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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are a bank holding company that operates through our wholly owned subsidiaries, Coastal Community Bank (Bank) and Arlington Olympic LLC . We are headquartered in Everett, Washington, which by population is the largest city in, and the county seat of, Snohomish County. We focus on providing a wide range of banking products and services to consumers and small to medium-sized businesses in the broader Puget Sound region in the state of Washington. We currently operate 15 full-service banking locations, 12 of which are located in Snohomish County, where we are the largest community bank by deposit market share, and three of which are located in neighboring counties (one in King County and two in Island County). The Bank announced the sale of its Freeland Branch (Island County) in February 2021. The Bank also provides banking as a service (BaaS), through our CCBX division, that allows broker-dealer and digital financial service providers to offer their customers banking services and we expect to introduce a digital bank offering, through our CCDB division, in collaboration with Google in 2021 or early 2022. As of December 31, 2020, we had total assets of $1.77 billion, total gross loans of $1.55 billion, total deposits of $1.42 billion and total shareholders’ equity of $140.2 million.

The following discussion and analysis presents our financial condition and results of operations on a consolidated basis. However, because we conduct all of our material business operations through the Bank, the discussion and analysis relate to activities primarily conducted by the Bank. This discussion and analysis should be read in conjunction with the audited consolidated financial statements and the accompanying notes presented elsewhere in this Annual Report on Form 10-K.

As a bank holding company that operates through one segment, community banking, we generate most of our revenue from interest on loans and investments. Our primary source of funding for our loans is commercial and retail deposits from our customer relationships. We place secondary reliance on wholesale funding, primarily borrowings from the Federal Home Loan Bank (FHLB). We are utilizing the Paycheck Protection Program Liquidity Facility (PPPLF), which provides an additional source of low cost funding for the Paycheck Protection Program (PPP) loans, with a contractual interest rate of 0.35%. The PPPLF borrowings are collateralized by PPP loans and must be paid down as the PPP loans are forgiven or paid down by customers. Less commonly used sources of funding include borrowings from the Federal Reserve System (Federal Reserve) discount window, draws on established federal funds lines from unaffiliated commercial banks, brokered funds, which allows us to obtain deposits from sources that do not have a relationship with the Bank and can be obtained through certificate of deposit listing services, via the internet or through other advertising methods, or a one-way buy through an insured cash sweep (ICS) account, which allows us to obtain funds from other institutions that have deposited funds through ICS. Our largest expenses are provision for loan losses, salaries and related employee benefits, interest on deposits and borrowings, occupancy and data processing. Our principal lending products are commercial real estate loans, commercial and industrial loans, residential real estate loans, construction, land and land development loans, and to a lesser extent consumer loans.

CARES Act

On March 27, 2020, the CARES Act was enacted, providing wide ranging economic relief for individuals and businesses impacted by the COVID-19 pandemic. Among other things, the statute created the PPP, which is a stimulus response to the potential economic impacts of COVID-19, and its purpose is to provide forgivable loans to smaller businesses that use the proceeds of the loans for payroll and certain other qualifying expenses. The Small Business Administration (SBA) manages and backs the PPP. If a loan is fully forgiven, the SBA will repay the lending bank in full. If a loan is partially forgiven or not forgiven at all, a bank must look to the borrower for repayment of unforgiven principal and interest. If the borrower defaults, the loan is guaranteed by the SBA. The PPP program closed to new loan applicants on August 8, 2020. We accepted and processed requests for existing and new customers for the duration of the program, and recently began accepting and processing applications for round three, which opened for applications on January 19, 2021. As of March 8, 2021, we have funded $259.3 million, representing 1,867 customers, in this latest round of PPP loans, consisting of $16.6 million in new PPP applications for first draws and $242.7 million in a second draw for small businesses that previously received PPP funds. Net deferred fees on these loans total $10.1 million and will be recognized in interest income in future periods. Round

three PPP loans have a maturity of five years. Loan payments will be deferred for borrowers who apply for loan forgiveness until SBA remits the borrower's loan forgiveness amount to the lender. If a borrower does not apply for loan forgiveness, payments are deferred 10 months after the end of the covered period for the borrower’s loan forgiveness (either 8 weeks or 24 weeks).

We are accepting applications from customers for loan forgiveness and as of March 8, 2021 we have received $180.8 million in forgiveness or principal paydowns. In order to obtain loan forgiveness, a PPP borrower must submit a forgiveness application to us, which we must review and forward to the SBA. We expect that the pace of forgiveness of PPP loans will increase in the first half of 2021. The initial payment deferral period on PPP loans was extended and customers with two-year loans can work with their lender to extend to a five year maturity, which we anticipate could be a popular option for customers not eligible for forgiveness.

The Company's Preparations and Responses to COVID-19 Pandemic

As part of its ongoing risk preparation and mitigation efforts, the Company had developed a detailed plan and action measures related to a possible pandemic scenario. This pandemic plan was implemented on March 12, 2020 and continued through the third quarter and into fourth quarter of 2020. The Company carefully executed the plan with limited operational disruptions, with attention to ensure continued customer support, and with the utmost care to safeguard employees, customers and vendors. Management continues to monitor and, when appropriate, make changes to our planned response. To date we have:

o Opens certain businesses with social distancing and capacity restrictions

PPP Overview

Throughout 2020, significant focus was placed on helping the small businesses in our communities through the PPP. These loans have had a significant impact on our financial statements for the year ended December 31, 2020 and will continue to impact our results in the future. Throughout this discussion, we will address the impact of these loans, including borrowings received through PPPLF to help fund these loans and to aid in liquidity, increased customer deposit accounts from unused disbursements, and earnings and expenses related to these activities. Any estimated adjusted ratios that exclude the impact of this activity are non-GAAP measures. For more information about non-GAAP financial measures, see the non-GAAP disclosure “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”

Key Factors Affecting our Business

Average Balances and Interest Rates

Our operating results depend primarily on our net interest income, which is the largest contributor to our net income and is the difference between the interest and fees earned on interest-earning assets (such as loans and securities) and the interest expense incurred in connection with interest-bearing liabilities (such as deposits and borrowings). Net interest income is primarily a function of the average balances of interest-earning assets and interest-bearing liabilities and the yields and costs with respect to these assets and liabilities. Average balances are influenced by internal considerations such as the types of products we offer and the amount of risk that we are willing to assume as well as external influences such as economic conditions, competition for loans and deposits, and interest rates. The yields generated by our loans and securities are typically affected by short-term and long-term interest rates and, in the case of loans, competition for similar products in our market area. Interest rates are often impacted by the actions of the Federal Reserve. The cost of our deposits and short-term borrowings is primarily based on short-term interest rates, which are largely driven by competition and by the actions of the Federal Reserve. The level of net interest income is influenced by movements in interest rates and the pace at which such movements occur, as well as the relationship between short- and long-term interest rates.

Credit Quality

We have well established loan policies and underwriting practices that have resulted in low levels of charge-offs and nonperforming assets. Through our thorough underwriting process, we strive to originate quality loans that will maintain and enhance the overall credit quality of our loan portfolio, and through our careful monitoring of our loan portfolio and prompt attention to delinquencies, we seek to minimize the impact of problem loans. However, credit trends in the markets in which we operate are largely impacted by economic conditions beyond our control and can adversely impact our financial condition.

Operating Efficiency

The largest component of noninterest expense is salaries and employee benefits. Other significant operating expenses include occupancy expense, data processing expense, director and staff expense, marketing expense, and legal and professional fees. Our operating efficiency, as measured by our efficiency ratio, has gradually improved primarily because the growth of our deposits and loans has enabled our net interest income and noninterest income to outpace the growth of our expenses. When we make substantial investments in the infrastructure of new divisions, open new branches or make investments to increase our operating capacity, our operating efficiency decreases until we generate enough revenue growth to offset the increased costs however, prior to making such investments, we focus on how best and most expediently we can achieve the revenue growth necessary to offset the costs of these investments or new branches.

Economic Conditions

Our business and financial performance are affected by economic conditions generally in the United States and more directly in the markets in the Puget Sound region where we operate. The significant economic factors that are most relevant to our business and our financial performance include, but are not limited to, real estate values,

interest rates and unemployment rates. In recent years, the Puget Sound region has experienced significant population gain, fueled in large part by the region’s technology industry, low unemployment and rising real estate values, all of which positively impacted our business. The economic effects of the COVID-19 pandemic have had a destabilizing effect on financial markets, key market indices and overall economic activity. The uncertainty regarding the duration of the pandemic and the resulting economic disruption has caused increased market volatility and may lead to an economic recession and/or a significant decrease in consumer confidence and business generally.

Critical Accounting Policies

Our accounting policies are integral to understanding our results of operations. Our accounting policies are described in greater detail in Note 1 to our consolidated financial statements included elsewhere in this Report on Form 10-K. We believe that of our accounting policies, the following accounting policies may involve a higher degree of judgment and complexity:

Securities

Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value. Unrealized gains and losses are excluded from earnings and reported in other comprehensive income. Securities within the available for sale portfolio may be used as part of our asset/liability strategy and may be pledged or sold in response to changes in interest rate risk, prepayment risk or other similar economic factors. Securities held to maturity are carried at cost, adjusted for the amortization of premiums and the accretion of discounts and may be pledged.

Interest earned on these assets is included in interest income. Interest income includes amortization of any purchase premium or discount. Premiums and discounts on securities are amortized using the level-yield method, except for mortgage backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

Management evaluates debt securities for other-than-temporary impairment (OTTI), on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: (1) OTTI related to credit loss, which must be recognized in the income statement, and (2) OTTI related to other factors, which is recognized in other comprehensive income, net of applicable taxes. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the security.

Loans Held for Investment

Loans held for investment are those that management has the intent and ability to hold for the foreseeable future or until maturity or payoff at the principal and interest balance outstanding, net of deferred loan fees and costs. Loans are typically secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. Interest income is accrued on the unpaid principal balance. Loan origination fees and certain direct origination costs are deferred and recognized as adjustments to interest income using a level yield methodology or a method approximating the level yield methodology.

Allowance for Loan Losses

The allowance for loan losses represents management’s estimate of probable and reasonably estimable credit losses inherent in the loan portfolio. In determining the allowance, the Company estimates losses on individual impaired loans, or groups of loans which are not impaired, where the probable loss can be identified and reasonably estimated. On a quarterly basis, the Company assesses the risk inherent in the Company’s loan portfolio based on qualitative and quantitative trends in the portfolio, including the internal risk classification of loans, historical loss rates, changes in the nature and volume of the loan portfolio, industry or borrower concentrations, delinquency trends, detailed reviews of significant loans with identified weaknesses and the impacts of local, regional and national economic factors on the quality of the loan portfolio. Based on this analysis, the Company records a provision for loan losses to maintain the allowance at appropriate levels.

Determining the amount of the allowance is considered a critical accounting estimate, as it requires significant judgment and the use of subjective measurements, including management’s assessment of overall portfolio quality. The Company maintains the allowance at an amount the Company believes is sufficient to provide for estimated losses inherent in the Company’s loan portfolio at each balance sheet date, and fluctuations in the provision for loan losses may result from management’s assessment of the adequacy of the allowance. Changes in these estimates and assumptions are possible and may have a material impact on the Company’s allowance, and therefore the Company’s financial position, liquidity or results of operations.

Stock-based Compensation

We grant stock options and restricted stock to our employees and directors. We record the related compensation expense based on the grant date fair value calculated in accordance with the authoritative guidance issued by FASB. We recognize these compensation costs on a straight-line basis over the requisite service period of the award. We estimate the grant date fair value of stock options using the Black-Scholes valuation model. Stock-based compensation expense related to awards of restricted stock is based on the fair value at the grant date.

The determination of fair value using the Black-Scholes model is affected by the price of our common stock, as well as the input of other subjective assumptions. These assumptions include, but are not limited to, the expected term of stock options and our stock price volatility. As there has been no public market for our common stock prior to July 20, 2018, the estimated fair value of our common stock was determined by our board of directors as of the date of each option grant, with input from management, based on our board of directors’ assessment of objective and subjective factors that it believed were relevant. The factors considered by our board of directors included the prices of known transactions in our common stock, the book value per share of our common stock, and our board of directors’ understanding of pricing multiples for comparable financial institutions that were not publicly traded.

The assumptions underlying these valuations represented management’s best estimate, which involved inherent uncertainties and the application of management’s judgment. As a result, if we had used different assumptions or estimates, the fair value of our common stock and our stock-based compensation expense could have been materially different.

Emerging Growth Company

The JOBS Act permits an “emerging growth company” to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. However, we have decided not to take advantage of this provision. As a result, we will comply with new or revised accounting standards to the same extent that compliance is required for non-emerging growth companies. Our decision to opt out of the extended transition period under the JOBS Act is irrevocable.

