UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549   FORM 10-Q x
        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2006 o
        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File Number:  0-19684  COASTAL FINANCIAL CORPORATION(Exact name of registrant as specified in its charter)  State of Delaware
        
        57-0925911(State or other jurisdiction ofincorporation or organization)
        
        (I.R.S. EmployerIdentification Number)2619 OAK STREET, MYRTLE BEACH, S. C.
        
        29577(Address of principal executive offices)
        
        (Zip Code)  Registrants telephone number, including area code (843) 205-2000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YESx
        NO  o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or non-accelerated filer. See definition of accelerated filer and a large accelerated filer in Rule 12b-2 of the Exchange Act. Large Accelerated Filer o
        Accelerated Filerx
        Non-accelerated Filer o Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) YES  o
        NOx Indicate the number of shares outstanding of each of the registrants classes of common stock, as of January 31, 2007.  Common Stock $.01 Par Value Per Share
        21,900,305 Shares(Class)
        (Outstanding)    COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED DECEMBER 31, 2006

TABLE OF CONTENTS







PAGEPART I-  Financial InformationItem1.
        
        Consolidated Financial Statements (unaudited):Consolidated Statements of Financial Condition as of September 30, 2006 and December 31, 2006
        
        3Consolidated Statements of Operations for the three months ended December 31, 2005 and 2006
        
        4Consolidated Statements of Stockholders Equity and Comprehensive Income for the three months ended December 31, 2005 and 2006
        
        5Consolidated Statements of Cash Flows for the three months ended December 31, 2005 and 2006
        
        6-7Notes to Consolidated Financial Statements
        
        8-142.
        
        Managements Discussion and Analysis of Financial Condition and Results of Operations
        
        15-213.
        
        Quantitative and Qualitative Disclosures About Market Risk
        
        224.
        
        Controls and Procedures
        
        22Part II -   Other InformationItem1.
        
        Legal Proceedings
        
        221A.
        
        Risk Factors
        
        22-252.
        
        Unregistered Sales of Equity Securities and Use of Proceeds
        
        253.
        
        Defaults Upon Senior Securities
        
        254.
        
        Submission of Matters to a Vote of Securities Holders
        
        255.
        
        Other Information
        
        256.
        
        Exhibits
        
        26Signatures
        
        27Exhibits31(a)
        
        Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)
        
        28(b)
        
        Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)
        
        2932(a)
        
        Section 1350 Certification (Chief Executive Officer)
        
        30(b)
        
        Section 1350 Certification (Chief Financial Officer)
        
        31



2



PART I. FINANCIAL INFORMATION

Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIALCONDITION





September 30,

    
        December 31,2006

    
        2006(Unaudited)(In thousands)ASSETS:Cash and amounts due from banks

    

    $

    31,055

    

    $

    29,729Short-term interest-bearing deposits

    

    

    5,797

    

    

    20,601Federal funds sold

    

    

    103

    

    

    252Investment securities available for sale

    

    

    39,300

    

    

    36,095Mortgage-backed securities available for sale

    

    

    392,989

    

    

    380,575Investment securities held to maturity (market value $12,000 at September 30, 2006 and$12,800 at December 31, 2006)

    

    

    11,997

    

    

    12,792Loans receivable (net of allowance for loan losses of $12,726 at September 30, 2006 and$12,768 at December 31, 2006)

    

    

    1,088,231

    

    

    1,079,410Loans receivable held for sale

    

    

    1,853

    

    

    11,542Real estate acquired through foreclosure, net

    

    

    571

    

    

    544Office property and equipment, net

    

    

    29,926

    

    

    29,339Federal Home Loan Bank (FHLB) stock, at cost

    

    

    20,291

    

    

    21,486Accrued interest receivable on loans

    

    

    5,000

    

    

    5,367Accrued interest receivable on securities

    

    

    2,898

    

    

    2,847Bank-owned life insurance

    

    

    23,541

    

    

    23,799Other assets

    

    

    5,923

    

    

    6,547$

    1,659,475

    

    $

    1,660,925LIABILITIES AND STOCKHOLDERS EQUITY:LIABILITIES:Deposits

    

    $

    1,063,105

    

    $

    1,060,967Securities sold under agreements to repurchase

    

    

    72,095

    

    

    43,161Advances from FHLB

    

    

    380,580

    

    

    407,130Junior subordinated debt

    

    

    15,464

    

    

    15,464Drafts outstanding

    

    

    2,023

    

    

    2,703Advances by borrowers for property taxes and insurance

    

    

    1,422

    

    

    5Accrued interest payable

    

    

    4,718

    

    

    5,626Other liabilities

    

    

    7,244

    

    

    9,897Total Liabilities

    

    

    1,546,651

    

    

    1,544,953STOCKHOLDERS EQUITY:Serial preferred stock, 1,000,000 shares authorized and unissued

    

    

    

    

    

    Common
            stock, $.01 par value, 50,000,000 shares authorized;  21,686,542
            shares atSeptember 30, 2006 and 21,717,228 shares at December 31, 2006 issued and outstanding

    

    

    217

    

    

    217Additional paid-in capital

    

    

    12,856

    

    

    13,139Retained earnings, restricted

    

    

    102,777

    

    

    105,488Accumulated other comprehensive loss, net of tax

    

    

    (3,026

    )

    

    (2,872

    )Total stockholders equity

    

    

    112,824

    

    

    115,972$

    1,659,475

    

    $

    1,660,925

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



3



PART I. FINANCIAL INFORMATION

Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OFOPERATIONS

FOR THE THREE MONTHS ENDED DECEMBER 31, 2005 AND 2006





2005
        
        2006(Unaudited)(In thousands, except per share data)Interest income:Loans receivable
        
        $
        17,147
        
        $
        21,635Investment securities
        
        
        1,615
        
        
        1,977Mortgage-backed securities
        
        
        4,109
        
        
        3,588Other
        
        
        167
        
        
        198Total interest income
        
        
        23,038
        
        
        27,398Interest expense:Deposits
        
        
        5,870
        
        
        8,092Securities sold under agreements to repurchase
        
        
        378
        
        
        494Advances from FHLB
        
        
        3,245
        
        
        4,623Junior subordinated debt
        
        
        269
        
        
        324Total interest expense
        
        
        9,762
        
        
        13,533Net interest income
        
        
        13,276
        
        
        13,865Provision for loan losses
        
        
        400
        
        
        225Net interest income after provision for loan losses
        
        
        12,876
        
        
        13,640Other income:Fees and service charges on deposit accounts
        
        
        2,089
        
        
        2,633Income from ATM and debit card transactions
        
        
        501
        
        
        674Income from sales of non-depository products
        
        
        405
        
        
        312Gain (loss)on sales of loans and loans receivable held for sale
        
        
        92
        
        
        659Gain (loss) on sales of investment securities, net
        
        
        (13
        )
        
        13Gain (loss) on sales of mortgage-backed securities, net
        
        
        (33
        )
        
        12Loss from real estate acquired through foreclosure, net
        
        
        (33
        )
        
        (20
        )FHLB stock dividends
        
        
        200
        
        
        318Bank-owned life insurance
        
        
        239
        
        
        258Other income
        
        
        141
        
        
        171Total other income
        
        
        3,588
        
        
        5,030General and administrative expenses:Salaries and employee benefits
        
        
        5,378
        
        
        6,114Net occupancy, furniture and fixtures and data processing expenses
        
        
        1,451
        
        
        1,893Depreciation
        
        
        802
        
        
        980FDIC insurance premium
        
        
        33
        
        
        32Marketing expenses
        
        
        437
        
        
        384Expense from ATM and debit card transactions
        
        
        329
        
        
        266Other expense
        
        
        1,250
        
        
        1,581Total general and administrative expense
        
        
        9,680
        
        
        11,250Income before income taxes
        
        
        6,784
        
        
        7,420Income taxes
        
        
        2,341
        
        
        2,539Net income
        
        $
        4,443
        
        $
        4,881Net income per common share:Basic
        
        $
        0.21
        
        $
        0.23Diluted
        
        $
        0.20
        
        $
        0.22Dividends declared per common share
        
        $
        0.04
        
        $
        0.10Weighted average common shares outstanding:Basic
        
        
        21,420,000
        
        
        21,698,000Diluted
        
        
        22,133,000
        
        
        22,408,000

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



4



PART I. FINANCIAL INFORMATION

Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OFSTOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME

FOR THE THREE MONTHS ENDED DECEMBER 31, 2005 AND 2006







AccumulatedOtherAdditional
    
    
    
    Comprehensive
    
    TotalCommon
    
    Paid-in
    
    Retained
    
    Income
    
    StockholdersStock
    
    Capital
    
    Earnings
    
    (Loss)
    
    Equity(Unaudited)(In
        thousands)Balance
        at September 30, 2005
    
    $
    214
    
    $
    11,391
    
    $
    86,723
    
    $
    (1,107
    )
    $
    97,221Exercise
        of stock options, including tax benefit of $91
    
    
    
    
    
    229
    
    
    
    
    
    
    
    
    229Stock
        compensation expense, net of tax of $16
    
    
    
    
    
    25
    
    
    
    
    
    
    
    
    25Cash
        dividends
    
    
    
    
    
    
    
    
    (974
    )
    
    
    
    
    (974
    )Net
        income
    
    
    
    
    
    
    
    
    4,443
    
    
    
    
    
    4,443Other
        comprehensive income:Unrealized
        losses arising during period, net of tax benefit of $1,082
    
    
    
    
    
    
    
    
    
    
    
    (1,764
    )
    
    Less:
        reclassification adjustment for losses included in net income net of tax
        benefit of $18
    
    
    
    
    
    
    
    
    
    
    
    28
    
    
    Other
        comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    (1,736
    )
    
    (1,736
    )Comprehensive
        income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,707Balance
        at December 31, 2005
    
    $
    214
    
    $
    11,645
    
    $
    90,192
    
    $
    (2,843
    )
    $
    99,208Balance
        at September 30, 2006
    
    $
    217
    
    $
    12,856
    
    $
    102,777
    
    $
    (3,026
    )
    $
    112,824Exercise
        of stock options, including tax benefit of $72
    
