UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                         ------------------------------

                                    FORM 10-Q

         (X)      QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF
                  THE SECURITIES EXCHANGE ACT OF 1934

                  For the quarterly period ended March 31, 2006

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

                  For the transition period from ________ to __________

                         Commission File Number: 0-19684

                          COASTAL FINANCIAL CORPORATION
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)


           State of Delaware                               57-0925911
     ----------------------------------------------------------------------
      (State or other jurisdiction of                   (I.R.S. Employer
       incorporation or organization)                Identification Number)

       2619 OAK STREET, MYRTLE BEACH, S. C.                     29577
     ----------------------------------------------------------------------
      (Address of principal executive offices)              (Zip Code)

Registrant's telephone number, including area code  (843) 205-2000
                                                    --------------

     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 |_|

     Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated  filer or  non-accelerated  filer. See definition of "accelerated
filer and a large accelerated filer" in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer |_|   Accelerated Filer |X|    Non-accelerated Filer |_|

Indicate by check mark whether the  registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act)

                 YES |_|      NO |X|

     Indicate  the  number of  shares  outstanding  of each of the  registrant's
classes of common stock, as of April 30, 2006.

Common Stock $.01 Par Value Per Share                         19,594,784 Shares
--------------------------------------------------------------------------------
(Class)                                                          (Outstanding)


                                       1
<PAGE>
<TABLE>
<CAPTION>


COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2006

TABLE OF CONTENTS                                                               PAGE
-----------------                                                               ----
<S>                                                                               <C>

PART I-  Financial Information
Item
     1.  Consolidated Financial Statements (unaudited):

             Consolidated Statements of Financial Condition
             as of September 30, 2005 and March 31, 2006                           3

             Consolidated Statements of Operations for the three
             months ended March 31, 2005 and 2006                                  4

             Consolidated Statements of Operations for the six
             Months ended March 31, 2005 and 2006                                  5

             Consolidated Statements of Stockholders' Equity
             and Comprehensive Income for the six months ended
             March 31, 2005 and 2006                                               6

             Consolidated Statements of Cash Flows for the six
             months ended March 31, 2005 and 2006                                7-8

             Notes to Consolidated Financial Statements                         9-16

     2. Management's Discussion and Analysis of
             Financial Condition and Results of Operations                     17-29

     3. Quantitative and Qualitative Disclosures About                         29-30
         Market Risk

     4. Controls and Procedures                                                   30


Part II - Other Information
Item
     1.  Legal Proceedings                                                        30

     1A. Risk Factors                                                          30-34

     1B. Unresolved Staff Comments                                                34

     2.  Unregistered Sales of Equity Securities and Use of Proceeds              34

     3.  Defaults Upon Senior Securities                                          34

     4.  Submission of Matters to a Vote of Securities Holders                    34

     5.  Other Information                                                        34

     6.  Exhibits                                                                 35

Signatures                                                                        36

Exhibits

      3(c)   Certificate of Amendment of Certificate of Incorporation             37

     31(a)   Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)     38

       (b)   Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)     39

     32(a)   Section 1350 Certification (Chief Executive Officer)                 40

       (b)   Section 1350 Certification (Chief Financial Officer)                 41
</TABLE>

                                       2
<PAGE>

PART I.  FINANCIAL INFORMATION
Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

<TABLE>
<CAPTION>
                                                         September 30,    March 31,
                                                             2005            2006
                                                             ----            ----
<S>                                                           <C>            <C>
                                                                 (Unaudited)
                                                                (In thousands)


ASSETS:
Cash and amounts due from banks                          $    52,592    $    39,204
Short-term interest-bearing deposits                          33,742         59,926
Federal funds sold                                             5,191            486
Investment securities available for sale                      25,616         21,501
Mortgage-backed securities available for sale                399,655        421,781
Investment securities held to maturity (market
  value $10,049 at September 30, 2005 and
  $10,000 at March 31, 2006)                                  10,000         10,000
Loans receivable (net of allowance for loan
  losses of $11,748 at September 30, 2005 and
  $12,208 at March 31, 2006)                                 924,260      1,004,385
Loans receivable held for sale                                18,121          3,783
Real estate acquired through foreclosure, net                    818          1,120
Office property and equipment, net                            22,758         26,657
Federal Home Loan Bank (FHLB) stock, at cost                  15,775         18,365
Accrued interest receivable on loans                           3,807          4,647
Accrued interest receivable on securities                      2,351          2,698
Bank-owned life insurance                                     22,574         23,050
Other assets                                                   6,199          6,388
                                                         -----------    -----------
                                                         $ 1,543,459    $ 1,643,991
                                                         ===========    ===========

LIABILITIES AND STOCKHOLDERS' EQUITY:

LIABILITIES:
Deposits                                                 $ 1,070,918    $ 1,080,440
Securities sold under agreements to repurchase                41,937         96,706
Advances from FHLB                                           289,007        337,765
Junior subordinated debt                                      15,464         15,464
Drafts outstanding                                            12,890          3,001
Advances by borrowers for property taxes and insurance         1,221            621
Accrued interest payable                                       3,415          4,367
Other liabilities                                             11,386          5,418
                                                         -----------    -----------
     Total Liabilities                                     1,446,238      1,543,782
                                                         -----------    -----------

STOCKHOLDERS' EQUITY:
Serial preferred stock, 1,000,000 shares authorized
  and unissued                                                    --             --
Common stock, $.01 par value, 50,000,000 shares
  authorized; 19,457,492 shares at September 30, 2005
  and 19,583,163 shares at March 31, 2006 issued
  and outstanding                                                195            196
Additional paid-in capital                                    11,410         11,941
Retained earnings, restricted                                 86,723         93,857
Accumulated other comprehensive loss, net of tax              (1,107)        (5,785)
                                                         -----------    -----------
     Total stockholders' equity                               97,221        100,209
                                                         -----------    -----------
                                                         $ 1,543,459    $ 1,643,991
                                                         ===========    ===========
</TABLE>


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


                                       3
<PAGE>
PART I.  FINANCIAL INFORMATION
Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2006

<TABLE>
<CAPTION>
                                                                  2005             2006
                                                                  ----             ----
<S>                                                           <C>             <C>
                                                                       (Unaudited)
                                                                     (In thousands,
                                                                    Except per share)
Interest income:
   Loans receivable                                           $     13,364    $     18,182
   Investment securities                                             1,231           1,672
   Mortgage-backed securities                                        4,250           4,077
   Other                                                                67             207
                                                              ------------    ------------
Total interest income                                               18,912          24,138
                                                              ------------    ------------

Interest expense:
   Deposits                                                          2,939           6,519
   Securities sold under agreements to repurchase                      746             539
   Advances from FHLB                                                3,128           3,623
   Other borrowings                                                    203             289
                                                              ------------    ------------
Total interest expense                                               7,016          10,970
                                                              ------------    ------------
   Net interest income                                              11,896          13,168
Provision for loan losses                                              625             330
                                                              ------------    ------------
   Net interest income after provision for loan losses              11,271          12,838
                                                              ------------    ------------

Other income:
   Fees and service charges on loan and deposit accounts             1,423           2,246
   Gain on sales of loans held for sale                                244             202
   Gain on sales of investment securities, net                          28              30
   Gain on sales of mortgage-backed securities, net                     60              --
   Gain on investment security held to maturity called by
      issuer                                                           160              --
   Loss from real estate acquired through foreclosure, net              (6)            (62)
   Income from sales of non-depository products                        470             505
   FHLB stock dividends                                                213             256
   Income from ATM and debit card transactions                         328             538
   Bank-owned life insurance                                           233             237
   Other income                                                        183             250
                                                              ------------    ------------
     Total other income                                              3,336           4,202
                                                              ------------    ------------

General and administrative expenses:
   Salaries and employee benefits                                    4,496           5,474
   Net occupancy, furniture and fixtures and data
     processing expenses                                             1,186           1,568
   Depreciation                                                        673             844
   FDIC insurance premium                                               26              34
   Marketing expenses                                                  482             520
   Expense from ATM and debit card transactions                        236             348
   Other expense                                                     1,220           1,138
                                                              ------------    ------------
     Total general and administrative expense                        8,319           9,926
                                                              ------------    ------------
Income before income taxes                                           6,288           7,114
Income taxes                                                         2,153           2,469
                                                              ------------    ------------
Net income                                                    $      4,135    $      4,645
                                                              ============    ============

Net income per common share:
   Basic                                                      $       0.21    $       0.24
                                                              ============    ============
   Diluted                                                    $       0.20    $       0.23
                                                              ============    ============

Dividends declared per common share                           $       0.04    $       0.05
                                                              ============    ============

Weighted average common shares outstanding:
   Basic                                                        19,362,000      19,547,000
                                                              ============    ============
   Diluted                                                      20,524,000      20,440,000
                                                              ============    ============
</TABLE>

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                       4
<PAGE>
PART I.  FINANCIAL INFORMATION
Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED MARCH 31, 2005 AND 2006

<TABLE>
<CAPTION>
                                                                 2005            2006
                                                                 ----            ----
<S>                                                              <C>             <C>
                                                                     (Unaudited)
                                                                    (In thousands,
                                                                   Except per share)
Interest income:
   Loans receivable                                          $     26,104    $     35,329
   Investment securities                                            2,375           3,287
   Mortgage-backed securities                                       8,257           8,186
   Other                                                              122             374
                                                             ------------    ------------
Total interest income                                              36,858          47,176
                                                             ------------    ------------

Interest expense:
   Deposits                                                         5,435          12,389
   Securities sold under agreements to repurchase                   1,312             917
   Advances from FHLB                                               6,296           6,868
   Other borrowings                                                   403             558
                                                             ------------    ------------
Total interest expense                                             13,446          20,732
                                                             ------------    ------------
   Net interest income                                             23,412          26,444
Provision for loan losses                                             975             730
                                                             ------------    ------------
   Net interest income after provision for loan losses             22,437          25,714
                                                             ------------    ------------

Other income:
   Fees and service charges on loan and deposit accounts            2,513           4,335
   Gain on sales of loans held for sale                               554             294
   Gain on sales of investment securities, net                         17              18
   Gain (loss) on sales of mortgage-backed securities, net            229             (33)
   Gain on investment security held to maturity called by
     issuer                                                           160              --
   Loss from real estate acquired through foreclosure, net            (45)            (95)
   Income from sales of non-depository products                       930             910
   FHLB stock dividends                                               350             456
   Income from ATM and debit card transactions                        624           1,039
   Bank-owned life insurance                                          474             476
   Other income                                                       296             390
                                                             ------------    ------------
     Total other income                                             6,102           7,790
                                                             ------------    ------------

General and administrative expenses:
   Salaries and employee benefits                                   8,920          10,852
   Net occupancy, furniture and fixtures and data
     processing expenses                                            2,328           3,019
   Depreciation                                                     1,271           1,646
   FDIC insurance premium                                              53              67
   Marketing expenses                                                 993             957
   Expense from ATM and debit card transactions                       465             677
   Other expense                                                    2,070           2,388
                                                             ------------    ------------
     Total general and administrative expense                      16,100          19,606
                                                             ------------    ------------
Income before income taxes                                         12,439          13,898
Income taxes                                                        4,260           4,810
                                                             ------------    ------------
Net income                                                   $      8,179    $      9,088
                                                             ============    ============