Recent Pronouncements

For a discussion of the expected impact of accounting pronouncements recently adopted and accounting pronouncements recently issued but not yet adopted by us as of December 31, 2020, see Note 2 of our audited consolidated financial statements included elsewhere in this Report on Form 10-K.

Results of Operations

Net Income

Year Ended December 31, 2020, Compared to Year Ended December 31, 2019. Net income for the year ended December 31, 2020, was $15.1 million, or $1.24 per diluted share, compared to $13.2 million, or $1.08 per diluted share, for the year ended December 31, 2019. The increase in net income over the prior year was attributable to a $15.4 million increase in net interest income partially offset by an $7.1 million increase in noninterest expense and $5.8 million increase in provision for loan losses.

Year Ended December 31, 2019, Compared to Year Ended December 31, 2018. Net income for the year ended December 31, 2019, was $13.2 million, or $1.08 per diluted share, compared to $9.7 million, or $0.91 per diluted share, for the year ended December 31, 2018. The increase in net income over the prior year was attributable to a $7.2 million increase in net interest income and a $2.8 million increase in noninterest income, which were partially offset by an $4.8 million increase in noninterest expense, $920,000 increase in provision for income taxes and $718,000 increase in provision for loan losses.

Net Interest Income

Year Ended December 31, 2020, Compared to Year Ended December 31, 2019. Net interest income for the year ended December 31, 2020, was $57.4 million compared to $42.0 million for the year ended December 31, 2019, an increase of $15.4 million, or 36.6%. The increase in net interest income consisted of a $14.5 million, or 29.7%, increase in interest income combined with a $924,000, or 14.1%, decrease in interest expense.

The increase is largely related to increased interest income resulting from loan growth, the recognition of deferred fees on PPP loans, including forgiven and paid off loans, and the additional $398,000 in interest and fee income recognized on MSLP loans. Interest and fees on loans increased $16.6 million, or 36.5%, over the prior year period, despite a decrease in yield on loans receivable of 0.74% for the year ended December 31, 2020, compared to the year ended December 31, 2019. Non-PPP loan growth of $248.0 million, which includes CCBX loan growth of $65.3 million, for the year ended December 31, 2020 contributed to this increase. Also contributing to the increase is PPP loans, which had an average balance of $302.7 million, and contributed $3.0 million from the 1% interest rate and $7.2 million in fees recognized, for a total of $10.2 million in interest income on PPP loans for the year ended December 31, 2020. Interest and fee income of $398,000 on MSLP loans also contributed to the increase, for the year ended December 31, 2020, compared to no income on MSLP loans for the year ended December 31, 2019. Net deferred fees on PPP loans are earned over the life of the loan, as a yield adjustment in interest income. Forgiveness of principal, early paydowns and payoffs on PPP loans will increase interest income earned in those periods from the recognition of PPP net deferred fees. As of December 31, 2020, $5.8 million in net deferred fees on PPP loans remained to be recognized. Interest income from interest earning deposits with other banks decreased $1.8 million, or 72.6%, to $663,000 for the year ended December 31, 2020, compared to $2.4 million for the year ended December 31, 2019, as a result of lower interest rates.

The table below summarizes key information regarding the PPP loans as of the period indicated:

Loan Size

(Dollars in thousands; unaudited)

Principal outstanding:

Number of loans:

Forgiveness/Payoffs/Paydowns in Quarter Ended December 31, 2020, net

Interest expense decreased $924,000, or 14.1%, to $5.7 million for the year ended December 31, 2020 compared to $6.6 million for the year ended December 31, 2019. Lower interest rates resulted in a decrease in interest expense despite a $158.6 million increase in average interest bearing deposits and $144.0 million increase in average borrowings for the year ended December 31, 2020, compared to the prior year period. Borrowings included $124.1 million in average PPPLF borrowings, which were obtained to partially fund the PPP loans.

For the year ended December 31, 2020, net interest margin and interest rate spread were 3.83% and 3.57%, respectively, compared to 4.23% and 3.76% for the year ended December 31, 2019. The net interest margin and spread declined as a result of the lower yielding PPP loans and lower interest rate environment.

Year Ended December 31, 2019, Compared to Year Ended December 31, 2018. Net interest income for the year ended December 31, 2019, was $42.0 million compared to $34.8 million for the year ended December 31, 2018, an increase of $7.2 million, or 20.7%. The increase in net interest income consisted of a $9.8 million, or 25.4%, increase in interest income offset by a $2.7 million, or 67.5%, increase in interest expense.

The growth in interest income was primarily attributable to a $138.2 million, or 19.6%, increase in average loans outstanding for the year ended December 31, 2019, compared to the prior year, combined with a 20 basis point increase in the yield on total loans. The increase in average loans outstanding was primarily due to our dual strategies of focusing on deepening relationships with existing borrowers and actively calling on new customers. Also contributing to the increase in 2019 was $8.1 million in purchased participation loans. The hiring of new lending teams and lenders in 2018 contributed to loan growth in 2019 as those lenders were able to transition more customers and increase new customer relationships overall. The increase in the yield on total loans reflects the total 1.25% interest rate increases by the Federal Open Market Committee (FOMC) between December 2017 and December 2018, resulting in higher rates on new and renewing loans during that period, the benefit of which was reflected throughout 2019.

The increase in interest expense for the year ended December 31, 2019, was primarily related to a $87.5 million, or 18.3%, increase in average interest-bearing deposits over the prior year. The majority of this increase is attributable to growth in core deposit accounts, which we define as deposits excluding all brokered and time deposits. Noninterest bearing deposits (such as demand or checking accounts) grew $77.7 million, or 26.5%, in 2019. NOW (which are interest bearing checking accounts) and money market accounts grew $88.0 million, or 25.1%, and savings accounts increased $793,000, or 1.5%, in 2019. Non-core deposits decreased $2.1 million in 2019 with time deposits decreasing $15.2 million, or 15.7%, partially offset by an increase in BaaS brokered deposits of $13.1 million, or 124.2%, in 2019. We do not regularly advertise time deposit rates or money market rates, although we occasionally advertise promotional rates in targeted portions of our market area. Market conditions for deposits are competitive and the aforementioned rate increase by the FOMC in 2018 resulted in a 23 basis point increase in cost of deposits as of December 31, 2019 as compared to December 31, 2018.

For the year ended December 31, 2019, net interest margin and net interest spread were 4.23% and 3.76%, respectively, compared to 4.24% and 3.92% for the year ended December 31, 2018.

The following table presents an analysis of the average balances of net interest income, net interest spread and net interest margin for the periods indicated. Loan fees included in interest income totaled $9.1 million and $1.4 million for the years ended December 31, 2020 and 2019, respectively. Of the $9.1 million fees recognized in 2020, $7.2 million were from PPP loans. For the years ended December 31, 2020 and 2019, the amount of interest income not recognized on nonaccrual loans was not material.

Average Balance Sheets For the Year Ended December 31,

Average Interest & Yield / Average Interest & Yield / Average Interest & Yield /

Assets

Interest earning assets:

Noninterest earning assets:

Liabilities and Shareholders’ Equity

Interest bearing liabilities:

(2) Includes nonaccrual loans.

The following table presents information regarding the dollar amount of changes in interest income and interest expense for the periods indicated for each major component of interest-earning assets and interest-bearing liabilities and distinguishes between the changes attributable to changes in volume and changes attributable to changes in interest rates. For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to volume.

Increase (Decrease) Total Increase (Decrease) Total

Due to Increase Due to Increase

(Dollars in thousands) Volume Rate (Decrease) Volume Rate (Decrease)

Interest income:

Investment securities, available for sale (120 ) (249 ) (369 ) (62 ) 21 (41 )

Investment securities, held to maturity 11 (47 ) (36 ) 50 8 58

Interest expense:

PPPLF borrowings 435 - 435 - - -

Subordinated debt - 2 2 1 (1 ) -

Junior subordinated debentures - (63 ) (63 ) - 11 11

Provision for Loan Losses

The provision for loan losses is an expense we incur to maintain an allowance for loan losses at a level that is deemed appropriate by management to absorb inherent losses on existing loans. For a description of the factors taken into account by our management in determining the allowance for loan losses see “Item 7. Management’s Discussion and Analysis of Financial Condition and Operations—Financial Condition—Allowance for Loan Losses.”

Year Ended December 31, 2020, Compared to Year Ended December 31, 2019. The provision for loan losses for the year ended December 31, 2020, was $8.3 million compared to $2.5 million for the year ended December 31, 2019. The increase of $5.8 million was primarily related to an increase in qualitative factors related to the economic uncertainties caused by the COVID-19 pandemic and loan growth. The Company is not required to implement the provisions of the Current Expected Credit Loss accounting standard until January 1, 2023 and will continue to account for the allowance for credit losses under the incurred loss model. Gross loans totaled $1.55 billion in 2020 compared to $939.1 million in 2019 and grew $608.0 million in 2020. Included in the loan growth for 2020 is $365.8 million in PPP loans, which are 100% guaranteed, and are excluded from the provision for loan losses calculation. The allowance for loan losses as a percentage of loans was 1.25% at December 31, 2020, compared to 1.22% at December 31, 2019. Excluding PPP loans, which are 100% guaranteed by the SBA, the allowance for loan losses as a percentage of loans was approximately 1.62% at December 31, 2020. A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”

Net charge-offs for the year ended December 31, 2020 totaled $516,000, or 0.04% of total average loans, as compared to net charge-offs of $481,000, or 0.06% of total average loans, for the year ended December 31, 2019. Net charge-offs were down slightly in 2020 compared to 2019 based on percent of average loans.

Year Ended December 31, 2019, Compared to Year Ended December 31, 2018. The provision for loan losses for the year ended December 31, 2019, was $2.5 million compared to $1.8 million for the year ended December 31, 2018. The increase of $718,000 was primarily due to gross loan growth. Gross loans totaled $939.1 million in 2019 compared to $767.9 million in 2018 and grew $171.2 million in 2019 compared to $111.1 million in 2018. The allowance for loan losses as a percentage of loans was 1.22% at December 31, 2019, compared to 1.23% at December 31, 2018.

Net charge-offs for the year ended December 31, 2019, totaled $481,000, or 0.06% of total average loans, as compared to net charge-offs of $436,000, or 0.06% of total average loans, for the year ended December 31, 2018. Net charge-offs for both years were consistent on a percentage basis.

Noninterest Income

Our primary sources of recurring noninterest income are deposit account service charges and fees, BaaS fees, loan referral fees, and mortgage broker fees. Noninterest income does not include loan origination fees to the extent they exceed the direct loan origination costs, which are generally recognized over the life of the related loan as an adjustment to yield using the interest method.

The following table presents, for the periods indicated, the major categories of noninterest income:

Year Ended Year Ended

December 31, Increase Percent December 31, Increase Percent

Deposit Service Charges and Fees. Deposit service charges and fees include service charges on accounts, point-of-sale fees, merchant services fees and overdraft fees. Together they constitute the largest component of our noninterest income. Deposit service charges and fees were $3.1 million for the year ended December 31, 2020, a decrease of $16,000, or 0.5%, over the prior year. Most accounts within the category remained fairly flat, despite an increase in the number of accounts, due to reduced activity from individuals and businesses resulting from the COVID-19 pandemic restrictions. Point-of-sale fees increased by $148,000, and check printing fees were up $16,000. These positive variances were partially offset by a decrease of $146,000 in overdraft fees. Deposit service charges and fees were $3.1 million for the year ended December 31, 2019,an increase of $46,000, or 1.5%, over the prior year. Despite increases in most accounts within this category, income remained fairly flat for the year ended December 31, 2019 as compared to the year ended December 31, 2018 in part due to a change in the accounting for certain point-of-sale fees which reduced fee income by $211,000 for that product in the current period.

BaaS Fees. Our CCBX division provides BaaS offerings that enable our broker dealer and digital financial service partners to offer their customers banking services. In exchange for providing these services, we earn fixed fees, volume-based fees and reimbursement of costs depending on the contract. For the year ended December 31, 2020, we earned $2.4 million in BaaS fees, which was an increase of $305,000, or 14.8%, over the year ended December 31, 2019, where we earned $2.1 million in BaaS fees. The increase was the result of increased relationships with broker dealers and digital financial service providers. For the year ended December 31, 2019, we earned $2.1 million in BaaS fees, which is an increase of $1.3 million, or 190.6%, over the year ended December 31, 2018, where we earned $709,000 in BaaS fees. The increase is the result of increased relationships with broker dealers and digital financial service providers. At December 31, 2020 there were six active CCBX relationships, two

CCBX relationship in friends and family trials, threeCCBX relationships in onboarding/implementation, four signed letters of intent and a solid pipeline of potential new relationships. As more CCBX customers move to active status, we expect that BaaS fees will increase.The following table illustrates the activity and growth in CCBX for the periods indicated:

As of

Friends and family 2 0

Implementation / onboarding 3 3

Signed letters of intent 4 0

Total CCBX relationships 15 5

Loan Referral Fees. We earn loan referral fees when we originate a variable rate loan and the borrower enters into an interest rate swap agreement with a third party to fix the interest rate for an extended period, usually 20 or 25 years. We recognize the loan referral fee for arranging the interest rate swap. By facilitating interest rate swaps to our clients, we are able to provide them with a long-term, fixed interest rate without the assuming the interest rate risk. Loan referral fees were $1.7 million for the year ended December 31, 2020, an increase of $288,000, or 20.0%, over the year ended December 31, 2019. Loan referral fees were $1.4 million for the year ended December 31, 2019, compared to $618,000 in the prior year, an increase of $820,000 or 132.7%. Interest rate volatility, swap rates, and the timing of loan closings all impact the demand for long-term fixed rate swaps. The recognition of loan referral fees fluctuates in response to these market conditions and as a result we recognize more or fewer, loan referral fees in some periods.

