|                                                                     
|---------------------------------------------------------------------
|UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, 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 June 30, 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 of
    incorporation or organization) |  | (I.R.S. Employer
Identification Number)
|                                                                   |  |                                        

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

|Registrants telephone number, including area code (843) 205-2000                                                                                                                                                                                                                                                                                        
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                         
|Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
|                                                                                                                                                                                                                                                                                                                                                         
|YESx                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                         
|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 FileroAccelerated FilerxNon-accelerated Filero                                                                                                                                                                                                                                                                                         
|                                                                                                                                                                                                                                                                                                                                                         
|Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                         
|YESo                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                         
|Indicate the number of shares outstanding of each of the registrants classes of common stock, as of July 31, 2006.                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                                                                                                                         

|Common Stock $.01 Par Value Per Share | 19,679,499 Shares
|------------------------------------- | -----------------
|                                     
|(Class)                               | (Outstanding)    

|
|



|COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESQUARTERLY REPORT ON FORM 10-QFOR THE QUARTER ENDED JUNE 30, 2006
|--------------------------------------------------------------------------------------------------------------
|                                                                                                              

|TABLE
      OF CONTENTS           |                                                                                                      |                                                                                                                                       |      
|--------------------------------- | ---------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------- | -----
|                                  |                                                                                                      |                                                                                                                                       |      
|                                  |                                                                                                      | PAGE                                                                                                                                  |      
|                                  |                                                                                                      |                                                                                                                                       |      
|PART
      I-                     | Financial
      Information                                                                          |                                                                                                                                       |      
|Item                              |                                                                                                      |                                                                                                                                       |      
|                                  | 1.
      Consolidated Financial Statements (unaudited):                                              |                                                                                                                                       |      
|                                  |                                                                                                      |                                                                                                                                       |      
|                                  |                                                                                                      | Consolidated
      Statements of Financial Condition as of September 30, 2005 and
      June 30, 2006                                 |      
|                                  |                                                                                                      | Consolidated
      Statements of Operations for the three months ended June 30, 2005 and 2006                                         |      
|                                  |                                                                                                      | Consolidated
      Statements of Operations for the nine months ended June 30, 2005 and 2006                                          |      
|                                  |                                                                                                      | Consolidated
      Statements of Stockholders Equity and Comprehensive Income for the
      nine months ended June 30, 2005 and 2006 |      
|                                  |                                                                                                      | Consolidated
      Statements of Cash Flows for the nine months ended June 30, 2005 and 2006                                          |      
|                                  |                                                                                                      | Notes
      to Consolidated Financial Statements                                                                                      |      
|                                  | 2.
      Managements Discussion and Analysis of Financial Condition
      and Results of Operations |                                                                                                                                       | 18-29
|                                  | 3.
      Quantitative and Qualitative Disclosures About Market Risk                                  |                                                                                                                                       | 29   
|                                  | 4.
      Controls and Procedures                                                                     |                                                                                                                                       | 30   
|Part
      II - Other Information |                                                                                                      |                                                                                                                                       |      
|Item                              |                                                                                                      |                                                                                                                                       |      
|                                  | 1.    Legal
      Proceedings                                                                        |                                                                                                                                       | 30   
|                                  | 1A. Risk
      Factors                                                                               |                                                                                                                                       | 30-33
|                                  | 2.    Unregistered
      Sales of Equity Securities and Use of Proceeds                              |                                                                                                                                       | 34   
|                                  | 3.    Defaults
      Upon Senior Securities                                                          |                                                                                                                                       | 34   
|                                  | 4.    Submission
      of Matters to a Vote of Securities Holders                                    |                                                                                                                                       | 34   
|                                  | 5.    Other
      Information                                                                        |                                                                                                                                       | 34   
|                                  | 6.    Exhibits                                                                                       |                                                                                                                                       | 34-35
|Signatures                        |                                                                                                      | 36                                                                                                                                    |      
|Exhibits                          |                                                                                                      |                                                                                                                                       |      
|31(a)                             | Rule 13a-14(a)/15d-14(a) Certification (Chief
      Executive Officer)                               |                                                                                                                                       | 37   
|(b)                               | Rule 13a-14(a)/15d-14(a) Certification (Chief
      Financial Officer)                               |                                                                                                                                       | 38   
|32(a)                             | Section 1350 Certification (Chief Executive
      Officer)                                           |                                                                                                                                       | 39   
|(b)                               | Section 1350 Certification (Chief Financial
      Officer)                                           |                                                                                                                                       | 40   

|2
|-



|PART I. FINANCIAL INFORMATIONItem 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
|----------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                  

|                                                                                                                                                                              | September 30,
      2005 |           | June 30,
      2006 |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------ | --------- | ------------------- | -
|
|
|                                                                                                                                                                             
|ASSETS:                                                                                                                                                                       |                          |           |                     |  
|Cash and amounts due from banks                                                                                                                                               | $                        | 52,592    |                     | $
|Short-term interest-bearing deposits                                                                                                                                          |                          | 33,742    |                     |  
|Federal funds sold                                                                                                                                                            |                          | 5,191     |                     |  
|Investment securities available for sale                                                                                                                                      |                          | 25,616    |                     |  
|Mortgage-backed securities available for sale                                                                                                                                 |                          | 399,655   |                     |  
|Investment securities held to maturity (market value $10,049 at 
     September 30, 2005 and $10,000 at June 30, 2006)                                                        |                          | 10,000    |                     |  
|Loans receivable (net of allowance for loan losses of $11,748 at 
     September 30, 2005 and $12,550 at June 30, 2006)                                                       |                          | 924,260   |                     |  
|Loans receivable held for sale                                                                                                                                                |                          | 18,121    |                     |  
|Real estate acquired through foreclosure, net                                                                                                                                 |                          | 818       |                     |  
|Office property and equipment, net                                                                                                                                            |                          | 22,758    |                     |  
|Federal Home Loan Bank (FHLB) stock, at cost                                                                                                                                  |                          | 15,775    |                     |  
|Accrued interest receivable on loans                                                                                                                                          |                          | 3,807     |                     |  
|Accrued interest receivable on securities                                                                                                                                     |                          | 2,351     |                     |  
|Bank-owned life insurance                                                                                                                                                     |                          | 22,574    |                     |  
|Other assets                                                                                                                                                                  |                          | 6,199     |                     |  
|
|                                                                                                                                                                              | $                        | 1,543,459 |                     | $
|
|                                                                                                                                                                              |                          |           |                     |  
|LIABILITIES AND STOCKHOLDERS EQUITY:                                                                                                                                         |                          |           |                     |  
|                                                                                                                                                                              |                          |           |                     |  
|LIABILITIES:                                                                                                                                                                  |                          |           |                     |  
|Deposits                                                                                                                                                                      | $                        | 1,070,918 |                     | $
|Securities sold under agreements to repurchase                                                                                                                                |                          | 41,937    |                     |  
|Advances from FHLB                                                                                                                                                            |                          | 289,007   |                     |  
|Junior subordinated debt                                                                                                                                                      |                          | 15,464    |                     |  
|Drafts outstanding                                                                                                                                                            |                          | 12,890    |                     |  
|Advances by borrowers for property taxes and insurance                                                                                                                        |                          | 1,221     |                     |  
|Accrued interest payable                                                                                                                                                      |                          | 3,415     |                     |  
|Other liabilities                                                                                                                                                             |                          | 11,386    |                     |  
|
|Total Liabilities                                                                                                                                                             |                          | 1,446,238 |                     |  
|
|                                                                                                                                                                              |                          |           |                     |  
|STOCKHOLDERS EQUITY:                                                                                                                                                         |                          |           |                     |  
|Serial preferred stock, 1,000,000 shares authorized and unissued                                                                                                              |                          |          |                     |  
|Common stock, $.01 par value, 50,000,000 shares authorized; 
     19,457,492 shares at September 30, 2005 and 19,678,327 shares at 
     June 30, 2006 issued and outstanding |                          | 195       |                     |  
|Additional paid-in capital                                                                                                                                                    |                          | 11,410    |                     |  
|Retained earnings, restricted                                                                                                                                                 |                          | 86,723    |                     |  
|Accumulated other comprehensive loss, net of tax                                                                                                                              |                          | (1,107    | )                   |  
|
|Total stockholders equity                                                                                                                                                    |                          | 97,221    |                     |  
|
|                                                                                                                                                                              | $                        | 1,543,459 |                     | $
|

|                                                           
|-----------------------------------------------------------
|SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|3
|-



|PART I. FINANCIAL INFORMATIONItem 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSFOR THE THREE MONTHS ENDED JUNE 30, 2005 AND 2006
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                          

|                                                                   | 2005 |            | 2006 |  
|------------------------------------------------------------------ | ---- | ---------- | ---- | -
|
|                                                                   |     
|                                                                  
|Interest income:                                                   |      |            |      |  
|Loans receivable                                                   | $    | 14,807     |      | $
|Investment securities                                              |      | 1,277      |      |  
|Mortgage-backed securities                                         |      | 4,147      |      |  
|Other                                                              |      | 106        |      |  
|
|Total interest income                                              |      | 20,337     |      |  
|
|                                                                   |      |            |      |  
|Interest expense:                                                  |      |            |      |  
|Deposits                                                           |      | 3,856      |      |  
|Securities sold under agreements to repurchase                     |      | 760        |      |  
|Advances from FHLB                                                 |      | 2,981      |      |  
|Junior subordinated debt                                           |      | 234        |      |  
|
|Total interest expense                                             |      | 7,831      |      |  
|
|Net interest income                                                |      | 12,506     |      |  
|Provision for loan losses                                          |      | 550        |      |  
|
|Net interest income after provision for loan losses                |      | 11,956     |      |  
|
|                                                                   |      |            |      |  
|Other income:                                                      |      |            |      |  
|Fees and service charges on loan and deposit accounts              |      | 1,611      |      |  
|Gain on sales of loans and loans receivable held for sale          |      | 215        |      |  
|Gain on sales of investment securities, net                        |      | 15         |      |  
|Loss on sales of mortgage-backed securities, net                   |      | (142       | )    |  
|Gain (loss) from real estate acquired through foreclosure, net     |      | (28        | )    |  
|Income from sales of non-depository products                       |      | 441        |      |  
|FHLB stock dividends                                               |      | 183        |      |  
|Income from ATM and debit card transactions                        |      | 418        |      |  
|Bank-owned life insurance                                          |      | 235        |      |  
|Other income                                                       |      | 153        |      |  
|
|Total other income                                                 |      | 3,101      |      |  
|
|                                                                   |      |            |      |  
|General and administrative expenses:                               |      |            |      |  
|Salaries and employee benefits                                     |      | 4,612      |      |  
|Net occupancy, furniture and fixtures and data processing expenses |      | 1,229      |      |  
|Depreciation                                                       |      | 739        |      |  
|FDIC insurance premium                                             |      | 26         |      |  
|Marketing expenses                                                 |      | 463        |      |  
|Expense from ATM and debit card transactions                       |      | 279        |      |  
|Other expense                                                      |      | 1,072      |      |  
|
|Total general and administrative expense                           |      | 8,420      |      |  
|
|Income before income taxes                                         |      | 6,637      |      |  
|Income taxes                                                       |      | 2,281      |      |  
|
|Net income                                                         | $    | 4,356      |      | $
|
|                                                                   |      |            |      |  
|Net income per common share:                                       |      |            |      |  
|Basic                                                              | $    | 0.22       |      | $
|
|Diluted                                                            | $    | 0.21       |      | $
|
|                                                                   |      |            |      |  
|Dividends declared per common share                                | $    | 0.04       |      | $
|
|                                                                   |      |            |      |  
|Weighted average common shares outstanding:                        |      |            |      |  
|Basic                                                              |      | 19,423,000 |      |  
|
|Diluted                                                            |      | 20,497,000 |      |  
|

|                                                           
|-----------------------------------------------------------
|SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|4
|-



|PART I. FINANCIAL INFORMATIONItem 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSFOR THE NINE MONTHS ENDED JUNE 30, 2005 AND 2006
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                         

