EXHIBIT 13 ANNUAL REPORT TO STOCKHOLDERS FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2006 COASTAL FINANCIAL CORPORATION2006 ANNUAL
  REPORT    (GRAPHIC)
The Guiding
  Vision of Coastal Financial Corporation
QUEST
  FOR EXCELLENCE
  Remarkable Progress TowardTransforming Our Very Good Organization
  Into An Exceptional Organization
  Through the extraordinary execution of
  TheExperience of FANtastic!
  Customer ServiceThanks to the most
incredible group of Associates imaginable, 2006 was another exciting,
fast-paced and successful year for Coastal Financial Corporation.

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

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

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

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

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

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

(BAR CHART)

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

2

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

At or
  for Years Ended September 30,2002

2003

2004

2005

2006(Dollars in thousands, except per share data)Financial Condition
Data:Total assets

$
950,796

$
1,181,209

$
1,305,094

$
1,543,459

$
1,659,475Loans receivable, net


536,851


682,737


790,730


924,260


1,088,231Mortgage-backed
securities


331,808


383,324


374,283


399,655


392,989Cash, interest-bearing deposits
and investment securities


27,816


37,484


62,304


127,141


88,252Deposits


637,081


697,012


753,379


1,070,918


1,063,105Borrowings


228,622


392,797


451,144


346,408


468,139Stockholders
equity


66,386


73,707


85,348


97,221


112,824Operating
Data:Interest income

$
53,873

$
59,214

$
65,805

$
78,558

$
99,653Interest expense


21,846


22,998


23,524


29,730


45,073Net interest income


32,027


36,216


42,281


48,828


54,580Provision for loan
losses


1,235


2,655


1,750


1,697


1,385Net interest income after
provision for loan losses


30,792


33,561


40,531


47,131


53,195Other Income:Fees and service charges on
loan and deposit accounts


3,148


3,489


3,771


6,137


9,385Gain on sales of loans held for
sale


1,462


2,985


1,523


1,201


1,176Gain (loss) on sales of
investment securities, net


102





(100
)

226


97Gain (loss) on sales of
mortgage-backed securities, net


238


469


(997
)

(551
)

(494
)Gain (loss) from real estate
operations


(137
)

(18
)

3


(76
)

3Other income


3,326


3,983


4,971


5,587


6,898Total other income


8,139


10,908


9,171


12,524


17,065Total general and
administrative expense


22,824


27,156


27,269


33,519


41,058Income before income
taxes


16,107


17,313


22,433


26,136


29,202Income taxes


5,901


6,141


7,627


8,982


10,201Net income

$
10,206

$
11,172

$
14,806

$
17,154

$
19,001Net income per common diluted
share

$
.48

$
.52

$
.67

$
.76

$
.85Cash dividends per common
share

$
.11

$
.12

$
.14

$
.16

$
.14Weighted average shares
outstanding diluted


21,319


21,647


22,128


22,465


22,406All share and per share data
have been restated as applicable to reflect 10% stock dividends declared on May
27, 2003, August 28, 2003, February 18, 2004, July 30, 2004, December 15, 2004,
October 26, 2005, and August 24, 2006.

Key Operating Ratios:

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

At or
  for Years Ended September 30,2002

2003

2004

2005

2006Other Data:Return on assets (net income
divided by average assets)


1.23
%

1.04
%

1.18
%

1.20
%

1.18
%Return on average equity (net
income divided by average equity)


16.92
%

15.84
%

18.77
%

18.75
%

18.55
%Average equity to average
assets


7.29
%

6.59
%

6.31
%

6.38
%

6.36
%Book value per share

$
3.22

$
3.55

$
4.04

$
4.54

$
5.20Dividend payout ratio


21.77
%

23.20
%

19.91
%

19.54
%

15.51
%Interest rate spread
(difference between average yield on
  interest-earning assets and average cost of interest-bearing liabilities)


4.14
%

3.65
%

3.64
%

3.70
%

3.67
%Net interest margin (net
interest income as a percentage of average
  interest-earning assets)


4.24
%

3.67
%

3.64
%

3.69
%

3.66
%Allowance for loan losses to
total net loans at end of period


1.42
%

1.40
%

1.39
%

1.25
%

1.17
%Ratio of non-performing assets
to total assets (1)


0.48
%

0.77
%

0.51
%

0.22
%

0.21
%Tangible capital
ratio


6.57
%

7.14
%

7.44
%

7.25
%

7.78
%Core capital ratio


6.57
%

7.14
%

7.44
%

7.25
%

7.78
%Risk-based capital
ratio


12.74
%

13.17
%

13.55
%

13.29
%

14.34
%(1)
Non-performing assets
  consist of nonaccrual loans 90 days or more past due and real estate acquired
  through foreclosure.3

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

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

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

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

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

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

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

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

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


Coastal Financial
  Corporations net income for 2006 totaled $19.0 million, compared to $17.2
  million in 2005. On a fully diluted basis, these results equated to a 11.8%
  increase, from $0.76 per share in 2005 to $0.85 per share in 2006. This
  growth was fueled by continued strong Core Deposit and loan growth and low
  credit loss expense.
Customer Deposits, which
  are Total Deposits less Brokered Deposits, increased by approximately $8.8
  million, or 1.0% to $910 million. Over the past three years, our average rate
  of Customer Deposit growth has been 10% per year.
Loans grew by 16%,
  primarily reflecting our continued strong focus on the Business Banking
  element of our operations.
Exceptional progress
  toward attainment of our quest for Exceeding the Expectations of Our Customer
  was reflected in the 7,489 independently conducted Mystery Shops, which
  produced an organizational score for the year of 92.6%. This outstanding
  result is the workproduct of our focus on giving every Customer The Experienceof
  FANtastic! Customer Service during every Coastal Federal
  interaction, every day.
We continued to raise the
  bar for Customer Service and Convenience in our marketplace with the
  following unique Community Service and Customer Convenience and Service
  offerings:
The Penny FLIERS (Financial Literacy and
  Education Resources) Initiative - designed to teach the basics of4

(GRAPHIC)money, economics and
  investing to K-4 through 5th Grade students throughout our
  Community.
Totally
  Free Business Checking With A Gift and Totally Free Online Banking and Bill
  Pay features
Instantly
  Issued Debit Cards
   No more long waits for the arrival of a Debit Card upon opening a new
  account or losing a card. Coastal Federal Debit Cards are issued to Customers
  at the Branch during the account opening process, or replaced immediately
  upon a loss of a card.
The significant expansion
  of our Customer Service Center
  which offers our Customers telephone support from real, live Customer Service
  Representatives - no more confusing electronic commands to interpret and
  decipher. This service, which offers our Customers the ultimate in ease and
  convenience, is provided from 7:30 am until 7:30 pm, Monday through Friday
  and from 7:30 am until 1:30 pm on Saturday.
Our exceptional Branch Delivery Channel continued to
  expand to serve more of the Communities of coastal North and South Carolina.
  Since 1998, Coastal Federal has added 14 new branches to our rapidly growing
  network  58 percent of our existing branches. During fiscal 2006, we opened
  the following new branch facilities:
North Carolina:
Oak Island
South Carolina:
Stephens Crossroad
North Conway
Hwy 544 West
Hwy 544  SayeBrook
  Village
Coastal
  Federal University
  significantly expanded both its teaching staff and curriculum offerings in
  support of Our Basic Corporate Objective
  of Maximizing The Value Of Our Shareholders Investment by making
  continual progress toward Our Long-Term
  Goal of Being The Best Financial Services Company In Our Marketplace.
  Each of our new Associates attends CFUs Pledge To Excellence offering which
  introduces them to ourQUEST FOR EXCELLENCE
  Business Model by taking a look back at our rich history and legacy and then
  a look forward by learning about our overriding focus on enriching the
  Customer experience through approaches such as The Experienceof
  FANtastic! Customer Service and other initiatives designed to
  instill a passion for excellence.Since 1990, our net income
has increased at a compound annualized rate in excess of 17%.

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

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

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


Coastal Financial
  Corporation, for the 7th consecutive year, was ranked the #1
  Community Bank in the Carolinas by U. S.
  Banker Magazine, in its September 2006 publication. In this
  edition, U. S. Banker Magazine
  featured its Ranking of the Top 100 Publicly Traded Mid-Tier Banks. This
  ranking spotlighted banks with assets between $1 and $10 billion, based upon
  a 3-year average measure of Return On Average Equity. Coastal Financial
  Corporation was ranked 1st in the Carolinas and 20th nationally in
  this listing.
Coastal Federal Bank, for
  the ninth consecutive year, placed 1st in voting by the readers of
  the (Myrtle Beach) SUN NEWS
  in the Financial Institutions category of the SUN NEWS Best Of The
  Beach Competition for 2006.
Coastal Federal Bank, for
  the fifth consecutive year, placed 1st in voting by the readers of
  the SUN NEWS in the
  Mortgage Company category of the SUN
  NEWS Best of the Beach
  Competition for 2006.
Raymond James Financial
  Services, Inc., for the fifth consecutive year, placed 1st in
  voting by the readers of the (Myrtle Beach) SUN NEWS in the Financial Planning category of the SUN NEWS
Best Of The Beach Competition for 2006.
The 2006 FDIC SUMMARY OF DEPOSITS REPORT,
  for the 6th consecutive year, ranked Coastal Federal Bank the leader in
  deposit market share for Horry County for the twelve months ended June 30,
  2006. Coastal Federal Bank has enjoyed this top ranking for eight of the past
  eleven years. This report also showed that Coastal Federal Bank is ranked 3rd
  in deposit market share for Brunswick County, North Carolina.5

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

Noteworthy Financial Results for Fiscal 2006

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

BOOK VALUE
  PER SHARE
Book value per share grew
  14.5% to $5.20.
Shareholders equity
  advanced 16.0% to $112.8 million.BAR CHART

6

(GRAPHIC)ASSETS
Total Assets increased
  7.6%, from $1.5 billion to $1.7 billion, the highest level in the Companys
  history.
Customer Deposits
  increased from $901.0 million to $909.8 million.
Net Loans increased 15.7%,
  from $942.4 million to $1,090.1 million.(BAR CHART)

NON-PERFORMING
  ASSETS TO TOTAL ASSETS
Non-performing Assets to
  Total Assets declined from 0.22% to 0.21%.(BAR CHART)

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

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

7

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

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

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

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

16 Year Peer Group Price Performance

(LINE GRAPH)

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


CFCP Relative Price Performance

(LINE GRAPH)

8

(GRAPHIC)Albert Einstein once said,
The significant problems we face today cannot be solved at the same level of
thinking we were at when we created them.