Mortgage Broker Fees. We earn mortgage broker fees for residential mortgage loans that we broker through mortgage lenders. Mortgage broker fees increased $208,000 for the year ended December 31, 2020 compared to the year ended December 31, 2019 as a result increased demand from lower mortgage interest rates which continue to make homes more affordable and mortgage refinancing an attractive option. Mortgage broker fees increased $232,000 for the year ended December 31, 2019 compared to the year ended December 31, 2018 as a result of higher demand and lower mortgage interest rates in our key markets, which increased the demand for new and refinanced mortgages.

Gain on Sale of Loans, net. Gain on sales of loans occurs when we sell in the secondary market the guaranteed portion (generally 75% of the principal balance) of the SBA and USDA loans that we originate. This activity fluctuates based on SBA and USDA loan activity. Gain on sale of loans decreased $408,000, or 83.3%, for the year ended December 31, 2020, to $82,000. In the year ended December 31, 2020, our primary focus was on SBA PPP loans, thereforefewer SBA and USDA loans were originated and sold to the secondary market. Gain on sale of loans increased to $490,000 for the year ended December 31, 2019 from $264,000 for the year ended December 31, 2018, due to an increase in loans sold.

Gain on Sale of Securities, net. No gain on sale of securities was recognized in 2020. In the quarter ended September 30, 2019 we restructured our investment portfolio to improve the rate of return and reduce the weighted average maturity, interest rate risk and price risk on the portfolio. As a result of this restructuring we were able to recognize $171,000 in net gains on the securities sold during the year ended December 31, 2019.

Other. This category includes a variety of other income-producing activities, annuity broker fees, and SBA and USDA servicing fees. Other noninterest income decreased $346,000, or 71.0%, for the year ended December 31, 2020 compared to the year ended December 31, 2019 most significantly because of a $400,000 write-down on an equity investment. Other noninterest income decreased $32,000, or 6.2%, for the year ended December 31, 2019 compared to the year ended December 31, 2018most significantly because of lower SBA servicing fees and lower annuity fees, as compared to the prior period. Other noninterest income was $487,000 for the year ended December 31, 2019 and $519,000 for the year ended December 31, 2018.

Noninterest Expense

Generally, noninterest expense includes all employee expenses and costs associated with operating our facilities, obtaining and retaining customer relationships, and providing bank services. The largest component of noninterest expense is salaries and employee benefits. Noninterest expense also includes operational expenses, such as occupancy expense, data processing expense, and legal and professional fees.

For the year ended December 31, 2020, noninterest expense totaled $38.1 million, an increase of $7.1 million, or 22.7%, compared to $31.1 million for the year ended December 31, 2019. For the year ended December 31, 2019, noninterest expense totaled $31.1 million, an increase of $4.9 million, or 18.5%, compared to $26.2 million for the year ended December 31, 2018.

The following table presents, for the periods indicated, the major categories of noninterest expense:

Year Ended Year Ended

December 31, Increase Percent December 31, Increase Percent

OREO and repossessed assets operations, net - - - N/A - (2 ) 2 100.0

Salaries and Employee Benefits. Salaries and employee benefits are the largest component of noninterest expense and include payroll expense, incentive compensation costs, benefit plans, health insurance and payroll taxes. Salaries and employee benefits were $23.3 million for the year ended December 31, 2020, an increase of $4.3 million, or 22.9%, compared to $19.0 million for the year ended December 31, 2019. The increase was primarily due to continued hiring staff for our BaaS division and additional staff for our ongoing banking related growth initiatives, including hiring staff for opening our Arlington branch in June 2020, as well as employing temporary help to assist with operations related to the PPP loans. As our CCBX and CCDB divisions grow, we expect to continue to add employees to support these lines of business. Salaries and employee benefits were $19.0 million for the year ended December 31, 2019, an increase of $3.0 million, or 18.3%, compared to $16.0 million for the year ended December 31, 2018. The increase was primarily due to hiring staff for our BaaS CCBX division, additional staff for our ongoing banking related growth initiatives, a full year of doing business as a public company and operating our Edmonds branch. As of December 31, 2020, we had 250 full-time equivalent employees, compared to 195 at December 31, 2019, and 183 at December 31, 2018.

Occupancy Expenses. Occupancy expenses were $4.0 million for the year ended December 31, 2020, compared to $3.8 million for the year ended December 31, 2019, an increase of $202,000, or 5.4%. Occupancy expenses were $3.8 million for the year ended December 31, 2019, compared to $3.3 million for the year ended December 31, 2018. This category includes building, leasehold, furniture, fixtures and equipment depreciation totaling $1.4 million, $1.2 million, and $1.1 million for years ended December 31, 2020, 2019, and 2018, respectively. The increase of $202,000 in occupancy expenses for 2020 compared to 2019, was primarily the result of $119,000 in a one-time building operating expense, the opening of our Arlington branch in June 2020 and as a result of the growth in CCBX. As we continue to grow, we expect occupancy expenses to increase. The increase of $461,000, or 13.9%, in occupancy expenses for 2019 compared to 2018 was primarily due to the addition of our Edmonds branch in October 2018 and includes increases in rent expense, depreciation, property taxes and utilities as well as higher maintenance and repair costs overall.

Data Processing. Data processing costs were $2.3 million for the year ended December 31, 2020, compared to $2.1 million for the year ended December 31, 2019, an increase of $267,000, or 12.8%. Data processing costs were $2.1 million for the year ended December 31, 2019, compared to $2.0 million for the year ended December 31, 2018. Data processing costs include all of our customer processing, computer processing, and network costs.Data processing costs grow as we grow and add new products, customers and branches. Additionally, CCBX and CCDB data processing expenses are included in this category and are expected to increase incrementally as these divisions grow, and infrastructures for these divisions are put in place. The increase for the year ended December 31, 2019 as compared to the year ended December 31, 2018 was offset due to a change in accounting related to certain point-of-sale transactions that reduced expenses by $211,000 for that account in the current period.

Legal and Professional Fees. Legal and professional costs were $1.8 million for the year ended December 31, 2020 compared to $1.1 million for the year ended December 31, 2019, and increase of $659,000, or 59.7%. Legal and professional costs were $1.1 million for the year ended December 31, 2019 compared to $677,000 for the year ended December 31, 2018. Legal and professional costs fluctuate with the development of contracts for CCBX customers and are also impacted by our reporting cycle and timing of legal and professional services. The increase in legal and professional expenses is associated with BaaS activities through CCBX operations and higher costs related to legal and accounting work related to reporting.

Excise Taxes. Excise taxes were $1.1 million for the year ended December 31, 2020, compared to $719,000 for the year ended December 31, 2019, an increase of $338,000, or 47.0%. Excise tax expense increased $160,000, or 28.6%, in the year ended December 31, 2019 from $559,000 for the year ended December 31, 2018. Excise taxes are based on gross income of $71.2 million, $56.8 million and $44.2 million for the years ended December 31, 2020, 2019 and 2018, respectively. Gross income is reduced by certain allowed deductions to arrive at the taxable base; however, as gross income increases, so does the excise tax expense. In addition, the tax rate that is applied to our industry increased 25 basis points effective April 1, 2020, which contributed to the increase in excise tax for the year ended December 31, 2020.

Director and Staff Expenses. Director and staff expenses includes compensation for director service, continuing education for employees and other director and staff related expenses. Director and staff expenses were $800,000 for the year ended December 31, 2020 compared to $1.0 million for the year ended December 31, 2019, a decrease of $200,000, or 20%. Reduced employee travel as a result of restrictions related to the COVID-19 pandemic contributed to the decrease in the year ended December 31, 2020 compared to the year ended December 31, 2019. Director and staff expenses were $1.0 million for the year ended December 31, 2019 compared to $701,000 for the year ended December 31, 2018, an increase of $299,000 or 42.7%. In mid-2019 a change in the structure of director compensation as a result of increased responsibilities of becoming a publicly traded company contributed to the increase for each of the years ended December 31, 2020 and 2019.

FDIC Assessments. FDIC assessments are assessed to fund the Deposit Insurance Fund (DIF) to insure and protect the depositors of insured banks and to resolve failed banks. The assessment rate is based on a number of factors and recalculated each quarter. FDIC assessments were $522,000 for the year ended December 31, 2020, compared to $184,000 for the year ended December 31, 2019, an increase of $338,000, or 183.7%. FDIC assessments were $184,000 for the year ended December 31, 2019, a decrease of $111,000, or 37.6%, from

$295,000for the year ended December 31, 2018. The DIF’s reserve was in excess of the required ratio in 2019, resulting in a credit in the year ended December 31, 2019 based on past activity and payments. The DIF reserve ratio is currently below the required ratio.

Business Development. Business development costs include sponsorships and other activities to cultivate business and community development.Business development costs were $344,000 for the year ended December 31, 2020, compared to $431,000 for the year ended December 31, 2019, a decrease of $87,000, or 20.2%. As expected, these expenses were reduced as a result of restrictions on in person meetings and business related activities due to the COVID-19 pandemic. Business Development costs were $431,000 for the year ended December 31, 2019, compared to $326,000 for the year ended December 31, 2018, an increase of $105,000, or 32.2%. The increase in expenses for 2019, compared to 2018 is the result of increased business and community development expenses as a result of the Company’s growth.

Marketing and promotion. Marketing and promotion costs were $317,000 for the year ended December 31, 2020, compared to $393,000 for the year ended December 31, 2019, a decrease of $76,000, or 19.3%. Marketing and promotion costs decreased year over year due to a conscious effort to reduce general advertising costs during the COVID-19 pandemic. The Bank is using more cost-effective advertising options; however, we expect to see advertising expenses increase as we deploy more branding and targeted advertising for the Bank, CCBX and CCDB. Marketing and promotion costs were relatively flat at $393,000 and $391,000 for the years ended December 31, 2019 and 2018, respectively.

Other. This category includes maintenance and subscription expenses, dues and memberships, office supplies, mail services, telephone, examination fees, internal loan expenses, services charges from banks, operational losses, directors and officer’s insurance, donations, provision for unfunded commitments, and miscellaneous other expenses. Other noninterest expense increased to $3.7 million for the year ended December 31, 2020, compared to $2.4 million for the year ended December 31, 2019, an increase of $1.3 million, or 52.6%. The increase was largely due to a $578,000 increase in software license, maintenance and subscription expenses, which is expected to increase as we invest more in automated processing and as we grow product lines and our CCBX division, $85,000 increase in the unfunded commitment provision, $83,000 increase in telephone costs, $73,000 increase in operational losses, $51,000 increase in service charges from banks, and overall increases resulting from growth for the year ended December 31, 2020, as compared to the same period last year. Other noninterest expense increased to $2.4 million for the year ended December 31, 2019, compared to $2.0 million for the year ended December 31, 2018. The increase was primarily due to an increase in the unfunded commitment provision, increases in software licenses and maintenance combined with standard increases throughout the accounts in this category.

Income Tax Expense

The amount of income tax expense we incur is impacted by the amounts of our pre-tax income, tax-exempt income and other nondeductible expenses. Deferred tax assets and liabilities are reflected at current income tax rates in effect for the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Valuation allowances are established when necessary to reduce our deferred tax assets to the amount expected to be realized.

Year Ended December 31, 2020, Compared to Year Ended December 31, 2019. For the year ended December 31, 2020, income tax expense totaled $4.0 million, compared to $3.5 million for the year ended December 31, 2019. Our effective tax rates for the years ended December 31, 2020 and 2019, was 20.9% and 20.8%, respectively.

Year Ended December 31, 2019, Compared to Year Ended December 31, 2018. For the year ended December 31, 2019, income tax expense totaled $3.5 million, compared to $2.5 million for the year ended December 31, 2018. Our effective tax rates for each of the years ended December 31, 2019 and 2018, was 20.8%.