|                                                                   | 2005 |            | 2006 |  
|------------------------------------------------------------------ | ---- | ---------- | ---- | -
|
|                                                                   |     
|                                                                  
|Interest income:                                                   |      |            |      |  
|Loans receivable                                                   | $    | 40,911     |      | $
|Investment securities                                              |      | 3,652      |      |  
|Mortgage-backed securities                                         |      | 12,403     |      |  
|Other                                                              |      | 229        |      |  
|
|Total interest income                                              |      | 57,195     |      |  
|
|                                                                   |      |            |      |  
|Interest expense:                                                  |      |            |      |  
|Deposits                                                           |      | 9,290      |      |  
|Securities sold under agreements to repurchase                     |      | 2,074      |      |  
|Advances from FHLB                                                 |      | 9,277      |      |  
|Junior subordinated debt                                           |      | 637        |      |  
|
|Total interest expense                                             |      | 21,278     |      |  
|
|Net interest income                                                |      | 35,917     |      |  
|Provision for loan losses                                          |      | 1,525      |      |  
|
|Net interest income after provision for loan losses                |      | 34,392     |      |  
|
|                                                                   |      |            |      |  
|Other income:                                                      |      |            |      |  
|Fees and service charges on loan and deposit accounts              |      | 4,124      |      |  
|Gain on sales of loans and loans receivable held for sale          |      | 769        |      |  
|Gain on sales of investment securities, net                        |      | 32         |      |  
|Gain (loss) on sales of mortgage-backed securities, net            |      | 87         |      |  
|Gain on investment security held to maturity called by issuer      |      | 160        |      |  
|Gain (loss) from real estate acquired through foreclosure, net     |      | (73        | )    |  
|Income from sales of non-depository products                       |      | 1,371      |      |  
|FHLB stock dividends                                               |      | 534        |      |  
|Income from ATM and debit card transactions                        |      | 1,042      |      |  
|Bank-owned life insurance                                          |      | 709        |      |  
|Other income                                                       |      | 449        |      |  
|
|Total other income                                                 |      | 9,204      |      |  
|
|General and administrative expenses:                               |      |            |      |  
|Salaries and employee benefits                                     |      | 13,532     |      |  
|Net occupancy, furniture and fixtures and data processing expenses |      | 3,557      |      |  
|Depreciation                                                       |      | 2,010      |      |  
|FDIC insurance premium                                             |      | 79         |      |  
|Marketing expenses                                                 |      | 1,456      |      |  
|Expense from ATM and debit card transactions                       |      | 744        |      |  
|Other expense                                                      |      | 3,142      |      |  
|
|Total general and administrative expense                           |      | 24,520     |      |  
|
|Income before income taxes                                         |      | 19,076     |      |  
|Income taxes                                                       |      | 6,541      |      |  
|
|Net income                                                         | $    | 12,535     |      | $
|
|                                                                   |      |            |      |  
|Net income per common share:                                       |      |            |      |  
|Basic                                                              | $    | 0.65       |      | $
|
|Diluted                                                            | $    | 0.61       |      | $
|
|                                                                   |      |            |      |  
|Dividends declared per common share                                | $    | 0.13       |      | $
|
|                                                                   |      |            |      |  
|Weighted average common shares outstanding:                        |      |            |      |  
|Basic                                                              |      | 19,314,000 |      |  
|
|Diluted                                                            |      | 20,400,000 |      |  
|

|                                                           
|-----------------------------------------------------------
|SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|5
|-



|PART I. FINANCIAL INFORMATIONItem 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOMEFOR THE NINE MONTHS ENDED JUNE 30, 2005 AND 2006
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                            

|                                                                                                           | Common
      Stock |     | Additional
      Paid-in
      Capital |   | Retained
      Earnings |  | Treasury
      Stock |        | Accumulated
      Other
      Compre-
      hensive
      Income
      (Loss) |   | Total
      Stockholders
      Equity |  
|---------------------------------------------------------------------------------------------------------- | ------------------ | --- | -------------------------------------- | - | ----------------------- |  | -------------------- | ------ | ----------------------------------------------------------------------------- | - | -------------------------------------- | -
|
|
|
|Balance at September 30, 2004                                                                              | $                  | 192 |                                        | $ | 10,607                  |  | $                    | 73,533 |                                                                               | $ | (1,182                                 | )
|Net income                                                                                                 |                    |    |                                        |   |                        |  |                      | 12,535 |                                                                               |   |                                       |  
|Other comprehensive income:                                                                                |                    |     |                                        |   |                         |  |                      |        |                                                                               |   |                                        |  
|Unrealized losses arising during
      period, net of tax benefit of $392                                  |                    |    |                                        |   |                        |  |                      |       |                                                                               |   |                                       |  
|                                                                                                          
|Less: reclassification adjustment
      for gains included in net income
      net of taxes of $45         |                    |    |                                        |   |                        |  |                      |       |                                                                               |   |                                       |  
|                                                                                                           |                    |     |                                        |   |                         |  |                      |        |                                                                               |   |                                        |  
|Other comprehensive income                                                                                 |                    |    |                                        |   |                        |  |                      |       |                                                                               |   |                                       |  
|                                                                                                           |                    |     |                                        |   |                         |  |                      |        |                                                                               |   |                                        |  
|Comprehensive income                                                                                       |                    |    |                                        |   |                        |  |                      |       |                                                                               |   |                                       |  
|                                                                                                           |                    |     |                                        |   |                         |  |                      |        |                                                                               |   |                                        |  
|Exercise of stock options,
      including tax benefits of $347                                            |                    | 2   |                                        |   | 546                     |  |                      | (602   | )                                                                             |   | 1,182                                  |  
|Cash dividends                                                                                             |                    |    |                                        |   |                        |  |                      | (2,468 | )                                                                             |   |                                       |  
|
|Balance at June 30, 2005                                                                                   | $                  | 194 |                                        | $ | 11,153                  |  | $                    | 82,998 |                                                                               | $ |                                       |  
|
|                                                                                                           |                    |     |                                        |   |                         |  |                      |        |                                                                               |   |                                        |  
|Balance at September 30, 2005                                                                              | $                  | 195 |                                        | $ | 11,410                  |  | $                    | 86,723 |                                                                               | $ |                                       |  
|Net Income                                                                                                 |                    |    |                                        |   |                        |  |                      | 14,025 |                                                                               |   |                                       |  
|Other comprehensive income:                                                                                |                    |     |                                        |   |                         |  |                      |        |                                                                               |   |                                        |  
|Unrealized losses arising during
      period, net of tax benefit of $4,395                                |                    |    |                                        |   |                        |  |                      |       |                                                                               |   |                                       |  
|                                                                                                          
|Less: reclassification adjustment
      for losses included in net income
      net of tax benefit of $174 |                    |    |                                        |   |                        |  |                      |       |                                                                               |   |                                       |  
|                                                                                                           |                    |     |                                        |   |                         |  |                      |        |                                                                               |   |                                        |  
|Other comprehensive income                                                                                 |                    |    |                                        |   |                        |  |                      |       |                                                                               |   |                                       |  
|                                                                                                           |                    |     |                                        |   |                         |  |                      |        |                                                                               |   |                                        |  
|Comprehensive income                                                                                       |                    |    |                                        |   |                        |  |                      |       |                                                                               |   |                                       |  
|                                                                                                           |                    |     |                                        |   |                         |  |                      |        |                                                                               |   |                                        |  
|Exercise of stock options, including
      tax benefit of $326                                             |                    | 2   |                                        |   | 1,085                   |  |                      |       |                                                                               |   |                                       |  
|                                                                                                          
|Stock compensation expense,
      net of tax of $42                                                        |                    |    |                                        |   | 69                      |  |                      |       |                                                                               |   |                                       |  
|Cash dividends                                                                                             |                    |    |                                        |   |                        |  |                      | (2,938 | )                                                                             |   |                                       |  
|
|Balance at June 30, 2006                                                                                   | $                  | 197 |                                        | $ | 12,564                  |  | $                    | 97,810 |                                                                               | $ |                                       |  
|

|                                                           
|-----------------------------------------------------------
|SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|6
|-



|Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS
  FOR THE NINE MONTHS ENDED JUNE 30, 2005 AND 2006
|-----------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                               

|                                                                              | 2005 |                                 | 2006     |  
|----------------------------------------------------------------------------- | ---- | ------------------------------- | -------- | -
|                                                                              |      |                                 |          |  
|                                                                              |      | (Unaudited) 
    (In thousands) |         
|                                                                             
|Cash flows from operating activities:                                         |      |                                 |          |  
|Net income                                                                    |      | $                               | 12,535   |  
|Adjustments to reconcile net income to net cash                               |      |                                 |          |  
|Provided by operating activities:                                             |      |                                 |          |  
|Depreciation                                                                  |      |                                 | 2,010    |  
|Provision for loan losses                                                     |      |                                 | 1,525    |  
|Gain on sale of investment securities available for sale, net                 |      |                                 | (32      | )
|(Gain) loss on sale of mortgage-backed securities available for sale, net     |      |                                 | (87      | )
|Gain on call of investment security called by issuer                          |      |                                 | (160     | )
|Stock option compensation expense                                             |      |                                 |         |  
|Loss on disposal of office properties and equipment                           |      |                                 | 124      |  
|Origination of loans receivable held for sale                                 |      |                                 | (46,843  | )
|Proceeds from sale of loans and loans receivable held for sale, net           |      |                                 | 12,306   |  
|Recovery from write-down of mortgage servicing rights                         |      |                                 | (223     | )
|Proceeds from securitization and sales of loans receivable held for sale, net |      |                                 | 33,657   |  
|Tax benefit from the exercise of stock options                                |      |                                 | (347     | )
|Increase in:                                                                  |      |                                 |          |  
|Cash value of life insurance                                                  |      |                                 | (709     | )
|Accrued interest receivable                                                   |      |                                 | (562     | )
|Other assets                                                                  |      |                                 | (5,098   | )
|Increase (decrease) in:                                                       |      |                                 |          |  
|Accrued interest payable                                                      |      |                                 | 1,228    |  
|Other liabilities                                                             |      |                                 | 1,661    |  
|                                                                              |      |                                 |          |  
|Net cash provided by operating activities                                     |      |                                 | 10,985   |  
|                                                                              |      |                                 |          |  
|                                                                              |      |                                 |          |  
|Cash flows from investing activities:                                         |      |                                 |          |  
|Proceeds from sales of investment securities available for sale               |      |                                 | 3,643    |  
|Proceeds from sales of mortgage-backed securities available for sale          |      |                                 | 145,392  |  
|Proceeds from issuer call of investment securities held to maturity           |      |                                 | 8,000    |  
|Proceeds from issuer call of investment securities available for sale         |      |                                 | 1,950    |  
|Purchases of investment securities available for sale                         |      |                                 | (3,659   | )
|Purchases of investment securities held to maturity                           |      |                                 | (10,000  | )
|Purchases of mortgage-backed securities available for sale                    |      |                                 | (243,250 | )
|Principal collected on mortgage-backed securities available for sale          |      |                                 | 66,892   |  
|Origination of loans receivable, net                                          |      |                                 | (587,153 | )
|Purchases of loans receivable                                                 |      |                                 |         |  
|Proceeds from sales of commercial loan participations                         |      |                                 | 19,456   |  
|Principal collected on loans receivable, net                                  |      |                                 | 453,382  |  
|Proceeds from sales of real estate acquired through foreclosure, net          |      |                                 | 1,081    |  
|Purchases of office properties and equipment                                  |      |                                 | (5,118   | )
|Change in FHLB stock, net                                                     |      |                                 | 1,373    |  
|                                                                              |      |                                 |          |  
|Net cash used in investing activities                                         |      |                                 | (148,011 | )
|                                                                              |      |                                 |          |  

|           
|-----------
|(CONTINUED)

|7
|-



|PART I. FINANCIAL INFORMATION
  Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
  CONSOLIDATED STATEMENTS OF CASH FLOWS
  FOR THE NINE MONTHS ENDED JUNE 30, 2005 AND 2006 (CONTINUED)
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                              

|                                                                                                                              | 2005 |                                         | 2006     |  
|----------------------------------------------------------------------------------------------------------------------------- | ---- | --------------------------------------- | -------- | -
|                                                                                                                              |      |                                         |          |  
|                                                                                                                              |      | (Unaudited)
      