Net income per common share:
   Basic                                                     $       0.42    $       0.47
                                                             ============    ============
   Diluted                                                   $       0.40    $       0.45
                                                             ============    ============

Dividends declared per common share                          $       0.08    $       0.10
                                                             ============    ============

Weighted average common shares outstanding:
   Basic                                                       19,278,000      19,488,000
                                                             ============    ============
   Diluted                                                     20,367,000      20,380,000
                                                             ============    ============
</TABLE>

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                       5
<PAGE>

PART I.  FINANCIAL INFORMATION
Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
FOR THE SIX MONTHS ENDED MARCH 31, 2005 AND 2006

<TABLE>
<CAPTION>
                                                                                               Accumulated
                                                                                                 Other
                                                                                                 Compre-
                                                Additional                                       hensive         Total
                                   Common        Paid-In       Retained         Treasury         Income       Stockholders'
                                    Stock        Capital       Earnings          Stock           (Loss)         Equity
                                ------------   ------------   ------------    ------------    ------------    ------------
<S>                             <C>            <C>            <C>             <C>             <C>             <C>

                                                                         (Unaudited)
                                                                        (In thousands)

Balance at September
  30, 2004                      $        192   $     10,607   $     73,533    $     (1,182)   $      2,198    $     85,348
Net income                                --             --          8,179              --              --           8,179
Other comprehensive
 income:
 Unrealized losses arising
 during period, net of
 taxes of $2,139                          --             --             --              --          (3,490)             --
 Less: reclassification
 adjustment for gains
 included in net income,
 net of taxes of $93                      --             --             --              --             153              --
                                                                                              ------------
Other comprehensive loss                  --             --             --              --          (3,337)         (3,337)
                                                                                                              ------------
Comprehensive income                      --             --             --              --              --           4,842
                                                                                                              ------------
Exercise of stock options
  including tax benefit of $262            1            347           (602)          1,182              --             928
Cash dividends                            --             --         (1,584)             --              --          (1,584)
                                ------------   ------------   ------------    ------------    ------------    ------------
Balance at March
  31, 2005                      $        193   $     10,954   $     79,526    $         --    $     (1,139)   $     89,534
                                ============   ============   ============    ============    ============    ============


Balance at September
  30, 2005                      $        195   $     11,410   $     86,723    $         --    $     (1,107)   $     97,221
Net income                                --             --          9,088              --              --           9,088
Other comprehensive
 income:
 Unrealized losses arising
 during period, net of
 tax benefit of $2,873                    --             --             --              --          (4,687)             --
 Less: reclassification
 adjustment for losses
 included in net income,
 net of taxes of $6                       --             --             --              --               9              --
                                                                                              ------------
Other comprehensive loss                  --             --             --              --          (4,678)         (4,678)
                                                                                              ------------    ------------
Comprehensive income                      --             --             --              --              --           4,410
                                                                                                              ------------
Exercise of stock options
  including tax benefit of $185            1            484             --              --              --             485
Stock compensation expense,
   net of tax                             --             47             --              --              --              47
Cash dividends                            --             --         (1,954)             --              --          (1,954)
                                ------------   ------------   ------------    ------------    ------------    ------------
Balance at March
  31, 2006                      $        196   $     11,941   $     93,857    $         --    $     (5,785)   $    100,209
                                ============   ============   ============    ============    ============    ============
</TABLE>

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                                            6
<PAGE>

Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 2005 AND 2006

<TABLE>
<CAPTION>
                                                                     2005         2006
                                                                     ----         ----
<S>                                                               <C>          <C>
                                                                       (Unaudited)
                                                                      (In thousands)

Cash flows from operating activities:
Net income                                                        $   8,179    $   9,088
Adjustments to reconcile net income to net cash
Provided by operating activities:
Depreciation                                                          1,271        1,646
Provision for loan losses                                               975          730
Gain on sale of investment securities
     available for sale, net                                            (17)         (18)
(Gain) loss on sale of mortgage-backed securities
     available for sale, net                                           (229)          33
Gain on call of investment security called by issuer                   (160)          --
Stock option compensation expense                                        --           75
Loss on disposal of office properties and equipment                     124           --
Origination of loans receivable held for sale                       (26,623)     (15,597)
Proceeds from sale of loans receivable held for sale, net             8,371        7,960
Recovery from write-down of mortgage servicing rights                  (155)          --
Proceeds from securitization and sales of loans receivable
      held for sale                                                  20,080       12,874
Tax benefit from exercise of stock options                             (262)        (185)
(Increase) decrease in:
     Cash value of life insurance                                      (474)        (476)
     Accrued interest receivable                                       (296)      (1,187)
     Other assets                                                     1,793         (189)
Increase (decrease) in:
     Accrued interest payable                                           492          952
     Other liabilities                                                  364       (2,945)
                                                                  ---------    ---------
Net cash provided by operating activities                            13,433       12,761
                                                                  ---------    ---------

Cash flows from investing activities:
Proceeds from sales of investment securities available for sale       3,371        7,175
Proceeds from sales of mortgage-backed securities
     available for sale                                              95,200       41,474
Proceeds from issuer call of investment securities held
     to maturity                                                      8,000           --
Proceeds from issuer call of investment securities
     available for sale                                               1,950           --
Purchases of investment securities available for sale                (3,659)      (3,691)
Purchases of investment securities held to maturity                 (10,000)          --
Purchases of mortgage-backed securities available for sale         (206,648)    (111,622)
Principal collected on mortgage-backed securities
     available for sale                                              42,678       41,094
Origination of loans receivable, net                               (349,851)    (358,349)
Purchase of loans receivable                                             --       (8,656)
Proceeds from sales of commercial loan participations                13,251        2,100
Principal collected on loans receivable, net                        267,904      292,251
Proceeds from sales of real estate acquired through
     foreclosure, net                                                   714          598
Purchases of office properties and equipment                         (2,866)      (5,545)
Change in FHLB stock, net                                               533       (2,590)
                                                                  ---------    ---------
Net cash used in investing activities                              (139,423)    (105,761)
                                                                  ---------    ---------


                                                                              (CONTINUED)

</TABLE>

                                            7
<PAGE>


PART I.  FINANCIAL INFORMATION
Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED MARCH 31, 2005 AND 2006 (CONTINUED)

<TABLE>
<CAPTION>
                                                                             2005         2006
                                                                             ----         ----
<S>                                                                       <C>          <C>

                                                                                (Unaudited)
                                                                               (In thousands)

Cash flows from financing activities:
Increase in deposits, net                                                 $ 136,902    $   9,522
Increase in securities sold under agreements to repurchase, net              28,827       54,769
Proceeds from FHLB advances                                                 372,850      568,300
Repayment of FHLB advances                                                 (399,200)    (519,542)
Decrease in advance payments by borrowers for
     property taxes and insurance, net                                         (681)        (600)
Increase(decrease) in drafts outstanding, net                                 1,487       (9,889)
Cash dividends to stockholders                                               (1,584)      (1,954)
Proceeds from exercise of stock options                                         666          300
Tax benefit from exercise of stock options                                      262          185
                                                                          ---------    ---------
Net cash provided by financing activities                                   139,529      101,091
                                                                          ---------    ---------
Net decrease in cash and cash equivalents                                    13,539        8,091
Cash and cash equivalents at beginning of period                             29,652       91,525
                                                                          ---------    ---------
Cash and cash equivalents at end of period                                $  43,191    $  99,616
                                                                          =========    =========

Supplemental information:
     Interest paid                                                        $  12,954    $  19,780
                                                                          =========    =========
     Income taxes paid                                                    $   3,492    $   5,077
                                                                          =========    =========

Supplemental schedule of non-cash investing and financing transactions:

Securitization of mortgage loans into mortgage-backed
     securities                                                           $  20,080    $  12,874
                                                                          =========    =========

Transfer of mortgage loans to real estate acquired
     through foreclosure                                                  $     463    $     900
                                                                          =========    =========


Change in unrealized loss in investment securities
     and mortgage-backed securities available for sale,
     net of tax                                                           $  (3,337)   $  (4,678)
                                                                          =========    =========
Transfer of loans held for sale to loans receivable                       $      --    $   9,100
                                                                          =========    =========
</TABLE>


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                            8
<PAGE>


PART I.  FINANCIAL INFORMATION
Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(1)  BASIS OF PRESENTATION

The accompanying  unaudited  consolidated  financial statements were prepared in
accordance with  instructions for Form 10-Q and,  therefore,  do not include all
disclosures  necessary  for a  complete  presentation  of  financial  condition,
results of  operations,  cash  flows and  changes  in  stockholders'  equity and
comprehensive income in conformity with accounting principles generally accepted
in the United  States of America.  All  adjustments,  consisting  only of normal
recurring  accruals,  which in the opinion of management  are necessary for fair
presentation  of the  interim  financial  statements,  have been  included.  The
results of operations  for the three and six-month  periods ended March 31, 2006
are not  necessarily  indicative  of the results  that may be  expected  for the
entire fiscal year. These unaudited  consolidated financial statements should be
read in conjunction with Coastal Financial  Corporation and  Subsidiaries'  (the
"Company") audited  consolidated  financial statements and related notes for the
year ended  September 30, 2005,  included in the Company's 2005 Annual Report to
Stockholders.  The  principal  business  of  the  Company  is  conducted  by its
wholly-owned  subsidiary,  Coastal  Federal Bank (the "Bank").  The  information
presented herein, therefore, relates primarily to the Bank.

Certain prior period amounts have been  reclassified  to conform to current year
presentation.

(2)  INVESTMENT SECURITIES AVAILABLE FOR SALE

The unrealized losses on investment securities were attributable to increases in
interest rates, rather than credit quality deterioration.  The unrealized losses
that had  continuous  losses  of less  than 12  months  are  comprised  of seven
securities at September 30, 2005 totaling $18,000 and thirty securities at March
31, 2006 totaling $235,000.  The unrealized losses that had continuous losses 12
months or longer are comprised of six  securities at September 30, 2005 totaling
$33,000 and five  securities  at March 31, 2006 totaling  $104,000.  None of the
individual investment securities had an unrealized loss that exceeded 10% of its
amortized  cost in either  period.  At  September  30, 2005 and March 31,  2006,
substantially  all investment  securities were rated AAA or higher. At September
30, 2005 and March 31, 2006,  none of the  investment  securities  available for
sale were considered impaired.

