit: Commercial and industrial loans $ 81,568 $ 70,848 Commercial and industrial loans - capital call lines 772,732 415,956 Construction – commercial real estate loans 109,715 90,946 Construction – residential real estate loans 32,827 43,339 Residential real estate loans 374,735 101,715 Commercial real estate loans 35,024 23,248 Consumer and other loans 793,563 163,510 Total commitments to extend credit $ 2,200,164 $ 909,562 Standby letters of credit $ 3,064 $ 3,040 Funding Risk Equity investment commitment $ 988 $ 1,090 133 Table of Contents 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 commercial and industrial loan commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. As of December 31, 2022, $ 1.57 billion of the $ 2.20 billion in total commitments to extend credit were unconditionally cancelable. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation. The type of collateral held varies but may include accounts receivable, inventory, property and equipment, and income- producing commercial properties. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Standby letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company’s policy for obtaining collateral, and the nature of such collateral, is essentially the same as that involved in making commitments to extend credit. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. No losses were incurred in 2022 or 2021 under these commitments. Commitments to extend credit on CCBX loans are included in the table above and are summarized below: (dollars in thousands; unaudited) 2022 2021 Commitments to extend credit: Commercial and industrial loans $ 952 $ — Commercial and industrial loans - capital call lines 772,732 415,956 Residential real estate loans 329,193 71,453 Consumer and other loans 792,447 162,266 Total commitments to extend credit $ 1,895,324 $ 649,675 As of December 31, 2022, $ 1.57 billion in CCBX commitments to extend credit are unconditionally cancelable, compared to $ 162.3 million at December 31, 2021. The increase in unconditionally cancelable commitments is attributed to growth in CCBX loans. Commitments that are unconditionally cancelable allow us to better manage loan growth, credit concentrations and liquidity. We also limit CCBX partners to a maximum aggregate customer loan balance originated and held on our balance sheet, as shown in the table below. (dollars in thousands; unaudited) Type of Lending Maximum Portfolio Size Commercial and industrial loans: Capital call lines Business - Venture Capital $ 350,000 All other commercial & industrial loans Business - Small Business 65,856 Real estate loans: Home equity lines of credit Home Equity - Secured Credit Cards 250,000 Consumer and other loans: Credit cards Credit Cards - Primarily Consumer 600,770 Installment loans Consumer 1,048,134 Other consumer and other loans Consumer - Secured Credit Builder & Unsecured consumer 190,240 2,505,000 The Company also has agreements with certain key officers that provide for potential payments upon retirement, disability, termination, change in control and death. The Company is subject to claims and lawsuits which arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the financial position of the Company. 134 Table of Contents Note 14 – Concentration of Credit Risk Most of the community bank’s business activity is with customers who are concentrated in the state of Washington. Investments in municipal securities involve governmental entities within the state. Generally, amounts placed or invested in bank accounts are insured by the FDIC up to $ 250,000 per depositor for each account ownership category at a bank. Uninsured deposits in bank accounts held by the Company and Bank at December 31, 2022 and 2021, totaled $ 45.4 million and $ 33.6 million, respectively. Loans to the same borrower are generally limited, by state banking regulations, to 20 % of the Bank’s capital and surplus. The Company manages asset quality and controls credit risk through diversification of the loan portfolio and the application of policies designed to promote sound underwriting and loan monitoring practices. The Company regularly utilizes real estate as collateral to reduce the risk of credit loss in the loan portfolio. As of December 31, 2022 and 2021, the Company has a concentration of credit in commercial real estate. Commercial real estate loans are typically secured by the Bank’s first lien position on the subject property. Standby letters of credit were granted primarily to commercial borrowers. Note 15 - Stock-Based Compensation Stock Options and Restricted Stock The 2018 Coastal Financial Corporation Omnibus Plan (2018 Plan) authorizes the Company to grant awards, including but not limited to, stock options, restricted stock units, and restricted stock awards, to eligible employees, directors or individuals that