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

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

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

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

(MAP)

SOUTH
  CAROLINA1. Carolina Forest2. Conway3. Dunes4. Hwy. 544 West5. Little River6. Loris7. Murrells Inlet8. Myrtle Beach/BI-LO9. North Conway10. North Myrtle Beach11. Oak Street12. Pawleys Island13. SayeBrook14. Socastee15. Stephens Crossroads16. Surfside17. Waccamaw Medical ParkNORTH CAROLINA18. Oak Island19. Shallotte20. Southport21. Sunset Beach22. Wilmington - Downtown23. Wilmington - 17th
  Street24. Wilmington - Oleander(LOGO)
in North
  Carolina25. Boiling Spring Lakes(LOGO)
in South
  Carolina26. Windy Hill9

(GRAPHIC)(PICTURE)

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

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

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

My sincere appreciation goes
to our Board of Directors, Leadership Group and Associates. Their never-ending
quest for improving the Customer experience enabled our 2006 results, and are a
direct reflection of their commitment to

 Our Basic Corporate Objective Of Maximizing The Value Of Our
Shareholders Investment
by working diligently toward the achievement of Our Long-Term Goal Of Being The Best Financial Services Company In Our
Marketplace.

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

-s- Michael C. Gerald

Michael C. Gerald 
President and 
Chief Executive Officer

10

Managements
Report on Internal Control Over Financial Reporting

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

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

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

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

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

11

Report of
Independent Registered Public Accounting Firm

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

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

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

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

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

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

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

(KPMG LLP LOGO)

Raleigh, North Carolina 
December 14, 2006

12

Report of Independent
    Registered Public Accounting Firm

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

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

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

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

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

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

(KPMG LLP LOGO)

Raleigh, North Carolina 
December 14, 2006

13

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESConsolidated Statements of Financial ConditionSeptember 30, 2005
and 2006

2005

2006(Dollars in thousands, 
  except per share data)ASSETSCash and amounts due from
banks

$
52,592


31,055Short-term interest-bearing
deposits


33,742


5,797Federal funds sold


5,191


103Investment securities available
for sale


25,616


39,300Mortgage-backed securities
available for
  sale


399,655


392,989Investment securities held to
maturity
  (market value of $10,049 at September 30, 2005 and $12,000 at September
  30, 2006)


10,000


11,997Loans receivable (net of
allowance for loan
  losses of $11,748 at September 30, 2005 and $12,726 at September
  30, 2006)


924,260


1,088,231Loans receivable held for
sale


18,121


1,853Real estate acquired through
foreclosure,
  net


818


571Office property and equipment,
net


22,758


29,926Federal Home Loan Bank (FHLB)
stock, at
  cost


15,775


20,291Accrued interest receivable on
loans


3,807


5,000Accrued interest receivable on
securities


2,351


2,898Bank-owned life
insurance


22,574


23,541Other assets


6,199


5,923$
1,543,459


1,659,475LIABILITIES AND
STOCKHOLDERS
  EQUITYLiabilities:Deposits


1,070,918


1,063,105Securities
sold under agreements to
  repurchase


41,937


72,095Advances from
FHLB


289,007


380,580Junior
subordinated debt


15,464


15,464Drafts
outstanding


12,890


2,023Advances by
borrowers for property taxes
  and insurance


1,221


1,422Accrued
interest payable


3,415


4,718Other
liabilities


11,386


7,244Total
liabilities


1,446,238


1,546,651Stockholders
equity:Serial
preferred stock, 1,000,000 shares
  authorized and unissued





Common stock
$.01 par value per share,
  50,000,000 shares authorized; 21,403,241 shares at September 30, 2005 and
  21,686,542 shares at September 30, 2006 issued and outstanding


214


217Additional
paid-in capital


11,391


12,856Retained
earnings, restricted


86,723


102,777Accumulated
          other comprehensive loss, net of tax


(1,107
)

(3,026
)Total
stockholders equity


97,221


112,824$
1,543,459


1,659,475See accompanying notes to consolidated financial
statements.

14

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIESConsolidated
Statements of OperationsYears ended September 30, 2004, 2005
and 2006

2004

2005

2006(In thousands, except share data)Interest:Loans
receivable

$
46,765


56,826


75,932Investment
securities


2,886


4,971


6,934Mortgage-backed securities


16,067


16,392


15,852Other


87


369


935Total interest income


65,805


78,558


99,653Interest expense:Deposits


10,024


14,079


26,743Securities
sold under agreements to
  repurchase


2,114


2,418


2,335Advances from
FHLB


10,724


12,341


14,803Other
borrowings


662


892


1,192Total interest
expense


23,524


29,730


45,073Net interest
income


42,281


48,828


54,580Provision for loan
losses


1,750


1,697


1,385Net interest
income after provision for
  loan losses


40,531


47,131


53,195Other income:Fees and
service charges on deposit
  accounts


3,771


6,137


9,385Income from
ATM and debit card transactions


954


1,532


2,334Income from
sales of non-depository
  products


1,909


1,840


1,631Gain on sales
of loans and loans receivable
  held for sale


1,523


1,201


1,176Gain (loss) on
sales of investment
  securities, net


(100
)

66


97Gain (loss) on
sales of mortgage-backed
  securities, net


(997
)

(551
)

(494
)Gain on call
of investment securities held
  to maturity





160


Gain (loss)
from real estate acquired
  through foreclosure


3


(76
)

3Federal Home
Loan Bank stock dividends


499


668


1,016Bank-owned
life insurance


962


948


967Other
income


647


599


950Total other
income


9,171


12,524


17,065General and administrative
expenses:Salaries and
employee benefits


16,099


18,460


22,242Net occupancy,
furniture and fixtures and data
  processing expense


4,001


4,844


6,784Depreciation


2,175


2,757


3,561FDIC insurance
premium


104


108


137FHLB
prepayment penalties


77





Marketing
expense


905


1,809


2,000Expense from
ATM and debit card transactions


630


1,039


1,399Other
expense


3,278


4,502


4,935Total general
and administrative expense


27,269


33,519


41,058Income before
income taxes


22,433


26,136


29,202Income
taxes


7,627


8,982


10,201Net
income

$
14,806


17,154


19,001Net income per
common shareBasic

$
0.71


0.81


0.88Diluted

$
0.67


0.76


0.85Dividends
declared per common share

$
0.14


0.16


0.14Average common
shares outstandingBasic


20,966,000


21,274,000


21,509,000Diluted


22,128,000


22,465,000


22,406,000See accompanying notes to consolidated
financial statements.

15

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIESConsolidated
Statements of Stockholders Equity
and Comprehensive IncomeYears ended September 30, 2004, 2005
and 2006

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

16

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIESConsolidated
Statements of Cash FlowsYears ended September 30, 2004, 2005
and 2006

2004

2005

2006(In thousands)Cash flows from operating
activities:Net
income

$
14,806


17,154


19,001Adjustments to
reconcile net income to net cash used in operating
  activities:Depreciation


2,175


2,757


3,561Provision for
loan losses


1,750


1,697


1,385Loss on sale of mortgage-backed securities available for sale


997


551


494(Gain) loss on
sale of investment securities available or sale


100


(66
)

(97
)(Gain) on call
of investment security called by issuer





(160
)

Loss
          on disposal of office properties and equipment





128


16Stock-based
compensation





76


146Origination of
loans receivable held for sale


(63,448
)

(81,207
)

(42,198
)Proceeds from
sales of loans receivable held for sale


27,453


18,704


18,012Proceeds from
securitization and sales of loans receivable held for
  sale


46,845


52,628


27,512Loss on early
extinguishment of debt


77





Tax benefit of
stock options


(434
)

(394
)

(345
)Increase
in:Cash value of
life insurance


(962
)

(947
)

(967
)Other
assets


(536
)

(174
)

276Accrued
interest receivable


(1,018
)

(808
)

(1,740
)Increase
(decrease) in:Accrued
interest payable


239


1,913


1,303Other
liabilities


(125
)

4,627


(2,676
)Net cash
provided by operating activities


27,919


16,479


23,683Cash flows from investing
activities:Proceeds from
sales of investment securities available for sale


2,881


4,163


10,567Proceeds from
issuer call of investment securities available for sale





1,950


Proceeds from
issuer call of investment securities held to maturity





8,000


Proceeds from
maturities of investment securities available for sale


2,000





Purchases of
investment securities available for sale


(11,866
)

(8,255
)

(24,110
)Purchases of
investment securities held to maturity


(7,840
)

(10,000
)

(1,997
)Proceeds from
sales of mortgage-backed securities available for sale


124,479


178,849


51,647Purchases of
mortgage-backed securities available for sale


(234,672
)

(312,217
)

(125,734
)Principal
collected on mortgage-backed securities available for sale


115,179


102,155


77,120Origination of
loans receivable, net


(513,858
)

(718,477
)

(758,558
)Proceeds from
sale of commercial loan participations





21,228


4,369Proceeds from
sale of credit card portfolio








3,618Principal
collected on loans receivable


403,501


560,469


597,228Purchase of
bank-owned life insurance


(4,500
)




Proceeds from
sales of real estate acquired through foreclosure


1,456


1,521


1,176Proceeds from
sale of office properties and equipment


58





Purchases of
office properties and equipment


(4,989
)

(6,800
)

(10,745
)Change in FHLB
stock, net


(2,909
)

1,125


(4,516
)Net cash used
in investing activities


(131,080
)

(176,289
)

(179,935
)Cash flows from financing
activities:Increase
(decrease) in deposits


56,367


317,539


(7,813
)Increase
(decrease) in securities sold under agreements to repurchase


(26,429
)

(65,236
)

30,158Proceeds from
FHLB advances


686,476


565,650


970,210Repayment of
FHLB advances


(602,083
)

(605,150
)

(878,637
)Repayments of
other borrowings, net


(81
)




Prepayment
penalties on early extinguishment of debt


(77
)




Increase
(decrease) in advance payments by borrowers for property
  taxes and insurance


(45
)

(529
)

201Increase in
drafts outstanding, net


148


10,098


(10,867
)Cash dividends
to stockholders and cash for fractional shares


(2,948
)

(3,361
)

(2,947
)Proceeds from
exercise of stock options


839


915


1,032Tax benefit of
stock options


434


394


345Net cash
provided by financing activities


112,601


220,320


101,682Net increase (decrease) in cash
and cash equivalents


9,440


60,510


(54,570
)Cash and cash equivalents at
beginning of year


21,575


31,015


91,525Cash and cash equivalents at
end of year

$
31,015


91,525


36,955Supplemental
information:Interest
paid

$
23,285


27,817


43,771Income taxes
paid

$
7,762


6,970


10,118Supplemental schedule of
non-cash investing and financing
  transactions:Securitization of mortgage
loans into mortgage-backed securities

$
46,845


52,628


27,512Transfer of mortgage loans to
real estate acquired through foreclosure

$
614


1,554


929Increase in
other assets and junior subordinated debt resulting from
  deconsolidation under FIN 46R

$
464





See accompanying notes to consolidated
financial statements.