(3)  MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE

Gross unrealized losses on mortgage-backed securities and the length of time the
securities have been in a continuous loss position were as follows:
<TABLE>
<CAPTION>
                                                      September 30, 2005
                          --------------------------------------------------------------------------
                            Less than 12 Months       12 Months or Longer               Total
                          ----------------------    -----------------------   ----------------------

                                                    (Dollars in thousands)
                            Fair       Unrealized     Fair       Unrealized     Fair       Unrealized
                            Value        Losses       Value        Losses       Value        Losses
                            -----        ------       -----        ------       -----        ------
<S>                       <C>               <C>        <C>            <C>        <C>          <C>
Collateralized Mortgage   $  55,560         (770)      19,518         (360)      75,078       (1,130)
  Obligations
FNMA                         78,664       (1,189)       5,893         (157)      84,557       (1,346)
GNMA                         32,787         (416)          --           --       32,787         (416)
FHLMC                        81,540         (988)       5,951          (99)      87,491       (1,087)
                          ---------    ---------    ---------    ---------    ---------    ---------
                          $ 248,551       (3,363)      31,362         (616)     279,913       (3,979)
                          =========    =========    =========    =========    =========    =========
<CAPTION>
                                                        March 31, 2006
                          --------------------------------------------------------------------------
                            Less than 12 Months       12 Months or Longer               Total
                          ----------------------    -----------------------   ----------------------

                                                    (Dollars in thousands)
                            Fair       Unrealized     Fair       Unrealized     Fair       Unrealized
                            Value        Losses       Value        Losses       Value        Losses
                            -----        ------       -----        ------       -----        ------
<S>                       <C>               <C>        <C>            <C>        <C>          <C>
Collateralized Mortgage   $  66,586       (1,240)      40,292       (1,444)     106,878       (2,684)
Obligations
FNMA                        100,563       (2,666)      24,510         (839)     125,073       (3,505)
GNMA                         12,133         (125)      22,049         (584)      34,182         (709)
FHLMC                       102,380       (2,307)      21,289         (718)     123,669       (3,025)
                          ---------    ---------    ---------    ---------    ---------    ---------
                          $ 281,662       (6,338)     108,140       (3,585)     389,802       (9,923)
                          =========    =========    =========    =========    =========    =========
</TABLE>

                                        9
<PAGE>


PART I.  FINANCIAL INFORMATION
Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED

(3)  MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE - CONTINUED

The  unrealized  losses  on  mortgage-backed  securities  were  attributable  to
increases  in interest  rates,  rather than credit  quality  deterioration.  The
unrealized  losses are  comprised of 72  securities at September 30, 2005 and 95
securities  at March 31,  2006 that have had  continuous  losses of less than 12
months.  There were 10  securities  at September  30, 2005 and 36  securities at
March  31,  2006  with  continuous  losses  12  months  or  longer.  None of the
individual  mortgage-backed  securities had an unrealized loss that exceeded 10%
of its  amortized  cost  at  September  30,  2005.  One  of the  mortgage-backed
securities had unrealized  losses which exceeded 10% of its amortized cost by an
immaterial  amount at March 31, 2006.  At September 30, 2005 and March 31, 2006,
all  mortgage-backed  securities were rated AAA or higher. At September 30, 2005
and March 31, 2006, none of the Company's securities were considered impaired.

(4) LOANS RECEIVABLE, NET

Loans receivable, net, consists of the following:

                                                 September 30,     March 31,
                                                      2005           2006
                                                  -----------    -----------

                                                          (Unaudited)
                                                     (Dollars in thousands)
First mortgage loans:
   Single family to four family units             $   352,893    $   396,752
   Land and land development                          121,170        138,661
   Residential lots                                    37,112         35,908
   Other, primarily commercial real estate            211,432        220,951
   Construction loans on residential properties       127,970        143,453
   Construction loans on commercial properties         14,989         15,330

Consumer and commercial loans:
   Installment consumer loans                          19,115         17,977
   Mobile home loans                                    4,308          3,821
   Savings account loans                                1,883          2,525
   Equity lines of credit                              34,019         36,528
   Commercial and other loans                          38,691         38,516
                                                  -----------    -----------
                                                      963,582      1,050,422

Less:
   Allowance for loan losses                           11,748         12,208
   Deferred loan costs, net                              (771)          (236)
   Undisbursed portion of loans in process             28,345         34,065
                                                  -----------    -----------
                                                  $   924,260    $ 1,004,385
                                                  ===========    ===========

The changes in the  allowance  for loan losses  consist of the following for the
six months ended:
                                               Six Months Ended March 31,
                                               --------------------------
                                                   2005        2006
                                                   ----        ----

                                                     (Unaudited)
                                                (Dollars in thousands)

Allowance at beginning of period                $  11,077   $  11,748
Provision for loan losses                             975         730
                                                ---------   ---------
Recoveries:
 Residential loans                                     --          --
 Commercial loans                                      17         179
 Consumer loans                                        56          90
                                                ---------   ---------
   Total recoveries                                    73         269
                                                ---------   ---------

Charge-offs:
 Residential loans                                     --          --
 Commercial loans                                     158         341
 Consumer loans                                       199         198
                                                ---------   ---------
Total charge-offs                                     357         539
                                                ---------   ---------
   Net charge-offs                                    284         270
                                                ---------   ---------
 Allowance at end of period                     $  11,768   $  12,208
                                                =========   =========

                                       10
<PAGE>
PART I.  FINANCIAL INFORMATION
Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED

(4)  LOANS RECEIVABLE, NET - CONTINUED

                                                      Six Months Ended March 31,
                                                      --------------------------
                                                            2005      2006
                                                            ----      ----
                                                              (Unaudited)
Ratio of allowance to total net loans
     outstanding at the end of the period                   1.36%     1.21%
                                                            ====      ====

Ratio of net charge-offs to average
     total loans outstanding during the period (annualized)  .07%      .05%
                                                            ====      ====

Non-accrual  loans,  which are  primarily  loans over  ninety  days  delinquent,
totaled  approximately  $2.6 million and $3.1 million at September  30, 2005 and
March 31, 2006, respectively.  For the six months ended March 31, 2005 and 2006,
interest income,  which would have been recorded,  would have been approximately
$243,000 and  $137,000,  respectively,  had  non-accruing  loans been current in
accordance with their original terms.

At September 30, 2005 and March 31, 2006 impaired loans totaled $2.6 million and
$2.5  million,  respectively.  Included  in the  allowance  for loan  losses  at
September 30, 2005 was $434,000  related to impaired  loans compared to $258,000
at March 31, 2006.  The average  recorded  investment in impaired  loans for the
year ended September 30, 2005 was $3.7 million  compared to $2.9 million for the
six months  ended  March 31,  2006.  Interest  income of $41,000 and $80,000 was
recognized  on impaired  loans for the  quarter  and six months  ended March 31,
2006.  Interest  income of $65,000 and $98,000 was  recognized on impaired loans
for the quarter and six months ended March 31, 2005, respectively.

(5)  DEPOSITS

Deposits consist of the following:

                                 September 30, 2005           March 31, 2006
                               ---------------------      ----------------------
                                            Weighted                    Weighted
                                             Average                     Average
                                 Amount       Rate          Amount        Rate
                                 ------       ----          ------        ----
                                                   (Unaudited)
                                              (Dollars in thousands)
Checking accounts:
Noninterest-bearing            $  219,080       --        $  214,352        --
Interest-bearing                  139,810     0.52%          124,659      0.60%
                               ----------                 ----------
     Total checking accounts      358,890     0.20           339,011      0.22
Money market accounts             213,078     2.26           212,726      2.91
Statement savings accounts         71,824     1.47            75,325      1.94
Certificate accounts              427,126     3.39           453,378      4.26
                               ----------                 ----------
                               $1,070,918     1.97%       $1,080,440      2.57%
                               ==========                 ==========

Included in certificate  accounts  ("CDs") are $169.9 million of brokered CDs at
September  30, 2005 and $189.3  million at March 31, 2006.  The average rate and
remaining   term  of  brokered   CD's  at  September  30,  2005  was  3.51%  and
approximately four months, respectively.  The average rate and remaining term of
brokered  CDs at March  31,  2006  was  4.54%  and  approximately  five  months,
respectively.

(6)  ADVANCES FROM FEDERAL HOME LOAN BANK

Advances from Federal Home Loan Bank ("FHLB") consist of the following:

                          September 30, 2005         March 31, 2006
                        ----------------------  -----------------------
                                      Weighted                 Weighted
                                       Average                 Average
                         Amount         Rate      Amount        Rate
                                           (Unaudited)
                                      (Dollars in thousands)
Fiscal Year Maturing:
Year 1                  $  4,177        2.79%   $  2,936        3.02%
Year 2                     3,560        2.83       3,560        2.83
Year 3                     3,977        3.18       3,977        3.18
Year 4                    31,803        2.36       6,802        3.74
Year 5                    63,651        5.74      63,651        5.74
After Year 5             181,839        3.64     256,839        3.84
                        --------                --------
                        $289,007        3.93%   $337,765        4.17%
                        ========                ========
                                       11
<PAGE>

PART I.  FINANCIAL INFORMATION
Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED

(6)  ADVANCES FROM FEDERAL HOME LOAN BANK (continued)

At September 30, 2005,  and March 31, 2006,  the Bank had pledged first mortgage
loans and  mortgage-backed  securities  with unpaid  balances  of  approximately
$362.5  million  and  $459.5  million,  respectively,  as  collateral  for  FHLB
advances.  At March 31, 2006, the excess first mortgage loan collateral  pledged
to FHLB will support additional borrowings of $94.8 million.

At March 31, 2006,  included in the one, two, three,  four, and after five years
maturities were advances of $241 million, with a weighted average rate of 3.91%,
subject to call provisions.  Callable  advances at March 31, 2006 are summarized
as follows:  $59.0 million callable in fiscal 2006, with a weighted average rate
of 4.84%; $45.0 million callable in fiscal 2007, with a weighted average rate of
3.17%;  $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
3.92%,  and $25.0  million  callable  in fiscal  2011 or later,  with a weighted
average rate of 4.36%.  Call  provisions  are more likely to be exercised by the
FHLB when market  interest  rates rise.  If called,  the Bank may be required to
replace these advances with higher cost funds.

(7)  EARNINGS PER SHARE

Basic earnings per share for the quarter and six months ended March 31, 2005 and
2006 are computed by dividing net income by the weighted  average  common shares
outstanding  during the respective  periods.  Diluted earnings per share for the
quarter and six months  ended  March 31, 2005 and 2006 are  computed by dividing
net earnings by the weighted  average  dilutive  shares  outstanding  during the
respective periods.  At March 31, 2006, the Company had antidilutive  securities
of approximately 225,000 options to purchase shares by Directors and Associates.
The average exercise price was approximately $15.26 per share.

The  following  is a  reconciliation  of  average  shares  outstanding  used  to
calculate basic and fully diluted earnings per share.

<TABLE>
<CAPTION>
                                                              For the Quarter Ended March 31,
                                                                        (Unaudited)

                                           2005                        2005     2006                        2006
                                           --------------------------------     --------------------------------
                                           BASIC                    DILUTED     BASIC                    DILUTED
                                           --------------------------------     --------------------------------
<S>                                        <C>                   <C>            <C>                   <C>
Weighted average shares outstanding        19,362,000            19,362,000     19,547,000            19,547,000
Effect of dilutive securities-
   stock options                                   --             1,162,000             --               893,000
                                           --------------------------------     --------------------------------
                                           19,362,000            20,524,000     19,547,000            20,440,000
                                           ================================     ================================

<CAPTION>

                                                              For the Six Months Ended March 31,
                                                                         (Unaudited)


                                           2005                        2005     2006                        2006
                                           --------------------------------     --------------------------------
                                           BASIC                    DILUTED     BASIC                    DILUTED
                                           --------------------------------     --------------------------------
<S>                                        <C>                   <C>            <C>                   <C>
Weighted average shares outstanding        19,278,000            19,278,000     19,488,000            19,488,000

Effect of dilutive securities-
   stock options                                   --             1,089,000             --               892,000
                                           --------------------------------     --------------------------------
                                           19,278,000            20,367,000     19,488,000            20,380,000
                                           ================================     ================================
</TABLE>

(8)      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 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.