    
    
    
    
    272
    
    
    
    
    
    
    
    
    272Stock
        compensation expense, net of tax of $7
    
    
    
    
    
    11
    
    
    
    
    
    
    
    
    11Cash
        dividends
    
    
    
    
    
    
    
    
    (2,170
    )
    
    
    
    
    (2,170
    )Net
        Income
    
    
    
    
    
    
    
    
    4,881
    
    
    
    
    
    4,881Other
        comprehensive income:Unrealized
        gains arising during period, net of tax of $104
    
    
    
    
    
    
    
    
    
    
    
    169
    
    
    Less:
        reclassification adjustment for gains included in net income net of tax
        of $10
    
    
    
    
    
    
    
    
    
    
    
    (15
    )
    
    Other
        comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    154
    
    
    154Comprehensive
        income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,035Balance
        at December 31, 2006
    
    $
    217
    
    $
    13,139
    
    $
    105,488
    
    $
    (2,872
    )
    $
    115,972SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



5



Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OFCASH FLOWS

FOR THE THREE MONTHS ENDED DECEMBER 31, 2005 AND 2006





  2005
      
      2006(Unaudited)(In
          thousands)Cash
          flows from operating activities:Net
          income
      
      $
      4,443
      
      $
      4,881Adjustments
          to reconcile net income to net cash provided by operating activities:Depreciation
      
      
      802
      
      
      980Provision
          for loan losses
      
      
      400
      
      
      225(Gain)
          loss on sale of investment securities available for sale, net
      
      
      13
      
      
      (13
      )(Gain)
          loss on sale of mortgage-backed securities available for sale, net
      
      
      33
      
      
      (12
      )Stock
          option compensation expense
      
      
      41
      
      
      18Origination
          of loans receivable held for sale
      
      
      (6,228
      )
      
      (21,817
      )Proceeds
          from sale of loans receivable held for sale, net
      
      
      5,584
      
      
      4,244Proceeds
          from securitization and sales of loans receivable held for sale, net
      
      
      5,970
      
      
      7,474Tax
          benefit from the exercise of stock options
      
      
      (91
      )
      
      (72
      )(Increase)
          decrease in:Cash
          value of life insurance
      
      
      (240
      )
      
      (258
      )Accrued
          interest receivable
      
      
      (1,349
      )
      
      (316
      )Other
          assets
      
      
      148
      
      
      (624
      )Increase
          in:Accrued
          interest payable
      
      
      1,015
      
      
      908Other
          liabilities
      
      
      979
      
      
      2,624Net
          cash provided by (used in) operating activities
      
      
      11,520
      
      
      (1,758
      )Cash
          flows from investing activities:Proceeds
          from call and sales of investment securities available for sale
      
      
      5,992
      
      
      6,117Purchases
          of investment securities available for sale
      
      
      (710
      )
      
      (3,106
      )Proceeds
          from issuer call of investment securities held to maturity
      
      
      
      
      
      1,996Purchases
          of investment securities held to maturity
      
      
      
      
      
      (2,791
      )Proceeds
          from sales of mortgage-backed securities available for sale
      
      
      28,601
      
      
      2,011Purchases
          of mortgage-backed securities available for sale
      
      
      (97,881
      )
      
      (1,844
      )Principal
          collected on mortgage-backed securities available for sale
      
      
      23,073
      
      
      17,301Origination
          of loans receivable, net
      
      
      (199,575
      )
      
      (136,118
      )Proceeds
          from securitization and sales of loans receivable, net
      
      
      
      
      
      18,863Proceeds
          from sales of commercial loan participations
      
      
      966
      
      
      1,302Purchases
          of loans receivable
      
      
      (8,656
      )
      
      Principal
          collected on loans receivable, net
      
      
      161,677
      
      
      120,372Proceeds
          from sales of real estate acquired through foreclosure, net
      
      
      447
      
      
      27Purchases
          of office properties and equipment
      
      
      (2,206
      )
      
      (393
      )Change
          in FHLB stock, net
      
      
      (2,355
      )
      
      (1,195
      )Net
          cash provided by (used in) investing activities
      
      $
      (90,627
      )
      $
      22,542

(CONTINUED)



6



PART I. FINANCIAL INFORMATION

Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED DECEMBER 31, 2005 AND 2006 (CONTINUED)







2005
        
        2006(Unaudited)(In thousands)Cash flows from financing activities:Decrease in deposits, net
        
        $
        (13,721
        )
        $
        (2,138
        )Increase (decrease) in securities sold under agreements to repurchase, net
        
        
        6,611
        
        
        (28,934
        )Proceeds from FHLB advances
        
        
        233,750
        
        
        317,350Repayments of FHLB advances
        
        
        (181,400
        )
        
        (290,800
        )Decrease in advance payments by borrowers for property taxes and insurance, net
        
        
        (1,138
        )
        
        (1,417
        )Increase (decrease) in drafts outstanding, net
        
        
        (9,349
        )
        
        680Cash dividends to stockholders
        
        
        (974
        )
        
        (2,170
        )Proceeds from exercise of stock options
        
        
        138
        
        
        200Tax benefit from the exercise of stock options
        
        
        91
        
        
        72Net cash provided by (used in) financing activities
        
        
        34,008
        
        
        (7,157
        )Net increase (decrease) in cash and cash equivalents
        
        
        (45,099
        )
        
        13,627Cash and cash equivalents at beginning of period
        
        
        91,525
        
        
        36,955Cash and cash equivalents at end of period
        
        $
        46,426
        
        $
        50,582Supplemental information:Interest paid
        
        $
        8,747
        
        $
        12,625Income taxes paid
        
        $
        98
        
        $
        35Supplemental schedule of non-cash investing and financing transactions:Securitization of loans held for sale into mortgage-backed securities
        
        $
        5,970
        
        $
        7,474Securitization of loans receivable into mortgage-backed securities
        
        $
        
        
        $
        23,450Transfer of loans held for sale to loans receivable
        
        $
        4,764
        
        $
        409

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



7



PART I. FINANCIAL INFORMATION

Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)



(1) BASIS OF PRESENTATION

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

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

(2) INVESTMENT SECURITIES AVAILABLE FOR SALE

The unrealized losses on investment securities were attributable to increases in interest rates, rather than credit quality deterioration. Investment securities that had continuous losses of less than 12 months are comprised of nine securities at September 30, 2006 totaling $19,000 in losses and 23 securities at December 31, 2006 totaling $105,000 in losses. The investment securities that had continuous losses 12 months or longer are comprised of fourteen securities at September 30, 2006 totaling $45,000 in losses and three securities at December 31, 2006 totaling $38,000 in losses. None of the individual investment securities had an unrealized loss that exceeded 10% of its amortized cost at either date. At September 30, 2006 and December 31, 2006, substantially all investment securities were rated AAA or higher. At September 30, 2006 and December 31, 2006, none of the investment securities available for
sale were considered impaired.

(3) MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE

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





September 30, 2006Less than 12 Months
        
        12 Months or Longer
        
        TotalFairValue
        
        UnrealizedLosses
        
        FairValue
        
        UnrealizedLosses
        
        FairValue
        
        UnrealizedLosses(Unaudited)(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
        
        (6,249
        )



December 31, 2006Less than 12 Months
        
        12 Months or Longer
        
        TotalFairValue
        
        UnrealizedLosses
        
        FairValue
        
        UnrealizedLosses
        
        FairValue
        
        UnrealizedLosses(Unaudited)(In thousands)Collateralized Mortgage Obligations
        
        $
        36,396
        
        (308
        )
        59,413
        
        (1,107
        )
        95,809
        
        (1,415
        )FNMA
        
        
        5,852
        
        (40
        )
        91,283
        
        (1,945
        )
        97,135
        
        (1,985
        )GNMA
        
        
        4,100
        
        (19
        )
        23,787
        
        (456
        )
        27,887
        
        (475
        )FHLMC
        
        
        27,315
        
        (346
        )
        78,831
        
        (1,524
        )
        106,146
        
        (1,870
        )$
        73,663
        
        (713
        )
        253,314
        
        (5,032
        )
        326,977
        
        (5,745
        )



8



PART I. FINANCIAL INFORMATION

Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED

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

The unrealized losses on mortgage-backed securities were attributable to increases in interest rates, rather than credit quality deterioration. The unrealized losses are comprised of 54 securities at September 30, 2006 and 31 securities at December 31, 2006 that have had continuous losses of less than 12 months. There were 67 securities at September 30, 2006 and 89 securities at December 31, 2006 with continuous losses 12 months or longer. None of the individual mortgage-backed securities had an unrealized loss that exceeded 10% of its amortized cost at September 30, 2006. One of the mortgage-backed securities had an unrealized loss which exceeded 10% of its amortized cost by an immaterial amount at December 31, 2006. At September 30, 2006 and December 31, 2006, all mortgage-backed securities were rated AAA or higher. At September 30, 2006 and December 31, 2006, none of the Companys securities were
considered impaired.