provide service to the Company, up to an aggregate of 500,000 shares of common stock. On May 24, 2021, the Company’s shareholders approved the First Amendment to the 2018 Plan, which increased the authorized plan shares by 600,000 . The 2018 Plan replaces both the 2006 Plan and the Directors’ Stock Bonus Plan (2006 Plan). Existing awards will vest under the terms granted and no further awards will be granted under these prior plans. Shares available to be granted under the 2018 plan were 522,822 at December 31, 2022. Stock Option Awards The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. Expected volatilities are based on historical volatility of the Company’s stock and other factors. The Company uses the vesting term and contractual life to determine the expected life. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Compensation expense related to unvested stock option awards is reversed at date of forfeiture. There were no new options granted in the year ended December 31, 2022. A summary of stock option activity under the Company’s Plan during the year ended December 31, 2022: Options Shares Weighted- Average Exercise Price Weighted- Average Remaining Contractual Term (Years) Aggregate Intrinsic Value (dollars in thousands, except per share amounts) Outstanding at December 31, 2021 694,519 $ 7.79 4.0 $ 29,744 Granted — $ — Exercised ( 247,221 ) $ 5.94 Expired ( 75 ) $ 13.35 Forfeited ( 9,120 ) $ 10.08 Outstanding at December 31, 2022 438,103 $ 8.79 4.1 $ 16,968 Vested or expected to vest at December 31, 2022 438,103 $ 8.79 4.1 $ 16,968 Exercisable at December 31, 2022 196,902 $ 8.07 3.5 $ 7,767 The total intrinsic value (which is the amount by which the stock price exceeds the exercise price) of options exercised during the year ended December 31, 2022 was $ 10.3 million. The intrinsic value of options exercised during the year ended December 31, 2021 was $ 1.2 million. 135 Table of Contents As of December 31, 2022, there was $ 1.1 million of total unrecognized compensation cost related to nonvested stock options granted under the Plan. Total unrecognized compensation costs is adjusted for unvested forfeitures. The Company expects to recognize that cost over a weighted-average period of approximately 4.5 years. Compensation expense recorded related to stock options was $ 331,000 and $ 357,000 for the years ended December 31, 2022 and 2021, respectively. Restricted Stock Units In the first quarter of 2022, the Company granted 53,721 restricted stock units under the 2018 Plan to employees, which vest ratably over 4 years and 150 restricted stock units which vest ratably over 10 years. In the second quarter of 2022, the Company granted 9,831 restricted stock units under the 2018 Plan to employees, which vest ratably over 5 years and 7,000 restricted stock units that vest ratably over 3 years. Additionally, the Company granted 53,000 performance-based restricted stock units under the 2018 Plan to an employee, that vest on June 1, 2028, the quantity of which is dependent upon achievement of specified performance goals. In the third quarter of 2022, the Company granted 20,000 restricted stock units under the 2018 Plan to employees, which vest in two blocks: 10,000 vest after 5 years and the remaining 10,000 vest after 7.5 years. In the fourth quarter of 2022, the Company granted 1,054 restricted stock units under the 2018 Plan to an employee which vests in two blocks: 527 shares vest after three years and the remaining 527 shares vest after five years . Restricted stock units provide for an interest in Company common stock to the recipient, the underlying stock is not issued until certain conditions are met. Vesting requirements include time-based, performance-based, or market-based conditions. Recipients of restricted stock units do not pay any cash consideration to the Company for the units and the holders of the restricted units do not have voting rights. The fair value of time-based and performance-based units is equal to the fair market value of the Company’s common stock on the grant date. The fair value of market-based units is estimated on the grant date using the Monte Carlo simulation model. Compensation expense is recognized over the vesting period that the awards are based. Restricted stock units are nonparticipating securities. As of December 31, 2022, there was $ 8.9 million of total unrecognized compensation cost related to nonvested restricted stock units. The Company expects to recognize that cost over the remaining weighted-average vesting period of approximately 3.4 years. Compensation expense recorded related to restricted stock units was $ 1.9 million and $ 616,000 for the year ended December 31, 2022 and 2021, respectively. A summary of the Company’s nonvested restricted stock units at December 31, 2022 and changes during the year is presented below: