CCB US Equity☆

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. Our business is conducted through two reportable segments: The community bank and CCBX. The primary focus of the community bank is 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 and through the Internet and our mobile banking application. We currently operate 14 full-service banking locations, 12 of which are located in Snohomish County, where we are the largest community bank by deposit market share, and two of which are located in neighboring counties (one in King County and one in Island County). The CCBX segment provides banking as a service (“BaaS”) that allows our broker-dealer and digital financial service partners to offer their customers banking services. The CCBX segment has grown to 28 partners as of December 31, 2021, compared to 15 as of December 31, 2020. The Bank’s deposits are insured in whole or in part by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is subject to regulation by the Federal Reserve and the Washington State Department of Financial Institutions Division of Banks. The Federal Reserve also has supervisory authority over the Company.

As of December 31, 2021, we had total assets of $2.64 billion, total loans receivable of $1.74 billion, total deposits of $2.36 billion and total shareholders’ equity of $201.2 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.

We generate most of our community bank revenue from interest on loans and investments and CCBX revenue from BaaS fee income. Our primary source of funding for our loans is commercial and retail deposits from our customer relationships and from our partner deposit relationships. We place secondary reliance on wholesale funding, primarily borrowings from the Federal Home Loan Bank (“FHLB”). 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 salaries and employee benefits, provision for loan losses, 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 consumer loans.

CARES Act and Paycheck Protection Program (“PPP”)

Our financial results for the year ended December 31, 2021 were also impacted by the coronavirus, and variants thereof, including the Delta and Omicron variants (“COVID-19”) pandemic. On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“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 was a stimulus response to the potential economic impacts of the COVID-19 pandemic. The purpose of the PPP was to provide forgivable loans to smaller businesses, sole proprietorships, independent contractors, and self-employed individuals that used the proceeds of the loans for payroll and certain other qualifying expenses. The Small Business Administration (“SBA”) manages 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. We accepted and processed applications for the duration of the initial PPP loan program, which closed for new applicants on August 8, 2020. The Consolidated Appropriations Act enacted on December 27, 2020, appropriated additional funding to the PPP and permitted certain PPP borrowers to make “second draw” loans. The American Rescue Plan Act of 2021, enacted on March 11, 2021, expanded the eligibility criteria for both first and second draw PPP loans and revised the exclusions from payroll costs for purposes of loan forgiveness. The PPP Extension Act of 2021, enacted on March 25, 2021, extended the PPP through May 31, 2021, at which time the program closed for new applications.

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In total, we funded $763.9 million in PPP loans, since the first round of PPP loans opened in March 2020 through the close of round three. Total net deferred fees on these loans were $26.3 million. As of December 31, 2021, $111.8 million in PPP loans remained with $3.6 million in net deferred fees, which will be recognized in interest income in future periods. Legislation extended the initial payment deferral period on PPP loans originated in 2020, and PPP borrowers with two-year loans can work with their lender to extend their loan to a five-year maturity, which has been a popular approach for customers with PPP loans that are not eligible for forgiveness. There are $4.3 million of these loans remaining as of December 31, 2021. PPP loans originated in 2021 are five-year loans, and $107.5 million remains of these loans as of December 31, 2021. 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 (generally between eight and 24 weeks).

We continue to accept applications from customers for loan forgiveness. To obtain loan forgiveness, a PPP borrower must submit a forgiveness application. We expect PPP forgiveness payments to continue through the second quarter of 2022.

The table below summarizes information about total PPP loans originated in 2020 and 2021.

Total PPP Loan Origination

(Dollars in thousands; unaudited)

Outstanding loans and deferred fees as of December 31, 2021

As of December 31, 2021 there was $111.8 million in PPP loans, including $4.3 million from rounds 1 and 2 and $107.5 million from round 3. The table below summarizes key information about the remaining PPP loans originated in 2020 and 2021 as of the period indicated:

Outstanding PPP Loans

Original Loan Size

As of and for the Three Months Ended December 31, 2021

(Dollars in thousands; unaudited)

Principal outstanding:

Net deferred fees outstanding

Number of loans:

Forgiveness/Payoffs/Paydowns in Three Months Ended December 31, 2021

PPP Overview

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These loans have had a significant impact on our financial statements for the year ended December 31, 2021 and 2020 and will continue to impact our results in the future. Throughout this discussion, we will address the impact of these loans on the balance sheet and income statement, including borrowings received through the Paycheck Protection Program Liquidity Facility ( “PPPLF”), which were paid in full during the quarter ended June 30 2021, 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.”

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The Company's Preparations, Responses and Re-Opening to the COVID-19 Pandemic

As part of our ongoing risk preparation and mitigation efforts, we 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 of 2021. 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. As of December 31, 2021 our re-opening plan includes the following elements:

London Interbank Offered Rate (“LIBOR”) Transition

On March 5, 2021, the United Kingdom’s Financial Conduct Authority, which regulates LIBOR, confirmed that the publication of most LIBOR term rates will end on June 30, 2023 (excluding 1-week U.S. LIBOR and 2-month U.S. LIBOR, the publication of which will end on December 31, 2021). Additionally, on April 6, 2021, New York Governor Cuomo signed into law legislation that provides for the substitution of an alternative reference rate, the Secured Overnight Financing Rate, in any LIBOR-based contract governed by New York state law that does not include clear fallback language, once LIBOR is discontinued but no later than December 31, 2021. The Federal Reserve and other federal banking agencies have continued to encourage banks to transition away from LIBOR as soon as practicable.

As of December 31, 2021, we had $216.9 million in loans that are tied to LIBOR, and $180.3 million of those are SWAPs. We have $3.6 million in floating rate junior subordinated debentures to Coastal (WA) Statutory Trust I, which was formed for the issuance of trust preferred securities. These debentures are also tied to LIBOR. The move to an alternate index may impact the rates we receive on loans and rates we pay on our junior subordinated debentures. We have identified the loans and debt instruments impacted, are reviewing LIBOR replacement options and are preparing for and evaluating the impact of the transition from LIBOR. We are no longer issuing any loans or debt tied to LIBOR.

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

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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 for the community bank. 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. We originate business and consumer loans through our CCBX partners and while these loans will have higher levels of charge-offs and nonperforming assets, we also obtain credit enhancements from many of our CCBX partners which protects the Bank by absorbing incurred charge-offs and losses, but if our partners are unable to fulfill their contracted obligations then the Bank would be exposed to additional loan losses as a result of this counterparty risk.

Operating Efficiency

The largest component of noninterest expense is salaries and employee benefits. Other significant operating expenses include BaaS expense, occupancy expense, legal and professional fees, data processing expense, director and staff expense and marketing expense. 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. In 2021, we made substantial investments in our BaaS infrastructure and our efficiency ratio slightly increased to 58.82% at December 31, 2021, compared to 58.14% at December 31, 2020.

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. Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies, which are discussed below, to be critical accounting policies. These assumptions, estimates and judgments we use can be influenced by a number of factors, including the general economic environment. Actual results could differ from these judgments and estimates under different conditions, resulting in a change that could have a material impact on the carrying values of our assets and liabilities and our results of operations. 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

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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. For more information and discussion related to securities, see “Note 3 - Investment Securities” in the Consolidated Financial Statements.

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.

As of December 31, 2021, loans receivable totaled $1.74 billion, an increase of $195.6 million, or 12.6%, compared to $1.55 billion as of December 31, 2020. Total loans receivable is net of $8.8 million in net deferred origination fees, $3.6 million of which is attributed to PPP loans. The increase is largely attributed to growth in our CCBX segment as a result of adding new partners, combined with loan growth in the community bank segment, partially offset by forgiveness or principal paydowns on PPP loans. For more information and discussion related to the loans held for investment, see “Note 4 - Loans and Allowance for Loan Losses” in the Consolidated Financial Statements.

Equity Investments

Equity investments include amounts invested in stock, venture capital funds, partnerships, and other business ventures. Some of these equity investments are in vendors/suppliers, private companies, government agencies, or government sponsored enterprises. The Company directly holds stock in organizations such as the Federal Reserve Bank, Federal Home Loan Bank of Des Moines, private companies, and venture capital funds. Equity investments are subject to the risk of loss if these organizations experience financial difficulties or fall on hard times. The Company carries these investments at market value or cost if market value is not readily determinable. During 2021, one private company investment increased in value by $1.5 million (unrealized gain) in response to the issuance of common equity awards, identical to the Company’s holdings, at a higher value. In 2020, one private company investment decreased in value by $400,000 (unrealized loss) in response to a decline in value in the stock based on that company’s financial performance and growth rate.