Financial Condition

Our total assets increased $637.6 million to $1.77 billion, or 56.5% at December 31, 2020, compared to $1.13 billion at December 31, 2019. This increase was largely the result of a $608.0 million increase in loans receivable, which includes $365.8 million in PPP loans as of December 31, 2020, combined with a $32.9 million increase in interest earning deposits with other banks. Our total assets increased $176.4 million, or 18.5%, to $1.13 billion as of December 31, 2019, from $952.1 million as of December 31, 2018. The increase was primarily the result of $169.1 million in net loans receivable growth during the year ended December 31, 2019. Additionally, the Company implemented the new lease accounting standard, which brought operating leases onto the balance sheet on January 1, 2019, and increased assets by $8.5 million as of December 31, 2019.

Loan Portfolio

Our primary source of income is derived through interest earned on loans. A substantial portion of our loan portfolio consists of commercial real estate loans and commercial and industrial loans in the Puget Sound region. Our loan portfolio represents the highest yielding component of our earning assets.

As of December 31, 2020, loans receivable totaled $1.55 billion, an increase of $608.0 million, or 64.7%, compared to $939.1 million as of December 31, 2019. Total loans receivable is net of $9.2 million in net deferred origination fees, $5.8 million of which is attributed to PPP loans. Deferred fees on PPP loans are earned over the life of the loan, with a maximum maturity of five years. As of December 31, 2020, $5.8 million, or 44.9%, of the total $12.9 million in net deferred fees on the first and second rounds of PPP loans remained unearned and will be earned in future periods. The increase in loans receivable over the quarter ended December 31, 2019 was due to a $365.8 million increase in PPP loans, and $249.4 million increase in non-PPP loans consisting of $161.5 million increase in commercial real estate loans, $62.0 million in other commercial and industrial loans and $28.9 million in residential real estate loans.

As of December 31, 2019, gross loans totaled $939.1 million, an increase of $171.2 million, or 22.3%, compared to $767.9 million as of December 31, 2018. This increase was primarily due to our efforts to increase income by building a secure loan portfolio while maintaining strong credit quality.

Loans as a percentage of deposits were 108.9% as of December 31, 2020, 97.0% as of December 31, 2019, and 95.6% as of December 31, 2018. We are focused on serving our communities and markets by growing loans locally and funding those loans with customer deposits. The increase in the loan to deposit ratio for 2020 is largely due to the large volume of PPP loans.

The following table summarizes our loan portfolio by type of loan as of the dates indicated:

As of December 31,

Commercial and industrial loans:

Real estate loans:

Net deferred origination fees - PPP loans (5,803 ) - - - -

Commercial and Industrial Loans. Commercial and industrial loans increased $427.8 million, or 384.0%, to $539.2 million as of December 31, 2020, from $111.4 million as of December 31, 2019. The increase in commercial and industrial loans receivable over the year ended December 31, 2019 was due to a $365.8 million increase in PPP loans and $62.0 million in other commercial and industrial loans. Included in the commercial and industrial loan balance is $65.6 million in capital call lines resulting from relationships with our CCBX customers as of December 31, 2020.

Commercial and industrial loans increased $21.0 million, or 23.2%, to $111.4 million as of December 31, 2019, from $90.4 million as of December 31, 2018. The $21.0 million increase is the result of $63.1 million in new loans, net of $42.1 million in principal reductions and payoffs. The 2019 increase was due, in part, to our diversification strategy, which includes sourcing loans from strong markets with good returns and risk characteristics to supplement growth in our existing markets.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and effectively. These loans are primarily made based on the borrower’s ability to service the debt from income. Most commercial and industrial loans are secured by the assets being financed or other business assets, such as accounts receivable, inventory or equipment, and we generally obtain personal guarantees on these loans.

In the first two rounds of the PPP loan program, our work with the SBA to help small businesses as provided in the CARES Act resulted in a total of $452.8 million in PPP loans, with a total of $12.9 million in net deferred fees. This includes over 2,800 loans, helping over 40,600 employees in our communities. We were able to provide loans to our existing customers and also provide assistance to new customers, by taking a proactive approach and reaching out to the communities we serve to offer aid through the PPP. These loans allowed small business owners to apply for financial relief under the PPP. This program allowed business owners that are impacted by the COVID-19 pandemic to apply for and receive financial relief to help pay for employee wages and certain other expenses. PPP loans have a maximum maturity of five years, bear a 1.0% interest rate and may be forgiven by the government if certain criteria are met. The deferred fees are or will be recognized in interest income over the life of the loans; however, if loans are forgiven or paid off remaining deferred fees will be recognized in the period the forgiveness or payoff occurs. These fees are recognized as interest income and will provide a source of income to the Company as we navigate through the COVID-19 pandemic and challenging economic times, as we continue to provide financial services to our customers and communities.

We accepted and processed requests through the duration of round one and two of the PPP, and recently began accepting and processing applications for round three, which opened for applications on January 19, 2021. As of March 8, 2021, we have funded $259.3 million, representing 1,867 customers, in this latest round of PPP loans, consisting of $16.6 million in new PPP applications for first draws and $242.7 million in a second draw for small businesses that previously received PPP funds. Net deferred fees on these loans total $10.1 million and will be recognized in interest income in future periods. Round three PPP loans have a maturity of five years. Loan payments will be deferred for borrowers who apply for loan forgiveness until SBA remits the borrower's loan forgiveness amount to the lender. If a borrower does not apply for loan forgiveness, payments are deferred 10 months after the end of the covered period for the borrower’s loan forgiveness (either 8 weeks or 24 weeks).

Construction, Land and Land Development Loans. Construction, land and land development loans decreased $2.6 million, or 2.7%, to $94.4 million as of December 31, 2020, from $97.0 million as of December 31, 2019, primarily due to construction projects migrating from construction to other loan categories. Unfunded loan commitments for construction, land and land development loans were $88.4 million at December 31, 2020, which is an increase of $24.6 million, or 38.6%, compared to $63.7 million in unfunded commitments at December 31, 2019.

Although we have not seen a significant drop in our market in the Puget Sound region thus far, the full extent of the long-term effects of the COVID-19 pandemic remain to be seen. We anticipate that as business restrictions related to COVID-19 are eased, projects will begin or resume, and we will see drawdowns on the available commitments.

Construction, land and land development loans increased $33.0 million, or 51.5%, to $97.0 million as of December 31, 2019, from $64.0 million as of December 31, 2018, primarily due to continued favorable economic conditions for building in our market area. Unfunded loan commitments for construction, land and land development loans were $63.7 million at December 31, 2019, which was comparable to the $63.4 million in unfunded commitments at December 31, 2018.

Construction, land and land development loans are comprised of loans to fund construction, land acquisition and land development construction. The properties securing these loans are primarily located in the Puget Sound region and are comprised of both residential and commercial properties, including owner occupied properties and investor properties. As of December 31, 2020, construction, land and land development loans included $21.6 million in residential construction loans, $43.5 million in commercial construction loans and $29.3 million in other construction, land and land development loans.

Residential Real Estate Loans. Our residential real estate loans increased $28.9 million, or 25.1%, to $143.9 million as of December 31, 2020, from $115.0 million as of December 31, 2019.

Our residential loans increased $20.3 million, or 21.4%, to $115.0 million as of December 31, 2019, from $94.7 million as of December 31, 2018.

We originate one-to-four adjustable-rate mortgage (ARM), loans for our portfolio and operate as a mortgage broker for mortgage lenders we have agreements with for customers who want a 15-year to 30-year, fixed-rate mortgage loan. As of December 31, 2020, the balance of our ARM portfolio loans was $20.5 million, compared to $11.7 million at December 31, 2019 and $7.5 million as of December 31, 2018. Our ARM loans typically do not meet the guidelines for sale in the secondary market due to characteristics of the property, the loan terms or exceptions from agency underwriting guidelines, which enables us to earn a higher interest rate. We also purchase residential mortgages originated by other financial institutions to hold for investment with the intent to diversify our residential mortgage loan portfolio, meet certain regulatory requirements and increase our interest income. We last purchased residential mortgage loans in 2018. As of December 31, 2020, we held $16.8 million in purchased residential real estate mortgage loans, compared to $28.6 million at December 31, 2019. These loans purchased typically have a fixed rate with a term of 15 to 30 years and are collateralized by one-to-four family residential real estate. We have a defined set of credit guidelines that we use when evaluating these loans. Although purchased loans were originated and underwritten by another institution, our mortgage, credit, and compliance departments conduct an independent review of each underlying loan that includes re-underwriting each of these loans to our credit and compliance standards. We also make one-to-four family loans to investors to finance their rental properties and to business owners to secure their business loans. As of December 31, 2020, residential real estate loans made to investors and business owners totaled $84.3 million. As of December 31, 2019 and 2018, residential real estate loans made to investors and business owners totaled $59.7 million and $34.1 million, respectively.

Like our commercial real estate loans, our residential real estate loans are secured by real estate, the value of which may fluctuate significantly over a short period of time as a result of market conditions in the area in which the real estate is located. Adverse developments affecting real estate values in our market areas could therefore increase the credit risk associated with these loans, impair the value of property pledged as collateral on loans, and affect our ability to sell the collateral upon foreclosure without a loss or additional losses.

Commercial Real Estate Loans. Commercial real estate loans increased $161.5 million, or 26.3%, to $774.9 million as of December 31, 2020, from $613.4 million as of December 31, 2019.

Commercial real estate loans increased $97.4 million, or 18.9%, to $613.4 million as of December 31, 2019, from $516.0 million as of December 31, 2018. These increases, which occurred across the various segments of our portfolio, were due to our commitment to grow this portfolio in the Puget Sound region. We actively seek

commercial real estate loans in our markets and our lenders are experienced in competing for these loans and managing these relationships.

We make commercial mortgage loans collateralized by owner-occupied and non-owner-occupied real estate, as well as multi-family residential loans. The real estate securing our existing commercial real estate loans includes a wide variety of property types, such as manufacturing and processing facilities, business parks, warehouses, retail centers, convenience stores, hotels and motels, office buildings, mixed-use residential and commercial, and other properties. We originate both fixed- and adjustable-rate loans with terms up to 20 years. Fixed-rate loans typically amortize over a 10-to-25 year period with balloon payments at the end of five to ten years. Adjustable-rate loans are generally based on the prime rate and adjust with the prime rate or are based on term equivalent FHLB rates. At December 31, 2020, approximately 41.4% of the commercial real estate loan portfolio consisted of fixed rate loans. Commercial real estate loans represented 49.8% of our loan portfolio at December 31, 2020 and are historically our largest source of revenue. At December 31, 2019 and 2018, approximately 38.3% and 40.8%, respectively, of the commercial real estate loan portfolio consisted of fixed rate loans. The addition of the $365.8 million in PPP loans during the year ended December 31, 2020 as commercial and industrial loans has significantly impacted the composition of our loan portfolio; without the PPP loans, commercial real estate loans would represent approximately 65.1% of the loan portfolio, which is more in line with what it has been historically. The Bank actively seeks commercial real estate loans in our markets and our lenders are experienced in originating, competing for, and managing these loans and relationships. Our credit administration team has substantial experience in underwriting, managing, monitoring and working out commercial real estate loans, and remains diligent in communicating and proactively working with borrowers to help mitigate potential credit deterioration.

Consumer and Other Loans. Consumer and other loans decreased $298,000, or 7.1%, to $3.9 million as of December 31, 2020, from $4.2 million as of December 31, 2019.

Consumer and other loans increased $630,000, or 17.6%, to $4.2 million as of December 31, 2019, from $3.6 million as of December 31, 2018. Our consumer and other loans are comprised of personal lines of credit, automobile, boat, and recreational vehicle loans, and secured term loans.

Contractual Maturity Ranges. The contractual maturity ranges of loans in our loan portfolio and the amount of such loans with fixed and floating interest rates in each maturity range as of date indicated are summarized in the following tables:

Due after One

Due in One Year Through Due after Gross

(Dollars in thousands) Year or Less Five Years Five Years Loans

Commercial and industrial loans:

Real estate loans:

The following table sets forth all loans at December 31, 2020, that are due after December 31, 2021, and have either fixed interest rates or floating or adjustable interest rates:

Floating or

(Dollars in thousands) Fixed Rates Adjustable Rates Total

Commercial and industrial loans:

Real estate loans:

Industry Exposure and Categories of Loans

We have a diversified loan portfolio, representing a wide variety of industries. As of December 31, 2020, three of our largest categories of our loans are commercial real estate, commercial and industrial, and construction, land and land development loans. Together they represent $1.04 billion in outstanding loan balances, or 87.6% of total gross loans outstanding, excluding PPP loans of $365.8 million as of December 31, 2020. When combined with $298.7 million in unused commitments the total of these three categories is $1.34 billion, or 88.9% of total outstanding loans and loan commitments as of December 31, 2020.