Nonvested shares - RSUs Shares Weighted- Average Grant Date Fair Value Total or Aggregate Intrinsic Value (dollars in thousands, except per share amounts) Nonvested shares at December 31, 2021 269,844 $ 21.70 $ 7,803 Granted 144,756 $ 39.66 Forfeited ( 6,734 ) $ 24.95 Vested ( 27,817 ) $ 20.03 Nonvested shares at December 31, 2022 380,049 $ 28.61 $ 7,187 The fair value of restricted stock awards is equal to the fair value of the Company’s stock at the date of grant. Compensation expense is recognized over the vesting period that the awards are based. Restricted stock awards are participating securities. Restricted Stock Awards Employees There were no new restricted stock awards granted to employees in the year ended December 31, 2022. 136 Table of Contents The fair value of restricted stock awards is equal to the fair value of the Company’s stock at the date of grant. Compensation expense is recognized over the vesting period that the awards are based. Restricted stock awards are participating securities. As of December 31, 2022, there was $ 45,000 of total unrecognized compensation cost related to nonvested restricted stock awards. The Company expects to recognize that cost over the remaining weighted-average vesting period of approximately 5.1 years. Compensation expense recorded related to restricted stock awards was $ 9,000 and $ 134,000 for the years ended December 31, 2022 and 2021, respectively. Director’s Stock Bonus Under the 2018 Plan, in May 2022 eligible directors were each granted stock with a total market value of $ 35,000 , and the Board Chair was granted stock with a total market value of $ 55,000 . Committee chairs received additional stock with a market value of $ 2,500 for each committee chaired at the time of the award. Stock is granted as of each annual meeting date and will cliff vest one day prior to the next annual meeting date. During the vesting period, the grants are considered participating securities. In May 2022, there were 10,396 shares granted to ten directors at an estimated fair value of $ 37.30 per share. As of December 31, 2022, there was $ 151,000 of total unrecognized compensation expense related to director stock awards. Compensation expense related to the Plan totaled $ 295,000 and $ 173,000 for the years ended December 31, 2022 and 2021, respectively. A summary of the Company’s nonvested shares at December 31, 2022 and changes during the year is presented below: Nonvested shares - RSAs Shares Weighted- Average Grant Date Fair Value Total or Aggregate Intrinsic Value (dollars in thousands, except per share amounts) Nonvested shares at December 31, 2021 10,203 $ 23.78 $ 274 Granted 10,396 $ 37.30 Forfeited — $ — Vested ( 7,203 ) $ 26.27 Nonvested shares at December 31, 2022 13,396 $ 32.94 $ 195 Note 16 – Employee Benefit Plans 401(k) plan - The Company has a combined 401(k) and profit-sharing plan covering substantially all employees. Contributions to the 401(k) plan may consist of matching contributions for employees. Match eligibility coincides with the first of the month following hire date in accordance with the 401(k) plan. Matching contributions are usually equal to a percentage of employee compensation. The Company determines and sets 401(k) contributions each year. Company matching contributions will be approved by the board of directors annually on a discretionary basis. In 2022 and 2021, the Company provided matching contributions totaling $ 1.3 million and $ 1.1 million, respectively. Deferred compensation plan - The Company established a deferred compensation plan in 2003 for certain management personnel. Two former employees were covered by this plan and the plan is now distributing benefits to these retired individuals. The plan was designed to help supplement retirement benefits for participants. The benefits may be funded by bank-owned life insurance policies. The life insurance policies had a cash surrender value of $ 12.7 million and $ 12.3 million at December 31, 2022 and 2021, respectively. Liabilities to employees, which are being accrued over the life of the participant’s Plan, were $ 616,000 and $ 744,000 at December 31, 2022 and 2021, respectively. Compensation expense related to this Plan was $ 48,000 and $ 56,000 for the years ended December 31, 2022 and 2021, respectively. Payments of accrued benefits totaling $ 175,000 were made during 2022 and 2021. 