The assumptions underlying these valuations represent management’s best estimates, which involve inherent uncertainties and the application of management’s judgment. While we believe the assumptions and estimates we have made are reasonable and appropriate, different assumptions or estimates could have resulted in materially different fair values for these equity investments. For more information and discussion related to securities, see Note 3 - Investment Securities” in the Consolidated Financial Statements.

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. Community bank loans are assessed at the individual loan level and

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CCBX loans are pooled and evaluated at both the partner and product level. 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.

The Company increased the allowance from $19.3 million at December 31, 2020 to $28.6 million at December 31, 2021. The allowance was significantly increased in response to growth in CCBX consumer loans. The Company uses CCBX partner data, industry data and its own loan loss data to develop an appropriate allowance for the risk inherent in the CCBX new loan volume. The Company increased the allowance from $11.5 million to $19.3 million in 2020 in response to the uncertainty of the COVID-19 pandemic, an increase in the unemployment rate, a decrease in GDP, and the unknown effects of the economic shutdown and stay at home orders on our communities, businesses, and consumers. For more information and discussion related to the allowance for loan losses, see “Note 4 - Loans and Allowance for Loan Losses” in the Consolidated Financial Statements.

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 and restricted stock units 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. For more information and discussion related to stock-based compensation, see “Note 15 – Stock-based Compensation” in the Consolidated Financial Statements.

Revenue Recognition

We record revenue from contracts with customers in accordance with ASU 2014-09, Revenue from Contracts with Customers (“Topic 606”). Under Topic 606, the Company must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract and recognize revenue when (or as) the Company satisfies a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods. A large portion of the Company’s revenue are derived from interest and fees earned on loans, investment securities and other financial instruments that are not within the scope of Topic 606. The Company generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed, charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.

The recording of BaaS income and expense is dependent upon the contractual agreement with each partner, however in accordance with accounting guidance the recording of certain components of BaaS income are as follows: Agreements with many of our CCBX partners provide for a credit enhancement which protects the Bank by absorbing incurred losses. In accordance with accounting guidance, we estimate and record a provision for probable losses for these CCBX loans. When the provision for loan losses and provision for unfunded commitments is recorded, a recovery receivable is also recorded on the balance sheet through noninterest income (BaaS fees -credit enhancement). Incurred losses are recorded in the allowance for loan losses, and as the credit enhancement recoveries are received from the CCBX partner, the recovery receivable is relieved. Many agreements with our CCBX partners also provide protection to the Bank from fraud by absorbing incurred fraud losses. Fraud losses are recorded when incurred

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as losses in noninterest expense, and the recovery received from the CCBX partner is recorded in noninterest income, resulting in a net impact of zero to the income statement. Credit enhancements that provide protection to the Bank from credit and fraud losses, are not within the scope of Topic 606.

For the year ended December 31, 2021 noninterest income subject to Topic 606 increased $5.5 million to $12.9 million, compared to $7.4 million for the year ended December 31, 2020. The increase was largely the due to an increase in BaaS fee income resulting from active CCBX partners gaining traction with their services. For more information and discussion related to revenue recognition, see “Note 19 – Revenue Recognition” in the Consolidated Financial Statements.

Emerging Growth Company

The Jumpstart Our Business Startups Act of 2012, (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, 2021, see “Note 2 – Recent Accounting Standards” in the accompanying notes to our audited consolidated financial statements included elsewhere in this Report on Form 10-K.

Results of Operations

Net Income

Year Ended December 31, 2021, Compared to Year Ended December 31, 2020. Net income for the year ended December 31, 2021, was $27.0 million, or $2.16 per diluted share, compared to $15.1 million, or $1.24 per diluted share, for the year ended December 31, 2020. The increase in net income over the prior year was attributable to a $22.0 million increase in net interest income, $19.9 million increase in noninterest income partially offset by an $25.1 million increase in noninterest expense.

Net Interest Income

Year Ended December 31, 2021, Compared to Year Ended December 31, 2020. Net interest income for the year ended December 31, 2021, was $79.4 million compared to $57.4 million for the year ended December 31, 2020, an increase of $22.0 million, or 38.4%. The increase in net interest income consisted of a $20.0 million, or 31.8%, increase in interest income combined with a $2.0 million, or 35.5%, decrease in interest expense.

The $20.0 million increase in interest income for the year ended December 31, 2021 compared to December 31, 2020 is largely related to increased interest income resulting from community bank and CCBX loan growth and the recognition of deferred fees on PPP loans, including forgiven and paid off loans,as well as increased yield on loans resulting from loan growth and a decrease in lower yielding PPP loans. Interest and fees on loans increased $20.2 million, or 32.6%, over the prior year period, and yield on loans receivable increased 22 basis points for the year ended December 31, 2021, compared to the year ended December 31, 2020. Non-PPP loan growth of $449.2 million, or 37.7%, which includes CCBX loan growth of $281.0 million, or 428.2%, for the year ended December 31, 2021, compared to December 31, 2020, also contributed to the increase in interest income. Community bank loan growth increased by $168.2 million, or 15.0%, despite a reduction in PPP loans of $254.0 million, or 69.4%, that were forgiven or repaid, compared to December 31, 2020, and also contributed to the increase in interest income. Net deferred fees recognized on forgiven or repaid PPP loans increased $8.4 million, or 117.1%, to $15.5 million for the year ended December 31, 2021, compared to $7.2 million for the year ended December 31, 2020. 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. Interest income from interest earning deposits with other banks was $608,000 for the year ended December 31, 2021, a decrease of $55,000, or 8.3%, compared to December 31, 2020, despite an average increase of $268.1 million in interest earning deposits with other banks, as a result of lower interest rates.

Interest expense decreased $2.0 million, or 35.5%, to $3.7 million for the year ended December 31, 2021 compared to $5.7 million for the year ended December 31, 2020. Lower interest rates resulted in a decrease in interest expense despite a $185.8 million increase in average interest bearing deposits. Interest expense on borrowings decreased $45,000 largely due to a reduction in

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outstanding PPPLF borrowings, which were paid off in full during the quarter ended June 2021. PPPLF borrowings were used to help fund PPP loans.

For the year ended December 31, 2021, net interest margin and interest rate spread were 3.73% and 3.54%, respectively, compared to 3.83% and 3.57% for the year ended December 31, 2020. Contributing to the net interest margin and spread decline compared to the year ended December 31, 2020, was the $268.1 million increase in average interest bearing deposits with other banks, which earned an average rate of 0.15% during the year ended December 31, 2021.

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 $18.4 million and $9.1 million for the years ended December 31, 2021 and 2020, respectively. Of the $18.4 million and $9.1 million in fees recognized in 2021 and 2020, $15.5 million and $7.2 million, respectively, were from PPP loans. For the years ended December 31, 2021 and 2020, the amount of interest income not recognized on nonaccrual loans was not material.

Average Balance Sheets For the Year Ended December 31,

Interest Average Interest Average

Average Income/ Yield/ Average Income/ Yield/

(Dollars in thousands) Balance Expense Rate Balance Expense Rate

Assets

Interest earning assets:

Noninterest earning assets:

Liabilities and Shareholders’ Equity

Interest bearing liabilities:

Interest rate spread 3.54 % 3.57 %

Net interest margin (3) 3.73 % 3.83 %

(2) Includes nonaccrual loans.

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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.