                                       12
<PAGE>

PART I.  FINANCIAL INFORMATION
Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED

(8)  STOCK BASED COMPENSATION (continued)

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 March 31, 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 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 expense of  approximately
$47,000, net of tax benefit of approximately $28,000 during the six months ended
March 31, 2006.

The Company's  stock option plan ("the 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 Plan.  The remaining  shares of stock
reserved for the stock option plan at March 31, 2006  amounted to  approximately
114,000 shares.

Options  awarded  prior to  September  21,  2005 vest  ratably  over a five-year
period.  Effective  September  21, 2005,  the vesting  period for  approximately
731,000 options awarded during the fiscal 2003, 2004 and 2005 through  September
20, 2005 that would have otherwise  vested at various times through  fiscal 2010
was accelerated,  as more fully described in note 1(p) of the 2005 Annual Report
to  Stockholders.  All other terms and  conditions  of the  accelerated  options
remain  unchanged as a result of the  acceleration.  In  addition,  in September
2005,  the Company  granted  options to  employees,  officers  and  directors of
approximately 390,000 shares, without a vesting requirement.  All options expire
ten years after the date of grant.

The  weighted  average fair value of all of the options  granted  during the six
months ended March 31 have been estimated using the Black-Scholes option-pricing
model with the following assumptions (unaudited):

                                                                  2005      2006
                                                                  ----      ----
Dividend yield                                                     1.1%      --%
Weighted average risk-free interest rate                          4.21%      --%
Weighted average expected volatility                              35.2%      --%
Weighted average expected life in years                            7.5       --

No options were granted during the six months ended March 31, 2006.

                                       13
<PAGE>

PART I.  FINANCIAL INFORMATION
Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED

(8) STOCK BASED COMPENSATION (continued)

A summary of share  option  activity  for the six months  ended  March 31,  2006
follows (Dollars in thousands, except share data):

<TABLE>
<CAPTION>

                                                                     Weighted
                                                      Weighted       Average
                                      Number          Average        Remaining    Aggregate
                                        Of            Exercise      Contractual   Intrinsic
                                      Shares           Price        Life (Years)    Value
                                      ------           -----        ------------    -----
<S>                                <C>          <C>                 <C>       <C>

                                                                              (Unaudited)

Outstanding at September 30, 2005     2,811,609    $       8.52
Granted                                      --              --
Exercised                              (150,423)   $       4.36
Forfeited or expired                     (7,074)   $      12.06
                                   ------------
Outstanding at March 31, 2006         2,654,112    $       8.75        6.1       $     13,264
                                   ============                                  ============

Exercisable at March 31, 2006         2,600,992    $       8.82        6.1       $     12,829
                                   ============                                  ============
</TABLE>

The weighted  average  grant-date  fair value of options  granted during the six
months ended March 31, 2005 was $5.46 per share.  The total  intrinsic  value of
options  exercised  during the six months ended March 31, 2005 and 2006 was $1.8
million and $1.4 million, respectively.

A summary of the status of the Company's nonvested options as of March 31, 2006,
and changes during the six months then ended, is presented below (unaudited):

                                                                       Weighted
                                                                       Average
                                                          Number      Grant-Date
                                                         Of Shares    Fair Value
                                                         ---------    ----------

Nonvested at September 30, 2005                            145,389    $     2.09
Granted                                                         --            --
Vested                                                     (92,269)         1.77
Forfeited                                                       --            --
                                                        ----------
Nonvested at March 31, 2006                                 53,120    $     2.64
                                                        ==========

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

As of March 31,  2006,  there was  approximately  $82,000 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 one year.

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


                                       14
<PAGE>

Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED

(8) 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 quarters ended March 31 (in thousands, except per share data)(unaudited):

                                                                 2005      2006
                                                                 ----      ----

Information as reported in the Financial Statements:

Net income                                                      $4,135   $4,645
                                                                ======   ======
Basic earnings per share                                        $ 0.21   $ 0.24
                                                                ======   ======
Diluted earnings per share                                      $ 0.20   $ 0.23
                                                                ======   ======
Share-based compensation cost, net of related tax effects       $   --   $   23
                                                                ======   ======


Information calculated as if fair value method had been
     applied to all awards:

Net income, as reported                                         $4,135   $4,645
Add: Stock-based compensation expense recognized during
     the period, net of related tax effects                         --       23
Less:  Stock-based compensation expense determined under the
     fair value-based method, net of related tax effects          (200)     (23)
                                                                ------   ------
Pro forma net income                                            $3,935   $4,645
                                                                ======   ======

Pro forma basic earnings per share                              $ 0.20   $ 0.24
                                                                ======   ======
Pro forma diluted earnings per share                            $ 0.19   $ 0.23
                                                                ======   ======

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 six months ended March 31 (in thousands, except per share data)(unaudited):

                                                                2005     2006
                                                                ----     ----

Information as reported in the Financial Statements:

Net income                                                     $8,179   $9,088
                                                               ======   ======
Basic earnings per share                                       $ 0.42   $ 0.47
                                                               ======   ======
Diluted earnings per share                                     $ 0.40   $ 0.45
                                                               ======   ======
Share-based compensation cost, net of related tax effects      $   --   $   47
                                                               ======   ======

Information calculated as if fair value method  had been
     applied to all awards:

Net income, as reported                                        $8,179   $9,088
Add: Stock-based compensation expense recognized during
     the period, net of related tax effects                        --       47
Less:  Stock-based compensation expense determined under the
     fair value-based method, net of related tax effects         (375)     (47)
                                                               ------   ------
Pro forma net income                                           $7,804   $9,088
                                                               ======   ======

Pro forma basic earnings per share                             $ 0.40   $ 0.47
                                                               ======   ======
Pro forma diluted earnings per share                           $ 0.38   $ 0.45
                                                               ======   ======

                                       15
<PAGE>

PART I.  FINANCIAL INFORMATION
Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED


(9)  COMMON STOCK DIVIDEND

On  December  15,  2004 and October 26,  2005,  the Company  declared  10% stock
dividends,   aggregating   approximately   1,594,000   and   1,770,000   shares,
respectively.  All share and per share data have been retroactively restated for
the stock dividends.

(10) GUARANTEES

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.  These  standby  letters  of  credit  are  generally   collateralized.
Commitments  under  standby  letters of credit are usually one year or less.  At
March 31, 2006,  the Company has recorded no liability for the current  carrying
amount of the obligation to perform as a guarantor. The maximum potential amount
of  undiscounted  future  payments  related  to  standby  letters  of  credit at
September  30,  2005 and  March  31,  2006 was $5.8  million  and $7.3  million,
respectively.

(11) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITES

The Bank originates  certain fixed rate residential  loans with the intention of
selling  these  loans in the  secondary  market.  Between the time that the Bank
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  due to potential  changes in interest rates.  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.  Since  such  instruments  do  not  qualify  for  hedge  accounting
treatment,  their  fair  value  adjustments  are  recorded  through  the  income
statement  in net gains on sales of loans  held for  sale.  The  commitments  to
originate  fixed rate  conforming  loans totaled $6.0 million at March 31, 2006.
The fair value of the loan commitments was an asset of approximately  $15,000 at
March 31,  2006.  As of March 31,  2006,  the Company  had sold $6.0  million in
forward commitments to deliver fixed rate mortgage-backed securities, which were
recorded as a derivative asset of $16,000.


                                       16
<PAGE>

PART I.  FINANCIAL INFORMATION
Item 2.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS


The following  discussion and analysis  should be read in  conjunction  with the
consolidated   financial   statements  of  Coastal  Financial   Corporation  and
Subsidiaries and the notes thereto.

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.  The Company  undertakes  no  obligation  to  publicly  update or
otherwise  revise  any  forward-looking  statement,  whether  as a result of new
information,  future events or otherwise. See Part II, Item 1.A., "Risk Factors"
for  disclosure  regarding  risks and  uncertainties  related  to the  Company's
business.

OVERVIEW
--------

Coastal  Financial  Corporation  (the  "Company")  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 is a full service  financial  services  company with 21 branches
located in four counties  throughout  the coastal  regions of South Carolina and
North Carolina.  The Bank has thirteen 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.  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, 2005 (the most recent date for which published data is available) with 17.9%
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, 2005 in Brunswick
County, North Carolina, with 8.1% 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.

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.

                                       17
<PAGE>

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 is continuing
the process of redesigning its infrastructure,  software and products to improve
Customer  service and convenience and Associate  productivity.  In addition,  in
order to improve  Customer  service  and  convenience,  the Bank added  extended
operating hours. The call center employs  approximately 20 Associates.  The Bank
experienced  increased  salary and  benefit  expenses  in fiscal 2005 and in the
first six months of fiscal 2006 and  anticipates  these  expenses  will continue
thereafter  associated  with the hiring,  training  and  placement  of these new
Associates.

The  second  initiative  was  "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 strategy.  The Bank expects to
realize  significant  benefits from this strategy  consisting of increased  Bank
lobby traffic,  increased  number of personal  checking  accounts and higher fee
income as a result of those checking accounts.  In the first six months of 2006,
checking  account  balances  grew  approximately  18% when  compared to the same
period a year ago.  This rate of growth  necessitated  the hiring of  additional
Associates to open and service these  accounts.  The Associates  hired for these
two  initiatives  are  expected  to have total  compensation  averaging  between
$28,000 and $35,000 per Associate.

In the latter part of fiscal 2005,  the Company began  preparations  to increase
lending  production in mortgage  originations.  The Company has hired leadership
and support  staff as well as additional  mortgage  lending  officers.  As a net
result of these plans, the Company has increased  support staff by approximately
five personnel and added approximately thirteen residential lending officers and
staffing as of March 31, 2006.  Increased  lending  volumes  from these  lending
personnel are not expected to increase significantly until the fourth quarter of
fiscal  2006 and the  first  quarter  of fiscal  2007.  Further,  the  amount of
increased  revenues in relation to the  increased  expense  cannot be accurately
predicted at this time.

During the first quarter of fiscal 2006,  the Bank opened two  branches;  in Oak
Island, North Carolina and at Stephens Crossroads in Longs, South Carolina.  The
Bank anticipates that it will open four additional branches during the remainder
of fiscal 2006.  The first of these  branches was opened in North Conway,  South
Carolina  in  April  2006.   The  opening  of  these   branches   will  increase
compensation,  occupancy  and  other  expenses  as  well  as  related  marketing
expenditures.  Generally,  the Bank will hire  personnel  three to six months in
advance  of a branch  opening to ensure  that they are  properly  trained.  As a
result of these  openings,  the Bank expects its total  investment in these four
offices to be approximately $6.5 million in land,  buildings and equipment costs
as well as increased lease expenses of approximately $200,000.