137 Table of Contents Note 17 - Regulatory Matters Banks and bank holding companies are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory (and possibly additional discretionary) actions by regulators that, if undertaken, could have a direct material effect on the financial statements of the Bank and the Company. Historically, the Company had been operating under the Small Bank Holding Company Policy Statement, which exempts bank holding companies that have total consolidated assets of less than $3.0 billion and meet other criteria from the Federal Reserve’s risk-based- and leverage capital rules. Because the Company’s consolidated assets exceeded $3.0 billion as of September 30, 2022, the Company is no longer eligible for the Federal Reserve’s Small Bank Holding Company Policy Statement and will also be evaluated relative to the capital adequacy standards established by the Federal Reserve going forward. A bank holding company that crosses the $3.0 billion total consolidated assets threshold as of June 30 of a particular year is no longer permitted to file reports as a small holding company beginning the following March. The Company was not in excess of $3.0 billion as of June 30, 2022, and accordingly prepared and filed financial reports with the Federal Reserve as a small bank holding company. Currently, the Federal Reserve assesses the capital position of the Company based on these reports by reviewing its debt-to-equity ratio and its capacity to serve as a source of strength to the Bank. If the Company’s total consolidated assets remain in excess of $3.0 billion as of June 30, 2023, starting in March 2024 the Company will cease filing financial reports with the Federal Reserve as though it were a small bank holding company. Under the regulatory capital adequacy guidelines, the Company and Bank must meet specific capital adequacy guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s and Bank’s capital ratios and the Bank’s classification under the prompt corrective action guidelines are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios of total risk-based capital, Tier 1 capital and common equity Tier 1 capital to risk- weighted assets (as defined in the regulations), and Tier 1 capital to average adjusted total consolidated assets (as defined). According to regulatory guidelines, only the amount of deferred tax assets that can be realized within the next 12 months based on projected taxable income is allowed in the computation. There were no disallowed deferred tax assets at December 31, 2022 and 2021. Under the capital adequacy guidelines on the regulatory framework for prompt corrective action (as set forth in the table on the next page), the Bank met the criteria to be considered well capitalized as of December 31, 2022 and 2021. Such determination has been made based on the Bank’s total risk-based capital ratio, Tier 1 risk-based capital ratio, common equity Tier 1 risk-based capital ratio, and leverage ratio. There have been no conditions or events since December 31, 2022, that management believes would change the Bank’s category. Under capital adequacy regulations, the Company and the Bank must maintain a capital conservation buffer of common equity Tier 1 capital of more than 2.5 % above the minimum risk-based capital ratios to avoid restrictions on the payment of capital distributions and discretionary bonus payments. Management believes the Company and the Bank exceed all capital adequacy requirements to which they are subject, including the ratios described below and the capital conservation buffer, as of December 31, 2022. 138 Table of Contents The Company and Bank’s actual and required capital amo unts and ratios are as follows: Actual Minimum Required for Capital Adequacy Purposes (1) Required to be Well Capitalized Under the Prompt Corrective Action Provisions Amount Ratio Amount Ratio Amount Ratio (dollars in thousands) December 31, 2022 Leverage Capital (to average assets) Consolidated $ 249,250 7.97 % $ 125,141 4.00 % N/A N/A Bank Only 267,699 8.56 % 125,025 4.00 % 156,281 5.00 % Common Equity Tier 1 risk-based capital ratio (to risk-weighted assets) Consolidated 245,750 8.92 % 124,027 4.50 % N/A N/A Bank Only 267,699 9.73 % 123,822 4.50 % 178,854 6.50 % Tier 1 Capital (to risk-weighted assets) Consolidated 249,250 9.04 % 165,370 6.00 % N/A N/A Bank Only 267,699 9.73 % 165,096 6.00 % 220,128 8.00 % Total Capital (to risk-weighted assets) Consolidated 329,203 11.94 % 220,493 8.00 % N/A N/A Bank Only 302,595 11.00 % 220,128 8.00 % 275,160 10.00 % December 31, 2021 Leverage Capital (to average assets) Consolidated $ 204,585 8.07 % $ 101,460 4.00 % N/A N/A Bank Only 201,783 7.96 % 101,350 4.00 % 126,687 5.00 % Common Equity Tier 1 risk-based capital ratio (to risk-weighted assets) Consolidated 201,085 11.06 % 81,834 4.50 % N/A N/A Bank Only 201,783 11.12 % 81,623 4.50 % 117,900 6.50 % Tier 1 Capital (to risk-weighted assets) Consolidated 204,585 11.25 % 109,112 6.00 % N/A N/A Bank Only 201,783 11.12 % 108,830 6.00 % 145,107 8.00 % Total Capital (to risk-weighted assets) Consolidated 252,405 13.88 % 145,483 8.00 % N/A N/A Bank Only 224,545 12.38 % 145,107 8.00 % 181,384 10.00 % (1) Presents the minimum capital adequacy requirements that apply to the Bank (excluding the capital conservation buffer) and the Company. Prior to September 30, 2022, the Company operated under the Small Bank Holding Company Policy Statement and therefore was not subject to Basel III capital adequacy requirements. 