Year Ended December 31, 2021 Compared to

Increase (Decrease) Total

Due to Increase

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

Interest income:

Interest earning deposits $ 405 $ (460 ) $ (55 )

Investment securities, available for sale 13 (140 ) (127 )

Investment securities, held to maturity (22 ) (2 ) (24 )

Other investments 58 (9 ) 49

Interest expense:

PPPLF borrowings (195 ) - (195 )

FHLB advances and other borrowings 49 - 49

Junior subordinated debentures - (21 ) (21 )

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, 2021, Compared to Year Ended December 31, 2020. The provision for loan losses for the year ended December 31, 2021, was $9.9 million compared to $8.3 million for the year ended December 31, 2020. The increase in the Company’s provision for loan losses during the year ended December 31, 2021, is largely related to the provision for CCBX partner loans. During the year ended December 31, 2021, a $8.6 million provision for loan losses was recorded for CCBX partner loans based on management’s analysis. The factors used in management’s analysis for community bank loan losses indicated that a provision for loan loss of $1.3 million was needed for the year ended December 31, 2021. The expected COVID-19 pandemic related loan losses have not materialized as originally anticipated in 2020, as evidenced by the low level of charge-offs and nonperforming loans. The economic environment is continuously changing and has shown some signs of improvement in 2021, with ongoing vaccination of its population and increased re-opening of economic activities, tempered by increased inflation, and a rise in new COVID-19 variants that have resulted in some economic uncertainty. The Company is not required to implement the provisions of the Current Expected Credit Loss (“CECL”) accounting standard until January 1, 2023 and continues to account for the allowance for credit losses under the incurred loss model. Gross loans totaled $1.74 billion in 2021 compared to $1.55 billion in 2020 and grew $195.6 million, or 12.6%, in 2021 compared to 2020. Included in total loans for 2021 is $111.8 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 1.64% at December 31, 2021, compared to 1.25% at December 31, 2020. Excluding PPP loans, which are 100% guaranteed by the SBA, the adjusted allowance for loan losses as a percentage of loans was approximately 1.75% at December 31, 2021. 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, 2021 totaled $545,000, or 0.03% of total average loans, as compared to net charge-offs of $516,000, or 0.04% of total average loans, for the year ended December 31, 2020. Net charge-offs were up slightly in 2021 compared to 2020 due to CCBX partner loans. In 2021, $172,000 in net charge-offs were for the community bank and $373,000 were for CCBX. In 2020, all of the charge-offs were for the community bank.

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The following table show the total charge-off activity by segment for the period indicated (prior to 2021 CCBX activity was immaterial and therefore not presented):

Year Ended

(Dollars in thousands) Community bank CCBX Total

Gross recoveries (83 ) (12 ) (95 )

The following table show the total provision expense by segment for the period indicated (prior to 2021 CCBX activity was immaterial and therefore not presented):

Year Ended

(Dollars in thousands) December 31, 2021

Community bank $ 1,275

Total provision expense $ 9,915

Noninterest Income

Our primary sources of recurring noninterest income are BaaS fees, deposit account service charges and 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. Additionally, in 2021 we had non-recurring income for the unrealized gain on an equity investment and a gain on the sale of a branch.

For the year ended December 31, 2021, noninterest income totaled $28.1 million, an increase of $19.9 million, or 243.7%, compared to $8.2 million for the year ended December 31, 2020. The following table presents, for the periods indicated, the major categories of noninterest income:

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

Year Ended

December 31, Increase Percent

(Dollars in thousands) 2021 2020 (Decrease) Change

Unrealized gain (loss) on equity securities, net 1,469 (400 ) 1,869 (467.3 )

Gain on sale of branch, net 1,263 - 1,263 n/a

Gain on sale of securities, net - - - n/a

BaaS Fees. Our CCBX segment provides BaaS offerings that enable our broker dealer and digital financial service providers 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. In accordance with GAAP, we recognize the reimbursement of non-credit fraud losses on partner’s customer loans and credit enhancements related to the allowance for loan losses and reserve for unfunded commitments provided by the partner as revenue. Partner customer credit losses are recognized in the allowance for loan loss and non-credit fraud loss is recognized in BaaS noninterest expense. For more information on the accounting for BaaS allowance for loan losses, reserve for unfunded commitments, credit enhancements and fraud recovery see the section titled “CCBX – BaaS Reporting Information.”

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For the year ended December 31, 2021, we earned $17.3 million in BaaS fees, which was an increase of $14.9 million, or 631.8%, over the year ended December 31, 2020, where we earned $2.4 million in BaaS fees. The increase over the year ended December 31, 2020 was primarily due to an increase of $3.9 million increase in total BaaS fee program income, which was the result of increased relationships with broker dealers and digital financial service providers, $9.1 million in BaaS fees – credit enhancements related to the allowance for loan losses and reserve for unfunded commitments, $1.5 million in BaaS fees – fraud recovery, and $411,000 increase in reimbursement of expenses.

The following table presents the BaaS fee income for the periods indicated:

Year Ended

December 31, Increase

(Dollars in thousands) 2021 2020 (Decrease)

Program income:

Reimbursements and guarantees:

Credit enhancement recovery 9,086 - 9,086

At December 31, 2021 there were 19 active CCBX relationships, one CCBX relationship in friends and family trials, five CCBX relationships in onboarding/implementation, three signed letters of intent and a solid pipeline of potential new relationships. At December 31, 2020 there were six active CCBX relationships, two CCBX relationship in friends and family trials, three CCBX relationships in onboarding/implementation and four signed letters of intent. 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 / testing 1 2

Implementation / onboarding 5 3

Signed letters of intent 3 4

Total CCBX relationships 28 15

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, outside of BaaS fee income. Deposit service charges and fees were $3.7 million for the year ended December 31, 2021, an increase of $607,000, or 19.6%, over the prior year primarily due to increases in point-of-sale fees of $457,000, merchant services revenue of $90,000, ATM fees of $30,000, and service charges on deposit accounts of $28,000. These increases were partially offset by a decrease of $18,000 in overdraft fees. NSF and overdraft fees were $316,000 for the year ended December 31, 2021, compared to $334,000 for the year ended December 31, 2020. In December 2021, the Bank reduced NSF and overdraft fees from $35 per item to $15 per item (with a maximum daily fee of $175). We anticipate NSF and overdraft fees will decrease approximately 50% as a result of this change, however, NSF and overdraft fees are not a significant source of revenue for us and therefore this change will not have a material impact on noninterest income.

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The following table presents deposit service charges and fees for the periods indicated:

Year Ended

December 31, Increase Percent

(Dollars in thousands) 2021 2020 (Decrease) Change

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 $2.1 million for the year ended December 31, 2021, an increase of $400,000, or 23.2%, over the year ended December 31, 2020. 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.

Unrealized gain (loss) on equity securities, net. During the year ended December 31, 2021, we recognized a $1.5 million unrealized holding gain on an equity security as a result of an observable price change, compared to a $400,000 unrealized loss for the year ended December 31, 2020, due to a write-down on an equity investment.

Gain on Sale of Branch, net. The sale of our Freeland branch closed on April 30, 2021. Noninterest income included a $1.3 million gain from sale of the branch during the year ended December 31, 2021. There was no similar income in the year ended December 31, 2020.

Mortgage Broker Fees. We earn mortgage broker fees for residential mortgage loans that we broker through mortgage lenders. Mortgage broker fees increased $265,000, or 40.5%, for the year ended December 31, 2021 compared to the year ended December 31, 2020 as a result increased demand from lower mortgage interest rates which continue to make homes more affordable and mortgage refinancing an attractive option.

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 increased $314,000, or 382.9%, for the year ended December 31, 2021 compared to the prior year, to $396,000, due to increased activity. In the year ended December 31, 2020, our primary focus was on SBA PPP loans, therefore fewer SBA and USDA loans were originated and sold to the secondary market.

Other. This category includes a variety of other income-producing activities, annuity broker fees, and SBA and USDA servicing fees. Other noninterest income increased $276,000, or 41.6%, for the year ended December 31, 2021 compared to the year ended December 31, 2020 most significantly because of a $141,000 increase in MSLP servicing fees, and $98,000 increase in credit card income.

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 BaaS expense, occupancy expense, legal and professional fees, data processing expense, and software licenses, maintenance and subscription expense.

For the year ended December 31, 2021, noninterest expense totaled $63.3 million, an increase of $25.1 million, or 66.0%, compared to $38.1 million for the year ended December 31, 2020.

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

Year Ended

December 31, Increase Percent

(Dollars in thousands) 2021 2020 (Decrease) Change

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 $37.1 million for the year ended December 31, 2021, an increase of $13.8 million, or 59.2%, compared to $23.3 million for the year ended December 31, 2020. The increase was primarily due to hiring staff for our CCBX segment and additional staff for our ongoing banking related growth initiatives. Bonus and incentive expense was $2.3 million higher for the year ended December 31, 2021 compared to the prior year due in part to incentives paid to employees that have been involved in the production and support of PPP loans. The increase in expense would have been greater if not for an increase in deferred loan costs recorded as salary offsets, largely from originating PPP loans, which was $296,000 higher and lowered expense by that same amount, for the year ended December 31, 2021, compared to the year ended December 31, 2020. As our CCBX segment grows, we expect to continue to add employees to support this line of business. As of December 31, 2021, we had 377 full-time equivalent employees, compared to 250 at December 31, 2020.

BaaS expense. Our CCBX segment provides BaaS offerings that enable our broker dealer and digital financial service providers to offer their customers banking services. Included in BaaS expense is partner loan expense and partner fraud expense. Partner loan expense represents the amount paid or payable to partners for credit enhancement and servicing CCBX loans. Partner fraud expense represents non-credit fraud losses on partner’s customer loan and deposit accounts. For the year ended December 31, 2021, BaaS expense was $4.5 million, compared to $294,000 for the year ended December 31, 2020 as a result of increased partner activity. For more information on the accounting for BaaS expenses see the section titled “CCBX – BaaS Reporting Information.”