      (In thousands) |         
|                                                                                                                             
|Cash flows
      from financing activities:                                                                                   |      |                                         |          |  
|Increase
      (decrease) in deposits, net                                                                                    |      | $                                       | 254,227  |  
|Increase
      (decrease) in securities sold under agreements to repurchase, net                                              |      |                                         | (42,155  | )
|Proceeds
      from FHLB advances                                                                                             |      |                                         | 544,400  |  
|Repayments
      of FHLB advances                                                                                             |      |                                         | (589,400 | )
|Decrease
      in advance payments by borrowers for property taxes and insurance, net                                         |      |                                         | (336     | )
|Increase
      (decrease) in drafts outstanding, net                                                                          |      |                                         | 1,370    |  
|Cash dividends
      to stockholders                                                                                          |      |                                         | (2,468   | )
|Proceeds
      from exercise of stock options                                                                                 |      |                                         | 781      |  
|Tax benefit
      from the exercise of stock options                                                                          |      |                                         | 347      |  
|                                                                                                                              |      |                                         |          |  
|Net cash
      provided by financing activities                                                                               |      |                                         | 166,766  |  
|                                                                                                                              |      |                                         |          |  
|Net increase
      (decrease) in cash and cash equivalents                                                                    |      |                                         | 29,740   |  
|Cash and
      cash equivalents at beginning of period                                                                        |      |                                         | 29,652   |  
|                                                                                                                              |      |                                         |          |  
|Cash and
      cash equivalents at end of period                                                                              |      | $                                       | 59,392   |  
|                                                                                                                              |      |                                         |          |  
|                                                                                                                              |      |                                         |          |  
|Supplemental
      information:                                                                                               |      |                                         |          |  
|Interest
      paid                                                                                                           |      | $                                       | 20,050   |  
|                                                                                                                              |      |                                         |          |  
|Income taxes
      paid                                                                                                       |      | $                                       | 5,040    |  
|                                                                                                                              |      |                                         |          |  
|                                                                                                                              |      |                                         |          |  
|Supplemental
      schedule of non-cash investing and financing transactions:                                                 |      |                                         |          |  
|Transfer
      of mortgage loans to real estate acquired through foreclosure                                                  |      | $                                       | 818      |  
|                                                                                                                              |      |                                         |          |  
|Securitization
      of mortgage loans into mortgage-backed securities                                                        |      | $                                       | 33,657   |  
|                                                                                                                              |      |                                         |          |  
|                                                                                                                              |      |                                         |          |  
|Change in
      unrealized loss in investment securities and mortgage-backed 
      securities available for sale, net of tax |      | $                                       | (714     | )
|                                                                                                                              |      |                                         |          |  
|Transfer
      of loans held for sale to loans receivable                                                                     |      | $                                       |         |  
|                                                                                                                              |      |                                         |          |  

|                                                           
|-----------------------------------------------------------
|SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

|8
|-



|PART I. FINANCIAL INFORMATIONItem 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements were prepared in accordance with instructions
for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation
of financial condition, results of operations, cash flows and changes in stockholders equity
and comprehensive income in conformity with accounting principles generally accepted in the United
States of America. All adjustments, consisting only of normal recurring accruals, which in the opinion
of management are necessary for fair presentation of the interim financial statements, have been
included. The results of operations for the three and nine-month periods ended June 30, 2006 are
not necessarily indicative of the results that may be expected for the entire fiscal year. These
unaudited consolidated financial statements should be read in conjunction with Coastal Financial
Corporation and Subsidiaries (the Company) audited consolidated financial statements
and related notes for the year ended September 30, 2005, included in the Companys 2005 Annual
Report to Stockholders. The principal business of the Company is conducted by its wholly-owned subsidiary,
Coastal Federal Bank (the Bank). The information presented herein, therefore, relates
primarily to the Bank.
Certain prior period amounts have been reclassified to conform to current year presentation.
(2) INVESTMENT SECURITIES AVAILABLE FOR SALE
The unrealized losses on investment securities were attributable to increases in interest rates, rather
than credit quality deterioration. The investment securities that had continuous losses of less than
12 months are comprised of seven securities at September 30, 2005 totaling $18,000 and forty-seven
securities at June 30, 2006 totaling $505,000. The investment securities that had continuous losses
12 months or longer are comprised of six securities at September 30, 2005 totaling $33,000 and five
securities at June 30, 2006 totaling $139,000. None of the individual investment securities had an
unrealized loss that exceeded 10% of its amortized cost in either period. At September 30, 2005 and
June 30, 2006, substantially all investment securities were rated AAA or higher. At September 30,
2005 and June 30, 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, 2005  |                                  
|----------------------- | ------------------- | ---------------------------------
|                        |                     |                                  
|                        | Less than 12 Months |                                  
|                        |                     |                                  
|                        | Fair
      Value    |                                  
|                        |                     |                                  
|                        |                     | (Unaudited) 
      (In thousands)
|                       
|Collateralized Mortgage |                     |                                  
|Obligations             |                     | $                                
|FNMA                    |                     |                                  
|GNMA                    |                     |                                  
|FHLMC                   |                     |                                  
|                        |                     |                                  
|                        |                     | $                                
|                        |                     |                                  
|                        |                     |                                  
|                        | June 30, 2006       |                                  
|                        |                     |                                  
|                        | Less than 12 Months |                                  
|                        |                     |                                  
|                        | Fair
      Value    |                                  
|                        |                     |                                  
|                        |                     | (Unaudited) 
      (In thousands)
|                       
|Collateralized Mortgage |                     |                                  
|Obligations             |                     | $                                
|FNMA                    |                     |                                  
|GNMA                    |                     |                                  
|FHLMC                   |                     |                                  
|                        |                     |                                  
|                        |                     | $                                
|                        |                     |                                  
|                        |                     |                                  
|                        |                     |                                  

|9
|-



|PART I. FINANCIAL INFORMATIONItem 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
(3) MORTGAGE-BACKED SECURITIES AVAILABLE FOR SALE - CONTINUED
The unrealized losses on mortgage-backed securities were attributable to increases in interest rates,
rather than credit quality deterioration. The unrealized losses are comprised of 72 securities at
September 30, 2005 and 101 securities at June 30, 2006 that have had continuous losses of less than
12 months. There were 10 securities at September 30, 2005 and 41 securities at June 30, 2006 with
continuous losses 12 months or longer. None of the individual mortgage-backed securities had an unrealized
loss that exceeded 10% of its amortized cost at September 30, 2005. One of the mortgage-backed securities
had unrealized losses which exceeded 10% of its amortized cost by an immaterial amount at June 30,
2006. At September 30, 2005 and June 30, 2006, all mortgage-backed securities were rated AAA or higher.
At September 30, 2005 and June 30, 2006, none of the Companys securities were considered impaired.
(4) LOANS RECEIVABLE, NET
Loans receivable, net, consists of the following:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

|                                           | September 30,
      2005 |  | June 30, 
      2006              |        
|------------------------------------------ | ------------------------ |  | --------------------------------- | -------
|                                           |                          |  |                                   |        
|                                           |                          |  | (Unaudited) 
      (In thousands) |        
|                                          
|First mortgage loans:                      |                          |  |                                   |        
|Single family to four family units         |                          |  | $                                 | 352,893
|Land and land development                  |                          |  |                                   | 121,170
|Residential lots                           |                          |  |                                   | 37,112 
|Other, primarily commercial real estate    |                          |  |                                   | 211,432
|Construction loans on residential property |                          |  |                                   | 127,970
|Construction loans on commercial property  |                          |  |                                   | 14,989 
|                                           |                          |  |                                   |        
|Consumer and commercial loans:             |                          |  |                                   |        
|Installment consumer loans                 |                          |  |                                   | 19,115 
|Mobile home loans                          |                          |  |                                   | 4,308  
|Savings account loans                      |                          |  |                                   | 1,883  
|Equity lines of credit                     |                          |  |                                   | 34,019 
|Commercial and other loans                 |                          |  |                                   | 38,691 
|                                           |                          |  |                                   |        
|                                           |                          |  |                                   | 963,582
|                                           |                          |  |                                   |        
|Less:                                      |                          |  |                                   |        
|Allowance for loan losses                  |                          |  |                                   | 11,748 
|Deferred loan costs, net                   |                          |  |                                   | (771   
|Undisbursed portion of loans in process    |                          |  |                                   | 28,345 
|                                           |                          |  |                                   |        
|                                           |                          |  | $                                 | 924,260
|                                           |                          |  |                                   |        

|10
|--



|PART I. FINANCIAL INFORMATIONItem 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
The changes in the allowance for loan losses consist of the following for the nine months ended:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                     

|                                 | Nine Months Ended June 30 | 
|-------------------------------- | ------------------------- | 
|                                 |                           | 
|                                 | 2005                      | 
|                                 |                           | 
|                                 |                           | 
|                                
|Allowance at beginning of period |                           | 
|Provision for loan losses        |                           | 
|                                 |                           | 
|Recoveries:                      |                           | 
|Residential loans                |                           | 
|Commercial loans                 |                           | 
|Consumer loans                   |                           | 
|                                 |                           | 
|Total recoveries                 |                           | 
|                                 |                           | 
|Charge-offs:                     |                           | 
|Residential loans                |                           | 
|Commercial loans                 |                           | 
|Consumer loans                   |                           | 
|                                 |                           | 
|Total charge-offs                |                           | 
|                                 |                           | 
|Net charge-offs                  |                           | 
|                                 |                           | 
|Allowance at end of period       |                           | 
|                                 |                           | 
|                                 |                           | 

|                                                                              | Nine Months Ended June 30, |            
|----------------------------------------------------------------------------- | -------------------------- | -----------
|                                                                              |                            |            
|                                                                              | 2005                       |            
|                                                                              |                            |            
|                                                                              |                            | (Unaudited)
|Ratio of allowance to total net loans outstanding at the end of the period    |                            |            
|                                                                              |                            |            
|Ratio of net charge-offs to average total loans outstanding during the period |                            |            
|(annualized)                                                                  |                            |            
|                                                                              |                            |            

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Non-accrual loans, which are primarily loans over ninety days delinquent, totaled approximately $2.6
million and $1.3 million at September 30, 2005 and June 30, 2006, respectively. For the nine months
ended June 30, 2005 and 2006, interest income, which would have been recorded, would have been approximately
$241,000 and $187,000, respectively, had non-accruing loans been current in accordance with their
original terms.
At September 30, 2005 and June 30, 2006 impaired loans totaled $2.6 million and $1.9 million, respectively.
Included in the allowance for loan losses at September 30, 2005 was $434,000 related to impaired
loans compared to $101,000 at June 30, 2006. The average recorded investment in impaired loans for
the year ended September 30, 2005 was $3.7 million compared to $2.7 million for the nine months ended
June 30, 2006. Interest income of $32,000 and $111,000 was recognized on impaired loans for the quarter
and nine months ended June 30, 2006. Interest income of $133,000 and $232,000 was recognized on impaired
loans for the quarter and nine months ended June 30, 2005, respectively.

|11
|--



|PART I. FINANCIAL INFORMATIONItem 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
(5) DEPOSITS
Deposits consist of the following:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                    

|                           | **September 30, 2005**                      |           | **June 30, 2006**                     | 
|-------------------------- | ------------------------------------------- | --------- | ------------------------------------- | 
|                           |                                             |           |                                       | 
|                           | **Amount**                                  |           | **Weighted
      Average
      Rate** | 
|                           |                                             |           |                                       | 
|                           | **(Unaudited) 
    (Dollars in thousands)** |          
|                          
|Checking accounts:         |                                             |           |                                       | 
|Noninterest-bearing        | $                                           | 219,080   |                                       | 
|Interest-bearing           |                                             | 139,810   |                                       | 
|                           |                                             |           |                                       | 
|Total checking accounts    |                                             | 358,890   |                                       | 
|Money market accounts      |                                             | 213,078   |                                       | 
|Statement savings accounts |                                             | 71,824    |                                       | 
|Certificate accounts       |                                             | 427,126   |                                       | 
|                           |                                             |           |                                       | 
|                           | $                                           | 1,070,918 |                                       | 
|                           |                                             |           |                                       | 