139 Table of Contents Note 18 - Fair Value Measurements The following tables present estimated fair values of the Company’s financial instruments as of the period indicated, whether or not recognized or recorded in the consolidated balance sheets at the period indicated: December 31, 2022 Fair Value Measurements Using Carrying Value Estimated Fair Value Level 1 Level 2 Level 3 (dollars in thousands) Financial assets Cash and due from banks $ 32,722 $ 32,722 $ 32,722 $ — $ — Interest earning deposits with other banks 309,417 309,417 309,417 — — Investment securities 98,353 98,233 97,015 1,218 — Other investments 10,555 10,555 — 7,983 2,572 Loans receivable 2,627,256 2,580,183 — — 2,580,183 Accrued interest receivable 17,815 17,815 — 17,815 — Financial liabilities Deposits $ 2,817,521 $ 2,816,602 $ — $ 2,816,602 $ — Subordinated debt 43,999 42,743 — 42,743 — Junior subordinated debentures 3,588 3,484 — 3,484 — Accrued interest payable 684 684 — 684 — _______________________________________ December 31, 2021 Fair Value Measurements Using Carrying Value Estimated Fair Value Level 1 Level 2 Level 3 (dollars in thousands) Financial assets Cash and due from banks $ 14,496 $ 14,496 $ 14,496 $ — $ — Interest earning deposits with other banks 798,665 798,665 798,665 — — Investment securities 36,623 36,675 34,998 1,677 — Other investments 8,478 8,478 — 6,156 2,322 Loans receivable, net 1,714,103 1,686,124 — — 1,686,124 Accrued interest receivable 8,105 8,105 — 8,105 — Financial liabilities Deposits $ 2,363,787 $ 2,363,624 $ — $ 2,363,624 $ — FHLB advances 24,999 24,447 — 24,447 — Subordinated debt 24,288 21,891 — 21,891 — Junior subordinated debentures 3,586 2,771 — 2,771 — Accrued interest payable 357 357 — 357 — The Company measures and discloses certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (that is, not a forced liquidation or distressed sale). GAAP establishes a consistent framework for measuring fair value and disclosure requirements about fair value measurements. Among other things, the accounting standard requires the reporting entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect market data obtained from independent sources, while 140 Table of Contents unobservable inputs reflect the Company’s estimates for market assumptions. These two types of inputs create the following fair value hierarchy: • Level 1 – Quoted prices in active markets for identical instruments. An active market is a market in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available. • Level 2 – Observable inputs other than Level 1 including quoted prices in active markets for similar instruments, quoted prices in less active markets for identical or similar instruments, or other observable inputs that can be corroborated by observable market data. • Level 3 – Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs from non-binding single dealer quotes not corroborated by observable market data. The estimated fair value amounts of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is required to interpret data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize at a future date. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. In addition, reasonable comparability between financial institutions may not be likely due to the wide range of permitted valuation techniques and numerous estimates that must be made given the absence of active secondary markets for certain financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values. Items measured at fair value on a recurring basis – The following fair value hierarchy table presents information about the Company’s assets that are measured at fair value on a recurring basis at the dates indicated: Level 1 Level 2 Level 3 Total Fair Value (dollars in thousands) December 31, 2022 Available-for-sale U.S. Treasury securities $ 97,015 $ — $ — $ 97,015 U.S. Agency collateralized mortgage obligations — 51 — 51 U.S. Agency residential mortgage-backed securities — 1 — 1 Municipals — 250 — 250 $ 97,015 $ 302 $ — $ 97,317 December 31, 2021 Available-for-sale U.S. Treasury securities $ 34,998 $ — $ — $ 34,998 U.S. Agency collateralized mortgage obligations — 70 — 70 U.S. Agency residential mortgage-backed securities — 3 — 3 Municipals — 256 — 256 $ 34,998 $ 329 $ — $ 35,327 The following methods were used to estimate the fair value of the class of financial instruments above: Investment securities - The fair value of securities is based on quoted market prices, pricing models, quoted prices of similar securities, independent pricing sources, and discounted cash flows. 