CRITICAL ACCOUNTING POLICIES
----------------------------

The Company's  accounting policies are in accordance with accounting  principles
generally  accepted in the United  States of America and with  general  practice
within the banking  industry.  In order to understand  the  Company's  financial
condition  and results of  operations,  it is important to  understand  the more
critical  accounting policies and the extent to which judgment and estimates are
used in applying those policies.  The Company  considers its policies  regarding
the  allowance  for  loan  losses  and  income  taxes  to be its  most  critical
accounting  policies due to the significant degree of the levels of subjectivity
and  management  judgment  necessary  to account  for these  matters.  Different
assumptions  in the  application  of these  policies  could  result in  material
changes  in the  Company's  consolidated  financial  statements.  The  Company's
accounting  policies  are set  forth  in  Note 1 of the  Notes  to  Consolidated
Financial  Statements in the Company's 2005 Annual Report to  Stockholders.  For
additional  discussion  concerning  the Company's  allowance for loan losses and
related  matters,  see  "Allowance  for Loan  Losses."  See  "Income  Taxes" for
additional  discussion  concerning  income  taxes in the  Company's  2005 Annual
Report to Stockholders.

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 recorded in amounts that differ from the notional amounts. These
transactions  involve,  to varying  degrees,  elements of credit risk,  interest
rate, and liquidity risk. Such  transactions are used by the Company for general
corporate purposes or to satisfy customer needs.  Corporate purpose transactions
are used to help manage customers' requests for funding.  The Bank's off-balance
sheet   arrangements,   which  principally   include  lending   commitments  and
derivatives, are described below.


                                       18
<PAGE>

Lending  Commitments:  Lending  commitments  include loan  commitments,  standby
letters of credit,  unused business and personal  credit card lines,  and unused
business and personal lines of credit. These instruments are not recorded in the
consolidated  balance sheet until funds are advanced under the commitments.  The
Bank  provides  these lending  commitments  to customers in the normal course of
business. Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the  commitments  expire
without  being  drawn  upon,  the total  commitment  amounts do not  necessarily
represent  future cash  requirements.  The Company applies  essentially the same
credit  policies  and  standards  as it does in the lending  process when making
these loans. For business customers,  commercial loan commitments generally take
the form of revolving credit  arrangements to finance customers' working capital
requirements.  For personal  customers,  loan commitments are generally lines of
credit  that are  unsecured  or are  secured by  residential  property.  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. Standby letters
of credit are generally collateralized and are usually one year or less.

At March 31, 2006,  the Company  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, 2005 and March
31, 2006 was $5.8 million and $7.3 million, respectively.

A summary of loans receivable with  undisbursed  commitments to extend credit at
September 30, 2005 and March 31, 2006 follows:

                                                        September 30,  March 31,
                                                             2005         2006
                                                             ----        ----
                                                               (Unaudited)
                                                          (Dollars in thousands)

Residential mortgage loans in process                     $  28,345   $  34,065
Business and consumer credit card lines                      14,065      14,338
Consumer home equity lines                                   41,117      44,521
Other consumer lines of credit                                6,818       7,551
Standby letters of credit                                     5,777       7,301
Commercial real estate and construction
     and land development                                   107,731     120,652
Other commercial lines of credit                             10,527       9,941
                                                          ---------   ---------
     Total loans receivable with undisbursed commitments  $ 214,380   $ 238,369
                                                          =========   =========

Derivatives  and Hedging  Activities:  The Bank  originates  certain  fixed rate
residential  loans with the intention of selling  these loans.  Between the time
that the Bank 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 due to potential  changes in interest  rates.  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.  Since  such  instruments  do  not  qualify  for  hedge  accounting
treatment,  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 $6.0 million at March 31, 2006.  The fair value of the
loan commitments was an asset of approximately  $15,000 at March 31, 2006. As of
March 31,  2006,  the Company had sold $6.0  million in forward  commitments  to
deliver  fixed  rate  mortgage-backed  securities,  which  were  recorded  as  a
derivative asset of $16,000.


                                       19
<PAGE>

DISCUSSION OF FINANCIAL  CONDITION  CHANGES FROM SEPTEMBER 30, 2005 TO MARCH 31,
--------------------------------------------------------------------------------
2006
----

LIQUIDITY AND CAPITAL RESOURCES
-------------------------------

Historically,  the Company has  maintained  its liquidity at levels  believed by
management  to be  adequate  to meet  the  requirements  of  normal  operations,
potential  deposit  out-flows and strong loan demand and still allow for optimal
investment of funds and return on assets. The principal sources of funds for the
Company  are cash flows from  operations,  consisting  mainly of loan  payments,
Customer  deposits,   advances  from  the  FHLB,  securitization  of  loans  and
subsequent  sales,  and  loan  sales.  The  principal  use of cash  flows is the
origination  of loans  receivable  and purchase of  investment  securities.  The
Company  originated  loans receivable of $376.5 million for the six months ended
March 31,  2005,  compared to $373.9  million for the six months ended March 31,
2006.  Loan  principal  repayments  amounted to $267.9  million in the first six
months of 2005  compared to $292.3  million  for the six months  ended March 31,
2006. In addition,  the Company  sells certain loans in the secondary  market to
finance  future loan  originations.  In the first six months of fiscal 2005, the
Company sold mortgage  loans or  securitized  and sold mortgage  loans  totaling
$28.5  million that compares to $20.8 million for the six months ended March 31,
2006. In addition, the Bank sold $13.3 million of commercial loan participations
in the six months  ended  March 31, 2005  compared to $2.1  million for the same
period in 2006.

During the six month period ended March 31, 2006, the Company  securitized $12.9
million of mortgage loans and concurrently sold these mortgage-backed securities
to outside  third  parties and  recognized a net gain on sale of  $176,000.  The
related mortgage  servicing rights  associated with the loans are $184,000.  The
gain is  included  in gains on sales of loans held for sale in the  consolidated
statement of operations.  The Company has no retained interest in the securities
that were sold other than servicing rights.

For the six months ended March 31, 2006, the Company purchased $115.3 million in
investment and mortgage-backed  securities. For the six months ended March 2005,
the  Company   purchased  $220.3  million  in  investment  and   mortgage-backed
securities.  These  purchases  during the six months  ended  March 31, 2006 were
primarily  funded  by  borrowings,   repayments  of  $41.1  million  within  the
securities portfolio and sales of mortgage-backed securities of $41.5 million.

Total Customer  Deposits,  defined as total deposits  excluding  certificates of
deposits obtained through brokers,  decreased $9.9 million between September 30,
2005 and March 31,  2006.  Money  market and checking  accounts  decreased  from
approximately  $572.0  million at September 30, 2005 to $551.7  million at March
31, 2006, a decrease of $20.2 million or 3.5%.  Core Deposits  (defined as money
market accounts,  checking accounts and statement  savings  accounts)  decreased
from $643.8 million at September 30, 2005 to $627.1 million at March 31, 2006, a
decrease of 2.6%. The Company believes these decreases are generally seasonal as
tourism  activity  decreases  during fall and winter months.  In addition,  real
estate  activities  slow in the fall and winter  months  resulting  in decreased
balances in checking  trust  accounts when comparing the March 31, 2006 balances
to the September 30, 2005 balances related to real estate  activities.  Customer
Deposits at March 31,  2006 and March 31,  2005,  are $891.1  million and $804.7
million, respectively, an increase of 10.7%. In addition, Core Deposits at March
31, 2006 and March 31, 2005 are $627.1 million and $575.4 million, respectively,
a 9.0% increase.

At March 31, 2006,  the Company had $418.5 million of  certificates  of deposits
("CDs")  that were due to mature  within  one year.  Included  in these CDs were
brokered CDs totaling  $189.3  million.  Based on past  experience,  the Company
believes  that the majority of the  non-brokered  certificates  of deposits will
renew with the  Company.  At March 31,  2006,  the  Company had  commitments  to
originate  $24.5  million  in  residential  mortgage  loans,  $62.0  million  in
undisbursed  business  and  retail  lines of  credit,  $14.3  million  in unused
business and personal  credit card lines,  and $120.7 million in commercial real
estate and construction  and land development  which the Company expects to fund
from normal operations.  At March 31, 2006, the Company had approximately  $91.5
million  available  in FHLB  advances.  In addition,  the Company had  unpledged
collateral that would support  approximately $57.5 million in additional reverse
repurchases.  At March 31, 2006, the Company also had an  outstanding  available
line for federal funds of $20.0 million.

As a result of $9.1  million  in net  income,  less the cash  dividends  paid to
stockholders of approximately $2.0 million,  proceeds of approximately  $485,000

                                       20
<PAGE>

from the exercise of stock options,  and the net increase in unrealized  loss on
securities available for sale, net of income tax of $4.7 million,  stockholders'
equity  increased  from $97.2 million at September 30, 2005 to $100.2 million at
March 31, 2006.

OTS  regulations  require  that  the  Bank  calculate  and  maintain  a  minimum
regulatory capital requirement on a quarterly basis and satisfy such requirement
as of the calculation  date and throughout the quarter.  The Bank's capital,  as
calculated under OTS regulations,  is approximately  $120.1 million at March 31,
2006,  exceeding the core capital  requirement  by $54.0  million.  At March 31,
2006, the Bank's risk-based capital of approximately $131.4 million exceeded its
current   risk-based  capital   requirement  by  $53.9  million.   (For  further
information see Regulatory Capital Matters.)

The table below summarizes future  contractual  obligations as of March 31, 2006
(unaudited):

<TABLE>
<CAPTION>
                                             Payments Due by Period
                         --------------------------------------------------------------
                                      1 Year and      2-3          4-5        After 5
                            Total        Less        Years        Years         Years
                         ----------   ----------   ----------   ----------   ----------
<S>                      <C>          <C>          <C>          <C>          <C>
Time deposits            $  453,378   $  418,527   $   30,891   $    3,265   $      695
Short-term borrowings        79,642       79,642           --           --           --
Long-term debt              370,293           --        7,537       70,453      292,303
Construction contracts        2,881        2,881           --           --           --
Operating leases              3,625          473          457          238        2,457
                         ----------   ----------   ----------   ----------   ----------
Total contractual cash
     obligations         $  909,819   $  501,523   $   38,885   $   73,956   $  295,455
                         ==========   ==========   ==========   ==========   ==========
</TABLE>

Purchase commitments.  The Company has signed a contract to purchase a 1.35 acre
tract of land in North  Carolina.  The  purchase  price  is  approximately  $1.2
million. After due diligence, the Company expects the sale to close in the third
quarter of fiscal 2006.

Lease commitments. The Bank executed a lease in the first quarter of fiscal 2006
for 5.48 acres of land and a  building,  which  includes  an option to  purchase
after one year of the lease for approximately $2.8 million. Rent during the year
prior to the purchase  option is  approximately  $200,000 and is included in the
operating leases line of the above schedule of future contractual obligations.

In April  2006,  the  Company  entered  into a lease for a branch.  The  Company
assumed the remaining  term of an existing  lease that expires  January 2009 and
also entered into a lease  agreement for an  additional 11 years ending  January
2020. In addition,  the Company will purchase certain leasehold improvements and
other  assets  from the  existing  tenant  for  $250,000.  The lease  expense is
approximately $84,000 per year.

