10-K

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

+-+
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
+-+ SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended September 30, 2006

OR

+-+
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
+-+ SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 0-19684

COASTAL FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	57-0925911
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer I.D.)
2619 Oak Street, Myrtle Beach, South Carolina	29577-3129
(Address of principal executive offices)	(Zip Code)
Registrant’s telephone number, including area code:     (843) 205-2000

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, par value $.01 per share

(Title of Class)

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES o NO x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES o NO x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. Large Accelerated Filer o Accelerated Filer x Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO x

1

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based upon the closing sales price of the registrant’s common stock as quoted on the NASDAQ System under the symbol “CFCP” as of the last business day of the registrant’s most recently completed second fiscal quarter, was $269,483,902 (21,541,479 shares at $12.51 per share.) It is assumed for purposes of this calculation that none of the registrant’s officers, directors and 5% stockholders are affiliates.

As of December 11, 2006, there were issued and outstanding 21,703,125 shares of the registrant’s Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

1.	Portions of the Annual Report to Stockholders for the Fiscal Year Ended September 30, 2006 (Parts I and II)
2.	Portions of the Proxy Statement for the 2007 Annual Meeting of Stockholders. (Part III)

2

PART I

Item 1. Business

General

          Coastal Financial Corporation (“Coastal Financial” or the “Company”) was incorporated in the State of Delaware in June 1990, for the purpose of becoming a savings and loan holding company for Coastal Federal Bank, formerly named Coastal Federal Savings Bank (“Coastal Federal” or the “Bank”). On January 28, 1991, the stockholders of the Bank approved a plan to reorganize the Bank into the holding company form of ownership. The reorganization was completed on November 6, 1991, on which date the Bank became the wholly owned subsidiary of the Company, and the stockholders of the Bank became stockholders of the Company. Prior to completion of the reorganization, the Company had no material assets or liabilities and engaged in no business activities. The financial results contained herein relate primarily to the Company’s principal subsidiary, Coastal Federal.

          Coastal Federal conducts its business from its main office in Myrtle Beach, South Carolina, sixteen branch offices located in South Carolina, and seven branch offices located in North Carolina. The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (“FDIC”) under the Deposit Insurance Fund (“DIF”). The corporate offices of the Company and the Bank are located at 2619 Oak Street, Myrtle Beach, South Carolina, and the telephone number at that location is (843) 205-2000.

          Coastal Federal’s twenty four offices are located in Horry and Georgetown Counties of South Carolina, and Brunswick and New Hanover Counties of North Carolina. The economy of these four counties depends primarily on tourism. To the extent area businesses rely heavily on tourism for business, decreased tourism would have a significant adverse effect on Coastal Federal’s primary deposit base and lending area. Moreover, Coastal Federal would likely experience a higher degree of loan delinquencies should the local economy be materially and adversely affected.

          Coastal Federal’s principal business currently consists of attracting deposits from the general public and using these funds to originate consumer loans, commercial business loans, commercial real estate loans, residential mortgage loans, and land and land development loans.

          The Company maintains an Internet website at http://www.coastalfederal.com. The Company makes available its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended, and other information related to the Company, free of charge, on this site as soon as reasonably practicable after it electronically files those documents with, or otherwise furnishes them to the SEC. The Company’s Internet website and the information contained therein or connected thereto are not intended to be incorporated into this annual report on Form 10-K.

3

Rate/Volume Analysis

The following table sets forth certain information regarding changes to interest income and interest expense of the Company for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributed to (i) changes in rate (changes in rate multiplied by old volume); (ii) changes in volume (changes in volume multiplied by old rate), (iii) changes in rate-volume (change in rate multiplied by change in volume), and (iv) the net change (the sum of the prior columns). Non-accrual loans are included in the average volume calculations only.

	Years Ended September 30,
	2004 Compared to 2003 Increase (Decrease) Due to											2005 Compared to 2004 Increase (Decrease) Due to										2006 Compared to 2005 Increase (Decrease) Due to
	Rate			Volume		Rate/ Volume			Net			Rate		Volume			Rate/ Volume			Net		Rate			Volume			Rate/ Volume			Net
	(Dollars in thousands)
Interest-earning assets:
Loans	$	(3,082	)	$	8,515	$	(626	)	$	4,807		$	2,506	$	7,170		$	385		$	10,061	$	8,575		$	9,150		$	1,381		$	19,106
Mortgage-backed securities/investments		(383	)		2,216		(49	)		1,784			478		2,160			54			2,692		638			1,312			39			1,989
Total net change in income on interest-earning assets		(3,465	)		10,731		(675	)		6,591			2,984		9,330			439			12,753		9,213			10,462			1,420			21,095
Interest-bearing liabilities:
Deposits		(2,233	)		373		(115	)		(1,975	)		855		584			93			1,532		5,617			1,290			632			7,539
Brokered CD’s		—			—		—			—			—		—			2,523			2,523		950			3,032			1,143			5,125
FHLB advances		(971	)		2,942		(315	)		1,656			59		1,550			8			1,617		1,280			1,071			111			2,462
Repurchase agreements		(344	)		925		(185	)		396			1,322		(626	)		(392	)		304		1,371			(928	)		(526	)		(83	)
Other borrowings		(46	)		630		(135	)		449			230		—			—			230		300			—			—			300
Total net change in expense on interest-bearing liabilities		(3,594	)		4,870		(750	)		526			2,466		1,508			2,232			6,206		9,518			4,465			1,360			15,343
Net change in net interest income	$	129		$	5,861	$	75		$	6,065		$	518	$	7,822		$	(1,793	)	$	6,547	$	(305	)	$	5,997		$	60		$	5,752

4

Average Balance Sheet

          The following table sets forth certain information relating to the Company’s average balance sheet and reflects the yield on average assets and cost of average liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented. Non-accrual loans are included in average balance calculations only.

	Years Ended September 30,
	2004							2005							2006
	Average Balance		Interest		Yield/ Rate (2)			Average Balance		Interest		Yield/ Rate (2)			Average Balance		Interest		Yield/ Rate (2)
	(Dollars in thousands)
Assets:
Loans	$	757,633	$	46,765		6.17	%	$	873,797	$	56,826		6.50	%	$	1,014,501	$	75,932		7.48	%
Mortgage-backed securities/investments(1)(3)		403,610		19,040		4.72			449,402		21,732		4.84			476,536		23,721		4.98
Total interest-earning assets	$	1,161,243	$	65,805		5.67	%	$	1,323,199	$	78,558		5.94	%	$	1,491,037	$	99,653		6.68	%
Liabilities:
Transaction accounts (4)		418,405		3,331		.80			505,340		4,457		.88			551,152		7,058		1.28
Statement savings accounts		50,509		405		.80			64,973		663		1.02			75,224		1,454		1.93
Certificate accounts		250,211		6,288		2.51			241,310		6,436		2.67			265,080		10,583		3.99
Brokered certificate accounts		—		—		—			79,369		2,523		3.18			174,761		7,648		4.38
FHLB advances		281,437		10,724		3.81			322,108		12,341		3.83			350,064		14,803		4.23
Securities sold under repurchase agreements		143,842		2,114		1.47			101,221		2,418		2.39			62,386		2,335		3.74
Other borrowings		15,000		662		4.41			15,000		892		5.95			15,000		1,192		7.95
Total interest-bearing liabilities	$	1,159,404	$	23,524		2.03	%	$	1,329,321	$	29,730		2.24	%	$	1,493,667	$	45,073		3.01	%
Net interest income/ interest rate spread			$	42,281		3.64	%			$	48,828		3.70	%			$	54,580		3.67	%
Net yield on interest earning assets						3.64	%						3.69	%						3.66	%
Ratio of interest earning assets to interest-bearing liabilities						1.00							1.00							1.00

(1)	Includes short-term interest-bearing deposits, Federal funds sold, and investments held to maturity.
(2)	Yield for average investments classified as available for sale is computed using historical cost balances and does not give effect to changes in fair value that are reflected as a component of stockholders’ equity.
(3)	Investment securities include taxable and tax-exempt securities. Net interest income has not been adjusted to produce a tax-equivalent yield.
(4)	Average noninterest-bearing deposits included in average transaction accounts above for 2004, 2005 and 2006 are $101,298, $163,278 and $211,713, respectively.

5

Lending Activities

          General. The principal lending activities of Coastal Federal are the origination of consumer loans, commercial business loans, commercial real estate loans, residential mortgage loans, and land and land development loans. The Bank originates construction and permanent loans on single family and multi-unit dwellings, as well as on commercial structures. The Bank emphasizes the origination of adjustable rate residential and commercial real estate mortgages.

          The Bank’s net loan portfolio, including loans held for sale, totaled approximately $1.1 billion at September 30, 2006, representing approximately 65.7% of its total assets. On that date, approximately 34.6% of Coastal Federal’s gross loan portfolio was secured by mortgages on one-to-four family residential properties.

          In an effort to ensure that the yields on its loan portfolio and investments are interest-rate sensitive, the Bank has implemented a number of measures, including: (i) emphasis on the origination of adjustable rate mortgages on residential and commercial properties; (ii) origination of construction loans secured by residential properties, generally with terms for a one-year period or less; and (iii) origination of commercial and consumer loans having either adjustable rates or relatively short maturities. At September 30, 2006, adjustable rate loans constituted approximately $917.3 million (or 84.2%) of the Bank’s net loan portfolio. Therefore, at such date, fixed rate loans comprised only 15.8% of the total loan portfolio. These lending practices are intended to shorten the term of the Bank’s assets and make the loan portfolio more responsive to interest rate volatility.

          The Company has identified one concentration of credit risk that it is monitoring. This involves loans for the acquisition of land and loans for the development of land, which totaled $162.5 million as September 30, 2006, and which is included in Mortgage Loans – Land, land development and other, primarily commercial real estate in the Loan Portfolio Analysis on the following page. See Note 1(h) of the Notes to Consolidated Financial Statements in the Annual Report to Stockholders for a complete discussion of this monitored credit risk.

6

Loan Portfolio Analysis

The following table set forth the composition of the Company’s loan portfolio by type of loan as of the dates indicated.

	At September 30,
	2002						2003						2004						2005						2006
	Amount			Percent			Amount			Percent			Amount			Percent			Amount			Percent			Amount			Percent
	(Dollars in thousands)
Mortgage loans:
Construction	$	45,544			7.99	%	$	81,227			11.16	%	$	93,292			11.23	%	$	142,959			14.56	%	$	203,755			17.96	%
Single family to 4 family units		261,296			45.88			308,293			42.37			337,533			40.62			371,014			37.79			392,425			34.59
Land, land development and other, primarily commercial real estate		202,117			35.49			263,688			36.24			312,460			37.60			369,714			37.66			437,968			38.60
Commercial business loans		18,377			3.23			24,475			3.36			32,101			3.86			38,691			3.94			38,656			3.41
Consumer loans:
Mobile home		3,446			0.61			4,607			0.63			4,618			0.56			4,308			0.44			5,194			0.46
Automobiles		7,117			1.25			8,516			1.17			8,177			0.98			8,221			0.84			7,039			0.62
Equity lines of credit		24,273			4.26			26,639			3.66			30,906			3.72			34,019			3.47			40,331			3.55
Other		7,378			1.29			10,234			1.41			11,905			1.43			12,777			1.30			9,178			0.81
Total loans and loans held for sale, gross	$	569,548			100.00	%	$	727,679			100.00	%	$	830,992			100.00	%	$	981,703			100.00	%	$	1,134,546			100.00	%
Add (Subtract):
Loans in process		(6,365	)					(16,570	)					(21,613	)					(28,345	)					(31,982	)
Deferred loan costs, net		245						556						674						771						246
Allowance for loan losses		(7,883	)					(9,832	)					(11,077	)					(11,748	)					(12,726	)
Total loans and loans held for sale, net	$	555,545					$	701,833					$	798,976					$	942,381					$	1,090,084

7

          Commercial Business Loans. The Bank is permitted under OTS regulations to make secured or unsecured loans for commercial, corporate, business or agricultural purposes, including the issuance of letters of credit secured by real estate, business equipment, inventories, accounts receivable and cash equivalents. The aggregate amount of such loans outstanding may not exceed 20% of such institution’s assets, provided that amounts in excess of 10% of assets may be used only for small business loans.

          Coastal Federal has been making commercial business loans since 1983 on both a secured and unsecured basis. The majority of these loans have interest rates that adjust with changes in the prime rate as published in The Wall Street Journal. The Bank’s non-real estate commercial loans primarily consist of short-term loans for working capital purposes, seasonal loans and lines of credit. The Bank customarily requires a personal guaranty of payment by the principals of any borrowing entity and reviews the financial statements and income tax returns of the guarantors. At September 30, 2006, the Bank had $38.7 million outstanding in commercial business loans, which represented approximately 3.4% of its gross loan portfolio and 2.3% of total assets.

          Commercial business lending is inherently riskier than secured mortgage lending and involves risks that are different from those associated with residential and commercial real estate lending. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of such collateral in the event of a borrower default is often not a sufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete, of limited use, or have limited marketability, among other things. Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and potentially insufficient source of repayment.

          Commercial Real Estate Loans. The Bank may invest, by OTS regulation, in non-residential real estate loans up to 400% of its capital as computed under GAAP plus general loan loss reserves. At September 30, 2006 this limited Coastal Federal’s aggregate non-residential real estate loans to approximately $519.2 million. At such date, the Bank had non-residential real estate loans outstanding of $438.0 million compared to $369.7 million at September 30, 2005. During fiscal 2003 through 2006, the Bank has opened nine offices. The Bank hired commercial lending officers to reside in many of these offices and intends to have commercial lending officers or business banking officers in the majority of its banking offices. As a result of this focus, the Bank has significantly increased the number of its commercial lending officers over the last three years. The Bank expects to continue to focus significant origination efforts in commercial real estate and commercial lending. It is expected that the Bank’s commercial real estate loans will continue to comprise the most significant portion of the Bank’s loan growth in future years.

          The commercial real estate loans originated by the Bank are primarily secured by shopping centers, office buildings, warehouse facilities, retail outlets, hotels, motels and multi-family apartment buildings. The interest rate of the commercial real estate loans presently offered by the Bank generally adjusts every one, three or five years and is indexed to U.S. Treasury securities or adjusts daily indexed to the prime interest rate. Such loans generally have a fifteen to twenty year term, with the payments based on a similar amortization schedule. In some cases, the Bank may require the loan to include a call option at the Bank’s option in three to ten years. The Bank generally requires that such loans have a minimum debt service coverage of 120% of projected net operating income together with other generally accepted underwriting criteria.

          Commercial real estate lending entails significant additional risks compared to residential lending. Commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. The payment experience of such loans is typically dependent upon the successful operation of the real estate project. These risks can be significantly affected by supply and demand conditions in the market for office and retail space and for apartments and, as such may be subject, to a greater extent, to adverse conditions in the economy. In dealing with these risk factors, Coastal Federal generally limits itself to a real estate market or to borrowers with which it has experience. The Bank generally concentrates on originating commercial real estate loans secured by properties located within its market areas of Horry and Georgetown Counties, South Carolina and Brunswick and New Hanover Counties, North Carolina.

8

          Consumer Loans. The Bank is permitted by OTS regulations to invest up to 35% of its total assets in consumer loans. The Bank currently offers a wide variety of consumer loans on a secured and unsecured basis including home improvement loans, loans secured by savings accounts and automobile, truck and boat loans. The Bank also offers a revolving line of credit secured by owner-occupied real estate. Total consumer loans, including equity lines of credit generally secured by one-to-four family residences, amounted to $61.7 million, or 5.4% of the gross loan portfolio, and 3.7% of total assets, at September 30, 2006.

          Coastal Federal offers consumer loans in order to provide a wider range of financial services to its customers. These loans also have a shorter term and normally higher interest rates than residential real estate loans.

          Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that may depreciate rapidly, such as automobiles, boats and other moving vehicles. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability and, thus, are more likely to be adversely affected by job loss, a change in family status such as divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount recoverable on such loans. Such loans may also give rise to claims and defenses by the borrower against Coastal Federal as the holder of the loan, and a borrower may be able to assert claims and defenses that it has against the seller of the underlying collateral.

          Residential Mortgage Loans. The Bank originates loans to enable borrowers to purchase existing homes or residential lots, refinance existing mortgage loans or construct new homes. Residential mortgage loans originated by the Bank are generally long-term loans, amortized on a monthly basis, with principal and interest due each month. The contractual loan payment period for residential mortgage loans typically ranges from 10 to 30 years. The Bank’s experience indicates that real estate loans remain outstanding for significantly shorter periods than their contractual terms. Borrowers may refinance or prepay loans at their option, subject to any prepayment penalty provisions included in the note. The Bank generally requires mortgagee title insurance on all single-family first mortgage and residential mortgage loans.

          The Bank offers adjustable rate residential mortgage loans (“ARMs”), the interest rates of which generally adjust based upon treasury securities indices. Although Coastal Federal’s ARMs are beneficial in helping the Bank improve the interest rate sensitivity of its assets, such loans may pose potential additional risks to Coastal Federal. A precipitous increase in interest rates could be expected to result in an increase in delinquencies or defaults on such loans, whereas a significant decrease in rates could cause repayments to increase significantly.

          Coastal Federal also offers residential mortgage loans with fixed rates of interest. These loans generally can be sold in the secondary market or are portfolio loans where the Bank offers such loans at rates above conforming loan rates. In addition, Coastal Federal securitized loans into FHLMC mortgage-backed securities of $52.6 million and $27.5 million in 2005 and 2006, respectively. The securitized mortgage-backed securities were generally sold in the secondary market within a few days of securitization.

          At September 30, 2006, approximately $392.4 million or 34.6% of the Bank’s gross loan portfolio, and 23.6% of total assets, consisted of one-to-four family residential loans.

          Construction Loans. The Bank originates residential construction loans that generally have a term of six to twelve months for individuals or one year for builders. The individual’s loans are generally tied to a commitment by the Bank to provide permanent financing upon completion of construction. The interest rate charged on construction loans is generally indexed to the prime rate as published in The Wall Street Journal or the current permanent loan rate and varies depending on the terms of the loan and the loan amount. The Bank customarily requires personal guaranties of payment from the principals of the borrowing entities.

          The interest rate on commercial real estate construction loans presently offered by the Bank is generally indexed to the prime rate as published in The Wall Street Journal. Residential and commercial real estate construction financing generally expose the Bank to a greater risk of loss than long-term financing on improved, occupied real estate, due in part to the fact that the loans are underwritten on projected, rather than historical, income and rental results. The Bank’s risk of loss on such loans generally depends largely upon the accuracy of the initial appraisal of the property’s

9

value at completion of construction and the estimated cost (including interest) of completion. If either estimate proves to have been inaccurate and the borrower is unable to provide additional funds pursuant to his guaranty, the lender either may be required to advance funds beyond the amount originally committed to permit completion of the development and/or be confronted at the maturity of the loan with a project whose value is insufficient to assure full repayment. Coastal Federal generally provides a permanent financing commitment on residential and commercial properties at the time the Bank provides the construction financing.

          The Bank’s underwriting criteria are designed to evaluate and to minimize the risks of each residential and commercial real estate construction loan. The Bank considers evidence of the financial stability and reputation of both the borrower and the contractor, the amount of the borrower’s cash equity in the project, independent evaluation and review of the building costs, local market conditions, pre-construction sale and leasing information based upon evaluation of similar projects and the borrower’s cash flow projections upon completion. The Bank generally requires personal guaranties of payment by the principals of any borrowing entity.

          At September 30, 2006, approximately $203.8 million (including $32.0 million of loans in process) or 18.0% of the Bank’s gross loan portfolio consisted of construction loans on both residential ($197.4 million) and commercial properties ($6.4 million).

Loan Maturity

          The following table sets forth certain information at September 30, 2006 regarding the dollar amount of loans maturing in the Company’s loan portfolio based on their contractual terms to maturity including scheduled payments and potential prepayments. Specific prepayment speeds applied to loans are a function of their underlying coupons, lifetime rate caps and maturities. Demand loans (without a stated maturity), loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year or less.

	One Year or Less		More than One Year Through Five Years		More than Five Years		Totals
	(In thousands)
First mortgage loans	$	248,496	$	193,338	$	122,364	$	564,198
Land, land development and other, primarily commercial real estate		181,722		196,833		59,413		437,968
Equity lines of credit		9,685		25,398		5,248		40,331
Consumer loans		7,443		13,019		949		21,411
Commercial loans		20,085		18,571		—		38,656
Total loans, net of LIP	$	467,431	$	447,159	$	187,974		1,102,564
Add (subtract):
Deferred loan costs, net								246
Allowance for loan losses								(12,726	)
Total loans, net							$	1,090,084

10

          The following table sets forth the dollar amount of all loans expected to be repaid one year or later after September 30, 2006, which have fixed interest rates and those which have floating or adjustable interest rates.

	Fixed Rates		Floating or Adjustable Rates		Totals
	(In thousands)
First mortgage loans	$	65,339	$	250,363	$	315,702
Land, land development and other, primarily commercial real estate		35,436		220,810		256,246
Equity lines of credit		—		30,646		30,646
Consumer loans		10,525		3,443		13,968
Commercial loans		8,755		9,816		18,571
Total loans	$	120,055	$	515,078	$	635,133

          Loan Solicitation and Processing. The Bank actively solicits mortgage loan applications from the communities it serves. Detailed loan applications are obtained to determine the borrower’s ability to repay, and more significant items on these applications are verified. After analysis of the loan application and property or collateral involved, including an independent appraisal of property, the Bank’s underwriter or Credit Administration Group reviews the loan, and the Bank makes a lending decision. With respect to commercial loans, the Bank also reviews the capital adequacy of the business, the ability of the borrower to repay the loan and honor its other obligations and general economic and industry conditions. Loans are approved based on size, requiring higher levels of authorization for larger dollar loan amounts. A member of the Bank’s Internal Loan Committee must approve all residential mortgage loan applications in excess of 80% of the lesser of appraised value or purchase price of the property, unless the borrowers have private mortgage insurance.

          The Bank’s general policy is to obtain customary title and flood insurance on real estate loans. Borrowers must also obtain paid hazard insurance policies prior to closing. Borrowers on residential mortgage loans, which exceed 80% of the value of the security property, are also generally required to escrow funds on a monthly basis for real estate taxes, hazard insurance premiums, and private mortgage insurance premiums.

          Residential Mortgage Loan Originations, Purchases and Sales. The Bank may, depending on economic conditions, purchase or sell mortgage loans to manage the interest rate sensitivity of interest-earning assets and interest-bearing liabilities, to provide additional funding for lending activities, and generate service fee income. The Bank retains a portion of the interest paid by the borrower on the loans as consideration for its servicing activities.

          Residential Loan Commitments. The Bank, upon the submission of a residential loan application, generally provides a written commitment as to the interest rate applicable to such loan. If the loan has not been closed within the rate lock period, the rate may be adjusted to reflect current market conditions at the Bank’s option. Loans that require closing time in excess of the rate lock period from the date of application are issued a written commitment, with a term ranging from three to six months. The Bank charges either a higher interest rate or a fee to lock in the rate for an extended rate lock period. Refer to Note 4 of the Notes to Consolidated Financial Statements for more information.

          Delinquencies. Coastal Federal’s collection procedures provide for a series of contacts with delinquent borrowers. If the delinquency continues, more formal efforts are made to contact the delinquent borrower. If a residential mortgage loan continues in a delinquent status for 90 days or more, Coastal Federal generally initiates foreclosure proceedings. Coastal Federal generally initiates collection activities on a commercial or consumer loan if the loan continues in a delinquent status for 30 days or more. In certain limited instances, however, Coastal Federal may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize its financial affairs.

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Problem Assets and Asset Classification. Loans are reviewed on a regular basis and a reserve for uncollectible interest is established on loans where collection of interest is questionable, generally when such loans become 90 days delinquent. Loan balances that relate to interest amounts reserved are considered to be on a nonaccrual basis.

          The following table sets forth information with respect to the Bank’s non-performing assets at the dates indicated.

	At September 30,
	2002			2003			2004			2005			2006
	(Dollars in thousands)
Loans accounted for on a non-accrual basis:
Real estate - -
Residential	$	785		$	3,538		$	3,852		$	998		$	1,707
Commercial		18			2,816			1,106			1,048			767
Commercial business		2,423			793			783			488			468
Consumer		288			302			115			107			48
Total		3,514			7,449			5,856			2,641			2,990
Accruing loans which are contractually past due 90 days or more:
Real estate - -
Residential		—			—			—			—			—
Commercial		—			—			—			—			—
Commercial business		—			—			—			—			—
Consumer		—			—			—			—			—
Total		—			—			—			—			—
Restructured loans		970			369			731			771			2,071
Real estate owned, net		1,046			1,627			785			818			571
Other nonperforming assets		—			—			—			—			—
Total nonperforming assets	$	5,530		$	9,445		$	7,372		$	4,230		$	5,632
Total non-accrual loans to net loans		0.63	%		1.06	%		0.73	%		0.28	%		0.27	%
Total non-accrual loans to total assets		0.37	%		0.63	%		0.45	%		0.17	%		0.18	%
Total nonperforming assets to total assets		0.58	%		0.80	%		0.56	%		0.27	%		0.34	%
Total nonperforming assets, excluding restructured loans which are generally performing under the restructured terms, to total assets		0.48	%		0.77	%		0.51	%		0.22	%		0.21	%

          Please refer to Note 4 of the Notes to Consolidated Financial Statements for additional information on impaired loans and reserved accrued interest.

          The allowance for uncollectible interest, which is netted against accrued interest receivable, totaled $427,000 and $194,000 at September 30, 2005 and 2006, respectively.

          OTS regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, OTS examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are four classifications for problem assets: special mention, substandard, doubtful and loss. Assets categorized as special mention have potential credit weakness and require close management attention, but are not yet classified further. Assets classified as substandard or doubtful have well defined weaknesses and the institution may sustain some loss if the weaknesses are not corrected. If an asset or portion thereof is classified loss, the insured institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss or charge off such amount. A portion of general loss allowances established to cover possible losses related to assets classified substandard or doubtful may be

12

included in determining an institution’s regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital.

          Coastal Federal had five individually classified assets in excess of $1.6 million as of September 30, 2006 totaling $29.3 million. At that date, classified assets amounted to $47.7 million ($8.9 million substandard; $207,000 doubtful; and $38.6 million special mention). Substandard assets consist primarily of sixteen loans with aggregate balances of approximately $7.5 million at September 30, 2006. The largest amount to any one borrower was $2.3 million. Special mention assets consist primarily of thirty one loans with aggregate balances of approximately $37.6 million at September 30, 2006.

          Allowance for Loan Losses. The adequacy of the allowance is analyzed on a quarterly basis. For purposes of this analysis, adequacy is defined as a level of reserves sufficient to absorb probable losses inherent in the loan portfolio. The methodology employed for this analysis considers historical loan loss experience, the results of loan reviews, current economic conditions, and other qualitative and quantitative factors that warrant current consideration in determining an adequate allowance.

          The evaluation of the allowance is segregated into general allocations and specific allocations. For general allocations, the portfolio is segregated into risk-similar segments for which historical loss ratios are calculated and adjusted for identified trends or changes in current portfolio characteristics. Historical loss ratios are calculated by product type and risk grade for consumer loans (installment and revolving), mortgage loans, and commercial loans. To allow for modeling error, a range of probable loss ratios is then derived for each segment. The resulting percentages are then applied to the dollar amounts of the loans in each segment to arrive at each segment’s range of probable loss levels.

          Certain nonperforming loans are individually assessed for impairment under SFAS 114 and assigned specific allocations. Other identified high-risk loans or credit relationships based on internal risk ratings are also individually assessed and assigned specific allocations.

          The general allocation also includes a component for probable losses inherent in the portfolio, based on management’s analysis, that are not fully captured elsewhere in the allowance. This component serves to address the inherent estimation and imprecision risk in the methodology as well as address management’s evaluation of various factors or conditions not otherwise directly measured in the evaluation of the general and specific allocations. Such factors or conditions may include evaluation of current general economic and business conditions; geographic, collateral, or other concentrations; system, procedural, policy, or underwriting changes; experience of lending staff; entry into new markets or new product offerings; and results from internal and external portfolio examinations.

          The allocation of the allowance to the respective loan segments is an approximation and not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses occurring in the overall loan portfolio.

          Assessing the adequacy of the allowance is a process that requires considerable judgment. Management’s methodology and judgments are based on the information currently available and includes numerous assumptions about current events, which are believed to be reasonable, but which may or may not be valid. Thus, there can be no assurance that loan losses in future periods will not exceed the current allowance amount or that future increases in the allowance will not be required. No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting the operating results of the Company. Management believes that the current level of the allowance for loan losses is presently adequate considering the composition of the loan portfolio, the portfolio’s loss experience, delinquency trends, current regional and local economic conditions and other factors.

          The allowance is also subject to examination and adequacy testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other adequacy tests. In addition, such regulatory agencies could require management to adjust the allowance based on information available to them at the time of their examination.

          See Note 4 of the Notes to Consolidated Financial Statements and “Management’s Discussion and Analysis – Non-performing Assets” in the 2006 Annual Report to Stockholders attached hereto and incorporated by reference.

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Loan Loss Allowance Analysis

          The following table sets forth analysis of the Company’s allowance for loan losses for the periods indicated. Where specific loan loss reserves have been established, any difference between the loss reserve and the amount of the loss realized has been charged or credited to the loan loss allowance as a charge-off or recovery.

	Years Ended September 30,
	2002			2003			2004			2005			2006
	(Dollars in thousands)
Allowance at beginning of period	$	7,159		$	7,883		$	9,832		$	11,077		$	11,748
Provision for loan losses		1,235			2,655			1,750			1,697			1,385
Recoveries:
Residential loans		4			—			—			—			—
Commercial loans		—			92			200			108			191
Construction loans		—			—			—			—			—
Consumer loans		62			44			49			116			116
Total recoveries		66			136			249			224			307
Charge-offs:
Residential loans		—			46			—			27			—
Commercial loans		90			388			268			781			413
Construction loans		—			—			—			—			—
Consumer loans		487			408			486			442			301
Total charge-offs		577			842			754			1,250			714
Net charge-offs		511			706			505			1,026			407
Allowance at end of period	$	7,883		$	9,832		$	11,077		$	11,748		$	12,726
Ratio of allowance to net loans outstanding at the end of the period		1.42	%		1.40	%		1.39	%		1.25	%		1.17	%
Ratio of net charge-offs to average loans outstanding during the period		0.10	%		0.11	%		0.07	%		0.12	%		0.04	%

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Loan Loss Allowance by Category

          The following table sets forth the breakdown of the allowance for loan losses by loan category for the periods indicated.