17

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements

(1)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESThe
following is a summary of the more significant accounting policies used in the
preparation and presentation of the accompanying consolidated financial
statements. The preparation of financial statements in conformity with U.S.
generally accepted accounting principles requires management to make estimates
and assumptions. These estimates and assumptions affect the reported amount of
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements. In addition, they affect the reported
amounts of income and expenses during the reporting period. Actual results
could differ from these estimates and assumptions. Material estimates that are
particularly susceptible to significant change relate to the determination of
the allowance for loan losses and income tax assets or liabilities. To a lesser
extent, significant estimates are also associated with the valuation of
derivative instruments and valuation of mortgage servicing rights.

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

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

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

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

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

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

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

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

18

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(1)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  CONTINUED(e)
Loans ReceivableLoans
receivable are stated at unpaid principal balances adjusted for unamortized
premiums and unearned discounts and deferred loan fees/costs. The Company recognizes
interest income on loans using the simple interest method.

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

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

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

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

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

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

19

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(1)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  CONTINUED(i)
Loan SecuritizationsThe
Company packages and sells loans receivable as securities to investors. These
transactions are recorded as sales in accordance with SFAS No. 140 when control
over these assets has been surrendered. The Company does not retain any
interest in the securities sold other than the servicing rights.

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

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

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

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

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

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

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

20

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

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

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

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

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

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

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

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

2004

2005

2006Dividend
  yield


1.25
%

1.50
%

1.52
%Weighted
  average risk-free interest rate


4.21
%

4.01
%

4.92
%Weighted
  average expected volatility


40.00
%

29.00
%

29.00
%Weighted
  average expected life in years


7.50


5.00


7.5021

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(1)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  CONTINUED(p)
Stock Based Compensation - CONTINUEDHad
the compensation cost for the Companys stock-based compensation plan been
determined under the fair value-based method, the Companys net income and
earnings per share would have been adjusted to the pro forma amounts below for
the years ended September 30 (Dollars in thousands, except per share data):

2004

2005

2006(Unaudited)Information
  as reported in the Financial Statements:Net income

$
14,806

$
17,154

$
19,001Basic earnings per
share

$
0.71

$
0.81

$
0.88Diluted earnings per
share

$
0.67

$
0.76

$
0.85Share-based compensation cost,
net of
  related tax effects

$
(599
)
$
(3,710
)
$
(91
)Information calculated as if
fair value
  method had been applied to all awards:Net income, as
reported

$
14,806


17,154


19,001Add: Stock-based compensation
expense
  recognized during the period, net of related tax effects





76


91Less: Stock-based compensation
expense
  determined under the fair value-based method, net of related tax effects


(599
)

(3,710
)

(91
)Pro forma net income

$
14,207

$
13,520

$
19,001Pro forma basic earnings per
share

$
0.68

$
0.64

$
0.88Pro forma diluted earnings per
share

$
0.64

$
0.60

$
0.85A summary of
share option activity for the twelve months ended September 30, 2006 follows:

Number
  of Shares

Weighted
  Average
  Exercise Price

Weighted
  Average
  Remaining
  Contractual
  Life (Years)

AggregateIntrinsic
  ValueOutstanding at September 30,
2005


3,092,770

$
7.75Granted


4,400

$
11.95Exercised


(333,942
)
$
4.97Forfeited or expired


(14,598
)
$
10.95Outstanding at September 30,
2006


2,748,630

$
8.07


5.7

$
11,578,000Exercisable at September 30,
2006


2,687,913

$
8.14


5.7

$
11,161,000The
weighted average grant-date fair value of options granted during the twelve
months ended September 30, 2004, 2005 and 2006 was $4.52 per share,
$4.11 per share and $4.22 per share, respectively. The total intrinsic value of
options exercised during the twelve months ended September 30, 2004, 2005 and
2006 was $2,718,000, $2,206,000 and $2,560,000, respectively.

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

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

Number
  of Shares

Weighted
  Average
  Grant-Date
  Fair ValueNonvested at
  September 30, 2005


159,928

$
2.09Granted


4,400

$
4.22Vested


(102,412
)
$
1.62Forfeited


(1,199
)
$
3.65Nonvested at
  September 30, 2006


60,717

$
2.51Fair
values have been retroactively restated for all stock dividends since the date
the option was granted.

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

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

22

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

1)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  CONTINUED(q)
Comprehensive IncomeSFAS
No. 130, Reporting Comprehensive Income establishes standards for the
reporting and presentation of comprehensive income and its components in a full
set of financial statements. Comprehensive income consists of net income and
net unrealized gains (losses) on securities and is presented in the statements
of stockholders equity and comprehensive income.

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

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

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

(2)
INVESTMENT SECURITIESThe
amortized cost and fair value of investment securities available for sale at
September 30, 2005 are summarized as follows:

2005Amortized
  Cost

Gross
  Unrealized
  Gains

Gross
  Unrealized
  Losses

Fair
  Value(In
  thousands)U.S. Government and agency
  obligations:Due after five years

$
3,947





(13
)

3,934State and municipal
obligations:Due after
  five years


21,285


434


(37
)

21,682$
25,232


434


(50
)

25,61623

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(2)
INVESTMENT SECURITIES  CONTINUEDThe
amortized cost and fair value of investment securities available for sale at
September 30, 2006 are summarized as follows:

2006Gross

GrossAmortized

Unrealized

Unrealized

FairCost

Gains

Losses

Value(In
  thousands)U.S.
  Government and agency obligations:Due after five
years

$
15,489


170


(29
)

15,630State and
  municipal obligations:Due after five
years


23,383


322


(35
)

23,670$
38,872


492


(64
)

39,300The
Company had no gross realized gains and gross realized losses were $100,000 for
the year ended September 30, 2004. For the year ended September 30, 2005, gross
realized gains were $92,000 and gross realized losses were $26,000. For the
year ended September 30, 2006, gross realized gains were $153,000 and gross
realized losses were $56,000.

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

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

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

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

2006One year

More than one

More than five

More thanor less

to five years

to ten years

ten yearsFair Value

Yield

Fair Value

Yield

Fair Value

Yield

Fair Value

Yield(Dollars in thousands)U.S. Government and agency
obligations:FFCB

$




%
$




%
$
2,969


5.33
%
$




%FHLB














19,503


4.28


5,157


5.30State and
municipal obligations








265


5.55


4,120


4.10


19,286


4.37Total

$




%
$
265


5.55
%
$
26,592


4.37
%
$
24,443


4.57
%The
yield on state and municipal obligations is not computed on a tax-equivalent
basis.

(3)
MORTGAGE-BACKED SECURITIESMortgagebacked
securities available for sale at September 30, 2005 consisted of the following:

2005Gross

GrossAmortized

Unrealized

Unrealized

FairCost

Gains

Losses

Value(In
  thousands)Collateralized Mortgage
Obligations

$
84,387


37


(1,130
)

83,294FNMA


152,075


1,052


(1,346
)

151,781GNMA


45,963


274


(416
)

45,821FHLMC


119,399


447


(1,087
)

118,759$
401,824


1,810


(3,979
)

399,65524

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(3)
MORTGAGE-BACKED SECURITIES  CONTINUEDMortgagebacked
securities available for sale at September 30, 2006 consisted of the following:

2006Gross

GrossAmortized

Unrealized

Unrealized

FairCost

Gains

Losses

Value(In
  thousands)Collateralized
  Mortgage Obligations

$
111,827


75


(1,869
)

110,033FNMA


133,530


608


(2,094
)

132,044GNMA


38,532


153


(509
)

38,176FHLMC


114,409


104


(1,777
)

112,736$
398,298


940


(6,249
)

392,989The
Company had gross realized gains of $772,000 and gross realized losses of $1.8
million for the year ended September 30, 2004. For the year ended September 30,
2005, the Company had gross realized gains of $719,000 and gross realized
losses of $1.3 million. For the year ended September 30, 2006, the Company had
gross realized gains of $102,000 and gross realized losses of $596,000.

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

2006Less than
  12 Months

12 Months
  or Longer

TotalFair

Unrealized

Fair

Unrealized

Fair

UnrealizedValue

Losses

Value

Losses

Value

Losses(In
  thousands)Collateralized Mortgage
Obligations

$
45,525


(377
)

53,531


(1,492
)

99,056


(1,869
)FNMA


45,174


(532
)

57,518


(1,562
)

102,692


(2,094
)GNMA


9,582


(61
)

20,078


(448
)

29,660


(509
)FHLMC


49,593


(521
)

58,982


(1,256
)

108,575


(1,777
)$
149,874


(1,491
)

190,109


(4,758
)

339,983


(2,649
)The
unrealized losses on mortgage-backed securities summarized above were
attributable to increases in interest rates, rather than credit quality. The
unrealized losses are comprised of 54 securities that have had continuous
losses of less than 12 months and 67 securities that have had continuous losses
12 months or longer. None of the Companys securities were considered impaired
at September 30, 2006. None of the individual mortgage-backed securities had an
unrealized loss which exceeded 10% of its amortized costs and all
mortgage-backed securities were rated AAA or higher.