141 Table of Contents Limitations: The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2022 and 2021. The factors used in the fair values estimates are subject to change subsequent to the dates the fair value estimates are completed, therefore, current estimates of fair value may differ significantly from the amounts presented herein. Items measured at fair value on a nonrecurring basis – The following table presents financial assets and liabilities measured at fair value on a nonrecurring basis and the level within the fair value hierarchy of the fair value measurements for those assets at the dates indicated: Level 1 Level 2 Level 3 Total Fair Value (dollars in thousands) December 31, 2022 Impaired loans $ — $ — $ 7,080 $ 7,080 Equity securities 2,572 2,572 Total $ — $ — $ 9,652 $ 9,652 December 31, 2021 Impaired loans $ — $ — $ 221 $ 221 Equity securities 2,322 2,322 Total $ — $ — $ 2,543 $ 2,543 Impaired loans - A loan is considered impaired when it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. Impairment is measured based on the fair value of the underlying collateral or the discounted cash expected future cash flows. Subsequent changes in the value of impaired loans are included within the provision for loan losses in the same manner in which impairment initially was recognized or as a reduction in the provision that would otherwise be reported. Impaired loans are evaluated quarterly to determine if valuation adjustments should be recorded. The need for valuation adjustments arises when observable market prices or current appraised values of collateral indicate a shortfall in collateral value compared to current carrying values of the related loan. If the Company determines that the value of the impaired loan is less than the carrying value of the loan, the Company either establishes an impairment reserve as a specific component of the allowance for loan losses or charges off the impairment amount. These valuation adjustments are considered nonrecurring fair value adjustments. Equity securities – The Company measures equity securities without readily determinable fair values at cost less impairment (if any), plus or minus observable price changes from an identical or similar investment of the same issuer, with price changes recognized in earnings. Assets measured at fair value using significant unobservable inputs (Level 3) The following table presents the carrying value of equity securities without readily determinable fair values, as of December 31, 2022 and 2021, with adjustments recorded during the periods presented for those securities with observable price changes, if applicable. These equity securities are included in other investments on the balance sheet. For the Year Ended December 31, (dollars in thousands) 2022 2021 Carrying value, beginning of period $ 2,322 $ 850 Purchases 350 — Observable price change ( 100 ) 1,472 Carrying value, end of period $ 2,572 $ 2,322 142 Table of Contents Assets measured at fair value using significant unobservable inputs (Level 3) The following table provides a description of the valuation technique, unobservable inputs, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a nonrecurring basis at the dates indicated: (unaudited) Valuation Technique Unobservable Inputs December 31, 2022 Weighted Average Rate December 31, 2021 Weighted Average Rate Impaired loans Collateral valuations Discount to appraised value 8.0 % 8.0 % Note 19 – Revenue from Contracts with Customers All of the Company’s revenue from contracts with customers in the scope of Topic 606 is recognized within noninterest income. The following table presents the Company’s noninterest income by revenue stream for the years ended December 31: 2022 2021 (dollars in thousands) Deposit service charges and fees Interchange income $ 2,055 $ 1,959 Merchant service fees 508 568 Overdraft fees 310 316 Other 931 855 Loan referral fees 810 2,126 Mortgage broker fees 257 920 BaaS program income (1) 12,934 6,716 Other income (2) 346 393 Total noninterest income subject to Topic 606 18,151 13,853 BaaS enhancements / guarantees (1) 105,945 10,591 Gain (loss) on equity investment ( 153 ) 1,469 Gain on sale of branch — 1,263 Gain on sale of loans, net — 396 Loan servicing fees 223 248 Earnings on life insurance 361 172 Lease and sublease income 157 126 Total noninterest income not subject to Topic 606 106,533 14,265 Total noninterest income $ 124,684 $ 28,118 (1) See description below for detailed components of BaaS fees and related Topic 606 applicability. (2) Includes the following immaterial income streams that are within the scope of Topic 606: wire transfer fees, annuity fees, and brokerage fees. A description of the Company’s revenue streams accounted for under Topic 606 is as follows: Service Charges on Deposit Accounts: The Company earns fees from deposit customers for transaction-based, account maintenance and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed at the point in the time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. 