(4) LOANS RECEIVABLE, NET

Loans receivable, net, consists of the following:





September 30,2006
        
        December 31,2006(Unaudited)(In thousands)First mortgage loans:Single family to four family units
        
        $
        390,572
        
        $
        367,251Land and land development
        
        
        162,538
        
        
        167,534Residential lots
        
        
        39,377
        
        
        42,253Other, primarily commercial real estate
        
        
        236,053
        
        
        241,087Construction loans on residential property
        
        
        197,345
        
        
        194,045Construction loans on commercial property
        
        
        6,410
        
        
        8,956Consumer and commercial loans:Installment consumer loans
        
        
        14,182
        
        
        13,977Mobile home loans
        
        
        5,194
        
        
        5,006Savings account loans
        
        
        2,035
        
        
        1,998Equity lines of credit
        
        
        40,331
        
        
        41,508Commercial and other loans
        
        
        38,656
        
        
        38,4591,132,693
        
        
        1,122,074Less:Allowance for loan losses
        
        
        12,726
        
        
        12,768Deferred loan costs, net
        
        
        (246
        )
        
        (175
        )Undisbursed portion of loans in process
        
        
        31,982
        
        
        30,071$
        1,088,231
        
        $
        1,079,410

The changes in the allowance for loan losses consist of the following for the three months ended:





Three Months Ended December 31,2005
        
        2006(Unaudited)(In thousands)Allowance at beginning of period
        
        $
        11,748
        
        $
        12,726Provision for loan losses
        
        
        400
        
        
        225Recoveries:Residential loans
        
        
        
        
        
        Commercial loans
        
        
        142
        
        
        1Consumer loans
        
        
        20
        
        
        18Total recoveries
        
        
        162
        
        
        19Charge-offs:Residential loans
        
        
        
        
        
        Commercial loans
        
        
        216
        
        
        172Consumer loans
        
        
        99
        
        
        30Total charge-offs
        
        
        315
        
        
        202Net charge-offs
        
        
        153
        
        
        183Allowance at end of period
        
        $
        11,995
        
        $
        12,768



9



PART I. FINANCIAL INFORMATION

Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED



(4) LOANS RECEIVABLE, NET-CONTINUED





    Three
        Months Ended December 31,2005
        
        
        
        2006**(Unaudited)**Ratio
        of allowance to total net loans outstanding at the end of the period
        
        
        1.22
        %
        
        
        1.17
        %Ratio
        of net charge-offs to average total loans outstanding during the period
        (annualized)
        
        
        0.06
        %
        
        
        0.07
        %

Non-accrual loans, which are primarily loans over ninety days delinquent, totaled approximately $3.0 million and $5.0 million at September 30, 2006 and December 31, 2006, respectively. For the three months ended December 31, 2005 and 2006, interest income, which would have been recorded, would have been approximately $83,000 and $153,000, respectively, had non-accruing loans been current in accordance with their original terms.

At September 30, 2006 and December 31, 2006, impaired loans totaled $3.5 million and $4.7 million, respectively. Included in the allowance for loan losses at September 30, 2006 was $235,000 related to impaired loans compared to $149,000 at December 31, 2006. The average recorded investment in impaired loans for the year ended September 30, 2006 was $2.8 million compared to $4.0 million for the three months ended December 31, 2006. Interest income of $51,000 was recognized on impaired loans for the quarter ended December 31, 2006. Interest income of $38,000 was recognized on impaired loans for the quarter ended December 31, 2005.

(5) DEPOSITS

Deposits consist of the following:





September 30, 2006
        
        December 31, 2006Amount
        
        WeightedAverageRate
        
        Amount
        
        WeightedAverageRate(Unaudited)(Dollars in thousands)Checking accounts:Noninterest-bearing
        
        $
        231,081
        
        
        
        $
        202,948
        
        Interest-bearing
        
        
        126,373
        
        0.54
        %
        
        127,541
        
        0.53
        %Total checking accounts
        
        
        357,454
        
        0.19
        
        
        330,489
        
        0.21Money market accounts
        
        
        198,500
        
        3.44
        
        
        192,396
        
        3.46Statement savings accounts
        
        
        76,263
        
        2.37
        
        
        73,493
        
        2.40Certificate accounts
        
        
        430,888
        
        4.83
        
        
        464,589
        
        5.02$
        1,063,105
        
        2.83
        %
        $
        1,060,967
        
        3.06
        %

Included in certificate accounts (CDs) are $153.3 million of brokered CDs at September 30, 2006 and $169.5 million at December 31, 2006. The average rate and remaining term of brokered CDs at September 30, 2006 was 5.16% and approximately five months, respectively. The average rate and remaining term of brokered CDs at December 31, 2006 was 5.26% and approximately four months, respectively.



10



PART I. FINANCIAL INFORMATION

Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED



(6) ADVANCES FROM FEDERAL HOME LOAN BANK

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





September 30, 2006
        
        December 31, 2006Amount
        
        WeightedAverageRate
        
        Amount
        
        WeightedAverageRate(Unaudited)(Dollars in thousands)Fiscal Year Maturing:Year 1
        
        $
        11,810
        
        4.77
        %
        $
        3,360
        
        2.84
        %Year 2
        
        
        3,977
        
        3.18
        
        
        3,977
        
        3.18Year 3
        
        
        16,803
        
        4.60
        
        
        16,803
        
        4.60Year 4
        
        
        73,651
        
        5.58
        
        
        73,651
        
        5.58Year 5
        
        
        40,440
        
        5.36
        
        
        40,440
        
        5.36After Year 5
        
        
        233,899
        
        3.89
        
        
        268,899
        
        4.02$
        380,580
        
        4.43
        %
        $
        407,130
        
        4.44
        %

At September 30, 2006 and December 31, 2006, the Bank had pledged first mortgage loans and mortgage-backed securities with unpaid balances of approximately $470.2 million and $430.7 million, respectively, as collateral for FHLB advances. At December 31, 2006, the excess first mortgage loans and mortgage-backed securities collateral pledged to FHLB will support additional borrowings of $23.6 million.



Callable advances at December 31, 2006 are summarized as follows:





December 31, 2006Amount
        
        WeightedAverageRate(Unaudited)(Dollars in thousands)Fiscal Year Callable:Year 1
        
        $
        126,000
        
        4.26
        %Year 2
        
        
        37,000
        
        2.98Year 3
        
        
        75,000
        
        4.11Year 4
        
        
        
        
        Year 5
        
        
        25,000
        
        4.91After Year 5
        
        
        
        
        $
        263,000
        
        4.10
        %

Call provisions are more likely to be exercised by the FHLB when market interest rates rise. If called, the Bank may be required to replace these advances with higher cost funds.

(7)  EARNINGS PER SHARE

Basic earnings per share 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 December 31, 2006 the Company had antidilutive securities of approximately 223,000 options to purchase shares by Directors and Associates. The average exercise price for such shares was $14.00 per share.



11



PART I. FINANCIAL INFORMATION

Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED

(7)  EARNINGS PER SHARE-CONTINUED



On November 10, 2005, the FASB issued FASB Staff Position (FSP) FAS123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards.  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 the 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 alternatives and make its one-time election. Effective October 1, 2006, the Company adopted the alternative transition method provided by FSP FAS 123(R)-3. Adoption of this FSP did not have a significant impact on the Companys financial position or cash flows. Fully
diluted earnings per share for the quarter ended December 31, 2005, after application of this FSP, did not change from the amount previously reported. On an annual basis, fully diluted earnings per share for the year ended September 30, 2006 will increase by approximately $.01. In accordance with FASB Statement No. 154, Accounting Changes and Error Corrections, adoption of this FSP is a change in accounting principle. Accordingly, earnings per share for the quarter ended December 31, 2005 and computation of the weighted average of fully diluted shares have been retroactively restated to apply the provisions of FAS 123(R)-3. The impact on earnings per share, weighted average fully diluted shares outstanding and cash flows is not material.

The following is a summary of the reconciliation of average shares outstanding for the quarters ended December 31:





For the three months ended December 31,2005
        
        2006Basic
        
        Diluted
        
        Basic
        
        DilutedWeighted average shares outstanding
        
        21,420,000
        
        21,420,000
        
        21,698,000
        
        21,698,000Effect of dilutive securities  Stock options
        
        
        
        713,000
        
        
        
        710,000Average shares outstanding
        
        21,420,000
        
        22,133,000
        
        21,698,000
        
        22,408,000

(8) STOCK BASED COMPENSATION



In December 2004, the FASB issued SFAS No. 123 (revised), Share-Based Payment (SFAS 123(R)). SFAS 123(R) replaces SFAS No. 123, Accounting for Stock-Based Compensation (SFAS 123), and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). SFAS 123(R) requires compensation costs related to share-based payment transactions to be recognized in the financial statements over the period that an employee provides service in exchange for the award. Public companies are required to adopt, and the Company has adopted effective October 1, 2005, the new standard using a modified prospective method. 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 December 31, 2006, the Company had one stock-based payment plan for directors, officers and other key Associates, which is described below. Prior to October 1, 2005, the Company, as permitted under SFAS 123, applied the intrinsic value method under APB 25, and related interpretations in accounting for its stock-based compensation plan.



Effective October 1, 2005, the Company adopted the provisions of SFAS 123(R) thereby expensing employee stock-based compensation using the fair value method prospectively for all awards granted, modified, or settled on or after October 1, 2005. The fair value at date of grant of the stock option is estimated using the Black-Scholes option-pricing model based on assumptions noted in a table below. The dividend yield is based on estimated future dividend yields. The risk-free rate for periods within the contractual term of the share option is based on the U.S. Treasury yield curve in effect at the time of grant. Expected volatilities are generally based on historical volatilities. The expected term of share options granted is generally derived from historical experience. Compensation expense is recognized on a straight-line basis over the stock option vesting period. The impact of adoption of the fair value
based method for expense recognition of employee awards resulted in expense of approximately $11,000, net of tax benefit of approximately $7,000 during the quarter ended December 31, 2006 and expense of $25,000, net of tax benefit of approximately $16,000, during the quarter ended December 31, 2005.



The Companys stock option plan (the Plan), which is stockholder approved, provides for stock options to be granted primarily to directors, officers and other key Associates. Options granted under the stock option plan may be incentive stock options or non-incentive stock options. Share option awards are generally granted with an exercise price equal to, or higher than, the market price of the Companys shares at the date of grant. Options vest ratably over a five-year period and expire after ten years from the date of grant, except as discussed below. Share options awards provide for accelerated vesting if there is a change in control, as defined in the Plan. The remaining shares of stock reserved for the stock option plan at December 31, 2006 amounted to approximately 105,000 shares.



12



PART I. FINANCIAL INFORMATION

Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED

(8) STOCK BASED COMPENSATION-CONTINUED



Options awarded prior to September 21, 2005 vest ratably over a five-year period. Effective September 21, 2005, the vesting period for approximately 804,000 options awarded during the fiscal 2003, 2004 and 2005 through September 20, 2005 that would have otherwise vested at various time through fiscal 2010 was accelerated, as more fully described in note 1(p) of the 2006 Annual Report to Stockholders. All other terms and conditions of the accelerated options remained unchanged as a result of the acceleration. In addition, in September 2005, the Company granted options to employees, officers and directors of approximately 429,000 shares, without a vesting requirement. All options expire ten years after the date of grant.