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Included in certificate accounts (CDs) are $169.9 million of brokered CDs at September
30, 2005 and $135.2 million at June 30, 2006. The average rate and remaining term of brokered CDs
at September 30, 2005 was 3.51% and approximately four months, respectively. The average rate and
remaining term of brokered CDs at June 30, 2006 was 4.68% and approximately three months, respectively.
(6) ADVANCES FROM FEDERAL HOME LOAN BANK
Advances from Federal Home Loan Bank (FHLB) consist of the following:
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

|                     | **September 30, 2005**                      |         | **June 30, 2006**                     | 
|-------------------- | ------------------------------------------- | ------- | ------------------------------------- | 
|                     |                                             |         |                                       | 
|                     | **Amount**                                  |         | **Weighted
      Average
      Rate** | 
|                     |                                             |         |                                       | 
|                     | **(Unaudited) 
    (Dollars in thousands)** |        
|                    
|Fiscal Year Maturing |                                             |         |                                       | 
|2006                 | $                                           | 4,177   |                                       | 
|2007                 |                                             | 3,560   |                                       | 
|2008                 |                                             | 3,977   |                                       | 
|2009                 |                                             | 31,803  |                                       | 
|2010                 |                                             | 63,651  |                                       | 
|After fiscal 2010    |                                             | 181,839 |                                       | 
|                     |                                             |         |                                       | 
|                     | $                                           | 289,007 |                                       | 
|                     |                                             |         |                                       | 

|                                                                                                                                                                                                                                                                                                                                                                                                           
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|At September 30, 2005, and June 30, 2006, the Bank had pledged first mortgage loans and mortgage-backed
securities with unpaid balances of approximately $362.5 million and $443.7 million, respectively,
as collateral for FHLB advances. At June 30, 2006, the excess first mortgage loans and mortgage-backed
securities collateral pledged to FHLB will support additional borrowings of $88.1 million.

|12
|--



|PART I. FINANCIAL INFORMATIONItem 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
Callable advances at June 30, 2006 are summarized as follows:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                  

|                      | **June 30, 2006**                             |         |                                        
|--------------------- | --------------------------------------------- | ------- | ---------------------------------------
|                      |                                               |         |                                        
|                      | **Amount**                                    |         | **Weighted 
      Average 
      Rate**
|                      |                                               |         |                                        
|                      | **(Unaudited) 
      (Dollars in thousands)** |         |                                        
|                     
|Fiscal Year Callable: |                                               |         |                                        
|2006                  | $                                             | 39,000  |                                        
|2007                  |                                               | 45,000  |                                        
|2008                  |                                               | 37,000  |                                        
|2009                  |                                               | 75,000  |                                        
|2010                  |                                               |        |                                        
|After fiscal 2010     |                                               | 25,000  |                                        
|                      |                                               |         |                                        
|                      | $                                             | 221,000 |                                        
|                      |                                               |         |                                        

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Call provisions are more likely to be exercised by the FHLB when market interest rates rise. If called,
the Bank may be required to replace these advances with higher cost funds.
(7)   EARNINGS PER SHARE
Basic earnings per share for the quarter and nine months ended June 30, 2005 and 2006 are computed
by dividing net income by the weighted average common shares outstanding during the respective periods.
Diluted earnings per share for the quarter and nine months ended June 30, 2005 and 2006 are computed
by dividing net earnings by the weighted average dilutive shares outstanding during the respective
periods. At June 30, 2006, the Company had antidilutive securities of approximately 477,500 options
to purchase shares by Directors and Associates. The average exercise price for these anti-dilutive
securities was approximately $14.16 per share.
The following is a reconciliation of average shares outstanding used to calculate basic and fully diluted
earnings per share.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

|                                                | **For the Quarter Ended June 30,** |           
|----------------------------------------------- | ---------------------------------- | ----------
|                                                |                                    |           
|                                                | **(Unaudited)**                    |           
|                                               
|                                                | **2005**                           |           
|                                                |                                    |           
|                                                | **Basic**                          |           
|                                                |                                    |           
|Weighted average shares outstanding             |                                    | 19,423,000
|Effect of dilutive securities-
   stock options |                                    |          
|                                                |                                    |           
|                                                |                                    | 19,423,000
|                                                |                                    |           
|                                                |                                    |           

|                                               | **For the Nine Months Ended June 30,** |           
|---------------------------------------------- | -------------------------------------- | ----------
|                                               |                                        |           
|                                               | **(Unaudited)**                        |           
|                                              
|                                               | **2005**                               |           
|                                               |                                        |           
|                                               | **Basic**                              |           
|                                               |                                        |           
|Weighted average shares outstanding            |                                        | 19,314,000
|Effect of dilutive securities-
  stock options |                                        |          
|                                               |                                        |           
|                                               |                                        | 19,314,000
|                                               |                                        |           

|13
|--



|I. FINANCIAL INFORMATIONItem 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
(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 June 30, 2006, the Company had one stock-based payment plan for directors, officers and other key
Associates, which is described below. Prior to October 1, 2005, the Company, as permitted under SFAS
123, applied the intrinsic value method under APB 25, and related interpretations in accounting for
its stock-based compensation plan.
Effective October 1, 2005, the Company adopted the provisions of SFAS 123(R) thereby expensing employee
stock-based compensation using the fair value method prospectively for all awards granted, modified,
or settled on or after October 1, 2005. The fair value at the date of grant of the stock option is
estimated using the Black-Scholes option-pricing model based on assumptions noted in a table below.
The dividend yield is based on estimated future dividend yields. The risk-free rate for periods within
the contractual term of the share option is based on the U.S. Treasury yield curve in effect at the
time of grant. Expected volatilities are generally based on historical volatilities. The expected
term of share options granted is generally derived from historical experience. Compensation expense
is recognized on a straight-line basis over the stock option vesting period. The impact of adoption
of the fair value based method for expense recognition of employee awards resulting in expense of
approximately $69,000, net of tax benefit of approximately $42,000, during the nine months ended June 30, 2006.
The Companys stock option plan (the Plan), which is stockholder approved, provides
for stock options to be granted primarily to directors, officers and other key Associates. Options
granted under the stock option plan may be incentive stock options or non-incentive stock options.
Share option awards are generally granted with an exercise price equal to, or higher than, the market
price of the Companys shares at the date of grant. Options vest ratably over a five-year period
and expire after ten years from the date of grant, except as discussed below. Share options awards
provide for accelerated vesting if there is a change in control, as defined in the Plan. The remaining
shares of stock reserved for the stock option plan at June 30, 2006 amounted to approximately 111,000
shares.
Options awarded prior to September 21, 2005 vest ratably over a five-year period. Effective September
21, 2005, the vesting period for approximately 731,000 options awarded during the fiscal 2003, 2004
and 2005 through September 20, 2005 that would have otherwise vested at various times through fiscal
2010 was accelerated, as more fully described in note 1(p) of the 2005 Annual Report to Stockholders.
All other terms and conditions of the accelerated options remain unchanged as a result of the acceleration.
In addition, in September 2005, the Company granted options to employees, officers and directors
of approximately 390,000 shares, without a vesting requirement. All options expire ten years after
the date of grant.
The weighted average fair value of all of the options granted during the nine months ended June 30
have been estimated using the Black-Scholes option-pricing model with the following assumptions (unaudited):
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

| |                                          | **2005** |       | **2006** | 
| | ---------------------------------------- | -------- | ----- | -------- | 
| |                                          |          |       |          | 
| | Dividend yield                           |          | 1.11  | %        | 
| | Weighted average risk-free interest rate |          | 4.20  | %        | 
| | Weighted average expected volatility     |          | 35.25 | %        | 
| | Weighted average expected life in years  |          | 7.50  |          | 

|14
|--



|PART I. FINANCIAL INFORMATIONItem 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  CONTINUED
(8) STOCK BASED COMPENSATION (continued)
A summary of share option activity for the nine months ended June 30, 2006 follows:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                   

|                                  | Number
      Of
      Shares |           | Weighted
      Average
      Exercise
      Price |   | Weighted
      Average
      Remaining
      Contractual
      Life (Years) |  | Aggregate
      Intrinsic
      Value | 
|--------------------------------- | ---------------------------- | --------- | ------------------------------------------------- | - | --------------------------------------------------------------------------- |  | ------------------------------------- | 
|                                  |                              |           |                                                   |   |                                                                             |  |                                       | 
|
|                                 
|Outstanding at September 30, 2005 |                              | 2,811,609 |                                                   | $ | 8.52                                                                        |  |                                       | 
|Granted                           |                              | 4,000     |                                                   | $ | 13.15                                                                       |  |                                       | 
|Exercised                         |                              | (252,574  | )                                                 | $ | 4.94                                                                        |  |                                       | 
|Forfeited or expired              |                              | (8,193    | )                                                 | $ | 11.11                                                                       |  |                                       | 
|                                  |                              |           |                                                   |   |                                                                             |  |                                       | 
|Outstanding at June 30, 2006      |                              | 2,554,842 |                                                   | $ | 8.88                                                                        |  | 5.9                                   | 
|                                  |                              |           |                                                   |   |                                                                             |  |                                       | 
|                                  |                              |           |                                                   |   |                                                                             |  |                                       | 
|Exercisable at June 30, 2006      |                              | 2,503,763 |                                                   | $ | 8.94                                                                        |  | 5.9                                   | 
|                                  |                              |           |                                                   |   |                                                                             |  |                                       | 

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The weighted average grant-date fair value of options granted during the nine months ended June 30,
2005 and 2006 was $5.51 per share and $3.87 per share, respectively. The total intrinsic value
of options exercised during the nine months ended June 30, 2005 and 2006 was $2,045,000 and
$2,190,000, respectively.
A summary of the status of the Companys nonvested options as of June 30, 2006, and changes during
the nine months then ended, is presented below (unaudited):
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

| |                                 | Number
      Of Shares |         | Weighted
      Average
      Grant-Date
      Fair Value |   |     
| | ------------------------------- | ---------------------- | ------- | -------------------------------------------------------- | - | ----
| |                                 |                        |         |                                                          |   |     
|
| | Nonvested at September 30, 2005 |                        | 145,389 |                                                          | $ | 2.09
| | Granted                         |                        | 4,000   |                                                          | $ | 3.87
| | Vested                          |                        | (97,191 | )                                                        | $ | 1.81
| | Forfeited                       |                        | (1,119  | )                                                        | $ | 2.59
| |                                 |                        |         |                                                          |   |     
| | Nonvested at June 30, 2006      |                        | 51,079  |                                                          | $ | 2.78
| |                                 |                        |         |                                                          |   |     

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Fair values have been retroactively restated for all stock dividends since the date the option was
granted.
As of June 30, 2006, there was approximately $47,000 of total unrecognized compensation cost related
to nonvested share-based compensation arrangements. That cost is expected to be recognized over a
weighted average period of approximately one year.
The Company generally issues authorized but previously unissued shares to satisfy option exercises.