Commercial real estate loans represent the largest segment of our loans, comprising 65.1% of our total balance of outstanding loans, excluding PPP loans, as of December 31, 2020. Unused commitments to extend credit represents an additional $20.5 million, the combined total exposure in commercial real estate loans represents $795.4 million, or 52.7% of our total outstanding loans and loan commitments, excluding PPP loans.

The following table summarizes our exposure by industry for our commercial real estate portfolio as of December 31, 2020:

Commercial and industrial loans comprise 14.6% of our total balance of outstanding loans, excluding PPP loans, as of December 31, 2020. Unused commitments to extend credit represents an additional $189.9 million,

the combined total exposure in commercial and industrial loans represents $363.2 million, or 24.1% of our total outstanding loans and loan commitments, excluding PPP loans.

The following table summarizes our exposure by industry, excluding PPP loans, for our commercial and industrial loan portfolio as of December 31, 2020:

Construction, land and land development loans comprise 7.9% of our total balance of outstanding loans, excluding PPP loans, as of December 31, 2020. Unused commitments to extend credit represents an additional $88.4 million, the combined total exposure in construction, land and land development loans represents $182.8 million, or 12.1% of our total outstanding loans and loan commitments, excluding PPP loans.

The following table details our exposure for our construction, land and land development portfolio as of December 31, 2020:

Nonperforming Assets

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by applicable regulations. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. In general, we place loans on nonaccrual status when they become 90 days past due. We also place loans on nonaccrual status if they are less than 90 days past due if the collection of principal or interest is in doubt. We are not required to report as nonperforming a loan for which we have allowed the borrower to defer payment on a short term basis because of financial pressure related to COVID-19. When loans are placed on nonaccrual status, all unpaid accrued interest is reversed from income and all interest accruals are stopped. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal balance. Loans are returned to accrual status if we believe that all remaining principal and interest is fully collectible and there has been at least six

months of sustained repayment performance since the loan was placed on nonaccrual status. We define nonperforming loans as loans on nonaccrual status and accruing loans 90 days or more past due. Nonperforming assets also include other real estate owned and repossessed assets.

We believe our lending practices and active approach to managing nonperforming assets has resulted in sound asset quality and timely resolution of problem assets. We have procedures in place to assist us in maintaining the overall credit quality of our loan portfolio. We have established underwriting guidelines, concentration limits and we also monitor our delinquency levels for any negative or adverse trends. We actively manage problem assets to reduce our risk for loss.

We had $712,000 in nonperforming assets, and no troubled debt restructurings (TDRs), as of December 31, 2020, compared to $1.0 million as of December 31, 2019. All of our nonperforming assets were nonperforming loans as of December 31, 2020 and 2019. Our nonperforming loans to loans receivable ratio was 0.05% at December 31, 2020, compared to 0.11% at December 31, 2019. The decrease in nonperforming assets was the result of the $500,000 in write-downs on five nonperforming loans combined with principal paydowns on nonperforming loans, partially offset by the addition of one loan to nonperforming status.

We had $1.0 million in nonperforming assets, and no TDRs, as of December 31, 2019, compared to $1.8 million as of December 31, 2018. All of our nonperforming assets were nonperforming loans as of December 31, 2019 and 2018. Our nonperforming loans to loans receivable ratio was 0.11% at December 31, 2019, compared to 0.24% at December 31, 2018. The decrease in nonperforming assets was the result of the payoff of a TDR and nonperforming loan in 2019, partially offset by the addition of five smaller loans to nonperforming status.

To date we have not seen a significant change in our credit quality metrics, as demonstrated by the low level of charge-offs and nonperforming loans for the year ended December 31, 2020. The long-term economic impact of the COVID-19 pandemic, political changes, and trade issues is unknown; however, the Company remains diligent in its efforts to communicate and proactively work with borrowers to help mitigate potential credit deterioration. Credit administration is closely analyzing higher risk segments within the loan portfolio, monitoring and tracking loan payment deferrals and customer liquidity, and providing timely reporting to management and the board of directors.

Pursuant to federal guidance, the Company deferred and/or modified payments on loans to assist customers financially during the COVID-19 pandemic and economic shutdown. There was a total of $233.9 million, or 247 loans, granted deferred or modified payments in the quarters ended June 30, 2020, September 30, 2020 and December 31, 2020. As of December 31, 2020, $209.8 million, or 220 loans, have successfully resumed payments as scheduled, a total of $7.9 million, or 7 loans, moved to active status with a payment due in the first quarter of 2021, $6.9 million, or 17 loans, have closed and paid-in-full, leaving $9.3 million, or 3 loans, on deferral. The purpose of this program is to provide cash flow relief for small business customers as they navigate through the uncertainties of the COVID-19 pandemic and economic challenges. The Company’s deferral program has been successful as evidenced by customers’ ability to migrate from deferral to active status and resume making payments as planned.

The following table presents information regarding nonperforming assets at the dates indicated:

As of As of As of As of As of

December 31, December 31, December 31, December 31, December 31,

Nonaccrual loans:

Real estate loans:

Construction, land and land development loans - - - - -

Consumer and other loans - - - - -

Accruing loans past due 90 days or more:

Real estate loans:

Construction, land and land development loans - - - - 122

Total accruing loans past due 90 days or more - - - - 122

Other real estate owned - - - - 1,297

Troubled debt restructurings, accruing - - - - 5,326

Total nonperforming loans to loans receivable 0.05 % 0.11 % 0.24 % 0.32 % 0.27 %

Total nonperforming assets to total assets 0.04 % 0.09 % 0.19 % 0.26 % 1.11 %

Potential Problem Loans

From a credit risk standpoint, we classify loans in one of five categories: pass, other loans especially mentioned, substandard, doubtful or loss. Within the pass category, we classify loans into one of the following five subcategories based on perceived credit risk, including repayment capacity and collateral security: minimal risk, low risk, modest risk, average risk and acceptable risk. The classifications of loans reflect a judgment about the risks of default and loss given default. We review the risk ratings of our credits on an annual basis, or more frequently if circumstances warrant. Risk ratings are adjusted to reflect the degree of risk and loss that is believed to be inherent in each credit as of each monthly reporting period. Our methodology is structured so that specific reserve allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).

The following table summarizes the internal ratings of our loans as of the dates indicated:

Pass Other Loans Especially Mentioned Sub- Standard Doubtful Total

(dollars in thousands)

Real estate loans:

Construction, land, and land development loans 94,423 - - - 94,423

Consumer and other loans 3,916 - - - 3,916

Less net deferred origination fees (9,195 )

Pass Other Loans Especially Mentioned Sub- Standard Doubtful Total

(dollars in thousands)

Real estate loans:

Construction, land, and land development loans 97,034 - - - 97,034

Less net deferred origination fees (1,955 )

Allowance for Loan Losses

We maintain an allowance for loan losses that represents management’s best estimate of the loan losses and risks inherent in our loan portfolio. The amount of the allowance for loan losses should not be interpreted as an indication that charge-offs in future periods will necessarily occur in those amounts. In determining the allowance for loan losses, we estimate losses on specific loans, or groups of loans, where the probable loss can be identified and reasonably determined. The balance of the allowance for loan losses is based on internally assigned risk classifications of loans, historical loan loss rates, changes in the nature of our loan portfolio, overall portfolio

quality, industry concentrations, delinquency trends, and current economic factors. See “—Critical Accounting Policies—Allowance for Loan Losses.”

In connection with the review of our loan portfolio, we consider risk elements applicable to particular loan types or categories in assessing the quality of individual loans. Some of the risk elements we consider include:

As of December 31, 2020, the allowance for loan losses totaled $19.3 million, or 1.25% of total loans. As of December 31, 2019, the allowance for loan losses totaled $11.5 million, or 1.22% of total loans. The increase in the provision for loan losses during the year ended December 31, 2020 is related to an increase in qualitative factors related to the economic uncertainties caused by the COVID-19 pandemic and loan growth. The Company is not required to implement the provisions of the Current Expected Credit Loss accounting standard until January 1, 2023 and will continue to account for the allowance for credit losses under the incurred loss model. Included in total loans is $365.8 million in PPP loans which are 100% guaranteed by the SBA. The allowance for loan losses to loans receivable, excluding the guaranteed PPP loans, is approximately 1.62% at December 31, 2020. A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.” As of December 31, 2019, the allowance for loan losses totaled $11.5 million, or 1.22% of total loans. As of December 31, 2018, the allowance for loan losses totaled $9.4 million, or 1.23% of total loans.

The following tables present, as of and for the periods indicated, an analysis of the allowance for loan losses and other related data:

As of or for the Year Ended December 31,

Charge-offs:

Real estate loans:

Construction, land and land development loans 369 75 - - -

Residential real estate loans - - - - 79

Recoveries:

Commercial and industrial loans 5 5 4 3 2

Real estate loans:

Construction, land and land development loans - - - 95 -

Residential real estate loans - - 65 - -

Commercial real estate loans - - - - -

Consumer and other loans 4 8 14 5 1

Although we believe that we have established our allowance for loan losses in accordance with GAAP and that the allowance for loan losses was adequate to provide for known and inherent losses in the portfolio at all times shown above, future provisions for loan losses will be subject to ongoing evaluations of the risks in our loan portfolio. As a result of the COVID-19 pandemic and its impact to the economy, we increased our provision during the year ended December 31, 2020. If the COVID-19 pandemic worsens or continues indefinitely, preventing businesses and consumers from conducting business in the ordinary course, the Washington state and Puget Sound region may experience a continued economic downturn, and our asset quality could deteriorate, which may require material additional provisions for loan losses. We remain focused on working with the communities we serve, offering payment deferrals and other resources available under the CARES Act to provide financial assistance to businesses and consumers until they are able recover from this uncertain and trying time.

The following table shows the allocation of the allowance for loan losses among loan categories and certain other information as of the dates indicated. The allocation of the allowance for loan losses as shown in the table should neither be interpreted as an indication of future charge-offs, nor as an indication that charge-offs in future periods will necessarily occur in these amounts or in the indicated proportions. The total allowance is available to absorb losses from any loan category.

At December 31,

Real estate loans:

Securities

We use our securities portfolio primarily as a source of liquidity and collateral that can be readily sold or pledged for public deposits or other business purposes. At December 31, 2020, $20.0 million, or 86.2%, of our investment portfolio consisted of U.S. Treasury securities. The remainder of our securities portfolio was invested in municipal bonds, U.S. Agency collateralized mortgage obligations, and U.S. Agency residential mortgage-backed securities. Because we target a loan-to-deposit ratio in the range of 90% to 100%, we prioritize liquidity over the earnings of our securities portfolio and had much of our excess cash in overnight bank deposits at the Federal Reserve. At December 31, 2020, our loan-to-deposit ratio was 108.9%, which is elevated as a result of the PPP loans. Our securities portfolio represented less than 2% of assets. To the extent our securities represent more than 5% of assets, absent an immediate need for liquidity, we anticipate investing excess funds to provide a higher return.

As of December 31, 2020, the carrying amount of our investment securities totaled $23.2 million, a decrease of $9.5 million, or 28.9%, compared to $32.7 million as of December 31, 2019. The decrease in the securities portfolio was due to maturities and principal paydowns. As of December 31, 2019, the carrying amount of our investment securities totaled $32.7 million, a decrease of $5.2 million, or 13.7%, compared to $37.9 million as of December 31, 2018. The decrease in the securities portfolio in 2019 was due to the restructuring of the investment portfolio to increase our overall rate of return, reduce weighted average maturity, and improve interest rate risk and pricing risk, which involved the sale of $30.0 million (par value) of existing available for sale securities and the purchase of $20.0 million (par value) of available for sale securities as well as an additional $10.0 million of one year certificates of deposits. Also contributing to the decrease was pay-downs on U.S. Agency residential mortgage-backed securities. Additionally, we purchased $3.2 million of a Community Reinvestment Act-qualified U.S. Agency residential mortgage-backed security. The fair value of available for sale securities improved during the year ended December 31, 2019. Investment securities represented 1.3% and 2.9%, and 4.0% of total assets as of December 31, 2020, 2019 and 2018, respectively.

Our investment portfolio consists of securities classified as available for sale and, to a lesser amount, held to maturity. The carrying values of our investment securities classified as available for sale are adjusted for unrealized gain or loss, and any gain or loss is reported on an after-tax basis as a component of other comprehensive income in shareholders’ equity.

The following table summarizes the amortized cost and estimated fair value of our investment securities as of the dates shown:

As of December 31,

Amortized Fair Amortized Fair Amortized Fair

(Dollars in thousands) Cost Value Cost Value Cost Value

Securities available-for-sale:

U.S. Agency residential mortgage- backed securities 10 10 27 27 39 38

Securities held-to-maturity:

All of our U.S. Agency residential mortgage-backed securities and U.S. Agency collateralized mortgage obligations are U.S. Government agency securities. As of December 31, 2020, we did not hold any Fannie Mae or

Freddie Mac preferred stock, collateralized debt obligations, collateralized loan obligations, structured investment vehicles, private label collateralized mortgage obligations, subprime, Alt-A or second lien elements in our investment portfolio.