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

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

2006One year

More than
  one

More than
  five

More thanor less

to five
  years

to ten
  years

ten yearsFair Value

Yield

Fair Value

Yield

Fair Value

Yield

Fair Value

Yield(Dollars in thousands)Mortgage-backed
securities:FHLMC

$




%
$




%
$




%
$
112,736


5.32
%FNMA














341


6.00


131,703


5.45GNMA














42


6.50


38,134


5.63Collateralized
Mortgage Obligations




















110,033


5.13Total

$




%
$




%
$
383


6.05
%
$
392,606


5.42
%25

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(4)
LOANS RECEIVABLE, NETLoans
receivable, net at September 30 consisted of the following:

2005

2006(In
  thousands)Mortgage
  loans:Single family
to 4 family units

$
352,893


390,572Land and land
development


121,170


162,538Residential
lots


37,112


39,377Other,
primarily commercial real estate


211,432


236,053Residential
construction loans


127,970


197,345Commercial
construction loans


14,989


6,410Consumer and
  commercial loans:Installment
consumer loans


19,115


14,182Mobile home
loans


4,308


5,194Savings
account loans


1,883


2,035Equity lines
of credit


34,019


40,331Commercial and
other loans


38,691


38,656963,582


1,132,693Less:Allowance for
loan losses


11,748


12,726Deferred loan
cost, net


(771
)

(246
)Undisbursed
portion of loans in process


28,345


31,982$
924,260


1,088,231The changes in the allowance
for loan losses for the years ended September 30 consisted of the following:

2004

2005

2006(In
  thousands)Beginning
  allowance

$
9,832


11,077


11,748Provision
  for loan losses


1,750


1,697


1,385Loan
  recoveries


249


224


307Loan
  charge-offs


(754
)

(1,250
)

(714
)$
11,077


11,748


12,726Nonaccrual
loans, which are all loans ninety days or more delinquent, totaled
approximately $2.6 million and $3.0 million at September 30, 2005 and 2006,
respectively. In fiscal years 2004, 2005 and 2006, interest income which would
have been recorded would have been approximately $277,000, $285,000 and
$255,000, respectively, had non accruing loans been current in accordance with
their original terms.

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

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

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

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

26

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(4)
LOANS RECEIVABLE, NET  CONTINUEDStandby
letters of credit obligate the Company to meet certain financial obligations of
its Customers, if, under the contractual terms of the agreement, the Customers
are unable to do so. Payment is only guaranteed under these letters of credit
upon the borrowers failure to perform its obligations to the beneficiary. The
Company can seek recovery of the amounts paid from the borrower and the letters
of credit are generally collateralized. Commitments under standby letters of
credit are usually one year or less. At September 30, 2006, the Company has
recorded no liability for the current carrying amount of the obligation to
perform as a guarantor, as such amounts are not considered material. The
maximum potential amount of undiscounted future payments related to standby
letters of credit at September 30, 2006 was $11.4 million.

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

2005

2006Residential
  mortgage loans in process

$
28,345


31,982Business and
  consumer credit card lines


14,065


Consumer
  home equity lines


43,388


48,811Other
  consumer lines of credit


4,547


6,721Standby
  letters of credit


5,777


11,356Commercial real estate and
construction and
  land development lines of credit


107,731


122,877Other
  commercial lines of credit


10,527


12,760$
214,380


234,507During
fiscal 2006, the Bank sold its business and consumer credit card portfolio.

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

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

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

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

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

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

Balance at
  September 30, 2005

$
833New loans


3Repayments


(282
)Balance at
  September 30, 2006

$
55427

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(5)
MORTGAGE SERVICING RIGHTSMortgage
servicing rights, net of the valuation allowance, are included in other assets
and totaled $3.2 million and $3.1 million at September 30, 2005 and 2006,
respectively. Amortization expense for MSRs, included in interest on loans
receivable, totaled $1.0 million, $1.1 million and $807,000 for the years ended
September 30, 2004, 2005 and 2006, respectively. The estimated amortization
expense for MSRs held as of September 30, 2006, is $728,000, $716,000,
$666,000, $596,000 and $350,000 for fiscal 2007, 2008, 2009, 2010 and 2011 respectively.
The estimated amortization expense is based on current information regarding
loan payments and prepayments. Amortization expense could change in future
periods based on changes in the volume of prepayments and various economic
factors.

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

2005

2006(In
  thousands)Balance at
  beginning of year

$
3,005


3,187MSRs
  capitalized


941


671MSRs
  amortized


(1,053
)

(807
)Recovery of
  impairment


294


5Balance at
  end of year

$
3,187


3,056(6)
OFFICE PROPERTY AND EQUIPMENT, NETOffice
property and equipment, net at September 30 consisted of the following:

2005

2006(In
  thousands)Land

$
7,530


8,354Building and
  improvements


15,493


20,728Furniture,
  fixtures and equipment


20,510


24,42843,533


53,510Less
  accumulated depreciation


(20,775
)

(23,584
)$
22,758


29,926The
    Company has eight leases for office space and two land leases under noncancelable
    operating leases with initial terms that expire over the next one to thirty
    years. Seven of these leases contain renewal options for periods ranging from
    one to thirty years and require the Company to pay all executory costs such
    as property taxes, utilities and insurance. Rental payments are based on contractual
    amounts as set forth in the lease agreements and do not include contingent
    rentals. All rental payments, including escalating rents, are recognized as
    rental expense on a straight-line basis over the term of the lease. The rent
    expense for the years ended September 30, 2004, 2005, and 2006 was approximately
    $285,000, $307,000 and $721,000, respectively.

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

2007

$
4782008


3622009


2742010


2502011


183Thereafter


3,105$
4,652(7)
INVESTMENT REQUIRED BY LAWThe
Bank, as a member of the FHLB of Atlanta, is required to acquire and hold
shares of capital stock in the FHLB of Atlanta in an amount equal to the
greater of (i) $500 (ii) 1.0% of the aggregate outstanding principal amount of
home mortgage loans, home purchase contracts and similar obligations at the end
of each calendar year, or (iii) 5% of its advances (borrowings) from the FHLB
of Atlanta at the end of each calendar year. The Bank is in compliance with
this requirement with an investment in FHLB stock of $20.3 million, carried at
cost, at September 30, 2006. No ready market exists for this stock and it has
no quoted market value. However, redemption of this stock has historically been
at par value.

28

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(8)
DEPOSITSDeposits at
  September 30 consisted of the following:2005

2006Amount

Weighted
  Average
  Rate

Amount

Weighted
  Average
  Rate(Dollars
  in thousands)Transaction
  accounts:Noninterest
bearing

$
219,080


%

$
231,081


%NOW


139,810


0.52


126,373


0.54Money market
checking


213,078


2.26


198,500


3.44Total
transaction accounts


571,968


0.97


555,954


1.35Statement
  savings accounts:Regular


71,119


1.47


75,790


2.37Money
market


705


1.24


473


1.87Total
statement savings accounts


71,824


1.47


76,263


2.37Certificate
  accounts:0.00-1.99%


15,660





2472.00-3.99%


381,253





44,2354.00-5.99%


29,545





385,5646.00-7.99%


8





1228.00-10.00%


660





720Total
certificate accounts


427,126


3.39


430,888


4.83$
1,070,918


1.97%

$
1,063,105


2.83%The
aggregate amount of all deposit accounts with a minimum denomination of
$100,000 or more was $637.9 million and $633.6 million at September 30, 2005
and 2006, respectively.

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

2005

2006(In
  thousands)Within 1
  year

$
392,731


389,272After 1 but
  within 2 years


22,666


33,154After 2 but
  within 3 years


8,555


4,000Thereafter


3,174


4,462$
427,126


430,888Included
in certificate accounts (CDs) are $153.3 million of brokered CDs at September
30, 2006. There were $169.9 million of brokered CDs at September 30, 2005. The
average rate and remaining term of brokered CDs at September 30, 2006 was 5.16%
and approximately five months, respectively.

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

2004

2005

2006(In
  thousands)Transaction
  accounts

$
3,331


4,457


7,058Passbook
  accounts


405


663


1,496Certificate
  accounts


6,288


8,959


18,189$
10,024


14,079


26,74329

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(9)
ADVANCES FROM FHLBMaturities
  for advances from the FHLB by fiscal year at September 30 consisted of the
  following:2005

2006Amount

Weighted
  Rate

Amount

Weighted
  Rate(Dollars
  in thousands)Fiscal Year MaturityYear 1

$
4,177


2.79%

$
11,810


4.77%Year 2


3,560


2.83


3,977


3.18Year 3


3,977


3.18


16,803


4.60Year 4


31,803


2.36


73,651


5.58Year 5


63,651


5.74


40,440


5.36After Year  5


181,839


3.64


233,899


3.89$
289,007


3.93%

$
380,580


4.43%Stock
in the FHLB of Atlanta and specific first mortgage loans and mortgage-backed
securities of approximately $378.3 million and $470.2 million at September 30,
2005 and 2006, respectively, are pledged as collateral for these advances. The
Bank has adopted the policy of pledging excess collateral to facilitate future
advances. At September 30, 2006, the excess first mortgage loan and
mortgage-backed securities collateral pledged to the FHLB will support
additional borrowings of approximately $69.3 million. At September 30, 2006,
included in the one, two, three, and five year maturities were $228.0 million
with a weighted average rate of 3.98% of advances subject to call provisions.
Callable advances at September 30, 2006 are summarized as follows: $91.0
million callable in fiscal 2007, with a weighted average rate of 4.05%; $37.0
million callable in fiscal 2008, with a weighted average rate of 2.98%; $75.0
million callable in fiscal 2009, with a weighted average rate of 4.11%; and
$25.0 million callable in fiscal 2011, with a weighted average rate of 4.89%.
Call provisions are more likely to be exercised by the FHLB when interest rates
rise. If exercised, the Company may have to replace called advances with
borrowings at a higher interest rate.