EARNINGS SUMMARY
----------------

Net income  increased from $8.2 million,  or $.40 per diluted share, for the six
months ended March 31, 2005 to $9.1  million,  or $.45 per diluted share for the
six months ended March 31, 2006. This 11.1% increase in net income resulted from
increased net interest  income of $3.0 million,  or 13.0%,  an increase in other
income of $1.7  million,  and a decrease  in the  provision  for loan  losses of
$245,000,  which were offset by increased general and administrative expenses of
$3.5 million, and increased income taxes of $550,000.

Net interest income  increased  13.0% as a result of growth in loans  receivable
and investments  despite a slight decrease in net interest margin from 3.67% for
the six months  ended March 31, 2005 to 3.64% for the six months ended March 31,
2006.  The  increase in net  interest  income is  primarily  attributable  to an
increase in average  earning assets of $185.9 million,  or 14.6%.  Average loans
receivable  increased  $144.3  million  for the six months  ended March 31, 2006
compared  to March  31,  2005.  In  addition,  average  balances  of  investment
securities increased approximately $41.6 million. The investment securities were
primarily  funded with brokered CD's. The average  balance of Customer  Deposits
increased  from $762.3  million at March 31, 2005 to $874.6 million at March 31,
2006,  which exclude  brokered CD average  balances of $190.1  million and $30.3
million at March 31, 2006 and 2005, respectively.


                                       21
<PAGE>

The provision for loan losses decreased  $245,000 for the six months ended March
31,  2006 when  compared  to the prior  year  primarily  due to a  reduction  in
individually  significant  special mention,  substandard and impaired loans that
carry specific reserve allocations when computing the allowance for loan losses.
Several of the special mention,  substandard and impaired loans were either paid
off or there was a significant improvement in the Company's collateral position.
The  allowance  for loan losses as a percentage  of loans was 1.21% at March 31,
2006 as compared to 1.36% at March 31, 2005.

Other income increased from $6.1 million for the six months ended March 31, 2005
to $7.8 million for the six months ended March 31, 2006. This was a result of an
increase  in fees and  service  charges  on loan and  deposit  accounts  of $1.8
million primarily as a result of the Company's "FANtastic! Customer Service" and
"Totally  Free  Checking  with a Gift"  initiatives.  ATM and debit card  income
increased  $415,000,  gains on sales of loans held for sale decreased  $260,000.
The Company also had loss on sales of mortgaged backed securities  available for
sale of $33,000 for the six months  ended March 31,  2006,  compared to gains of
$229,000 for the six months ended March 31, 2005.

General and  administrative  expenses  increased  from $16.1 million for the six
months ended March 31, 2005 to $19.6  million for the six months ended March 31,
2006.  Compensation  and benefits  increased from $8.9 million for the first two
quarters  of fiscal  2005 to $10.9  million  in the six  months of fiscal  2006,
primarily due to an increase in the number of banking Associates in business and
residential  banking,  Associates in the Company's  expanded  hours call center,
Associates in new branches and normal salary increases.  Marketing expenses were
$957,000 for the six months  ended March 31, 2006,  compared to $993,000 for the
six months ended March 31, 2005. In addition, other expense was $2.1 million for
the six months ended March 31, 2005, compared to $2.4 million for the six months
ended March 31, 2006.

MANAGEMENT'S  DISCUSSION  AND ANALYSIS OF OPERATIONS  FOR THE THREE MONTHS ENDED
--------------------------------------------------------------------------------
MARCH 31, 2005 AND 2006
-----------------------

INTEREST INCOME
---------------

Interest  income for the three months  ended March 31, 2006,  increased to $24.1
million as compared to $18.9  million for the three months ended March 31, 2005.
The earning  asset yield for the three months  ended March 31,  2006,  was 6.51%
compared to 5.83% for the three months ended March 31, 2005.  The average  yield
on loans  receivable  for the  three  months  ended  March 31,  2006,  was 7.27%
compared to 6.34% for three months ended March 31, 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 7.75% at March 31,
2006, compared to 5.75% at March 31, 2005. The yield on investments increased to
4.95% for the three months ended March 31, 2006, from 4.88% for the three months
ended March 31, 2005. Long-term interest rates have remained relatively constant
during the last year despite rising short-term rates,  resulting in a flat yield
curve.  Consequently,  most of the  cash  flows  received  from  the  investment
portfolio have been reinvested at approximately  the same interest rate.  Should
short-term  rates  continue to rise more quickly  than  long-term  rates,  it is
possible  that the yield  curve  would  become  inverted.  A flat yield curve or
inverted  yield  curve  would  likely  cause the Bank's net  interest  margin to
decline and reduce opportunities for using securities to leverage capital. Total
average  interest-earning  assets were $1.5 billion for the quarter  ended March
31, 2006 as compared to $1.3 billion for the quarter  ended March 31,  2005,  an
increase of 14.2%. The increase in average  interest-earning assets is primarily
due to an increase in average loans receivable of approximately  $157.9 million,
an increase of 18.7%,  resulting  primarily from growth in the  commercial  loan
portfolio.


                                       22
<PAGE>

INTEREST EXPENSE
----------------

Interest expense on interest-bearing liabilities was $11.0 million for the three
months  ended March 31,  2006,  as compared to $7.0 million for the three months
ended March 31, 2005. The average cost of Customer Deposits for the three months
ended March 31,  2006,  was 2.03%  compared to 1.33% for the three  months ended
March 31, 2005. The cost of interest-bearing liabilities was 2.94% for the three
months  ended March 31, 2006  compared to 2.16% for the three months ended March
31, 2005.  The cost of brokered  CD's,  FHLB  advances,  repurchase  and reverse
repurchase  agreements and other borrowings was 4.37%,  4.07%,  3.64% and 7.71%,
respectively,  for the three months  ended March 31, 2006.  For the three months
ended  March  31,  2005,  the  cost of FHLB  advances,  repurchase  and  reverse
repurchase   agreements  and  other  borrowings  was  3.69%,  2.35%  and  5.41%,
respectively.  The  increased  cost of funds on other  borrowings  is due to the
increased  short-term  interest rates. At March 31, 2006, the federal funds rate
was 5.00% compared to 2.96% at March 31, 2005.

Total average interest-bearing  liabilities increased from $1.3 billion at March
31,  2005  to  $1.5  billion  at  March  31,  2006.   The  increase  in  average
interest-bearing  liabilities is due to an increase in average Customer Deposits
of  approximately  $107.8  million,  increased  average  FHLB  advances of $17.6
million and increased average customer  repurchase  agreements of $18.0 million.
This was partially  offset by a decrease in average  broker  reverse  repurchase
agreements  of $85.7  million.  Brokered  CD's  increased  by $133.3  million in
average  balances when  comparing the two periods and were used to fund loan and
investment securities growth.

NET INTEREST INCOME
-------------------

Net interest income was $13.2 million for the three months ended March 31, 2006,
as compared to $11.9 million for the three months ended March 31, 2005.  The net
interest margin was 3.57% for the three months ended March 31, 2006, compared to
3.68% for the three months ended March 31, 2005.

The following table  summarizes the average balance sheet and the related yields
on  interest-earning  assets and  deposits and  borrowings  for the three months
ended March 31, 2005 and 2006:

<TABLE>
<CAPTION>
                                                Three Months Ended March 31,
                                                ----------------------------
                                        2006                                    2005
                                        ----                                    ----
                          Average      Income/       Yield/       Average      Income/       Yield/
                        Balance (1)    Expense       Rate       Balance (1)    Expense       Rate
                        -----------    -------       ----       -----------    -------       ----
<S>                      <C>             <C>         <C>      <C>            <C>             <C>
                                                         (Unaudited)
                                                     (Dollars in Thousands)
Assets
Earning assets
  Loans (2)              $1,000,737   $   18,182         7.27%   $  842,846   $   13,364         6.34%
  Investment
    Securities, MBS
    Securities and
    Other (3)               481,382        5,956         4.95%      454,434        5,548         4.88%
                         ----------   ----------                 ----------   ----------

Total earning assets     $1,482,119       24,138         6.51%   $1,297,280   $   18,912         5.83%
                         ==========   ----------                 ==========   ----------
Liabilities
  Customer Deposits         869,213        4,414         2.03%      761,534        2,536         1.33%
  Brokered CD's             192,458        2,105         4.37%       59,201          403         2.72%
  Borrowings                430,601        4,451         4.13%      480,771        4,077         3.39%

                         ----------   ----------                 ----------   ----------
Total interest-bearing
  Liabilities            $1,492,272       10,970         2.94%   $1,301,506        7,016         2.16%
                         ==========   ----------                 ==========   ----------

Net interest income                   $   13,168                              $   11,896
                                      ==========                              ==========
Net interest margin                                      3.57%                                   3.68%
Net yield on earning
  assets                                                 3.55%                                   3.67%
</TABLE>

(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.
(4)  Net interest income has not been adjusted to produce a tax-equivalent
     yield.

                                       23
<PAGE>

PROVISION FOR LOAN LOSSES
-------------------------

The provision for loan losses decreased from $625,000 for the three months ended
March  31,2005,  to $330,000 for the three months ended March 31, 2006 primarily
due to a reduction in individually significant special mention,  substandard and
impaired  loans that carry  specific  reserve  allocations  when  computing  the
allowance  for loan  loss.  Several  of the  special  mention,  substandard  and
impaired  loans were either paid off or there was a significant  improvement  in
the  Company's  collateral  position at March 31, 2006.  The  allowance for loan
losses as a percentage of loans was 1.21% at March 31, 2006 as compared to 1.36%
at March 31,  2005.  The  allowance  as a  percentage  of loans  declined due to
improving  economic  conditions  and the risk factors  related to the underlying
portfolio.  Loans  delinquent 90 days or more were $3.1 million or .31% of total
loans at March 31,  2006,  compared  to $7.1  million or .82% of total  loans at
March 31, 2005 and $2.6  million or .28% of total loans at  September  30, 2005.
The allowance for loan losses was 389% of loans  delinquent more than 90 days at
March 31,  2006,  compared to 165% at March 31, 2005 and 445% at  September  30,
2005.  Net  charge-offs  for the three months ended March 31, 2006 were $117,000
compared to $269,000 for the three months ended March 31, 2005.

Management  believes  that the current level of the allowance for loan losses at
March 31, 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 three  months  ended  March 31,  2006,  other  income  was $4.2  million
compared to $3.3 million for the three  months  ended March 31,  2005.  Fees and
service  charges  from  deposit  accounts  increased  $823,000  or 57.8% to $2.2
million for the three months ended March 31, 2006,  compared to $1.4 million for
the three months ended March 31, 2005.  The majority of this  increase is due to
fee income from  increased  number of personal and business  checking  accounts.
Gain on sale of loans  was  $202,000  for the  quarter  ended  March  31,  2006,
compared to $244,000 for the quarter  ended March 31,  2005.  During the quarter
ended  March 31,  2006,  the  Company  sold $9.3  million in loans held for sale
compared to $13.5 million in the comparable prior year period.  Margins on sales
of  conforming  mortgage  loans  declined in fiscal 2006 due to rising  interest
rates.  Gains on sales of  securities  available  for sale were  $30,000 for the
quarter ended March 31, 2006, compared to gains of $88,000 for the quarter ended
March 31, 2005.  Income from Federal  Home Loan Bank Stock  dividends  increased
from  $213,000 to $256,000  due to  increased  dividends  resulting  from higher
interest  rates.  In  addition,  income  from ATM and  debit  card  transactions
increased 64.0% to $538,000 during the second quarter of fiscal 2006,  primarily
due to increased personal checking accounts.