Our management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.

As of December 31, 2020, and December 31, 2019, we did not own securities of any one issuer, other than the U.S. Government and its agencies, for which aggregate adjusted cost exceeded 10.0% of consolidated shareholders’ equity.

Restricted equity securities totaled $5.2 million as of December 31, 2020 and $4.0 million as of December 31, 2019. The increase was attributable to net additions of Federal Reserve, FHLB stock and Pacific Coast Banker's Bank stock. Federal Reserve and FHLB stock are carried at par and do not have a readily determinable fair value. Ownership of FHLB stock is restricted to the FHLB and member institutions, and can only be purchased and redeemed at par.

As of December 31, 2020, we held $100,000 in corporate equity securities which was recorded in other investments on the balance sheet. The equity interest consists of 9,000 shares of stock and was previously carried at cost of $500,000, which approximated fair value at time of purchase. During the year ended December 31, 2020 the Company re-evaluated the value and recorded an unrealized loss on equity investment. The Company also purchased an additional and separate $750,000 equity interest during the year ended December 31, 2020, which consists of 1.6 million shares of common stock and 873,853 preferred shares. The Company elects to account for the investments under ASC 321 Investments – Equity Securities without Readily Determinable Value. The investments will be held at cost minus impairment, the measurement should be applied until the investment does not qualify for the measurement election (e.g., if the investment has a readily determinable fair value). The Company will reassess at each reporting period whether the equity investment without a readily determinable fair value qualifies to be measured at cost minus impairment.

The following table sets forth the amortized cost of held to maturity securities and the fair value of available for sale securities, maturities and approximated weighted average yield based on estimated annual income divided by the average amortized cost of our securities portfolio as of the dates indicated. The contractual maturity of a mortgage-backed security is the date at which the last underlying mortgage matures.

Securities available-for-sale:

Securities held to maturity:

Deposits

We offer a variety of deposit products that have a wide range of interest rates and terms, including demand, savings, money market and time accounts, BaaS brokered deposits, and reciprocal deposits. Reciprocal deposits enable us to extend FDIC insurance to customers that have balances in excess of the FDIC insurance limit. This service trades our customer’s funds as CDs or, for DDA accounts, insured cash sweeps (ICS) in increments under the FDIC insured amount to other participating financial institutions and in exchange we receive investments from participating financial institutions in a reciprocal agreement. We rely primarily on competitive pricing policies, convenient locations, electronic delivery channels (Internet and mobile), and personalized service to attract and retain our deposits.

Total deposits as of December 31, 2020, were $1.42 billion, an increase of $453.3 million, or 46.8%, compared to $968.0 million as of December 31, 2019. Included in total deposits is $68.7 million in deposits derived from CCBX deposit relationships, an increase of $30.2 million, or 78.3%, compared to $38.5 million as of December 31, 2019. CCBX customer deposit relationships include deposits with CCBX end customers, operating and non-operating deposit accounts. Total deposits as of December 31, 2019, were $968.0 million, an increase of $164.4 million, or 20.5%, compared to $803.6 million as of December 31, 2018. The increase in core deposits is primarily the result of expanding and growing banking relationships with new customers, including deposit relationships from PPP loans made to noncustomers moving their banking relationship to the Bank, and growth in our CCBX division. We define core deposits as all deposits except time deposits including BaaS-brokered deposits. We focus on growing core deposits and our branch managers, treasury service personnel and lenders work together to grow deposits from existing and new customers.

Noninterest-bearing demand deposits as of December 31, 2020, were $592.3 million, an increase of $221.1 million, or 59.5%, compared to $371.2 million as of December 31, 2019. Noninterest-bearing deposits as of December 31, 2019, were $371.2 million, an increase of $77.7 million, or 26.5%, compared to $293.5 million as of December 31, 2018. The increase is primarily the result of expanding and growing banking relationships with new customers, including deposit relationships from PPP loans made to noncustomers, who moved their banking relationship to the Bank. Noninterest bearing deposits represent 41.7% and 38.4% of total deposits December 31, 2020 and December 31, 2019, respectively.

Total interest-bearing account balances, excluding time deposits, as of December 31, 2020, were $769.4 million, an increase of $254.6 million, or 49.4%, from $514.9 million as of December 31, 2019. Total interest-bearing account balances, excluding time deposits, as of December 31, 2019, were $514.9 million, an increase of $101.8 million, or 24.6%, from $413.0 million as of December 31, 2018. The increases were due to our team focusing on growing core deposits, including deposit relationships from PPP loans made to noncustomers, who moved their banking relationship to the Bank. Included in interest bearing account balances is $33.5 million in BaaS-brokered deposits, an increase of $9.9 million, from $23.6 million at December 31, 2019. Also included in interest bearing deposits is $8.7 million in reciprocal deposits. In 2019 we introduced reciprocal deposits as a product available for time deposit customers and beginning in 2020 we added ICS, an interest bearing demand reciprocal deposit product.

Total time deposit balances as of December 31, 2020, were $59.6 million, a decrease of $22.3 million, or 27.2%, from $81.9 million as of December 31, 2019. Total time deposit balances as of December 31, 2019, were $81.9 million, a decrease of $15.1 million, or 15.7%, from $97.0 million as of December 31, 2018. The decrease is due to the strong increase in core deposits, and thus not requiring the replacement of time deposits as they mature. We have seen competitors increase rates on time deposits, and we have not globally matched their rates in response as we have been able to grow and retain less costly core deposits.

The following table sets forth deposit balances at the dates indicated.

As of December 31,

Percent of Percent of Percent of

The following table sets forth the Company’s time deposits of $100,000 or more by time remaining until maturity as of the dates indicated:

(Dollars in thousands) As of December 31, 2020 As of December 31, 2019

Maturity Period:

Average deposits for the year ended December 31, 2020, were $1.24 billion, an increase of $350.1 million, or 39.4%, compared to the year ended December 31, 2019. Average deposits for the year ended December 31, 2019, were $887.8 million, an increase of $142.3 million, or 19.1%, compared to the year ended December 31, 2018. The increase in average deposits was primarily due to an increase in core deposits, both in noninterest bearing deposits and in low rate interest bearing deposits. Included in this increase is deposit relationships gained from PPP loans made to noncustomers that moved their banking/deposit relationship to the Bank. We expect deposits to continue to increase as we see growth in our primary market areas, the increase in commercial lending relationships for which we also seek deposit balances and the results of business development efforts by our branch managers, treasury service personnel, and lenders.

The average rate paid on total interest-bearing deposits was 0.59% for the year ended December 31, 2020, compared to 1.03% for the year ended December 31, 2019. The average rate paid on total interest-bearing deposits was 1.03% for the year ended December 31, 2019, compared to 0.66% for the year ended December 31, 2018. The average rate paid on BaaS-brokered deposits decreased 1.63% for the year ended December 31, 2020, compared to December 31, 2019, and NOW and money market accounts decreased 34 basis points, for the year ended December 31, 2020. The decrease in average rate paid on deposit accounts for the year ended December 31, 2020, is the result of the decreased Fed funds rates since June 2019 and management lowering rates in response to the decrease; the impact of these rate decreases will continue to be reflected in future periods. Any further changes to the Fed funds rate and rate pressure from market competition is expected to continue to impact future cost of deposits and our pricing strategies.

The following table presents the average balances and average rates paid on deposits for the periods indicated:

For the Year Ended December 31,

(Dollars in thousands) Average Balance Average Rate Average Balance Average Rate

The ratio of average noninterest-bearing deposits to average total deposits for the years ended December 31, 2020 and 2019, was 41.5% and 36.3%, respectively.

Factors affecting the cost of funding interest-bearing assets include the volume of noninterest- and interest-bearing deposits, changes in market interest rates and economic conditions in the Puget Sound region and their impact on interest paid on deposits, competition from other financial institutions, as well as the ongoing execution of our growth strategies. Cost of total interest-bearing liabilities is calculated as total interest expense divided by average total interest-bearing deposits plus average total borrowings. Our cost of total interest-bearing liabilities was 0.64%, 1.13% and 0.80% for the years ended December 31, 2020, 2019 and 2018, respectively. The decreasein our cost of deposits in 2020 was primarily due to rate decreases from the Federal Reserve since June 2019 and the subsequent lowering of rates by management in response to the decrease and overall market conditions. We actively manage our interest rates on deposits, however, rate changes from the Federal Reserve and competition can impact our deposit costs.

Borrowings

We have the ability to utilize short-term to long-term borrowings to supplement deposits to fund our lending and investment activities, each of which is discussed below.

Federal Reserve Bank Line of Credit. The Federal Reserve allows us to borrow against our line of credit through a borrower in custody agreement utilizing the discount window, which is collateralized by certain loans. As of December 31, 2020, and December 31, 2019, total borrowing capacity of $21.3 million and $21.4 million, respectively, was available under this arrangement. As of December 31, 2020, and December 31, 2019, Federal Reserve borrowings against our line of credit totaled zero.

Paycheck Protection Program Liquidity Facility. To bolster the effectiveness of the SBA’s PPP loan program, the Federal Reserve is supplying liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. Financial institutions participating in the PPP have provided loans to small businesses so that they can keep their employees on the payroll and pay for other allowed expenses. If the borrowers meet certain criteria, the loan may be forgiven. The PPPLF extends credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. The interest rate is 0.35% and as PPP loans are paid down, the borrowing line must also be paid down. As of December 31, 2020, we had $153.7 million outstanding in PPPLF advances. This new borrowing arrangement has favorable capital treatment and is specific to the PPP loan program, and therefore there was no balance at December 31, 2019 and December 31, 2018.

The table below provides details on PPPLF borrowings for the periods indicated:

Year Ended December 31,

Maximum amount outstanding at any month-end during period:

Average outstanding balance during period:

Weighted average interest rate during period:

Balance outstanding at end of period:

Weighted average interest rate at end of period:

Federal Home Loan Bank (FHLB) Advances. The FHLB allows us to borrow against our line of credit, which is collateralized by certain loans. As of December 31, 2020, 2019 and 2018, total borrowing capacity of $90.7 million, $84.9 million and $79.3 million, respectively, was available under this arrangement. As of December 31, 2020, we borrowed a total of $25.0 million in FHLB medium term advances. This includes $10.0 million for a 2.25-year remaining term and $15.0 million advance with a 4.25-year remaining term. FHLB advances totaled $25.0 million as of December 31, 2020, $10.0 million as of December 31, 2019 and $20.0 million as of December 31, 2018. Although there are no immediate plans to borrow additional funds, additional borrowing capacity of $65.7 million was available under this arrangement as of December 31, 2020.

The following table presents details on FHLB short term borrowings for the periods indicated:

As of and For the Years Ended December 31,

Maximum amount outstanding at any month-end during period:

Average outstanding balance during period:

Weighted average interest rate during period:

Balance outstanding at end of period:

FHLB Advances $ - $ 10,000

Weighted average interest rate at end of period:

The following table presents details on FHLB medium term borrowings for the periods indicated:

Year Ended December 31,

Maximum amount outstanding at any month-end during period:

FHLB Advances $ 24,999 $ -

Average outstanding balance during period:

FHLB Advances $ 20,669 $ -

Weighted average interest rate during period:

Balance outstanding at end of period:

FHLB Advances $ 24,999 $ -

Weighted average interest rate at end of period:

Junior Subordinated Debentures. In 2004, we issued $3.6 million in junior subordinated debentures to Coastal (WA) Statutory Trust (the Trust), of which we own all of the outstanding common securities. The Trust used the proceeds from the issuance of its underlying common securities and preferred securities to purchase the debentures issued by the Company. These debentures are the Trust’s only assets and the interest payments from the debentures finance the distributions paid on the preferred securities. The debentures bear interest at a rate per annum equal to the 3-month LIBOR plus 2.10%. The effective rate as of December 31, 2020, 2019 and 2018, was 2.32%, 3.99% and 4.88%, respectively. We generally have the right to defer payment of interest on the debentures at any time or from time to time for a period not exceeding five years provided that no extension period may extend beyond the stated maturity of the debentures. During any such extension period, distributions on the trust’s preferred securities will also be deferred, and our ability to pay dividends on our common stock will be restricted. The Trust’s preferred securities are mandatorily redeemable upon maturity of the debentures, or upon earlier redemption as provided in the indenture. If the debentures are redeemed prior to maturity, the redemption price will be the principal amount and any accrued but unpaid interest. We unconditionally guarantee payment of accrued and unpaid distributions required to be paid on the Trust Securities subject to certain exceptions, the redemption price with respect to any Trust securities called for redemption and amounts due if the Trust is liquidated or terminated.