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

(10)
REPURCHASE AGREEMENTSThe
following tables set forth certain information regarding repurchase agreements
by the Bank at the end of and during the periods indicated:

At
  September 30,2004

2005

2006(Dollars
  in thousands)Outstanding
  balance:Securities
sold under agreements to
  repurchase:Customer

$
12,931

$
31,937

$
42,095Broker


94,242


10,000


30,000Weighted
  average rate (at month end) paid on:Securities
sold under agreements to
  repurchase:Customer


1.42
%

2.82
%

3.79
%Broker


1.74


2.39


4.44Maximum amount of borrowings
outstanding at
  any month end:Securities
sold under agreements to
  repurchase:Customer

$
12,931

$
39,317

$
76,706Broker


184,129


109,958


30,000Approximate
  average outstanding with respect to:Securities
sold under agreements to
  repurchase:Customer

$
9,033

$
27,498

$
42,754Broker


134,809


73,723


19,632Weighted
  average rate (year to date) paid on:Securities
sold under agreements to repurchase:Customer


1.01
%

2.43
%

3.76
%Broker


1.50


2.37


3.70The
Company has three securities sold under agreements to repurchase with $10
million maturing in approximately one month and $20 million maturing in ten
years. These reverse repurchase agreements are collateralized by securities of
the United States government or its agencies, which have been delivered to a
third party custodian for safekeeping. Assets pledged to collateralize

30

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(10)
REPURCHASE AGREEMENTS - CONTINUEDsecurities
sold under agreements to repurchase had a fair value of $32.8 million at
September 30, 2006 and are included in mortgage-backed securities available for
sale in the consolidated statement of condition.

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

(11)
JUNIOR SUBORDINATED DEBTThe
Company determines whether it has a controlling financial interest in an entity
by first evaluating whether the entity is a voting interest entity or a
variable interest entity under accounting principles generally accepted in the
United States of America. Voting interest entities are entities in which the
total equity investment at risk is sufficient to enable each entity to finance
itself independently and provides the equity holders with the obligation to
absorb losses, the right to receive residual returns and the right to make
decisions about the entitys activities. The Company consolidates voting
interest entities in which it has all, or at least a majority of, the voting
interest. As defined in applicable accounting standards, variable interest
entities (VIEs) are entities that lack one or more of the characteristics of
a voting interest entity described above. A controlling financial interest in
an entity is present when an enterprise has a variable interest or a
combination of variable interests that will absorb a majority of the entitys
expected losses, receive a majority of the entitys expected residual returns,
or both. The enterprise with a controlling financial interest, known as the
primary beneficiary, consolidates the VIE.

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

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

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

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

(12)
INCOME TAXESIncome
tax expense (benefit) for the years ended September 30 consisted of the
following:

Current

Deferred

Total(In
  thousands)2004:Federal

$
7,070


126


7,196State


433


(2
)

431$
7,503


124


7,6272005:Federal

$
7,739


582


8,321State


614


47


661$
8,353


629


8,9822006:Federal

$
9,501


(202
)

9,299State


979


(77
)

902$
10,480


(279
)

10,20131

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(12)
INCOME TAXES - CONTINUEDThe
tax effect of the Companys temporary differences between the financial
statement carrying amounts and tax basis of assets and liabilities that give
rise to the net deferred tax asset (liability) at September 30, 2005 and 2006
relate to the following:

2005

2006(In
  thousands)Deferred tax
  assets:Allowance for
loan losses

$
4,406


4,823Accrued
medical reserves


85


80Other real
estate reserves and deferred
  gains on other real estate


20


24Net operating
loss carryforwards


81


137Unrealized
loss on securities available for
  sale


679


1,855Other


282


385Total
  deferred tax assets


5,553


7,304Less
  valuation allowance


(81
)

(137
)Net deferred
  tax assets


5,472


7,167Deferred tax
  liabilities:Property and
equipment principally due to
  differences in depreciation


398


185Deferred loan
fees


885


911Book over tax
basis in investment in
  unconsolidated subsidiary


5,053


5,425Mortgage
servicing rights


1,221


1,183Other


417


510Total
  deferred tax liabilities


7,974


8,214Net deferred
  tax liability

$
(2,502
)

(1,047
)The
Company has a Real Estate Investment Trust (REIT) that acquires, holds and
manages real estate loans. The REIT is consolidated with the Bank and is,
therefore, included in the consolidated financial statements of the Company.
The REIT must meet specific provisions of the Internal Revenue Code and state
tax laws. If the REIT fails to meet any of the required provisions of federal
and state tax laws, the Companys tax expense could increase.

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

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

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

2004

2005

2006(In thousands)Computed
  federal income taxes

$
7,852


9,148


10,221State tax, net
  of federal benefit


280


430


586Bank-owned
  life insurance


(337
)

(332
)

(338
)Tax exempt
  securities net


(220
)

(275
)

(230
)Other, net


52


11


(38
)Total income
  tax expense

$
7,627


8,982


10,20132

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(12)
INCOME TAXES - CONTINUEDThe
Bank had been permitted under the Internal Revenue Code to deduct an annual
addition to the tax reserve for bad debts in determining taxable income,
subject to certain limitations. This addition may differ significantly from the
bad debt expense for financial reporting purposes and was based on either 8% of
taxable income (the Percentage of Taxable Income Method) or actual loan loss
experience (the Experience Method) for the years prior to 1997. As a result
of tax legislation, the Bank recaptured tax bad debt reserves in excess of
pre-1988 based year amounts over a six-year period ended September 30, 2004.

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

(13)
BENEFIT PLANThe
Company has a defined contribution plan covering substantially all Associates.
The Company matches Associate contributions based upon the Company meeting
certain return on equity operating results. Matching contribution expense was
approximately $684,000, $435,000 and $474,000 for fiscal years 2004, 2005 and
2006, respectively.

(14)
REGULATORY MATTERSThe
Bank is subject to various capital requirements administered by federal banking
agencies. Failure to meet minimum capital requirements can initiate mandatory
and possibly additional discretionary actions by regulators that, if
undertaken, could have a direct material adverse effect on the Companys
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the assets, liabilities and
certain off-balance sheet items as calculated under regulatory accounting
practices. The Banks capital amounts and classifications are also subject to
qualitative judgments by the regulators about components, risk-weighting and
other factors. Quantitative measures established by regulation to ensure
capital adequacy require the Bank to maintain minimum amounts and ratios (set
forth in the following table) of total and tier 1 capital (as defined in the
regulation) to risk-weighted assets (as defined) and to average assets (as
defined). At September 30, 2006, the Banks loans-to-one borrower limit was
approximately $21.1 million. Management believes, as of September 30, 2006,
that the Bank met all capital adequacy requirements and loans-to-one-borrower
limits.

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

Actual

For
  Capital
  Adequacy Purposes

Amount
  to be
  Categorized as
  Well CapitalizedAmount

Ratio

Amount

Ratio

Amount

RatioAs of September 30,
2005:Total
Capital:

$
122,693


13.29
%
$
73,877


8.00
%
$
92,347


10.00
%(To Risk
Weighted Assets)Tier 1
Capital:

$
112,055


12.13
%

N/A


N/A

$
55,408


6.00
%(To Risk
Weighted Assets)Tier 1
Capital:

$
112,055


7.25
%
$
46,356


3.00
%
$
77,260


5.00
%(To Adjusted
Total Assets)Tangible
Capital:

$
112,055


7.25
%
$
23,178


1.50
%

N/A


N/A(To Adjusted
Total Assets)As of September 30,
2006:Total
Capital:

$
140,946


14.34
%
$
78,638


8.00
%
$
98,298


10.00
%(To Risk
Weighted Assets)Tier 1
Capital:

$
129,643


13.19
%

N/A


N/A

$
58,979


6.00
%(To Risk
Weighted Assets)Tier 1
Capital:

$
129,643


7.78
%
$
49,891


3.00
%
$
83,151


5.00
%(To Adjusted
Total Assets)Tangible
Capital:

$
129,643


7.78
%
$
24,945


1.50
%

N/A


N/A(To Adjusted
Total Assets)33

COASTAL
FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(15)
LIQUIDATION ACCOUNTIn
conjunction with the Banks conversion to stock form on October 4, 1990, the
Bank established, as required by Office of Thrift Supervision (the OTS)
regulations, a liquidation account and maintains this account for the benefit
of the remaining eligible account holders as defined under the Banks plan of
conversion. The initial balance of this liquidation account was equal to the
Banks net worth defined by OTS regulations as of the date of the latest
statement of financial condition contained in the final offering circular. In
the event of a complete liquidation of the Bank (and only in such event) each
eligible holder shall be entitled to receive a liquidation distribution from
this account in the amount of the then current adjusted balance for deposits
then held, before any liquidation distribution may be made to the stockholders.
The Bank is prohibited from declaring cash dividends or repurchasing its
capital stock if it would cause a reduction in the Banks net worth below
either the balance of the liquidation account or the statutory net worth
requirements set by the OTS.

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

(16)
EARNINGS PER SHAREBasic
earnings per share are computed by dividing net income by the weighted-average
number of common shares outstanding. Diluted earnings per share are computed by
dividing net income by the weighted average number of common shares and
potential common shares outstanding. Potential common shares consist of
dilutive stock options determined using the treasury stock method and the
average market price of common stock. All share and per share data have been
retroactively restated for all common stock dividends. At September 30, 2006
the Company had antidilutive securities of approximately 245,000 options to
purchase shares by Directors and Associates. The average exercise price for
such shares was $13.86 per share.

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

2004

2005

2006Basic

Diluted

Basic

Diluted

Basic

DilutedWeighted average shares
outstanding

20,966,000

20,966,000

21,274,000

21,274,000

21,509,000

21,509,000Effect of dilutive securities
 Stock
  options



1,162,000



1,191,000



897,000Average shares
outstanding

20,966,000

22,128,000

21,274,000

22,465,000

21,509,000

22,406,000(17)
STOCK OPTION PLANAt
September 30, 2006, the Company had the following options outstanding:

Fiscal 
  Year

Range
  of exercise prices:

NumberOptionsOutstanding

Weighted
  Average
  Remaining
  Contractual
  Life

WeightedAverageExercisePrice

Number
  Options
  Exercisable

Weighted
  Average
  Exercise
  Price1997

$ 3.30 -
  $3.42


34,434


0.3 Years

$
3.30


34,434

$
3.301998

$ 4.81 -
  $7.33


239,831


1.2 Years

$
5.45


239,831

$
5.451999

$ 5.33 -
  $5.77


256,519


2.1 Years

$
5.38


256,519

$
5.382000

$ 3.25 -
  $4.23


213,806


3.2 Years

$
3.85


213,806

$
3.852001

$ 3.12 -
  $4.87


218,888


4.1 Years

$
3.19


218,888

$
3.192002

$ 4.67 -
  $7.67


248,375


5.1 Years

$
4.75


192,058

$
4.762003

$ 6.21 -
  $7.89


318,504


6.1 Years

$
7.45


318,504

$
7.452004

$ 10.00 -
  $10.89


363,437


7.2 Years

$
10.46


363,437

$
10.462005

$ 11.20 -
  $14.20


850,436


8.6 Years

$
12.30


850,436

$
12.312006

$ 11.45 -
  $12.12


4,400


9.6 Years

$
11.95




$
$ 3.12 -
  $14.20


2,748,630


5.7 Years

$
8.07


2,687,913

$
8.1434

COASTAL
FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(17)
STOCK OPTION PLAN - CONTINUEDThe
following is a summary of the activity of the stock option plans for the years
2004, 2005, and 2006.