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








2005
        
        
        
        
        
        2006Dividend yield
        
        
        %
        
        
        
        
        1.43
        %Weighted
            average risk-free interest rate
        
        
        %
        
        
        
        
        4.62
        %Weighted average expected volatility
        
        
        %
        
        
        
        
        29.0
        %Weighted average expected life in years
        
        
        
        
        
        
        
        7.50

A summary of share option activity for the quarter ended December 31, 2006 follows (Dollars in thousands, except share data)(unaudited):




    WeightedWeighted
        
        
        AverageNumber
        
        
        Average
        
        
        Remaining
        
        
        AggregateOf
        
        
        Exercise
        
        
        Contractual
        
        
        IntrinsicShares
        
        
        Price
        
        
        Life
            (Years)
        
        
        ValueOutstanding
            at September 30, 2006
        
        2,748,630
        
        
        $
        8.07Granted
        
        23,025
        
        
        $
        13.97Exercised
        
        (30,687
        )
        
        $
        6.52Forfeited
            or expired
        
        
        
        
        
        Outstanding
            at December 31, 2006
        
        2,740,968
        
        
        $
        8.14
        
        
        5.5
        
        
        $
        16,007Exercisable
            at December 31, 2006
        
        2,711,197
        
        
        $
        8.09
        
        
        5.4
        
        
        $
        15,987

The weighted average grant-date fair value of options granted during the quarter ended December 31, 2006 is $4.90 per share. No options were granted during the quarter ended December 31, 2005. The total intrinsic value of options exercised during the quarters ended December 31, 2005 and 2006 was $337,000 and $259,000, respectively.



A summary of the status of the Companys nonvested options as of December 31, 2006, and changes during the quarter then ended, is presented below (unaudited):







WeightedAverageNumber
        
        
        
        Grant-DateOf Shares
        
        
        
        Fair ValueNonvested
            at September 30, 2006
        
        60,717
        
        
        
        $
        2.51Granted
        
        23,025
        
        
        
        $
        4.90Vested
        
        (53,971
        )
        
        
        $
        2.38Forfeited
        
        
        
        
        
        
        Nonvested at December 31, 2006
        
        29,771
        
        
        
        $
        4.59

Fair values have been retroactively restated for all stock dividends since the date the option was granted. Total fair value of shares vested during the quarters ended December 31, 2005 and 2006 were approximately $158,000 and $128,000, respectively.



As of December 31, 2006, there was approximately $123,000 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 4.8 years.



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



13



PART I. FINANCIAL INFORMATION

Item 1. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  CONTINUED

(9) COMMON STOCK DIVIDEND

On October 26, 2005 and August 24, 2006, the Company declared 10% stock dividends, aggregating approximately 1,770,000 and 1,971,000 shares, respectively. All share and per share data have been retroactively restated for the stock dividends.

(10) GUARANTEES

Standby letters of credit obligate the Company to meet certain financial obligations of its customers, if, under the contractual terms of the agreement, the customers are unable to do so. Payment is only guaranteed under these letters of credit upon the borrowers failure to perform its obligations to the beneficiary. The Company can seek recovery of the amounts paid from the borrower. These standby letters of credit are generally collateralized. Commitments under standby letters of credit are usually one year or less. At December 31, 2006, the Company has recorded no liability for the current carrying amount of the obligation to perform as a guarantor. The maximum potential amount of undiscounted future payments related to standby letters of credit at September 30, 2006 and December 31, 2006 was $11.4 million and $12.4 million, respectively.

(11) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

The Bank originates certain fixed rate residential loans with the intention of selling these loans in the secondary market. Between the time that the Bank enters into an interest rate lock or a commitment to originate a fixed rate residential loan with a potential borrower and the time the closed loan is sold, the Company is subject to variability in the market prices related to these commitments due to potential changes in interest rates. The Company believes that it is prudent to limit the variability of expected proceeds from the sales through forward sales of to be issued mortgage-backed securities and loans (forward sales commitments). The commitment to originate fixed rate residential loans and forward sales commitments are freestanding derivative instruments. Since such instruments do not qualify for hedge accounting treatment, their fair value adjustments are recorded through
the income statement in net gains on sales of loans held for sale. The commitments to originate fixed rate conforming loans totaled $3.9 million at December 31, 2006. The fair value of the loan commitments was an asset of approximately $5,000 at December 31, 2006. As of December 31, 2006, the Company had sold $8.0 million in forward commitments to deliver fixed rate mortgage-backed securities, which were recorded as a derivative asset of $50,000.

(12) MERGER AGREEMENT WITH BB&T

On December 20, 2006, Coastal Financial Corporation (the Company) and BB&T Corporation (BB&T) entered into an Agreement and Plan of Merger (the Merger Agreement) pursuant to which the Company will merge with and into BB&T, with BB&T as the surviving entity, in an all-stock transaction valued at approximately $394.6 million. Under the terms of the Merger Agreement, shareholders of the Company will receive .385 shares of BB&T common stock for each share of Company common stock held at the closing date. The merger is currently expected to be completed in the second quarter of calendar 2007, pending receipt of Company shareholder approval and regulatory approvals. The Merger Agreement also provides that the Company must pay to BB&T a cash fee of $15 million if the Merger Agreement is terminated under certain conditions.

In connection with the Merger Agreement, Michael C. Gerald, the Companys President and Chief Executive Officer, entered into a seven-year employment/consulting agreement with BB&T that will become effective upon the closing of the merger. Pursuant to the Merger Agreement, the Companys current board members will also be asked to serve on local BB&T advisory boards.

Certain employee agreements contain a severance payment provision that is effective upon announcement of a change in control. The announcement of the proposed merger between the Company and BB&T constitutes such a change in control for purposes of the employee agreements. For the employee to be eligible for the severance payment, the employee must terminate employment with the Company. If all of the employees terminated employment in accordance with their agreements, the Company would incur expense of approximately $6.8 million. As of the date of this filing, no employees covered under these employment agreements have terminated employment with the Company. Accordingly, no expense related to these severance agreements has been recorded.



14



PART I. FINANCIAL INFORMATION

Item 2. COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

FORWARD LOOKING STATEMENTS

This report may contain certain forward-looking statements within the meaning of Section 27A of the Securities Exchange Act of 1934, as amended, that represent the Companys expectations or beliefs concerning future events. All forward-looking statements are based on assumptions and involve risks and uncertainties, many of which are beyond the Companys control and which may cause its actual results, performance or achievements to differ materially from the results, performance or achievements contemplated by the forward-looking statements. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as believe, expect, anticipate, intend, plan, estimate or words of similar meaning, or future or conditional verbs such as
will, would, should, could or may. Forward-looking statements speak only as of the date they are made. The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statement, whether as a result of new information, future events or otherwise. See Part II, Item 1.A., Risk Factors for disclosure regarding risks and uncertainties related to the Companys business.

OVERVIEW

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

Coastal Federal is a full service financial services company with 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. 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.

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.

On December 20, 2006, Coastal Financial Corporation (the Company) and BB&T Corporation (BB&T) entered into an Agreement and Plan of Merger (the Merger Agreement) pursuant to which the Company will merge with and into BB&T, with BB&T as the surviving entity, in an all-stock transaction valued at approximately $394.6 million. Under the terms of the Merger Agreement, shareholders of the Company will receive .385 shares of BB&T common stock for each share of Company common stock held at the closing date. The merger is currently expected to be completed in the second quarter of calendar 2007, pending receipt of Company shareholder approval and regulatory approvals. The Merger Agreement also provides that the Company must pay to BB&T a cash fee of $15 million if the Merger Agreement is terminated under certain conditions.

In connection with the Merger Agreement, Michael C. Gerald, the Companys President and Chief Executive Officer, entered into a seven-year employment/consulting agreement with BB&T that will become effective upon the closing of the merger. Pursuant to the Merger Agreement, the Companys current board members will also be asked to serve on local BB&T advisory boards.

CRITICAL ACCOUNTING POLICIES

The Companys accounting policies are in accordance with accounting principles generally accepted in the United States of America and with general practice within the banking industry. In order to understand the Companys financial condition and results of operations, it is important to understand the more critical accounting policies and the extent to which judgment and estimates are used in applying those policies. The Company considers its policies regarding the allowance for loan losses and income taxes to be its most critical accounting policies due to the significant degree of the levels of subjectivity and management judgment necessary to account for these matters. Different assumptions in the application of these policies could result in material changes in the Companys consolidated financial
statements. The Companys accounting policies are set forth in Note 1 of the Notes to Consolidated Financial Statements in the Companys 2006 Annual Report to Stockholders. For additional discussion concerning the Companys allowance for loan losses and related matters, see Allowance for Loan Losses. See Income Taxes for additional discussion concerning income taxes in the Companys 2006 Annual Report to Stockholders.


15



OFF-BALANCE SHEET ARRANGEMENTS

In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit risk, interest rate, and liquidity risk. Such transactions are used by the Company for general corporate purposes or to satisfy customer needs. Corporate purpose transactions are used to help manage customers requests for funding. The Banks off-balance sheet arrangements, which principally include lending commitments and derivatives, are described below.

Lending Commitments:Lending commitments include loan commitments, standby letters of credit, and unused business and personal lines of credit. These instruments are not recorded in the consolidated balance sheet until funds are advanced under the commitments. The Bank provides these lending commitments to customers in the normal course of business. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company applies essentially the same credit policies and standards as it does in the lending process when making these loan commitments. For business customers, commercial loan commitments generally consist of financing real estate and construction and land development
or take the form of revolving credit arrangements to finance customers working capital requirements. For personal customers, loan commitments are generally lines of credit that are unsecured or are secured by residential property. Standby letters of credit obligate the Company to meet certain financial obligations of its customers, if, under the contractual terms of the agreement, the customers are unable to do so. Payment is only guaranteed under these letters of credit upon the borrowers failure to perform its obligations to the beneficiary. The Company can seek recovery of the amounts paid from the borrower. Standby letters of credit are generally collateralized and are usually one year or less.