143 Table of Contents Interchange Income: The Company earns interchange fees from debit card holder transactions conducted through various payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transactions value and are recognized daily, concurrently with the transaction processing services provided by the cardholder. Interchange income is included in Service Charges on Deposit Accounts in the consolidated statements of income. Merchant Service Fees: The Company earns a percentage of fees from cardholder transactions conducted through a third-party payment network provider. The Company is obligated to provide sales, customer support, marketing, deployment and installation of equipment, and savings analysis to merchant service customers. An exclusivity agreement is in place between the Company and the third-party payment network provider. Fees are recognized on a monthly basis, as earned. Merchant service fees are included in Services Charges on Deposit Accounts in the consolidated statements of income. Loan Referral Fees: The Company earns loan referral fees when the Company originates 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. The Company recognizes the loan referral fee for arranging the interest rate swap. Mortgage Broker Fees: Mortgage broker fees are governed by contract arrangements executed with a third-party mortgage company. The Company earns broker fees by partially underwriting mortgage loans and referring qualified loans to the third-party mortgage company. Revenue is recognized at the date the mortgage company funds the mortgage loan. The contract arrangement includes a fee reimbursement requirement for funded mortgage loans that pay off within three months of origination. BaaS Fees: The Company earns fees and is reimbursed for certain expenses, as specified in the program agreement, for providing banking services to broker-dealers and digital financial service providers. Earned program fees and reimbursement of expenses are recorded gross and recognized on a monthly basis, as earned. Credit enhancements for fraud and credit losses are not within the scope of Topic 606. The following tables presents the BaaS fees that are within and not within the scope of Topic 606: Year Ended December 31, Increase (Decrease) (dollars in thousands) 2022 2021 Program income - within the scope of Topic 606 Servicing and other BaaS fees $ 4,408 $ 4,467 $ ( 59 ) Transaction 3,211 544 2,667 Interchange 2,583 701 1,882 Reimbursement of expenses 2,732 1,004 1,728 Total BaaS program income 12,934 6,716 6,218 Guarantees - not within the scope of Topic 606: BaaS credit enhancement 76,374 9,086 67,288 BaaS fraud enhancement 29,571 1,505 28,066 Total BaaS enhancements / guarantees 105,945 10,591 95,354 Total BaaS fees $ 118,879 $ 17,307 $ 101,572 144 Table of Contents Note 20 - Earnings Per Common Share The following is a computation of basic and diluted earnings per common share at the periods indicated: Year Ended (dollars in thousands, except per share data) December 31, 2022 December 31, 2021 Net Income $ 40,625 $ 27,005 Basic weighted average number common shares outstanding 12,949,266 12,022,954 Dilutive effect of equity-based awards 565,686 498,472 Diluted weighted average number common shares outstanding 13,514,952 12,521,426 Basic earnings per share $ 3.14 $ 2.25 Diluted earnings per share $ 3.01 $ 2.16 Antidilutive stock options and restricted stock outstanding 147,423 176,097 Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings, however the difference in the two-class method was not significant. Note 21 – Segment Reporting As defined in ASC 280, Segment Reporting , an operating segment is a component of an enterprise that engages in business activities from which it may earn revenues and incur expenses, whose operating results are regularly reviewed by the enterprise’s chief operating decision makers to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available. We evaluate performance based on an internal performance measurement accounting system, which provides line of business results. This system uses various techniques to assign balance sheet and income statement amounts to the business segments, including allocations of income and expense. A primary objective of this measurement system and related internal financial reporting practices are to produce consistent results that reflect the underlying financial impact of the segments on the Company and to provide a basis of support for strategic decision making. The accounting policies applicable to our segments are those that apply to our preparation of the accompanying Consolidated Financial Statements. Based on these criteria, we have identified two segments: The community bank and CCBX. Income and expenses