2004

2005

2006Shares

Weighted
  Average
  Exercise
  Price

Shares

Weighted
  Average
  Exercise
  Price

Shares

Weighted
  Average
  Exercise
  PriceOutstanding, October
1


2,544,623

$
4.74


2,533,676

$
5.84


3,092,770

$
7.75Granted


397,158


10.46


879,735


11.18


4,400


11.95Cancelled


(6,714
)

6.85


(51,666
)

8.41


(14,598
)

10.95Exercised


(401,391
)

3.40


(268,975
)

4.51


(333,942
)

4.97Outstanding, September
30


2,533,676

$
5.84


3,092,770

$
7.75


2,748,630

$
8.07(18)
COMMON STOCK DIVIDENDSOn
each of February 18, 2004, July 30, 2004, December 15, 2004, October 26, 2005
and August 24, 2006, the Company declared a 10% stock dividend aggregating
approximately 1,308,000, 1,442,000, 1,594,000, 1,770,000 and 1,971,000 shares,
respectively. All share and per share data has been retroactively restated to
give effect to the common stock dividends.

(19)
CASH DIVIDENDSOn
each of December 15, 2003, March 17, 2004 and June 16, 2004, the Company
declared quarterly cash dividends of $0.034 per share. On each of September 29, 2004,
December 17, 2004 and March 16, 2005, the Company declared quarterly cash
dividends of $0.037 per share. On each of June 22, 2005 and September 21, 2005,
the Company declared quarterly cash dividends of $0.041 per share. On each of
December 21, 2005, March 15, 2006 and June 21, 2006, the Company declared
quarterly cash dividends of $0.045 per share. Under Delaware law, the Company
is permitted to declare and pay dividends either out of its surplus or, if
there is no surplus, out of its net profits for the fiscal year in which the
dividend is declared and/or the preceding fiscal year.

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

(20)
LEGAL MATTERSThe
Company is not a defendant in any lawsuits. The subsidiaries are defendants in
lawsuits arising out of the normal course of business. Based upon current
information received from counsel representing the subsidiaries in these
matters, the Company believes none of the lawsuits would have a material impact
on the Companys financial status.

(21)
QUARTERLY FINANCIAL DATA (UNAUDITED)Quarterly
operating data for the years ended September 30 is summarized as follows (in
thousands, except share data):

FirstQuarter

SecondQuarter

ThirdQuarter

FourthQuarter2005:Total interest
income

$
17,946


18,912


20,337


21,363Total interest
expense


6,431


7,016


7,831


8,452Net interest
income


11,515


11,896


12,506


12,911Provision for
loan losses


350


625


550


172Net interest
income after provision for loan
losses


11,165


11,271


11,956


12,739Other
income


2,767


3,336


3,101


3,320General and
administrative expenses


7,781


8,319


8,420


8,999Income before
income taxes


6,151


6,288


6,637


7,060Income
taxes


2,106


2,153


2,281


2,442Net
income

$
4,045


4,135


4,356


4,618Net income per
common share - diluted

$
0.18


0.18


0.19


0.20Weighted
average shares outstanding-diluted


22,400,000


22,576,000


22,547,00


22,567,00035

COASTAL
FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(21)
QUARTERLY FINANCIAL DATA
          (UNAUDITED)  CONTINUEDFirst 
  Quarter

Second 
  Quarter

Third 
  Quarter

Fourth 
  Quarter2006:Total interest
income

$
23,038


24,138


25,572


26,905Total interest
expense


9,762


10,970


11,661


12,680Net interest
income


13,276


13,168


13,911


14,225Provision for
loan losses


400


330


430


225Net interest
income after provision for
  loan losses


12,876


12,838


13,481


14,000Other
income


3,588


4,202


4,671


4,604General and
administrative expenses


9,680


9,926


10,556


10,896Income before
income taxes


6,784


7,114


7,596


7,708Income
taxes


2,341


2,469


2,659


2,732Net income

$
4,443


4,645


4,937


4,976Net income per
common share - diluted

$
0.20


0.21


0.22


0.22Weighted
average shares outstanding-diluted


22,413,000


22,484,000


22,480,000


22,477,000(22)
COASTAL FINANCIAL CORPORATION FINANCIAL STATEMENTS (PARENT COMPANY
ONLY)The
following is condensed financial information of Coastal Financial Corporation
(parent company only), the primary asset of which is its investment in its bank
subsidiary, for the periods indicated (In thousands):

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

2005

2006Assets:Cash

$
297


19Investment
  in subsidiaries


111,034


126,740Deferred tax
  asset


50


50Other assets


2,214


1,526Total
assets

$
113,595


128,335Liabilities
  and Stockholders Equity:Accounts
  payable (principally dividends)


910


47Junior
  subordinated debt


15,464


15,464Total
  stockholders equity


97,221


112,824Total
liabilities and stockholders equity

$
113,595


128,33536

COASTAL
FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated
Financial Statements  Continued

(22)
COASTAL FINANCIAL CORPORATION FINANCIAL STATEMENTS (PARENT COMPANY ONLY) -
CONTINUEDCoastal Financial Corporation 
Condensed Statements of Operations 
Years Ended September 30, 2004, 2005 and 2006

2004

2005

2006Income:Interest
income

$
2


2


2Management
fees


242


242


242Dividends from
subsidiary


2,230


3,400


2,500Equity in
undistributed earnings of
  subsidiaries


13,063


14,444


17,432Total
income


15,537


18,088


20,176Expenses:Professional
fees


72


83


72Supplies and
printing


33


40


51Interest
expense


662


892


1,192Other
expenses


213


280


359Income tax
benefit


(249
)

(361
)

(499
)Total
expenses


731


934


1,175Net income

$
14,806


17,154


19,001Coastal Financial Corporation 
Condensed Statements of Cash Flows 
Years Ended September 30, 2004, 2005 and 2006

2004

2005

2006Operating
  activities:Net
income

$
14,806


17,154


19,001Adjustments to
reconcile net income to net  cash provided by operating activities:Stock-based
compensation





76


91Equity in
undistributed net income of
  subsidiary


(13,063
)

(14,444
)

(17,432
)(Increase)
decrease in other assets


(624
)

(489
)

688Increase
(decrease) in other liabilities


43


107


(864
)Total cash
provided by operating activities


1,162


2,404


1,484Financing
  activities:Cash dividends
to stockholders


(2,948
)

(3,361
)

(2,957
)Proceeds from
stock options


1,273


1,309


1,377Capital
contribution to subsidiary


(100
)

(150
)

(200
)Other
financing activities, net


(74
)

9


18Total cash
used by financing activities


(1,849
)

(2,193
)

(1,762
)Net increase
(decrease) in cash and cash
  equivalents


(687
)

211


(278
)Cash and cash
equivalents at beginning of
  the year


773


86


297Cash and cash
equivalents at end of the
  years

$
86


297


1937

COASTAL
FINANCIAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial
Statements  Continued

(23)
CARRYING AMOUNTS AND FAIR VALUE OF FINANCIAL INSTRUMENTSThe
carrying amounts and fair value of financial instruments as of September 30,
2005 and 2006 are summarized below:

2005

2006Carrying
  Amount

Estimated
  Fair Value

Carrying
  Amount

Estimated
  Fair Value(In thousands)Financial
  Assets:Cash and cash
equivalents

$
91,525


91,525

$
36,955


36,955Investment
securities available for sale


25,616


25,616


39,300


39,300Mortgage-backed securities available for
  sale


399,655


399,655


392,989


392,989Investment
securities held to maturity


10,000


10,049


11,997


12,000Loans
receivable held for sale


18,121


18,126


1,853


1,868Loans
receivable, net


924,260


938,058


1,088,231


1,102,547FHLB
stock


15,775


15,775


20,291


20,291Bank-owned
life insurance


22,574


22,574


23,541


23,541Financial
  Liabilities:Deposits:Demand
accounts


643,792


643,792


632,217


632,217Certificate
accounts


427,126


426,482


430,888


430,529Advances from
Federal Home Loan Bank


289,007


286,993


380,580


376,417Securities
sold under agreements to
  repurchase and reverse repurchase agreements


41,937


41,937


72,095


71,828Junior
subordinated debt


15,464


15,464


15,464


15,464Drafts
outstanding


12,890


12,890


2,023


2,023SFAS
107, Disclosures about Fair Value of Financial Instruments, requires
disclosure of fair value information, whether or not recognized in the
statement of financial position, when it is practicable to estimate the fair
value. SFAS 107 defines a financial instrument as cash, evidence of an
ownership interest in an entity or contractual obligations, which require the
exchange of cash, or other financial instruments. Certain items are
specifically excluded from the disclosure requirements, including the Companys
common stock, premises and equipment, accrued interest receivable and payable,
and other assets and liabilities.

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

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

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

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

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

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

38

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

  Notes to Consolidated Financial
    Statements  Continued

(23)
CARRYING AMOUNTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS - CONTINUEDThe
Company had $257.8 million of off-balance sheet financial commitments as of September
30, 2006, which are commitments to originate loans, unused consumer lines of
credit, letters of credit and undisbursed portion of loans in process. Since
these obligations are based on current market rates, the carrying amount is
considered to be a reasonable estimate of fair value.

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

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

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

(24)
COMMITMENTS AND CONTINGENCIESThe
Company has entered into three contracts to purchase land. At September 30,
2006, the undisbursed future obligations under these signed contracts
approximated $3.1 million. These contracts are scheduled to close during fiscal
2007. Additionally, the Company has entered into two contracts to license
specialized banking computer software for approximately $300,000. It is
anticipated that the installation will be completed prior to the end of the
second quarter of fiscal 2007.