The following table presents, for the periods indicated, the BaaS expenses:

Year Ended

December 31, Increase

(Dollars in thousands) 2021 2020 (Decrease)

Occupancy Expenses. Occupancy expenses were $4.1 million for the year ended December 31, 2021, compared to $4.0 million for the year ended December 31, 2020, an increase of $151,000, or 3.8%. This category includes building, leasehold, furniture, fixtures and equipment depreciation totaling $1.6 million and $1.4 million for years ended December 31, 2021 and 2020, respectively. The increase of $151,000 in occupancy expenses for 2021 compared to 2020, was primarily the result of $232,000 increase in depreciation expense, resulting from increased costs associated with the increase in FTE and growth in CCBX, partially offset by a decrease in rent expense. As we continue to grow, we expect occupancy expenses to increase.

Legal and Professional Fees. Legal and professional costs were $3.1 million for the year ended December 31, 2021 compared to $1.8 million for the year ended December 31, 2020, and increase of $1.4 million, or 77.8%. The increase in legal and

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professional costs is due to the development of contracts for CCBX partners and also fluctuates based on our reporting cycle and timing of legal and professional services.

Data Processing. Data processing costs were $3.0 million for the year ended December 31, 2021, compared to $2.3 million for the year ended December 31, 2020, an increase of $611,000, or 26.0%. 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 data processing expenses are included in this category and are expected to increase incrementally as this segment grows, and infrastructures are put in place.

Software Licenses, Maintenance and Subscriptions. Software licenses, maintenance and subscriptions includes expenses related to obtaining and maintaining software required for various functions throughout the Company. Software licenses, maintenance and subscriptions were $2.8 million for the year ended December 31, 2021, compared to $1.3 million for the year ended December 31, 2020. Software that aids in the reporting of CCBX and helps to automate and create other efficiencies in reporting contributed to the increase. These expenses are expected to increase as we invest more in automated processing and as we grow product lines and our CCBX segment.

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 $1.6 million for the year ended December 31, 2021, compared to $522,000 for the year ended December 31, 2020, an increase of $1.1 million, or 212.6%. Deposit growth in the community bank and CCBX contributed to this increase.

Excise Taxes. Excise taxes were $1.6 million for the year ended December 31, 2021, compared to $1.1 million for the year ended December 31, 2020, an increase of $532,000, or 50.3%. Excise taxes are based on gross income of $111.2 million and $71.2 million for the years ended December 31, 2021 and 2020, 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 Washington State tax rate that is applied to our industry increased 25 basis points effective April 1, 2020, which was assessed and contributed to the increase in excise tax for the full year ended December 31, 2021 and for part of 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 $1.2 million for the year ended December 31, 2021 compared to $800,000 for the year ended December 31, 2020, an increase of $405,000, or 50.6%. In 2021 we saw an increase in employee travel and training return to a more typical level after a year of reduced activity in 2020 as a result of restrictions related to the COVID-19 pandemic. Additionally, director expense increased in 2021 as a result of a change to the compensation structure for directors that was effective in October 2020.

Marketing and promotion. Marketing and promotion costs were $451,000 for the year ended December 31, 2021, compared to $317,000 for the year ended December 31, 2020, an increase of $134,000, or 42.3%. Marketing and promotion costs decreased in 2020 due to a conscious effort to reduce general advertising costs during the COVID-19 pandemic, with marketing and promotion costs starting to return to a more typical level in 2021 compared to 2020. 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 community bank and CCBX .

Other. This category includes 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 $3.8 million for the year ended December 31, 2021, compared to $2.4 million for the year ended December 31, 2020, an increase of $1.3 million, or 55.2%. The increase was largely due to a $445,000 increase in the unfunded commitment provision, $200,000 increase in donations, largely made to community-based organizations, $152,000 increase in office equipment, $118,000 in increased operational losses, $90,000 increase in service charges from banks, $89,000 increase in telephone costs, and overall increases resulting from growth for the year ended December 31, 2021, as compared to the same period last year.

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. The Company is subject to various state taxes that are assessed as CCBX

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activities expand into other states, which has increased the overall tax rate used in calculating the provision for income taxes in the current and future periods.

Year Ended December 31, 2021, Compared to Year Ended December 31, 2020. For the year ended December 31, 2021, income tax expense totaled $7.4 million, compared to $4.0 million for the year ended December 31, 2020. Our effective tax rates for the years ended December 31, 2021, and 2020, was 21.4% and 20.9%, respectively.

Segment Information

For financial reporting purposes our Company has two reportable segments: The community bank and CCBX, which has been determined based upon the Company's relationship with the end customer. This determination also gave consideration to the structure and management of our various products. The community bank segment includes the operations of Coastal Community Bank, excluding CCBX BaaS operations. The community bank segment derives its revenue primarily from interest on loans and investments as well as noninterest income typical for the banking industry. The CCBX segment includes BaaS operations. The CCBX segment derives its revenue from BaaS partnerships that allow our broker-dealer and digital financial partners to offer their customers banking services.

Reported segments and the financial information of the reported segments are not necessarily comparable with similar information reported by other financial institutions. Additionally, because of the interrelationships of the various segments, the information presented is not indicative of how the segments would perform if they operated as independent entities. Changes in management structure or allocation methodologies and procedures may result in future changes to previously reported segment financial data. The accounting policies of the segments are the same as those described in “Note 1 – Description of Business and Summary of Significant Accounting Policies” in the accompanying notes to the consolidated financial statements included elsewhere in this report.

Community bank total assets as of December 31, 2021 increased $582.4 million, or 34.3%, to $2.28 billion, compared to $1.70 billion as of December 31, 2020. Total community bank loans receivable decreased $85.4 million, or 5.8%, to $1.40 billion as of December 31, 2021, compared to $1.48 billion as of December 31, 2020. The decrease in loans receivable is the result of $254.0 million in PPP loan forgiveness and paydowns during the year ended December 31, 2021. Non-PPP community bank loan growth was $168.2 million, or 15.0%, as a result of increased loan activity. Total community bank deposits increased $294.9 million, or 21.8%, to $1.65 billion, as of December 31, 2021, compared to $1.35 billion as of December 31, 2020. The increase in deposits is largely due to initiatives to expand and grow banking relationships with new customers, including new customers that obtained PPP loans through the bank. The overall increase in deposits was achieved despite a decrease of $25.6 million in total deposits due to the sale of our Freeland branch, which were included in the total deposits as of December 31, 2020.

Net interest income for the community bank was $73.0 million for the year ended December 31, 2021, an increase of $16.2 million, or 28.5%, compared to $56.8 million for the year ended December 31, 2020. The increase in net interest income is largely due to net deferred fee income recognized on forgiven or repaid PPP loans as well as increased yield on loans resulting from non-PPP loan growth and a decrease in lower yielding PPP loans. Provision for loan losses was $1.3 million for the year ended December 31, 2021, compared to $8.2 million for the year ended December 31, 2020. The provision for loan losses was increased in 2020 as a result of economic uncertainties of the COVID-19 pandemic and loan growth, however losses have not realized as anticipated. Noninterest income for the community bank was $10.7 million, for the year ended December 31, 2021, an increase of $4.9 million, or 84.2%, compared to $5.8 million for the year ended December 31, 2020, due to an unrealized holding gain on an equity investment, gain on sale of a branch, increased deposit service charges and higher loan referral fees. Noninterest expenses for the community bank increased $17.0 million, or 49.1%, to $51.5 million as of December 31, 2021, compared to $34.6 million as of December 31, 2020. The increase in noninterest expense is largely due to increased salaries and employee benefits as a result of growth, higher software licenses maintenance and subscription costs related to new reporting software that helps to automate and create efficiencies in reporting, and other expense increases related to growth.

CCBX total assets as of December 31, 2021 increased $287.0 million, or 434.8%, to $353.0 million, compared to $66.0 million as of December 31, 2020. Total CCBX loans receivable increased $281.0 million, or 428.0%, to $346.7 million as of December 31, 2021, compared to $65.7 million as of December 31, 2020. The increase in loans receivable is the result of adding new CCBX relationships. CCBX allowance for loan losses increased to $8.3 million as of December 31, 2021, compared to $66,000 as of December 31, 2020 as a result of loan growth and portfolio mix. Total CCBX deposits increased $647.6 million, or 942.8%, to $716.3 million, compared to $68.7 million as of December 31, 2020 as a result of adding new CCBX relationships. CCBX partners have grown 86.7% to 28 total CCBX relationships as of December 31, 2021, compared to 15 total relationships as of December 31, 2020.