	September 30,
	2002								2003								2004
	Amount		As a % of out- standing loans in category			Loan Type As a % of out- standing loans			Amount		As a % of out- standing loans in category			Loan Type As a % of out- standing loans			Amount		As a % of out- standing loans in category			Loan Type As a % of out- standing loans
	(Dollars in thousands)
Residential	$	2,272		0.72	%		57.08	%	$	1,992		0.61	%		55.61	%	$	1,007		0.23	%		53.78	%
Commercial		5,273		2.39			39.69			7,229		2.51			41.06			9,222		2.68			43.13
Consumer		338		1.88			3.23			611		2.62			3.33			848		3.43			3.09
Total allowance for loan losses	$	7,883		1.42	%		100.00	%	$	9,832		1.40	%		100.00	%	$	11,077		1.39	%		100.00	%

	September 30,
	2005								2006
	Amount		As a % of out- standing loans in category			Loan Type As a % of out- standing loans			Amount		As a % of out- standing loans in category			Loan Type As a % of out- standing loans
	(Dollars in thousands)
Residential	$	980		0.19	%		53.91	%	$	1,985		0.34	%		54.31	%
Commercial		9,794		2.39			43.40			10,130		2.13			43.72
Consumer		974		3.85			2.69			611		2.85			1.96
Total allowance for loan losses	$	11,748		1.25	%		100.00	%	$	12,726		1.17	%		100.00	%

Investment Activities

          Under OTS regulations, the Bank has authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and of state and municipal governments, deposits at the FHLB of Atlanta, certificates of deposit of federally insured institutions, certain bankers’ acceptances and federal funds. Subject to various restrictions, such regulated institutions may also invest a portion of their assets in commercial paper, corporate debt securities and mutual funds, the assets of which conform to the investments that OTS-chartered institutions are otherwise authorized to make directly. These institutions are also required to maintain minimum levels of liquid assets which vary from time to time. See “Regulation and Supervision – Federal Home Loan Bank System.” The Bank may decide to increase its liquidity above the required levels depending upon the availability of funds and comparative yields on investments in relation to return on loans.

15

          Coastal Federal is required under federal regulations to maintain a minimum amount of liquid assets and is also permitted to make certain other securities investments. See “Regulation and Supervision” herein and “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in the 2006 Annual Report to Stockholders.

          Investment decisions are made in accordance with the Bank’s approved Investment Policy by the Investment Officer who reports quarterly to the Asset/Liability Management Committee (“ALCO Committee”). The ALCO Committee meets quarterly and consists of Directors Benton, Bishop, Calliham, Clemmons, Creel, Dusenbury, Gerald and Thompson, and Executive Vice Presidents Douglas, Graham, Rexroad, Sherry and Stalvey and Senior Vice Presidents Benjamin and Gehman and Vice President Loehr. The ALCO Committee acts within policies established by the Board of Directors. At September 30, 2006 the Bank’s investment portfolio had a market value of approximately $444.3 million. The investment securities portfolio consisted primarily of mortgage-backed securities. For further information concerning the Bank’s securities portfolio, see Notes 2 and 3 of the Notes to Consolidated Financial Statements attached hereto and incorporated by reference.

          Service Corporation Activities

     The Company has four wholly owned subsidiaries, Coastal Federal Bank, Coastal Financial Capital Trust I (see Note 11 of the Notes to Consolidated Financial Statements), Coastal Planners Holding Corporation, and Coastal Investor Services, Inc. (inactive).

          Coastal Federal Bank has two wholly-owned subsidiaries: Coastal Mortgage Bankers and Realty Co., Inc. (“Coastal Mortgage Bankers”), which was incorporated in 1970 under the laws of South Carolina, and Coastal Federal Holding Corporation (“CHFC”), which was incorporated in 1998 under the laws of Delaware. As of September 30, 2006, Coastal Mortgage Bankers has one first tier subsidiary, Sherwood Development Corporation, which is inactive. Coastal Mortgage Bankers is not active in any real estate operations.

          On February 20, 1998, Coastal Real Estate Investment Corporation (“CREIC”) was incorporated in North Carolina. CREIC is a wholly owned operating subsidiary of CFHC and is a real estate investment trust (“REIT”). CREIC engages in the investment in, and management of, real estate related assets, primarily mortgage loans. CFHC engages in the management of its investment in CREIC and the management of the related dividends received on that investment. On September 1, 1998, CREIC was capitalized with approximately $131.8 million of mortgage loans from Coastal Federal. On December 10, 1998, CREIC became a wholly owned subsidiary of CFHC through an exchange of stock transaction. In January 2003, 2004 and 2005, CREIC received capital contributions from CFHC of $50.0 million each year to purchase loans.

          Coastal Federal Capital Trust I was formed as a statutory trust under the laws of the state of Delaware, for the purpose of issuing capital securities to institutional investors in a trust preferred issue. During fiscal 2004, the Company deconsolidated the Trust for financial reporting purposes as a result of Financial Accounting Standards Board Interpretation No. 46 “Consolidation of Variable Interest Entities”. Refer to Note 11 of the Notes to Consolidated Financial Statements for further information.

          Coastal Planners Holding Corporation has one subsidiary, Coastal Retirement, Estate and Tax Planners, Inc., which was formed during the fourth fiscal quarter of 2003 and offers objective, fee-based financial planning and tax preparation services.

Deposit Activities and Other Sources of Funds

          General. Deposits and loan repayments are the major source of Coastal Federal’s funds for lending and other investment purposes. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions. Borrowings may be used to compensate for reductions in the availability of funds from other sources. They may also be used for general business purposes.

          Deposit Accounts. Deposits are attracted from within Coastal Federal’s primary market area through the offering of a broad selection of deposit instruments, including checking accounts, money market accounts, savings accounts, certificates of deposit and retirement accounts. Deposit account terms vary, according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, Coastal Federal considers the rates offered by its competition, profitability to Coastal Federal, matching deposit and loan products and its customer preferences and concerns. Coastal Federal generally reviews its deposit mix and pricing at least monthly.

16

Time Deposits with balances of $100,000 or More

          The following table sets forth the amount and maturities of time deposits with balances of $100,000 or more at September 30, 2006.

Amount Due
Up to 3 Months			Over 3 through 6 months			Over 6 through 12 months			Over 12 Months			Total
(In thousands)
	$	87,821		$	102,574		$	55,658		$	21,466		$	267,519

17

Deposit Flow

          The following table sets forth the balances of deposits in the various types of deposit accounts offered by the Bank at the dates indicated.

	At September 30,
	2004								2005								2006
	Amount		Percent of Total			Increase (Decrease)			Amount		Percent of Total			Increase (Decrease)			Amount		Percent of Total			Increase (Decrease)
	(Dollars in thousands)
NOW checking	$	110,802		14.71	%	$	12,631		$	139,810		13.05	%	$	29,008		$	126,373		11.89	%	$	(13,437	)
Noninterest-bearing checking		122,357		16.24			36,099			219,080		20.45			96,723			231,081		21.73			12,001
		233,159		30.95			48,730			358,890		33.50			125,731			357,454		33.62			(1,436	)
Money market checking accounts		224,437		29.79			18,427			213,078		19.89			(11,359	)		198,500		18.67			(14,578	)
Statement savings accounts		55,205		7.33			8,969			71,824		6.71			16,619			76,263		7.17			4,439
Fixed-rate certificates
(original maturity):
3 months		3,865		.51			388			2,775		0.26			(1,090	)		3,138		0.30			363
6 months		33,052		4.39			(49,297	)		93,805		8.76			60,753			65,020		6.12			(28,785	)
9 months		51,159		6.79			44,457			17,204		1.61			(33,955	)		8,708		0.82			(8,496	)
12 months		57,696		7.66			(81	)		56,980		5.32			(716	)		131,800		12.40			74,820
18 months		37,978		5.04			(8,066	)		215,767		20.15			177,789			175,843		16.54			(39,924	)
24 months		28,264		3.75			(8,049	)		21,795		2.04			(6,469	)		28,541		2.68			6,746
30 months		2,673		.35			(250	)		2,684		0.25			11			2,213		0.21			(471	)
36 months		11,559		1.53			(90	)		4,361		0.41			(7,198	)		4,257		0.40			(104	)
48 months		11,662		1.55			1,554			9,444		0.88			(2,218	)		8,986		0.85			(458	)
60 months		—		—			(20	)		—		—			—			—		—			—
		237,908		31.57			(19,454	)		424,815		39.68			186,907			428,506		40.32			3,691
Variable rate certificates:
(original maturity)
12 months		161		.02			31			170		0.02			9			175		0.01			5
18 months		1,115		.15			(196	)		936		0.09			(179	)		1,134		0.11			198
30 months		1,394		.19			(140	)		1,205		0.11			(189	)		1,073		0.10			(132	)
Total variable		2,670		.36			(305	)		2,311		0.22			(359	)		2,382		0.22			71
Total certificates		240,578		31.93			(19,759	)		427,126		39.90			186,548			430,888		40.54			3,762
Total deposits	$	753,379		100.00	%	$	56,367		$	1,070,918		100.00	%	$	317,539		$	1,063,105		100.00	%	$	(7,813	)

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          Borrowings. Demand and time deposits are the primary source of funds for Coastal Federal’s lending and investment activities and other general business purposes. The Bank also relies upon advances from the FHLB of Atlanta to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB of Atlanta has served as one of the Bank’s primary borrowing sources. Advances from the FHLB of Atlanta are typically secured by the Bank’s first mortgage loans and certain of the Bank’s mortgage-backed securities portfolio. At September 30, 2006, Coastal Federal had advances totaling $380.6 million from the FHLB of Atlanta due on various dates through 2018 with a weighted average interest rate of 4.43%. Certain of these advances are subject to call provisions. Call provisions are more likely to be exercised by the FHLB when rates rise. At September 30, 2006, the Company had excess collateral pledged to the FHLB which would support additional FHLB advance borrowings of $69.3 million. See Note 9 of the Notes to Consolidated Financial Statements of the 2006 Annual Report to Stockholders for further information on the call provisions of various FHLB advances.

          The FHLB of Atlanta functions as a central reserve bank providing credit for financial institutions and certain other member financial institutions. As a member, Coastal Federal is required to own capital stock in the FHLB of Atlanta and is authorized to apply for advances on the security of such stock and certain of its mortgage loans, certain commercial real estate loans, and other assets (principally securities which are obligations of, or guaranteed by, the United States) provided certain standards related to creditworthiness have been met. The FHLB of Atlanta determines specific lines of credit for each member institution.

          The Bank also may borrow funds under reverse repurchase agreements pursuant to which it sells securities (generally secured by government securities and mortgage-backed securities) under an agreement to buy them back at a specified price at a later date. These agreements to repurchase are deemed to be borrowings collateralized by the securities sold. At September 30, 2006, the Company had excess available collateral consisting of investment securities and mortgage-backed securities to support additional borrowings of up to $129.0 million, as well as a federal funds line available of $20.0 million.

          The Company had $15.5 million of junior subordinated debentures outstanding on September 30, 2006. For more information on these debentures, please see Note 11 of the Notes to Consolidated Financial Statements in the 2006 Annual Report to Stockholders attached hereto and incorporated by reference.

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The following tables set forth certain information regarding short-term borrowings by the Bank at the end of and during the periods indicated:

	At September 30,
	2004			2005			2006
	(Dollars in thousands)
Outstanding balance:
Securities sold under agreements to repurchase:
Customer	$	12,931		$	31,937		$	42,095
Broker		94,242			10,000			30,000
Short-term FHLB advances (1)		147,500			88,177			102,810
Weighted average rate(at month end)paid on:
Securities sold under agreements to repurchase:
Customer		1.42	%		2.82	%		3.79	%
Broker		1.74			2.39			4.44
Short-term FHLB advances (1)		4.15			3.94			4.13
Maximum amount of borrowings outstanding At any month end:
Securities sold under agreements to repurchase:
Customer	$	12,931		$	39,317		$	76,706
Broker		184,129			109,958			30,000
Short-term FHLB advances (1)		159,735			216,200			140,727
Approximate average short-term borrowings outstanding with respect to:
Securities sold under agreements to repurchase:
Customer	$	9,033		$	27,498		$	42,754
Broker		134,809			73,723			19,632
Short-term FHLB advances (1)		103,360			146,150			107,661
Weighted average rate (year to date) paid on:
Securities sold under agreements to repurchase:
Customer		1.01	%		2.43	%		3.76	%
Broker		1.50			2.37			3.70
Short-term FHLB advances (1)		4.15			3.94			4.13

(1) Short-term FHLB advances include various advances which are subject to call by FHLB within one year.

Competition

          As of June 30, 2006, the most recent date for which published data is available, Coastal Federal held the largest share of deposits, a 15.7% share, in Horry County, S.C. according to the Federal Deposit Insurance

20

Corporation. Coastal Federal also held the third highest market share of deposits in Brunswick County, N.C. with an 8.7% share. The Bank faces strong competition in the attraction of deposits (its primary source of lendable funds) and in the origination of loans. Its most direct competition for deposits and loans has historically come from other financial institutions located in its primary market area. The Bank estimates that there are 115 offices of other financial institutions in Horry County, and 37 offices in Brunswick County. Particularly in times of high interest rates, the Bank has faced additional significant competition for investors’ funds from short-term money market securities and other corporate and government securities. The Bank’s competition for loans comes principally from other financial institutions, mortgage banking companies and mortgage brokers.

Personnel

          As of September 30, 2006, the Company had 508 full-time Associates and 57 part-time Associates. The Associates are not represented by a collective bargaining unit. The Bank believes its relationship with its Associates is excellent.

REGULATION AND SUPERVISION

General

          As a savings and loan holding company, the Company is required by federal law to file reports with, and otherwise comply with, the rules and regulations of the Office of Thrift Supervision. The Bank is subject to extensive regulation, examination and supervision by the Office of Thrift Supervision, as its primary federal regulator, and the Federal Deposit Insurance Corporation, as the deposit insurer. The Bank is a member of the Federal Home Loan Bank System and, with respect to deposit insurance, of the Savings Association Insurance Fund managed by the Federal Deposit Insurance Corporation. The Bank must file reports with the Office of Thrift Supervision and the Federal Deposit Insurance Corporation concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. The Office of Thrift Supervision and/or the Federal Deposit Insurance Corporation conduct periodic examinations to test the Bank’s safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Office of Thrift Supervision, the Federal Deposit Insurance Corporation or the Congress, could have a material adverse impact on the Company, the Bank and their operations. Certain of the regulatory requirements applicable to the Bank and to the Company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to OTS regulated institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Bank and the Company.

Holding Company Regulation

          The Company is a nondiversified unitary savings and loan holding company within the meaning of federal law. Under prior law, a unitary savings and loan holding company, such as the Company, was not generally restricted as to the types of business activities in which it may engage, provided that the Bank continued to be a qualified thrift lender. See “Federal Savings Institution Regulation - QTL Test.” The Gramm-Leach-Bliley Act of 1999 provides that no company may acquire control of an OTS regulated institution after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies as described below. Further, the Gramm-Leach-Bliley Act specifies that existing savings and loan holding companies may only engage in such activities. The Gramm-Leach-Bliley Act, however, grandfathered the unrestricted authority for activities with respect to unitary savings and loan holding companies existing prior to May 4, 1999, so long as the Bank continues to comply with the QTL Test. The Company does qualify for the grandfathering. Upon any non-supervisory acquisition by the Company of another savings institution or savings bank that meets the qualified thrift lender test and is deemed to be a savings institution by the Office of Thrift Supervision, the Company would become a multiple savings and loan holding company (if the acquired institution is held as a separate subsidiary) and would generally be limited to activities permissible for bank holding companies under Section 4(c)(8)

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of the Bank Holding Company Act, subject to the prior approval of the Office of Thrift Supervision, and certain activities authorized by Office of Thrift Supervision regulation.

          A savings and loan holding company is prohibited from, directly or indirectly, acquiring more than 5% of the voting stock of another financial institution or savings and loan holding company, without prior written approval of the Office of Thrift Supervision and from acquiring or retaining control of a depository institution that is not insured by the Federal Deposit Insurance Corporation. In evaluating applications by holding companies to acquire savings institutions, the Office of Thrift Supervision considers the financial and managerial resources and future prospects of the Company and institution involved, the effect of the acquisition on the risk to the deposit insurance funds, the convenience and needs of the community and competitive factors.

          The Office of Thrift Supervision may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

          Although savings and loan holding companies are not currently subject to specific capital requirements or specific restrictions on the payment of dividends or other capital distributions, federal regulations do prescribe such restrictions on subsidiary savings institutions as described below. The Bank must notify the Office of Thrift Supervision 30 days before declaring any dividend to the Company. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the Office of Thrift Supervision and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.

          Acquisition of the Company. Under the Federal Change in Bank Control Act (“CIBCA”), a notice must be submitted to the Office of Thrift Supervision if any person (including a company), or group acting in concert, seeks to acquire 10% or more of the Company’s outstanding voting stock, unless the Office of Thrift Supervision has found that the acquisition will not result in a change of control of the Company. Under the CIBCA, the Office of Thrift Supervision has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that so acquires control would then be subject to regulation as a savings and loan holding company.

Sarbanes-Oxley Act of 2002

          The Sarbanes-Oxley Act of 2002, which implemented legislative reforms intended to address corporate and accounting fraud, restricts the scope of services that may be provided by accounting firms to their public company audit clients and any non-audit services being provided to a public company audit client will require preapproval by the company’s audit committee. In addition, the Sarbanes-Oxley Act requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the Securities and Exchange Commission, subject to civil and criminal penalties if they knowingly or willingly violate this certification requirement.

          Under the Sarbanes-Oxley Act, bonuses issued to top executives before restatement of a company’s financial statements are now subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirement plan “blackout” periods, and loans to company executives (other than loans by financial institutions permitted by federal rules and regulations) are restricted. The legislation accelerates the time frame for disclosures by public companies and changes in ownership in a company’s securities by directors and executive officers.

          The Sarbanes-Oxley Act also increases the oversight of, and codifies certain requirements relating to audit committees of public companies and how they interact with the company’s “registered public accounting firm.” Among other requirements, companies must disclose whether at least one member of the committee is a “financial expert” (as such term is defined by the Securities and Exchange Commission) and if not, why not.

          Although the Company has incurred additional expense in complying with the provisions of the Sarbanes-

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Oxley Act and the resulting regulations, management does not believe that such compliance had a material impact on results of operations or financial condition.

Federal Savings Institution Regulation

          Business Activities. Federal law and regulations govern the activities of federal savings banks. These laws and regulations delineate the nature and extent of the activities in which federal savings banks may engage. In particular, certain lending authority for federal savings banks, e.g., commercial, non-residential real property loans and consumer loans, is limited to a specified percentage of the institution’s capital or assets.

          Capital Requirements. The Office of Thrift Supervision capital regulations require their regulated institutions to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS examination rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system), and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The Office of Thrift Supervision regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.

          The risk-based capital standard for savings institutions requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the Office of Thrift Supervision capital regulation based on the risks believed inherent in the type of asset. Core (Tier 1) capital is defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus, and minority interests in equity accounts of consolidated subsidiaries less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.

          The OTS has authority to establish higher capital requirements where it determines that the circumstances of a particular institution require it. At September 30, 2006 the Bank met each of its capital requirements. See Note 14 of the Notes to Consolidated Financial Statements for further information.

          Prompt Corrective Regulatory Action. The Office of Thrift Supervision is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization. Generally, an institution that has a ratio of total capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core) capital to risk-weighted assets of less than 4% or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be “undercapitalized.” An institution that has a total risk-based capital ratio less than 6%, a Tier 1 capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be “significantly undercapitalized” and an institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be “critically undercapitalized.” Subject to a narrow exception, the Office of Thrift Supervision is required to appoint a receiver or conservator for an institution that is “critically undercapitalized.” The regulation also provides that a capital restoration plan must be filed with the Office of Thrift Supervision within 45 days of the date an institution receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Compliance with the plan must be guaranteed by any parent holding company. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The Office of Thrift Supervision could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.

          Insurance of Deposit Accounts. Deposits of Coastal Federal are insured by the Deposit Insurance Fund

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(“DIF”) of the FDIC. The FDIC determines insurance premiums based on a number of factors, primarily the risk of loss that insured institutions pose to the DIF. Recent legislation eliminated the minimum 1.25% reserve ratio for the insurance funds, the mandatory assessments when the ratio falls below 1.25% and the prohibition on assessing the highest quality banks when the ratio is above 1.25%. The FDIC has the ability to adjust the new insurance fund’s reserve ratio between 1.15% and 1.5%, depending on projected losses, economic changes and assessment rates at the end of a calendar year. The FDIC has adopted regulations that set assessment rates that took effect at the beginning of 2007. The new assessment rates for most banks vary between five cents and seven cents for every $100 of deposits. A change in insurance premiums could have an adverse effect on the operating expenses and results of operations of Coastal Federal. The Bank cannot predict what insurance assessment rates will be in the future. Assessment credits have been provided to institutions that paid high premiums in the past, and Coastal Federal will have credits of approximately $450,000 to offset premiums in 2007.

          Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OTS. The Bank does not know of any practice, condition or violation that might lead to termination of its deposit insurance.

          In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund.

          Loans to One Borrower. Federal law provides that OTS regulated institutions are generally subject to the limits on loans to one borrower applicable to national banks. Such an institution may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily marketable collateral. At September 30, 2006, the Bank’s limit on loans to one borrower was $21.1 million, and the Bank’s largest aggregate outstanding balance of loans to one borrower was $15.6 million.

          QTL Test. The Home Owners Loan Act requires OTS regulated institutions to meet a qualified thrift lender test. Under the test, such an institution is required to either qualify as a “domestic building and loan association” under the Internal Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12 month period.

          An institution that fails the qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a bank charter. As of September 30, 2006, the Bank met the qualified thrift lender test. Recent legislation has expanded the extent to which education loans, credit card loans and small business loans may be considered “qualified thrift investments.”

          Limitation on Capital Distributions. Office of Thrift Supervision regulations impose limitations upon all capital distributions by a regulated institution, including cash dividends, payments to repurchase its shares and payments to stockholders of another institution in a cash-out merger. Under the regulations, an application to and the prior approval of the Office of Thrift Supervision is required prior to any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under Office of Thrift Supervision regulations (i.e., generally, examination ratings in the two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with Office of Thrift Supervision. If an application is not required, the institution must still provide prior notice to Office of Thrift Supervision of the capital distribution if, like the Bank, it is a subsidiary of a holding company. In the event the Bank’s capital fell below its regulatory requirements or the Office of Thrift Supervision notified it that it was in need of more than normal supervision, the Bank’s ability to make capital distributions could be restricted. In addition, the Office of Thrift Supervision could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the Office of Thrift Supervision determines that such distribution would constitute an unsafe or unsound practice.

          Assessments. OTS regulated institutions are required to pay assessments to the Office of Thrift Supervision to fund the agency’s operations. The general assessments, paid on a semi-annual basis, are computed upon the

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institution’s total assets, including consolidated subsidiaries, as reported in the Bank’s latest quarterly thrift financial report. The assessments paid by the Bank for the fiscal year ended September 30, 2006 totaled $289,000.

          Transactions with Related Parties. The Bank’s authority to engage in transactions with “affiliates” (e.g., any company that controls or is under common control with an institution, including the Company and its non-OTS regulated institution subsidiaries) is limited by federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the institution’s capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type described in federal law. The purchase of low quality assets from affiliates is generally prohibited. The transactions with affiliates must be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, OTS regulated institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no such institution may purchase the securities of any affiliate other than a subsidiary.

          The Bank’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities such persons control, is also governed by federal law. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. Recent legislation created an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. The law limits both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank’s capital position and requires certain board approval procedures to be followed.

          Enforcement. The Office of Thrift Supervision has primary enforcement responsibility over their regulated institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order, to removal of officers and/or directors, to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. The Federal Deposit Insurance Corporation has the authority to recommend to the Director of the Office of Thrift Supervision that enforcement action to be taken with respect to a particular regulated institution. If the Director does not take action, the Federal Deposit Insurance Corporation has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.

          Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the Office of Thrift Supervision determines that a regulated institution fails to meet any standard prescribed by the guidelines, the Office of Thrift Supervision may require the institution to submit an acceptable plan to achieve compliance with the standard.

Federal Home Loan Bank System

          The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. The Bank, as a member of the Federal Home Loan Bank, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank in an amount at least equal to $500, 1.0% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the Federal Home Loan Bank, whichever is greater. The Bank was in compliance with this requirement with an investment in Federal Home Loan Bank stock of $20.3 million at September 30, 2006.

          The Federal Home Loan Banks are required to provide funds for the resolution of insolvent thrifts in the late 1980s and to contribute funds for affordable housing programs. These requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on

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future Federal Home Loan Bank advances increased, the Bank’s net interest income would likely also be reduced. Recent legislation has changed the structure of the Federal Home Loan Banks funding obligations for insolvent thrifts, revised the capital structure of the Federal Home Loan Banks and implemented entirely voluntary membership for Federal Home Loan Banks. Management cannot predict the effect that these changes may have with respect to its Federal Home Loan Bank membership.

Federal Reserve System

          The Federal Reserve Board regulations require OTS regulated institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts up to and including $47.6 million; a 10% reserve ratio is applied above $47.6 million. The first $7.0 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The amounts are adjusted annually. The Bank complies with the foregoing requirements.

Privacy Requirements of the GLBA

          The Gramm-Leach-Bliley Act of 1999 provides for sweeping financial modernization for commercial banks, savings banks, securities firms, insurance companies, and other financial institutions operating in the United States. Among other provisions, the Gramm-Leach-Bliley Act places limitations on the sharing of consumer financial information with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of personal financial information with unaffiliated third parties.

Anti-Money Laundering

          The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (referred to as the “USA PATRIOT Act”) significantly expands the responsibilities of financial institutions, including savings and loan associations, in preventing the use of the U.S. financial system to fund terrorist activities. Title III of the USA PATRIOT Act provides for a significant overhaul of the U.S. anti-money laundering regime. Among other provisions, it requires financial institutions operating in the United States to develop new anti-money laundering compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control Regulations. Management has established policies and procedures to ensure compliance with the USA PATRIOT Act’s provisions, and the impact of the USA PATRIOT Act on our operations has not been material.

Other Regulations

          Interest and other charges collected or contracted for by Coastal Federal are subject to state usury laws and federal laws concerning interest rates. Coastal Federal’s loan operations are also subject to federal laws applicable to credit transactions, such as the:

a.	Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
b.	Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
c.	Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
d.	Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;

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e.	Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and
f.	rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

The deposit operations of Coastal Federal also are subject to the:

g.	Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
h.	Electronic Funds Transfer Act and Regulation E promulgated thereunder, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and
i.	Check Clearing for the 21st Century Act (also known as “Check 21”), which, effective October 28, 2004, gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check.

TAXATION

Federal Taxation

          General. The Company and the Bank report their income via a consolidated return on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank’s reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Company.

          Tax Bad Debt Reserves. For discussion related to the Bank’s Tax Bad Debt Reserves, please refer to Note 12 of the Notes to Consolidated Financial Statements.

          Distributions. To the extent that the Bank makes “nondividend distributions” to the Company that are considered as made: (i) from the reserve for losses on qualifying real property loans, to the extent the reserve for such losses exceeds the amount that would have been allowed under the experience method; or (ii) from the supplemental reserve for losses on loans (“Excess Distributions”), then an amount based on the amount distributed will be included in the Bank’s taxable income. Nondividend distributions include distributions in excess of the Bank’s current and accumulated earnings and profits, distributions in redemption of stock, and distributions in partial or complete liquidation. However, dividends paid out of the Bank’s current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Bank’s bad debt reserve. Thus, any dividends to the Company that would reduce amounts appropriated to the Bank’s bad debt reserve and deducted for federal income tax purposes would create a tax liability for the Bank. The amount of additional taxable income attributable to an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if, the Bank makes a “nondividend distribution,” then approximately one and one-half times the amount so used would be includable in gross income for federal income tax purposes, assuming a 35% corporate income tax rate (exclusive of state and local taxes). See “Regulation” for limits on the payment of dividends by the Bank. The Bank does not intend to pay dividends that would result in a recapture of any portion of its tax bad debt reserve.

          Corporate Alternative Minimum Tax. The Code imposes a tax on alternative minimum taxable income (“AMTI”) at a rate of 20%. Generally, only 90% of AMTI can be offset by net operating loss carryovers. AMTI is increased by an amount equal to 75% of the amount by which the Bank’s adjusted current earnings exceeds its AMTI (prior to reduction for net operating losses).

          Dividends-Received Deduction and Other Matters. The Company may exclude from its income 100% of

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dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends-received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Company and the Bank will not file a consolidated tax return, except that if the Company or the Bank owns more than 20% of the stock of a corporation distributing a dividend, then 80% of any dividends received may be deducted.

          State Income Taxation. South Carolina has adopted the Code as it relates to OTS regulated institutions, effective for taxable years beginning after December 31, 1985. Coastal Federal is subject to South Carolina income tax at the rate of 6% and North Carolina income tax at a rate of 6.9%. This rate of tax is imposed on OTS regulated institutions in lieu of the general state business corporation income tax.

          For information regarding income taxes payable by Coastal Federal, see Note 12 of the Notes to Consolidated Financial Statements.

          Audits. There have not been any audits of the Company’s federal or state income tax returns during the past five years.

Item 1.A. Risk Factors

          Investing in our common stock involves various risks which are particular to our Company, our industry and our market area. Several risk factors regarding investing in our common stock are discussed below. This listing should not be considered as all-inclusive. If any of the following risks were to occur, we may not be able to conduct our business as currently planned and financial condition or operating results could be negatively impacted. These matters could cause the trading price of our common stock to decline in future periods.

•	We are geographically concentrated along the coastlines of South Carolina and North Carolina. Changes in local economic conditions and catastrophic weather could have a significantly adverse impact on our profitability.
	We operate primarily along the coastlines of South Carolina and North Carolina and substantially all of our loan customers and most of our deposits and other customers live or have operations in these areas. Accordingly, our success significantly depends upon the growth in population, income levels, deposits and housing starts in the region, along with continued attraction of business ventures to the area. Our profitability is impacted by changes in economic conditions, particularly changes in the real estate and tourism industries. Exposure to changes in tourism or the real estate market, whether due to changing economic conditions or catastrophic weather, could reduce our growth rate, affect the ability of our customers to repay their loans to us, and generally affect our financial condition and results of operations.
•	If our loan customers do not pay us as they have contracted to, we may experience losses.
	Our principal revenue producing business is making loans. If our customers do not repay the loans, we will suffer losses. Even though we maintain an allowance for loan losses, the amount of the allowance may not be adequate to cover the losses we experience. We attempt to mitigate this risk by a thorough review of creditworthiness of loan customers. Nevertheless, there is risk that our credit evaluation will prove to be inaccurate due to changed circumstances or otherwise.
•	Fluctuations in interest rates could reduce our profitability.
	Changes in interest rates may affect our level of interest income, the primary component of our gross revenue, as well as the level of our interest expense. Interest rate fluctuations are caused by many factors which, for the most part, are not under our direct control. For example, national monetary policy plays a significant role in the determination of interest rates. Additionally, competitor pricing and the resulting negotiations that occur with customers also impact the rates we collect on loans and the rates we pay on deposits.
	As interest rates change, we expect we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market rates should move contrary to our position, this “gap” may work against us, and our earnings may be negatively affected.