GENERAL AND ADMINISTRATIVE EXPENSES
-----------------------------------

General and  administrative  expenses  were $8.3  million for the quarter  ended
March 31, 2005  compared to $9.9  million for the quarter  ended March 31, 2006.
Salaries  and  employee  benefits  were $4.5  million for the three months ended
March 31, 2005, as compared to $5.5 million for the three months ended March 31,
2006,  an  increase of 21.8%.  Increased  compensation  is due to the  increased
number of Associates in the Company's  expanded hours call center,  in three new
branches  opened since  September  30, 2005 plus one new branch  opened in April
2006, and in residential banking. In the latter part of fiscal 2005, the Company
began preparations to increase lending production in mortgage originations.  The
Company has hired  leadership  and support staff as well as additional  mortgage
lending officers.  As a result of these plans, the Company has increased support
staff  by  approximately  five  personnel  and  added   approximately   thirteen
residential  lending  officers as of March 31, 2006.  Increased  lending volumes
from these lending  personnel are not expected to increase  significantly  until
the fourth quarter of fiscal 2006 and the first quarter of fiscal 2007. Over the
past year, the Company also added several  Associates in a Banking Group that is
focused on growing small to medium sized business  banking  relationships.  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 by $553,000,  including increased  depreciation of
$171,000,  when comparing the two periods.  Marketing expenses were $482,000 for
the three months ended March 31, 2005, compared to $520,000 for the three months
ended March 31, 2006.  The decrease from the prior period results from decreased
initial  startup  expense for the Bank's  "Totally  Free  Checking  with A Gift"
initiative and the introduction of Penny Pavilion, the Bank's free coin counting
service.  Other  expenses were $1.2 million for the quarter ended March 31, 2005
compared to $1.1 million for the quarter ended March 31, 2006.


                                       24
<PAGE>

Other expense  decreased  $82,000 due to the  non-recurring  charge to write-off
signage of $111,000, a reduction in audit and accounting costs of $95,000 as the
initial  compliance   activities   associated  with   Sarbanes-Oxley  have  been
completed,  partially  offset by increased  legal expense of $40,000,  increased
courier  service of $41,000  resulting  from the  increased  number of branches,
reduced  recoveries of prior period mortgage  servicing  impairments of $74,000,
and increased other operating expenses of $37,000.

INCOME TAXES
------------

Income  taxes  were $2.5  million  for the three  months  ended  March 31,  2006
compared  to $2.2  million  for the  three  months  ended  March 31,  2005.  The
effective income tax rate as a percentage of pretax income was 34.71% and 34.25%
for the  quarters  ended March 31, 2006 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.  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 the future  taxable
income, in order to ultimately realize deferred income tax assets.

MANAGEMENT'S  DISCUSSION  AND  ANALYSIS OF  OPERATIONS  FOR THE SIX MONTHS ENDED
--------------------------------------------------------------------------------
MARCH 31, 2005 AND 2006
-----------------------

INTEREST INCOME
---------------

Interest  income for the six months  ended March 31,  2006,  increased  to $47.2
million as compared to $36.9  million for the six months  ended March 31,  2005.
The earning  asset  yield for the six months  ended  March 31,  2006,  was 6.46%
compared  to a yield of 5.78%  for the six  months  ended  March 31,  2005.  The
average yield on loans  receivable  for the six months ended March 31, 2006, was
7.21%  compared to 6.25% for the six months ended March 31, 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 7.75% at March
31,  2006,  compared  to 5.75% at  March  31,  2005.  The  yield on  investments
increased to 4.92% for the six months  ended March 31, 2006,  from 4.89% for the
six months ended March 31, 2005. Total average interest-earning assets were $1.5
billion for the six months  ended March 31, 2006 as compared to $1.3 billion for
the six months  ended March 31, 2005.  The increase in average  interest-earning
assets  is  primarily  due  to  an  increase  in  average  loans  receivable  of
approximately  $144.3 million resulting  primarily from growth in the commercial
loan portfolio and an increase in investment  securities of approximately  $41.6
million, primarily funded by brokered CD's.

INTEREST EXPENSE
----------------

Interest expense on  interest-bearing  liabilities was $20.7 million for the six
months  ended March 31,  2006,  as compared to $13.4  million for the six months
ended March 31, 2005.  The average cost of Customer  Deposits for the six months
ended March 31, 2006, was 1.93% compared to 1.32% for the six months ended March
31, 2005. The cost of interest-bearing  liabilities was 2.82% for the six months
ended March 31, 2006  compared to 2.11% for the six months ended March 31, 2005.
The cost of brokered CD's,  FHLB  advances,  reverse  repurchase  agreements and
other borrowings was 4.13%,  4.05%, 3.48% and 7.44%,  respectively,  for the six
months ended March 31, 2006.  For the six months ended March 31, 2005,  the cost
of  brokered  CD's,  FHLB  advances,  reverse  repurchase  agreements  and other
borrowings was 2.73%, 3.68%, 2.15% and 5.37%,respectively. The increased cost of
funds on other borrowings is due to the increased  short-term interest rates. At
March 31, 2006,  the federal funds rate was 5.00% compared to 2.96% at March 31,
2005. Total average interest-bearing  liabilities increased from $1.3 billion at
March 31,  2005 to $1.5  billion  at March 31,  2006.  The  increase  in average
interest-bearing  liabilities is due to an increase in average Customer Deposits


                                       25
<PAGE>

of  approximately  $112.3 million as a result of the Company's focus on checking
growth,  increased average brokered CD's of $159.8 million and increased average
customer  repurchase  agreements of $10.1  million.  This increase was partially
offset by a decrease in average  reverse broker  repurchase  agreements of $82.3
million.

NET INTEREST INCOME
-------------------

Net interest  income was $26.4  million for the six months ended March 31, 2006,
as compared to $23.4  million for the six months ended March 31,  2005.  The net
interest  margin was 3.64% for the six months ended March 31, 2006,  compared to
3.67% for the six months ended March 31, 2005.

The following table  summarizes the average balance sheet and the related yields
on interest-earning  assets and deposits and borrowings for the six months ended
March 31, 2006 and 2005:

<TABLE>
<CAPTION>
                                                Six Months Ended March 31,
                                                --------------------------
                                        2006                                    2005
                                        ----                                    ----
                          Average      Income/         Yield/     Average      Income/         Yield/
                        Balance (1)    Expense         Rate     Balance (1)    Expense         Rate
                        -----------    -------         ----     -----------    -------          ----
<S>                      <C>             <C>         <C>      <C>            <C>             <C>

Assets
Earning assets
  Loans (2)              $  980,118   $   35,329         7.21%   $  835,820   $   26,104         6.25%
  Investment
    Securities, MBS
    Securities and
    Other (3)               481,417       11,847         4.92%      439,783       10,754         4.89%

                         ----------   ----------                 ----------   ----------
Total earning assets     $1,461,535   $   47,176         6.46%   $1,275,603   $   36,858         5.78%
                         ==========    ----------                ==========   ----------

Liabilities
  Customer Deposits         874,557        8,461         1.93%      762,293        5,021         1.32%
  Brokered CD's             190,141        3,928         4.13%       30,342          414         2.73%
  Borrowings                406,098        8,343         4.11%      481,365        8,011         3.33%

Total interest-bearing
                         ----------   ----------                 ----------   ----------
  Liabilities            $1,470,796       20,732         2.82%   $1,274,000       13,446         2.11%
                         ==========   ----------                 ==========    ----------

Net interest income                   $   26,444                              $   23,412
                                      ==========                              ==========
Net interest margin                                      3.64%                                   3.67%
Net yield on earning
  assets                                                 3.62%                                   3.67%

</TABLE>

(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.
(4)  Net interest income has not been adjusted to produce a tax-equivalent
     yield.

PROVISION FOR LOAN LOSSES
-------------------------

The  provision  for loan losses  decreased  $245,000  from  $975,000 for the six
months ended March 31, 2005, to $730,000 for the six months ended March 31, 2006
primarily  due to a  reduction  in  individually  significant  special  mention,
substandard  and impaired loans that carry  specific  reserve  allocations  when
computing  the  allowance  for  loan  loss.  Several  of  the  special  mention,
substandard  and impaired  loans were either paid off or there was a significant
improvement in the Company's collateral position.  The allowance for loan losses
as a  percentage  of loans was 1.21% at March 31,  2006 as  compared to 1.36% at
March 31, 2005.  Loans delinquent 90 days or more were $3.1 million at March 31,
2006.  The allowance for loan losses was 389% of loans  delinquent  more than 90
days at March 31, 2006, compared to 165% at March 31, 2005 and 445% at September
30, 2005. Net  charge-offs for the six months ended March 31, 2006 were $270,000
compared  to  $284,000  for the six  months  ended  March 31,  2005.  Management
believes  that the current  level of the  allowance  for loan losses 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.

                                       26
<PAGE>

OTHER INCOME
------------

For the six months ended March 31, 2006,  other income was $7.8 million compared
to $6.1  million  for the six months  ended  March 31,  2005.  Fees and  service
charges from deposit  accounts  increased  $1.8 million or 72.5% to $4.3 million
for the six months  ended March 31,  2006,  compared to $2.5 million for the six
months ended March 31, 2005.  The majority of this increase is due to fee income
resulting  from an  increase  in the number of personal  and  business  checking
accounts.  During the six months ended March 31, 2006,  the Company  securitized
mortgage loans into mortgage-backed  securities("MBS") and then sold the MBS and
sold loans  aggregating  $20.8  million of loans held for sale compared to $28.5
million  for the six  months  ended  March 31,  2005.  Gain on sale of loans was
$294,000 for the six months  ended March 31, 2006,  compared to $554,000 for the
six months ended March 31, 2005. Loss on sales of securities was $15,000 for the
six months  ended March 31,  2006,  compared  to gains of  $246,000  for the six
months ended March 31, 2005.  In  addition,  the Company had gain on  investment
security held to maturity  called by issuer of $160,000 for the six months ended
March 31, 2005 and none for the six months  ended March 31,  2006.  Other income
was $390,000  for the six months  ended March 31, 2006,  as compared to $296,000
for the six months  ended March 31,  2005.  ATM and debit card income  increased
$415,000  for the six  months  ended  March 31,  2006 to $1.0  million  over the
similar period in fiscal 2005 primarily due to the increased  number of personal
checking accounts.