Subordinated Debt. In 2016, the Company issued a subordinated note to a commercial bank in the amount of $10.0 million. The note matures on August 1, 2026, and bears interest at the rate of 5.65% per year for five years and, thereafter, at a rate equal to The Wall Street Journal prime rate plus 2.50%. Principal payments of $500,000 per quarter commence November 1, 2021. We may redeem the subordinated note, in whole or in part, without premium or penalty after July 29, 2021, subject to any required regulatory approvals.

Liquidity and Capital Resources

Liquidity Management

Liquidity refers to our capacity to meet our cash obligations at a reasonable cost. Our cash obligations require us to have cash flow that is adequate to fund loan growth and maintain on-balance sheet liquidity while meeting present and future obligations of deposit withdrawals, borrowing maturities and other contractual cash obligations. In managing our cash flows, management regularly confronts situations that can give rise to increased liquidity risk. These include funding mismatches, market constraints in accessing sources of funds and the ability to convert assets into cash. Changes in economic conditions or exposure to credit, market, and operational, legal and reputational risks also could affect the Bank’s liquidity risk profile and are considered in the assessment of liquidity management.

We continually monitor our liquidity position to ensure that our assets and liabilities are managed in a manner to meet all reasonably foreseeable short-term, long-term and strategic liquidity demands. Management has established a comprehensive process for identifying, measuring, monitoring and controlling liquidity risk. Because of its critical importance to the viability of the Bank, liquidity risk management is fully integrated into our risk management processes. Critical elements of our liquidity risk management include: effective corporate governance consisting of oversight by the board of directors and active involvement by management, appropriate strategies, policies, procedures, and limits used to manage and mitigate liquidity risk, comprehensive liquidity risk measurement and monitoring systems that are commensurate with the complexity of our business activities; active management of intraday liquidity and collateral; an appropriately diverse mix of existing and potential future funding sources; adequate levels of readily available cash, deposits and highly liquid marketable securities free of legal, regulatory, or operational impediments, that can be used to meet liquidity needs in stressful situations; contingency funding policies and plans that sufficiently address potential adverse liquidity events and emergency cash flow requirements; and internal controls and internal audit processes sufficient to determine the adequacy of the Bank’s liquidity risk management process.

Our liquidity position is supported by management of our liquid assets and liabilities and access to alternative sources of funds. Our liquidity requirements are met primarily through our deposits, FHLB advances and the principal and interest payments we receive on loans and investment securities. Cash on hand, cash at third-party banks, investments available-for-sale and maturing or prepaying balances in our investment and loan portfolios are our most liquid assets. Other sources of liquidity that are routinely available to us include funds from retail, commercial, and BaaS deposits, advances from the FHLB and proceeds from the sale of loans. Less commonly used sources of funding include borrowings from the Federal Reserve discount window, draws on established federal funds lines from unaffiliated commercial banks, funds from online rate services, brokered funds, a one-way buy through an ICS account, and the issuance of debt or equity securities. We are also participating in the PPPLF, which provides an additional source of low cost funding, at a 0.35% interest rate, and favorable capital treatment. We have pledged 703 of these loans, or $153.7 million, as of December 31, 2020. Under the terms of the agreement, the borrowings will be paid down as the loans are forgiven or paid down by the customer. We also added a new liquidity source, which provides an overnight, one-way purchase of funds that would be classified as brokered deposits, but do not anticipate using it very often. We believe we have ample liquidity resources to fund future growth and meet other cash needs as necessary and are closely monitoring liquidity in this uncertain economic environment.

The Company is a corporation separate and apart from our Bank and, therefore, must provide for its own liquidity, including liquidity required to meet its debt service requirements on its subordinated note and junior subordinated debentures. The Company’s main source of cash flow has been through equity and debt offerings. The Company has consistently retained a portion of the funds from equity and debt offerings so that is has sufficient funds for its operating and debt costs for the next few years. The Company down-streamed $7.5 million in capital to the Bank during the first quarter of 2020, bringing the Company’s cash holding to $5.1 million at December 31, 2020. The Company uses approximately $1.3 million for debt servicing and operating purposes each year, leaving about $2.5 million for other purposes after deducting $2.6 million to cover operating purposes for the next two years. In addition, the Bank can declare and pay dividends to the Company to meet the Company’s debt and operating expenses. There are statutory and regulatory limitations that affect the ability of the Bank to pay dividends to the Company. We believe that these limitations will not impact the ability of the Bank to pay dividends to the Company to meet ongoing operating needs. For contingency purposes, the Company maintains a minimum level of cash to fund one year’s projected operating cash flow needs and the Bank targets a liquidity ratio of 5% or greater of assets. Both of these minimum liquidity levels are on-balance sheet sources. Per policy and the Bank’s liquidity contingency plan, in event of a liquidity emergency the Bank can utilize wholesale funds in an amount up to 30% of assets. PPPLF borrowings are not considered wholesale funds for the purpose of calculating the 30% of assets limit. Since the Bank uses only a small portion of its borrowing capacity, the Bank has access to funds if needed in a liquidity emergency.

Capital Adequacy

Capital management consists of providing equity and other instruments that qualify as regulatory capital to support current and future operations. Banking regulators view capital levels as important indicators of an

institution’s financial soundness. As a general matter, FDIC-insured depository institutions and their holding companies are required to maintain minimum capital levels relative to the amount and types of assets they hold. We are subject to regulatory capital requirements at the bank level. The Company will become subject to regulatory capital requirements once its consolidated assets exceed a certain threshold. Federal legislation enacted in May 2018 and implemented by the Federal Reserve effective August 30, 2018, raised the threshold of the Federal Reserve’s “Small Bank Holding Company” exception to the application of consolidated capital requirements from $1 billion to $3 billion of consolidated assets. Consequently, bank holding companies of under $3 billion of consolidated assets are no longer subject to the consolidated requirements unless otherwise directed by the Federal Reserve Board. See “Item 1. Business—Regulation and Supervision—Bank Regulation and Supervision—Capital Adequacy” for additional discussion regarding the regulatory capital requirements applicable to the Bank.

As of December 31, 2020, and 2019, the Bank was in compliance with all applicable regulatory capital requirements, and the Bank was classified as “well capitalized” for purposes of the Federal Reserve’s prompt corrective action regulations. As we deploy our capital and continue to grow our operations, our regulatory capital levels may decrease depending on our level of earnings. However, we will monitor our capital needs and manage our growth in order to remain in compliance with all regulatory capital standards applicable to us.

The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (Basel III rules) became effective for the Bank on January 1, 2015, with all of the requirements fully phased in by January 1, 2019. Under the Basel III rules, the Bank must maintain a capital conservation buffer of common equity Tier 1 capital of 2.50% above the minimum risk-based capital ratios. The Company and the Bank exceed all capital adequacy requirements to which they are subject, including the Basel III rules, as of December 31, 2020.

The following table presents the Company’s and the Bank’s regulatory capital ratios as of the dates presented, as well as the regulatory capital ratios that are required by Federal Reserve regulations to maintain “well-capitalized” status:

Amount Ratio Amount Ratio Amount Ratio

(dollars in thousands)

Leverage Capital (to average assets)

Common Equity Tier I risk-based capital ratio (to risk-weighted assets)

Tier I Capital (to risk-weighted assets)

Total Capital (to risk-weighted assets)

Leverage Capital (to average assets)

Common Equity Tier I risk-based capital ratio (to risk-weighted assets)

Tier I Capital (to risk-weighted assets)

Total Capital (to risk-weighted assets)

Contractual Obligations

The following table summarizes contractual obligations and other commitments to make future payments (other than non-time deposit obligations), which consist of future cash payments associated with our contractual obligations, as of December 31, 2020.

Payments Due by Period

Less than 1 to 3 3 to 5 More than

(Dollars in thousands) Total 1 Year Years Years 5 Years

Contractual Cash Obligations

Paycheck Protection Program Liquidity Facility $ 153,716 - 153,716 - -

Junior subordinated debentures 3,609 - - - 3,609

For a discussion of our borrowings, see “—Financial Condition—Borrowings.”

We believe that we will be able to meet our contractual obligations as they come due. Adequate cash levels are expected through profitability, repayments from loans and securities, deposit gathering activity, access to borrowing sources and periodic loan sales.

Off-Balance Sheet Items

In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our consolidated balance sheets. We enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby and commercial letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in our consolidated balance sheets.

Our commitments associated with outstanding commitments to extend credit and standby and commercial letters of credit are summarized below. Since commitments associated with commitments to extend credit and letters of credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements.

As of December 31, 2020, we held $65.6 million in capital call lines, included in commercial and industrial loans, provided to venture capital firms through one of our BaaS clients. These loans are secured by the capital call rights and are individually underwritten to the Bank’s credit standards and the underwriting is reviewed by the Bank on every line.

The following table presents commitments associated with outstanding commitments to extend credit and standby and commercial letters of credit as of the periods indicated:

As of December 31,

Commitments to extend credit:

Commercial and industrial loans - capital call lines $ 128,208 $ 13,200

Commercial and industrial loans - other 61,676 $ 53,363

Construction – commercial real estate loans 69,866 42,371

Construction – residential real estate loans 18,489 21,361

Standby letters of credit $ 2,754 $ 2,250

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being fully drawn upon, the total commitment amounts disclosed above do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if considered necessary by us, upon extension of credit, is based on management’s credit evaluation of the customer.

Standby and commercial letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. In the event of nonperformance by the customer, we have rights to the underlying collateral, which can include commercial real estate, physical plant and property, inventory, receivables, cash and/or marketable securities. Our credit risk associated with issuing letters of credit is essentially the same as the risk involved in extending loan facilities to our customers.

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

The Company uses certain non-GAAP financial measures to provide meaningful supplemental information regarding the Company’s operational performance and to enhance investors’ overall understanding of such financial performance. However, these non-GAAP financial measures are supplemental and are not a substitute for an analysis based on GAAP measures. As other companies may use different calculations for these adjusted measures, this presentation may not be comparable to other similarly titled adjusted measures reported by other companies.

We believe that these non-GAAP financial measures provide information that is important to investors and that is useful in understanding our results of operations. Our management uses the non-GAAP financial measures set forth below in its analysis of our performance for 2017 to exclude the impact of a deferred tax asset revaluation due to the enactment of the Tax Cuts and Jobs Act. However, these non-GAAP financial measures are supplemental and are not a substitute for an analysis based on GAAP measures. As other companies may use different calculations for these measures, this presentation may not be comparable to other similarly titled measures by other companies.

Reconciliations of the GAAP and non-GAAP measures are presented below.

Adjusted net income:

Plus: additional income tax expense for deferred tax asset valuation 1,295

Adjusted net income $ 6,731

Adjusted earnings per share—diluted

Plus: additional income tax expense for deferred tax asset valuation 1,295

Adjusted net income $ 6,731

Weighted average common shares outstanding—diluted (1) 9,237,629

Adjusted earnings per share—diluted (1) $ 0.73

Adjusted return on average assets

Plus: additional income tax expense for deferred tax asset valuation 1,295

Adjusted net income $ 6,731

Adjusted return on average assets 0.90 %

Adjusted return on average shareholders’ equity

Plus: additional income tax expense for deferred tax asset valuation 1,295

Adjusted net income $ 6,731

Average shareholders’ equity 65,720

Adjusted return on average shareholders’ equity 10.24 %

We believe these non-GAAP measures are useful to investors in evaluating our performance and in demonstrating resources available with and without provision for loan losses and income taxes. The following non-GAAP measures are presented to illustrate the impact of provision for loan losses and provision for income taxes on net income and return on average assets.

“Pre-tax, pre-provision net income” is a non-GAAP measure that excludes the impact of provision for loan losses and provision for income taxes from net income. The most directly comparable GAAP measure is net income.

“Pre-tax, pre-provision return on average assets” is a non-GAAP measure that excludes the impact of provision for loan losses and provision for income taxes from return on average assets. The most directly comparable GAAP measure is return on average assets.

Reconciliations of the GAAP and non-GAAP measures are presented below.

As of and for the Years Ended

(Dollars in thousands, unaudited) December 31, 2020 December 31, 2019

Plus: provision for loan losses 8,308 2,544

Plus: provision for income taxes 3,995 3,461

Pre-tax, pre-provision net income $ 27,449 $ 19,206

Return on average assets 0.98 % 1.28 %

Pre-tax, pre-provision return on average assets: 1.78 % 1.86 %

The following non-GAAP financial measures are presented to illustrate and identify the impact of PPP loans on loans receivable related measures. By removing these significant items and showing what the results would have been without them, we are providing investors with the information to better compare results with periods that did not have these significant items. We believe that these non-GAAP financial measures provide information that is important to investors and that is useful in understanding our results of operations. These measures include the following:

“Adjusted allowance for loan losses to loans receivable” is a non-GAAP measure that excludes the impact of PPP loans on balance sheet. The most directly comparable GAAP measure is allowance for loan losses to loans receivable.

