A $3 billion community bank is experiencing rapid growth and making inroads into banking as a service by taking on some high-profile financial technology projects.

Within one year, Everett, Wash.-based Coastal Community Bank, a subsidiary of Coastal Financial Corp., has grown net interest income from its banking as a service, or BaaS, division more than twentyfold, to $19.93 million in the second quarter from $859,000 in the second quarter of 2021. Coastal is partnering with the Walmart Inc.-backed fintech platform and is assisting with the development of the retailer's new digital checking accounts in beta for its workers and some online customers.

The track record of securing scalable partnerships makes Coastal stand out in the competitive BaaS landscape, analysts said.

"Coastal is probably our top pick in BaaS today," said Michael Perito, managing director on the U.S. regional bank equity research team at Keefe Bruyette & Woods Inc. "They've significantly bolstered up their regulatory compliance element of their platform, and we feel very comfortable that they're invested at the right rate for the growth they're seeing."

In addition to the Walmart partnership, Coastal was one of the 11 bank partners selected by Alphabet Inc. in 2020 along with the likes of Citigroup Inc. to work on Google Plex, a digital checking account within Google Pay. Although Google halted this project in 2021, Coastal still gained momentum by rapidly growing a team of BaaS professionals and reallocated them to other fintech projects, noted Brett Rabatin, head of equity research at Hovde Group LLC.

Coastal had 195 employees at the end of 2019 and has more than doubled the team to 433. Its assets stood at $2.97 billion as of June 30, up 48.50% from $2.00 billion in June 2021. It has been reporting BaaS activities under the segment dubbed CCBX since early 2020, in addition to a community bank division that has 14 branches in Washington state.

The $10B conundrum

For banks operating in BaaS, bigger is not always better because once they surpass $10 billion in assets, card-issuing banks will no longer be exempted from the Durbin amendment, which applies a cap on interchange fees. As a result, profits earned from swipe fees, a core economic benefit to BaaS providers, could go down dramatically, KBW's Perito said.

But Coastal does have the opportunity to pursue growth. Perito noted that Coastal is much further away from the $10 billion threshold than established BaaS players such as The Bancorp Inc. and Pathward Financial Inc.

Coastal CEO Eric Sprink said the company recognizes the benefit of avoiding the Durbin amendment, given that Coastal is heavily involved in providing checking, savings accounts and issuing debit cards in its BaaS offerings. It will manage the growth of assets in a measured way and has no plans to surpass $10 billion in assets anytime soon, Sprink said in an interview.

Rigorous vetting process

Since it has taken a measured approach to growth, Coastal is mindful about each of its fintech partnerships.

Aside from the Walmart relationship, Coastal works with 29 fintech partners as of June 30. It vets 15 to 20 potential fintech partners a week and only onboards four to five a year, Sprink said. Coastal's vetting process includes examining the potential partner's mission, customer base and access to capital and liquidity, he added.

"We like to stand behind companies that are mission driven and are focused on disparate communities that maybe don't have historical access to the banking system," Sprink said. Coastal currently works with Aspiration Partners Inc., a neobank aiming to address environmental issues, and Greenwood Inc., a neobank catering to Black and Latino customers.

From there, Coastal will conduct due diligence and analysis on policies, procedures, oversight and operations. After formulating a plan, the board gets involved, and it will then discuss the ideas with its regulators, Sprink said.

"We have extreme vetting criteria, because any partner you can enter in a relationship with, you're trying to do the best you can to make sure that you believe on day one — they're going to be successful over the next five or 10 years," Sprink said.

Future growth opportunities

A key growth driver could be working with Walmart, which has been increasing its exposure to financial services. In January 2021, Walmart launched a fintech company in partnership with Ribbit Capital. About a year later, the venture announced acquisitions of Even Responsible Finance Inc., an application for earned wage access, and neobank One Finance Inc.

Walmart is looking to create a closed-loop system to provide financial services and Coastal is working with One Finance, which is at the center of the retailer's planned endeavors, Hovde's Rabatin said.

Using a closed-loop method could help reduce the cost of the payments flowing inside Walmart's ecosystem, Rabatin explained. For instance, Walmart employees could spend some of their paycheck at a Walmart store using a card managed by the retailer. One Finance also attempts to attract its debit card users to Walmart, offering 2% cashback rewards on purchases at Walmart for the first 12 months, according to its website.

Coastal's involvement could give it the opportunity to operate those deposit accounts, process the payments, and maybe, at some point, underwrite loans, Rabatin said.

"It is going to be super interesting to see how that impacts Coastal and their balance sheet," Rabatin said. "At some point, the sky could be the limit."