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	Changes in the level of interest rates also may negatively affect our ability to originate real estate loans, the value of our assets and our ability to realize gains from the sale of our assets, all ultimately affect our earnings. A decline in the market value of our assets may limit our ability to borrow additional funds. As a result, we could be required to sell some of our loans and investments under adverse market conditions, upon terms that are not favorable to us, in order to maintain our liquidity. If those sales are made at prices lower than the amortized cost of the investments, we will incur losses.
•	The banking industry is highly competitive.
	The banking industry in our market area is highly competitive. We compete with many different financial and financial services institutions. A substantial number of the banks in our market area are branches or subsidiaries of much larger organizations affiliated with statewide, regional, or national banking companies, and as a result, may have greater resources and lower costs of funds. These competitors aggressively solicit customers within their market area by advertising through direct mail, electronic media and other means. These competitors may offer services, such as international banking services, that we can offer only through correspondents, if at all. Additionally, larger competitors have greater capital resources and, consequently, higher lending limits.
•	We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects.
	Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge and experience in the South Carolina banking industry. The process of recruiting personnel with a combination of skills and attributes required to carryout our strategies is often lengthy. Our success depends, to a significant degree, upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel. We are dependent upon a number of key executives who are integral to implementing our business plan. The loss of the services of any one of our senior executive management team or other key executives could have a material adverse effect on our business, financial condition, results of operations and cash flows.
•	Provisions in our articles of incorporation and Delaware law may discourage or prevent takeover attempts, and these provisions may have the effect of reducing the market price of our stock.
	Our articles of incorporation include several provisions that may have the effect of discouraging or preventing hostile takeover attempts, and therefore, making the removal of incumbent management difficult. The provisions include staggered terms for our board of directors and requirements of supermajority votes to approve certain business transactions. In addition, Delaware law contains several provisions that may make it more difficult for a third party to acquire control of us without the approval of the board of directors, and may make it more difficult or expensive for a third party to acquire a majority of our outstanding stock. To the extent that these provisions are effective in discouraging or preventing takeover attempts, they may tend to reduce the market price for our stock.
•	We are subject to governmental regulations which could change and increase our cost of doing business or have an adverse effect on our business.
	We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies. Our compliance with the requirements of these agencies is costly and may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged and location of offices. We are also subject to capitalization guidelines established by federal authorities and our failure to meet those guidelines could result, in an extreme case, in our bank being placed in receivership. Supervision, regulation and examination of banks and bank holding companies by financial institution regulatory agencies are intended for the protection of depositors and our other customers rather than the holders of our common stock.
•	Changes in accounting standards could impact reported earnings.
	The accounting standard setters, including FASB, SEC and other regulatory bodies, periodically change financial accounting and reporting standards that govern the preparation of our consolidated statements. These changes can be hard to predict and can materially impact how the Company records and reports its

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	financial condition and results of operations. In some cases, we could be required to apply a new or revised accounting standard retroactively, resulting in the restatement of prior period financial statements.
•	We are susceptible to changes in monetary policy and other economic factors which may adversely affect our ability to operate profitably.
	Changes in governmental, economic and monetary policies may affect the ability of our bank to attract deposits and make loans. The rates of interest payable on deposits and chargeable on loans are affected by governmental regulation and fiscal policy as well as by national, state and local economic conditions. All of these matters are outside of our control and affect our ability to operate profitably.
•	The preparation of financial statements requires the use of estimates that may vary from actual results.
	Preparation of consolidated financial statements in conformity with accounting principles accepted in the United States of America requires management to make significant estimates that affect the financial statements. One of our most critical estimates is the level of the allowance for loan losses. Due to the inherent nature of this estimate, we cannot provide absolute assurance that we will not significantly increase allowances for losses that are significantly higher than the provided allowance.
•	We rely on communications, information, operating and financial control systems, and technology from third-party service providers, and we may suffer an interruption in those systems that may result in lost business. Further, we may not be able to substitute providers on terms that are as favorable if our relationships with our existing service providers are interrupted.
	We rely heavily on third-party service providers for much of our communications, information, operating and financial controls systems, and technology. Any failure or interruption or breach in security of these systems could result in failures or interruptions in our customer relationships management, general ledger, deposit, servicing and/or loan origination systems. We cannot assure you that such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. The occurrence of any failure or interruption could have a material adverse effect on our business, financial condition, results of operations and cash flows. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to locate alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing systems, without the need to expend substantial resources, if at all. Any of these circumstances could have a material adverse effect on our business, financial condition, results of operations and cash flows.
•	If the business continuity and disaster recovery plans that we have in place are not adequate to continue our operations in the event of a disaster, the business disruption can adversely impact our operations.
	External events, including terrorist or military actions, or an outbreak of disease, such as Asian Influenza, or “bird flu” and resulting political and social turmoil could cause unforeseen damage to our physical facilities or could cause delays or disruptions to operational functions, including information processing and financial market settlement functions. Additionally, our customers, vendors and counterparties could suffer from such events. Should these events affect us, or our customers, or vendors or counterparties with which we conduct business, our results of operations could be adversely affected.
•	From time to time, we are subject to claims and litigation from customers and other individuals.
	Whether such claims and legal actions are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us, they may result in significant financial liability and/or adversely affect the market perception of us and our products and services. Any financial liability or reputation damage could have a material adverse effect on our business and financial performance.
•	Even though our common stock is currently traded on the Nasdaq Stock Market, it has less liquidity than the average stock quoted on national stock exchanges.
	The trading volume in our common stock on the Nasdaq Stock Market has been relatively low when compared with larger companies on the Nasdaq National Market or national stock exchanges. As a result, it may be more difficult for stockholders to sell a substantial number of shares for the same price at which

30

	stockholders could sell a small number of shares. We also cannot predict the effect, if any, that future sales of our common stock in the market, or the availability of shares of common stock for sale in the market, will have on the market price of our common stock. We can give no assurance that sales of substantial amounts of common stock in the market, or the potential for large amounts of sales in the market, would not cause the price of our common stock to decline or impair our future ability to raise capital through sales of common stock. The market price of our common stock may fluctuate in the future, and these fluctuations may be unrelated to our performance. General market price declines or overall stock market volatility in the future could adversely affect the price of our common stock. Further, the current market price of our stock may not be indicative of future market prices.
•	Decline in home values in the Company’s markets could adversely impact results from operations.
	Like all banks, the Company is subject to the effects of any economic downturn, and in particular, a significant decline in home values in the Company’s markets could have a negative effect on the results of operations A significant decline in home values would likely lead to a decrease in new home equity loan originations and increased delinquencies and defaults in both the consumer home equity loan and the residential real estate loan portfolios and result in increased losses in these portfolios.
•	The Company is subject to federal and state income tax regulations.
	Income tax regulations are often complex and require interpretation. Changes in income tax regulations could negatively impact the Company’s results of operations. If the Company’s REIT affiliate fails to qualify as a REIT, or should states enact legislation taxing these or related entities, the Company will be subject to a higher consolidated effective tax rate. The REIT and related companies must meet specific provisions of the Internal Revenue Code (“IRC”) and state tax laws. If these companies fail to meet any of the required provisions of the federal and state tax laws, tax expense could increase. Use of these companies is and has been the subject of federal and state audits. See “Management’s Discussion and Analysis of Operations-Income Taxes” for additional information.
•	The Company is subject to the USA Patriot and Bank Secrecy Acts.
	The USA Patriot and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury Department’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. During the past year, several banking institutions have received large fines for non-compliance with these laws and regulations. The Company has developed policies and procedures designed to ensure compliance.
•	Our common stock is not insured, so you could lose your total investment.
	Our common stock is not a deposit or savings account, and will not be insured by the Federal Deposit Insurance Corporation any other government agency. Should our business decline or fail, you could lose your total investment.

Item 1.B. Unresolved Staff Comments

          Not applicable.

Item 2. Properties

          The principal offices of the Company are located in a 25,000 square foot Main Office at 2619 Oak Street in Myrtle Beach, SC. This facility also houses Coastal Mortgage Bankers and Realty Co, Inc, Coastal Investor Services, a division of Coastal Federal Bank, and many corporate functions. Several of the Bank’s operations groups, including loan and deposit servicing, human resources, marketing, and residential lending administration, are in separate buildings owned and leased by the Bank in Myrtle Beach. The Bank also owns a facility in Conway, SC, which houses its Item Processing and Technology functions.

          At September 30, 2006, the Bank operated seventeen branches in South Carolina and seven branches in North

31

Carolina. Of these, two branches have land leases, four of the branches lease land and building and eighteen are owned.

          The net book value of the Company’s investment in office, properties and equipment totaled $29.9 million at September 30, 2006. See Note 6 of the Notes to Consolidated Financial Statements. Coastal Federal uses the services of an independent data processing service to process customer records and monetary transactions, post deposit and general ledger entries and record activity in installment lending, loan servicing and loan originations.

Item 3. Legal Proceedings

          The Company is not a defendant in any lawsuits. The subsidiaries are defendants in lawsuits arising out of the normal course of business. Based upon current information received from counsel representing the subsidiaries in these matters, the Company believes none of the lawsuits would have a material impact on the Company’s financial status.

Item 4. Submission of Matters to a Vote of Security Holders

          Not Applicable.

PART II

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

          The information contained under the section captioned “Market for the Corporation’s Common Stock and Related Stockholder Matters” in the Corporation’s Annual Report to Stockholders for the Fiscal Year Ended September 30, 2006 (“Annual Report”) is incorporated herein by reference.

          The Company did not repurchase any of its outstanding shares of common stock during the quarter and year ended September 30, 2006.

Item 6. Selected Financial Data

          The information contained in the section captioned “Financial Highlights” in the Annual Report is incorporated herein by reference.

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

          The information contained in the section captioned “Management’s Discussion and Analysis” in the Annual Report is incorporated herein by reference.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

          The information contained in the section captioned “Interest Rate Risk Disclosure” in the Annual Report is incorporated herein by reference.

Item 8. Financial Statements and Supplementary Data

          The consolidated financial statements contained in the Annual Report which are listed under Item 14 herein are incorporated herein by reference.

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

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          The registrant has not, within the 24 months before the date of the most recent financial statements, changed its accountants, nor have there been any disagreements on accounting and financial disclosure.

Item 9A. Controls and Procedures

          The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no change in the Company’s internal control over financial reporting occurred during the year ended September 30, 2006 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Management’s annual report on internal control over financial reporting and the attestation report of the registered public accounting firm are incorporated herein by reference to the section captioned “Management’s Report on Internal Control over Financial Reporting” and “Report of Independent Registered Public Accounting Firm” in the annual report.

Item 9B. Other Information

          None.

PART III

Item 10. Directors and Executive Officers of the Registrant

          The information called for by Item 10 with respect to directors and Section 16 matters is set forth in the Registrant’s Proxy Statement for its 2007 Annual Meeting of Stockholders under the caption “Elections of Directors” and “ Section 16(a) Beneficial Ownership Reporting Compliance”, respectively, and is hereby incorporated by reference. The information called for by Item 10 with respect to the identification of the members of the Registrant’s Audit Committee and the presence of an audit committee financial expert is set forth in the Registrant’s Proxy Statement for the 2007 Annual Meeting of Stockholders under the captions “Committees of the Board of Directors” and is hereby incorporated by reference.

          Certain executive officers of the Bank also serve as executive officers of the Company. The day-to-day management duties of the executive officers of the Company and the Bank relate primarily to their duties as to the Bank. The executive officers of the Company and the Bank are elected annually by the respective Boards of Directors and hold office until their successors have been elected and qualified or until they are removed from office.

33

Executive Officers of the Registrant
Name, Age and Position	Business Experience
Michael C. Gerald, 57 President, Chief Executive Officer and a Director	Mr. Gerald has been associated with Coastal Federal since 1974 and serves as Director, President and Chief Executive Officer of the Corporation and Bank. Mr. Gerald also serves as Director and President of Coastal Mortgage Bankers & Realty Company, Inc., as Director and President of Coastal Real Estate Investment Corporation, and as a Director of Coastal Retirement, Estate and Tax Planners, Inc. He currently serves on the Board of Visitors of Coastal Carolina University’s Wall School of Business, as Chairman of the Board of Directors of the Waccamaw Community Foundation, on the Board of Directors of the Coastal Education Foundation, and on the Board of Trustees of the USC Business Partnership Foundation.
Jimmy R. Graham, 58, Executive Vice President and Chief Operations Officer	Mr. Graham serves as Executive Vice President and Chief Operations Officer of Coastal Federal. Mr. Graham serves as Executive Vice President of Coastal Financial Corporation. He has been associated with the bank since 1977.
Jerry L. Rexroad, CPA, 46, Executive Vice President and Chief Financial Officer	Mr. Rexroad joined the Company in April 1995 and is Executive Vice President and Chief Financial Officer of Coastal Federal and Coastal Financial Corporation. Mr. Rexroad also serves as the Chief Financial Officer and a Director for Coastal Mortgage Bankers & Realty Company, Inc., Coastal Investor Services, Inc., Coastal Planners Holding Corporation, Coastal Retirement Estate and Tax Planners, Coastal Real Estate Investment Corporation and President of Coastal Federal Holding Corporation. He is a Past Chairman of the Board of Directors for Junior Achievement of Horry County as well as Past Chairman of the Board of Directors for Junior Achievement of Greenville. Mr. Rexroad is a Director of PowerHouse Ministries, Inc. and Chairman of the Board of Deacons at Grand Strand Baptist Church. He is a certified public accountant, and is a member of the AICPA and SCACPA. Prior to joining the Company, Mr. Rexroad was a partner with KPMG LLP where he was partner in charge of the Financial Institutions practice in South Carolina.
Phillip G. Stalvey, 50, Executive Vice President and Banking Group Leader	Mr. Stalvey is Executive Vice President and Banking Group Leader for the Bank. He also serves as an Executive Vice President of the Corporation and is a director of Coastal Investor Services, Inc. He has been associated with Coastal Federal for the past 25 years. In addition, Mr. Stalvey is a member of the Florence Stake Presidency with his Church and a member of the Myrtle Beach Air Force Base Redevelopment Authority.
Steven J. Sherry, 55 Executive Vice President and Director of Marketing	Mr. Sherry joined the Company in May 1998 and is Executive Vice President and Director of Marketing for the Bank. He also serves as Executive Vice President and Chief Marketing Officer for Coastal Financial Corporation. He is active with a variety of local community groups and serves as the Chairman of the Board of Trustees of the Franklin G. Burroughs-Simeon B. Chapin Art Museum. Mr. Sherry holds numerous achievement awards for marketing and advertising.

34

Susan J. Cooke, 56 Senior Vice President and Corporate Secretary

Ms. Cooke is Senior Vice President and Corporate Secretary for Coastal Federal and for Coastal Financial Corporation, Corporate Secretary for Coastal Mortgage Bankers & Realty Company, Inc., and Coastal Investor Services, Inc. Ms. Cooke has been employed with Coastal Federal for nineteen years. She is a member of the American Society of Corporate Secretaries, Inc. and the National Association for Female Executives.

Robert D. Douglas, 47 Executive Vice President Human Resources/Coastal Federal University Group

Mr. Douglas joined the corporation in June 1994 and serves as Executive Vice President of the Bank and Coastal Financial Corporation. He previously served as Chairman of the Human Resources Committee of the South Carolina Community Bankers Association. He has served on various advisory committees for the Horry County Drug and Alcohol Commission, the South Carolina Employment Security Commission, Coastal Carolina University and Horry Georgetown Technical College, and the Grand Strand Area Chamber of Commerce. He is a member of the Coastal Organization for Human Resources Management and serves as a member of Coastal Carolina University Career Services Advisory Board. He also serves on the Board of Directors for the Coastal Samaritan Counseling Center and is Chairman of the Finance Committee.

          The Company has adopted a Code of Ethics, a copy of which is incorporated by reference to the September 30, 2003 Form 10-K filed on December 22, 2003. The Company is required to disclose any amendments to or waivers from the Code of Ethics in a report on Form 8-K.

Item 11. Executive Compensation

          The information contained under the section captioned “Proposal I –- Election of Directors –- Executive Compensation” in the Proxy Statement is incorporated herein by reference.

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

(a)	Security Ownership of Certain Beneficial Owners
	Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” of the Proxy Statement.
(b)	Security Ownership of Management
	Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” of the Proxy Statement.
(c)	Management of the Corporation knows of no arrangements, including any pledge by any person of securities of the Corporation, the operation of which may at a subsequent date result in a change in control of the registrant.

35

(d) Equity Compensation Plan Information as of September 30, 2006

Plan Category (a)	Number of securities to be issued upon exercise of outstanding options, warrants and rights (b)		Weighted-average price of outstanding options, warrants and rights (c)			Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (d)
Equity compensation plans approved by security holders		2,748,630		$	8.07		127,920
Equity compensation plans not approved by security holders		N/A			N/A		N/A
Total		2,748,630		$	8.07		127,920

Item 13. Certain Relationships and Related Transactions

          The information required by this item is incorporated herein by reference to the section captioned “Transactions with Management” in the Proxy Statement.

Item 14. Principal Accountant Fees and Services

          The information required by this item is incorporated herein by reference to the section captioned “Auditing and Related Fees” in the Proxy Statement.

PART IV

Item 15. Exhibits and Financial Statement Schedules

1.	Report of Independent Registered Public Accounting Firm (1)
2.	All Financial Statements (1)
	(a)	Consolidated Statements of Financial Condition as of September 30, 2005 and 2006.
	(b)	Consolidated Statements of Operations for the Years Ended September 30, 2004, 2005 and 2006.
	(c)	Consolidated Statements of Stockholders’ Equity and Comprehensive Income for the Years Ended September 30, 2004, 2005 and 2006.
	(d)	Consolidated Statements of Cash Flows for the Years Ended September 30, 2004, 2005 and 2006.
	(e)	Notes to Consolidated Financial Statements.
3.	All Schedules have been omitted, as the required information is either inapplicable or included in the Notes to consolidated Financial Statements.
4.	Exhibits

36

3	(a)	Certificate of Incorporation of Coastal Financial Corporation (1)
3	(b)	Certificate of Amendment to Certificate of Incorporation of Coastal Financial Corporation (5)
3	(c)	Certificate of Amendment to Certificate of Incorporation of Coastal Financial Corporation (7)
3	(d)	Bylaws of Coastal Financial Corporation (1)
10	(a)	Employment Agreement with Michael C. Gerald (7)
	(b)	Employment Agreement with Jerry L. Rexroad (7)
	(c)	Employment Agreement with Phillip G. Stalvey (7)
	(d)	Employment Agreement with Steven J. Sherry (7)
	(e)	Employment Agreement with Jimmy R. Graham (7)
	(f)	1990 Stock Option Plan (2)
	(g)	Directors Performance Plan (3)
	(h)	2000 Stock Option Plan (4)
13	Annual Report to Stockholders for the Fiscal Year Ended September 30, 2006
14	Code of Ethics (6)
21	Subsidiaries of the Registrant
23	Consent of Independent Registered Public Accounting Firm
31	1	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31	2	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32	1	Section 1350 Certification of Chief Executive Officer
32	2	Section 1350 Certification of Chief Financial Officer

(1)	Incorporated by reference to Registration Statement on Form S-4 filed with the Securities and Exchange Commission on November 26, 1990.
(2)	Incorporated by reference to 1995 Form 10-K filed with the Securities and Exchange Commission on December 29, 1995.
(3)	Incorporated by reference to the proxy statement for the 1996 Annual Meeting of Stockholders.
(4)	Incorporated by reference to the proxy statement for the 2000 Annual Meeting of Stockholders.
(5)	Incorporated by reference to the March 31, 1998 Form 10-Q filed with the Securities and Exchange Commission on May 15, 1998.

37

(6)	Incorporated by reference to the September 30, 2003 Form 10-K filed with the Securities and Exchange Commission on December 22, 2003.
(7)	Incorporated by reference to the March 31, 2006 Form 10-Q filed with the Securities and Exchange Commission on May 10, 2006.

38

SIGNATURES

Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
		COASTAL FINANCIAL CORPORATION
Date: December 14, 2006	By:	/s/ Michael C. Gerald
		Michael C. Gerald
		President/Chief Executive
		Officer
		(Duly Authorized Representative)

39

	Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By:	/s/ Michael C. Gerald	By:	/s/ Jerry L. Rexroad
	Michael C. Gerald President/Chief Executive Officer And a Director (Principal Executive Officer)		Jerry L. Rexroad Executive Vice President And Chief Financial Officer (Principal Financial and Accounting Officer)
Date:	December 14, 2006		December 14, 2006
By:	/s/ James T. Clemmons	By:	/s/ Frank A. Thompson, II
	James T. Clemmons Chairman of the Board		Frank A. Thompson, II Director
Date:	December 14, 2006	Date:	December 14, 2006
By:	/s/ William O. Marsh	By:	/s/ James P. Creel
	William O. Marsh Director		James P. Creel Director
Date:	December 14, 2006	Date:	December 14, 2006
By:	/s/ G. David Bishop	By:	/s/ James H. Dusenbury
	G. David Bishop Director		James H. Dusenbury Director
Date:	December 14, 2006	Date:	December 14, 2006
By:	/s/ E. Lawton Benton	By:	/s/ J. Robert Calliham
	E. Lawton Benton Director		J. Robert Calliham Director
Date:	December 14, 2006	Date:	December 14, 2006
By:	/s/ W. Cecil Worsley, III
	W. Cecil Worsley, III Director
Date:	December 14, 2006

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EX-13

EXHIBIT 13

ANNUAL REPORT TO STOCKHOLDERS FOR THE

FISCAL YEAR ENDED SEPTEMBER 30, 2006

COASTAL FINANCIAL CORPORATION

2006 ANNUAL
REPORT

The Guiding Vision of Coastal Financial Corporation QUEST FOR EXCELLENCE

Remarkable Progress Toward
Transforming Our Very Good Organization
Into An Exceptional Organization
Through the extraordinary execution of
The Experience of FANtastic! Customer Service

Thanks to the most incredible group of Associates imaginable, 2006 was another exciting, fast-paced and successful year for Coastal Financial Corporation.

2006 marked the 13^th year since the introduction of our QUEST FOR EXCELLENCE Business Model. This was a defining moment in our history, because it launched us on a never-ending journey toward the Transformation Of Our Very Good Organization Into An Exceptional Organization.

The Mission Statement element of that foundation document clearly maps our journey with the statement “We are totally Committed to Exceeding the Expectations of our Customer,” and defines success in this journey as extraordinary execution of our Experience of FANtastic! Customer Service Model.

Coastal Financial Corporation’s continued success is the direct result of our laser-like focus on understanding and exceeding the expectations of our Customer. Over the years, our strong emphasis on continuously improving the Customer experience has inspired us to introduce an ever-increasing range of innovative products, services and convenience offerings. Several good examples are: 6 Day Branch Banking With Extended Operating Hours, Totally Free Business and Personal Checking With A Free Gift, Instantly Issued Debit Cards, and Penny Pavilion Totally Free Coin Counting For Customers and Non-Customers at every Branch. At Coastal Financial, we continuously push the Customer Service envelope because of our collective belief that nothing will ever be good enough for our Customers.

Due to the overwhelming response from the Businesses and residents of our Community to our launch of The Carolinas’ Most Convenient Bank in February of 2005, we continued to raise the bar during 2006 by taking even more steps to transform Coastal Financial into a financial services retailer. That is, a company that delivers a full range of banking services while maintaining the business hours and Customer focus of a successful retailer. This is in keeping with our strong belief that the best way to attract, retain and develop broad and durable Customer relationships is by actively competing for their business in the same aggressive way as the great retailers. Our approach involves reaching out to Customers with attractive promotions, offering a warm welcome and an inviting branch environment and consistently providing superior personal service that we call The Experience of FANtastic! Customer Service.

Over the sixteen years since becoming a publicly owned company, we have always viewed change and continuous improvement as essential to the accomplishment of Our Basic Corporate Objective Of Maximizing The Value Of Our Shareholders’ Investment and Our Long-Term Goal Of Being The Best Financial Services Company In Our Marketplace.

And, thanks to our incredible Associates and their extraordinary execution of The Experience of FANtastic! Customer Service Model, 2006 was certainly no exception. Our ever-increasing commitment to our QUEST FOR EXCELLENCE Business Model has enabled another year of exceptional progress toward The Transformation Of Our Very Good Organization Into An Exceptional Organization and produced outstanding results for our Shareholders.

The share price performance of Coastal Financial Corporation’s common stock has grown at a compounded annual rate of over 28% since 1990. The share price performance reflects all stock splits, stock dividends and reinvestment of cash dividends. These historical results may not be indicative of future stock price performance.

2

The following table sets forth certain information concerning the financial position of the Company (including data from operations of its subsidiaries) as of the dates and for the periods indicated. The consolidated data is derived from, and should be read in conjunction with, the Consolidated Financial Statements of the Company and its subsidiaries presented herein.

	At or for Years Ended September 30,
	2002			2003			2004			2005			2006
	(Dollars in thousands, except per share data)
Financial Condition Data:
Total assets	$	950,796		$	1,181,209		$	1,305,094		$	1,543,459		$	1,659,475
Loans receivable, net		536,851			682,737			790,730			924,260			1,088,231
Mortgage-backed securities		331,808			383,324			374,283			399,655			392,989
Cash, interest-bearing deposits and investment securities		27,816			37,484			62,304			127,141			88,252
Deposits		637,081			697,012			753,379			1,070,918			1,063,105
Borrowings		228,622			392,797			451,144			346,408			468,139
Stockholders’ equity		66,386			73,707			85,348			97,221			112,824
Operating Data:
Interest income	$	53,873		$	59,214		$	65,805		$	78,558		$	99,653
Interest expense		21,846			22,998			23,524			29,730			45,073
Net interest income		32,027			36,216			42,281			48,828			54,580
Provision for loan losses		1,235			2,655			1,750			1,697			1,385
Net interest income after provision for loan losses		30,792			33,561			40,531			47,131			53,195
Other Income:
Fees and service charges on loan and deposit accounts		3,148			3,489			3,771			6,137			9,385
Gain on sales of loans held for sale		1,462			2,985			1,523			1,201			1,176
Gain (loss) on sales of investment securities, net		102			—			(100	)		226			97
Gain (loss) on sales of mortgage-backed securities, net		238			469			(997	)		(551	)		(494	)
Gain (loss) from real estate operations		(137	)		(18	)		3			(76	)		3
Other income		3,326			3,983			4,971			5,587			6,898
Total other income		8,139			10,908			9,171			12,524			17,065
Total general and administrative expense		22,824			27,156			27,269			33,519			41,058
Income before income taxes		16,107			17,313			22,433			26,136			29,202
Income taxes		5,901			6,141			7,627			8,982			10,201
Net income	$	10,206		$	11,172		$	14,806		$	17,154		$	19,001
Net income per common diluted share	$	.48		$	.52		$	.67		$	.76		$	.85
Cash dividends per common share	$	.11		$	.12		$	.14		$	.16		$	.14
Weighted average shares outstanding diluted		21,319			21,647			22,128			22,465			22,406

All share and per share data have been restated as applicable to reflect 10% stock dividends declared on May 27, 2003, August 28, 2003, February 18, 2004, July 30, 2004, December 15, 2004, October 26, 2005, and August 24, 2006.

Key Operating Ratios:

The table below sets forth certain performance ratios of the Company at the dates or for the periods indicated.

	At or for Years Ended September 30,
	2002			2003			2004			2005			2006
Other Data:
Return on assets (net income divided by average assets)		1.23	%		1.04	%		1.18	%		1.20	%		1.18	%
Return on average equity (net income divided by average equity)		16.92	%		15.84	%		18.77	%		18.75	%		18.55	%
Average equity to average assets		7.29	%		6.59	%		6.31	%		6.38	%		6.36	%
Book value per share	$	3.22		$	3.55		$	4.04		$	4.54		$	5.20
Dividend payout ratio		21.77	%		23.20	%		19.91	%		19.54	%		15.51	%
Interest rate spread (difference between average yield on interest-earning assets and average cost of interest-bearing liabilities)		4.14	%		3.65	%		3.64	%		3.70	%		3.67	%
Net interest margin (net interest income as a percentage of average interest-earning assets)		4.24	%		3.67	%		3.64	%		3.69	%		3.66	%
Allowance for loan losses to total net loans at end of period		1.42	%		1.40	%		1.39	%		1.25	%		1.17	%
Ratio of non-performing assets to total assets (1)		0.48	%		0.77	%		0.51	%		0.22	%		0.21	%
Tangible capital ratio		6.57	%		7.14	%		7.44	%		7.25	%		7.78	%
Core capital ratio		6.57	%		7.14	%		7.44	%		7.25	%		7.78	%
Risk-based capital ratio		12.74	%		13.17	%		13.55	%		13.29	%		14.34	%

(1) Non-performing assets consist of nonaccrual loans 90 days or more past due and real estate acquired through foreclosure.

3

On behalf of our entire team at Coastal Financial Corporation, I am pleased to report that 2006 was another very good year.

It was also a year of continued growth and progress resulting from the extraordinary execution of the strategies emanating from our QUEST FOR EXCELLENCE Business Model.

Undergirding these efforts is our The Carolinas’ Most Convenient Bank initiative, which we first unveiled on February 25, 2005. The philosophy behind this new paradigm of banking in the Carolinas is simple: Because we are totally committed to Exceeding the Expectations of our Customer, we continually think of every possible way we can make banking easier for them – from making it quicker, more convenient and more accessible, to creating a fun and memorable experience. This mind-set has prompted us to offer 6 Day Branch Banking, holiday hours and extended weekday hours in all of our branches.

Our commitment to convenience is focused on meeting the busy schedules of our Customers. We also provide convenience by providing free services, like Totally Free Business and Personal Checking With A Gift, Totally Free Online Banking and Bill Pay, Instantly Issued Debit Cards and Totally Free Coin Counting by Penny Pavilion coin counters in every branch for both Customers and non-Customers alike. Then we top all that off by supporting our Customers with a Customer Service Center, which offers telephone support from real, live Customer Service Representatives from 7:30 am until 7:30 pm, Monday through Friday of each week and from 7:30 am until 1:30 pm on Saturday.