At December 31, 2006, the Company recorded no liability for the current carrying amount of the obligation to perform as a guarantor, as such amounts are not considered material. The maximum potential amount of undiscounted future payments related to standby letters of credit at September 30, 2006 and December 31, 2006 was $11.4 million and $12.4 million, respectively.

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





September 30,2006
        
        December 31,2006(Unaudited)( In thousands)Residential mortgage loans in process
        
        $
        31,982
        
        $
        30,071Consumer home equity lines
        
        
        48,811
        
        
        47,874Other consumer lines of credit
        
        
        6,721
        
        
        6,156Standby letters of credit
        
        
        11,356
        
        
        12,420Commercial real estate and construction and land development
        
        
        122,877
        
        
        118,334Other commercial lines of credit
        
        
        12,760
        
        
        11,325Total loans receivable with undisbursed commitments
        
        $
        234,507
        
        $
        226,180

Derivative Instruments and Hedging Activities:See Note 11 Derivative Instruments and Hedging Activities in the accompanying Coastal Financial Corporation and Subsidiaries Consolidated Financial Statements as of, and for the quarter ended December 31, 2006, for disclosure.

DISCUSSION OF FINANCIAL CONDITION CHANGES FROM SEPTEMBER 30, 2006 TO DECEMBER 31, 2006

LIQUIDITY AND CAPITAL RESOURCES

Historically, the Company has maintained its liquidity at levels believed by management to be adequate to meet the requirements of normal operations, potential deposit out-flows and strong loan demand and still allow for optimal investment of funds and return on assets. The principal sources of funds for the Company are cash flows from operations, consisting mainly of loan payments, Customer deposits, advances from the FHLB, securitization of loans and subsequent sales, and loan sales. The principal use of cash flows is the origination of loans receivable and purchase of investment securities. The Company originated loans receivable of $205.8 million for the three months ended December 31, 2005, compared to $134.5 million for the three months ended December 31, 2006. Loan principal repayments amounted to $161.7 million in the first fiscal quarter of 2005 compared to $96.9 million for the three months ended
December 31, 2006. In addition, the Company sells certain loans in the secondary market to finance future loan originations. In the first quarter of fiscal 2005, the Company sold loans held for sale or securitized and sold loans held for sale totaling $11.6 million compared to $11.7 million for the three months ended December 31, 2006. In December 2006, the Company also securitized $23.4 million of loans receivable and concurrently sold $18.9 million of these mortgage-backed securities to third parties and recognized a net gain on sale of $433,000, which included $211,000 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 Company has no retained interest in the securities that were sold other than servicing rights. The remaining $4.5 million of loans receivable securitized into mortgage-backed securities were retained in the Companys mortgage-backed securities
available for sale. The Company completed this transaction to take advantage of the competitive pricing for such loans in the marketplace, while providing current funding requirements. In addition, the Bank sold $1.3 million of commercial loan participations in the quarter ended December 31, 2006 compared to $966,000 for the same period in 2005.



16







For the three month period ended December 31, 2006, the Company purchased $7.7 million in investment and mortgage-backed securities. For the three month period ended December 31, 2005, the Company purchased $104.6 million in investment and mortgage-backed securities. These purchases during the three-month period ended December 31, 2006 were primarily funded by mortgage-backed securities principal repayments of $17.3 million.

Total customer deposits, which exclude certificates of deposits obtained through
brokers, decreased $18.3 million between September 30, 2006 and December 31,
2006. Money market and checking accounts decreased from approximately $556.0
million at September 30, 2006 to $522.9 million at December 31, 2006, a decrease
of $33.1 million or 6.0%. Core deposits (defined as money market accounts,
checking accounts and statement savings accounts) decreased from $632.2 million
at September 30, 2006 to $596.4 million at December 31, 2006, a decrease of
5.7%. The Company believes these decreases are generally due to a slowing real
estate market which has affected balances in attorney trust accounts, as well as
seasonality. During the fall and winter, the Company typically experiences a
decrease in its deposit balances compared to other times during the year.

At December 31, 2006, the Company had $424.7 million of certificates of deposits (CDs) that were due to mature within one year. Included in these CDs were brokered CDs totaling $169.5 million. Based on past experience, the Company believes that the majority of the non-brokered CDs will renew with the Company. At December 31, 2006, the Company had commitments to originate $13.7 million in residential mortgage loans, $65.4 million in undisbursed business and retail lines of credit, and $118.3 million in commercial real estate and construction and land development which the Company expects to fund from normal operations. At December 31, 2006, the Company had approximately $23.6 million available in FHLB advances. In addition, the Company had unpledged collateral that would support up to approximately $120.8 million in additional borrowings. At December 31, 2006, the Company also had an outstanding
available line for federal funds of $20.0 million.

As a result of $4.9 million in net income, less the cash dividends paid to stockholders of approximately $2.2 million, proceeds of approximately $272,000 from the exercise of stock options, and the net decrease in unrealized loss on securities available for sale, net of income tax of $154,000, stockholders equity increased from $112.8 million at September 30, 2006 to $116.0 million at December 31, 2006.

OTS regulations require that the Bank calculate and maintain a minimum regulatory capital requirement on a quarterly basis and satisfy such requirement as of the calculation date and throughout the quarter. The Banks capital, as calculated under OTS regulations, is approximately $133.6 million at December 31, 2006, exceeding the core capital requirement by $108.6 million. At December 31, 2006, the Banks risk-based capital of approximately $144.6 million exceeded its current risk-based capital requirement by $65.4 million. (For further information see Regulatory Capital Matters).

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





Payments Due by PeriodTotal
        
        1 Year andLess
        
        2-3Years
        
        4-5Years
        
        After 5YearsTime deposits
        
        $
        464,589
        
        
        424,722
        
        
        35,510
        
        
        3,761
        
        
        596Short-term borrowings
        
        
        26,521
        
        
        26,521
        
        
        
        
        
        
        
        
        Long-term debt
        
        
        439,234
        
        
        
        
        
        20,780
        
        
        114,091
        
        
        304,363Purchase commitment
        
        
        2,810
        
        
        2,810
        
        
        
        
        
        
        
        
        Operating leases
        
        
        4,507
        
        
        429
        
        
        606
        
        
        408
        
        
        3,064Total contractual cash obligations
        
        $
        937,661
        
        
        454,482
        
        
        56,896
        
        
        118,260
        
        
        308,023

Purchase commitments.In the first quarter of fiscal 2006, the Company entered into a lease for 5.48 acres of land and a building, with an option to purchase this property after one year. In December 2006, the Company exercised its option to purchase the property. This purchase commitment, which is included in the table above, closed in January 2007.

EARNINGS SUMMARY



Net income increased from $4.4 million, or $.20 per diluted share, for the three months ended December 31, 2005 to $4.9 million, or $.22 per diluted share for the three months ended December 31, 2006. This 9.9% increase in net income resulted from increased net interest income of $589,000, or 4.4%, an increase in other income of $1.4 million, coupled with a decrease in the provision for loan losses of $175,000, increased general and administrative expenses of $1.6 million, and increased income taxes of $198,000.

Overall net interest income increased 4.4% due to higher net interest-earning average balances over interest-bearing liabilities average balances even though there was a decrease in the net interest margin. Net interest margin decreased from 3.70% for the three months ended December 31, 2005 to 3.54% for the three months ended December 31, 2006. The increase in net interest income is primarily attributable to an increase in average earning assets of $107.9 million, or 7.5%. Average loans receivable increased $138.6 million for the three months ended December 31, 2006 compared to December 31, 2005. Average balances of investment securities decreased approximately $30.7 million. The investment securities were primarily funded with advances from FHLB. The Companys customer deposits average balances increased from $879.9 million at December 31, 2005 to $887.0 million at December 31, 2006, excluding
brokered CD average balances of $177.4 million and $187.8 million at December 31, 2006 and 2005, respectively.



17



The Companys provision for loan losses decreased $175,000 for the three months ended December 31, 2006 when compared to the prior year primarily due to risk factors related to the underlying portfolio. The allowance for loan losses as a percentage of loans was 1.17% at December 31, 2006 as compared to 1.17% at September 30, 2006 and 1.22% at December 31, 2005.

Other income increased from $3.6 million for the three months ended December 31, 2005 to $5.0 million for the three months ended December 31, 2006. This was a result of an increase in fees and service charges on deposit accounts of $544,000; an increase in gain on the sales of loans and loans held for sale of $567,000; increased ATM and Debit Card income of $173,000; and Federal Home Loan Bank stock dividends of $118,000, offset by a decrease in non-depository income of $93,000. The Company also had gains on sales of investment and mortgage-backed securities of $25,000 for the three months ended December 31, 2006, compared to losses of $46,000 for the three months ended December 31, 2005.

General and administrative expenses increased from $9.7 million for the three months ended December 31, 2005 to $11.3 million for the three months ended December 31, 2006. Compensation and employee benefits increased from $5.4 million for the first quarter of fiscal 2006 to $6.1 million in the first quarter of fiscal 2007, primarily due to an increase in the number of banking Associates. The Companys number of Associates increased by approximately 38 Associates, or 7.3%, primarily due to three new branches, increased Associates in the expanded hours call center and deposit servicing, increased Associates in existing branches to serve extended banking hours and increased checking volumes, and increased Associates in residential banking. Marketing expenses were $437,000 for the three months ended December 31, 2005, compared to $384,000 for the three months ended December 31, 2006. In addition, other
expense was $1.3 million for the three months ended December 31, 2005, compared to $1.6 million for the three months ended December 31, 2006. Other expense increased primarily due to merger-related expenses.