GENERAL AND ADMINISTRATIVE EXPENSES
-----------------------------------

General and administrative  expenses were $16.1 million for the six months ended
March 31,  2005  compared to $19.6  million  for the six months  ended March 31,
2006.  Salaries and employee benefits were $8.9 million for the six months ended
March 31, 2005,  as compared to $10.9 million for the six months ended March 31,
2006,  an  increase  of 21.7%,  primarily  due to an  increase  in the number of
Associates in the Company's  expanded  hours call center,  in three new branches
opened  since  September  30,  2005 plus one branch  opened in April  2006,  and
increased  personnel in residential  banking. In the latter part of fiscal 2005,
the Company began preparations to increase production in mortgage  originations.
As a  result  of  these  plans,  the  Company  has  increased  support  staff by
approximately  five  personnel  and  added  approximately  thirteen  residential
lending  officers as of March 31,  2006.  Increased  lending  volumes from these
lending  personnel are not expected to increase  significantly  until the fourth
quarter of fiscal 2006 and the first  quarter of fiscal  2007.  The Company also
added several  Associates in a Banking Group that is focused on growing small to
medium  sized  business  banking  relationships.  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  $1.1 million  including  increased  depreciation  of  $375,000,  when
comparing the two periods.  Marketing  expenses were $993,000 for the six months
ended March 31,  2005,  compared to $957,000  for the six months ended March 31,
2006. The decrease from the prior period results from decreased  initial startup
expense for the Bank's  "Totally Free Checking With A Gift"  initiative  and the
introduction of Penny Pavilion,  the Bank's free coin counting service.  ATM and
debit card  expenses  increased  $212,000 from $465,000 for the six months ended
March 31, 2005 to $677,000 for the six months ended March 31, 2006  primarily as
a result of an increased number of personal  checking  accounts.  Other expenses
were $2.1  million  for the six months  ended  March 31,  2005  compared to $2.4
million for the six months ended March 31, 2006. Other expense  increased due to
increased legal costs of $71,000, increased courier service costs of $36,000 due
the increased number of branches, increased charitable contributions of $62,000,
and  reduced  income  from  reduced   recovery  of  mortgage   servicing  rights
impairments of $150,000.  The increased costs in 2006 are partially  offset by a
decrease in write-off of signage of $111,000 as the Bank changed its logo, a net
increase in the recovery of checking  charge-offs  of $44,000 and a reduction in
accounting and auditing fees of $37,000.

INCOME TAXES
------------

Income taxes were $4.3 million for the six months ended March 31, 2005  compared
to $4.8 million for the six months ended March 31, 2006.  The  effective  income
tax rate as a  percentage  of pretax  income  was  34.25% and 34.61% for the six
months ended March 31, 2005 and 2006,  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.  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

                                       27
<PAGE>

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 the future taxable income, in order to ultimately realize deferred
income tax assets.

REGULATORY CAPITAL MATTERS
--------------------------

To be  categorized  as "Well  Capitalized"  under the prompt  corrective  action
regulations  adopted by the Federal Banking  Agencies,  the Bank must maintain a
total  risk-based  capital ratio as set forth in the following  table and not be
subject to a capital directive order.

<TABLE>
<CAPTION>
                                                                             Categorized as "Well
                                                                              Capitalized" under
                                                          For Capital         Prompt Corrective
                                      Actual           Adequacy Purposes       Action Provision
                                      ------           -----------------       ----------------

                                Amount       Ratio    Amount        Ratio     Amount       Ratio
                                ------       -----    ------        -----     ------       -----
<S>                            <C>           <C>      <C>            <C>     <C>           <C>
                                                     (Dollars In Thousands)

As of March 31, 2006:
 Total Capital:                $131,406      13.56%   $ 77,513       8.00%   $ 96,891      10.00%
   (To Risk Weighted Assets)
 Tier 1 Capital:               $120,076      12.39%        N/A        N/A    $ 58,135       6.00%
   (To Risk Weighted Assets)
 Tier 1 Capital:               $120,076       7.27%   $ 49,358       3.00%   $ 82,263       5.00%
   (To Total Assets)
 Tangible Capital:             $120,076       7.27%   $ 24,679       1.50%        N/A        N/A
   (To Total Assets)

</TABLE>

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
-----------------------------------------

In February 2006, the Financial  Accounting  Standards Board issued Statement of
Financial  Accounting  Standard  (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  remeasurement  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  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 Statement of Financial  Accounting  Standards 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.


                                       28
<PAGE>

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.   See  Note  8  of  the  accompanying   unaudited
consolidated financial statements for additional discussion.

EFFECT ON INFLATION AND CHANGING PRICES
---------------------------------------

The accompanying  unaudited consolidated financial statements have been prepared
in accordance with 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 effects of  inflation.  Interest
rates do not necessarily  change in the same magnitude as the price of goods and
services.

Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
-------------------------------------------------------------------

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  Company'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 with 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 three  hundred  basis  point
increase or decrease in market interest rates.  The following table presents the
Bank's  change in NPV as computed by the OTS for various rate shock levels as of
March 31, 2006 (Dollars in thousands).

<TABLE>
<CAPTION>

                                                                                                        Market
                                             Board                 Board               Market           Value
                                             Limit                 Limit               Value          Portfolio
                                          Minimum NPV             Maximum            Of Assets          Equity           NPV
     Change in interest rates                Ratio            Decline in NPV          3/31/06          3/31/06          Ratio
------------------------------------    ----------------    --------------------    -------------    -------------    ----------
<C>                                          <C>                  <C>                  <C>                <C>            <C>
300 basis point rise                         5.00%                400 BPS              1,650,299          170,659        10.34%
200 basis point rise                         6.00%                300 BPS              1,670,119          180,085        10.78%
100 basis point rise                         6.00%                250 BPS              1,689,060          188,178        11.14%
No change                                    6.00%                                     1,705,899          193,651        11.35%
100 basis point decline                      6.00%                250 BPS              1,719,705          195,511        11.37%
200 basis point decline                      6.00%                300 BPS              1,726,714          188,617        10.92%
300 basis point decline                      6.00%                350 BPS                    N/A              N/A           N/A

</TABLE>

The preceding  table  indicates that at March 31, 2006, in the event of a sudden
and  sustained  increase in prevailing  market  interest  rates,  the Bank's Net
Portfolio Value (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 decrease  minimally.  A value for the 300 basis point decline is not
indicated  due to the level of interest  rates at March 31,  2006.  At March 31,
2006, the Bank's estimated changes in NPV were within the limits  established by
the Board of Directors.

                                       29
<PAGE>

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.

Item 4.  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)  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  officer,   as
appropriate  to  allow  timely  decisions  regarding  required  disclosure.   In
addition,  based  on that  evaluation,  no  material  changes  in the  Company's
internal  control over  financial  reporting  occurred  during the quarter ended
March  31,  2006  that has  materially  affected,  or is  reasonably  likely  to
materially affect, the Company's internal control over financial reporting.

PART II.  OTHER INFORMATION
COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Item 1.  Legal Proceedings
         -----------------
     The Company is a  defendant  in one lawsuit  related to  activities  in the
Bank,  arising out of the normal course of business.  The  subsidiaries are also
defendants in lawsuits arising out of the normal course of business.  Based upon
current  information  received  from  counsel  representing  the Company and its
subsidiaries in these matters,  the Company  believes none of the lawsuits would
have a  material  impact on the  Company's  financial  condition  or  results of
operations.

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.

     o    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.


                                       30
<PAGE>

     o    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.

     o    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.

          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.

     o    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.

     o    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 carry  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.

                                       31
<PAGE>

     o    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.

     o    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.

     o    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 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.


     o    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.

     o    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  loan   losses   that  are
          significantly higher than the provided allowance.

                                       32
<PAGE>

     o    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
          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.

     o    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.

     o    Litigation Risk.

          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.

     o    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  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 of
          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.

                                       33
<PAGE>

     o    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  or any other
          government agency. Should our business decline or fail, you could lose
          your total investment.

Item 1.B.  Unresolved Staff Comments
           -------------------------

     There are no comments  from the staff of the SEC  regarding our periodic or
     current reports under the Exchange Act that remain unresolved.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
         -----------------------------------------------------------

     Not Applicable.

Item 3.  Defaults Upon Senior Securities
         -------------------------------

     Not Applicable.

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


At the  Company's  annual  stockholders'  meeting held on January 31, 2006,  the
following items were ratified:

         A.   The election of directors of all nominees:  G. David Bishop, James
              T. Clemmons, William O. Marsh, Frank A. Thompson II.

              At the meeting,  a total of  16,792,972  votes were entitled to be
              cast.  Votes for G.  David  Bishop  were  16,711,367  with  81,605
              withheld; votes for James T. Clemmons were 16,596,687 with 196,285
              withheld;  votes for William O. Marsh were 16,622,474 with 170,498
              withheld;  votes for Frank A.  Thompson  II were  16,715,502  with
              77,470 withheld. The directors whose terms continued and the years
              their terms  expire are as follows:  J.  Robert  Calliham  (2007),
              James H. Dusenbury (2007)  and Michael C. Gerald (2007), E. Lawton
              Benton (2008), James P. Creel (2008), W. Cecil Worsley (2008).

         B.   An amendment to the  Company's  Certificate  of  Incorporation  to
              increase  the  authorized  number of  shares  of  common  stock to
              50,000,000.

              At the  meeting a total of  16,792,972  votes were  entitled to be
              cast. Votes  for  were 16,177,792; votes against were 366,334; and
              votes withheld were 248,846.

Item 5.  Other Information
         -----------------

     Not Applicable.


                                       34
<PAGE>

Item 6.   Exhibits
          --------

          Exhibits

              3    (a)   Certificate of Incorporation of Coastal Financial
                         Corporation (1)

                   (b)   Certificate  of Amendment to  Certificate of
                         Incorporation of Coastal Financial Corporation (4)

                   (c)   Certificate  of Amendment  dated February 1, 2006 to
                         the Certificate of  Incorporation of Coastal Financial
                         Corporation.

                   (d)   Bylaws of Coastal Financial Corporation (1)

             10    (a)   Employment Agreement with Michael C. Gerald (6)

                   (b)   Employment Agreement with Jerry L. Rexroad (6)

                   (c)   Employment Agreement with Phillip G. Stalvey (6)

                   (d)   Employment Agreement with Jimmy R. Graham (6)

                   (e)   Employment Agreement with Steven J. Sherry (6)

                   (f)   1990 Stock Option Plan (2)

                   (g)   Directors Performance Plan (3)

                   (h)   Coastal Financial Corporation 2000 Stock Option
                         Plan (5)

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

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

             3     (a)   Section 1350 Certification (Chief Executive Officer)

                   (b)   Section 1350 Certification (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 definitive  proxy  statement for the
          1996 Annual Meeting of Stockholders.

     (4)  Incorporated  by  reference  to December 31, 1998 Form 10-Q filed with
          Securities and Exchange Commission on May 15, 1998.

     (5)  Incorporated  by reference to the definitive  proxy  statement for the
          2000 Annual Meeting of Stockholders filed December 22, 1999.

     (6)  Incorporated  by reference to 2003 Form 10-K filed with Securities and
          Exchange Commission on December 22, 2003.


                                       35
<PAGE>

                                   SIGNATURES


Pursuant  to the  requirement  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

      May 10, 2006                         /s/ Michael C. Gerald
      ------------                        ----------------------
      Date                                Michael C. Gerald
                                          President and Chief Executive Officer

      May 10, 2006                         /s/ Jerry L. Rexroad
      ------------                        ---------------------
      Date                                Jerry L. Rexroad
                                          Executive Vice President and
                                          Chief Financial Officer


                                       36