At the heart of our The Carolinas’ Most Convenient Bank initiative is Coastal Federal’s outstanding level of personal service, which is focused on giving every Customer The Experience of FANtastic! Customer Service during every Coastal Federal interaction, every day. We hold celebrations for our Front of the House and Heart of The House service award winners each month and bring our Penny Pavilion mascot to our branches and special events for guest appearances. We complement The Experience of FANtastic! Customer Service branch experience through Community programs like The Penny Pavilion “FLIERS” (Financial Literacy and Education Resources) initiative. This program teaches 4 year Kindergarten through 5^th grade students in the Horry County School district, more than 20,000 students in over 900 classrooms, the basics of money, economics and investing.

Every Friday at Coastal Federal is known as “Red Friday.” We feature those days to express our appreciation to our Customers and to demonstrate the “Passion and energy” we have for Customer Service by offering gifts to those Customers who dress in red (one of our primary Corporate colors).

The Coastal Federal Leadership team not only establishes the standards for our Customer Service Model, but they also personally take charge of managing for quality by working closely with our Associates to make The Experience of FANtastic! Customer Service a reality. Everyone in our Leadership Group works aggressively toward instilling a passion for Customer Service excellence by educating our Associates about our Customer Service Model and by providing recognition and rewards for those who inspire Customer praise. Our efforts have resulted in an inspired and passionate team which is rapidly developing a legend for Customer Service excellence.

Thanks largely to our laser-like focus on ensuring the consistent delivery of The Experience of FANtastic! Customer Service, in addition to achieving record results in Customer Satisfaction measurements, Core Deposits, Loans Receivable, Total Assets, Net Income and Share Price during 2006, we also witnessed a new level of genuinely caring conduct towards our Customers and each other.

Our progress this year elevated our confidence in and commitment to our QUEST FOR EXCELLENCE Business Model to new levels and also produced another year of exceptional financial results and noteworthy accomplishments:

• Coastal Financial Corporation’s net income for 2006 totaled $19.0 million, compared to $17.2 million in 2005. On a fully diluted basis, these results equated to a 11.8% increase, from $0.76 per share in 2005 to $0.85 per share in 2006. This growth was fueled by continued strong Core Deposit and loan growth and low credit loss expense.

• Customer Deposits, which are Total Deposits less Brokered Deposits, increased by approximately $8.8 million, or 1.0% to $910 million. Over the past three years, our average rate of Customer Deposit growth has been 10% per year.

• Loans grew by 16%, primarily reflecting our continued strong focus on the Business Banking element of our operations.

• Exceptional progress toward attainment of our quest for Exceeding the Expectations of Our Customer was reflected in the 7,489 independently conducted “Mystery Shops,” which produced an organizational score for the year of 92.6%. This outstanding result is the workproduct of our focus on giving every Customer The Experience of FANtastic! Customer Service during every Coastal Federal interaction, every day.

• We continued to raise the bar for Customer Service and Convenience in our marketplace with the following unique Community Service and Customer Convenience and Service offerings:

• The Penny FLIERS (Financial Literacy and Education Resources) Initiative - designed to teach the basics of

4

	money, economics and investing to K-4 through 5th Grade students throughout our Community.
•	Totally Free Business Checking With A Gift and Totally Free Online Banking and Bill Pay features
•	Instantly Issued Debit Cards – No more long waits for the arrival of a Debit Card upon opening a new account or losing a card. Coastal Federal Debit Cards are issued to Customers at the Branch during the account opening process, or replaced immediately upon a loss of a card.
•	The significant expansion of our Customer Service Center which offers our Customers telephone support from real, live Customer Service Representatives - no more confusing electronic commands to interpret and decipher. This service, which offers our Customers the ultimate in ease and convenience, is provided from 7:30 am until 7:30 pm, Monday through Friday and from 7:30 am until 1:30 pm on Saturday.
•	Our exceptional Branch Delivery Channel continued to expand to serve more of the Communities of coastal North and South Carolina. Since 1998, Coastal Federal has added 14 new branches to our rapidly growing network – 58 percent of our existing branches. During fiscal 2006, we opened the following new branch facilities:
		†	North Carolina:
			†	Oak Island
		†	South Carolina:
			†	Stephens Crossroad
			†	North Conway
			†	Hwy 544 West
			†	Hwy 544 – SayeBrook Village
•	Coastal Federal University significantly expanded both its teaching staff and curriculum offerings in support of Our Basic Corporate Objective of Maximizing The Value Of Our Shareholders’ Investment by making continual progress toward Our Long-Term Goal of Being The Best Financial Services Company In Our Marketplace. Each of our new Associates attends CFU’s Pledge To Excellence offering which introduces them to our QUEST FOR EXCELLENCE Business Model by taking a look back at our rich history and legacy and then a look forward by learning about our overriding focus on enriching the Customer experience through approaches such as The Experience of FANtastic! Customer Service and other initiatives designed to instill a passion for excellence.

Since 1990, our net income has increased at a compound annualized rate in excess of 17%.

Equally as important, since becoming a publicly owned company in 1990 Coastal Financial Corporation’s stock has grown at a compound annual rate of over 28%, taking our market capitalization from $4.6 million in October 1990, to $273.3 million at the close of this fiscal year. Put another way, an initial investment of $10,000 in October of 1990 would have grown to $543,000 at September 30, 2006.

One of the best indicators of performance is Return On Shareholders’ Equity, and this measure for 2006 was, again, outstanding. Our Return On Average Shareholders’ Equity of 18.6% ranks us among the top performing financial services companies in the United States.

Our own sense of satisfaction with these financial results during 2006 was augmented with continued public recognition of our progress toward the attainment of Our Basic Corporate Objective Of Maximizing The Value Of Our Shareholders’ Investment and Our Long-Term Goal Of Being The Best Financial Services Company In Our Marketplace. Consider these very good examples:

• Coastal Financial Corporation, for the 7^th consecutive year, was ranked the #1 Community Bank in the Carolinas by U. S. Banker Magazine, in its September 2006 publication. In this edition, U. S. Banker Magazine featured its Ranking of the Top 100 Publicly Traded Mid-Tier Banks. This ranking spotlighted banks with assets between $1 and $10 billion, based upon a 3-year average measure of Return On Average Equity. Coastal Financial Corporation was ranked 1st in the Carolinas and 20^th nationally in this listing.

• Coastal Federal Bank, for the ninth consecutive year, placed 1^st in voting by the readers of the (Myrtle Beach) SUN NEWS in the Financial Institutions category of the SUN NEWS Best Of The Beach Competition for 2006.

• Coastal Federal Bank, for the fifth consecutive year, placed 1^st in voting by the readers of the SUN NEWS in the Mortgage Company category of the SUN NEWS Best of the Beach Competition for 2006.

• Raymond James Financial Services, Inc., for the fifth consecutive year, placed 1^st in voting by the readers of the (Myrtle Beach) SUN NEWS in the Financial Planning category of the SUN NEWS Best Of The Beach Competition for 2006.

• The 2006 FDIC SUMMARY OF DEPOSITS REPORT, for the 6th consecutive year, ranked Coastal Federal Bank the leader in deposit market share for Horry County for the twelve months ended June 30, 2006. Coastal Federal Bank has enjoyed this top ranking for eight of the past eleven years. This report also showed that Coastal Federal Bank is ranked 3^rd in deposit market share for Brunswick County, North Carolina.

5

  

Our continued evolution toward the organization envisioned in our QUEST FOR EXCELLENCE Business Model has enabled the financial performance during fiscal 2006, which again met our high expectations

Noteworthy Financial Results for Fiscal 2006

DILUTED EARNINGS PER SHARE
•	Net income for 2006 totaled $19.0 million, compared to $17.2 million in 2005. On a fully diluted basis, these results equated to a 11.8% increase, from $0.76 per share in 2005 to $0.85 per share in 2006.

BOOK VALUE PER SHARE
•	Book value per share grew 14.5% to $5.20.
•	Shareholders’ equity advanced 16.0% to $112.8 million.

6

  

ASSETS
•	Total Assets increased 7.6%, from $1.5 billion to $1.7 billion, the highest level in the Company’s history.
•	Customer Deposits increased from $901.0 million to $909.8 million.
•	Net Loans increased 15.7%, from $942.4 million to $1,090.1 million.

NON-PERFORMING ASSETS TO TOTAL ASSETS
•	Non-performing Assets to Total Assets declined from 0.22% to 0.21%.

ALLOWANCE FOR LOAN LOSSES TO NET LOANS
•	Allowance for Loan Losses to Net Loans was 1.17%.
•	The Company had Net Loan Charge Offs as a percentage of Average Loans of 0.04% in 2006.

Our success in these key measures of performance is the result of the commitment, dedication and aligned effort of a truly outstanding group of Associates who share a passion for ensuring the consistent delivery of The Experience of FANtastic! Customer Service and continuously raising the bar in our quest to Exceed the Expectations of our Customer. This continuing trend of exceptional performance has been rewarded in the financial markets by a 4,166% increase in the price of our shares since becoming a public company in October of 1990, vs. 340% for the Standard & Poors 500 Index over the same period.

7

  

The momentum we have built since our conversion to public ownership has resulted from the methodical focus of our individual and collective efforts on accomplishing Our Basic Corporate Objective Of Maximizing The Value Of Our Shareholders’ Investment by working diligently toward the achievement of Our Long-Term Goal Of Being The Best Financial Services Company In Our Marketplace.

Over the past sixteen years, our compounded Shareholder return of 28% has, indeed, been impressive. In evaluating our progress toward the attainment of Our Basic Corporate Objective since becoming publicly owned in 1990, it is both informative and illustrative to compare the share price performance of Coastal Financial Corporation to the share price performance of other publicly traded financial services companies operating within our marketplace over that period, and to the financial markets as a whole.

In the following graphs, we have compared the share price performance of (CFCP) Coastal Financial Corporation to the Nasdaq, S&P 500 and Dow Indices, and to (TSFG) The South Financial Group, the parent company of Carolina First Bank, (WB) Wachovia Corporation, the parent company of Wachovia Bank, (SNV) Synovus Financial Corporation, the parent company of NBSC, (BBT) BB&T Corporation, the parent company of BB&T, (BAC) Bank of America Corporation, the parent company of Bank of America, (FFCH) First Financial Holdings, Inc., the parent company of First Federal Savings and Loan Association of Charleston and (COOP) Cooperative Bankshares, Inc., the parent company of Cooperative Bank.

As shown by these graphic representations, which take a look back over our history as a publicly owned company, the price of Coastal Financial Corporation’s shares has significantly outperformed the price of the shares of the other publicly traded financial services companies in our marketplace, as well as the Nasdaq, S&P 500 and Dow Indices.

16 Year Peer Group Price Performance

These historical results may not be indicative of future stock price performance.

CFCP Relative Price Performance

8

  

Albert Einstein once said, “The significant problems we face today cannot be solved at the same level of thinking we were at when we created them.”

Einstein was describing paradigms . . . the way individuals perceive, understand and interpret the surrounding world. Our culture, as a learning organization, embraces change as the catalyst for growth and progress. Consequently, we have learned that, if we want to achieve significant change, we must first change our paradigms.

Accordingly, as we began our Vision 2010 Strategic Planning Process in early 2003, we started by examining our existing paradigms about what the businesses and residents of our marketplace expected from their bank. This critical review process, together with the ensuing initiatives, resulted in the launch of The Carolinas’ Most Convenient Bank in February of 2005.

Over the past 18 months, our progress toward rebranding Coastal Federal in this manner has resonated with our Customers as a hallmark of exceptional convenience and phenomenal service. Through following our QUEST FOR EXCELLENCE Business Model, we have successfully leveraged our 53 year-old reputation by building systems and processes to ensure that every Customer, on every occasion, every day, always receives The Experience of FANtastic! Customer Service.

So, as you can see from this description of the growth and progress we experienced during this past year, our journey toward Transforming Coastal Financial From A Very Good Organization Into An Exceptional Organization proceeded nicely in 2006. However, as good as our results were, it is very important that we not lose sight of the fact that our efforts can never be viewed as a sprint to a well-defined finishing point, but rather as merely one more waypoint in a never-ending marathon.

SOUTH CAROLINA
1. Carolina Forest
2. Conway
3. Dunes
4. Hwy. 544 West
5. Little River
6. Loris
7. Murrells Inlet
8. Myrtle Beach/BI-LO
9. North Conway
10. North Myrtle Beach
11. Oak Street
12. Pawleys Island
13. SayeBrook
14. Socastee
15. Stephens Crossroads
16. Surfside
17. Waccamaw Medical Park
NORTH CAROLINA
18. Oak Island
19. Shallotte
20. Southport
21. Sunset Beach
22. Wilmington - Downtown
23. Wilmington - 17th Street
24. Wilmington - Oleander
	in North Carolina
25. Boiling Spring Lakes
	in South Carolina
26. Windy Hill

9

  

Fiscal 2007 will be a year of significant challenges. Coastal Federal, as well as the banking industry as a whole, is facing increasing headwinds in the forms of the inverted-to-flat yield curve, intense loan and deposit pricing competition, the rising costs of delivering Customer Service and Convenience and maintaining compliance with a rapidly escalating regulatory environment.

Our plan for addressing these challenges involves the continuation of our focus on attracting significant growth in both Business and Personal Checking Accounts and Checking Account based banking relationships, and in retaining and developing our Business and Personal banking relationships by remaining focused on our Mission of Exceeding the Expectations of our Customer.

Over the 13 years since its introduction in 1993, our ever-increasing commitment to our QUEST FOR EXCELLENCE Business Model has well positioned us for this ambitious quest. And, while we are very fortunate to be located in one of the best markets in America, and enjoy many competitive advantages, all of the success that has been achieved over these years is due to our exceptional Coastal Financial team. And we have the best team imaginable.

My sincere appreciation goes to our Board of Directors, Leadership Group and Associates. Their never-ending quest for improving the Customer experience enabled our 2006 results, and are a direct reflection of their commitment to Our Basic Corporate Objective Of Maximizing The Value Of Our Shareholders’ Investment by working diligently toward the achievement of Our Long-Term Goal Of Being The Best Financial Services Company In Our Marketplace.

All of us at Coastal Financial Corporation appreciate your continued encouragement, loyalty and support.

Michael C. Gerald
President and
Chief Executive Officer

10

Management’s Report on Internal Control Over Financial Reporting

The management of Coastal Financial Corporation and subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.

Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of September 30, 2006, utilizing the framework established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has determined that the Company’s internal control over financial reporting as of September 30, 2006 is effective.

Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of assets; and provide reasonable assurance that (i) transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States; (ii) receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the Company’s financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of September 30, 2006 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report.

11

Report of Independent Registered Public Accounting Firm

The Board of Directors
Coastal Financial Corporation:
Myrtle Beach, South Carolina

We have audited management’s assessment, included in the accompanying, Management’s Report on Internal Control Over Financial Reporting, that Coastal Financial Corporation and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of September 30, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of September 30, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial condition of Coastal Financial Corporation and subsidiaries as of September 30, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended September 30, 2006, and our report dated December 14, 2006, expressed an unqualified opinion on those consolidated financial statements. Our report refers to the fact that Coastal Financial Corporation and subsidiaries adopted, effective October 1, 2005, the provisions of Statement of Financial Accounting Standard No. 123R, Share-Based Payment.

Raleigh, North Carolina
December 14, 2006

12

Report of Independent Registered Public Accounting Firm

The Board of Directors
Coastal Financial Corporation:
Myrtle Beach, South Carolina

We have audited the accompanying consolidated statements of financial condition of Coastal Financial Corporation and subsidiaries (the “Company”) as of September 30, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended September 30, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial condition of the Company as of September 30, 2006 and 2005, and the results of its operations and its cash flows for each of the years in the three-year period ended September 30, 2006, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of September 30, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated December 14, 2006 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

As discussed in Note 1 to the consolidated financial statements, the Company adopted, effective October 1, 2005, the provisions of Statement of Financial Accounting Standard No. 123R, Share-Based Payment.

Raleigh, North Carolina
December 14, 2006

13

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Financial Condition
September 30, 2005 and 2006

	2005			2006
	(Dollars in thousands, except per share data)
ASSETS
Cash and amounts due from banks	$	52,592			31,055
Short-term interest-bearing deposits		33,742			5,797
Federal funds sold		5,191			103
Investment securities available for sale		25,616			39,300
Mortgage-backed securities available for sale		399,655			392,989
Investment securities held to maturity (market value of $10,049 at September 30, 2005 and $12,000 at September 30, 2006)		10,000			11,997
Loans receivable (net of allowance for loan losses of $11,748 at September 30, 2005 and $12,726 at September 30, 2006)		924,260			1,088,231
Loans receivable held for sale		18,121			1,853
Real estate acquired through foreclosure, net		818			571
Office property and equipment, net		22,758			29,926
Federal Home Loan Bank (FHLB) stock, at cost		15,775			20,291
Accrued interest receivable on loans		3,807			5,000
Accrued interest receivable on securities		2,351			2,898
Bank-owned life insurance		22,574			23,541
Other assets		6,199			5,923
	$	1,543,459			1,659,475
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits		1,070,918			1,063,105
Securities sold under agreements to repurchase		41,937			72,095
Advances from FHLB		289,007			380,580
Junior subordinated debt		15,464			15,464
Drafts outstanding		12,890			2,023
Advances by borrowers for property taxes and insurance		1,221			1,422
Accrued interest payable		3,415			4,718
Other liabilities		11,386			7,244
Total liabilities		1,446,238			1,546,651
Stockholders’ equity:
Serial preferred stock, 1,000,000 shares authorized and unissued		—			—
Common stock $.01 par value per share, 50,000,000 shares authorized; 21,403,241 shares at September 30, 2005 and 21,686,542 shares at September 30, 2006 issued and outstanding		214			217
Additional paid-in capital		11,391			12,856
Retained earnings, restricted		86,723			102,777
Accumulated other comprehensive loss, net of tax		(1,107	)		(3,026	)
Total stockholders’ equity		97,221			112,824
	$	1,543,459			1,659,475

See accompanying notes to consolidated financial statements.

14

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Operations
Years ended September 30, 2004, 2005 and 2006

	2004			2005			2006
	(In thousands, except share data)
Interest:
Loans receivable	$	46,765			56,826			75,932
Investment securities		2,886			4,971			6,934
Mortgage-backed securities		16,067			16,392			15,852
Other		87			369			935
Total interest income		65,805			78,558			99,653
Interest expense:
Deposits		10,024			14,079			26,743
Securities sold under agreements to repurchase		2,114			2,418			2,335
Advances from FHLB		10,724			12,341			14,803
Other borrowings		662			892			1,192
Total interest expense		23,524			29,730			45,073
Net interest income		42,281			48,828			54,580
Provision for loan losses		1,750			1,697			1,385
Net interest income after provision for loan losses		40,531			47,131			53,195
Other income:
Fees and service charges on deposit accounts		3,771			6,137			9,385
Income from ATM and debit card transactions		954			1,532			2,334
Income from sales of non-depository products		1,909			1,840			1,631
Gain on sales of loans and loans receivable held for sale		1,523			1,201			1,176
Gain (loss) on sales of investment securities, net		(100	)		66			97
Gain (loss) on sales of mortgage-backed securities, net		(997	)		(551	)		(494	)
Gain on call of investment securities held to maturity		—			160			—
Gain (loss) from real estate acquired through foreclosure		3			(76	)		3
Federal Home Loan Bank stock dividends		499			668			1,016
Bank-owned life insurance		962			948			967
Other income		647			599			950
Total other income		9,171			12,524			17,065
General and administrative expenses:
Salaries and employee benefits		16,099			18,460			22,242
Net occupancy, furniture and fixtures and data processing expense		4,001			4,844			6,784
Depreciation		2,175			2,757			3,561
FDIC insurance premium		104			108			137
FHLB prepayment penalties		77			—			—
Marketing expense		905			1,809			2,000
Expense from ATM and debit card transactions		630			1,039			1,399
Other expense		3,278			4,502			4,935
Total general and administrative expense		27,269			33,519			41,058
Income before income taxes		22,433			26,136			29,202
Income taxes		7,627			8,982			10,201
Net income	$	14,806			17,154			19,001
Net income per common share
Basic	$	0.71			0.81			0.88
Diluted	$	0.67			0.76			0.85
Dividends declared per common share	$	0.14			0.16			0.14
Average common shares outstanding
Basic		20,966,000			21,274,000			21,509,000
Diluted		22,128,000			22,465,000			22,406,000

See accompanying notes to consolidated financial statements.

15

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity and Comprehensive Income
Years ended September 30, 2004, 2005 and 2006

	Common Stock		Additional Paid-in Capital		Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Income			Total Stockholders’ Equity
	(In thousands)
Balance at September 30, 2003	$	209		10,155		63,030			(3,375	)		3,688			73,707
Exercise of stock options		3		432		(1,355	)		2,193			—			1,273
Cash dividends		—		—		(2,948	)		—			—			(2,948	)
Net income		—		—		14,806			—			—			14,806
Other comprehensive income, net of tax:
Unrealized losses arising during period, net of taxes of $1,330		—		—		—			—			(2,170	)		—
Less: reclassification adjustment for losses included in net income, net of tax benefit of $417		—		—		—			—			680			—
Other comprehensive loss		—		—		—			—			(1,490	)		(1,490	)
Comprehensive income		—		—		—			—			—			13,316
Balance at September 30, 2004		212		10,587		73,533			(1,182	)		2,198			85,348
Exercise of stock options		2		728		(603	)		1,182			—			1,309
Stock compensation related to accelerated vesting		—		76		—			—			—			76
Cash dividends		—		—		(3,361	)		—			—			(3,361	)
Net income		—		—		17,154			—			—			17,154
Other comprehensive income, net of tax:
Unrealized losses arising during period, net of taxes of $2,210		—		—		—			—			(3,606	)		—
Less: reclassification adjustment for losses included in net income, net of tax benefit of $184		—		—		—			—			301			—
Other comprehensive loss		—		—		—			—			(3,305	)		(3,305	)
Comprehensive income		—		—		—			—			—			13,849
Balance at September 30, 2005		214		11,391		86,723			—			(1,107	)		97,221
Exercise of stock options		3		1,374		—			—			—			1,377
Stock compensation expense, net of tax of $55		—		91		—			—			—			91
Cash dividends		—		—		(2,947	)		—			—			(2,947	)
Net income		—		—		19,001			—			—			19,001
Other comprehensive income, net of tax:
Unrealized losses arising during period, net of taxes of $1,327		—		—		—			—			(2,165	)		—
Less: reclassification adjustment for losses included in net income, net of tax benefit of $151		—		—		—			—			246			—
Other comprehensive loss		—		—		—			—			(1,919	)		(1,919	)
Comprehensive income		—		—		—			—			—			15,603
Balance at September 30, 2006	$	217		12,856		102,777			—			(3,026	)		112,824

See accompanying notes to consolidated financial statements.

16

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows
Years ended September 30, 2004, 2005 and 2006

	2004			2005			2006
	(In thousands)
Cash flows from operating activities:
Net income	$	14,806			17,154			19,001
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation		2,175			2,757			3,561
Provision for loan losses		1,750			1,697			1,385
Loss on sale of mortgage-backed securities available for sale		997			551			494
(Gain) loss on sale of investment securities available or sale		100			(66	)		(97	)
(Gain) on call of investment security called by issuer		—			(160	)		—
Loss on disposal of office properties and equipment		—			128			16
Stock-based compensation		—			76			146
Origination of loans receivable held for sale		(63,448	)		(81,207	)		(42,198	)
Proceeds from sales of loans receivable held for sale		27,453			18,704			18,012
Proceeds from securitization and sales of loans receivable held for sale		46,845			52,628			27,512
Loss on early extinguishment of debt		77			—			—
Tax benefit of stock options		(434	)		(394	)		(345	)
Increase in:
Cash value of life insurance		(962	)		(947	)		(967	)
Other assets		(536	)		(174	)		276
Accrued interest receivable		(1,018	)		(808	)		(1,740	)
Increase (decrease) in:
Accrued interest payable		239			1,913			1,303
Other liabilities		(125	)		4,627			(2,676	)
Net cash provided by operating activities		27,919			16,479			23,683
Cash flows from investing activities:
Proceeds from sales of investment securities available for sale		2,881			4,163			10,567
Proceeds from issuer call of investment securities available for sale		—			1,950			—
Proceeds from issuer call of investment securities held to maturity		—			8,000			—
Proceeds from maturities of investment securities available for sale		2,000			—			—
Purchases of investment securities available for sale		(11,866	)		(8,255	)		(24,110	)
Purchases of investment securities held to maturity		(7,840	)		(10,000	)		(1,997	)
Proceeds from sales of mortgage-backed securities available for sale		124,479			178,849			51,647
Purchases of mortgage-backed securities available for sale		(234,672	)		(312,217	)		(125,734	)
Principal collected on mortgage-backed securities available for sale		115,179			102,155			77,120
Origination of loans receivable, net		(513,858	)		(718,477	)		(758,558	)
Proceeds from sale of commercial loan participations		—			21,228			4,369
Proceeds from sale of credit card portfolio		—			—			3,618
Principal collected on loans receivable		403,501			560,469			597,228
Purchase of bank-owned life insurance		(4,500	)		—			—
Proceeds from sales of real estate acquired through foreclosure		1,456			1,521			1,176
Proceeds from sale of office properties and equipment		58			—			—
Purchases of office properties and equipment		(4,989	)		(6,800	)		(10,745	)
Change in FHLB stock, net		(2,909	)		1,125			(4,516	)
Net cash used in investing activities		(131,080	)		(176,289	)		(179,935	)
Cash flows from financing activities:
Increase (decrease) in deposits		56,367			317,539			(7,813	)
Increase (decrease) in securities sold under agreements to repurchase		(26,429	)		(65,236	)		30,158
Proceeds from FHLB advances		686,476			565,650			970,210
Repayment of FHLB advances		(602,083	)		(605,150	)		(878,637	)
Repayments of other borrowings, net		(81	)		—			—
Prepayment penalties on early extinguishment of debt		(77	)		—			—
Increase (decrease) in advance payments by borrowers for property taxes and insurance		(45	)		(529	)		201
Increase in drafts outstanding, net		148			10,098			(10,867	)
Cash dividends to stockholders and cash for fractional shares		(2,948	)		(3,361	)		(2,947	)
Proceeds from exercise of stock options		839			915			1,032
Tax benefit of stock options		434			394			345
Net cash provided by financing activities		112,601			220,320			101,682
Net increase (decrease) in cash and cash equivalents		9,440			60,510			(54,570	)
Cash and cash equivalents at beginning of year		21,575			31,015			91,525
Cash and cash equivalents at end of year	$	31,015			91,525			36,955
Supplemental information:
Interest paid	$	23,285			27,817			43,771
Income taxes paid	$	7,762			6,970			10,118
Supplemental schedule of non-cash investing and financing transactions:
Securitization of mortgage loans into mortgage-backed securities	$	46,845			52,628			27,512
Transfer of mortgage loans to real estate acquired through foreclosure	$	614			1,554			929
Increase in other assets and junior subordinated debt resulting from deconsolidation under FIN 46R	$	464			—			—

See accompanying notes to consolidated financial statements.

17

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

          The following is a summary of the more significant accounting policies used in the preparation and presentation of the accompanying consolidated financial statements. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions affect the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. In addition, they affect the reported amounts of income and expenses during the reporting period. Actual results could differ from these estimates and assumptions. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and income tax assets or liabilities. To a lesser extent, significant estimates are also associated with the valuation of derivative instruments and valuation of mortgage servicing rights.

(a) Principles of Consolidation

          The accompanying consolidated financial statements include the accounts of Coastal Financial Corporation (the “Company”), and its wholly-owned subsidiaries, Coastal Investor Services, Inc., Coastal Planners Holding Corporation (and Coastal Planners Holding Corporation’s wholly-owned subsidiary, Coastal Retirement, Estate and Tax Planners, Inc.), Coastal Federal Bank (the “Bank”) (and the Bank’s wholly-owned subsidiaries, Coastal Federal Holding Company (and Coastal Federal Holding Company’s wholly-owned subsidiary, Coastal Real Estate Investment Corporation)), and Coastal Mortgage Bankers and Realty Co., Inc. (and Coastal Mortgage Bankers and Realty Co. Inc.’s wholly-owned subsidiary, Sherwood Development Corporation).

          The Company also has an investment in Coastal Financial Capital Trust I, a statutory trust that is not consolidated in accordance with Financial Accounting Board Interpretation No. 46 (see Note 11).

          In consolidation, all significant intercompany balances and transactions have been eliminated. Coastal Financial Corporation is a unitary thrift holding company organized under the laws of the state of Delaware.

(b) Cash and Cash Equivalents

          For purposes of reporting cash flows, cash and cash equivalents include cash and amounts due from banks, short-term interest-bearing deposits and federal funds sold. Cash and cash equivalents have maturities of three months or less. Accordingly, the carrying amount of such instruments is considered to be a reasonable estimate of fair value.

(c) Investment and Mortgage-backed Securities

          Investment and mortgage-backed securities are accounted for in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities”. Investments are classified into three categories as follows: (1) Held to Maturity - debt securities that the Company has the positive intent and ability to hold to maturity, which are reported at amortized cost; (2) Trading - debt and equity securities that are bought and held principally for the purpose of selling them in the near term, which are reported at fair value, with unrealized gains and losses included in earnings and (3) Available for Sale - debt and equity securities that may be sold under certain conditions, which are reported at fair value, with unrealized gains and losses excluded from earnings and reported in accumulated other comprehensive income as a separate component of stockholders’ equity, net of income taxes.

          The Company determines investment and mortgage-backed securities classification at the time of purchase. Premiums and discounts on securities are accreted or amortized as an adjustment to income over the estimated life of the security using a method which approximates a level yield. Dividends and interest income are recognized when earned. Unrealized losses on securities, reflecting a decline in value judged by the Company to be other than temporary, are charged to income in the consolidated statements of operations.

          The cost basis of securities sold is determined by specific identification. Purchases and sales of securities are recorded on a trade date basis. The fair value of securities is based on quoted market prices or dealer quotes.

(d) Loans Receivable Held for Sale

          Mortgage loans originated and intended for sale in the secondary market, which generally consist of conforming fixed rate loans, are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are provided for in a valuation allowance by charges to operations. At September 30, 2005 and 2006, the Company had approximately $18.1 million and $1.9 million in mortgage loans held for sale, respectively. Gains or losses on sales of loans are recognized when control over these assets has been surrendered in accordance with SFAS No. 140, “Accounting for Transfer and Servicing of Financial Assets and Extinguishment of Liabilities” (“SFAS No. 140”).

18

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

(e) Loans Receivable

          Loans receivable are stated at unpaid principal balances adjusted for unamortized premiums and unearned discounts and deferred loan fees/costs. The Company recognizes interest income on loans using the simple interest method.