MANAGEMENTS DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2005 AND 2006

INTEREST INCOME

Interest income for the three months ended December 31, 2006, increased to $27.4
million as compared to $23.0 million for the three months ended December 31,
2005. The earning asset yield for the three months ended December 31, 2006, was
7.07% compared to 6.39% for the three months ended December 31, 2005. The
average yield on loans receivable for the three months ended December 31, 2006,
was 7.88% compared to 7.15% for three months ended December 31, 2005. The
increased yield on loans is primarily due to the increased yield on commercial
loans with interest rates tied to the prime lending rate. The prime rate was
8.25% at December 31, 2006, compared to 7.25% at December 31, 2005. The yield on
investments increased to 5.11% for the three months ended December 31, 2006,
from 4.89% for the three months ended December 31, 2005. Long-term interest
rates have remained relatively constant during the last year despite rising
short-term rates, resulting in a flat yield curve. Consequently, most of the
cash flows received from the investment portfolio have been reinvested at
approximately the same interest rate. Should short-term rates continue to rise
more quickly than long-term rates, it is possible that the yield curve would
become inverted. A flat yield curve or inverted yield curve would likely cause
the Banks net interest margin to decline and reduce opportunities for
using securities to leverage capital. Total average interest-earning assets were
$1.5 billion for the quarter ended December 31, 2006 as compared to $1.4 billion
for the quarter ended December 31, 2005, an increase of 7.5%. The increase in
average interest-earning assets is primarily due to an increase in average loans
receivable of approximately $138.6 million, resulting primarily from growth in
the commercial loan portfolio, net of a decrease in investment and
mortgage-backed securities.

INTEREST EXPENSE

Interest
expense on interest-bearing liabilities was $13.5 million for the three months
ended December 31, 2006, as compared to $9.8 million for the three months ended
December 31, 2005. The average cost of deposits for the three months ended
December 31, 2006, was 2.60% compared to 1.84% for the three months ended
December 31, 2005. The cost of interest-bearing liabilities was 3.53% for the
three months ended December 31, 2006 compared to 2.69% for the three months
ended December 31, 2005. The cost of brokered CDs, FHLB advances,
repurchase and reverse repurchase agreements and other borrowings was 5.25%,
4.56%, 4.06% and 8.64%, respectively, for the three months ended December 31,
2006. For the three months ended December 31, 2005 the cost of brokered
CDs, FHLB advances, reverse repurchase agreements and other borrowings was
3.88%, 4.03%, 3.38% and 7.17%, respectively. The increased cost of funds on
other borrowings is due to the increased short-term interest rates. At December
31, 2006, the federal funds rate was 5.17% compared to 4.09% at December 31,
2005. Total average interest-bearing liabilities increased from $1.4 billion at
December 31, 2005 to $1.5 billion at December 31, 2006.

The increase in average interest-bearing liabilities is due to an increase in average deposits of approximately $7.1 million, decreased average Brokered CDs of $10.4 million; increased average FHLB Advances of $83.3 million and a net increase in Customer repurchase and reverse repurchase agreements of $4.0 million. The increase in FHLB advances was used to fund loan growth.

NET INTEREST INCOME

Net interest income was $13.9 million for the three months ended December 31, 2006, as compared to $13.3 million for the three months ended December 31, 2005. The net interest margin was 3.54% for the three months ended December 31, 2006 compared to 3.70% for the three months ended December 31, 2005.



18



The following table summarizes the average balance sheets and the related yields on interest-earning assets and interest-bearing liabilities for the three months ended December 31, 2005 and 2006:





Three Months Ended December 31,2005
        
        
        
        
        
        2006AverageBalance (1)
        
        Income/Expense
        
        Yield/Rate
        
        AverageBalance (1)
        
        Income/Expense
        
        Yield/Rate(Unaudited)(Dollars in thousands)Assets:Loans (2)
        
        $
        959,498
        
        $
        17,147
        
        7.15
        %
        $
        1,098,127
        
        $
        21,635
        
        7.88
        %Investment
            Securities, MBS Securities and Other (3)
        
        
        481,452
        
        
        5,891
        
        4.89
        %
        
        450,787
        
        
        5,762
        
        5.11
        %Total earning assets
        
        
        1,440,950
        
        
        23,038
        
        6.39
        %
        
        1,548,914
        
        
        27,397
        
        7.07
        %Liabilities:Customer Deposits
        
        
        879,901
        
        
        4,047
        
        1.84
        %
        
        886,992
        
        
        5,765
        
        2.60
        %Brokered CDs
        
        
        187,823
        
        
        1,823
        
        3.88
        %
        
        177,395
        
        
        2,327
        
        5.25
        %FHLB Advances
        
        
        321,953
        
        
        3,245
        
        4.03
        %
        
        405,239
        
        
        4,623
        
        4.56
        %Customer Repurchase Agreements
        
        
        14,333
        
        
        127
        
        3.54
        %
        
        21,828
        
        
        223
        
        4.05
        %Junior Subordinated Debt
        
        
        15,000
        
        
        269
        
        7.17
        %
        
        15,000
        
        
        324
        
        8.64
        %Reverse Repurchase Agreements
        
        
        30,310
        
        
        251
        
        3.30
        %
        
        26,796
        
        
        271
        
        4.09
        %Total interest-bearing liabilities
        
        $
        1,449,320
        
        
        9,762
        
        2.69
        %
        $
        1,533,250
        
        
        13,533
        
        3.53
        %Net interest income (4)
        
        
        
        
        $
        13,276
        
        
        
        
        
        
        $
        13,864Net interest margin
        
        
        
        
        
        
        
        3.70
        %
        
        
        
        
        
        
        3.54
        %Net yield on earning assets
        
        
        
        
        
        
        
        3.69
        %
        
        
        
        
        
        
        3.58
        %



(1)
        The average balances are derived from monthly balances.(2)
        Nonaccrual loans are included in average balances for yield computations.(3)
        Investment securities include taxable and tax-exempt securities.(4)
        Net interest income has not been adjusted to produce a tax-equivalent yield.PROVISION FOR LOAN LOSSES

The
Companys provision for loan losses decreased from $400,000 for the three
months ended December 31, 2005, to $225,000 for the three months ended December
31, 2006 primarily due to changes in credit quality at December 31, 2006. The
allowance for loan losses as a percentage of loans was 1.17% at December 31,
2006 as compared to 1.22% at December 31, 2005. The allowance as a percentage of
loans declined due to improving economic conditions and the risk factors related
to the underlying portfolio. Loans delinquent 90 days or more were $5.0 million
or .46% of total loans at December 31, 2006, compared to $4.1 million or .42% of
total loans at December 31, 2005 and $3.0 million or .27% of total loans at
September 30, 2006. The allowance for loan losses was 255% of loans delinquent
more than 90 days at December 31, 2006, compared to 293% at December 31, 2005
and 426% at September 30, 2006. Net charge-offs for the three months ended
December 31, 2006 were $183,000 compared to $153,000 for the three months ended
December 31, 2005.

Management believes that the current level of the allowance for loan losses at December 31, 2006 is adequate considering the composition of the loan portfolio, the portfolios loss experience, delinquency trends, current regional and local economic conditions and other factors at that date.

OTHER INCOME

For the three months ended
December 31, 2006, other income was $5.0 million compared to $3.6 million for the three months ended December 31, 2005.
Fees and service charges from deposit accounts increased $544,000 or 26.0% to $2.6 million for the three months ended
December 31, 2006, compared to $2.1 million for the three months ended December 31, 2005. The majority of this
increase is due to fee income from increased number of personal and business checking accounts. Gain on sale of
loans and loans receivable held for sale was $659,000 for the quarter ended December 31, 2006, compared to $92,000
 for the quarter ended December 31, 2005.  Additionally, in the first quarter of fiscal 2006, the Company sold loans held for sale or securitized and sold loans held for sale totaling $11.6 million compared to $11.7 million for the three months ended December 31, 2006. In December 2006, the Company also securitized
$23.4 million of loans receivable and concurrently sold $18.9 million of these mortgage-backed securities to third parties and recognized a net gain on sale of $433,000, which included $211,000 related to mortgage servicing rights. Gain on sales of investment and mortgage-backed securities available for sale were $25,000 for the quarter ended December 31, 2006, compared to losses of $46,000 for the quarter ended December 31, 2005. Income from Federal Home Loan Bank Stock dividends increased from $200,000 to $318,000 due to increased dividends rates and higher average balances. In addition, income from ATM and debit card transactions increased 34.5% to $674,000 during the first quarter of fiscal 2007, primarily due to increased personal checking accounts.




19



GENERAL AND ADMINISTRATIVE EXPENSES

  General
    and administrative expenses were $9.7 million for the quarter ended December
    31, 2005 compared to $11.3 million for the quarter ended December 31, 2006.
    Salaries and employee benefits were $5.4 million for the three months ended
    December 31, 2005, as compared to $6.1 million for the three months ended
    December 31, 2006, an increase of 13.7%. Increased compensation is due to
    increased numbers of Associates and normal salary increases. The Companys
    number of Associates has increased by approximately 38 Associates, or 7.3%,
    primarily due to three new branches, increased Associates in the expanded
    hours call center and deposit servicing, increased Associates in existing
    branches to serve extended banking hours and increased checking volumes, and
    increased Associates in residential banking. 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 by $620,000, including increased depreciation of $178,000, when
    comparing the two periods. Marketing expenses were $437,000 for the three
    months ended December 31, 2005, compared to $384,000 for the three months
    ended December 31, 2006. The decrease from the prior period results from decreased
    initial startup expense for the Banks Totally Free Checking With
    A Gift initiative and the introduction of Penny Pavilion, the Banks
    free coin counting service. Other expenses were $1.3 million for the quarter
    ended December 31, 2005 compared to $1.6 million for the quarter ended December
    31, 2006. Other expense increased $331,000 primarily due to merger related
    legal costs of approximately $380,000.

INCOME TAXES

Income taxes were $2.5 million
 for the three months ended December 31, 2006 compared to $2.3 million for the three months ended December 31, 2005.
 The effective income tax rate as a percentage of pretax income was 34.2% and 34.5% for the quarters ended December 31, 2006
and 2005, respectively. The effective income tax rate differs from the statutory rate primarily due to income generated by
bank-owned life insurance, municipal securities that are exempt from federal and certain state taxes. The Companys
effective income tax rates take into consideration certain assumptions and estimates made by management.
No assurance can be given that either the tax returns submitted by management or the income tax reported on
the consolidated financial statements will not be adjusted by either adverse rulings by the U.S. Tax court,
 changes in the tax code, or assessments made by the Internal Revenue Service.