Net interest income for CCBX was $6.4 million for the year ended December 31, 2021, an increase of $5.9 million, or 1,063.3%, compared to $553,000 for the year ended December 31, 2020. The increase in net interest income is due to loan growth

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from new CCBX relationships. Provision for loan losses was $8.6 million for the year ended December 31, 2021, compared to $66,000 for the year ended December 31, 2020, as a result of loan growth from adding new partners. Noninterest income for CCBX was $17.4 million, for the year ended December 31, 2021, an increase of $15.0 million, or 635.9%, compared to $2.4 million for the year ended December 31, 2020, due to an increase of $14.9 million in BaaS fees, $3.9 million increase in total BaaS fee program income, which was the result of increased relationships with broker dealers and digital financial service providers, $9.1 million in BaaS fees – credit enhancements related to the allowance for loan losses and reserve for unfunded commitments, and $1.5 million in BaaS fees – fraud recovery Noninterest expenses for CCBX increased $8.1 million, or 229.5%, to $11.7 million as of December 31, 2021, compared to $3.6 million as of December 31, 2020. The increase in noninterest expense is largely due to an increase in BaaS loan expense, BaaS fraud expense and increased salaries and benefits, for the year ended December 31, 2021, compared to the year ended December 31, 2020. For more information on the accounting for BaaS income and expenses see the section titled “CCBX – BaaS Reporting Information.”.

The following tables present summary financial information for each segment for the periods indicated:

Community Bank CCBX Total Community Bank CCBX Total

(dollars in thousands)

Year Ended

Community Bank CCBX Total Community Bank CCBX Total

(dollars in thousands)

Financial Condition

Our total assets increased $869.4 million to $2.64 billion, or 49.2% at December 31, 2021, compared to $1.77 billion at December 31, 2020. This increase was largely the result of a $195.6 million increase in loans receivable, combined with an increase of $654.5 million in interest earning deposits with other banks. As of December 31, 2021, $111.8 million in PPP loans remain on the balance sheet.

Loan Portfolio

We accepted and processed requests for PPP loans from the beginning of the program in March 2020 for the duration of round one and two of the PPP, and throughout round three, which closed for applications on May 31, 2021. As a preferred SBA lender, we worked diligently with the SBA to offer assistance to small businesses as provided in the CARES Act, as amended by subsequent legislation, which significantly impacted our loan totals. These SBA loans are discussed further in this section under “Commercial and Industrial Loans”.

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, 2021, loans receivable totaled $1.74 billion, an increase of $195.6 million, or 12.6%, compared to $1.55 billion as of December 31, 2020. Total loans receivable is net of $8.8 million in net deferred origination fees, $3.6 million of which is attributed to PPP loans. The increase includes CCBX loan growth of $281.0 million, or 428.2%, non-PPP community bank loan growth of $168.2 million, or 15.0%, partially offset by a reduction of $254.0 million, or 69.4%, in PPP loans due to forgiveness and

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principal paydowns. Additionally, unused loan commitments increased, with unused commitments on capital call lines increasing $287.7 million to $416.0 million at December 31, 2021 compared to $128.2 million at December 31, 2020, which will likely translate to loan growth as the commitments are utilized in future periods.

Loans as a percentage of deposits were 73.7% as of December 31, 2021 and 108.9% as of December 31, 2020. We are focused on serving our communities and markets by growing loans locally and funding those loans with customer deposits. The decrease in the loan to deposit ratio for 2021 compared to 2020 was largely due to the increase in interest earning deposits with other banks, primarily due to the increase in CCBX deposits.

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

As of December 31,

(Dollars in thousands) Amount Percent Amount Percent

Commercial and industrial loans:

Real estate loans:

Net deferred origination fees - PPP loans (3,633 ) (5,803 )

Net deferred origination fees - Other loans (5,133 ) (3,392 )

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Commercial and Industrial Loans. Commercial and industrial loans, decreased $120.1 million, or 22.3%, to $419.1 million as of December 31, 2021, from $539.2 million as of December 31, 2020. The decrease in commercial and industrial loans receivable over the year ended December 31, 2020 was due to $254.0 million in forgiveness and repaid PPP loans, partially offset by an increase of $137.3 million increase in capital call lines. Included in the commercial and industrial loan balance is $202.9 million and $65.6 million in capital call lines resulting from relationships with our CCBX customers as of December 31, 2021, and December 31, 2020, respectively. Also included in commercial and industrial loans is $111.8 million and $365.8 million in PPP loans as of December 31, 2021, and December 31, 2020, respectively.

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.

The purpose of the PPP was to provide forgivable loans to smaller businesses, sole proprietorships, independent contractors, and self-employed individuals that use the proceeds of the loans for payroll and certain other qualifying expenses. The Small Business Administration (“SBA”) manages 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. We accepted and processed applications for the duration of the initial PPP loan program, which closed for new applicants on August 8, 2020. The Consolidated Appropriations Act, 2021, enacted on December 27, 2020, appropriated additional funding to the PPP and permitted certain PPP borrowers to make “second draw” loans. The American Rescue Plan Act of 2021, enacted on March 11, 2021, expanded the eligibility criteria for both first and second draw PPP loans and revised the exclusions from payroll costs for purposes of loan forgiveness. The PPP Extension Act of 2021, enacted on March 25, 2021, extended the PPP through May 31, 2021, at which time the program closed for new applications.

In total, we funded $763.9 million in PPP loans, since the first round of PPP loans opened in March 2020 through the close of round three on May 31, 2021. Total net deferred fees on these loans were $26.3 million. As of December 31, 2021, $111.8 million in PPP loans remained with $3.6 million in net deferred fees, which will be recognized in interest income in future periods. Legislation extended the initial payment deferral period on PPP loans originated in 2020, and PPP borrowers with two-year loans can work with their lender to extend their loan to a five-year maturity, which we anticipate could be a popular approach for customers with PPP loans that are not eligible for forgiveness. There are $4.3 million of these loans remaining as of December 31, 2021. PPP loans originated in 2021 are five-year loans, and $107.5 million remains of these loans as of December 31, 2021. 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 (generally between eight and 24 weeks).

We continue to accept applications from customers for loan forgiveness. To obtain loan forgiveness, a PPP borrower must submit a forgiveness application. We expect PPP forgiveness payments to continue through the second quarter of 2022.

Construction, Land and Land Development Loans. Construction, land and land development loans increased $89.2 million, or 94.4%, to $183.6 million as of December 31, 2021, from $107.8 million as of December 31, 2020, primarily due to growth.

Unfunded loan commitments for construction, land and land development loans were $134.3 million at December 31, 2021, which is an increase of $45.9 million, or 52.0%, compared to $88.4 million in unfunded commitments at December 31, 2020. 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.

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, 2021, construction, land and land development loans included $28.9 million in residential construction loans, $82.8 million in commercial construction loans and $71.9 million in other construction, land and land development loans, compared to $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 as of December 31, 2020.

Residential Real Estate Loans. Our one-to-four family residential real estate loans increased $60.5 million, or 42.1%, to $204.4 million as of December 31, 2021, from $143.9 million as of December 31, 2020.

We originate one-to-four family residential real estate 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

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mortgage loan. As of December 31, 2021, the balance of our ARM portfolio loans was $22.2 million, compared to $20.5 million at December 31, 2020. 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, 2021, we held $11.9 million in purchased residential real estate mortgage loans, compared to $16.8 million at December 31, 2020. 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, 2021, residential real estate loans made to investors and business owners totaled $114.0 million. As of December 31, 2020, residential real estate loans made to investors and business owners totaled $84.3 million.

As of December 31, 2021 there were $36.9 million in CCBX home equity loans included in residential real estate, compared to $0 at December 31, 2020, as a result of adding new partners.

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 $60.7 million, or 7.8%, to $835.6 million as of December 31, 2021, from $774.9 million as of December 31, 2020.

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 ratesand adjust with the term-equivalent FHLB rate. At December 31, 2021, approximately 28.0% of the commercial real estate loan portfolio consisted of fixed rate loans. Commercial real estate loans represented 47.7% of our loan portfolio at December 31, 2021 and are historically our largest source of revenue. At December 31, 2020, approximately 41.4% of the commercial real estate loan portfolio consisted of fixed rate loans. 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 increased $105.0 million, or 2,680.2%, to $108.9 million, from $3.9 million as of December 31, 2020, primarily as a result of CCBX loans from adding new partners. Our consumer and other loans are comprised of personal lines of credit, automobile, boat, and recreational vehicle loans, and secured term loans.