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

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




39




COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

  Managements Discussion
    and Analysis

Forward Looking Statements

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


Competitive
  pressures among depository and other financial institutions in the Companys
  market areas may increase significantly.
Adverse
  changes in the economy or business conditions, either nationally or in the
  Companys market areas, could increase credit-related losses and expenses
  and/or limit growth
Increases in
  defaults by borrowers and other delinquencies could result in increases in
  the Companys provision for losses on loans and related expenses.
The
  Companys inability to manage growth effectively, including the successful
  expansion of the Companys Customer support, administrative infrastructure
  and internal management systems, could adversely affect the Companys results
  of operations and prospects.
Fluctuations
  in interest rates and market prices could reduce the Companys net interest
  margin and asset valuations and increase expenses.
The
  consequences of continued bank acquisitions and mergers in the Companys
  market areas, resulting in fewer but much larger and financially stronger
  competitors, could increase competition for financial services to the
  Companys detriment.
The
  Companys continued growth will depend in part on its ability to enter new
  markets successfully and capitalize on other growth opportunities.
Changes in
  legislative or regulatory requirements, or actions by the Securities and
  Exchange Commission (SEC), the Financial Accounting Standards Board
  (FASB), or the Public Company Accounting Oversight Board, applicable to the
  Company and its subsidiaries could increase costs, limit certain operations
  and adversely affect results of operations.
Changes in
  tax requirements, including tax rate changes, new tax laws and revised tax
  law interpretations may increase the Companys tax expense or adversely
  affect its Customers businesses.
Company
  initiatives now in place or introduced in the future, not producing results
  consistent with historic growth rates or results which justify their costs.In
light of these risks, uncertainties and assumptions, you should not place undue
reliance on any forward-looking statements in this report. Except as may be
required by applicable law or regulation, the Company undertakes no obligation
to publicly update or otherwise revise any forward-looking statements, whether
as a result of new information, future events or otherwise.

Overview

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

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

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


40





COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Managements Discussion and Analysis - Continued

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

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

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

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

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

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

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

Critical Accounting Policies

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

General

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

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



41





COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Managements Discussion and Analysis - Continued

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

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

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

Liquidity and Capital Resources

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

Payment
  Due by PeriodTotal

Less
  than
  1 Year

1-3
  Years

4-5
  Years

After 5
  Years(Dollars
  in thousands)Contractual
  Obligations:Time
  deposits

$
430,888

$
389,272

$
37,154

$
3,867

$
595Short-term
  borrowings


63,905


63,905








Long-term
  debt


404,234





20,780


114,091


269,363Construction
  contracts


1,737


1,737








Operating leases


4,652


478


636


433


3,105Total contractual cash
obligations

$
905,416

$
455,392

$
58,570

$
118,391

$
273,063The
Company has entered into three commitments to purchase land. See Note 24 of the
Notes to Consolidated Financial Statements for information regarding these
commitments.

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

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

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

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

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

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



42





COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Managements Discussion and Analysis - Continued

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

Results of OperationsComparison of the
Years Ended September 30, 2005 and 2006

Interest Income

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

Interest Expense

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

Net Interest Income

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


43






COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Managements Discussion and Analysis - Continued

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

2005

2006Average
  Balance (1)

Income/
  Expense

Yield/Rate

Average
  Balance (1)

Income/
  Expense

Yield/RateAssetsEarning assetsLoans (2)

$
873,797

$
56,826


6.50
%

$
1,014,501

$
75,932

7.48
%Investment securities, MBS
securities and
  others (3)


449,402


21,732

4.84
%



476,536


23,721

4.98
%Total earning assets

$
1,323,199

$
78,558

5.94
%

$
1,491,037

$
99,653

6.68
%LiabilitiesCustomer Deposits

$
811,623

$
11,556

1.42
%


$
891,456

$
19,095

2.14
%Brokered CDs


79,369


2,523

3.18
%


174,761


7,648

4.38
%FHLB Advances


322,108


12,341

3.83
%


350,064


14,803

4.23
%Customer Repurchase
Agreements


27,498


668

2.43
%


42,754


1,608

3.76
%Junior Subordinated
Debt


15,000


892

5.95
%


15,000


1,192

7.95
%Reverse Repurchase
Agreements


73,723


1,750

2.37
%


19,632


727

3.70
%Total interest-bearing
liabilities

$
1,329,321

$
29,730

2.24
%

$
1,493,667

$
45,073

3.01
%Net interest income




$
48,828







$
54,580Net interest margin







3.70
%







3.67
%Net yield on earning
assets







3.69
%







3.66
%(1)
The average
  balances are derived from monthly balances.(2)
Nonaccrual
  loans are included in average balances for yield computations.(3)
Investment
  securities include taxable and tax-exempt securities. Net interest income has
  not been adjusted to produce a tax-equivalent yield.Provision for Loan Losses

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

Other Income

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


44






COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Managements Discussion and Analysis - Continued

General and Administrative Expenses

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

Income Taxes

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

Results of OperationsComparison of the
Years Ended September 30, 2004 and 2005

Interest Income

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

Interest Expense

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


45





COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Managements Discussion and
Analysis - Continued

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

Net Interest Income

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

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

2004

2005Average
  Balance (1)

Income/
  Expense

Yield/Rate
Average
Balance (1)

Income/
Expense

Yield/RateAssetsEarning
assetsLoans
(2)

$
757,633

$
46,765


6.17
%
$
873,797

$
56,826


6.50
%Investment
securities, MBS securities and
  others (3)


403,610


19,040


4.72
%

449,402


21,732


4.84
%Total earning
assets

$
1,161,243

$
65,805


5.67
%
$
1,323,199

$
78,558


5.94
%LiabilitiesDeposits

$
719,125

$
10,024


1.39
%
$
890,992

$
14,079


1.58
%Borrowings


440,279


13,500


3.07
%

438,329


15,651


3.57
%Total
interest-bearing liabilities

$
1,159,404

$
23,524


2.03
%
$
1,329,321

$
29,730


2.24
%Net interest
income




$
42,281







$
48,828Net interest
margin








3.64
%







3.70
%Net yield on
earning assets








3.64
%







3.69
%(1)
The average
  balances are derived from monthly balances.(2)
Nonaccrual
  loans are included in average balances for yield computations.(3)
Investment
  securities include taxable and tax-exempt securities. Net interest income has
  not been adjusted to produce a tax-equivalent yield.Provision for Loan Losses

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

46

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Managements Discussion and
Analysis - Continued

Other Income

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

General and Administrative Expenses

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

Income Taxes

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

Non-performing Assets

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

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

47

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Managements Discussion and
Analysis - Continued

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

Allowance for Loan Losses

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

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

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

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

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

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

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

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

Off-Balance Sheet Arrangements

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

48

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Managements Discussion and
Analysis - Continued

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

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

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

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

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

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

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

Interest Rate Risk Disclosure

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

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

Change in Interest Rates



Board Limit
  Minimum NPVRatio

Board Limit
  MaximumDecline in NPV
Market Value
  Of Assets9/30/06

Market Value
  Portfolio Equity9/30/06


NPVRatio300 basis
  point rise


5.00
%

400 BPS

$
1,658,193

$
176,374


10.64
%200 basis
  point rise


6.00
%

300 BPS

$
1,679,009

$
187,916


11.19
%100 basis
  point rise


6.00
%

250 BPS

$
1,698,259

$
196,866


11.59
%No Change


6.00
%



$
1,715,670

$
203,444


11.86
%100 basis
  point decline


6.00
%

250 BPS

$
1,733,420

$
209,896


12.11
%200 basis
  point decline


6.00
%

300 BPS

$
1,747,920

$
212,466


12.18
%300 basis
  point decline


6.00
%

350 BPS


N/A


N/A


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

49

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Managements Discussion and
Analysis - Continued

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

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

Recently Adopted Accounting Pronouncements

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

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

Recently Issued Accounting Pronouncements

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

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

50

COASTAL FINANCIAL CORPORATION AND
SUBSIDIARIES

Managements Discussion and
Analysis - Continued

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

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

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

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

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

Capital Standards and Regulatory Matters

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

Effects of Inflation and Changing Prices

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

51

Board of Directors

Coastal
  Financial CorporationE. Lawton BentonPresidentC.L. Benton & Sons,
  Inc.G. David BishopManaging DirectorWhite Harvest Trading Co.,
  LLCJ. Robert CallihamPresident and Chief
  Executive OfficerSmith, Sapp, Bookhout,
  Crumpler &Calliham, P.A.James T. ClemmonsChairmanCoastal Financial
  CorporationJames P. CreelPresidentCreel CorporationJames. H. DusenburyRetired  AttorneyDusenbury and Clarkson Law
  FirmMichael C. GeraldPresident and Chief
  Executive OfficerCoastal Financial
  CorporationWilliam O. MarshPresidentPalmetto ChevroletFrank A. Thompson, IIPresidentPeoples Underwriters, Inc.W. Cecil Worsley, IIIPresident and Chief
  Executive OfficerWorsley CompaniesCoastal
  Federal BankE. Lawton BentonPresidentC.L. Benton & Sons,
  Inc.G. David BishopManaging DirectorWhite Harvest Trading Co.,
  LLCJ. Robert CallihamPresident and Chief
  Executive OfficerSmith, Sapp, Bookhout,
  Crumpler &Calliham, P.A.James T. ClemmonsChairmanCoastal Federal BankJames P. CreelPresidentCreel CorporationJames. H. DusenburyRetired  AttorneyDusenbury and Clarkson Law
  FirmMichael C. GeraldPresident and Chief
  Executive OfficerCoastal Federal BankWilliam O. MarshPresidentPalmetto ChevroletFrank A. Thompson, IIPresidentPeoples Underwriters, Inc.W. Cecil Worsley, IIIPresident and Chief
  Executive OfficerWorsley CompaniesCoastal
  Planners Holding CorporationJames T. ClemmonsChairmanCoastal Financial CorporationMichael C. GeraldPresident and Chief
  Executive OfficerCoastal Financial
  CorporationJerry L. Rexroad, CPAChief Financial OfficerCoastal Planners Holding
  Corporation52