that are specific to CCBX are recorded to the CCBX segment. Included in noninterest expense for the community bank is administrative overhead of $ 27.2 million and $ 19.0 million for the year ended December 31, 2022 and December 31, 2021, respectively. Both the community bank and the CCBX segment benefit from this administrative overhead and services, which includes shared operational activities such as data management, compliance monitoring and other administration functions. Summarized financial information concerning the Company's reportable segments and the reconciliation to the consolidated financial results is shown in the following tables for the periods indicated: December 31, 2022 December 31, 2021 Bank CCBX Total Bank CCBX Total (dollars in thousands) Total assets $ 2,097,885 $ 1,046,582 $ 3,144,467 $ 2,282,514 $ 353,003 $ 2,635,517 Total loans receivable 1,614,751 1,012,505 2,627,256 1,396,060 346,675 1,742,735 Allowance for loan losses ( 20,636 ) ( 53,393 ) ( 74,029 ) ( 20,299 ) ( 8,333 ) ( 28,632 ) Total deposits 1,538,218 1,279,303 2,817,521 1,647,529 716,258 2,363,787 145 Table of Contents Year Ended December 31, 2022 Year Ended December 31, 2021 Bank CCBX Total Bank CCBX Total (dollars in thousands) Net interest income $ 85,075 $ 86,700 $ 171,775 $ 73,004 $ 6,433 $ 79,437 Provision for loan losses $ 719 78,345 79,064 1,275 8,640 9,915 Noninterest income (1) $ 5,652 119,032 124,684 10,713 17,405 28,118 Noninterest expense $ 64,114 102,660 166,774 51,547 11,716 63,263 (1) For the year ended December 31, 2022, CCBX noninterest income includes credit enhancement recovery of $ 76.4 million, fraud recovery of $ 29.6 million, servicing and other BaaS fees of $ 7.6 million, reimbursement of expenses of $ 2.7 million, and interchange income of $ 2.6 million. For the year ended December 31, 2021, CCBX noninterest income includes credit enhancement recovery of $ 9.1 million, fraud recovery of $ 1.5 million, servicing and other BaaS fees of $ 5.0 million, reimbursement of expenses of $ 1.0 million, and interchange income of $ 701,000 . Note 22 – Parent Company Only Condensed Financial Information Condensed financial information of Coastal Financial Corporation follows: December 31, 2022 December 31, 2021 ASSETS Cash $ 22,904 $ 24,306 Investment in trust equities 109 109 Investment in subsidiaries 265,741 202,258 Other investments 3,028 2,482 Total loans receivable — 350 Other assets ( 150 ) 124 TOTAL ASSETS $ 291,632 $ 229,629 LIABILITIES AND SHAREHOLDERS' EQUITY Junior subordinated debentures, net of issuances costs $ 3,588 $ 3,586 Subordinated debt, net of debt issuance costs 43,999 24,288 Interest and dividends payable 546 290 Other liabilities 5 243 Shareholders' equity 243,494 201,222 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 291,632 $ 229,629 146 Table of Contents Year ended December 31, 2022 2021 INTEREST INCOME Interest earned loans receivable $ ( 14 ) $ 14 Interest bearing other investments 4 3 Total interest income ( 10 ) 17 INTEREST EXPENSE Interest on borrowed funds 1,322 795 Total interest expense 1,322 795 Net interest expense ( 1,332 ) ( 778 ) PROVISION FOR LOAN LOSSES 350 — Net interest expense after provision for loan losses ( 1,682 ) ( 778 ) NONINTEREST INCOME Unrealized (loss) gain on equity investment ( 153 ) 1,469 Other income 23 — Total noninterest income ( 130 ) 1,469 NONINTEREST EXPENSE Other expenses 711 576 Total noninterest expense 711 576 Loss before income taxes and undistributed net income of subsidiary ( 2,523 ) 115 Equity in undistributed income of consolidated subsidiaries 42,674 26,917 Income tax (benefit) expense ( 474 ) 27 NET INCOME $ 40,625 $ 27,005 147 Table of Contents Year ended December 31, 2022 2021 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 40,625 $ 27,005 Adjustments to reconcile net income to net cash used by operating activities: Equity in undistributed income of consolidated subsidiaries ( 42,674 ) ( 26,917 ) Stock-based compensation 295 162 Unrealized loss (gain) on equity investment 153 ( 1,469 ) Decrease (increase) in other assets 274 5 Increase in other liabilities 106 452 Net cash used by operating activities ( 1,221 ) ( 762 ) CASH FLOWS FROM INVESTING ACTIVITIES: Investments in subsidiaries ( 20,925 ) ( 26,500 ) Investments in loans receivable 350 ( 350 ) Investments in other, net ( 699 ) ( 163 ) Net cash used by investing activities ( 21,274 ) ( 27,013 ) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from exercise of stock options 1,468 360 Proceeds from public offering, net — 32,387 Proceeds from subordinated debt 19,625 24,263 Repayment of subordinated debt — ( 10,000 ) Net cash provided by financing activities 21,093 47,010 NET CHANGE IN CASH ( 1,402 ) 19,235 Cash, beginning of year 24,306 5,071 Cash, end of year $ 22,904 $ 24,306 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None.