Included in consumer and other loans is $106.8 million in CCBX loans as of December 31, 2021, compared to $67,000 as of December 31, 2020. CCBX consumer loans are primarily comprised of credit cards and secured and unsecured consumer loans.

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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 after Five

Due in One Year Through Years Through Due After Gross

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

Commercial and industrial loans:

Real estate loans:

The following table sets forth all loans at December 31, 2021, that are due after December 31, 2022, 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. Three of our largest categories of our loans, excluding PPP loans, are commercial real estate, commercial and industrial, and construction, land and land development loans. Together, as of December 31, 2021, they represent $1.33 billion in outstanding loan balances, or 80.9% of total gross loans outstanding, excluding PPP loans of $111.8 million. When combined with the full loan portfolio’s $909.6 million in unused commitments the total of these three categories is $1.97 billion, or 77.3% of total outstanding loans and loan commitments.

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Commercial real estate loansrepresent the largest segment of our loans, comprising 51.0% of our total balance of outstanding loans, excluding PPP loans, as of December 31, 2021. Unused commitments to extend credit represents an additional $23.2 million, the combined total exposure in commercial real estate loans represents $858.8 million, or 33.8% 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, 2021:

Commercial and industrial loans comprise 18.7% of our total balance of outstanding loans, excluding PPP loans, as of December 31, 2021. Unused commitments to extend credit represents an additional $486.8 million, the combined total exposure in commercial and industrial loans represents $794.1 million, or 31.2% 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, 2021:

Construction, land and land development comprise 11.2% of our total balance of outstanding loans, excluding PPP loans, as of December 31, 2021. Unused commitments to extend credit represents an additional $134.3 million, the combined total exposure in construction, land and land development loans represents $317.9 million, or 12.5% of our total outstanding loans and loan commitments, excluding PPP loans.

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The following table details our exposure for our construction, land and land development portfolio as of December 31, 2021:

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. CCBX partner loans are placed on nonaccrual status in accordance with the partner’s practice and policy for treatment of nonaccrual loans, and may remain on accrual status beyond such time it becomes 90 days past due. 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 $1.7 million in nonperforming assets, and no troubled debt restructurings (“TDRs”), as of December 31, 2021, compared to $712,000 as of December 31, 2020. All of our nonperforming assets were nonperforming loans as of December 31, 2021 and 2020. Our nonperforming loans to loans receivable ratio was 0.10% at December 31, 2021, compared to 0.05% at December 31, 2020. The increase in nonperforming assets was the result of $1.5 million in CCBX partner accruing loans past due 90 days or more, partially offset by a decrease of $491,000 in nonaccrual community bank loans.

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, 2021. The long-term economic impact of the COVID-19 pandemic, political gridlock, and trade issues remains unknown; however, the Company remains diligent in its efforts to communicate and proactively work with borrowers to help mitigate potential credit deterioration.

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

As of As of

December 31, December 31,

Nonaccrual loans:

Commercial and industrial loans $ 166 $ 537

Real estate loans:

Residential real estate loans 55 175

Loans on accrual status and past due 90 days or more:

Total loans on accrual status and past due 90 days or more 1,506 -

Total nonperforming assets $ 1,727 $ 712

Total nonaccrual loans to loans receivable 0.01 % 0.05 %

Total nonperforming loans to loans receivable 0.10 % 0.05 %

Total nonperforming assets to total assets 0.07 % 0.04 %

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).

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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 183,594 - - - 183,594

Less net deferred origination fees (8,766 )

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 )

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:

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As of December 31, 2021, the allowance for loan losses totaled $28.6 million, or 1.64% of total loans. As of December 31, 2020, the allowance for loan losses totaled $19.3 million, or 1.25% of total loans. The increase in the Company’s provision for loan losses for the year ended December 31, 2021 compared to the year ended December 31, 2020, is largely related to the provision for CCBX partner loans. During the year ended December 31, 2021, a $8.6 million provision for loan losses was recorded for CCBX partner loans based on management’s analysis. The factors used in management’s analysis for community bank loan losses indicated that a provision for loan losses of $1.2 million was needed for the year ended December 31, 2021. The expected COVID-19 pandemic related loan losses have not materialized as originally anticipated in 2020, as evidenced by the low level of charge-offs and nonperforming loans. The economic environment is continuously changing and has shown some signs of improvement in 2021, with ongoing vaccination of its population and increased re-opening of economic activities, tempered by increased inflation, and a rise in new COVID-19 variants that have resulted in some economic uncertainty. CCBX loans have a higher level of expected losses than our community bank loans, which is reflected in the factors for the allowance for loan losses. Many agreements with our CCBX partners provide for a credit enhancement which protects the Bank by absorbing incurred losses. In accordance with accounting guidance, we estimate and record a provision for probable losses for these CCBX loans. When the provision for loan losses and provision for unfunded commitments is recorded, a recovery receivable is also recorded on the balance sheet through noninterest income (BaaS fees -credit enhancement). Incurred losses are recorded in the allowance for loan losses, and as the credit enhancement recoveries are received from the CCBX partner, the recovery receivable is relieved. Although many agreements with our CCBX partners provide for credit enhancements that provide protection to the Bank from credit and fraud losses by absorbing incurred credit and fraud losses, if our partner is unable to fulfill their contracted obligations then the bank would be exposed to additional loan losses, as a result of this counterparty risk. The Company is not required to implement the provisions of the CECL accounting standard until January 1, 2023 and continues to account for the allowance for credit losses under the incurred loss model.

The following table presents the loans receivable and allowance for loan losses by segment for the period indicated:

As of

(Dollars in thousands) Community Bank CCBX Total

Allowance for loan losses to total loans receivable 1.45 % 2.40 % 1.64 %

Included in total loans is $111.8 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 1.75% and 1.62% at December 31, 2021 and 2020, respectively. A reconciliation of this non-GAAP measure is set forth in the section titled “GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures.”

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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:

Commercial and industrial loans 222 141

Real estate loans:

Construction, land and land development loans - 369

Residential real estate loans 79 -

Consumer and other loans 339 15

Recoveries:

Commercial and industrial loans 67 5

Consumer and other loans 28 4

Total recoveries 95 9

Allowance for loan losses to nonperforming loans 1657.90 % 2705.34 %

Allowance for loan losses to nonaccrual loans 12955.66 % 2705.34 %

Allowance for loan losses to total loans receivable 1.64 % 1.25 %

Net charge-offs to average loans 0.03 % 0.04 %

The allowance for loan losses to nonaccrual loans ratio increased substantially at December 31, 2021, compared to December 31, 2020 as a result of a decrease of $491,000 in nonaccrual community bank loans, combined with an increase of $9.4 million in the allowance for loan losses. The increase in the allowance for loan losses for the year ended December 31, 2021 compared to the year ended December 31, 2020, is largely related to the increase in the allowance for CCBX partner loans. At December 31, 2021, there was a balance of $8.3 million in the allowance for loan losses for CCBX partner loans, compared to $66,000 at December 31, 2020.

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. The expected loan losses have not materialized as originally anticipated in 2020, as evidenced by the low level of charge-offs and nonperforming loans, however 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.

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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:

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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, 2021, $35.0 million, or 95.4%, 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, 2021, our loan-to-deposit ratio was 73.7%, which is lower compared to 108.9% as of December 31, 2020 as a result of the increased balance in interest earning deposits with other banks, primarily as a result of growth in CCBX deposits. 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, 2021, the carrying value of our investment securities totaled $36.6 million, an increase of $13.4 million, or 57.5%, compared to $23.2 million as of December 31, 2020. The increase in the securities portfolio was due to the purchase of $117.5 million in Treasury securities during the year ended December 31, 2021, which was needed to replace maturing securities and pledged to secure public deposits and for other purposes as required or permitted by law, partially offset by maturities and principal paydowns. Investment securities represented 1.4%, and 1.3%, of total assets as of December 31, 2021 and 2020, 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 certain of our investment securities as of the dates shown:

As of December 31,

Amortized Fair Amortized Fair

(Dollars in thousands) Cost Value Cost Value

Securities available-for-sale:

U.S. Government securities - - - -

U.S. Agency collateralized mortgage obligations 68 70 96 100

U.S. Agency residential mortgage-backed securities 3 3 10 10

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, 2021, 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, 2021 and 2020, 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 $6.0 million as of December 31, 2021 and $5.2 million as of December 31, 2020 The increase was attributable to net additions of Federal Reserve, FHLB 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.