The Company is subject to potential adverse adjustments, including but not limited to: an increase in the statutory federal or state income tax rates, the permanent non-deductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of the future taxable income, in order to ultimately realize deferred income tax assets.

REGULATORY CAPITAL MATTERS

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





Actual
        
        For CapitalAdequacy Purposes
        
        Categorized as WellCapitalized underPrompt CorrectiveAction ProvisionAmount
        
        Ratio
        
        Amount
        
        Ratio
        
        Amount
        
        RatioAs of  December 31, 2006Total Capital:
        
        $
        144,593
        
        14.61
        %
        $
        79,185
        
        8.00
        %
        $
        98,981
        
        10.00
        %(To Risk Weighted Assets)Tier 1 Capital:
        
        $
        133,555
        
        13.49
        %
        $
        N/A
        
        N/A
        
        $
        59,389
        
        6.00
        %(To Risk Weighted Assets)Tier 1 Capital:
        
        $
        133,555
        
        8.02
        %
        $
        49,891
        
        3.00
        %
        $
        83,151
        
        5.00
        %(To Total Assets)Tangible Capital:
        
        $
        133,555
        
        8.02
        %
        $
        24,945
        
        1.50
        %
        $
        N/A
        
        N/A(To Total Assets)

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued SFAS No. 157 (FAS 157), Fair Value Measurements, which defines fair value, establishes guidelines 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.



20



FSP FAS 123R-5, which amends FSP FAS 123R-1, addresses instruments originally issued as employee compensation and later modified solely to reflect an equity restructuring that occurs when the holders are no longer employees. In that situation, no change in the recognition or measurement of those instruments will result if: (1) there is no increase in fair value of the award (or the ratio of intrinsic value to the exercise price of the award is preserved and (2) all holders of the same class of equity instruments are treated in the same manner. FSP FAS 123R-5 applied to the first reporting period beginning after October 10, 2006 (January 1, 2007 for the Company). The Company does not believe that this FSP will have a material impact on its results of operations and statement of condition.

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

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 did not have a significant impact on the Companys
financial position and increased the fully diluted earnings per share for the twelve month period ended September 30, 2006 by approximately $.01. In addition, the effects of applying this FSP were reported as a change in accounting principle in accordance with FASB Statement No. 154 Accounting Changes and Error Corrections and are reflected for all periods presented in this form 10-Q as of, and for the quarter ended, December 31, 2006.

Effective October 1, 2005, the Company adopted the provisions of SFAS 123(R) thereby expensing employee stock-based compensation using the fair value method prospectively for all awards granted, modified, or settled on or after October 1, 2005. The fair value at date of grant of the stock option is estimated using the Black-Scholes option-pricing model based on assumptions noted in a table in Note 7 of the Notes to Consolidated Financial Statements.. 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 effects of applying this pronouncement are reflected for all periods presented in this Form 10-Q as of, and for the quarter ended, December 31, 2006.

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. The Company adopted FAS 154 effective October 1, 2006. Adoption of FAS 154 did not 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  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 adoption of FAS 155 did not have a material effect on the results of the Companys 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. The Company adopted the provisions of this pronouncement effective October 1, 2006, but elected to continue to use the Amortization Method. The
adoption of FAS 156 did not have a material effect on the results of the Companys operations or statement of condition.

EFFECT ON INFLATION AND CHANGING PRICES

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





21



Item 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Net portfolio value (NPV) represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items over a range of assumed changes in market interest rates. The Banks Board of Directors has adopted an interest rate risk policy which establishes maximum allowable decreases in NPV in the event of a sudden and sustained one hundred to three hundred basis point increase or decrease in market interest rates. The following table presents the Banks change in NPV as computed by the OTS for various rate shock levels as of December 31, 2006 (Dollars in thousands).





Change in interest rates
        
        BoardLimitMinimumNPVRatio
        
        BoardLimitMaximumDecline inNPV
        
        MarketValueOf Assets12/31/06
        
        MarketValuePortfolioEquity12/31/06
        
        NPVRatio300 basis point rise
        
        5.00
        %
        
        400 BPS
        
        $
        1,671,718
        
        $
        180,906
        
        10.82
        %200 basis point rise
        
        6.00
        %
        
        300 BPS
        
        $
        1,694,220
        
        $
        196,705
        
        11.61
        %100 basis point rise
        
        6.00
        %
        
        250 BPS
        
        $
        1,714,009
        
        $
        205,526
        
        11.99
        %No change
        
        6.00
        %
        
        
        
        $
        1,728,570
        
        $
        208,644
        
        12.07
        %100 basis point decline
        
        6.00
        %
        
        250 BPS
        
        $
        1,741,142
        
        $
        209,237
        
        12.02
        %200 basis point decline
        
        6.00
        %
        
        300 BPS
        
        $
        1,752,348
        
        $
        207,943
        
        11.87
        %300 basis point decline
        
        6.00
        %
        
        350 BPS
        
        
        N/A
        
        
        N/A
        
        N/A

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

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

Item 4. CONTROLS AND PROCEDURES

The Companys management, including the Companys principal executive officer and principal financial officer, have evaluated the effectiveness of the Companys disclosure controls and procedures, as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Companys disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the SEC) (1) is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and
(2) is accumulated and communicated to the Companys management, including its principal executive and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no material changes in the Companys internal control over financial reporting occurred during the quarter ended December 31, 2006 that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.

PART II. OTHER INFORMATION

COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES

Item 1.LegalProceedings

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

Item 1.A.Risk Factors

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



22




        We are geographically concentrated along the coastlines of South Carolina and North Carolina. Changes in local economic conditions and catastrophic weather could have a significantly adverse impact on our profitability.We operate primarily along the coastlines of South Carolina and North Carolina and substantially all of our loan customers and most of our deposits and other customers live or have operations in these areas. Accordingly, our success significantly depends upon the growth in population, income levels, deposits and housing starts in the region, along with continued attraction of business ventures to the area. Our profitability is impacted by changes in economic conditions, particularly changes in the real estate and tourism industries. Exposure to changes in tourism or the real estate market, whether due to changing economic conditions or catastrophic weather, could reduce our growth rate, affect the ability of our customers to repay their loans to us, and generally affect our financial condition and results of operations.




        If our loan customers do not pay us as they have contracted to, we may experience losses.Our principal revenue producing business is making loans. If our customers do not repay the loans, we will suffer losses. Even though we maintain an allowance for loan losses, the amount of the allowance may not be adequate to cover the losses we experience. We attempt to mitigate this risk by a thorough review of creditworthiness of loan customers. Nevertheless, there is risk that our credit evaluation will prove to be inaccurate due to changed circumstances or otherwise.




        Fluctuations in interest rates could reduce our profitability.Changes in interest rates may affect our level of interest income, the primary component of our gross revenue, as well as the level of our interest expense. Interest rate fluctuations are caused by many factors which, for the most part, are not under our direct control. For example, national monetary policy plays a significant role in the determination of interest rates. Additionally, competitor pricing and the resulting negotiations that occur with customers also impact the rates we collect on loans and the rates we pay on deposits.

As interest rates change, we expect we will periodically experience gaps in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market rates should move contrary to our position, this gap may work against us, and our earnings may be negatively affected.

Changes in the level of interest rates also may negatively affect our ability to originate real estate loans, the value of our assets and our ability to realize gains from the sale of our assets, all ultimately affect our earnings. A decline in the market value of our assets may limit our ability to borrow additional funds. As a result, we could be required to sell some of our loans and investments under adverse market conditions, upon terms that are not favorable to us, in order to maintain our liquidity. If those sales are made at prices lower than the amortized cost of the investments, we will incur losses.




        The banking industry is highly competitive.The banking industry in our market area is highly competitive. We compete with many different financial and financial services institutions. A substantial number of the banks in our market area are branches or subsidiaries of much larger organizations affiliated with statewide, regional, or national banking companies, and as a result, may have greater resources and lower costs of funds. These competitors aggressively solicit customers within their market area by advertising through direct mail, electronic media and other means. These competitors may offer services, such as international banking services, that we can offer only through correspondents, if at all. Additionally, larger competitors have greater capital resources and, consequently, higher lending limits.




        We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects.Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge and experience in the South Carolina banking industry. The process of recruiting personnel with a combination of skills and attributes required to carry out our strategies is often lengthy. Our success depends, to a significant degree, upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel. We are dependent upon a number of key executives who are integral to implementing our business plan. The loss of the services of any one of our senior executive management team or other key executives could have a material adverse effect on our business, financial condition, results of operations and cash flows.




        Provisions in our articles of incorporation and Delaware law may discourage or prevent takeover attempts, and these provisions may have the effect of reducing the market price of our stock.Our articles of incorporation include several provisions that may have the effect of discouraging or preventing hostile takeover attempts, and therefore, making the removal of incumbent management difficult. The provisions include staggered terms for our board of directors and requirements of supermajority votes to approve certain business transactions. In addition, Delaware law contains several provisions that may make it more difficult for a third party to acquire control of us without the approval of the board of directors, and may make it more difficult or expensive for a third party to acquire a majority of our outstanding stock. To the extent that these provisions are effective in discouraging or preventing takeover attempts, they may tend to reduce the market price for our stock.




        We are subject to governmental regulations which could change and increase our cost of doing business or have an adverse effect on our business.



23



We
    operate in a highly regulated industry and are subject to examination, supervision
    and comprehensive regulation by various federal and state agencies. Our compliance
    with the requirements of these agencies is costly and may limit our growth
    and restrict certain of our activities, including payment of dividends, mergers
    and acquisitions, investments, loans and interest rates charged and location
    of offices. We are also subject to capitalization guidelines established by
    federal authorities and our failure to meet those guidelines could result,
    in an extreme case, in our bank being placed in receivership. Supervision,
    regulation and examination of banks and bank holding companies by financial
    institution regulatory agencies are intended for the protection of depositors
    and our other customers rather than the holders of our common stock.