|15
|--



|Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  CONTINUED
(8) STOCK BASED COMPENSATION (continued)
Had the compensation cost for the Companys stock-based compensation plan been determined under
the fair value-based method, the Companys net income and earnings per share would have been
adjusted to the pro forma amounts below for the quarters ended June 30 (Dollars in thousands, except
per share data):
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

| |                                                                                                                | 2005 |       | 2006 |  
| | -------------------------------------------------------------------------------------------------------------- | ---- | ----- | ---- | -
| |                                                                                                                |      |       |      |  
|
|
| | Information as reported in the Financial Statements:                                                           |      |       |      |  
| |                                                                                                                |      |       |      |  
| | Net income                                                                                                     | $    | 4,356 |      | $
| |                                                                                                                |      |       |      |  
| | Basic earnings per share                                                                                       | $    | 0.22  |      | $
| |                                                                                                                |      |       |      |  
| | Diluted earnings per share                                                                                     | $    | 0.21  |      | $
| |                                                                                                                |      |       |      |  
| | Share-based compensation cost, net of related tax effects                                                      | $    | 201   |      | $
| |                                                                                                                |      |       |      |  
| |                                                                                                                |      |       |      |  
| | Information calculated as if fair value method had beenapplied to all awards:                                  |      |       |      |  
| |                                                                                                                |      |       |      |  
| | Net income, as reported                                                                                        | $    | 4,356 |      | $
| | Add: Stock-based compensation expense recognized duringthe period, net of related tax effects                  |      |      |      |  
| | Less: Stock-based compensation expense determined under thefair value-based method, net of related tax effects |      | (201  | )    |  
| |                                                                                                                |      |       |      |  
| | Pro forma net income                                                                                           | $    | 4,155 |      | $
| |                                                                                                                |      |       |      |  
| |                                                                                                                |      |       |      |  
| | Pro forma basic earnings per share                                                                             | $    | 0.21  |      | $
| |                                                                                                                |      |       |      |  
| | Pro forma diluted earnings per share                                                                           | $    | 0.20  |      | $
| |                                                                                                                |      |       |      |  

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

| |                                                                                                                | 2005 |        | 2006 |  
| | -------------------------------------------------------------------------------------------------------------- | ---- | ------ | ---- | -
| |                                                                                                                |      |        |      |  
|
|
| | Information as reported in the Financial Statements:                                                           |      |        |      |  
| |                                                                                                                |      |        |      |  
| | Net income                                                                                                     | $    | 12,535 |      | $
| |                                                                                                                |      |        |      |  
| | Basic earnings per share                                                                                       | $    | 0.65   |      | $
| |                                                                                                                |      |        |      |  
| | Diluted earnings per share                                                                                     | $    | 0.61   |      | $
| |                                                                                                                |      |        |      |  
| | Share-based compensation cost, net of related tax effects                                                      | $    | 577    |      | $
| |                                                                                                                |      |        |      |  
| |                                                                                                                |      |        |      |  
| | Information calculated as if fair value method had beenapplied to all awards:                                  |      |        |      |  
| |                                                                                                                |      |        |      |  
| | Net income, as reported                                                                                        | $    | 12,535 |      | $
| | Add: Stock-based compensation expense recognized duringthe period, net of related tax effects                  |      |       |      |  
| | Less: Stock-based compensation expense determined under thefair value-based method, net of related tax effects |      | (577   | )    |  
| |                                                                                                                |      |        |      |  
| | Pro forma net income                                                                                           | $    | 11,958 |      | $
| |                                                                                                                |      |        |      |  
| |                                                                                                                |      |        |      |  
| | Pro forma basic earnings per share                                                                             | $    | 0.62   |      | $
| |                                                                                                                |      |        |      |  
| | Pro forma diluted earnings per share                                                                           | $    | 0.59   |      | $
| |                                                                                                                |      |        |      |  

|16
|--



|Item 1.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  CONTINUED
(9)  COMMON STOCK DIVIDEND
On December 15, 2004 and October 26, 2005, the Company declared 10% stock dividends, aggregating approximately
1,594,000 and 1,770,000 shares, respectively. All share and per share data have been retroactively
restated for the stock dividends.
(10) GUARANTEES
Standby letters of credit obligate the Company to meet certain financial obligations of its customers,
if, under the contractual terms of the agreement, the customers are unable to do so. Payment is only
guaranteed under these letters of credit upon the borrowers failure to perform its obligations
to the beneficiary. The Company can seek recovery of the amounts paid from the borrower. These standby
letters of credit are generally collateralized. Commitments under standby letters of credit are usually
one year or less. At June 30, 2006, the Company has recorded no liability for the current carrying
amount of the obligation to perform as a guarantor. The maximum potential amount of undiscounted
future payments related to standby letters of credit at September 30, 2005 and June 30, 2006 was
$5.8 million and $6.2 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 $5.0 million at June 30, 2006. The fair value of
the loan commitments was an asset of approximately $14,000 at June 30, 2006. As of June 30, 2006,
the Company had sold $5.0 million in forward commitments to deliver fixed rate mortgage-backed securities,
which were recorded as a derivative asset of $17,000.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|17
|--



|PART I. FINANCIAL INFORMATIONItem 2.  COASTAL FINANCIAL CORPORATION AND SUBSIDIARIESMANAGEMENT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 22 branches located in four counties
throughout the coastal regions of South Carolina and North Carolina. The Bank has fourteen offices
in Horry County, South Carolina; one office in Georgetown County, South Carolina; four offices in
Brunswick County, North Carolina; and three offices in New Hanover County, North Carolina.
The Banks primary market areas are located along the coastal regions of South Carolina and North
Carolina and predominately center around the Metro regions of Myrtle Beach, South Carolina and Wilmington,
North Carolina, and their surrounding counties. Coastal Federals primary market is Horry County,
South Carolina, where the Bank has the number one market share of deposits as of June 30, 2005 (the
most recent date for which published data is available) with 17.9% of deposits as reported by the
FDIC Summary of Deposits Report. The Bank also has the third highest market share of deposits as
of June 30, 2005 in Brunswick County, North Carolina, with 8.1% of deposits as reported by the FDIC
Summary of Deposits Report.
The primary business activities in Horry County are centered around the tourism industry. To the extent
that Horry County businesses rely heavily on tourism business, decreased tourism would have a significant
adverse effect on Coastal Federals primary deposit base and lending area. Moreover, the Bank
would likely experience a higher degree of loan delinquencies should the local economy be materially
and adversely affected.
Through its branch locations, the Bank provides a wide range of banking products, including interest-bearing
and non-interest bearing checking accounts; business sweep accounts; business cash management services;
statement savings accounts; money market accounts; certificate of deposit accounts; individual retirement
accounts; merchant services; commercial, business, personal, real estate, residential mortgage and
home equity loans; safe deposit boxes; and electronic banking services. The Bank has six ATMs at
off-site locations and an ATM at each branch. The Bank also makes available a wide range of financial
products through its relationship with Raymond James Financial Services, including stocks, bonds,
mutual funds, annuities, insurance, and retirement products.
In the fourth fiscal quarter of 2004, the Bank began two significant new initiatives. The first was
The Experience of FANtastic! Customer Service. This initiative focuses on Customer service
and convenience. The Bank is continuing the process of redesigning its infrastructure, software and
products to improve Customer service and convenience and Associate productivity. In addition, in
order to improve Customer service and convenience, the Bank added extended operating hours and expanded
the call center which employs approximately 20 Associates. The Bank experienced increased salary
and benefit expenses in fiscal 2005 and in the first nine months of fiscal 2006 and anticipates these
expenses will continue thereafter associated with the hiring, training and placement of these new Associates.
      The second
        initiative was Totally Free Checking with A Gift that was
        introduced in September 2004. The Bank has incurred, and will continue
        to incur, significant marketing costs associated with this strategy. The
        Bank expects to realize significant benefits from this strategy consisting
        of increased Bank lobby traffic, increased number of personal checking
        accounts and higher fee income as a result of those checking accounts.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|18
|--



|Checking account
        balances at June 30, 2006 grew approximately 12.3% when compared to the
        same period a year ago. This rate of growth necessitated the hiring of
        additional Associates to open and service these accounts. The Associates
        hired for these two initiatives are expected to have total compensation
        averaging between $28,000 and $35,000 per Associate.
In the latter part of fiscal 2005, the Company began preparations to increase lending production in
mortgage originations. The Company has hired leadership and support staff as well as additional mortgage
lending officers. The nine month average of the number of support staff increased by eight and residential
lending officers by nine when comparing June 30, 2005 and 2006. Increased lending volumes from these
lending personnel have been slow to materialize, and are not expected to increase until the fourth
quarter of fiscal 2006 and the first quarter of fiscal 2007. Further, the amount of increased revenues
in relation to the increased expense cannot be accurately predicted at this time.
During the first quarter of fiscal 2006, the Bank opened two branches; in Oak Island, North Carolina
and at Stephens Crossroads in Longs, South Carolina. In April 2006, a new branch was opened in North
Conway, South Carolina, and in July 2006 a new branch was opened in Conway, South Carolina. The Bank
anticipates that it will open one additional branch during the remainder of fiscal 2006. The opening
of these branches will increase compensation, occupancy and other expenses as well as related marketing
expenditures. Generally, the Bank will hire personnel three to nine months in advance of a branch
opening to ensure that they are properly trained. The Bank expects its total investment in the branch
opened in July 2006 and the branch to be opened by the end of fiscal 2006 to be approximately $3.5
million in land, buildings and equipment costs as well as increased lease expenses of approximately $85,000.
CRITICAL ACCOUNTING POLICIES
The Companys accounting policies are in accordance with accounting principles generally accepted
in the United States of America and with general practice within the banking industry. In order to
understand the Companys financial condition and results of operations, it is important to understand
the more critical accounting policies and the extent to which judgment and estimates are used in
applying those policies. The Company considers its policies regarding the allowance for loan losses
and income taxes to be its most critical accounting policies due to the significant degree of the
levels of subjectivity and management judgment necessary to account for these matters. Different
assumptions in the application of these policies could result in material changes in the Companys
consolidated financial statements. The Companys accounting policies are set forth in Note 1
of the Notes to Consolidated Financial Statements in the Companys 2005 Annual Report to Stockholders.
For additional discussion concerning the Companys allowance for loan losses and related matters,
see Allowance for Loan Losses. See Income Taxes for additional discussion
concerning income taxes in the Companys 2005 Annual Report to Stockholders.
OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, the Company engages in a variety of financial transactions that,
in accordance with generally accepted accounting principles, are recorded in amounts that differ
from the notional amounts. These transactions involve, to varying degrees, elements of credit risk,
interest rate, and liquidity risk. Such transactions are used by the Company for general corporate
purposes or to satisfy customer needs. Corporate purpose transactions are used to help manage customers
requests for funding. The Banks off-balance sheet arrangements, which principally include lending
commitments and derivatives, are described below.
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.
Effective May 31, 2006, the Bank sold its entire credit card portfolio. Accordingly, there are no unused
business or consumer credit card commitments outstanding at June 30, 2006. See additional disclosures
regarding the sale of the credit card portfolio hereafter.
      At June 30,
        2006, the Company recorded no liability for the current carrying amount
        of the obligation to perform as a guarantor, as such amounts are not considered
        material. The maximum potential amount of undiscounted future payments
        related to standby letters of credit at September 30, 2005 and June 30,
        2006 was $5.8 million and $6.2 million, respectively.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|19
|--



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

|                                                             | September 30,
      2005 |         | June 30,
      2006 |   |        
|------------------------------------------------------------ | ------------------------ | ------- | ------------------- | - | -------
|                                                             |                          |         |                     |   |        
|
|                                                            
|Residential mortgage loans in process                        | $                        | 28,345  |                     | $ | 32,576 
|Business and consumer credit card lines                      |                          | 14,065  |                     |   |       
|Consumer home equity lines                                   |                          | 41,117  |                     |   | 46,411 
|Other consumer lines of credit                               |                          | 6,818   |                     |   | 6,937  
|Standby letters of credit                                    |                          | 5,777   |                     |   | 6,245  
|Commercial real estate and construction and land development |                          | 107,731 |                     |   | 123,465
|Other commercial lines of credit                             |                          | 10,527  |                     |   | 9,052  
|                                                             |                          |         |                     |   |        
|Total loans receivable with undisbursed commitments          | $                        | 214,380 |                     | $ | 224,686
|                                                             |                          |         |                     |   |        