The Company held a $750,000 equity interest during as of December 31, 2020, which consists of 1.6 million shares of common stock and 873,853 preferred shares. During the year ended December 31, 2021, the Company recognized a $1.5 million

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unrealized holding gain due to an observable price change in the equity. 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. This method 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.

As of December 31, 2021, 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.

During the year ended December 31, 2021, the Company entered agreements for a capital commitment of up to $1.3 million in investment funds designed to help accelerate technology adoption at banks. During the year the Company contributed $163,000 in with recognized losses of $3,000 during the year resulting in an equity interest of $160,000 for the year ended December 31, 2021.

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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:

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Deposits

We offer a variety of deposit products that have a wide range of interest rates and terms, including demand, money market, savings, BaaS-brokered deposits and time accounts as well as reciprocal deposits. Reciprocal deposits enable us to provide an FDIC insured deposit option to customers that have balances in excess of the FDIC insurance limit. This service trades our customers’ funds as certificates of deposit or interest bearing demand deposits in increments under the FDIC insured amount to other participating financial institutions and in exchange we receive time deposit or interest bearing demand 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 new deposits and retain existing deposits. Additionally, we offer deposit products through our CCBX segment. Although the CCBX products are similar to the community bank offerings, the CCBX deposit products allow us to offer a broader range of partner specific products, which are often designed to reach specific under-served or under-banked populations served by our CCBX partners.

Total deposits as of December 31, 2021, were $2.36 billion, an increase of $942.5 million, or 66.3%, compared to $1.42 billion as of December 31, 2020. The overall increase in total deposits was achieved despite a decrease of $25.4 million in deposits compared to December 31, 2020, due to the sale of our Freeland branch. The increase in deposits was largely in core deposits, which increased $921.4 million to $2.25 billion from $1.33 billion at December 31, 2020. The $921.4 million increase in core deposits is also largely from growth in the CCBX segment, which accounted for $610.3 million of the increase, combined with the initiatives to expand and grow banking relationships with new customers, which accounted for $311.1 million of the increase. We define core deposits as all deposits except time deposits and brokered deposits. Additionally, as of December 31, 2021 we have access to $252.4 million in CCBX customer deposits that are currently being transferred from the Bank’s balance sheet to other financial institutions on a daily basis. Depending on the circumstances of how the Bank retains these deposits and its relationship with the customer, these retained deposits could be classified as 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.

Included in total deposits is $716.3 million in CCBX deposits, an increase of $647.6 million, or 942.8%, compared to $68.7 million as of December 31, 2020. CCBX customer deposit relationships include deposits with CCBX end customers, operating and non-operating deposit accounts. The deposits from our CCBX segment are predominately classified as noninterest bearing, or NOW and money market accounts, but a portion of such CCBX deposits may be classified as brokered deposits as a result of the relevant relationship agreement. Currently, the majority of CCBX deposits are noninterest bearing, however, as the Federal Reserve Open Market Committee raises interest rates, a majority of these accounts will bear interest and be reclassified to interest bearing deposits once rates exceed the minimum interest rate set in the program agreement and begin to earn interest.

Total noninterest bearing deposits as of December 31, 2021 were $1.36 billion, an increase of $763.6 million, or 128.9%, compared to $592.3 million as of December 31, 2020. The $763.6 million increase is primarily the result of growth in the CCBX segment, which accounted for $606.5 million of the increase, and expanding and growing banking relationships with new customers, which accounted for $157.1 million of the increase, including deposit relationships from PPP loans made to noncustomers, who moved their banking relationship to the Bank. Noninterest bearing deposits represent 57.4% and 41.7% of total deposits for December 31, 2021 and December 31, 2020, respectively.

Total interest bearing account balances, excluding time deposits, as of December 31, 2021 were $964.4 million, an increase of $195.0 million, or 25.3%, from $769.4 million as of December 31, 2020. Included in interest bearing account balances is $70.8 million in BaaS-brokered deposits, an increase of $37.3 million from December 31, 2020. Also included in interest bearing deposits is $3.8 million in reciprocal deposits.

Total time deposit balances as of December 31, 2021 were $43.5 million, a decrease of $16.2 million, or 27.1%, from $59.6 million as of December 31, 2020. The decrease is due to the strong increase in core deposits, and our focus on core deposits and letting higher rate deposits run off 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

(Dollars in thousands) Amount Total Deposits Amount Total Deposits

The following table presents the CCBX deposits which are include in the total deposit portfolio table above:

As of

(Dollars in thousands, unaudited) Balance % to Total Balance % to Total

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, 2021 As of December 31, 2020

Maturity Period:

Over three through six months 6,520 7,799

Average deposits for the year ended December 31, 2021, were $1.90 billion, an increase of $662.2 million, or 53.5%, compared $1.24 billion for the year ended December 31, 2020. The increase in average deposits was primarily due to an increase in core deposits, both in noninterest bearing deposits and in low interest 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. Also included in this increase is growth in CCBX deposits. We expect deposits to grow with continued 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 branch managers, treasury service personnel and lenders.

The average rate paid on total interest-bearing deposits was 0.12% for the year ended December 31, 2021, compared to 0.35% for the year ended December 31, 2020. The average rate paid on total interest-bearing deposits was 0.26% for the year ended December 31, 2021, compared to 0.59% for the year ended December 31, 2020. The average rate paid on BaaS-brokered deposits decreased 0.18% for the year ended December 31, 2021, compared to December 31, 2020, and NOW and money market accounts decreased 33 basis points, for the year ended December 31, 2021. The decrease in average rate paid on deposit accounts for the year ended December 31, 2021, 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 until market conditions change. The market is expecting at least one if not two 25 basis point rate changes from the Federal Open Market Committee (FOMC) in March of

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2022. A rate change in March would likely reverse our downward trend on deposits costs and result in increased deposit costs. 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, 2021 and 2020, was 52.1% and 41.5%, 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 0.36% and 0.64% for the years ended December 31, 2021 and 2020, respectively. The decreasein our cost of deposits in 2021 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. The Federal Reserve has indicated that it is considering increasing rates in 2022.

Uninsured Deposits

The FDIC insures our deposits up to $250,000 per depositor, per insured bank for each account ownership category. Deposits that exceed insurance limits are uninsured. At December 31, 2021, deposits totaled $2.36 billion, of which total estimated uninsured deposits were $823.5 million. At December 31, 2020, deposits totaled $1.42 billion, of which total estimated uninsured deposits were $618.4 million.

The table below shows the estimated uninsured time deposits, by account, for the maturity periods indicated:

(Dollars in thousands) As of December 31, 2021

Maturity Period:

Three months or less $ 1,463

Over three through six months 558

Over six through twelve months 539

Over twelve months 1,841

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, 2021, and December

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31, 2020, total borrowing capacity of $21.9 million and $21.3million, respectively, was available under this arrangement. As of December 31, 2021, and December 31, 2020, 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 supplied liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. The PPP provided loans to small businesses so that they 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 extended credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. The interest rate was 0.35% and as PPP loans were paid down, the borrowing line also had to be paid down. The borrowing was paid in full in June 2021 and as of December 31, 2021, no PPPLF advances were outstanding, compared to $153.7 million as of December 31, 2020. PPPLF advances were a new borrowing arrangement beginning in 2020 that had favorable capital treatment and was specific to the PPP loan program. The last day to take new advances on the PPPLF was July 31, 2021.

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, 2021 and 2020, total borrowing capacity of $101.3 million and $90.7 million, respectively, was available under this arrangement. As of December 31, 2021, we borrowed a total of $25.0 million in FHLB medium term advances. This includes a $10.0 million advance that matures in March 2023 and a $15.0 million advance that matures in March 2025. FHLB advances totaled $25.0 million as of December 31, 2021. Although there are no immediate plans to borrow additional funds, additional borrowing capacity of $76.3 million was available under this arrangement as of December 31, 2021.

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:

FHLB Advances $ - $ 67

Weighted average interest rate during period:

Balance outstanding at end of period:

FHLB Advances $ - $ -

Weighted average interest rate at end of period:

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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:

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:

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, 2021 and 2020, was 2.30% and 2.32%, 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 August 2021, the Company issued a subordinated note in the amount of $25.0 million. The note matures on September 1, 2031, and bears interest at the rate of 3.375% per year for five years and, thereafter, reprices quarterly beginning September 1, 2026, at a rate equal to the three-month SOFR plus 2.76%. The five-year 3.375% interest period ends on September 1, 2026. We may redeem the subordinated note, in whole or in part, without premium or penalty, in principal redemption multiples of $1,000, after August 18, 2026, subject to any required regulatory approvals. Proceeds were used to repay $10.0 million in existing 5.65% interest subordinated debt on August 9, 2021 and $11.5 million was contributed to the Bank as capital during the year ended December 31, 2021.