“Adjusted yield on loans receivable” is a non-GAAP measure that excludes the impact of PPP loans on balance sheet. The most directly comparable GAAP measure is yield on loans.

“Adjusted contractual yield on loans receivable, excluding net earned fees and interest on PPP loans” is a non-GAAP measure that excludes the impact of PPP loans on balance sheet. The most directly comparable GAAP measure is contractual yield on loans, excluding fees.

Reconciliations of the GAAP and non-GAAP measures are presented in the following table.

Year Ended

(Dollars in thousands, unaudited) December 31, 2020

Adjusted allowance for loan losses to loans receivable:

Total loans, net of deferred fees $ 1,547,138

Less: net deferred fees on PPP loans 5,803

Adjusted loans, net of deferred fees $ 1,187,099

Allowance for loan losses $ (19,262 )

Allowance for loan losses to loans receivable 1.25 %

Adjusted allowance for loan losses to loans receivable 1.62 %

Adjusted yield on loans receivable:

Total average loans receivable $ 1,333,028

Less: average PPP loans (302,685 )

Plus: average net deferred fees on PPP loans 6,432

Adjusted total average loans receivable $ 1,036,775

Interest income on loans $ 61,910

Less: interest and net deferred fee income recognized on PPP loans (10,172 )

Adjusted interest income on loans $ 51,738

Yield on loans receivable 4.64 %

Adjusted yield on loans receivable: 4.99 %

Total average loans receivable $ 1,333,028

Less: average PPP loans (302,685 )

Plus: average net deferred fees on PPP loans $ 6,432

Adjusted total average loans receivable, excluding net earned fees $ 1,036,775

Interest and net earned fee income on loans $ 61,910

Less: net earned fee income on all loans $ (9,065 )

Less: interest income on PPP loans (3,030 )

Adjusted interest income on loans $ 49,815

Contractual yield on loans receivable, excluding net earned fees 3.96 %

Quantitative and Qualitative Disclosures about Market Risk

As a financial institution, our primary component of market risk is interest rate volatility. Our asset liability and funds management policy provides management with the guidelines for effective funds management, and we have established a measurement system for monitoring our net interest rate sensitivity position. We have historically managed our sensitivity position within our established guidelines.

Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of our assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which have a short term to maturity. Interest rate risk is the potential for economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a decrease in current fair market values. Our objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing net income.

We manage our exposure to interest rates by structuring our balance sheet in the ordinary course of business. We do not enter into instruments such as leveraged derivatives, financial options, financial future contracts

or forward delivery contracts for the purpose of reducing interest rate risk. Based upon the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets.

Our exposure to interest rate risk is managed by the Asset Liability Committee (ALCO), of the Bank and reviewed by the Asset Liability and Investment Committee of our board of directors in accordance with policies approved by our board of directors. ALCO formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, ALCO considers the impact on earnings and capital on the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. ALCO meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, purchase and sale activities, commitments to originate loans and the maturities of investments and borrowings. Additionally, ALCO reviews liquidity, cash flows, maturities of deposits and consumer and commercial deposit activity. Management employs various methodologies to manage interest rate risk including an analysis of relationships between interest-earning assets and interest-bearing liabilities and interest rate simulations using a model. The Asset Liability and Investment Committee of our board of directors meets quarterly to review the Bank’s interest rate risk profile, liquidity position, including contingent liquidity, and investment portfolio.

We use interest rate risk simulation models to test interest rate sensitivity of net interest income and fair value of equity, and the impact of changes in interest rates on other financial metrics. Contractual maturities and re-pricing opportunities of loans are incorporated in the model, as are prepayment assumptions, maturity data and call options within the investment portfolio. Average life of non-maturity deposit accounts are based on historical decay rates and assumptions and are incorporated into the model. The assumptions used are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.

On a quarterly basis, we run multiple simulations under two different premises of which one is a static balance sheet and the other is a dynamic growth balance sheet. The static balance sheet approach produces results that show the interest risk currently inherent in our balance sheet at that point in time. The dynamic balance sheet includes our projected growth levels going forward and produces results that shows how net income, net interest income, and interest risk change based on our projected growth. These simulations test the impact on net interest income and fair value of equity from changes in market interest rates under various scenarios. Under the static and dynamic approaches, rates are shocked instantaneously and ramped over a 12-month horizon assuming parallel yield curve shifts. Parallel shock scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Non-parallel simulations are also conducted and involve analysis of interest income and expense under various changes in the shape of the yield curve including a forward curve, flat curve, steepening curve, and an inverted curve. Our internal policy regarding internal rate risk simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net income at risk for the subsequent one- and two-year period should not decline by more than 10% for a 100 basis point shift, 15% for a 200 basis point shift, 20% for a 300 basis point shift, and 25% for a 400 basis point shift.

The following tables summarize the simulated change in net interest income over a 12-month horizon as of the dates indicated:

Estimated Increase (Decrease) in Net Interest Income

Static Balance Sheet and Rate Shifts

Dynamic Balance Sheet and Rate Shifts

The results illustrate that the Bank is asset sensitive and generally performs better in an increasing interest rate environment. The results are primarily due to behavior of demand, money market and savings deposits during such rate fluctuations. We have found that, historically, interest rates on these deposits change more slowly than changes in the discount and federal funds rates. This assumption is incorporated into the simulation model. The assumptions incorporated into the model are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various strategies.

The -100, -200, and -300 basis point change in market interest rates no longer reflects viable interest rate changes as interest rates would have to go negative since the Fed Funds rate target range is set at 0.00% to 0.25%. Until rates increase, these rate shock scenarios may not reflect what may happen to net interest income if interest rates were to go negative.

Impact of Inflation

Our consolidated financial statements and related notes to those financial statements included elsewhere in this Report on Form 10-K have been prepared in accordance with GAAP. GAAP requires the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession.

Unlike many industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, other operating expenses do reflect general levels of inflation.

100

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

The information required by this item is incorporated herein by reference to the section captioned “Item 7. Management’s Discussion and Analysis of Financial Condition and Operations-Quantitative and Qualitative Disclosures about Market Risk.”

Item 8. Financial Statements and Supplementary Data

The information required by this item is included beginning on page F-1 of this Report on Form 10-K.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Exchange Act) as of December 31, 2020. In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well-designed and operated, can provide only a reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported as of the end of the period covered by this annual report.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the fourth quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining effective internal control over financial reporting (as defined in Rule 13a-15(f) and 15d- 15(f) of the Exchange Act). The Company’s internal control system is designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published financial statements in accordance with GAAP. Internal control over financial reporting includes self monitoring mechanisms, and actions are taken to correct deficiencies as they are identified.

There are inherent limitations in any internal control over financial reporting, no matter how well designed, misstatements due to error or fraud may occur and not be detected, including the possibility of circumvention or overriding of controls. Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of an internal control system may vary over time.

Management assessed its internal control structure over financial reporting as of December 31, 2020 using the criteria set forth in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring

101

Organizations of the Treadway Commission. Based on this assessment, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2020.

Item 9B. Other Information

None.

102

PART III

Item 10. Directors, Executive Officers and Corporate Governance

Board of Directors

For information relating to the directors of the Company, the section captioned “Items to be Voted on by Shareholders—Item 1—Election of Directors” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders is incorporated herein by reference.

Executive Officers

For information relating to officers of the Company, see Part I, Item 1, “Business—Information About Our Executive Officers” to this Annual Report on Form 10-K.

Delinquent Section 16(a) Reports

For information regarding compliance with Delinquent Section 16(a) Reports and the section captioned “Stock Information—Delinquent Section 16(a) Reports” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders are incorporated herein by reference.

Disclosure of Code of Ethics

For information concerning the Company’s Code of Ethics, the information contained under the section captioned “Corporate Governance—Code of Ethics and Business Conduct” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders is incorporated by reference. A copy of the Code of Ethics and Business Conduct is available to shareholders on the Company’s website at www.coastalbank.com.

Audit Committee

For information regarding the Audit Committee and its composition and the audit committee financial expert, the section captioned “Corporate Governance—Meetings and Committees of the Board of Directors—Audit Committee” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders is incorporated herein by reference.

Item 11. Executive Compensation

Executive Compensation

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

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

(a)Security Ownership of Certain Beneficial Owners

Information required by this item is incorporated herein by reference to the section captioned “Stock Information” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders.

(b)Security Ownership of Management

Information required by this item is incorporated herein by reference to the section captioned “Stock Information” in in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders.

103

(c)Changes in Control

Management of the Company knows of no arrangements, including any pledge by any person or securities of the Company the operation of which may at a subsequent date result in a change in control of the registrant.

(d)Equity Compensation Plan Information

The following table sets forth information about the Company common stock that may be issued upon the exercise of stock options, warrants and rights under all of the Company’s equity compensation plans as of December 31, 2020.

Equity compensation plan not approved by shareholders - - -

Item 13. Certain Relationships and Related Transactions, and Director Independence

Certain Relationships and Related Transactions

For information regarding certain relationships and related transactions, the section captioned “Other Information Relating to Directors and Executive Officers—Transactions with Related Persons” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders is incorporated herein by reference.

Director Independence

For information regarding director independence, the section captioned “Corporate Governance—Director Independence” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders is incorporated herein by reference.

Item 14. Principal Accountant Fees and Services

For information regarding the principal accountant fees and expenses, the section captioned “Item 2—Ratification of Selection of Independent Registered Public Accounting Firm” in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders is incorporated herein by reference.

104

PART IV

Item 15. Exhibits and Financial Statement Schedules

(3) Exhibits

No. Description Location

105

106

23.1 Consent of Moss Adams LLP Filed herewith

107

+ Management contract or compensatory plan, contract or arrangement.

Item 16.Form 10-K Summary

None.

108

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

COASTAL FINANCIAL CORPORATION

Dated: March 11, 2021 /s/ Eric M. Sprink

Eric M. Sprink

President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Name Title Date

/s/ Christopher D. Adams Christopher D. Adams Chair of the Board March 11, 2021

/s/ Andrew P. Skotdal Andrew P. Skotdal Vice Chair of the Board March 11, 2021

/s/ Andrew R. Dale Andrew R. Dale Director March 11, 2021

/s/ Rilla Delorier Rilla Delorier Director March 11, 2021

/s/ Steven D. Hovde Steven D. Hovde Director March 11, 2021

/s/ Stephan Klee Stephan Klee Director March 11, 2021

/s/ Thomas D. Lane Thomas D. Lane Director March 11, 2021

/s/ Sadhana Akella-Mishra Sadhana Akella-Mishra Director March 11, 2021

/s/ Gregory A. Tisdel Gregory A. Tisdel Director March 11, 2021

109

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 consolidatedbalance sheets of Coastal Financial Corporation and Subsidiary (the “Company”) as of December 31, 2020 and 2019, 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, 2020 and 2019, 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 consolidatedfinancial 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, WA

March 11, 2021

We have served as the Company’s auditor since 2016.

F-1

COASTAL FINANCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

ASSETS

December 31, December 31,

Investment securities, available for sale, at fair value 20,399 28,360

Investment securities, held to maturity, at amortized cost 2,848 4,350

Operating lease right-of-use assets 7,120 8,493

Bank-owned life insurance, net 7,082 6,882

LIABILITIES AND SHAREHOLDERS’ EQUITY

LIABILITIES

Federal Home Loan Bank (FHLB) advances 24,999 10,000

Paycheck Protection Program Liquidity Facility 153,716 -

Subordinated debt

Junior subordinated debentures

Accrued interest payable 531 308

Commitments and contingencies (Note 13)

SHAREHOLDERS’ EQUITY

CCB US Equity

CCB · 10-K · period ended 2020-12-31

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

Item 8. Financial Statements and Supplementary Data

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Item 9A. Controls and Procedures

Item 9B. Other Information

Item 10. Directors, Executive Officers and Corporate Governance

Item 11. Executive Compensation

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Item 13. Certain Relationships and Related Transactions, and Director Independence

Item 14. Principal Accountant Fees and Services

Item 15. Exhibits and Financial Statement Schedules

Item 16.Form 10-K Summary

CCB US Equity☆

CCB · 10-K · period ended 2020-12-31

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

Item 8. Financial Statements and Supplementary Data

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Item 9A. Controls and Procedures

Item 9B. Other Information

Item 10. Directors, Executive Officers and Corporate Governance

Item 11. Executive Compensation

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Item 13. Certain Relationships and Related Transactions, and Director Independence

Item 14. Principal Accountant Fees and Services

Item 15. Exhibits and Financial Statement Schedules

Item 16.Form 10-K Summary

CCB US Equity