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Derivatives 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 period
ended June 30, 2006, for disclosure.
DISCUSSION OF FINANCIAL CONDITION CHANGES FROM SEPTEMBER 30, 2005 TO JUNE 30, 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 $634.0 million for the nine months ended June 30, 2005, compared
to $590.9 million for the nine months ended June 30, 2006. Loan principal repayments amounted to
$453.4 million in the first nine months of 2005 compared to $446.4 million for the nine months ended
June 30, 2006. In addition, the Company sells certain loans in the secondary market to finance future
loan originations. In the first nine months of fiscal 2005, the Company sold mortgage loans or securitized
and sold mortgage loans totaling $46.0 million that compares to $33.7 million for the nine months
ended June 30, 2006. The Bank also sold $19.5 million of commercial loan participations in the nine
months ended June 30, 2005 compared to $3.1 million for the same period in 2006.
During the nine month period ended June 30, 2006, the Company securitized $18.7 million of mortgage
loans and concurrently sold these mortgage-backed securities to outside third parties and recognized
a net gain on sale of $238,000. The related mortgage servicing rights associated with the loans are
$277,000. 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.
Effective May 31, 2006, the Company sold its entire credit card portfolio to an unrelated third party
for approximately $3.6 million, realizing a gain of approximately $507,000 that is included in gains
on sales of loans and loans receivable held for sale in the consolidated statement of operations.
The Company has retained no interest in the credit card portfolio other than short-term servicing
until the purchaser converts the portfolio to its system. The Company will continue to issue branded
credit cards through a third party bank. In connection with the sale, the Company also recorded approximately
$100,000 of other expense to reflect de-conversion costs and the termination of the credit card awards
program that is reflected in other expense in the consolidated statement of operations.
For the nine months ended June 30, 2006, the Company purchased $135.0 million in investment and mortgage-backed
securities. For the nine months ended June 2005, the Company purchased $256.9 million in investment
and mortgage-backed securities. These purchases during the nine months ended June 30, 2006 were primarily
funded by borrowings, repayments of $59.4 million within the securities portfolio and proceeds from
sales of investments and mortgage-backed securities of $58.3 million.
Total Customer Deposits, defined as total deposits excluding certificates of deposits (CDs)
obtained through brokers, increased $26.0 million between September 30, 2005 and June 30, 2006. Money
market and checking accounts increased from approximately $572.0 million at September 30, 2005 to
$589.5 million at June 30, 2006, an increase of $17.5 million or 3.1%. Core Deposits (defined as
money market accounts, checking accounts and statement savings accounts) increased from $643.8 million
at September 30, 2005 to $664.3 million at June 30, 2006, an increase of 3.2%. Customer Deposits
at June 30, 2006 and June 30, 2005, are $927.1 million and $876.6 million, respectively, an increase
of 5.8%. In addition, Core Deposits at June 30, 2006 and June 30, 2005 are $664.3 million and $633.7
million, respectively, a 4.8% increase.

|20
|--



|At June 30, 2006, the Company had $366.0 million of CDs that were due to mature within one year.
Included in these CDs were brokered CDs totaling $135.2 million. Based on past experience, the Company
believes that the majority of the non-brokered certificates of deposits will renew with the Company.
At June 30, 2006, the Company had commitments to originate $26.3 million in residential mortgage
loans, $62.4 million in undisbursed business and retail lines of credit, and $123.5 million in commercial
real estate and construction and land development which the Company expects to fund from normal operations.
At June 30, 2006, the Company had approximately $88.1 million available in FHLB advances. In addition,
the Company had unpledged collateral that would support approximately $91.2 million in additional
borrowings. At June 30, 2006, the Company also had an outstanding available line for federal funds
of $20.0 million.
As a result of $14.0 million in net income, less the cash dividends paid to stockholders of approximately
$2.9 million, proceeds of approximately $1.1 million from the exercise of stock options, and the
net increase in unrealized loss on securities available for sale, net of income tax of $6.9 million,
stockholders equity increased from $97.2 million at September 30, 2005 to $102.6 million at
June 30, 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 $124.4 million at
June 30, 2006, exceeding the core capital requirement by $59.0 million. At June 30, 2006, the Banks
risk-based capital of approximately $135.1 million exceeded its current risk-based capital requirement
by $59.6 million. (For further information see Regulatory Capital Matters.)
The table below summarizes future contractual obligations as of June 30, 2006 (In thousands)(unaudited):
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

|                                   | Payments Due by Period |        
|---------------------------------- | ---------------------- | -------
|                                   |                        |        
|
|                                   |                        |        
|Time deposits                      | $                      | 397,947
|Short-term borrowings              |                        | 75,157 
|Long-term debt                     |                        | 370,293
|Construction contracts             |                        | 645    
|Operating leases                   |                        | 4,757  
|                                   |                        |        
|Total contractual cash obligations | $                      | 848,799
|                                   |                        |        
|                                   |                        |        

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Purchase commitments.The Company has signed contracts to purchase four parcels of land for branches in Brunswick and New
Hanover Counties in North Carolina. The purchase commitments total approximately $4.1 million. After
due diligence, the Company expects these four sales to close around the end of the fiscal year. Because
these contracts are subject to due diligence, they are not included in the table of future contractual
obligations above.
Lease commitments.The Bank executed a lease in the first quarter of fiscal 2006 for 5.48 acres of land and a building,
which includes an option to purchase after one year of the lease for approximately $2.8 million.
Rent during the year prior to the purchase option is approximately $200,000 and is included in the
operating leases line of the above schedule of future contractual obligations.

|21
|--



|EARNINGS SUMMARY
Net income increased from $12.5 million, or $.61 per diluted share, for the nine months ended June
30, 2005 to $14.0 million, or $.69 per diluted share for the nine months ended June 30, 2006. This
11.9% increase in net income resulted from increased net interest income of $4.4 million, or 12.4%,
an increase in other income of $3.3 million, and a decrease in the provision for loan losses of $365,000,
which were offset by increased general and administrative expenses of $5.6 million, and increased
income taxes of $928,000.
Net interest income increased 12.4% as a result of growth in loans receivable and investments despite
a slight decrease in net interest margin from 3.69% for the nine months ended June 30, 2005 to 3.65%
for the nine months ended June 30, 2006. The increase in net interest income is primarily attributable
to an increase in average earning assets of $177.1 million, or 13.6%. Average loans receivable increased
$143.2 million for the nine months ended June 30, 2006 compared to June 30, 2005. The average balance
of Customer Deposits increased from $790.1 million for the nine months ended June 30, 2005 to $889.8
million for the nine months ended June 30, 2006, which exclude brokered CD average balances of $182.4
million and $51.5 million for the nine months ended June 30, 2006 and 2005, respectively. The provision
for loan losses decreased $365,000 for the nine months ended June 30, 2006 when compared to the prior
year primarily due to a reduction in individually significant special mention, substandard and impaired
loans which carry higher risk allocations when computing the allowance for loan losses and the sale
of the credit card portfolio which consisted of higher risk loans. Several of the special mention,
substandard and impaired loans were either paid off or there was a significant improvement in the
Companys collateral position. The allowance for loan losses as a percentage of loans was 1.19%
at June 30, 2006 as compared to 1.30% at June 30, 2005.
Other income increased from $9.2 million for the nine months ended June 30, 2005 to $12.5 million for
the nine months ended June 30, 2006. This was a result of an increase in fees and service charges
on loan and deposit accounts of $2.7 million primarily as a result of the Companys FANtastic!
Customer Service and Totally Free Checking with a Gift initiatives. ATM and debit
card income increased $610,000, and gains on sales of loans and loans receivable held for sale increased
$199,000, which includes a $507,000 gain from the sale of the credit card portfolio. The Company
had a net loss on sales of mortgage-backed securities available for sale of $511,000 for the nine
months ended June 30, 2006, compared to net gains of $87,000 for the nine months ended June 30, 2005.
General and administrative expenses increased from $24.5 million for the nine months ended June 30,
2005 to $30.2 million for the nine months ended June 30, 2006. Compensation and benefits increased
from $13.5 million for the first nine months of fiscal 2005 to $16.6 million in the first nine months
of fiscal 2006, primarily due to an increase in the number of banking Associates in business and
residential banking, Associates in the Companys expanded hours call center, Associates in new
branches and normal salary increases. Marketing expenses were $1.5 million for the nine months ended
June 30, 2006 and 2005. Expenses for ATM and debit card transactions increased $330,000 when comparing
the two periods. In addition, other expense was $3.1 million for the nine months ended June 30, 2005,
compared to $3.6 million for the nine months ended June 30, 2006.
MANAGEMENTS DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2005 AND
2006
INTEREST INCOME
Interest income for the three months ended June 30, 2006, increased to $25.6 million as compared to
$20.3 million for the three months ended June 30, 2005. The earning asset yield for the three months
ended June 30, 2006, was 6.75% compared to 6.00% for the three months ended June 30, 2005. The average
yield on loans receivable for the three months ended June 30, 2006, was 7.57% compared to 6.64% for
three months ended June 30, 2005. The increased yield on loans is primarily due to the increased
yield on commercial loans with interest rates tied to the prime lending rate. The prime rate was
8.25% at June 30, 2006, compared to 6.25% at June 30, 2005. The yield on investments increased to
5.00% for the three months ended June 30, 2006, from 4.77% for the three months ended June 30, 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 June 30, 2006 as compared to $1.4 billion for the
quarter ended June 30, 2005, an increase of 11.8%. The increase in average interest-earning assets
is primarily due to an increase in average loans receivable of approximately $140.8 million, an increase
of 15.8%, resulting primarily from growth in the commercial loan portfolio.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|22
|--



|INTEREST EXPENSE
Interest expense on interest-bearing liabilities was $11.7 million for the three months ended June
30, 2006, as compared to $7.8 million for the three months ended June 30, 2005. The average cost
of Customer Deposits for the three months ended June 30, 2006, was 2.21% compared to 1.47% for the
three months ended June 30, 2005. The cost of interest-bearing liabilities was 3.07% for the three
months ended June 30, 2006 compared to 2.29% for the three months ended June 30, 2005. The increased
cost of funds is due to the increased short-term interest rates. At June 30, 2006, the federal funds
rate was 5.05% compared to 3.35% at June 30, 2005.
Total average interest-bearing liabilities increased from $1.4 billion at June 30, 2005 to $1.5 billion
at June 30, 2006. The increase in average interest-bearing liabilities is due to an increase in average
Customer Deposits of approximately $84.7 million, increased average FHLB advances of $48.6 million
and increased average customer repurchase agreements of $19.0 million. This was partially offset
by a decrease in average broker reverse repurchase agreements of $63.5 million. Brokered CDs
increased by $62.9 million in average balances when comparing the two periods and were used to fund
loan and investment securities growth.
NET INTEREST INCOME
Net interest income was $13.9 million for the three months ended June 30, 2006, as compared to $12.5
million for the three months ended June 30, 2005. The net interest margin was 3.68% for the three
months ended June 30, 2006, compared to 3.71% for the three months ended June 30, 2005.
The following table summarizes the average balance sheet and the related yields on interest-earning
assets and deposits and borrowings for the three months ended June 30, 2005 and 2006:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

|                                                                      |   | Three Months Ended June 30, |  |   |       
|--------------------------------------------------------------------- | - | --------------------------- |  | - | ------
|
|
|
|
|
|
|                                                                      |   |                             |  |   |       
|Assets                                                                |   |                             |  |   |       
|Earning assets
      Loans (2)                                        | $ | 892,027                     |  | $ | 14,807
|Investment
          Securities, MBS Securities and
        Other (3) |   | 463,320                     |  |   | 5,530 
|                                                                      |   |                             |  |   |       
|                                                                      |   |                             |  |   |       
|Total earning assets                                                  | $ | 1,355,347                   |  |   | 20,337
|                                                                      |   |                             |  |   |       
|Liabilities                                                           |   |                             |  |   |       
|Customer Deposits                                                     | $ | 832,420                     |  |   | 3,053 
|Brokered CDs                                                         |   | 107,214                     |  |   | 803   
|FHLB Advances                                                         |   | 301,406                     |  |   | 2,981 
|Customer Repurchase Agreements                                        |   | 26,574                      |  |   | 175   
|Junior Subordinated Debt                                              |   | 15,000                      |  |   | 234   
|Reverse Repurchase Agreements                                         |   | 83,457                      |  |   | 585   
|                                                                      |   |                             |  |   |       
|                                                                      |   |                             |  |   |       
|Total interest-bearing
      Liabilities                              | $ | 1,366,071                   |  |   | 7,831 
|                                                                      |   |                             |  |   |       
|                                                                      |   |                             |  |   |       
|Net interest income (4)                                               |   |                             |  | $ | 12,506
|                                                                      |   |                             |  |   |       
|Net interest margin                                                   |   |                             |  |   |       
|Net yield on earning
      assets                                     |   |                             |  |   |       
|                                                                      |   |                             |  |   |       
|                                                                      |   |                             |  |   |       