          The Company follows SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” for determining impairment on certain loans. SFAS No. 114 requires that nonhomogenous impaired loans and certain restructured loans be measured at the present value of expected future cash flows discounted at the loan’s effective interest rate, at the loan’s observable market price or at the fair value of the collateral if the loan is collateral dependent. A specific reserve, if deemed necessary, is set up for each impaired loan. Accrual of interest income on impaired loans is suspended when, in management’s judgment, doubt exists as to the collectibility of principal and interest. If amounts are received on impaired or restructured loans for which the accrual of interest has been discontinued, a determination is made as to whether payments received should be recorded as a reduction of the principal balance or as interest income depending on management’s judgment as to the collectibility of principal. The loan is returned to accrual status when, in management’s judgment, the borrower has demonstrated the ability to make periodic interest and principal payments on a timely basis.

          Loans are charged-off when the amount of loss is reasonably quantifiable and the loss is likely to occur. Commercial, consumer and mortgage loans are placed in nonaccrual status when they become 90 days delinquent or earlier if full collection of principal and interest becomes doubtful. Interest payments received after a loan is placed in nonaccrual are applied as a principal reduction until such time as the loan is returned to accrual status. Generally, loans are returned to accrual status when the loan is brought current and the ultimate collectibility of principal and interest is no longer in doubt. The Company maintains an allowance for the loss of uncollected interest primarily on loans which are 90 days or more past due. This allowance is reviewed periodically and necessary adjustments, if any, are included in the determination of current interest income. The allowance for uncollectible interest totaled $427,000 and $194,000 as of September 30, 2005 and 2006, respectively.

(f) Loan Fees and Discounts

          The net of origination fees received and direct costs incurred in the origination of loans are deferred as part of the basis of loans and amortized to interest income over the contractual life of the loans adjusted for actual principal repayments using a method approximating a level yield.

(g) Allowance for Loan Losses

          The allowance for loan losses is based on management’s ongoing evaluation of the loan portfolio and reflects an amount, that in management’s opinion, is adequate to absorb probable losses in the existing portfolio. All loan losses are charged to the allowance and all recoveries are credited to the allowance. Additions to the allowance for loan losses are provided by charges to operations based on various factors which, in management’s judgment, deserve current recognition in estimating losses. Such factors considered by management include the market value of the underlying collateral, growth and composition of credit risk within the loan portfolio, loss experience, review of problem assets, delinquency trends, and local and regional economic conditions. Management evaluates the carrying value of loans periodically and the allowance is adjusted accordingly. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. The allowance for loan losses is subject to periodic evaluation by various regulatory authorities and may be subject to adjustment upon their examination.

(h) Concentration of Credit Risk

          The Company’s primary market area includes northeastern South Carolina and southeastern North Carolina, predominately along the coastal regions. At September 30, 2006, the majority of the total loan portfolio, as well as a substantial portion of the commercial and real estate loan portfolios, were to borrowers within this region.

          The Company has identified one concentration of credit risk that it is monitoring. This concentration involves loans for the acquisition of land and loans for the development of land, which totaled $162.5 million at September 30, 2006, representing 144.1% of total equity and 15.0% of net loans receivable. At September 30, 2005, this concentration totaled $121.2 million, representing 124.6% of total equity and 13.1% of net loans receivable. Economic growth and low interest rate environments have created opportunities for land acquisition and development activities in the Company’s market area. Adverse changes in such factors can also slow absorption of developing projects and moderate market values of land and developed lots. Management continues to monitor this concentration of credit risk at this time and has considered this concentration in its evaluation of the allowance for loan losses. The Company experienced no significant loan losses related to this identified risk during the years ending September 30, 2004, 2005 and 2006.

19

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

(i) Loan Securitizations

          The Company packages and sells loans receivable as securities to investors. These transactions are recorded as sales in accordance with SFAS No. 140 when control over these assets has been surrendered. The Company does not retain any interest in the securities sold other than the servicing rights.

(j) Real Estate Owned

          Real estate acquired in settlement of loans is initially recorded at the lower of cost or net fair value (less estimated costs to sell). If cost exceeds net fair value, the asset is written down to net fair value with the difference being charged against the allowance for loan losses. Subsequent to foreclosure, such assets are carried at the lower of cost or net fair value with any additional write downs being charged as real estate losses.

(k) Office Properties and Equipment

          Office properties and equipment are carried at cost less accumulated depreciation. Depreciation is computed primarily on the straight-line method over the shorter of the estimated useful lives or the lease term. Estimated lives range up to thirty-nine years for buildings and improvements and up to ten years for furniture, fixtures and equipment. Maintenance and repairs are charged to expense as incurred. Improvements which extend the lives of the respective assets are capitalized. When property or equipment is sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the respective accounts and the resulting gain or loss is reflected in income.

(l) Mortgage Servicing Rights

          The Company follows SFAS No. 140, which requires the recognition of originated mortgage servicing rights (“mortgage servicing rights” or “MSRs”) as assets by allocating total costs incurred between the originated loan and the servicing rights retained based on their relative fair values. SFAS No. 140 also requires the recognition of purchased mortgage servicing rights at fair value, which is presumed to be the price paid for the rights. MSRs are amortized in proportion to the servicing income over the estimated life of the related mortgage loan. The amortization method is designed to approximate a level-yield method, taking into consideration the estimated prepayment of the underlying loans. For purposes of measuring impairment, MSRs are reviewed for impairment by management on a quarterly basis, primarily considering prepayments and interest rates. Impairment is measured on a disaggregated basis. The Company establishes an impairment valuation allowance to record any impairment for MSRs. Subsequent increases in value are recognized only to the extent of the impairment valuation allowance within the same tranche. (See Note 5).

(m) Income Taxes

          Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in the period that includes the statutory enactment date. A deferred tax asset valuation allowance is recorded when it is more likely than not that deferred tax assets will not be realized.

(n) Drafts Outstanding

          The Company invests all excess funds on deposit at other banks (including amounts on deposit for payment of outstanding disbursement checks) on a daily basis in an overnight interest-bearing account. Accordingly, outstanding checks are reported as a liability.

(o) Securities Sold Under Agreement to Repurchase

          The Company maintains collateral for certain Customers who wish to deposit amounts greater than $100,000. These agreements function similarly to a certificate of deposit in that the agreement is for a fixed length of time at a fixed interest rate. However, these deposits are not insured by the Federal Deposit Insurance Corporation (the “FDIC”), but are collateralized by an interest in the pledged securities. The Company has classified these borrowings separately from deposits.

          The Company enters into sales of securities under agreements to repurchase. Fixed-coupon, repurchase agreements are treated as financing, with the obligation to repurchase securities sold being reflected as a liability and the securities underlying the agreements remaining as assets.

20

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

(p) Stock Based Compensation

          In December 2004, the FASB issued SFAS No. 123 (revised), “Share-Based Payment” (“SFAS 123(R)”). SFAS 123(R) replaces SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). SFAS 123(R) requires compensation costs related to share-based payment transactions to be recognized ratably in the financial statements over the period that an employee provides service in exchange for the award. Public companies are required to adopt, and the Company has adopted effective October 1, 2005, the new standard using a modified prospective method. Under the modified prospective method, companies are allowed to record compensation cost for new and modified awards over the related vesting period of such awards prospectively and record compensation cost prospectively on the nonvested portion, at the date of adoption, of previously issued and outstanding awards over the remaining vesting period of such awards. No change to prior periods presented is permitted under the modified prospective method. At September 30, 2006, the Company had one stock-based payment plan for directors, officers and other key Associates, which is described below. Prior to October 1, 2005, the Company, as permitted under SFAS 123, applied the intrinsic value method under APB 25, and related interpretations in accounting for its stock-based compensation plan.

          Effective October 1, 2005, the Company adopted the provisions of SFAS 123(R) thereby expensing employee stock-based compensation using the fair value method prospectively for all awards granted, modified, or settled on or after October 1, 2005. The fair value at the date of grant of the stock option is estimated using the Black-Scholes option-pricing model based on assumptions noted in a table below. The dividend yield is based on estimated future dividend yields. The risk-free rate for periods within the contractual term of the share option is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatilities are generally based on historical volatilities. The expected term of share options granted is generally derived from historical experience. Compensation expense is recognized on a straight-line basis over the stock option vesting period. The impact of adoption of the fair value based method for expense recognition of employee awards resulting in net expense of approximately $91,000, net of tax benefit of approximately $55,000, during the twelve months ended September 30, 2006.

          The Company’s stock option plan, which is stockholder approved, provides for stock options to be granted primarily to directors, officers and other key Associates. Options granted under the stock option plan may be incentive stock options or non-incentive stock options. Share option awards are generally granted with an exercise price equal to, or higher than, the market price of the Company’s shares at the date of grant. Options vest ratably over a five-year period and expire after ten years from the date of grant, except as discussed below. Share options awards provide for accelerated vesting if there is a change in control, as defined in the stock option plan. The remaining shares of stock reserved under the stock option plan at September 30, 2006 amounted to approximately 128,000 shares.

          Options awarded prior to September 21, 2005 vest ratably over a five-year period. Effective September 21, 2005, upon recommendation of the Compensation Committee of the Board of Directors of Coastal Financial Corporation, the vesting period for approximately 804,000 options awarded during fiscal 2003, 2004 and 2005 through September 20, 2005 that would have otherwise vested at various times through fiscal 2010 was accelerated (the “Acceleration”). All other terms and conditions of the accelerated options remain unchanged as a result of the Acceleration.

          The Board of Directors determined that the Acceleration was in the best interests of the Company and its stockholders because it reduced compensation expense that the Company would otherwise be required to record in future periods when the Company becomes subject to the requirements of Financial Accounting Standards Board (“FASB”) Statement No. 123 “Share-Based Payment (Revised 2004)” (“SFAS 123R”). As a result of the Acceleration and based on estimated Black-Scholes value calculations, the Company expected to not incur pre-tax compensation expense related to the options subject to the Acceleration of approximately $965,000 in fiscal 2006, $885,000 in fiscal 2007, $670,000 in fiscal 2008, $400,000 in fiscal 2009, and $50,000 in fiscal 2010.

          The Acceleration met the criteria for variable accounting under FIN No. 44. Based upon past experience, the Company believed that the majority of the holders of the options subject to the Acceleration would remain employed or otherwise affiliated with the Company and/or its affiliates over the full term of the original vesting period. Consequently, under the provisions included in FIN No. 44, the Company recorded in the fourth fiscal quarter ending September 30, 2005, a pre-tax charge to earnings of $76,000, in the form of compensation expense, related to the Acceleration.

          The weighted average fair value of all of the options granted during the twelve months ended September 30 have been estimated using the Black-Scholes option-pricing model with the following assumptions:

	2004			2005			2006
Dividend yield		1.25	%		1.50	%		1.52	%
Weighted average risk-free interest rate		4.21	%		4.01	%		4.92	%
Weighted average expected volatility		40.00	%		29.00	%		29.00	%
Weighted average expected life in years		7.50			5.00			7.50

21

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

(p) Stock Based Compensation - CONTINUED

          Had the compensation cost for the Company’s stock-based compensation plan been determined under the fair value-based method, the Company’s net income and earnings per share would have been adjusted to the pro forma amounts below for the years ended September 30 (Dollars in thousands, except per share data):

	2004			2005			2006
	(Unaudited)
Information as reported in the Financial Statements:
Net income	$	14,806		$	17,154		$	19,001
Basic earnings per share	$	0.71		$	0.81		$	0.88
Diluted earnings per share	$	0.67		$	0.76		$	0.85
Share-based compensation cost, net of related tax effects	$	(599	)	$	(3,710	)	$	(91	)
Information calculated as if fair value method had been applied to all awards:
Net income, as reported	$	14,806			17,154			19,001
Add: Stock-based compensation expense recognized during the period, net of related tax effects		—			76			91
Less: Stock-based compensation expense determined under the fair value-based method, net of related tax effects		(599	)		(3,710	)		(91	)
Pro forma net income	$	14,207		$	13,520		$	19,001
Pro forma basic earnings per share	$	0.68		$	0.64		$	0.88
Pro forma diluted earnings per share	$	0.64		$	0.60		$	0.85

          A summary of share option activity for the twelve months ended September 30, 2006 follows:

	Number of Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)		Aggregate Intrinsic Value
Outstanding at September 30, 2005		3,092,770		$	7.75
Granted		4,400		$	11.95
Exercised		(333,942	)	$	4.97
Forfeited or expired		(14,598	)	$	10.95
Outstanding at September 30, 2006		2,748,630		$	8.07		5.7	$	11,578,000
Exercisable at September 30, 2006		2,687,913		$	8.14		5.7	$	11,161,000

          The weighted average grant-date fair value of options granted during the twelve months ended September 30, 2004, 2005 and 2006 was $4.52 per share, $4.11 per share and $4.22 per share, respectively. The total intrinsic value of options exercised during the twelve months ended September 30, 2004, 2005 and 2006 was $2,718,000, $2,206,000 and $2,560,000, respectively.

          Subsequent to September 30, 2006, the Company issued approximately 23,000 options to Associates on November 16, 2006 at an exercise price of $13.97 per share.

          A summary of the status of the Company’s nonvested options as of September 30, 2006, and changes during the twelve months then ended, is presented below:

	Number of Shares			Weighted Average Grant-Date Fair Value
Nonvested at September 30, 2005		159,928		$	2.09
Granted		4,400		$	4.22
Vested		(102,412	)	$	1.62
Forfeited		(1,199	)	$	3.65
Nonvested at September 30, 2006		60,717		$	2.51

          Fair values have been retroactively restated for all stock dividends since the date the option was granted.

          As of September 30, 2006, there was approximately $29,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements. That cost is expected to be recognized over a weighted average period of approximately three years.

          The Company generally issues authorized but previously unissued shares to satisfy option exercises.

22

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements — Continued

1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – CONTINUED

(q) Comprehensive Income

          SFAS No. 130, “Reporting Comprehensive Income” establishes standards for the reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income consists of net income and net unrealized gains (losses) on securities and is presented in the statements of stockholders’ equity and comprehensive income.

(r) Disclosures Regarding Segments

          The Company reports operating segments in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS No. 131”). Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. SFAS No. 131 requires that a public enterprise report a measure of segment profit or loss, certain specific revenue and expense items, segment assets, information about the way that the operating segments were determined and other items. The Company has one reportable operating segment, Coastal Federal Bank.

(s) Derivative Instruments and Hedging Activities

          Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) as amended by SFAS No. 137, 138, and 149 establishes accounting and reporting standards for derivatives and hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet, and measures those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on the purpose for which the derivative is held and whether the derivative qualifies for hedge accounting. The Company does not currently engage in any activities that qualify for hedge accounting under SFAS 133. Accordingly, changes in fair value of these derivative instruments are included in gain on sales of loans held for sale in the consolidated statements of operations. (See Note 23).

(t) Reclassifications

          Certain amounts in the 2004 and 2005 consolidated financial statements have been reclassified to conform to the 2006 presentation. Such reclassifications did not change net income or equity as previously reported.

(2) INVESTMENT SECURITIES

          The amortized cost and fair value of investment securities available for sale at September 30, 2005 are summarized as follows:

	2005
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In thousands)
U.S. Government and agency obligations:
Due after five years	$	3,947		—		(13	)		3,934
State and municipal obligations:
Due after five years		21,285		434		(37	)		21,682
	$	25,232		434		(50	)		25,616

23

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(2) INVESTMENT SECURITIES – CONTINUED

         The amortized cost and fair value of investment securities available for sale at September 30, 2006 are summarized as follows:

	2006
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In thousands)
U.S. Government and agency obligations:
Due after five years	$	15,489		170		(29	)		15,630
State and municipal obligations:
Due after five years		23,383		322		(35	)		23,670
	$	38,872		492		(64	)		39,300

          The Company had no gross realized gains and gross realized losses were $100,000 for the year ended September 30, 2004. For the year ended September 30, 2005, gross realized gains were $92,000 and gross realized losses were $26,000. For the year ended September 30, 2006, gross realized gains were $153,000 and gross realized losses were $56,000.

          The unrealized losses on investment securities were attributable to increases in interest rates, rather than credit quality. The unrealized losses are comprised of nine securities that have had continuous losses of less than 12 months and seven securities that have had continuous losses 12 months totaling $19,000 and seven securities that have had continuous losses for 12 months or longer totaling $45,000. None of the individual investment securities had an unrealized loss which exceeded 10% of its amortized cost. None of the Company’s securities were considered impaired at September 30, 2006 and substantially all investment securities were rated AAA or higher.

          At September 30, 2005 and 2006, investment securities held to maturity due after five years totaled $10.0 million and $12.0 million, respectively.

          The Company had one investment security held to maturity with an amortized cost and fair value of $7.8 million that was called by the issuer, which resulted in a gross realized gain of $160,000 in fiscal 2005.

          The following table sets forth the final maturities and weighted average yields of the securities available for sale and held to maturity at fair value at September 30, 2006:

	2006
	One year					More than one					More than five					More than
	or less					to five years					to ten years					ten years
	Fair Value		Yield			Fair Value		Yield			Fair Value		Yield			Fair Value		Yield
	(Dollars in thousands)
U.S. Government and agency obligations:
FFCB	$	—		—	%	$	—		—	%	$	2,969		5.33	%	$	—		—	%
FHLB		—		—			—		—			19,503		4.28			5,157		5.30
State and municipal obligations		—		—			265		5.55			4,120		4.10			19,286		4.37
Total	$	—		—	%	$	265		5.55	%	$	26,592		4.37	%	$	24,443		4.57	%

         The yield on state and municipal obligations is not computed on a tax-equivalent basis.

(3) MORTGAGE-BACKED SECURITIES

         Mortgage–backed securities available for sale at September 30, 2005 consisted of the following:

	2005
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In thousands)
Collateralized Mortgage Obligations	$	84,387		37		(1,130	)		83,294
FNMA		152,075		1,052		(1,346	)		151,781
GNMA		45,963		274		(416	)		45,821
FHLMC		119,399		447		(1,087	)		118,759
	$	401,824		1,810		(3,979	)		399,655

24

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(3) MORTGAGE-BACKED SECURITIES – CONTINUED

         Mortgage–backed securities available for sale at September 30, 2006 consisted of the following:

	2006
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
	(In thousands)
Collateralized Mortgage Obligations	$	111,827		75		(1,869	)		110,033
FNMA		133,530		608		(2,094	)		132,044
GNMA		38,532		153		(509	)		38,176
FHLMC		114,409		104		(1,777	)		112,736
	$	398,298		940		(6,249	)		392,989

          The Company had gross realized gains of $772,000 and gross realized losses of $1.8 million for the year ended September 30, 2004. For the year ended September 30, 2005, the Company had gross realized gains of $719,000 and gross realized losses of $1.3 million. For the year ended September 30, 2006, the Company had gross realized gains of $102,000 and gross realized losses of $596,000.

          Gross unrealized losses on mortgage-backed securities and the length of time the securities have been in a continuous unrealized loss position, at September 30, 2006, were as follows:

	2006
	Less than 12 Months					12 Months or Longer					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
	(In thousands)
Collateralized Mortgage Obligations	$	45,525		(377	)		53,531		(1,492	)		99,056		(1,869	)
FNMA		45,174		(532	)		57,518		(1,562	)		102,692		(2,094	)
GNMA		9,582		(61	)		20,078		(448	)		29,660		(509	)
FHLMC		49,593		(521	)		58,982		(1,256	)		108,575		(1,777	)
	$	149,874		(1,491	)		190,109		(4,758	)		339,983		(2,649	)

          The unrealized losses on mortgage-backed securities summarized above were attributable to increases in interest rates, rather than credit quality. The unrealized losses are comprised of 54 securities that have had continuous losses of less than 12 months and 67 securities that have had continuous losses 12 months or longer. None of the Company’s securities were considered impaired at September 30, 2006. None of the individual mortgage-backed securities had an unrealized loss which exceeded 10% of it’s amortized costs and all mortgage-backed securities were rated AAA or higher.

          Certain mortgage-backed securities are pledged to secure other borrowed money, Federal Home Loan Bank advances and customer deposits in excess of FDIC insurance coverage. The carrying value of the securities pledged at September 30, 2006 was $367.7 million with a fair value of $362.8 million.

          The following table sets forth the final contractural maturities and weighted average yields of the mortgage-backed securities at fair value at September 30, 2006:

	2006
	One year					More than one					More than five					More than
	or less					to five years					to ten years					ten years
	Fair Value		Yield			Fair Value		Yield			Fair Value		Yield			Fair Value		Yield
	(Dollars in thousands)
Mortgage-backed securities:
FHLMC	$	—		—	%	$	—		—	%	$	—		—	%	$	112,736		5.32	%
FNMA		—		—			—		—			341		6.00			131,703		5.45
GNMA		—		—			—		—			42		6.50			38,134		5.63
Collateralized Mortgage Obligations		—		—			—		—			—		—			110,033		5.13
Total	$	—		—	%	$	—		—	%	$	383		6.05	%	$	392,606		5.42	%

25

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(4) LOANS RECEIVABLE, NET

         Loans receivable, net at September 30 consisted of the following:

	2005			2006
	(In thousands)
Mortgage loans:
Single family to 4 family units	$	352,893			390,572
Land and land development		121,170			162,538
Residential lots		37,112			39,377
Other, primarily commercial real estate		211,432			236,053
Residential construction loans		127,970			197,345
Commercial construction loans		14,989			6,410
Consumer and commercial loans:
Installment consumer loans		19,115			14,182
Mobile home loans		4,308			5,194
Savings account loans		1,883			2,035
Equity lines of credit		34,019			40,331
Commercial and other loans		38,691			38,656
		963,582			1,132,693
Less:
Allowance for loan losses		11,748			12,726
Deferred loan cost, net		(771	)		(246	)
Undisbursed portion of loans in process		28,345			31,982
	$	924,260			1,088,231

         The changes in the allowance for loan losses for the years ended September 30 consisted of the following:

	2004			2005			2006
	(In thousands)
Beginning allowance	$	9,832			11,077			11,748
Provision for loan losses		1,750			1,697			1,385
Loan recoveries		249			224			307
Loan charge-offs		(754	)		(1,250	)		(714	)
	$	11,077			11,748			12,726

          Nonaccrual loans, which are all loans ninety days or more delinquent, totaled approximately $2.6 million and $3.0 million at September 30, 2005 and 2006, respectively. In fiscal years 2004, 2005 and 2006, interest income which would have been recorded would have been approximately $277,000, $285,000 and $255,000, respectively, had non accruing loans been current in accordance with their original terms.

          There were $2.6 million in impaired loans at September 30, 2005. At September 30, 2006, impaired loans totaled $3.5 million. Included in the allowance for loan losses at September 30, 2005 was $434,000 related to impaired loans compared to $235,000 at September 30, 2006. The average recorded investment in impaired loans for the year ended September 30, 2005 was $3.7 million compared to $2.8 million for the year ended September 30, 2006. Interest income recognized on impaired loans in fiscal 2004, 2005 and 2006 was $607,000, $292,000 and $168,000, respectively.

          In the normal course of business, to meet the financing needs of its Customers, the Company is a party to financial instruments with off-balance-sheet risk. These financial instruments include commitments to extend credit and stand by letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.

          The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

          Commitments to extend credit are agreements to lend 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 may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each Customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation.

26

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(4) LOANS RECEIVABLE, NET – CONTINUED

         Standby letters of credit obligate the Company to meet certain financial obligations of its Customers, if, under the contractual terms of the agreement, the Customers are unable to do so. Payment is only guaranteed under these letters of credit upon the borrower’s failure to perform its obligations to the beneficiary. The Company can seek recovery of the amounts paid from the borrower and the letters of credit are generally collateralized. Commitments under standby letters of credit are usually one year or less. At September 30, 2006, the Company has recorded no liability for the current carrying amount of the obligation to perform as a guarantor, as such amounts are not considered material. The maximum potential amount of undiscounted future payments related to standby letters of credit at September 30, 2006 was $11.4 million.

          A summary of loans receivable with undisbursed commitments to extend credit at September 30, 2005 and September 30, 2006 follows (in thousands):

	2005		2006
Residential mortgage loans in process	$	28,345		31,982
Business and consumer credit card lines		14,065		—
Consumer home equity lines		43,388		48,811
Other consumer lines of credit		4,547		6,721
Standby letters of credit		5,777		11,356
Commercial real estate and construction and land development lines of credit		107,731		122,877
Other commercial lines of credit		10,527		12,760
	$	214,380		234,507

          During fiscal 2006, the Bank sold its business and consumer credit card portfolio.

          In addition, the Company had commitments to originate $23.3 million in residential loans at September 30, 2006.

          Loans serviced for the benefit of others amounted to approximately $250.5 million, $291.9 million and $292.5 million at September 30, 2004, 2005 and 2006, respectively. Loans serviced for others at September 30, 2004 and September 30, 2005 consisted primarily of residential mortgage loans. At September 30, 2006, residential mortgage loans serviced for others was $279.2 million and commercial mortgage loans serviced for others was $13.3 million.

          During fiscal 2006, the Company securitized $27.5 million of mortgage loans and concurrently sold these mortgage-backed securities to outside third parties and recognized a net gain on sale of $485,000, which included the recognition of a $418,000 mortgage servicing right asset. During fiscal 2005 the Company securitized $52.6 million of mortgage loans and concurrently sold these mortgage-backed securities to outside third parties and recognized a net gain on sale of $1.0 million, which included the recognition of a $690,000 mortgage servicing right asset. The gain is included in gains on sales of loans held for sale in the consolidated statement of operations. The proceeds from sale are included in proceeds from sales of mortgage-backed securities available for sale in the consolidated statement of cash flows.

          As disclosed in Note 9, certain mortgage loans are pledged to secure advances from the Federal Home Loan Bank (“FHLB”) of Atlanta.

          The Bank offers mortgage and consumer loans to its directors, and Associates for the financing of their personal residences and for other personal purposes. The Bank also offers commercial loans to companies affiliated with directors. These loans are made in the ordinary course of business and, in management’s opinion, are made on substantially the same terms, including interest rates and collateral, prevailing at the time for comparable transactions with other persons and companies. Management does not believe these loans involve more than the normal risk of collectibility or present other unfavorable features. At September 30, 2006, such loans were current with respect to their payment terms.

          The following is a summary of the activity of loans outstanding to certain executive officers, directors and their affiliates for the year ended September 30, 2006 (in thousands):

Balance at September 30, 2005	$	833
New loans		3
Repayments		(282	)
Balance at September 30, 2006	$	554

27

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(5) MORTGAGE SERVICING RIGHTS

         Mortgage servicing rights, net of the valuation allowance, are included in other assets and totaled $3.2 million and $3.1 million at September 30, 2005 and 2006, respectively. Amortization expense for MSRs, included in interest on loans receivable, totaled $1.0 million, $1.1 million and $807,000 for the years ended September 30, 2004, 2005 and 2006, respectively. The estimated amortization expense for MSRs held as of September 30, 2006, is $728,000, $716,000, $666,000, $596,000 and $350,000 for fiscal 2007, 2008, 2009, 2010 and 2011 respectively. The estimated amortization expense is based on current information regarding loan payments and prepayments. Amortization expense could change in future periods based on changes in the volume of prepayments and various economic factors.

          At September 30, 2005, the valuation allowance for MSRs totaled $5,000. There was no MSR valuation allowance at September 30, 2006. In 2005 and 2006, the Company recorded $294,000 and $5,000 for impairment recoveries, respectively. MSR impairment recovery is included in other expense.

	2005			2006
	(In thousands)
Balance at beginning of year	$	3,005			3,187
MSRs capitalized		941			671
MSRs amortized		(1,053	)		(807	)
Recovery of impairment		294			5
Balance at end of year	$	3,187			3,056

(6) OFFICE PROPERTY AND EQUIPMENT, NET

         Office property and equipment, net at September 30 consisted of the following:

	2005			2006
	(In thousands)
Land	$	7,530			8,354
Building and improvements		15,493			20,728
Furniture, fixtures and equipment		20,510			24,428
		43,533			53,510
Less accumulated depreciation		(20,775	)		(23,584	)
	$	22,758			29,926

          The Company has eight leases for office space and two land leases under noncancelable operating leases with initial terms that expire over the next one to thirty years. Seven of these leases contain renewal options for periods ranging from one to thirty years and require the Company to pay all executory costs such as property taxes, utilities and insurance. Rental payments are based on contractual amounts as set forth in the lease agreements and do not include contingent rentals. All rental payments, including escalating rents, are recognized as rental expense on a straight-line basis over the term of the lease. The rent expense for the years ended September 30, 2004, 2005, and 2006 was approximately $285,000, $307,000 and $721,000, respectively.

          Future minimum rental payments for operating leases having remaining noncancelable lease terms in excess of one year at September 30, 2006 are as follows (in thousands):

2007	$	478
2008		362
2009		274
2010		250
2011		183
Thereafter		3,105
	$	4,652

(7) INVESTMENT REQUIRED BY LAW

         The Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in the FHLB of Atlanta in an amount equal to the greater of (i) $500 (ii) 1.0% of the aggregate outstanding principal amount of home mortgage loans, home purchase contracts and similar obligations at the end of each calendar year, or (iii) 5% of its advances (borrowings) from the FHLB of Atlanta at the end of each calendar year. The Bank is in compliance with this requirement with an investment in FHLB stock of $20.3 million, carried at cost, at September 30, 2006. No ready market exists for this stock and it has no quoted market value. However, redemption of this stock has historically been at par value.

28

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(8)	DEPOSITS
	Deposits at September 30 consisted of the following:

	2005				2006
	Amount		Weighted Average Rate		Amount		Weighted Average Rate
	(Dollars in thousands)
Transaction accounts:
Noninterest bearing	$	219,080		—%	$	231,081		—%
NOW		139,810		0.52		126,373		0.54
Money market checking		213,078		2.26		198,500		3.44
Total transaction accounts		571,968		0.97		555,954		1.35
Statement savings accounts:
Regular		71,119		1.47		75,790		2.37
Money market		705		1.24		473		1.87
Total statement savings accounts		71,824		1.47		76,263		2.37
Certificate accounts:
0.00-1.99%		15,660				247
2.00-3.99%		381,253				44,235
4.00-5.99%		29,545				385,564
6.00-7.99%		8				122
8.00-10.00%		660				720
Total certificate accounts		427,126		3.39		430,888		4.83
	$	1,070,918		1.97%	$	1,063,105		2.83%

          The aggregate amount of all deposit accounts with a minimum denomination of $100,000 or more was $637.9 million and $633.6 million at September 30, 2005 and 2006, respectively.

          The amounts and scheduled maturities of certificate accounts at September 30, are as follows:

	2005		2006
	(In thousands)
Within 1 year	$	392,731		389,272
After 1 but within 2 years		22,666		33,154
After 2 but within 3 years		8,555		4,000
Thereafter		3,174		4,462
	$	427,126		430,888

          Included in certificate accounts (“CDs”) are $153.3 million of brokered CDs at September 30, 2006. There were $169.9 million of brokered CDs at September 30, 2005. The average rate and remaining term of brokered CDs at September 30, 2006 was 5.16% and approximately five months, respectively.