COASTAL FINANCIAL CORPORATION

Leadership Group

Sherri AdamsBranch ManagerNorth Myrtle Beach BranchGinger AllenAVP Underwriter Group
  LeaderTony AmbuhlAVP Commercial Banking
  OfficerPhillip AmmonsVP Community Banking LeaderDonna BaileyAVP Branch Operations
  SpecialistRandy BakerVP Network ServicesGroup LeaderJeffrey BenjaminSVP Credit AdministrationGroup LeaderApril BentonStaffing Group LeaderSteven BrockmannAVP Investment Rep-CISCynthia BuffingtonAVP Item ProcessingGroup LeaderRonnie BurbankVP Sr. Banking LeaderAnne CaldwellVP - Deposit ServicingGroup LeaderMarie CanadyMortgage SpecialistGroup LeaderTamra CannonAVP Sr. Branch ManagerChristopher CarboneVP Senior Business Banking OfficerShonda ChestnutAVP Loan Officer IIChristopher ClarkAVP Business Banking
  OfficerDeanna CookeAVP Fiserv Applications
  SupportGroup LeaderSusan J. CookeSVP Adminstrative ServicesGroup LeaderCorporate SecretaryMarshall CooperAVP Sr. Banking LeaderBenjamin CorleySr. Branch ManagerSouthport BranchJoe CoxVP Community Banking LeaderJohn CreamerVP Investment Rep-CISPerry L. DaltonService LeaderOak Street BranchGwendolyn DavisBranch ManagerMurrells Inlet BranchDeborah DillardBranch ManagerSunset Beach BranchRobert D. DouglasEVP Human ResourcesGroup LeaderTiffany DudleyAVP Electronic BankingGroup LeaderTrina DusenburySVP Residential BankingOperations Group LeaderBrandon EdensAVP Sr. Branch ManagerMichael EvansVP Loan Review Group LeaderRita FecteauVP Accounting Group LeaderPatricia FloydVP Branch DevelopmentCoordinatorDaniel FogleVP Community Banking LeaderJoel FosterSVP Loan AdministrationGroup LeaderWilliam GehmanSVP Corporate ControllerMary GeistVP IT AdministrationMichael C. GeraldPresident & CEOJimmy R. GrahamEVP Chief Operations
  OfficerE. Haden Hamilton Jr.President -CISDon HamiltonVP Residential Brokerage
  LeaderKathy HaneAVP Sr. Branch ManagerLauren HensonSVP Dean Of CFUJennifer HenthornBranch ManagerSouthport BranchMike HillVP Investment Rep-CISDebra HinsonVP Operations Group
  Leader-CISChristopher HippBranch ManagerStephens Crossroads BranchGlenn HumbertSVP NC Banking Group LeaderCameron JacksonAVP Consumer Loan
  AdministratorMike JacksonVP Sr. Banking LeaderLisa JamesSVP Operations Group LeaderWendy JohnsonBranch ManagerLoris BranchJennifer JulianAVP Facility ServicesGroup LeaderRuthie KearnsSVP Community Relations
  OfficerAlvin KennedyBranch ManagerHwy 544 West BranchKara KessingerPresident-CRETPEric KeysVP - Sr. Commercial Banking
  LeaderLinwood Koonce JrAVP Banking Closing Group
  Leader53

COASTAL FINANCIAL CORPORATION

Leadership Group - Continued

Louis LaBruceVP Sr. Banking LeaderJustin LeeAVP Commercial/Residential
  OfficerEdward Loehr Jr.VP Budgeting & TreasuryMary LundyBranch ManagerShallotte BranchKathleen LutesAVP Secondary MarketingGroup LeaderLeslie LydonVP Residential Banking
  SalesPatsy MaddenResidential Loan ServicingGroup LeaderMichael MauneyVP Collections Group LeaderAmy McLaurinAVP Sr. Banking LeaderCarol MercoliniBranch ManagerSurfside BranchJanice MetzAVP Advertising OfficerJoy MetzSales LeaderOak Street BranchAbigail MishoeAVP Residential Banking
  OfficerPhyllis MonarchBranch ManagerNorth Conway BranchLeslie MorseCommercial/Consumer LoanServicing Group LeaderLynn MurraySVP Checking Acct ProductDevelopment & Managment
  OfficerDeborah OrobelloBranch ManagerLittle River BranchBruce PatonaySr. Branch ManagerDunes BranchCharles PageVP Commercial Banking
  OfficerDan RettigAVP Security OfficerJerry L. RexroadEVP Chief Financial OfficerDavid RoeSVP Business Banking LeaderEulette SaulsAVP Information ManagementGroup LeaderSherry G. SchoolfieldVP Compliance OfficerDouglas E. ShafferSVP Horry County BankingGroup LeaderSteven J. SherryEVP Marketing Group LeaderJoseph ShumboAVP Residential Banking
  OfficerLeeann SlackOperations LeaderOak Street BranchDawn SmallAVP Branch Operations
  LeaderJ. Marcus Smith Jr.SVP Internal AuditGroup LeaderMarcus SmithAVP Commercial Banking
  OfficerPhillip StalveyEVP Banking Group LeaderAllison StoutElectronic Banking Business
  ServicesLeaderAnnette StroudSr. Branch ManagerCarolina Forest BranchCharlene SullivanBranch ManagerSocastee BranchSandra SzarekAVP Commercial Loan
  ServicingGroup LeaderAndrea TaianiCustomer Service Group
  LeaderJames TalericoAVP Sr. Business Banking
  OfficerGary ThompsonVP Financial Reporting
  &Compliance LeaderMatthew TownsVP Credit AdministrationAudrey WaldronBranch ManagerOak Island BranchDouglas WaltersVP Residential Banking
  OfficerBrian WhiteSVP Chief Information
  OfficerTheresa WhitleyConstruction Group LeaderJosh WiseAVP Business Banking LoanAdministratorSandra R. ZanfiniAVP Corp. Support Group
  LeaderAsst. Corporate Secretary54

Branch Locations

Coastal
  Federal BankCarolina Forest Branch3894 Renee DriveMyrtle Beach, SC 29579843.205.2016Conway Branch310 Wright BoulevardConway, SC 29526843.205.2005Dunes Branch7500 North Kings HighwayMyrtle Beach, SC 29572843.205.2001Highway 544 West Branch1571 Hwy 544Conway, SC 29526843.205.2023Little River Branch1602 Highway 17Little River, SC 29566843.205.2014Loris Branch3610 Broad StreetLoris, SC 29569843.205.2018Murrells Inlet Branch3348 Highway 17 South& Inlet CrossingMurrells Inlet, SC 29576843.205.2008North Conway Branch2600 Main StreetConway, SC 29526843.205.2017North Myrtle Beach Branch521 Main StreetNorth Myrtle Beach, SC
  29582843.205.2002Oak Island Branch8001 East Oak Island DriveOak Island, NC 28465843.205.2036910.201.1481Oak Street Branch2619 Oak StreetMyrtle Beach, SC 29577-3129843.205.2000Pawleys Island BranchCoastal Federal Town Center11403 Ocean HighwayPawleys Island, SC 29585843.205.2020SayeBrook Branch201 Chartwell CourtMyrtle Beach, SC 29588843.205.2024Shallotte Branch200 Smith AvenueShallotte, NC 28470843.205.2035910.754.6186Socastee Branch4801 Socastee BoulevardMyrtle Beach, SC 29575843.205.2007Southport Branch4956-1 Long Beach Road SESouthport, NC 28461843.205.2032910.454.4173Stephens Crossroads Branch2496 Highway 9 EastHighways 9 and 57Little River, SC 29566843.205.2013Sunset Beach Branch1625 Seaside Road SWSunset Beach, NC 28468843.205.2012910.579.8160Surfside Branch112 Highway 17 South& Glenns Bay RoadSurfside Beach, SC 29575843.205.2003Waccamaw Medical Park
  Branch112 Waccamaw Medical Park
  DriveConway, SC 29526843.205.200938th Avenue Branch (BI-LO)1245 38th Avenue NorthMyrtle Beach, SC 29577843.205.2041Wilmington Branch4320 17th Street ExtensionWilmington, NC 28412843.205.2034910.392.2265Wilmington Branch5710 Oleander Drive, Suite
  209Wilmington, NC 28403843.205.2031910.313.1161Wilmington Branch109 Market StreetWilmington, NC 28401843.205.2033910.763.237255

Corporate Information

Common Stock and Dividend Information

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

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

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

Market Price of Common Stock

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

HIGH

LOW

CASHBID

BID

DIVIDENDFiscal Year 2006:First
Quarter

$
15.20

$
12.75

$
0.045Second
Quarter


14.50


12.55


0.045Third
Quarter


14.12


12.23


0.045Fourth
Quarter


13.64


11.55


Note: On October 3, 2006, the Company declared a $0.05
        per share cash dividend payable November 3, 2006 to stockholders of record as of October 20, 2006.Fiscal Year 2005:First
Quarter

$
14.39

$
10.15

$
0.037Second
Quarter


14.91


10.18


0.037Third
Quarter


11.67


10.52


0.041Fourth
Quarter


11.84


10.65


0.041Form 10-KA copy of Coastal Financial
Corporations Annual Report on Form 10-K, as filed with the Securities Exchange
Commission for the year ended September 30, 2006, may be obtained or viewed on
www.coastalfederal.com by clicking on Investor Services.

Annual Meeting of Stockholders

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

Additional Information

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

Corporate
  OfficesCoastal Financial
  Corporation2619 Oak StreetMyrtle Beach, South
  Carolina 29577843.205.2000Transfer
  Agent and RegistrarRegistrar and Transfer
  CompanyP.O. Box 1010Cranford, NJ 070161.800.866.1340 Ext. 2514Independent
  Registered Public Accounting FirmKPMG LLP150 Fayetteville Street
  MallSuite 1200Raleigh, NC 27601Special
  CounselMuldoon Murphy &
  Aguggia LLP5101 Wisconsin AvenueWashington, DC 20016Stockholder
  Relations OfficerSusan J. CookeCoastal Financial
  Corporation2619 Oak StreetMyrtle Beach, South
  Carolina 29577843.205.2000(FDIC LOGO)

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

(RAYMOND JAMES LOGO)

Securities and investment
  advisory services offered exclusively through Raymond James Financial
  Services, Inc., member NASD/SIPC, an independent broker/dealer, and are not
  insured by the FDIC or any other bank insurance, are not deposits or
  obligations of the bank, are not guaranteed by the bank, and are subject to
  risk, including the possible loss of principal.Coastal
  Investor Services is a division of Coastal Federal Bank.56