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

|23
|--



|PROVISION FOR LOAN LOSSES
The provision for loan losses decreased from $550,000 for the three months ended June 30, 2005, to
$430,000 for the three months ended June 30, 2006 primarily due to a reduction in individually significant
special mention, substandard and impaired loans that carry increased risk allocations and the sale
of the credit card portfolio, when computing the allowance for loan loss. Several of the special
mention, substandard and impaired loans were either paid off or there was a significant improvement
in the Companys collateral position at June 30, 2006. The allowance for loan losses as a percentage
of loans was 1.19% at June 30, 2006 as compared to 1.30% at June 30, 2005. Loans delinquent 90 days
or more were $1.3 million or .12% of total loans at June 30, 2006, compared to $3.8 million or .41%
of total loans at June 30, 2005 and $2.6 million or .28% of total loans at September 30, 2005. The
allowance for loan losses was 973% of loans delinquent more than 90 days at June 30, 2006, compared
to 314% at June 30, 2005 and 445% at September 30, 2005. Net charge-offs for the three months ended
June 30, 2006 were $88,000 compared to $464,000 for the three months ended June 30, 2005. Management
believes the level of the allowance for loan losses at June 30, 2006 is adequate considering the
composition of the loan portfolio, the portfolios loss experience, delinquency trends, current
regional and local economic conditions and other factors at that date.
OTHER INCOME
For the three months ended June 30, 2006, other income was $4.7 million compared to $3.1 million for
the three months ended June 30, 2005. Fees and service charges from deposit accounts increased $834,000
or 51.8% to $2.4 million for the three months ended June 30, 2006, compared to $1.6 million for the
three months ended June 30, 2005. The majority of this increase is due to fee income from increased
number of personal and business checking accounts. The number of checking accounts increased 24%
from June 30, 2005 to June 30, 2006. During the quarter ended June 30, 2006, the Company securitized
mortgage loans into mortgaged backed securities (MBS), and then sold MBS and sold loans
aggregating $16.4 million, compared to $17.5 million for the quarter ended June 30, 2005. Included
in the $16.4 million of MBS and loans sold were proceeds of $3.6 million related to the sale of the
credit card portfolio. Gain on sale of loans and loans receivable held for sale was $674,000 for
the quarter ended June 30, 2006, compared to $215,000 for the quarter ended June 30, 2005. The gain
on sale of loans and loans receivable held for sale for the quarter ended June 30, 2006 included
a gain on the sale of the Companys credit card portfolio totaling $507,000. Margins on sales
of conforming mortgage loans declined in fiscal 2006 due to rising interest rates. Losses on sales
of securities available for sale, net of gains, were $444,000 for the quarter ended June 30, 2006,
compared to $127,000 for the quarter ended June 30, 2005. Income from Federal Home Loan Bank Stock
dividends increased from $183,000 to $264,000 due to increased dividends resulting from higher interest
rates. In addition, income from ATM and debit card transactions increased 45.5% to $608,000 during
the third quarter of fiscal 2006, primarily due to increased personal checking accounts. In addition,
other income increased approximately $206,000 to $359,000 for the quarter ended June 30, 2006 over
the quarter ended June 30, 2005, primarily due to the recovery of certain litigation costs from the
Companys insurance carrier of $143,000.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $8.4 million for the quarter ended June 30, 2005 compared
to $10.6 million for the quarter ended June 30, 2006. Salaries and employee benefits were $4.6 million
for the three months ended June 30, 2005, as compared to $5.7 million for the three months ended
June 30, 2006, an increase of 23.6%. Increased compensation is due to the increased number of Associates
in (i) the Companys expanded hours call center, (ii) four new branches opened since September
30, 2005 and, (iii) residential and business banking. In the latter part of fiscal 2005, the Company
began preparations to increase lending production in mortgage originations. The Company has hired
leadership and support staff as well as additional mortgage lending officers. As a result of these
plans, the Company has increased the average number of support staff by approximately eight and residential
lending officers by approximately nine for the nine month period ended June 30, 2006 as compared
to the comparable prior year period. Increased lending volumes from these lending personnel have
been slow to materialize and are not expected to increase until the fourth quarter of fiscal 2006
and the first quarter of fiscal 2007. Over the past year, the Company also added several Associates
in a Banking Group that is focused on growing small to medium sized business banking relationships.
As a result of new branches, equipment purchased to improve Customer convenience and increased checking
activity, net occupancy, furniture and fixtures and data processing expenses increased by $528,000,
and depreciation increased $189,000, when comparing the two periods. Marketing expenses were $463,000
for the three months ended June 30, 2005, compared to $545,000 for the three months ended June 30,
2006. Other expenses were $1.1 million for the quarter ended June 30, 2005 compared to $1.2 million
for the quarter ended June 30, 2006.
INCOME TAXES
      Income
        taxes were $2.7 million for the three months ended June 30, 2006 compared
        to $2.3 million for the three months ended June 30, 2005. The effective
        income tax rate as a percentage of pretax income was 35.0% and 34.4% for
        the quarters ended June 30, 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.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|24
|--



|The
        Company is subject to potential adverse adjustments, including but not
        limited to: an increase in the statutory federal or state income
        tax rates, the permanent non-deductibility of amounts currently considered
        deductible either now or in future periods, and the dependency on the
        generation of the future taxable income, in order to ultimately realize
        deferred income tax assets.
MANAGEMENTS DISCUSSION AND ANALYSIS OF OPERATIONS FOR THE NINE MONTHS ENDED JUNE 30, 2005 AND
2006
INTEREST INCOME
Interest income for the nine months ended June 30, 2006, increased to $72.7 million as compared to
$57.2 million for the nine months ended June 30, 2005. The earning asset yield for the nine months
ended June 30, 2006, was 6.56% compared to a yield of 5.86% for the nine months ended June 30, 2005.
The average yield on loans receivable for the nine months ended June 30, 2006, was 7.33% compared
to 6.38% for the nine months ended June 30, 2005. The increased yield on loans is primarily due to
the increased yield on commercial loans with interest rates tied to the prime lending rate. The prime
rate was 8.25% at June 30, 2006, compared to 6.25% at June 30, 2005. The yield on investments increased
to 4.95% for the nine months ended June 30, 2006, from 4.85% for the nine months ended June 30, 2005.
Total average interest-earning assets were $1.5 billion for the nine months ended June 30, 2006 as
compared to $1.3 billion for the nine months ended June 30, 2005. The increase in average interest-earning
assets is primarily due to an increase in average loans receivable of approximately $143.1 million
resulting primarily from growth in the commercial loan portfolio and an increase in investment securities
of approximately $33.9 million, primarily funded by brokered CDs.
INTEREST EXPENSE
Interest expense on interest-bearing liabilities was $32.4 million for the nine months ended June 30,
2006, as compared to $21.3 million for the nine months ended June 30, 2005. The average cost of Customer
Deposits for the nine months ended June 30, 2006, was 2.05% compared to 1.38% for the nine months
ended June 30, 2005. The cost of interest-bearing liabilities was 2.91% for the nine months ended
June 30, 2006 compared to 2.17% for the nine months ended June 30, 2005.
The increased cost of funds on other borrowings is due to increased short-term interest rates. At June
30, 2006, the federal funds rate was 5.05% compared to 3.35% at June 30, 2005. Total average interest-bearing
liabilities increased from $1.3 billion at June 30, 2005 to $1.5 billion at June 30, 2006. The increase
in average interest-bearing liabilities is due to an increase in average Customer Deposits of approximately
$99.7 million as a result of the Companys focus on checking growth, increased average brokered
CDs of $130.9 million and increased average customer repurchase agreements of $13.1 million.
This increase was partially offset by a decrease in average reverse broker repurchase agreements
of $76.0 million.
NET INTEREST INCOME
Net interest income was $40.4 million for the nine months ended June 30, 2006, as compared to $35.9
million for the nine months ended June 30, 2005. The net interest margin was 3.65% for the nine months
ended June 30, 2006, compared to 3.69% for the nine months ended June 30, 2005.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|25
|--



|The following table summarizes the average balance sheet and the related yields on interest-earning
assets and deposits and borrowings for the nine months ended June 30, 2006 and 2005:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                        

|                                                                      |   | Nine months Ended June 30, |  |   |       
|--------------------------------------------------------------------- | - | -------------------------- |  | - | ------
|
|
|
|
|
|
|                                                                      |   |                            |  |   |       
|Assets                                                                |   |                            |  |   |       
|Earning assets
      Loans (2)                                        | $ | 854,556                    |  | $ | 40,911
|Investment
          Securities, MBS Securities and
        Other (3) |   | 447,630                    |  |   | 16,284
|                                                                      |   |                            |  |   |       
|                                                                      |   |                            |  |   |       
|Total earning assets                                                  | $ | 1,302,186                  |  |   | 57,195
|                                                                      |   |                            |  |   |       
|                                                                      |   |                            |  |   |       
|Liabilities                                                           |   |                            |  |   |       
|Customer Deposits                                                     | $ | 790,148                    |  |   | 8,174 
|Brokered CDs                                                         |   | 51,487                     |  |   | 1,116 
|FHLB Advances                                                         |   | 328,634                    |  |   | 9,277 
|Customer Repurchase Agreements                                        |   | 25,313                     |  |   | 421   
|Junior Subordinated Debt                                              |   | 15,000                     |  |   | 637   
|Reverse Repurchase Agreements                                         |   | 94,109                     |  |   | 1,653 
|                                                                      |   |                            |  |   |       
|                                                                      |   |                            |  |   |       
|Total interest-bearingLiabilities                                     | $ | 1,304,691                  |  |   | 21,278
|                                                                      |   |                            |  |   |       
|                                                                      |   |                            |  |   |       
|Net interest income                                                   |   |                            |  | $ | 35,917
|                                                                      |   |                            |  |   |       
|Net interest margin                                                   |   |                            |  |   |       
|Net yield on earning
      assets                                     |   |                            |  |   |       
|                                                                      |   |                            |  |   |       

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

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|PROVISION FOR LOAN LOSSES
The provision for loan losses decreased $365,000 from $1.5 million for the nine months ended June 30,
2005, to $1.2 million for the nine months ended June 30, 2006 primarily due to a reduction in individually
significant special mention, substandard and impaired loans that carry increased risk allocations
and the sale of the credit card portfolio, when computing the allowance for loan loss. Several of
the special mention, substandard and impaired loans were either paid off or there was a significant
improvement in the Companys collateral position. The allowance for loan losses as a percentage
of loans was 1.19% at June 30, 2006 as compared to 1.30% at June 30, 2005. Loans delinquent 90 days
or more were $1.3 million or .12% of total loans at June 30, 2006 as compared to $3.8 million or
..41% of total loans at June 30, 2005 and $2.6 million or .28% at September 30, 2005. The allowance
for loan losses was 973% of loans delinquent more than 90 days at June 30, 2006, compared to 314%
at June 30, 2005 and 445% at September 30, 2005. Net charge-offs for the nine months ended June 30,
2006 were $358,000 compared to $748,000 for the nine months ended June 30, 2005. Management believes
that the level of the allowance for loan losses at June 30, 2006 is adequate considering the composition
of the loan portfolio, the portfolios loss experience, delinquency trends, current regional
and local economic conditions and other factors at that date.
OTHER INCOME
      For the nine
        months ended June 30, 2006, other income was $12.5 million compared to
        $9.2 million for the nine months ended June 30, 2005. Fees and service
        charges from deposit accounts increased $2.7 million or 64.4% to $6.8
        million for the nine months ended June 30, 2006, compared to $4.1 million
        for the nine months ended June 30, 2005. The majority of this increase
        is due to fee income resulting from an increase in the number of personal
        and business checking accounts. The number of checking accounts increased
        24% from June 30, 2005 to June 30, 2006. During the nine months ended
        June 30, 2006, the Company securitized mortgage loans into mortgage-backed
        securities (MBS) and then sold the MBS and sold loans aggregating
        $37.3 million of loans held for sale compared to $46.0 million for the
        nine months ended June 30, 2005.