          Interest expense on deposits for the years ended September 30 consisted of the following:

	2004		2005		2006
	(In thousands)
Transaction accounts	$	3,331		4,457		7,058
Passbook accounts		405		663		1,496
Certificate accounts		6,288		8,959		18,189
	$	10,024		14,079		26,743

29

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(9)	ADVANCES FROM FHLB
	Maturities for advances from the FHLB by fiscal year at September 30 consisted of the following:

	2005				2006
	Amount		Weighted Rate		Amount		Weighted Rate
	(Dollars in thousands)
Fiscal Year Maturity
Year 1	$	4,177		2.79%	$	11,810		4.77%
Year 2		3,560		2.83		3,977		3.18
Year 3		3,977		3.18		16,803		4.60
Year 4		31,803		2.36		73,651		5.58
Year 5		63,651		5.74		40,440		5.36
After Year 5		181,839		3.64		233,899		3.89
	$	289,007		3.93%	$	380,580		4.43%

          Stock in the FHLB of Atlanta and specific first mortgage loans and mortgage-backed securities of approximately $378.3 million and $470.2 million at September 30, 2005 and 2006, respectively, are pledged as collateral for these advances. The Bank has adopted the policy of pledging excess collateral to facilitate future advances. At September 30, 2006, the excess first mortgage loan and mortgage-backed securities collateral pledged to the FHLB will support additional borrowings of approximately $69.3 million. At September 30, 2006, included in the one, two, three, and five year maturities were $228.0 million with a weighted average rate of 3.98% of advances subject to call provisions. Callable advances at September 30, 2006 are summarized as follows: $91.0 million callable in fiscal 2007, with a weighted average rate of 4.05%; $37.0 million callable in fiscal 2008, with a weighted average rate of 2.98%; $75.0 million callable in fiscal 2009, with a weighted average rate of 4.11%; and $25.0 million callable in fiscal 2011, with a weighted average rate of 4.89%. Call provisions are more likely to be exercised by the FHLB when interest rates rise. If exercised, the Company may have to replace called advances with borrowings at a higher interest rate.

          During fiscal 2004, the Company prepaid approximately $4.6 million of advances from FHLB and incurred gross penalties of approximately $77,000. During fiscal 2005 and 2006, the Company did not prepay any FHLB advances.

(10)  REPURCHASE AGREEMENTS

          The following tables set forth certain information regarding repurchase agreements by the Bank at the end of and during the periods indicated:

	At September 30,
	2004			2005			2006
	(Dollars in thousands)
Outstanding balance:
Securities sold under agreements to repurchase:
Customer	$	12,931		$	31,937		$	42,095
Broker		94,242			10,000			30,000
Weighted average rate (at month end) paid on:
Securities sold under agreements to repurchase:
Customer		1.42	%		2.82	%		3.79	%
Broker		1.74			2.39			4.44
Maximum amount of borrowings outstanding at any month end:
Securities sold under agreements to repurchase:
Customer	$	12,931		$	39,317		$	76,706
Broker		184,129			109,958			30,000
Approximate average outstanding with respect to:
Securities sold under agreements to repurchase:
Customer	$	9,033		$	27,498		$	42,754
Broker		134,809			73,723			19,632
Weighted average rate (year to date) paid on:
Securities sold under agreements to repurchase:
Customer		1.01	%		2.43	%		3.76	%
Broker		1.50			2.37			3.70

          The Company has three securities sold under agreements to repurchase with $10 million maturing in approximately one month and $20 million maturing in ten years. These reverse repurchase agreements are collateralized by securities of the United States government or its agencies, which have been delivered to a third party custodian for safekeeping. Assets pledged to collateralize

30

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(10)  REPURCHASE AGREEMENTS - CONTINUED

securities sold under agreements to repurchase had a fair value of $32.8 million at September 30, 2006 and are included in mortgage-backed securities available for sale in the consolidated statement of condition.

          At September 30, 2006, two of these reverse repurchase agreements contain one time call provisions as follows: $10 million callable September 6, 2007 with a rate of 3.57% and $10 million callable on November 22, 2010 with a rate of 4.42%

(11) JUNIOR SUBORDINATED DEBT

          The Company determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity under accounting principles generally accepted in the United States of America. Voting interest entities are entities in which the total equity investment at risk is sufficient to enable each entity to finance itself independently and provides the equity holders with the obligation to absorb losses, the right to receive residual returns and the right to make decisions about the entity’s activities. The Company consolidates voting interest entities in which it has all, or at least a majority of, the voting interest. As defined in applicable accounting standards, variable interest entities (“VIEs”) are entities that lack one or more of the characteristics of a voting interest entity described above. A controlling financial interest in an entity is present when an enterprise has a variable interest or a combination of variable interests that will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both. The enterprise with a controlling financial interest, known as the primary beneficiary, consolidates the VIE.

          Prior to January 1, 2005, the Company consolidated its wholly-owned subsidiary, Coastal Financial Capital Trust I (“Trust”). In December 2003, the Financial Accounting Standards Board issued a revised version of Interpretation No. 46 (“FIN 46”) “Consolidation of Variable Interest Entities.” The revised FIN 46 clarifies some of the provisions of the original interpretation and adds new scope exceptions. As a result of the changes, the Company deconsolidated the Trust, increasing other assets by $464,000, increasing junior subordinated debt-trust preferred securities by $15.5 million and reducing debt associated with trust preferred securities (“Capital Securities”) by $15.0 million.

          The junior subordinated debentures are unsecured obligations of the Company and are subordinate and junior in right of payment to all present and future senior indebtedness of the Company. The Company has entered into a guarantee, which together with its obligations under the junior subordinated debentures and the declaration of trust governing the Trust, provides a full and unconditional guarantee of the Capital Securities.

          The Capital Securities accrue and pay distributions at a rate per annum equal to 90-day LIBOR plus 305 basis points. At September 30, 2006, the distribution rate on the Capital Securities was 8.55%. The distributions payable on the Capital Securities are cumulative and payable quarterly in arrears. The Capital Securities interest payments for fiscal 2004, 2005 and 2006 were $662,000, $892,000 and $1.2 million, respectively, and are included in interest expense on other borrowings. The Company has the right, subject to events of default, to defer payments of interest on the Capital Securities for a period not to exceed 20 consecutive quarters. The Company has no current intention to exercise its right to defer payment of interest on the Capital Securities.

          The Capital Securities are mandatorily redeemable upon maturity on July 3, 2033. The Company has the right to redeem the Capital Securities in whole or in part, on or after July 3, 2008. If the Capital Securities are redeemed on or after July 3, 2008, the redemption price will be 100% of the principal amount plus accrued and unpaid interest. In addition, the Company may redeem the Capital Securities in whole (but not in part) at any time within 90 days following the occurrence of a tax event, an investment company event, or a capital treatment event at a special redemption price (as defined in the indenture).

(12)  INCOME TAXES

          Income tax expense (benefit) for the years ended September 30 consisted of the following:

	Current		Deferred			Total
	(In thousands)
2004:
Federal	$	7,070		126			7,196
State		433		(2	)		431
	$	7,503		124			7,627
2005:
Federal	$	7,739		582			8,321
State		614		47			661
	$	8,353		629			8,982
2006:
Federal	$	9,501		(202	)		9,299
State		979		(77	)		902
	$	10,480		(279	)		10,201

31

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(12)  INCOME TAXES - CONTINUED

          The tax effect of the Company’s temporary differences between the financial statement carrying amounts and tax basis of assets and liabilities that give rise to the net deferred tax asset (liability) at September 30, 2005 and 2006 relate to the following:

	2005			2006
	(In thousands)
Deferred tax assets:
Allowance for loan losses	$	4,406			4,823
Accrued medical reserves		85			80
Other real estate reserves and deferred gains on other real estate		20			24
Net operating loss carryforwards		81			137
Unrealized loss on securities available for sale		679			1,855
Other		282			385
Total deferred tax assets		5,553			7,304
Less valuation allowance		(81	)		(137	)
Net deferred tax assets		5,472			7,167
Deferred tax liabilities:
Property and equipment principally due to differences in depreciation		398			185
Deferred loan fees		885			911
Book over tax basis in investment in unconsolidated subsidiary		5,053			5,425
Mortgage servicing rights		1,221			1,183
Other		417			510
Total deferred tax liabilities		7,974			8,214
Net deferred tax liability	$	(2,502	)		(1,047	)

          The Company has a Real Estate Investment Trust (REIT) that acquires, holds and manages real estate loans. The REIT is consolidated with the Bank and is, therefore, included in the consolidated financial statements of the Company. The REIT must meet specific provisions of the Internal Revenue Code and state tax laws. If the REIT fails to meet any of the required provisions of federal and state tax laws, the Company’s tax expense could increase.

          The valuation allowance for deferred tax assets was $81,000 and $137,000 at September 30, 2005 and 2006, respectively. The net change in the total valuation allowance for the years ended September 30, 2005 and 2006 was an increase of $43,000 and $56,000, respectively. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. In order to fully realize the deferred tax asset, the company will need to generate future taxable income prior to the expiration of the deferred tax assets governed by the tax code. Based upon the level of historical taxable income and projections for future taxable income over the periods, which the deferred tax assets are deductible, management believes it more likely than not the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at September 30, 2006. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.

          The net deferred tax asset (liability) is included in other liabilities in the consolidated financial statements. The valuation allowance relates to the state loss carryforwards which may not be ultimately realized to reduce taxes of the Company. A portion of the change in the net deferred tax liability relates to unrealized gains and losses on securities available for sale. A current period deferred tax benefit of $1.2 million unrealized loss on securities available for sale has been recorded directly to stockholders’ equity. The balance of the change in the deferred tax liability results from the current period deferred tax expense of $279,000.

          Income taxes of the Company attributable to income before income taxes differ from the amounts computed by applying the Federal income tax rate of 35% for the years ended September 30 to earnings before income taxes as follows:

	2004			2005			2006
	(In thousands)
Computed federal income taxes	$	7,852			9,148			10,221
State tax, net of federal benefit		280			430			586
Bank-owned life insurance		(337	)		(332	)		(338	)
Tax exempt securities net		(220	)		(275	)		(230	)
Other, net		52			11			(38	)
Total income tax expense	$	7,627			8,982			10,201

32

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(12)  INCOME TAXES - CONTINUED

          The Bank had been permitted under the Internal Revenue Code to deduct an annual addition to the tax reserve for bad debts in determining taxable income, subject to certain limitations. This addition may differ significantly from the bad debt expense for financial reporting purposes and was based on either 8% of taxable income (the “Percentage of Taxable Income Method”) or actual loan loss experience (the “Experience Method”) for the years prior to 1997. As a result of tax legislation, the Bank recaptured tax bad debt reserves in excess of pre-1988 based year amounts over a six-year period ended September 30, 2004.

          Retained earnings at September 30, 2006 includes approximately $5.2 million representing pre-1988 tax bad debt base year reserve amounts for which no deferred income tax liability has been provided since these reserves are not expected to reverse until indefinite future periods and may never reverse. Circumstances that would require an accrual of a portion or all of this unrecorded tax liability are a reduction in qualifying loan levels relative to the end of 1987, failure to meet the tax definition of a savings bank, dividend payments in excess of current year or accumulated tax earnings and profits, or other distributions in dissolution, liquidation or redemption of the Bank’s stock.

(13)  BENEFIT PLAN

          The Company has a defined contribution plan covering substantially all Associates. The Company matches Associate contributions based upon the Company meeting certain return on equity operating results. Matching contribution expense was approximately $684,000, $435,000 and $474,000 for fiscal years 2004, 2005 and 2006, respectively.

(14)  REGULATORY MATTERS

          The Bank is subject to various capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk-weighting and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and tier 1 capital (as defined in the regulation) to risk-weighted assets (as defined) and to average assets (as defined). At September 30, 2006, the Bank’s loans-to-one borrower limit was approximately $21.1 million. Management believes, as of September 30, 2006, that the Bank met all capital adequacy requirements and loans-to-one-borrower limits.

          As of September 30, 2006, the most recent notification from federal banking agencies categorized the Bank as “well capitalized” under the regulatory framework. To be categorized as “well capitalized,” the Bank must maintain minimum total risk-based capital, tier 1 capital, and tier 1 leverage ratios as set forth in the table. Since September 30, 2006, there have been no events or conditions that management believes have changed the Bank’s categories. (Dollars in thousands)

	Actual					For Capital Adequacy Purposes					Amount to be Categorized as “Well Capitalized”
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of September 30, 2005:
Total Capital:	$	122,693		13.29	%	$	73,877		8.00	%	$	92,347		10.00	%
(To Risk Weighted Assets)
Tier 1 Capital:	$	112,055		12.13	%		N/A		N/A		$	55,408		6.00	%
(To Risk Weighted Assets)
Tier 1 Capital:	$	112,055		7.25	%	$	46,356		3.00	%	$	77,260		5.00	%
(To Adjusted Total Assets)
Tangible Capital:	$	112,055		7.25	%	$	23,178		1.50	%		N/A		N/A
(To Adjusted Total Assets)
As of September 30, 2006:
Total Capital:	$	140,946		14.34	%	$	78,638		8.00	%	$	98,298		10.00	%
(To Risk Weighted Assets)
Tier 1 Capital:	$	129,643		13.19	%		N/A		N/A		$	58,979		6.00	%
(To Risk Weighted Assets)
Tier 1 Capital:	$	129,643		7.78	%	$	49,891		3.00	%	$	83,151		5.00	%
(To Adjusted Total Assets)
Tangible Capital:	$	129,643		7.78	%	$	24,945		1.50	%		N/A		N/A
(To Adjusted Total Assets)

33

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(15)  LIQUIDATION ACCOUNT

          In conjunction with the Bank’s conversion to stock form on October 4, 1990, the Bank established, as required by Office of Thrift Supervision (the “OTS”) regulations, a liquidation account and maintains this account for the benefit of the remaining eligible account holders as defined under the Bank’s plan of conversion. The initial balance of this liquidation account was equal to the Bank’s net worth defined by OTS regulations as of the date of the latest statement of financial condition contained in the final offering circular. In the event of a complete liquidation of the Bank (and only in such event) each eligible holder shall be entitled to receive a liquidation distribution from this account in the amount of the then current adjusted balance for deposits then held, before any liquidation distribution may be made to the stockholders. The Bank is prohibited from declaring cash dividends or repurchasing its capital stock if it would cause a reduction in the Bank’s net worth below either the balance of the liquidation account or the statutory net worth requirements set by the OTS.

          The Company’s ability to pay dividends depends primarily on the Bank’s ability to pay dividends to the Company. The Bank is prohibited from declaring cash dividends on its common stock or repurchasing its common stock if the effect thereof would cause its net worth to be reduced below either the amount required for the liquidation account or the minimum regulatory capital requirement. In addition, the Bank is also prohibited from declaring cash dividends and repurchasing its own stock without prior regulatory approval if the total amount of all dividends and stock repurchases (including any proposed dividends and stock repurchases) for the applicable year exceeds its current year’s net income plus its retained net income for the preceding two years.

(16)  EARNINGS PER SHARE

          Basic earnings per share are computed by dividing net income by the weighted-average number of common shares outstanding. Diluted earnings per share are computed by dividing net income by the weighted average number of common shares and potential common shares outstanding. Potential common shares consist of dilutive stock options determined using the treasury stock method and the average market price of common stock. All share and per share data have been retroactively restated for all common stock dividends. At September 30, 2006 the Company had antidilutive securities of approximately 245,000 options to purchase shares by Directors and Associates. The average exercise price for such shares was $13.86 per share.

          The following is a summary of the reconciliation of average shares outstanding for the years ended September 30:

	2004		2005		2006
	Basic	Diluted	Basic	Diluted	Basic	Diluted
Weighted average shares outstanding	20,966,000	20,966,000	21,274,000	21,274,000	21,509,000	21,509,000
Effect of dilutive securities – Stock options	—	1,162,000	—	1,191,000	—	897,000
Average shares outstanding	20,966,000	22,128,000	21,274,000	22,465,000	21,509,000	22,406,000

(17)  STOCK OPTION PLAN

          At September 30, 2006, the Company had the following options outstanding:

Fiscal Year	Range of exercise prices:	NumberOptionsOutstanding		Weighted Average Remaining Contractual Life		WeightedAverageExercisePrice		Number Options Exercisable		Weighted Average Exercise Price
1997	$ 3.30 - $3.42		34,434		0.3 Years	$	3.30		34,434	$	3.30
1998	$ 4.81 - $7.33		239,831		1.2 Years	$	5.45		239,831	$	5.45
1999	$ 5.33 - $5.77		256,519		2.1 Years	$	5.38		256,519	$	5.38
2000	$ 3.25 - $4.23		213,806		3.2 Years	$	3.85		213,806	$	3.85
2001	$ 3.12 - $4.87		218,888		4.1 Years	$	3.19		218,888	$	3.19
2002	$ 4.67 - $7.67		248,375		5.1 Years	$	4.75		192,058	$	4.76
2003	$ 6.21 - $7.89		318,504		6.1 Years	$	7.45		318,504	$	7.45
2004	$ 10.00 - $10.89		363,437		7.2 Years	$	10.46		363,437	$	10.46
2005	$ 11.20 - $14.20		850,436		8.6 Years	$	12.30		850,436	$	12.31
2006	$ 11.45 - $12.12		4,400		9.6 Years	$	11.95		—	$	—
	$ 3.12 - $14.20		2,748,630		5.7 Years	$	8.07		2,687,913	$	8.14

34

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(17)  STOCK OPTION PLAN - CONTINUED

          The following is a summary of the activity of the stock option plans for the years 2004, 2005, and 2006.

	2004					2005					2006
	Shares			Weighted Average Exercise Price		Shares			Weighted Average Exercise Price		Shares			Weighted Average Exercise Price
Outstanding, October 1		2,544,623		$	4.74		2,533,676		$	5.84		3,092,770		$	7.75
Granted		397,158			10.46		879,735			11.18		4,400			11.95
Cancelled		(6,714	)		6.85		(51,666	)		8.41		(14,598	)		10.95
Exercised		(401,391	)		3.40		(268,975	)		4.51		(333,942	)		4.97
Outstanding, September 30		2,533,676		$	5.84		3,092,770		$	7.75		2,748,630		$	8.07

(18)  COMMON STOCK DIVIDENDS

          On each of February 18, 2004, July 30, 2004, December 15, 2004, October 26, 2005 and August 24, 2006, the Company declared a 10% stock dividend aggregating approximately 1,308,000, 1,442,000, 1,594,000, 1,770,000 and 1,971,000 shares, respectively. All share and per share data has been retroactively restated to give effect to the common stock dividends.

(19)  CASH DIVIDENDS

          On each of December 15, 2003, March 17, 2004 and June 16, 2004, the Company declared quarterly cash dividends of $0.034 per share. On each of September 29, 2004, December 17, 2004 and March 16, 2005, the Company declared quarterly cash dividends of $0.037 per share. On each of June 22, 2005 and September 21, 2005, the Company declared quarterly cash dividends of $0.041 per share. On each of December 21, 2005, March 15, 2006 and June 21, 2006, the Company declared quarterly cash dividends of $0.045 per share. Under Delaware law, the Company is permitted to declare and pay dividends either out of its surplus or, if there is no surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.

          Subsequent to September 30, 2006, the Company declared a $0.05 per share cash dividend on October 3, 2006, payable November 3, 2006 to Stockholders of record as of October 20, 2006.

(20)  LEGAL MATTERS

          The Company is not a defendant in any lawsuits. The subsidiaries are defendants in lawsuits arising out of the normal course of business. Based upon current information received from counsel representing the subsidiaries in these matters, the Company believes none of the lawsuits would have a material impact on the Company’s financial status.

(21)  QUARTERLY FINANCIAL DATA (UNAUDITED)

          Quarterly operating data for the years ended September 30 is summarized as follows (in thousands, except share data):

	First Quarter		Second Quarter		Third Quarter		Fourth Quarter
2005:
Total interest income	$	17,946		18,912		20,337		21,363
Total interest expense		6,431		7,016		7,831		8,452
Net interest income		11,515		11,896		12,506		12,911
Provision for loan losses		350		625		550		172
Net interest income after provision for loan losses		11,165		11,271		11,956		12,739
Other income		2,767		3,336		3,101		3,320
General and administrative expenses		7,781		8,319		8,420		8,999
Income before income taxes		6,151		6,288		6,637		7,060
Income taxes		2,106		2,153		2,281		2,442
Net income	$	4,045		4,135		4,356		4,618
Net income per common share - diluted	$	0.18		0.18		0.19		0.20
Weighted average shares outstanding-diluted		22,400,000		22,576,000		22,547,00		22,567,000

35

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(21) QUARTERLY FINANCIAL DATA (UNAUDITED) – CONTINUED

	First Quarter		Second Quarter		Third Quarter		Fourth Quarter
2006:
Total interest income	$	23,038		24,138		25,572		26,905
Total interest expense		9,762		10,970		11,661		12,680
Net interest income		13,276		13,168		13,911		14,225
Provision for loan losses		400		330		430		225
Net interest income after provision for loan losses		12,876		12,838		13,481		14,000
Other income		3,588		4,202		4,671		4,604
General and administrative expenses		9,680		9,926		10,556		10,896
Income before income taxes		6,784		7,114		7,596		7,708
Income taxes		2,341		2,469		2,659		2,732
Net income	$	4,443		4,645		4,937		4,976
Net income per common share - diluted	$	0.20		0.21		0.22		0.22
Weighted average shares outstanding-diluted		22,413,000		22,484,000		22,480,000		22,477,000

(22)  COASTAL FINANCIAL CORPORATION FINANCIAL STATEMENTS (PARENT COMPANY ONLY)

          The following is condensed financial information of Coastal Financial Corporation (parent company only), the primary asset of which is its investment in its bank subsidiary, for the periods indicated (In thousands):

Coastal Financial Corporation
Condensed Balance Sheets
September 30, 2005 and 2006

	2005		2006
Assets:
Cash	$	297		19
Investment in subsidiaries		111,034		126,740
Deferred tax asset		50		50
Other assets		2,214		1,526
Total assets	$	113,595		128,335
Liabilities and Stockholders’ Equity:
Accounts payable (principally dividends)		910		47
Junior subordinated debt		15,464		15,464
Total stockholders’ equity		97,221		112,824
Total liabilities and stockholders’ equity	$	113,595		128,335

36

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(22)  COASTAL FINANCIAL CORPORATION FINANCIAL STATEMENTS (PARENT COMPANY ONLY) - CONTINUED

Coastal Financial Corporation
Condensed Statements of Operations
Years Ended September 30, 2004, 2005 and 2006

	2004			2005			2006
Income:
Interest income	$	2			2			2
Management fees		242			242			242
Dividends from subsidiary		2,230			3,400			2,500
Equity in undistributed earnings of subsidiaries		13,063			14,444			17,432
Total income		15,537			18,088			20,176
Expenses:
Professional fees		72			83			72
Supplies and printing		33			40			51
Interest expense		662			892			1,192
Other expenses		213			280			359
Income tax benefit		(249	)		(361	)		(499	)
Total expenses		731			934			1,175
Net income	$	14,806			17,154			19,001

Coastal Financial Corporation
Condensed Statements of Cash Flows
Years Ended September 30, 2004, 2005 and 2006

	2004			2005			2006
Operating activities:
Net income	$	14,806			17,154			19,001
Adjustments to reconcile net income to net cash provided by operating activities:
Stock-based compensation		—			76			91
Equity in undistributed net income of subsidiary		(13,063	)		(14,444	)		(17,432	)
(Increase) decrease in other assets		(624	)		(489	)		688
Increase (decrease) in other liabilities		43			107			(864	)
Total cash provided by operating activities		1,162			2,404			1,484
Financing activities:
Cash dividends to stockholders		(2,948	)		(3,361	)		(2,957	)
Proceeds from stock options		1,273			1,309			1,377
Capital contribution to subsidiary		(100	)		(150	)		(200	)
Other financing activities, net		(74	)		9			18
Total cash used by financing activities		(1,849	)		(2,193	)		(1,762	)
Net increase (decrease) in cash and cash equivalents		(687	)		211			(278	)
Cash and cash equivalents at beginning of the year		773			86			297
Cash and cash equivalents at end of the years	$	86			297			19

37

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(23)  CARRYING AMOUNTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS

          The carrying amounts and fair value of financial instruments as of September 30, 2005 and 2006 are summarized below:

	2005				2006
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
	(In thousands)
Financial Assets:
Cash and cash equivalents	$	91,525		91,525	$	36,955		36,955
Investment securities available for sale		25,616		25,616		39,300		39,300
Mortgage-backed securities available for sale		399,655		399,655		392,989		392,989
Investment securities held to maturity		10,000		10,049		11,997		12,000
Loans receivable held for sale		18,121		18,126		1,853		1,868
Loans receivable, net		924,260		938,058		1,088,231		1,102,547
FHLB stock		15,775		15,775		20,291		20,291
Bank-owned life insurance		22,574		22,574		23,541		23,541
Financial Liabilities:
Deposits:
Demand accounts		643,792		643,792		632,217		632,217
Certificate accounts		427,126		426,482		430,888		430,529
Advances from Federal Home Loan Bank		289,007		286,993		380,580		376,417
Securities sold under agreements to repurchase and reverse repurchase agreements		41,937		41,937		72,095		71,828
Junior subordinated debt		15,464		15,464		15,464		15,464
Drafts outstanding		12,890		12,890		2,023		2,023

          SFAS 107, “Disclosures about Fair Value of Financial Instruments,” requires disclosure of fair value information, whether or not recognized in the statement of financial position, when it is practicable to estimate the fair value. SFAS 107 defines a financial instrument as cash, evidence of an ownership interest in an entity or contractual obligations, which require the exchange of cash, or other financial instruments. Certain items are specifically excluded from the disclosure requirements, including the Company’s common stock, premises and equipment, accrued interest receivable and payable, and other assets and liabilities.

          Fair value approximates book value for the following financial instruments due to the short-term nature of the instrument: cash and due from banks, interest-bearing bank balances, federal funds sold, federal funds purchased, drafts outstanding and other short-term borrowings. Investments and mortgage-backed securities are valued using quoted market prices.

          Fair value for variable rate loans and bank-owned life insurance that reprice frequently is based on the carrying value. Fair values for mortgage loans, consumer loans and all other loans (primarily commercial) which have fixed rates of interest are based on the discounted present value of the estimated future cash flows. Discount rates used in these computations approximates the rates currently offered for similar loans of comparable terms and credit quality.

          Fair value for demand deposit accounts and interest-bearing accounts with no fixed maturity date is equal to the carrying value. Certificate of deposit accounts are estimated by discounting cash flows from expected maturities using current interest rates on similar instruments.

          Fair value for FHLB advances, repurchase and reverse repurchase agreements and fixed rate long-term debt is based on discounted cash flows using the Company’s current incremental borrowing rate.

          The junior subordinated debentures are unsecured obligations of the Company and are subordinate and junior in right of payment to all present and future senior indebtedness of the Company. The Company has entered into a guarantee, which together with its obligations under the junior subordinated debentures and the declaration of trust governing the Trust provides a full and unconditional guarantee of the Capital Securities. The variable interest rate of the junior subordinated debentures reprices quarterly. Accordingly, fair value approximates carrying cost. See Note 11 for additional disclosure.

          The Company has used management’s best estimate of fair value based upon the above assumptions. Therefore, the fair values presented may not be the amounts which could be realized in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses, which would be incurred in an actual sale or settlement, are not taken into consideration in the fair values presented.

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements – Continued

(23) CARRYING AMOUNTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUED

          The Company had $257.8 million of off-balance sheet financial commitments as of September 30, 2006, which are commitments to originate loans, unused consumer lines of credit, letters of credit and undisbursed portion of loans in process. Since these obligations are based on current market rates, the carrying amount is considered to be a reasonable estimate of fair value.

          The Company originates certain fixed rate residential loans with the intention of selling these loans. Between the time that the Company enters into an interest rate lock or a commitment to originate a fixed rate residential loan with a potential borrower and the time the closed loan is sold, the Company is subject to variability in the market prices related to these commitments. The Company believes that it is prudent to limit the variability of expected proceeds from the sales through forward sales of “to be issued” mortgage backed securities and loans (“forward sales commitments”). The commitment to originate fixed rate residential loans and forward sales commitments are freestanding derivative instruments. They do not generally qualify for hedge accounting treatment so their fair value adjustments are recorded through the income statement in net gains on sale of loans. The commitments to originate fixed rate conforming loans totaled $5.6 million at September, 30 2006. The fair value of these commitments was an asset of approximately $41,000 at September 30, 2006, and is reflected in gain on sales of loans held for sale in the consolidated statements of operations. The forward sales commitments totaled $4.0 million at September 30, 2006. The fair value of these commitments was a liability of approximately $10,000 at September 30, 2006, and is reflected in gain on sales of loans held for sale in the consolidated statements of operations.

          Fair value estimates are made at the dates indicated above, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the Company’s entire holdings of a particular financial instrument. Because no active market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, current interest rates and prepayment trends, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in any of these assumptions used in calculating fair value would also significantly affect the estimates. Changes in market interest rates and prepayment assumptions could significantly change the fair value.

          Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Company has significant assets and liabilities that are not considered financial assets or liabilities including deposit franchise value, loan servicing portfolio, real estate, deferred tax liabilities, premises and equipment, and goodwill. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates.

(24) COMMITMENTS AND CONTINGENCIES

          The Company has entered into three contracts to purchase land. At September 30, 2006, the undisbursed future obligations under these signed contracts approximated $3.1 million. These contracts are scheduled to close during fiscal 2007. Additionally, the Company has entered into two contracts to license specialized banking computer software for approximately $300,000. It is anticipated that the installation will be completed prior to the end of the second quarter of fiscal 2007.

          In the first quarter of fiscal 2006, the Company entered into a lease for 5.48 acres of land and building with an option to purchase this property after one year for $2.75 million. In December 2006, the Company exercised its option to purchase the property.

          The Company has an unsecured unused short-term line of credit to purchase federal funds from an unrelated bank totaling $20.0 million. This line of credit expires January 1, 2007.

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis

Forward Looking Statements

          This report may contain certain “forward-looking statements” within the meaning of Section 27A of the Securities Exchange Act of 1934, as amended, that represent the Company’s expectations or beliefs concerning future events. All forward-looking statements are based on assumptions and involve risks and uncertainties, many of which are beyond the Company’s control and which may cause its actual results, performance or achievements to differ materially from the results, performance or achievements contemplated by the forward-looking statements. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.” Forward-looking statements speak only as of the date they are made. Such risks and uncertainties include, among other things:

• Competitive pressures among depository and other financial institutions in the Company’s market areas may increase significantly.

• Adverse changes in the economy or business conditions, either nationally or in the Company’s market areas, could increase credit-related losses and expenses and/or limit growth

• Increases in defaults by borrowers and other delinquencies could result in increases in the Company’s provision for losses on loans and related expenses.