Equity Offering

During the quarter ended December 31, 2021, the Company completed a public offering of 851,853 shares of its common stock at a price to the public of $40.50 per share. Gross proceeds from the offering of $34.5 million, before deducting underwriting discounts and offering expenses, will be used for general corporate purposes, including, without limitation, to support investment opportunities and the Bank’s growth. A total of $15.0 million of those proceeds was contributed to the Bank, and the balance of the amount was retained in cash at the Company level.

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. Relationships with CCBX partners could impact liquidity risk. The loss of partners could put pressure on liquidity, requiring the Company to pay higher funding rates, which would also impact net income. 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.

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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. 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.

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. During the quarter ended September 30, 2021, the Company entered into a subordinated note purchase agreement pursuant to which we issued and sold $25.0 million in subordinated notes. The proceeds were used to repay existing higher rate debt, with the balance of the net proceeds retained for general corporate purposes. During the quarter ended December 31, 2021, the Company completed a public offering of 851,853 shares of its common stock at a price to the public of $40.50 per share. Gross proceeds from the offering of $34.5 million, before deducting underwriting discounts and offering expenses, will be used for general corporate purposes, including, without limitation, to support investment opportunities and the Bank’s growth. A total of $15.0 million of those proceeds were contributed to the Bank in 2021, and the balance of the amount was retained in cash at the Company level. Additionally, as of December 31, 2021 we have access to $252.4 million in CCBX customer deposits that are currently being transferred off the Bank’s balance sheet to other financial institutions on a daily basis. Depending on the circumstances of how the Bank retains these deposits and its relationship with the customer, these retained deposits could be classified as brokered deposits. 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 $26.5 million of capital during the year ended December 31, 2021, bringing the Company’s cash holding to $24.3 million at December 31, 2021. The Company uses approximately $1.3 million for debt servicing and operating purposes each year, leaving about $19.9 million for other purposes after deducting $2.6 million to cover operating purposes for the next two years, and $1.8 million for possible future investments. 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. See “Item 1. Business—Regulation and Supervision—Bank Holding Company Regulation—Dividends” for additional discussion about these limitations. 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

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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. Currently, the Company operates under the Federal Reserve’sSmall Bank Holding Company Policy Statement,” which creates an exception to the application of consolidated capital requirements for certain bank holding companies with less than $3 billion of consolidated assets. 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, 2021, and 2020, 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.

Under the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (“U.S. 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 U.S. Basel III rules, as of December 31, 2021.

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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 1 risk-based capital ratio (to risk-weighted assets)

Tier 1 Capital (to risk-weighted assets)

Total Capital (to risk-weighted assets)

Leverage Capital (to average assets)

Common Equity Tier 1 risk-based capital ratio (to risk-weighted assets)

Tier 1 Capital (to risk-weighted assets)

Total Capital (to risk-weighted assets)

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Material Cash Requirements and Capital Resources

The following table provides the material cash requirements from known contractual and other obligations as of December 31, 2021:

Less than Over

(Dollars in thousands) Total 1 Year 1 year Other (1)

Cash requirements

Junior subordinated debentures 3,609 - 3,609 -

Unfunded commitments - loans and letters of credit 912,602 912,602 - -

Equity investment commitment 1,090 1,090 - -

We maintain sufficient cash and cash equivalents and investment securities to meet short-term cash requirements and the levels of these assets are dependent on our operating, investing and financing activities during any given period. 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.

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, 2021, we held $202.9 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.

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As of December 31, 2021, we had $909.6 million in commitments to extend credit, compared to $318.0 million as of December 31, 2020. The $591.6 million increase is largely attributed to growth in our CCBX segment, due to the addition of new partners, resulting in an increase of $521.5 million in commitments to extend credit on CCBX loans. The following table presents commitments associated with outstanding commitments to extend credit, standby and commercial letters of creditand equity investment commitments as of the periods indicated:

As of December 31,

Commitments to extend credit:

Commercial and industrial loans - capital call lines $ 415,956 $ 128,208

Commercial and industrial loans - other 70,848 61,676

Construction – commercial real estate loans 90,946 69,866

Construction – residential real estate loans 43,339 18,489

Standby letters of credit $ 3,040 $ 2,754

Equity investment commitment $ 1,090 $ -

Commitments to extend credit on CCBX loans are included in the table above and are summarized below:

As of December 31,

(dollars in thousands)

Commitments to extend credit:

Construction - commercial real estate loans - -

Construction - residential real estate loans - -

Commercial real estate loans - -

Residential real estate loans 71,453 -

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.

We believe that we will be able to meet our long-term cash requirements 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.

CCBX – BaaS Reporting Information

Beginning with and during the year ended December 31, 2021, $9.1 million was recorded in BaaS fees - credit enhancements related to the provision for loan losses and reserve for unfunded commitments for CCBX partner loans. Agreements with our CCBX partners provide for a credit enhancement which protects the Bank by absorbing incurred losses. In accordance with accounting

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guidance, we estimate and record a provision for probable losses for these CCBX loans. When the provision for loan losses and provision for unfunded commitments is recorded, a recovery receivable is also recorded on the balance sheet through noninterest income (BaaS fees -credit enhancement). Incurred losses are recorded in the allowance for loan losses, and as the credit enhancement recoveries are received from the CCBX partner, the recovery receivable is relieved. Agreements with our CCBX partners also provide protection to the Bank from fraud by absorbing incurred fraud losses. Fraud losses are recorded when incurred as losses in noninterest expense, and the recovery received from the CCBX partner is recorded in noninterest income, resulting in a net impact of zero to the income statement.Although many agreements with our CCBX partners provide for credit enhancements that provide protection to the Bank from credit and fraud losses by absorbing incurred credit and fraud losses, if our partner is unable to fulfill their contracted obligations then the bank would be exposed to additional loan losses, as a result of this counterparty risk.

For CCBX partner loans the Bank records contractual interest earned from the borrower on loans in interest income, adjusted for origination costs which are paid or payable to the CCBX partner. BaaS loan expense represents the amount paid or payable to partners for credit enhancement and servicing CCBX loans. To determine net revenue (Net BaaS loan income) earned from CCBX loan relationships, one takes BaaS loan interest income and deducts BaaS loan expense to arrive at Net BaaS loan income which can be compared to interest income on the Company’s community bank loans.

The following table illustrates how CCBX partner loan income and expenses are recorded in the financial statements:

Loan income and related loan expense Year Ended

December 31, Increase

(Dollars in thousands) 2021 2020 (Decrease)

The addition of new CCBX partners resulted in increases in direct fees, expenses and interest for the year ended December 31, 2021 compared to December 31, 2020. The following tables are a summary of the direct fees, expenses and interest components of BaaS for the periods indicated and are not inclusive of all income and expense related to BaaS.

Interest income Year Ended

December 31, Increase

(Dollars in thousands) 2021 2020 (Decrease)

Interest expense Year Ended

December 31, Increase

(Dollars in thousands) 2021 2020 (Decrease)

BaaS interest expense $ 99 $ 178 $ (79 )

Total BaaS interest expense $ 99 $ 178 $ (79 )

Noninterest income Year Ended

December 31, Increase

(Dollars in thousands) 2021 2020 (Decrease)

Program income:

Reimbursements and guarantees:

Credit enhancement recovery 9,086 - 9,086

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Noninterest expense Year Ended

December 31, Increase

(Dollars in thousands) 2021 2020 (Decrease)

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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.

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.

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

Year Ended

(Dollars in thousands, unaudited) December 31, 2021 December 31, 2020

Adjusted allowance for loan losses to loans receivable:

Less: net deferred fees on PPP loans 3,633 5,803

Allowance for loan losses to loans receivable 1.64 % 1.25 %

Adjusted allowance for loan losses to loans receivable 1.75 % 1.62 %

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

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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

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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.

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 follows.

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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, 2021 and 2020, 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, 2021 and 2020, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting in accordance with the standards of the PCAOB. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting in accordance with the standards of the PCAOB. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Moss Adams LLP

Everett, WA

March 11, 2022

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

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

ASSETS

December 31, December 31,

Investment securities, available for sale, at fair value 35,327 20,399