        Changes in accounting standards could impact reported earnings.The accounting standard setters, including FASB, SEC and other regulatory bodies, periodically change financial accounting and reporting standards that govern the preparation of our consolidated statements. These changes can be hard to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, we could be required to apply a new or revised accounting standard retroactively, resulting in the restatement of prior period financial statements.




        We are susceptible to changes in monetary policy and other economic factors which may adversely affect our ability to operate profitably.Changes in governmental, economic and monetary policies may affect the ability of our bank to attract deposits and make loans. The rates of interest payable on deposits and chargeable on loans are affected by governmental regulation and fiscal policy as well as by national, state and local economic conditions. All of these matters are outside of our control and affect our ability to operate profitably.




        The preparation of financial statements requires the use of estimates that may vary from actual results.Preparation of consolidated financial statements in conformity with accounting principles accepted in the United States of America requires management to make significant estimates that affect the financial statements. One of our most critical estimates is the level of the allowance for loan losses. Due to the inherent nature of this estimate, we cannot provide absolute assurance that we will not significantly increase allowances for losses that are significantly higher than the provided allowance.




        We rely on communications, information, operating and financial control systems, and technology from third-party service providers, and we may suffer an interruption in those systems that may result in lost business. Further, we may not be able to substitute providers on terms that are as favorable if our relationships with our existing service providers are interrupted.We rely heavily on third-party service providers for much of our communications, information, operating and financial controls systems, and technology. Any failure or interruption or breach in security of these systems could result in failures or interruptions in our customer relationships management, general ledger, deposit, servicing and/or loan origination systems. We cannot assure you that such failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. The occurrence of any failure or interruption could have a material adverse effect on our business, financial condition, results of operations and cash flows. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be
required to locate alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing systems, without the need to expend substantial resources, if at all. Any of these circumstances could have a material adverse effect on our business, financial condition, results of operations and cash flows.




        If the business continuity and disaster recovery plans that we have in place are not adequate to continue our operations in the event of a disaster, the business disruption can adversely impact our operations.External events, including terrorist or military actions, or an outbreak of disease, such as Asian Influenza, or bird flu and resulting political and social turmoil could cause unforeseen damage to our physical facilities or could cause delays or disruptions to operational functions, including information processing and financial market settlement functions. Additionally, our customers, vendors and counterparties could suffer from such events. Should these events affect us, or our customers, or vendors or counterparties with which we conduct business, our results of operations could be adversely affected.




        From time to time, we are subject to claims and litigation from customers and other individuals.Whether
    such claims and legal actions are founded or unfounded, if such claims and
    legal actions are not resolved in a manner favorable to us, they may result
    in significant financial liability and/or adversely affect the market perception
    of us and our products and services. Any financial liability or reputation
    damage could have a material adverse effect on our business and financial
    performance.



24




        Even
            though our common stock is currently traded on the Nasdaq Stock Market,
            it has less liquidity than the average stock quoted on national stock
            exchanges.The
    trading volume in our common stock on the Nasdaq Stock Market has been relatively
    low when compared with larger companies on the Nasdaq National Market or national
    stock exchanges. As a result, it may be more difficult for stockholders to
    sell a substantial number of shares for the same price at which stockholders
    could sell a small number of shares. We also cannot predict the effect, if
    any, that future sales of our common stock in the market, or the availability
    of shares of common stock for sale in the market, will have on the market
    price of our common stock. We can give no assurance that sales of substantial
    amounts of common stock in the market, or the potential for large of amounts
    of sales in the market, would not cause the price of our common stock to decline
    or impair our future ability to raise capital through sales of common stock.
    The market price of our common stock may fluctuate in the future, and these
    fluctuations may be unrelated to our performance. General market price declines
    or overall stock market volatility in the future could adversely affect the
    price of our common stock. Further, the current market price of our stock
    may not be indicative of future market prices.



        Decline in home values in the Companys markets could adversely impact results from operations.Like all banks, the Company is subject to the effects of any economic downturn, and in particular, a significant decline in home values in the Companys markets could have a negative effect on the results of operations.  A significant decline in home values would likely lead to a decrease in new home equity loan originations and increased delinquencies and defaults in both the consumer home equity loan and the residential real estate loan portfolios and result in increased losses in these portfolios.




        The Company is subject to federal and state income tax regulations.Income tax regulations are often complex and require interpretation. Changes in income tax regulations could negatively impact the Companys results of operations. If the Companys REIT affiliate fails to qualify as a REIT, or should states enact legislation taxing these or related entities, the Company will be subject to a higher consolidated effective tax rate. The REIT and related companies must meet specific provisions of the Internal Revenue Code (IRC) and state tax laws. If these companies fail to meet any of the required provisions of the federal and state tax laws, tax expense could increase. Use of these companies is and has been subject of federal and state audits. See Managements Discussion and Analysis of Operations-Income Taxes for additional information.




        The Company is subject to the USA Patriot and Bank Secrecy Acts.The USA Patriot and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury Departments Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. During the past year, several banking institutions have received large fines for non-compliance with these laws and regulations. The Company has developed policies and procedures designed to ensure compliance.




        Our common stock is not insured, so you could lose your total investment.Our common stock is not a deposit or savings account, and will not be insured by the Federal Deposit Insurance Corporation or any other government agency. Should our business decline or fail, you could lose your total investment.

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

Not Applicable.

Item 3.Defaults Upon Senior Securities

Not Applicable.

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

Not Applicable

Item 5.Other Information

The following disclosure is provided pursuant to Item 5.02(e) of Form 8-K.



During the quarter ended December 31, 2006, the Corporation adopted the Fiscal 2007 Leadership Bonus Plan (the Bonus Plan).  The named executive officers disclosed in the Corporations annual meeting proxy statement dated December 18, 2006 are among the employees eligible to participate in the Bonus Plan.  The named executive officers are Michael C. Gerald (President and Chief Executive Officer), Jimmy R. Graham (Executive Vice President), Jerry L. Rexroad (Executive Vice President and Chief Financial Officer), Steven J. Sherry (Executive Vice President) and Phillip G. Stalvey (Executive Vice President).



The Bonus Plan provides for the payment of a cash bonus, calculated as a percentage of the participants annual base salary on October 1, 2006, on a graduated scale based on the Corporations consolidated return on average equity, excluding unrealized gains or losses on investment securities available for sale (the Consolidated ROE).  Realized gains or losses on sales of investment securities, prepayment penalties for early repayment of advances from the Federal Home Loan Bank, expenses related to a change in control transaction, and other non-recurring transactions as determined by the Compensation Committee are excluded when calculating Consolidated ROE.  Any bonuses would be paid semi-annually based on Consolidated ROE calculations for the six months ending March 31, 2007 and for the year ending September 30, 2007.  For purposes of the Bonus Plan, a change
in control transaction is defined in the same manner as defined in the CEO employment agreement.  The merger with BB&T would constitute a change in control transaction.  The Bonus Plan provides for initial semi-annual bonus payments if Consolidated ROE for the six months ending March 31, 2007 equals or exceeds 13.5% and for the remaining semi-annual bonus payments if Consolidated ROE for the year ending September 30, 2007 equals or exceeds 14%.



Provided that the threshold Consolidated ROE targets are satisfied, the Corporations named executive officers would be entitled to receive bonus payments calculated as follows:




Name
        Base Salary on October 1, 2006
        Bonus Range as a Percent of Base SalaryMichael C. Gerald
        $288,750
        26%  to 108%Jimmy R. Graham
        $168,000
        24%  to 104%Jerry L. Rexroad
        $227,850
        24%  to 104%Steven J. Sherry
        $176,925
        24%  to 104%Philip G. Stalvey
        $211,000
        24%  to 104%










25



Item 6.Exhibits

Exhibits





2
        
        Agreement and Plan of Merger as of December 20, 2006 by and between Costal Financial Corporation and BB&T Corporation (8)3
        (a)
        Certificate of Incorporation of Coastal Financial Corporation (1)(b)
        Certificate of Amendment to Certification of Incorporation of Coastal Financial Corporation (4)(c)
        Certificate of Amendment dated February 1, 2006 to the Certificate of Incorporation of Coastal Financial Corporation (7)(d)
        Bylaws of Coastal Financial Corporation (1)10
        (a)
        Employment Agreement with Michael C. Gerald (6)(b)
        Employment Agreement with Jerry L. Rexroad (6)(c)
        Employment Agreement with Philip G. Stalvey (6)(d)
        Employment Agreement with Jimmy R. Graham (6)(e)
        Employment Agreement with Steven J. Sherry (6)(f)
        1990 Stock Option Plan (2)(g)
        Directors Performance Plan (3)(h)
        Coastal Financial Corporation 2000 Stock Option Plan (5)31
        (a)
        Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)(b)
        Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)32
        (a)
        Section 1350 Certification (Chief Executive Officer)(b)
        Section 1350 Certification (Chief Financial Officer)


(1)
        Incorporated by reference to Registration Statement on Form S-4 filed with the Securities and Exchange Commission on November 26, 1990.(2)
        Incorporated by reference to 1995 Form 10-K filed with the Securities and Exchange Commission on December 29, 1995.(3)
        Incorporated by reference to the definitive proxy statement for the 1996 Annual Meeting of Stockholders.(4)
        Incorporated by reference to December 31, 1998 Form 10-Q filed with Securities and Exchange Commission on May 15, 1998.(5)
        Incorporated by reference to the definitive proxy statement for the 2000 Annual Meeting of Stockholders filed December 22, 1999.(6)
        Incorporated by reference to 2003 Form 10-K filed with Securities and Exchange Commission on December 22, 2003.(7)
        Incorporated by reference to March 31, 2006 Form 10-Q filed with the Securities and Exchange Commission on May 10, 2006.(8)
        Incorporated by reference to Form 8-K filed with Securities and Exchange Commission on December 20, 2006.



26



SIGNATURES

Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.





COASTAL FINANCIAL CORPORATIONFebruary 9, 2007
        
        
        /s/ Michael C. GeraldDate
        
        
        Michael C. GeraldPresident and Chief Executive Officer



February 9, 2007
        
        
        /s/ Jerry L. RexroadDate
        
        
        Jerry L. RexroadExecutive Vice President andChief Financial Officer



27