• The Company’s inability to manage growth effectively, including the successful expansion of the Company’s Customer support, administrative infrastructure and internal management systems, could adversely affect the Company’s results of operations and prospects.

• Fluctuations in interest rates and market prices could reduce the Company’s net interest margin and asset valuations and increase expenses.

• The consequences of continued bank acquisitions and mergers in the Company’s market areas, resulting in fewer but much larger and financially stronger competitors, could increase competition for financial services to the Company’s detriment.

• The Company’s continued growth will depend in part on its ability to enter new markets successfully and capitalize on other growth opportunities.

• Changes in legislative or regulatory requirements, or actions by the Securities and Exchange Commission (“SEC”), the Financial Accounting Standards Board (“FASB”), or the Public Company Accounting Oversight Board, applicable to the Company and its subsidiaries could increase costs, limit certain operations and adversely affect results of operations.

• Changes in tax requirements, including tax rate changes, new tax laws and revised tax law interpretations may increase the Company’s tax expense or adversely affect its Customers’ businesses.

• Company initiatives now in place or introduced in the future, not producing results consistent with historic growth rates or results which justify their costs.

          In light of these risks, uncertainties and assumptions, you should not place undue reliance on any forward-looking statements in this report. Except as may be required by applicable law or regulation, the Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

          Coastal Financial Corporation is a unitary thrift holding company incorporated in Delaware with one wholly-owned banking subsidiary, Coastal Federal Bank (the “Bank” or “Coastal Federal”). The Company also owns Coastal Planners Holding Corporation, whose subsidiary, Coastal Retirement, Estate and Tax Planners, Inc., offers fee-based financial planning and tax preparation services. The primary business activities of the Company are conducted by the Bank. The Company and Bank’s principal executive offices are located in Myrtle Beach, South Carolina.

          Coastal Federal Bank is a full service financial services company with 24 branches located in four counties throughout the coastal regions of South Carolina and North Carolina. The Bank has sixteen offices in Horry County, South Carolina; one office in Georgetown County, South Carolina; four offices in Brunswick County, North Carolina; and three offices in New Hanover County, North Carolina.

          The Bank’s primary market areas are located along the coastal regions of South Carolina and North Carolina and predominately center around the Metro regions of Myrtle Beach, South Carolina and Wilmington, North Carolina, and their surrounding counties.

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis - Continued

Coastal Federal’s primary market is Horry County, South Carolina, where the Bank has the number one market share of deposits as of June 30, 2006 (the most recent date for which published data is available) with 15.7% of deposits as reported by the FDIC Summary of Deposits Report. The Bank also has the third highest market share of deposits as of June 30, 2006 in Brunswick County, North Carolina, with 8.7% of deposits as reported by the FDIC Summary of Deposits Report.

          The primary business activities in Horry County are centered around the tourism industry. To the extent that Horry County businesses rely heavily on tourism business, decreased tourism would have a significant adverse effect on Coastal Federal’s primary deposit base and lending area. Moreover, the Bank would likely experience a higher degree of loan delinquencies should the local economy be materially and adversely affected.

          Coastal Federal’s principal business consists of attracting core deposits from Customers in its primary market locations and using these funds to meet the lending needs of its Customers as well as providing numerous financial products and services for its Customers.

          Through its branch locations, the Bank provides a wide range of banking products, including interest-bearing and non-interest bearing checking accounts; business sweep accounts; business cash management services; statement savings accounts; money market accounts; certificate of deposit accounts; individual retirement accounts; merchant services; commercial, business, personal, real estate, residential mortgage and home equity loans; safe deposit boxes; and electronic banking services. The Bank has six ATMs at off-site locations and an ATM at each branch. The Bank also makes available a wide range of financial products through its relationship with Raymond James Financial Services, including stocks, bonds, mutual funds, annuities, insurance, and retirement products.

          In the fourth fiscal quarter of 2004, the Bank began two significant new initiatives. The first was “The Experience of FANtastic! Customer Service”. This initiative focuses on Customer service and convenience. The Bank has been in the process of redesigning its infrastructure, software and products to improve Customer service and convenience. In addition, in order to improve Customer service and convenience, the Bank added an extended-hours Call Center and introduced “6 Day Branch Banking” with extended operating hours. The Call Center employs approximately 30 Associates. The Bank experienced increased salary and benefit expenses in fiscal 2005 and 2006 and anticipates these expenses continuing thereafter associated with the hiring, training and placement of these new Associates.

          The second initiative was “The Carolinas’ Best Totally Free Checking With A Gift” that was introduced in September 2004. The Bank has incurred, and will continue to incur, significant marketing costs associated with this campaign. In fiscal 2006, 2005, and 2004 marketing expenses were $2.0 million, $1.8 million and $905,000 respectively.

          The Bank expects to realize significant benefits from these strategies consisting of increased Bank lobby traffic, increased number of personal checking accounts and higher fee income as a result of those checking accounts. In 2006, the number of personal checking accounts increased approximately 7,000 accounts or 21.7% over fiscal 2005. Primarily, as a result of the increase in the number of personal checking accounts, fees and service charges on deposit accounts has increased approximately $3.3 million coupled with an increase in ATM and Debit Card income of $802,000.

Critical Accounting Policies

          The Company’s significant accounting policies are set forth in Note 1 of the Notes to Consolidated Financial Statements. Of these policies, the Company considers the allowance for loan losses and the income taxes to be the most critical accounting policies, because they require many of management’s most subjective and complex judgments. For additional discussion concerning the Company’s allowance for loan losses and related matters, see “Allowance for Loan Losses” and see “Income Taxes” for additional discussion concerning income taxes.

General

          The Company reported $19.0 million in net income for the year ended September 30, 2006, compared to $17.2 million for the year ended September 30, 2005. Net interest income increased $5.8 million as a result of increased interest income of $21.1 million offset by an increase of $15.3 million in interest expense. Provision for loan losses decreased from $1.7 million for the year ended September 30, 2005, to $1.4 million for the year ended September 30, 2006. Other income increased 36.3% from $12.5 million in fiscal 2005, to $17.1 million in 2006. General and administrative expenses increased $7.5 million, or 22.5%, for fiscal 2006 as compared to fiscal 2005.

          Total assets increased from $1.5 billion at September 30, 2005 to $1.7 billion at September 30, 2006, or 7.5%. Liquid assets, consisting of cash, interest-bearing deposits, and securities, decreased from $526.8 million at September 30, 2005, to $481.2 million

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis - Continued

at September 30, 2006. Loans receivable increased 17.7% from $924.3 million at September 30, 2005, to $1.1 billion at September 30, 2006. Total loan originations for fiscal 2006 were $800.1 million as compared to $799.7 million for fiscal 2005.

          The decrease in liquid assets was the net result of an increase in loans receivable of $147.7 million, an increase in advances from the Federal Home Loan Bank (“FHLB”) of Atlanta of $91.6 million and an increase in repurchase and reverse repurchase agreements of $30.2 million offset by a decrease in deposits of $7.8 million. During the same period, noninterest bearing checking accounts increased $12.0 million.

          As a result of $19.0 million in net earnings, proceeds from the exercise of stock options of approximately $1.4 million, less cash dividends paid to stockholders of approximately $2.9 million, and the net change in unrealized loss on securities available for sale, stockholders’ equity increased from $97.2 million at September 30, 2005 to $112.8 million at September 30, 2006.

Liquidity and Capital Resources

          Historically, the Company has maintained its liquidity at levels believed by management to be adequate to meet requirements of normal operations, potential deposit outflows and expected loan demand and still allow for optimal investment of funds and return on assets. The following table summarizes future contractual obligations as of September 30, 2006.

	Payment Due by Period
	Total		Less than 1 Year		1-3 Years		4-5 Years		After 5 Years
	(Dollars in thousands)
Contractual Obligations:
Time deposits	$	430,888	$	389,272	$	37,154	$	3,867	$	595
Short-term borrowings		63,905		63,905		—		—		—
Long-term debt		404,234		—		20,780		114,091		269,363
Construction contracts		1,737		1,737		—		—		—
Operating leases		4,652		478		636		433		3,105
Total contractual cash obligations	$	905,416	$	455,392	$	58,570	$	118,391	$	273,063

          The Company has entered into three commitments to purchase land. See Note 24 of the Notes to Consolidated Financial Statements for information regarding these commitments.

          The principal sources of cash flows for the Company consist mainly of mortgage, consumer and commercial loan payments, retail customer deposits, repurchase agreements securitized by mortgage-backed securities and advances from the FHLB of Atlanta.

          The principal use of cash flows is the origination of loans receivable. The Company originated loans receivable of $577.3 million, $799.7 million and $800.8 million for the years ended September 30, 2004, 2005 and 2006, respectively. A large portion of these loan originations were financed through loan principal repayments which amounted to $403.5 million, $560.5 million and $597.2 million for the years ended September 30, 2004, 2005 and 2006, respectively. In addition, the Company has generally sold conforming fixed rate mortgage loans, primarily servicing retained, to correspondent financial institutions in the secondary market to finance future loan originations. For the years ended September 30, 2004, 2005 and 2006, the Company sold residential loans amounting to $27.5 million, $18.7 million and $18.0 million, respectively. During fiscal 2005 and 2006, the Company sold commercial loan participations totaling $21.2 million and $4.4 million, respectively. The Company sold no commercial loan participations in fiscal 2004.

          During fiscal 2006, the Company securitized $27.5 million of mortgage loans, concurrently sold these mortgage-backed securities to outside third parties and recognized a net gain on sale of $485,000, which included $418,000 related to mortgage servicing rights. The gain is included in gains on sales of loans and loans receivable held for sale in the consolidated statement of operations. The proceeds from sale are included in proceeds from securitization and sales of loans receivable held for sale in the consolidated statement of cash flows. The Company has no retained interest in the securities that were sold other than the servicing rights.

          In fiscal 2006 deposits remained comparable to fiscal 2005 at $1.1 billion. Savings accounts and CD’s increased $8.2 million as customers moved into higher yield accounts. This is offset by a decrease in transaction accounts.

          At September 30, 2006, the Company had commitments to originate $23.3 million in loans, disburse $32.0 million in mortgage loans, and $202.5 million in unused lines of credit, which the Company expects to fund from normal operations. Traditionally, a significant portion of the unused lines of credit may never be used by the Customer.

          At September 30, 2006, the Company had $430.9 million of certificates of deposit, including $153.3 million of brokered CDs, which were due to mature within one year. Based upon previous experience, the Company believes that a major portion of these certificates, excluding the brokered CDs, will be redeposited. At September 30, 2006, the Company had excess collateral pledged to the FHLB which would support additional FHLB advance borrowings of $69.3 million. Additionally, at September 30, 2006, the Company had excess available collateral consisting of investment securities and mortgage-backed securities to support additional borrowings of up to $129.0 million, as well as a federal funds line available of $20.0 million.

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis - Continued

          As a condition of deposit insurance, OTS regulations require that the Bank calculate and maintain a minimum regulatory capital requirement on a quarterly basis and satisfy such requirement at the calculation date and throughout the ensuing quarter. The Bank’s tangible and core capital approximated $129.6 million at September 30, 2006, exceeding the Bank’s tangible and core capital requirements by $104.7 million and $62.6 million, respectively. At September 30, 2006, the Bank’s capital exceeded its current risk-based minimum capital requirement by $63.0 million. The risk-based capital requirement may increase in the future. Also see Note 14 of the Notes to Consolidated Financial Statements.

Results of Operations
Comparison of the Years Ended September 30, 2005 and 2006

Interest Income

          Interest income for the year ended September 30, 2006, increased to $99.7 million as compared to $78.6 million for the year ended September 30, 2005. The earning asset yield for the year ended September 30, 2006, was 6.68% compared to a yield of 5.94% for the year ended September 30, 2005. The average yield on loans receivable for the year ended September 30, 2006, was 7.48% compared to 6.50% for the year ended September 30, 2005. The increased yield on loans is primarily due to the increased yield on commercial loans with interest rates tied to the prime lending rate. The prime rate was 8.25% at September 30, 2006, compared to 6.75% at September 30, 2005. The yield on investments increased to 4.98% for the year ended September 30, 2006, from 4.84% for the year ended September 30, 2005. Total average interest-earning assets were $1.5 billion for the year ended September 30, 2006 as compared to $1.3 billion for the year ended September 30, 2005. The increase in average interest-earning assets is primarily due to an increase in average loans receivable of approximately $140.7 million resulting primarily from growth in the commercial loan portfolio. Average investment securities, mortgage-backed securities and other interest-earning assets increased $27.1 million, primarily funded by borrowings, including brokered CD’s.

Interest Expense

          Interest expense on interest-bearing liabilities was $45.1 million for the year ended September 30, 2006, as compared to $29.7 million for the year ended September 30, 2005. The average cost of customer deposits for the year ended September 30, 2006, was 2.14% compared to 1.42% for the year ended September 30, 2005. The cost of interest-bearing liabilities was 3.01% for the year ended September 30, 2006 compared to 2.24% for the year ended September 30, 2005. The average cost of FHLB advances, reverse repurchase agreements and other borrowings was 4.23%, 3.70% and 7.95%, respectively, for the year ended September 30, 2006. For the year ended September 30, 2005, the average cost of FHLB advances, reverse repurchase agreements and other borrowings was 3.83%, 2.37% and 5.95%, respectively. The increased cost of funds on other borrowings is due to the increased short-term interest rates. At September 30, 2006, the federal funds rate was 5.34% compared to 3.93% at September 30, 2005. Total average interest-bearing liabilities increased from $1.3 billion at September 30, 2005 to $1.5 billion at September 30, 2006. The increase in average interest-bearing liabilities is due to an increase in average customer deposits of approximately $79.8 million as a result of the Company’s focus on checking growth, increased average FHLB advances of $28.0 million used to fund loan and investment securities growth and increased average Customer repurchase agreements of $15.3 million. Average brokered CD’s increased by $95.4 million in average balances when comparing the two periods. This increase was partially offset by a decrease in average reverse repurchase agreements of $54.1 million.

Net Interest Income

          Net interest income was $54.6 million for the year ended September 30, 2006, as compared to $48.8 million for the year ended September 30, 2005. The net interest margin was 3.67% for the year ended September 30, 2006, compared to 3.70% for the year ended September 30, 2005.

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COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis - Continued

          The following table summarizes the average balance sheet and the related yields on interest-earning assets and deposits and borrowings for the year ended September 30, 2005 and 2006 (Dollars in thousands):

	2005						2006
	Average Balance (1)		Income/ Expense		Yield/Rate		Average Balance (1)		Income/ Expense		Yield/Rate
Assets
Earning assets
Loans (2)	$	873,797	$	56,826	6.50	%	$	1,014,501	$	75,932	7.48	%
Investment securities, MBS securities and others (3)		449,402		21,732	4.84	%		476,536		23,721	4.98	%
Total earning assets	$	1,323,199	$	78,558	5.94	%	$	1,491,037	$	99,653	6.68	%
Liabilities
Customer Deposits	$	811,623	$	11,556	1.42	%	$	891,456	$	19,095	2.14	%
Brokered CD’s		79,369		2,523	3.18	%		174,761		7,648	4.38	%
FHLB Advances		322,108		12,341	3.83	%		350,064		14,803	4.23	%
Customer Repurchase Agreements		27,498		668	2.43	%		42,754		1,608	3.76	%
Junior Subordinated Debt		15,000		892	5.95	%		15,000		1,192	7.95	%
Reverse Repurchase Agreements		73,723		1,750	2.37	%		19,632		727	3.70	%
Total interest-bearing liabilities	$	1,329,321	$	29,730	2.24	%	$	1,493,667	$	45,073	3.01	%
Net interest income			$	48,828					$	54,580
Net interest margin					3.70	%					3.67	%
Net yield on earning assets					3.69	%					3.66	%

(1)	The average balances are derived from monthly balances.
(2)	Nonaccrual loans are included in average balances for yield computations.
(3)	Investment securities include taxable and tax-exempt securities. Net interest income has not been adjusted to produce a tax-equivalent yield.

Provision for Loan Losses

          The Company’s provision for loan losses decreased from $1.7 million for the year ended September 30, 2005, to $1.4 million for the year ended September 30, 2006 primarily due to the risk factors related to the underlying portfolio. The allowance for loan losses as a percentage of loans was 1.17% at September 30, 2006 as compared to 1.25% at September 30, 2005. Loans delinquent 90 days or more were $3.0 million or 0.27% of total loans at September 30, 2006, compared to $2.6 million or 0.28% of total loans at September 30, 2005. The allowance for loan losses was 426% of loans delinquent 90 days or more at September 30, 2006, compared to 445% at September 30, 2005. Net charge-offs for the year ended September 30, 2006 were $407,000 compared to $1.0 million for the year ended September 30, 2005. Management believes that the level of the allowance for loan losses at September 30, 2006 is adequate considering the composition of the loan portfolio, the portfolio’s loss experience, delinquency trends, current regional and local economic conditions and other factors at that date.

Other Income

          For the year ended September 30, 2006, other income was $17.1 million compared to $12.5 million for the year ended September 30, 2005. Fees and service charges from deposit accounts increased $3.2 million or 52.9% to $9.4 million for the year ended September 30, 2006, compared to $6.1 million for the year ended September 30, 2005. The majority of this increase is due to fee income from increased number of personal checking accounts. In fiscal 2006, the number of personal checking account balances grew approximately 7,000 accounts. During the year ended September 30, 2005, the Company securitized and concurrently sold $52.6 million of mortgage loans compared to $27.5 million for the year ended September 30, 2006. Gain on sale of loans was $485,000 for the year ended September 30, 2006, compared to $1.2 million for the year ended September 30, 2005. In addition, gain on sale of loans and loans receivable held for sale included a gain on the sale of the Company’s credit card portfolio totaling $507,000 in fiscal 2006. Losses on sales of securities available for sale were $397,000 for the year ended September 30, 2006, compared to losses of $485,000 for the year ended September 30, 2005. In addition, the Company had a gain on call of an investment security held to maturity called by the issuer of $160,000 for the year ended September 30, 2005. Due to the increase in checking accounts, income from ATM and debit card transactions increased 52.4% from $1.5 million in fiscal 2005 to $2.3 million in fiscal 2006.

44

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis - Continued

General and Administrative Expenses

          General and administrative expenses were $41.1 million for the year ended September 30, 2006 compared to $33.5 million for the year ended September 30, 2005. Salaries and employee benefits were $22.2 million for the year ended September 30, 2006, as compared to $18.5 million for the year ended September 30, 2005, an increase of 20.5%, primarily due to an increase in the number of banking Associates in business banking, Associates in the Company’s expanded hours call center, Associates in new branches and normal salary increases. The Company has added several Associates in a Banking Group that is focused on growing small to medium sized business banking relationships. Also, as a result of new branches, equipment purchased to improve Customer convenience and increased checking activity, net occupancy, furniture and fixtures and data processing expenses increased $1.9 million and depreciation expense increased $804,000, when comparing the two periods. Marketing expenses were $1.8 million for the year ended September 30, 2005, compared to $2.0 million for the year ended September 30, 2006. This is primarily attributed to the Bank’s “The Carolinas’ Best Totally Free Checking With A Gift” initiative; continued marketing of Penny Pavilion, the Bank’s free coin counting service into new branches coupled with on-going advertising support; marketing of the Bank’s expanded banking hours, including Saturday banking at all Bank branches; and marketing of the Bank’s new branches in South Carolina and North Carolina. The Bank’s “The Carolinas’ Best Totally Free Checking With A Gift” promotion involves significant direct mail advertising as well as direct media advertising. Expenses related to ATM and debit card transactions increased $360,000 or 34.7% when comparing fiscal 2005 to 2006. Other expense was $4.5 million for the year ended September 30, 2005 compared to $4.9 million for the year ended September 30, 2006. Other expense increased due increased bank clearing charges of $115,000; legal expenses primarily associated with Home Equity Lines of Credit of $110,000; increased costs for professional liability insurance of $66,000; and courier services of $58,000.

Income Taxes

          Income taxes were $9.0 million for the year ended September 30, 2005 compared to $10.2 million for the year ended September 30, 2006. The effective income tax rate as a percentage of pretax income was 34.4% and 34.9% for the years ended September 30, 2005 and 2006, respectively. The effective income tax rate differs from the statutory rate primarily due to income generated by bank-owned life insurance, and municipal securities that are exempt from federal and certain state taxes. The Company’s effective income tax rates take into consideration certain assumptions and estimates made by management. No assurance can be given that either the tax returns submitted by management or the income tax reported on the consolidated financial statements will not be adjusted by either adverse rulings by the U.S. Tax court, changes in the tax code, or assessments made by the Internal Revenue Service. The Company is subject to potential adverse adjustments, including but not limited to: an increase in the statutory federal or state income tax rates, the permanent non-deductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, in order to ultimately realize deferred income tax assets.

Results of Operations
Comparison of the Years Ended September 30, 2004 and 2005

Interest Income

          Interest income for the year ended September 30, 2005, increased to $78.6 million as compared to $65.8 million for the year ended September 30, 2004. The earning asset yield for the year ended September 30, 2005, was 5.94% compared to a yield of 5.67% for the year ended September 30, 2004. The average yield on loans receivable for the year ended September 30, 2005, was 6.50% compared to 6.17% for the year ended September 30, 2004. The increased yield on loans is primarily due to the increased yield on commercial loans with interest rates tied to the prime lending rate. The prime rate was 6.75% at September 30, 2005, compared to 4.75% at September 30, 2004. The yield on investments increased to 4.84% for the year ended September 30, 2005, from 4.72% for the year ended September 30, 2004. Total average interest-earning assets were $1.3 billion for the year ended September 30, 2005 as compared to $1.2 billion for the year ended September 30, 2004. The increase in average interest-earning assets is primarily due to an increase in average loans receivable of approximately $116.2 million resulting primarily from growth in the commercial loan portfolio. Average investment securities, mortgage-backed securities and other interest-earning assets increased $45.8 million, primarily funded by borrowings, including brokered CD’s.

Interest Expense

          Interest expense on interest-bearing liabilities was $29.7 million for the year ended September 30, 2005, as compared to $23.5 million for the year ended September 30, 2004. The average cost of deposits for the year ended September 30, 2005, was 1.58% compared to 1.39% for the year ended September 30, 2004. The cost of interest-bearing liabilities was 2.24% for the year ended September 30, 2005 compared to 2.03% for the year ended September 30, 2004. The cost of FHLB advances, reverse repurchase agreements and other borrowings was 3.83%, 2.37% and 5.95%, respectively, for the year ended September 30, 2005. For the year

45

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis - Continued

ended September 30, 2004, the cost of FHLB advances, reverse repurchase agreements and other borrowings was 3.81%, 1.50% and 4.41%, respectively. The increased cost of funds on other borrowings is due to the increased short-term interest rates. At September 30, 2005, the federal funds rate was 3.93% compared to 1.94% at September 30, 2004. Total average interest-bearing liabilities increased from $1.2 billion at September 30, 2004 to $1.3 billion at September 30, 2005. The increase in average interest-bearing liabilities is due to an increase in average deposits of approximately $171.9 million as a result of the Company’s focus on checking growth, increased average FHLB advances of $40.7 million used to fund loan and investment securities growth and increased average Customer repurchase agreements of $18.5 million. Included in increased average deposits, were brokered CD’s which increased by $79.4 million in average balances when comparing the two periods. This increase was partially offset by a decrease in average reverse repurchase agreements of $61.1 million.

Net Interest Income

          Net interest income was $48.8 million for the year ended September 30, 2005, as compared to $42.3 million for the year ended September 30, 2004. The net interest margin was 3.70% for the year ended September 30, 2005, compared to 3.64% for the year ended September 30, 2004.

          The following table summarizes the average balance sheet and the related yields on interest-earning assets and deposits and borrowings for the year ended September 30, 2004 and 2005 (Dollars in thousands):

	2004							2005
	Average Balance (1)		Income/ Expense		Yield/Rate			Average Balance (1)		Income/ Expense		Yield/Rate
Assets
Earning assets Loans (2)	$	757,633	$	46,765		6.17	%	$	873,797	$	56,826		6.50	%
Investment securities, MBS securities and others (3)		403,610		19,040		4.72	%		449,402		21,732		4.84	%
Total earning assets	$	1,161,243	$	65,805		5.67	%	$	1,323,199	$	78,558		5.94	%
Liabilities
Deposits	$	719,125	$	10,024		1.39	%	$	890,992	$	14,079		1.58	%
Borrowings		440,279		13,500		3.07	%		438,329		15,651		3.57	%
Total interest-bearing liabilities	$	1,159,404	$	23,524		2.03	%	$	1,329,321	$	29,730		2.24	%
Net interest income			$	42,281						$	48,828
Net interest margin						3.64	%						3.70	%
Net yield on earning assets						3.64	%						3.69	%

(1)	The average balances are derived from monthly balances.
(2)	Nonaccrual loans are included in average balances for yield computations.
(3)	Investment securities include taxable and tax-exempt securities. Net interest income has not been adjusted to produce a tax-equivalent yield.

Provision for Loan Losses

          The Company’s provision for loan losses decreased from $1.8 million for the year ended September 30, 2004, to $1.7 million for the year ended September 30, 2005 primarily due to the risk factors related to the underlying portfolio. The allowance for loan losses as a percentage of loans was 1.25% at September 30, 2005 as compared to 1.39% at September 30, 2004. Loans delinquent 90 days or more were $2.6 million or 0.28% of total loans at September 30, 2005, compared to $5.9 million or 0.73% of total loans at September 30, 2004. The allowance for loan losses was 445% of loans delinquent 90 days or more at September 30, 2005, compared to 189% at September 30, 2004. Net charge-offs for the year ended September 30, 2005 were $1.0 million compared to $505,000 for the year ended September 30, 2004. Included in charge-offs for the year ended September 30, 2005 were two loans totaling $196,000 guaranteed by the Small Business Administration (SBA). The SBA has denied the guarantee. The Bank is appealing this decision. Management believes that the level of the allowance for loan losses at September 30, 2005 is adequate considering the composition of the loan portfolio, the portfolio’s loss experience, delinquency trends, current regional and local economic conditions and other factors at that date.

46

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis - Continued

Other Income

          For the year ended September 30, 2005, other income was $12.5 million compared to $9.2 million for the year ended September 30, 2004. Fees and service charges from deposit accounts increased $2.4 million or 62.7% to $6.1 million for the year ended September 30, 2005, compared to $3.8 million for the year ended September 30, 2004. The majority of this increase is due to fee income from increased number of personal checking accounts. In fiscal 2005, checking account balances grew approximately 54%. During the year ended September 30, 2004, the Company securitized and concurrently sold $46.8 million of mortgage loans compared to $52.6 million for the year ended September 30, 2005. Gain on sale of loans was $1.2 million for the year ended September 30, 2005, compared to $1.5 million for the year ended September 30, 2004. Losses on sales of securities available for sale were $485,000 for the year ended September 30, 2005, compared to losses of $1.1 million for the year ended September 30, 2004. In addition, the Company had a gain on call of an investment security held to maturity called by the issuer of $160,000 for the year ended September 30, 2005 and $0 for the year ended September 30, 2004. Due to the increase in checking accounts, income from ATM and debit card transactions increased 60.6% from $954,000 in fiscal 2004 to $1.5 million in fiscal 2005.

General and Administrative Expenses

          General and administrative expenses were $33.5 million for the year ended September 30, 2005 compared to $27.3 million for the year ended September 30, 2004. Salaries and employee benefits were $18.5 million for the year ended September 30, 2005, as compared to $16.1 million for the year ended September 30, 2004, an increase of 14.7%, primarily due to an increase in the number of banking Associates in business banking, Associates in the Company’s expanded hours call center, Associates in new branches and normal salary increases. The Company has added several Associates in a Banking Group that is focused on growing small to medium sized business banking relationships. Also, as a result of new branches, equipment purchased to improve Customer convenience and increased checking activity, net occupancy, furniture and fixtures and data processing expenses increased $843,000 and depreciation expense increased $582,000, when comparing the two periods. Marketing expenses were $905,000 for the year ended September 30, 2004, compared to $1.8 million for the year ended September 30, 2005. This is primarily attributed to the Bank’s “The Carolinas’ Best Totally Free Checking With A Gift” initiative; introduction of Penny Pavilion, the Bank’s free coin counting service; marketing of the Bank’s expanded banking hours, including Saturday banking at all Bank branches; and marketing of the Bank’s new branch in Wilmington, NC. The Bank’s “The Carolinas’ Best Totally Free Checking With A Gift” promotion involves significant direct mail advertising as well as direct media advertising. Expenses related to ATM and debit card transactions increased $409,000 or 64.9% when comparing fiscal 2004 to 2005. Other expense was $3.3 million for the year ended September 30, 2004 compared to $4.5 million for the year ended September 30, 2005. Other expense increased due to loss on write-off of signage related to the Bank’s re-branding efforts in conjunction with the initiation of “6 Day Branch Banking” of $122,000, increased costs incurred related to compliance with Sarbanes-Oxley of $428,000 and increased deposit account losses of $370,000. The increase in net deposit losses is directly attributed to the increased number of personal checking accounts.

Income Taxes

          Income taxes were $7.6 million for the year ended September 30, 2004 compared to $9.0 million for the year ended September 30, 2005. The effective income tax rate as a percentage of pretax income was 34.0% and 34.4% for the years ended September 30, 2004 and 2005, respectively. The effective income tax rate differs from the statutory rate primarily due to income generated by bank-owned life insurance, municipal securities that are exempt from federal and certain state taxes, and the increase in the current fiscal year earnings over the comparable prior year earnings that are subject to higher incremental tax rates. The Company’s effective income tax rates take into consideration certain assumptions and estimates made by management. No assurance can be given that either the tax returns submitted by management or the income tax reported on the consolidated financial statements will not be adjusted by either adverse rulings by the U.S. Tax court, changes in the tax code, or assessments made by the Internal Revenue Service. The Company is subject to potential adverse adjustments, including but not limited to: an increase in the statutory federal or state income tax rates, the permanent non-deductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, in order to ultimately realize deferred income tax assets.

Non-performing Assets

          Non-performing assets were $3.6 million at September 30, 2006 compared to $3.5 million at September 30, 2005. Loans past due 90 days or more increased to $3.0 million at September 30, 2006, from $2.6 million at September 30, 2005. Real estate acquired through foreclosure decreased slightly from $818,000 at September 30, 2005, to $571,000 at September 30, 2006.

          At September 30, 2005, impaired loans totaled $2.6 million. There were $3.5 million in impaired loans at September 30, 2006. Included in the allowance for loan losses at September 30, 2005 was $434,000 related to impaired loans compared to $235,000 at September 30, 2006. The average recorded investment in impaired loans for the year ended September 30, 2005 was $3.7 million compared to $2.8 million for the year ended September 30, 2006. Interest income recognized on impaired loans in fiscal 2005 was $292,000. Interest income recognized on impaired loans in fiscal 2006 was $168,000.

47

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis - Continued

          Loans are reviewed on a regular basis and an allowance for uncollectible interest is established on loans where collection is questionable, generally when such loans become 90 days delinquent. Loan balances for which interest amounts have been reserved and all loans more than 90 days delinquent are placed on nonaccrual status. Typically, payments received on a nonaccrual loan are applied to the outstanding principal or recognized as interest based upon the collectability of the loan as determined by management.

Allowance for Loan Losses

          The adequacy of the allowance is analyzed on a quarterly basis. For purposes of this analysis, adequacy is defined as a level of reserves sufficient to absorb probable losses inherent in the portfolio. The methodology employed for this analysis considers historical loan loss experience, the results of loan reviews, current economic conditions, and other qualitative and quantitative factors that warrant current consideration in determining an adequate allowance.

          The evaluation of the allowance is segregated into general allocations and specific allocations. For general allocations, the portfolio is segregated into risk-similar segments for which historical loss ratios are calculated and adjusted for identified trends or changes in current portfolio characteristics. Historical loss ratios are calculated by product type for consumer loans (installment and revolving), mortgage loans, and commercial loans and may be adjusted for other risk factors. To allow for modeling error, a range of probable loss ratios is then derived for each segment. The resulting percentages are then applied to the dollar amounts of the loans in each segment to arrive at each segment’s range of probable loss levels.

          Certain non-performing loans are individually assessed for impairment under SFAS 114 and assigned specific allocations. Other identified high-risk loans or credit relationships based on internal risk ratings are also individually assessed and assigned specific allocations.

          The general allocation also includes a component for probable losses inherent in the portfolio, based on management’s analysis, that are not fully captured elsewhere in the allowance. This component serves to address the inherent estimation and imprecision risk in the methodology as well as address management’s evaluation of various factors or conditions not otherwise directly measured in the evaluation of the general and specific allocations. Such factors or conditions may include evaluation of current general economic and business conditions; geographic, collateral, or other concentrations; system, procedural, policy, or underwriting changes; experience of lending staff; entry into new markets or new product offerings; and results from internal and external portfolio examinations.

          The allocation of the allowance to the respective loan segments is an approximation and not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses occurring in the overall loan portfolio.

          Assessing the adequacy of the allowance is a process that requires considerable judgment. Management’s methodology and judgments are based on the information currently available and includes numerous assumptions about current events, which we believe to be reasonable, but which may or may not be valid. Thus, there can be no assurance that loan losses in future periods will not exceed the current allowance amount or that future increases in the allowance will not be required. No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting the operating results of the Company. Management believes that the current level of the allowance for loan losses is presently adequate considering the composition of the loan portfolio, the portfolio’s loss experience, delinquency trends, current regional and local economic conditions and other factors.

          The allowance is also subject to examination and adequacy testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other adequacy tests. In addition, such regulatory agencies could require the Company to adjust the allowance based on information available to them at the time of their examination.

          The Company established provisions for loan losses for the years ended September 30, 2004, 2005 and 2006, of $1.8 million, $1.7 million and $1.4 million, respectively. For the years ended September 30, 2004, 2005 and 2006, the Company had net charge-offs of $505,000, $1.0 million and $407,000, respectively. Net charge-offs as a percentage of average outstanding loans were ..07%, .12%, and .04% for fiscal years ended 2004, 2005 and 2006, respectively. At September 30, 2006, the Company had an allowance for loan losses of $12.7 million, which was 1.17% of net loans.

Off-Balance Sheet Arrangements

          In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in the financial statements, or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used

48

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis - Continued

by the Company for general corporate purposes or for Customer needs. Corporate purpose transactions are used to help manage credit, interest rate, and liquidity risk or to optimize capital. Customer transactions are used to manage Customers’ requests for funding.

          The Company’s off-balance sheet arrangements, which principally include lending commitments and derivatives are described below.

          Lending Commitments. Lending commitments include loan commitments, standby letters of credit and unused business and personal credit card lines. These instruments are not recorded in the consolidated statements of financial condition until funds are advanced under the commitments. The Company provides these lending commitments to Customers in the normal course of business.

          Loan commitments for residential housing and land totaled $23.3 million. For retail Customers, loan commitments are generally lines of credit secured by residential property. At September 30, 2006 retail loan commitments totaled $55.5 million. Standby letters of credit are conditional commitments to guarantee performance, typically contract or financial integrity, of a Customer to a third party and totaled $11.4 million at September 30, 2006. Commercial lines of credit and unused business and personal credit card lines, which totaled $135.6 million at September 30, 2006, are generally for short-term borrowings.

          The Company applies essentially the same credit policies and standards as it does in the lending process when making these commitments.

          Derivatives. In accordance with SFAS No. 133, the Company records derivatives at fair value, as either assets or liabilities, on the consolidated balance sheet. Derivative transactions are measured in terms of the notional amount, but this amount is not recorded on the balance sheet and is not, when viewed in isolation, a meaningful measure of the risk profile of the instrument. The notional amount is not exchanged, but is used only as the basis upon which interest and other payments are calculated.

          At September 30, 2006, the fair value of derivative assets totaled $31,000, net. The related notional amounts, which are not recorded on the consolidated balance sheet, totaled $5.6 million for the derivative assets and $4.0 million for the derivative liabilities. (See Note 23 of the Notes to Consolidated Financial Statements).

Interest Rate Risk Disclosure

          The Bank’s Asset Liability Management Committee (“ALCO”) monitors and considers methods of managing exposure to interest rate risk. The ALCO consists of members of the Board of Directors and Senior Leadership of the Company and meets quarterly. The Bank’s exposure to interest rate risk is reviewed on at least a quarterly basis by the ALCO. Interest rate risk exposure is measured using interest rate sensitivity analysis to determine the Bank’s change in net portfolio value in the event of hypothetical changes in interest rates. The ALCO is charged with the responsibility to maintain the level of sensitivity of the Bank’s net portfolio value within Board approved limits.

          Net portfolio value (NPV) represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items over a range of assumed changes in market interest rates. The Bank’s Board of Directors has adopted an interest rate risk policy which establishes maximum allowable decreases in NPV in the event of a sudden and sustained one hundred to four hundred basis point increase or decrease in market interest rates. The following table presents the Bank’s projected change in NPV as computed by the OTS for the various rate shock levels as of September 30, 2006.

Change in Interest Rates	Board Limit Minimum NPV Ratio		Board Limit Maximum Decline in NPV	Market Value Of Assets9/30/06		Market Value Portfolio Equity9/30/06		NPV Ratio
300 basis point rise	5.00	%	400 BPS	$	1,658,193	$	176,374	10.64	%
200 basis point rise	6.00	%	300 BPS	$	1,679,009	$	187,916	11.19	%
100 basis point rise	6.00	%	250 BPS	$	1,698,259	$	196,866	11.59	%
No Change	6.00	%		$	1,715,670	$	203,444	11.86	%
100 basis point decline	6.00	%	250 BPS	$	1,733,420	$	209,896	12.11	%
200 basis point decline	6.00	%	300 BPS	$	1,747,920	$	212,466	12.18	%
300 basis point decline	6.00	%	350 BPS		N/A		N/A	N/A

          The preceding table indicates that at September 30, 2006, in the event of a sudden and sustained increase in prevailing market interest rates, the Bank’s NPV would be expected to decrease, and that in the event of a sudden decrease in prevailing market interest rates, the Bank’s NPV would be expected to increase minimally. At September 30, 2006, the Bank’s estimated changes in NPV were within the limits established by the Board of Directors.

49

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis - Continued

          Computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the ALCO could undertake in response to sudden changes in interest rates.

          The Bank also uses interest rate sensitivity gap analysis to monitor the relationship between the maturity and repricing of its interest-earning assets and interest-bearing liabilities. Interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within the same time period. A gap is considered positive when the amount of interest-rate-sensitive assets exceeds the amount of interest-rate-sensitive liabilities. Generally, during a period of rising rates, a positive gap would result in an increase in net interest income. Conversely, during a period of falling interest rates, a positive gap would result in a decrease in net interest income. It is ALCO’s goal to maintain reasonable balance between exposure to interest rate fluctuations and earnings.

Recently Adopted Accounting Pronouncements

          In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 123R, Share-Based Payment which revised SFAS No. 123, Accounting for Stock-Based Compensation. This Statement supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and related implementation guidance and amends SFAS No. 95, Statement of Cash Flows. It requires that all stock-based compensation now be measured at fair value and recognized as expense in the income statement. This Statement also clarifies and expands guidance on measuring fair value of stock compensation, requires estimation of forfeitures when determining expense, and requires that excess tax benefits be shown as financing cash inflows versus a reduction of taxes paid in the Statement of Cash Flows. Various other changes are also required. The Company adopted this Statement effective beginning October 1, 2005. The Company experienced no significant effect on its financial statements as a result of the adoption of this Statement. The adoption of this pronouncement and its effects on the consolidated financial statements of the Company are more fully described in Note 1(p) in the Notes to Consolidated Financial Statements.

          On November 10, 2005, the FASB issued FASB Staff Position (FSP) FAS 123R-3, Transition Election Related to Accounting for the Effects of Share-Based Payment Awards (FSP FAS 123R-3). This FSP provides a practical transition election related to accounting for the tax effects of share-based payment awards to employees. An entity shall follow either the transition guidance for additional paid-in capital pool in SFAS 123R or the alternative transition method described in a one-time election to adopt the transition method described in this FSP. The Company may take up to one year from its initial adoption of SFAS 123R to evaluate its available alternatives and makes its one-time election. Effective October 1, 2006, the Company adopted the alternative transition method under FSP FAS 123R-3. Adoption of this FSP is not expected to have a significant impact on the Company’s financial position and is expected to increase fully diluted earnings per share by approximately $.01. In addition, the effects of applying this FSP will be reported as a change in accounting principle in accordance with FASB Statement No. 154 “Accounting Changes and Error Corrections” in the year of adoption. The adoption of this pronouncement and its effects on the consolidated financial statements of the Company are more fully described in Note 1(p) in the Notes to Consolidated Financial Statements.

Recently Issued Accounting Pronouncements

          In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 154, “Accounting for Changes and Error Corrections – a replacement of Accounting Principles Board Opinion No. 20 and FASB Statement No. 3 (FAS 154),” which eliminates the requirement to reflect changes in accounting principles as cumulative adjustments to net income in the period of change and requires retrospective application to prior periods’ financial statements for voluntary changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. If it is impracticable to determine the cumulative effect of the change to all prior periods, FAS 154 requires the new accounting principle to be adopted prospectively. For new accounting pronouncements, the transition guidance in the pronouncement should be followed. Retrospective application refers to the application of a different accounting principle to previously issued financial statements as if that principle had always been used. FAS 154 did not change the guidance for reporting corrections of errors, changes in estimates or for justification of a change in accounting principle on the basis of preferability. FAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005 (October 1, 2006 for the Company). The Company does not expect the adoption of FAS 154 to have a material effect on the results of operations or statement of condition.

          In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments” an amendment of FASB Statements No. 133 and 140 (FAS 155). FAS 155 permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest only-strips and principal-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized financial assets to identify

50

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis - Continued

interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. FAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006 (October 1, 2006 for the Company). The Company does not expect the adoption of FAS 155 to have a material effect on the results of operations or statement of condition.

          In March 2006, FASB issued SFAS No. 156 “Accounting for Servicing of Financials Assets” an amendment of FASB Statement No. 140 (FAS 140 and FAS 156). FAS 140 establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities. This Statement amends FAS 140 to require that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. This Statement permits, but does not require, the subsequent measurement of separately recognized servicing assets and servicing liabilities at fair value. Under this Statement, an entity can elect subsequent fair value measurement to account for its separately recognized servicing assets and servicing liabilities. Adoption of this Statement is required as of the beginning of the first fiscal year that begins after September 15, 2006. Upon adoption, the Company will apply the requirements for recognition and initial measurement of servicing assets and servicing liabilities prospectively to all transactions. The Company will adopt FAS 156 for the fiscal year beginning October 1, 2006 and currently has not determined if it will adopt FAS 156 using the fair value election.

          In September 2006, the FASB issued SFAS No. 157 (FAS 157), “Fair Value Measurements”, which defines fair value, establishes guidlines for measuring fair value and expands disclosure regarding fair value measurements. FAS 157 does not require any new fair value measurements, but rather eliminates inconsistencies found in various prior accounting pronouncements. FAS 157 is effective for fiscal years beginning after November 15, 2007 (October 1, 2008 for the Company). The Company is currently not in a position to determine the effect of adopting this standard on its consolidated financial statements.

          In July 2006, The FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes,” which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 provides guidance on the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006 (October 1, 2007 for the Company). The Company is currently evaluating the impact of this standard on its results of operations and statement of condition.

          In September 2006, the Securities and Exchange Commission (SEC) Office of the Chief Accountant and Divisions of Corporation Finance and Investment Management released Staff Accounting Bulletin No. 108 (SAB 108), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” that provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SEC staff believes that registrants should quantify errors using both a balance sheet and an income statement approach to evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB 108 is effective for fiscal years ending after November 15, 2006 (September 30, 2007 for the Company). The Company is currently evaluating the impact of this standard on its results of operations and statement of condition.

Capital Standards and Regulatory Matters

          The Bank’s capital standards include: (1) a leverage limit requiring all OTS chartered financial institutions to maintain core capital in an amount not less than 4% of the financial institution’s total assets; (2) a tangible capital requirement of not less than 1.5% of total assets; and (3) a risk-based capital requirement of not less than 8.0% of risk weighted assets. For further information concerning the Bank’s capital standards, refer to Note 14 of the Notes to the Consolidated Financial Statements.

Effects of Inflation and Changing Prices

          The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles which require the measurement of financial position and results of operations in terms of historical dollars, without consideration of change in the relative purchasing power over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effect of inflation. Interest rates do not necessarily change in the same magnitude as the price of goods and services.

51

Board of Directors

Coastal Financial Corporation
	E. Lawton Benton
	President
	C.L. Benton & Sons, Inc.
	G. David Bishop
	Managing Director
	White Harvest Trading Co., LLC
	J. Robert Calliham
	President and Chief Executive Officer
	Smith, Sapp, Bookhout, Crumpler &
	Calliham, P.A.
	James T. Clemmons
	Chairman
	Coastal Financial Corporation
	James P. Creel
	President
	Creel Corporation
	James. H. Dusenbury
	Retired – Attorney
	Dusenbury and Clarkson Law Firm
	Michael C. Gerald
	President and Chief Executive Officer
	Coastal Financial Corporation
	William O. Marsh
	President
	Palmetto Chevrolet
	Frank A. Thompson, II
	President
	Peoples Underwriters, Inc.
	W. Cecil Worsley, III
	President and Chief Executive Officer
	Worsley Companies
Coastal Federal Bank
	E. Lawton Benton
	President
	C.L. Benton & Sons, Inc.
	G. David Bishop
	Managing Director
	White Harvest Trading Co., LLC
	J. Robert Calliham
	President and Chief Executive Officer
	Smith, Sapp, Bookhout, Crumpler &
	Calliham, P.A.
	James T. Clemmons
	Chairman
	Coastal Federal Bank
	James P. Creel
	President
	Creel Corporation
	James. H. Dusenbury
	Retired – Attorney
	Dusenbury and Clarkson Law Firm
	Michael C. Gerald
	President and Chief Executive Officer
	Coastal Federal Bank
	William O. Marsh
	President
	Palmetto Chevrolet
	Frank A. Thompson, II
	President
	Peoples Underwriters, Inc.
	W. Cecil Worsley, III
	President and Chief Executive Officer
	Worsley Companies
Coastal Planners Holding Corporation
	James T. Clemmons
	Chairman
	Coastal Financial Corporation
	Michael C. Gerald
	President and Chief Executive Officer
	Coastal Financial Corporation
	Jerry L. Rexroad, CPA
	Chief Financial Officer
	Coastal Planners Holding Corporation

52

COASTAL FINANCIAL CORPORATION

Leadership Group

Sherri Adams

Branch Manager

North Myrtle Beach Branch

Ginger Allen

AVP Underwriter Group Leader

Tony Ambuhl

AVP Commercial Banking Officer

Phillip Ammons

VP Community Banking Leader

Donna Bailey

AVP Branch Operations Specialist

Randy Baker

VP Network Services

Group Leader

Jeffrey Benjamin

SVP Credit Administration

Group Leader

April Benton

Staffing Group Leader

Steven Brockmann

AVP Investment Rep-CIS

Cynthia Buffington

AVP Item Processing

Group Leader

Ronnie Burbank

VP Sr. Banking Leader

Anne Caldwell

VP - Deposit Servicing

Group Leader

Marie Canady

Mortgage Specialist

Group Leader

Tamra Cannon

AVP Sr. Branch Manager

Christopher Carbone

VP Senior Business Banking Officer

Shonda Chestnut

AVP Loan Officer II

Christopher Clark

AVP Business Banking Officer

Deanna Cooke

AVP Fiserv Applications Support

Group Leader

Susan J. Cooke

SVP Adminstrative Services

Group Leader

Corporate Secretary

Marshall Cooper

AVP Sr. Banking Leader

Benjamin Corley

Sr. Branch Manager

Southport Branch

Joe Cox

VP Community Banking Leader

John Creamer

VP Investment Rep-CIS

Perry L. Dalton

Service Leader

Oak Street Branch

Gwendolyn Davis

Branch Manager

Murrells Inlet Branch

Deborah Dillard

Branch Manager

Sunset Beach Branch

Robert D. Douglas

EVP Human Resources

Group Leader

Tiffany Dudley

AVP Electronic Banking

Group Leader

Trina Dusenbury

SVP Residential Banking

Operations Group Leader

Brandon Edens

AVP Sr. Branch Manager

Michael Evans

VP Loan Review Group Leader

Rita Fecteau

VP Accounting Group Leader

Patricia Floyd

VP Branch Development

Coordinator

Daniel Fogle

VP Community Banking Leader

Joel Foster

SVP Loan Administration

Group Leader

William Gehman

SVP Corporate Controller

Mary Geist

VP IT Administration

Michael C. Gerald

President & CEO

Jimmy R. Graham

EVP Chief Operations Officer

E. Haden Hamilton Jr.

President -CIS

Don Hamilton

VP Residential Brokerage Leader

Kathy Hane

AVP Sr. Branch Manager

Lauren Henson

SVP Dean Of CFU

Jennifer Henthorn

Branch Manager

Southport Branch

Mike Hill

VP Investment Rep-CIS

Debra Hinson

VP Operations Group Leader-CIS

Christopher Hipp

Branch Manager

Stephen’s Crossroads Branch

Glenn Humbert

SVP NC Banking Group Leader

Cameron Jackson

AVP Consumer Loan Administrator

Mike Jackson

VP Sr. Banking Leader

Lisa James

SVP Operations Group Leader

Wendy Johnson

Branch Manager

Loris Branch

Jennifer Julian

AVP Facility Services

Group Leader

Ruthie Kearns

SVP Community Relations Officer

Alvin Kennedy

Branch Manager

Hwy 544 West Branch

Kara Kessinger

President-CRETP

Eric Keys

VP - Sr. Commercial Banking Leader

Linwood Koonce Jr

AVP Banking Closing Group Leader

53

COASTAL FINANCIAL CORPORATION

Leadership Group - Continued

Louis LaBruce

VP Sr. Banking Leader

Justin Lee

AVP Commercial/Residential Officer

Edward Loehr Jr.

VP Budgeting & Treasury

Mary Lundy

Branch Manager

Shallotte Branch

Kathleen Lutes

AVP Secondary Marketing

Group Leader

Leslie Lydon

VP Residential Banking Sales

Patsy Madden

Residential Loan Servicing

Group Leader

Michael Mauney

VP Collections Group Leader

Amy McLaurin

AVP Sr. Banking Leader

Carol Mercolini

Branch Manager

Surfside Branch

Janice Metz

AVP Advertising Officer

Joy Metz

Sales Leader

Oak Street Branch

Abigail Mishoe

AVP Residential Banking Officer

Phyllis Monarch

Branch Manager

North Conway Branch

Leslie Morse

Commercial/Consumer Loan

Servicing Group Leader

Lynn Murray

SVP Checking Acct Product

Development & Managment Officer

Deborah Orobello

Branch Manager

Little River Branch

Bruce Patonay

Sr. Branch Manager

Dunes Branch

Charles Page

VP Commercial Banking Officer

Dan Rettig

AVP Security Officer

Jerry L. Rexroad

EVP Chief Financial Officer

David Roe

SVP Business Banking Leader

Eulette Sauls

AVP Information Management

Group Leader

Sherry G. Schoolfield

VP Compliance Officer

Douglas E. Shaffer

SVP Horry County Banking

Group Leader

Steven J. Sherry

EVP Marketing Group Leader

Joseph Shumbo

AVP Residential Banking Officer

Leeann Slack

Operations Leader

Oak Street Branch

Dawn Small

AVP Branch Operations Leader

J. Marcus Smith Jr.

SVP Internal Audit

Group Leader

Marcus Smith

AVP Commercial Banking Officer

Phillip Stalvey

EVP Banking Group Leader

Allison Stout

Electronic Banking Business Services

Leader

Annette Stroud

Sr. Branch Manager

Carolina Forest Branch

Charlene Sullivan

Branch Manager

Socastee Branch

Sandra Szarek

AVP Commercial Loan Servicing

Group Leader

Andrea Taiani

Customer Service Group Leader

James Talerico

AVP Sr. Business Banking Officer

Gary Thompson

VP Financial Reporting &

Compliance Leader

Matthew Towns

VP Credit Administration

Audrey Waldron

Branch Manager

Oak Island Branch

Douglas Walters

VP Residential Banking Officer

Brian White

SVP Chief Information Officer

Theresa Whitley

Construction Group Leader

Josh Wise

AVP Business Banking Loan

Administrator

Sandra R. Zanfini

AVP Corp. Support Group Leader

Asst. Corporate Secretary

54

Branch Locations

Coastal Federal Bank

Carolina Forest Branch

3894 Renee Drive

Myrtle Beach, SC 29579

843.205.2016

Conway Branch

310 Wright Boulevard

Conway, SC 29526

843.205.2005

Dunes Branch

7500 North Kings Highway

Myrtle Beach, SC 29572

843.205.2001

Highway 544 West Branch

1571 Hwy 544

Conway, SC 29526

843.205.2023

Little River Branch

1602 Highway 17

Little River, SC 29566

843.205.2014

Loris Branch

3610 Broad Street

Loris, SC 29569

843.205.2018

Murrells Inlet Branch

3348 Highway 17 South

& Inlet Crossing

Murrells Inlet, SC 29576

843.205.2008

North Conway Branch

2600 Main Street

Conway, SC 29526

843.205.2017

North Myrtle Beach Branch

521 Main Street

North Myrtle Beach, SC 29582

843.205.2002

Oak Island Branch

8001 East Oak Island Drive

Oak Island, NC 28465

843.205.2036

910.201.1481

Oak Street Branch

2619 Oak Street

Myrtle Beach, SC 29577-3129

843.205.2000

Pawleys Island Branch

Coastal Federal Town Center

11403 Ocean Highway

Pawleys Island, SC 29585

843.205.2020

SayeBrook Branch

201 Chartwell Court

Myrtle Beach, SC 29588

843.205.2024

Shallotte Branch

200 Smith Avenue

Shallotte, NC 28470

843.205.2035

910.754.6186

Socastee Branch

4801 Socastee Boulevard

Myrtle Beach, SC 29575

843.205.2007

Southport Branch

4956-1 Long Beach Road SE

Southport, NC 28461

843.205.2032

910.454.4173

Stephens Crossroads Branch

2496 Highway 9 East

Highways 9 and 57

Little River, SC 29566

843.205.2013

Sunset Beach Branch

1625 Seaside Road SW

Sunset Beach, NC 28468

843.205.2012

910.579.8160

Surfside Branch

112 Highway 17 South

& Glenns Bay Road

Surfside Beach, SC 29575

843.205.2003

Waccamaw Medical Park Branch

112 Waccamaw Medical Park Drive

Conway, SC 29526

843.205.2009

38th Avenue Branch (BI-LO)

1245 38th Avenue North

Myrtle Beach, SC 29577

843.205.2041

Wilmington Branch

4320 17th Street Extension

Wilmington, NC 28412

843.205.2034

910.392.2265

Wilmington Branch

5710 Oleander Drive, Suite 209

Wilmington, NC 28403

843.205.2031

910.313.1161

Wilmington Branch

109 Market Street

Wilmington, NC 28401

843.205.2033

910.763.2372

55

Corporate Information

Common Stock and Dividend Information

The common stock of Coastal Financial Corporation is quoted through the Nasdaq Stock Market under the symbol CFCP. For information contact the Stockholder Relations office.

As of November 30, 2006, the Corporation had 1,137 stockholders and 21,701,967 shares of Common Stock outstanding. This does not reflect the number of persons or entities who hold stock in nominee or “street name.”

The Company’s ability to pay dividends depends primarily on the ability of Coastal Federal Bank to pay dividends to the Company. See Notes 14, 15, and 19 of the Notes to Consolidated Financial Statements for further information.

Market Price of Common Stock

The table below reflects the high and low bid stock prices published by Nasdaq for each quarter. Such prices may reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not necessarily represent actual transactions. The prices have been adjusted retroactive to reflect stock dividends.

	HIGH		LOW		CASH
	BID		BID		DIVIDEND
Fiscal Year 2006:
First Quarter	$	15.20	$	12.75	$	0.045
Second Quarter		14.50		12.55		0.045
Third Quarter		14.12		12.23		0.045
Fourth Quarter		13.64		11.55		—
Note: On October 3, 2006, the Company declared a $0.05 per share cash dividend payable November 3, 2006 to stockholders of record as of October 20, 2006.
Fiscal Year 2005:
First Quarter	$	14.39	$	10.15	$	0.037
Second Quarter		14.91		10.18		0.037
Third Quarter		11.67		10.52		0.041
Fourth Quarter		11.84		10.65		0.041
Form 10-K

A copy of Coastal Financial Corporation’s Annual Report on Form 10-K, as filed with the Securities Exchange Commission for the year ended September 30, 2006, may be obtained or viewed on www.coastalfederal.com by clicking on Investor Services.

Annual Meeting of Stockholders

The Annual Meeting of Stockholders of Coastal Financial Corporation will be held at Ocean Reef Resort, 7100 North Ocean Boulevard, Myrtle Beach, South Carolina, on Monday, January 29, 2007 at 2:00 p.m., Eastern Standard Time.

Additional Information

If you are receiving duplicate mailing of stockholder reports due to multiple accounts, we can consolidate the mailings without affecting your account registration. To do this, or for additional information, contact the Stockholder Relations Office, at the Corporate address shown below.

Corporate Offices

Coastal Financial Corporation

2619 Oak Street

Myrtle Beach, South Carolina 29577

843.205.2000

Transfer Agent and Registrar

Registrar and Transfer Company

P.O. Box 1010

Cranford, NJ 07016

1.800.866.1340 Ext. 2514

Independent Registered Public Accounting Firm

KPMG LLP

150 Fayetteville Street Mall

Suite 1200

Raleigh, NC 27601

Special Counsel

Muldoon Murphy & Aguggia LLP

5101 Wisconsin Avenue

Washington, DC 20016

Stockholder Relations Officer

Susan J. Cooke

Coastal Financial Corporation

2619 Oak Street

Myrtle Beach, South Carolina 29577

843.205.2000

Coastal Financial Corporation is an equal opportunity employer and pledges equal opportunities without regard to religion, citizenship, race, color, creed, sex, age, national origin, disability or status as a disabled or Vietnam-Era veteran.

	Securities and investment advisory services offered exclusively through Raymond James Financial Services, Inc., member NASD/SIPC, an independent broker/dealer, and are not insured by the FDIC or any other bank insurance, are not deposits or obligations of the bank, are not guaranteed by the bank, and are subject to risk, including the possible loss of principal.
	Coastal Investor Services is a division of Coastal Federal Bank.

56

EX-21

EX-23

EXHIBIT 23

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors
Coastal Financial Corporation:

We consent to incorporation by reference in the registration statements (Nos. 33-52212, 333-01274, 333-49741, 333-54794, and 333-114040) on Forms S-8 of Coastal Financial Corporation and subsidiaries of our report dated December 14, 2006, with respect to the consolidated statements of financial condition of Coastal Financial Corporation and subsidiaries as of September 30, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended September 30, 2006, management’s assessment of the effectiveness of internal control over financial reporting as of September 30, 2006, and the effectiveness of internal control over financial reporting as of September 30, 2006, which reports are incorporated by reference in the September 30, 2006 Annual Report on Form 10-K of Coastal Financial Corporation. Our reports refer to the fact that Coastal Financial Corporation and subsidiaries adopted, October 1, 2005, the provisions of Statement of Financial Accounting Standard No. 123R, Share-Based Payment.

/s/ KPMG LLP

Raleigh, North Carolina
December 14, 2006

43

EX-31.1

EXHIBIT 31.1

Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)

I, Michael C. Gerald, certify that:

1.	I have reviewed this annual report on Form 10-K of Coastal Financial Corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15e and 15d-15e) for the registrant and have:
	a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
	b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
	c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
	d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
	a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
	b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:	December 14, 2006	/s/ Michael C. Gerald
		Michael C. Gerald
		President/Chief Executive Officer

44

EX-31.2

EXHIBIT 31.2

Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)

I, Jerry L. Rexroad, certify that:

1.	I have reviewed this annual report on Form 10-K of Coastal Financial Corporation;
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15e and 15d-15e) for the registrant and have:
	a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
	b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
	c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
	d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):
	a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
	b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:	December 14, 2006	/s/ Jerry L. Rexroad
		Jerry L. Rexroad
		Executive Vice President/Chief Financial Officer

45

EX-32.1

EXHIBIT 32.1

SECTION 1350 Certification (Chief Executive Officer)

In connection with the Annual Report of Coastal Financial Corporation, Inc. (the “Company”) on Form 10-K for the period ended September 30, 2006 as filed with the Securities and Exchange Commission (the “Report”), I, Michael C. Gerald, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

1.	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the Report.

This Certification is provided as of December 14, 2006.

/s/ Michael C. Gerald

Michael C. Gerald

President/Chief Executive Officer

46

EX-32.2

EXHIBIT 32.2

SECTION 1350 Certification (Chief Financial Officer)

In connection with the Annual Report of Coastal Financial Corporation, Inc. (the “Company”) on Form 10-K for the period ended September 30, 2006 as filed with the Securities and Exchange Commission (the “Report”), I, Jerry L. Rexroad, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

1.	The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
2.	The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of and for the period covered by the Report.

This Certification is provided as of December 14, 2006.

/s/ Jerry L. Rexroad

Jerry L. Rexroad

Executive Vice President and
Chief Financial Officer

47