|26
|--



|Included in
        the $37.3 million of MBS and sold loans were proceeds of $3.6 million
        related to the sale of the credit card portfolio. Gain on sale of loans
        and loans receivable held for sale was $968,000 for the nine months ended
        June 30, 2006, compared to $769,000 for the nine months ended June 30,
        2005. Gain on sale of loans and loans receivable held for sale for the
        nine months ended June 30, 2006 included a gain on the sale of the Companys
        credit card portfolio totaling $507,000. Loss on sales of securities,
        net of gains, was $459,000 for the nine months ended June 30, 2006, compared
        to net gains of $119,000 for the nine months ended June 30, 2005. In addition,
        the Company had gain on investment security held to maturity called by
        issuer of $160,000 for the nine months ended June 30, 2005 and none for
        the nine months ended June 30, 2006. Other income increased $295,000 to
        $744,000 for the nine months ended June 30, 2006, as compared to the nine
        months ended June 30, 2005 primarily due to the recovery of litigation
        costs from the Companys insurance carrier of $143,000. ATM and debit
        card income increased $610,000 for the nine months ended June 30, 2006
        to $1.7 million over the similar period in fiscal 2005 primarily due to
        the increased number of personal checking accounts.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $24.5 million for the nine months ended June 30, 2005 compared
to $30.2 million for the nine months ended June 30, 2006. Salaries and employee benefits were $13.5
million for the nine months ended June 30, 2005, as compared to $16.6 million for the nine months
ended June 30, 2006, an increase of 22.3%, primarily due to an increase in the number of Associates
in (i) the Companys expanded hours call center, (ii) the four new branches opened since September
30, 2005, and (iii) residential and business banking. In the latter part of fiscal 2005, the Company
began preparations to increase production in mortgage originations. As a result of these plans, the
Company has increased the average number of support staff by approximately eight and residential
lending officers by approximately nine when comparing the nine month averages for the periods ended
June 30, 2006 and June 30, 2005. Increased lending volumes have been slow to materialize from these
lending personnel and are not expected to increase until the fourth quarter of fiscal 2006 and the
first quarter of fiscal 2007. The Company also added several Associates in a Banking Group that is
focused on growing small to medium sized business banking relationships. As a result of new branches,
equipment purchased to improve Customer convenience and increased checking activity, net occupancy,
furniture and fixtures and data processing expenses increased $1.2 million and depreciation increased
by $564,000, when comparing the two periods. Marketing expenses were $1.5 million for the nine months
ended June 30, 2005 and 2006. ATM and debit card expenses increased $330,000 from $744,000 for the
nine months ended June 30, 2005 to $1.1 million for the nine months ended June 30, 2006 primarily
as a result of an increased number of personal checking accounts. Other expenses were $3.1 million
for the nine months ended June 30, 2005 compared to $3.6 million for the nine months ended June 30, 2006.
INCOME TAXES
Income taxes were $6.5 million for the nine months ended June 30, 2005 compared to $7.5 million for
the nine months ended June 30, 2006. The effective income tax rate as a percentage of pretax income
was 34.3% and 34.8% for the nine months ended June 30, 2005 and 2006, respectively. The effective
income tax rate differs from the statutory rate primarily due to income generated by bank-owned life
insurance, 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.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|27
|--



|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 Capital 
      Adequacy Purposes** |  | **Categorized as Well
      Capitalized under 
      Prompt Corrective 
      Action Provision** |  
|------------------------- | ---------- | ------- | ---------------------------------------- |  | -------------------------------------------------------------------------------------------------- | -
|                          |            |         |                                          |  |                                                                                                    |  
|                          | **Amount** |         | **Ratio**                                |  | **Amount**                                                                                         |  
|                          |            |         |                                          |  |                                                                                                    |  
|As of June 30, 2006       |            |         |                                          |  |                                                                                                    |  
|Total Capital:            | $          | 135,120 |                                          |  | 14.32                                                                                              | %
|(To Risk Weighted Assets) |            |         |                                          |  |                                                                                                    |  
|Tier 1 Capital:           | $          | 124,361 |                                          |  | 13.18                                                                                              | %
|(To Risk Weighted Assets) |            |         |                                          |  |                                                                                                    |  
|Tier 1 Capital:           | $          | 124,361 |                                          |  | 7.61                                                                                               | %
|(To Total Assets)         |            |         |                                          |  |                                                                                                    |  
|Tangible Capital:         | $          | 124,361 |                                          |  | 7.61                                                                                               | %
|(To Total Assets)         |            |         |                                          |  |                                                                                                    |  

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards No. 154, Accounting for Changes and Error Corrections  a replacement of Accounting
Principles Board Opinion No. 20 and FASB Statement No. 3 (FAS 154), which eliminates the requirement
to reflect changes in accounting principles as cumulative adjustments to net income in the period
of change and requires retrospective application to prior periods financial statements for
voluntary changes in accounting principle, unless it is impracticable to determine either the period-specific
effects or the cumulative effect of the change. If it is impracticable to determine the cumulative
effect of the change to all prior periods, FAS 154 requires the new accounting principle to be adopted
prospectively. For new accounting pronouncements, the transition guidance in the pronouncement should
be followed. Retrospective application refers to the application of a different accounting principle
to previously issued financial statements as if that principle had always been used. FAS 154 did
not change the guidance for reporting corrections of errors, changes in estimates or for justification
of a change in accounting principle on the basis of preferability. FAS 154 is effective for accounting
changes made in fiscal years beginning after December 15, 2005 (October 1, 2006 for the Company).
The Company does not expect the adoption of FAS 154 to have a material effect on the results of operations
or statement of condition.
In February 2006, the Financial Accounting Standards Board issued Statement of Financial Accounting
Standard (SFAS) No. 155, Accounting for Certain Hybrid Financial Instruments an amendment
of FASB Statements No. 133 and 140 (FAS 155). FAS 155 permits fair value remeasurement for any
hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation,
clarifies which interest only-strips and principal-only strips are not subject to the requirements
of Statement 133, establishes a requirement to evaluate interests in securitized financial assets
to identify interests that are freestanding derivatives or that are hybrid financial instruments
that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit
risk in the form of subordination are not embedded derivatives, and amends Statement 140 to eliminate
the prohibition on a qualifying special purpose entity from holding a derivative financial instrument
that pertains to a beneficial interest other than another derivative financial instrument. FAS 155
is effective for all financial instruments acquired or issued after the beginning of an entitys
first fiscal year that begins after September 15, 2006 (October 1, 2006 for the Company). The
Company does not expect the adoption of FAS 155 to have a material effect on the results of operations
or statement of condition.
In March 2006, FASB issued Statement of Financial Accounting Standards No. 156 Accounting for
Servicing of Financials Assets an amendment of FASB Statement No. 140 (FAS 140 and FAS 156).
FAS 140 establishes, among other things, the accounting for all separately recognized servicing assets
and servicing liabilities. This Statement amends FAS 140 to require that all separately recognized
servicing assets and servicing liabilities be initially measured at fair value, if practicable. This
Statement permits, but does not require, the subsequent measurement of separately recognized servicing
assets and servicing liabilities at fair value. Under this Statement, an entity can elect subsequent
fair value measurement to account for its separately recognized servicing assets and servicing liabilities.
Adoption of this Statement is required as of the beginning of the first fiscal year that begins after
September 15, 2006. Upon adoption, the Company will apply the requirements for recognition and initial
measurement of servicing assets and servicing liabilities prospectively to all transactions. The
Company will adopt FAS 156 for the fiscal year beginning October 1, 2006 and currently has not determined
if it will adopt FAS 156 using the fair value election.

|28
|--



|In July 2006, The Financial Accounting Standards Board (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 derecognition, 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.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting
Standard No. 123R, Share-Based Payment which revised SFAS No. 123, Accounting for Stock-Based Compensation.
This Statement supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and related
implementation guidance and amends SFAS No. 95, Statement of Cash Flows. It requires that all stock-based
compensation now be measured at fair value and recognized as expense in the income statement. This
Statement also clarifies and expands guidance on measuring fair value of stock compensation, requires
estimation of forfeitures when determining expense, and requires that excess tax benefits be shown
as financing cash inflows versus a reduction of taxes paid in the Statement of Cash Flows. Various
other changes are also required. The Company adopted this Statement effective beginning October 1,
2005. The Company experienced no significant effect on its financial statements as a result of the
adoption of this Statement. See Note 8 of the accompanying unaudited consolidated financial statements
for additional discussion.
EFFECT ON INFLATION AND CHANGING PRICES
The accompanying unaudited consolidated financial statements have been prepared in accordance with
generally accepted accounting principles which require the measurement of financial position and
results of operations in terms of historical dollars, without consideration of change in the relative
purchasing power over time due to inflation. Unlike most industrial companies, virtually all of the
assets and liabilities of a financial institution are monetary in nature. As a result, interest rates
have a more significant impact on a financial institutions performance than the effects of
inflation. Interest rates do not necessarily change in the same magnitude as the price of goods and
services.
Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Banks Asset Liability Management Committee (ALCO) monitors and considers methods
of managing exposure to interest rate risk. The ALCO consists of members of the Board of Directors
and Senior Leadership of the Company and meets quarterly. The Banks exposure to interest rate
risk is reviewed on at least a quarterly basis by the ALCO. Interest rate risk exposure is measured
using interest rate sensitivity analysis to determine the Companys change in net portfolio
value in the event of hypothetical changes in interest rates. The ALCO is charged with the responsibility
to maintain the level of sensitivity of the Banks net portfolio value with Board approved limits.
Net portfolio value (NPV) represents the market value of portfolio equity and is equal to the market
value of assets minus the market value of liabilities, with adjustments made for off-balance sheet
items over a range of assumed changes in market interest rates. The Banks Board of Directors
has adopted an interest rate risk policy which establishes maximum allowable decreases in NPV in
the event of a sudden and sustained one hundred to three hundred basis point increase or decrease
in market interest rates. The following table presents the Banks change in NPV as computed
by the OTS for various rate shock levels as of June 30, 2006 (Dollars in thousands).
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

|**Change in interest rates** |  | **Board 
Limit 
Minimum
NPV
      Ratio** |   |  | **Board 
Limit 
Maximum 
Decline in NPV** |  |   | **Market 
Value 
Of Assets
6/30/06** |  |   | **Market 
Value 
Portfolio
Equity 
6/30/06** |  |  | **NPV
      Ratio** |  
|---------------------------- |  | ----------------------------------------- | - |  | ----------------------------------------- |  | - | ------------------------------------ |  | - | -------------------------------------------- |  |  | ------------------- | -
|                             |  |                                           |   |  |                                           |  |   |                                      |  |   |                                             
|300 basis point rise         |  | 5.00                                      | % |  | 400 BPS                                   |  | $ | 1,626,177                            |  | $ | 163,307                                      |  |  | 10.04               | %
|200 basis point rise         |  | 6.00                                      | % |  | 300 BPS                                   |  | $ | 1,647,693                            |  | $ | 175,849                                      |  |  | 10.67               | %
|100 basis point rise         |  | 6.00                                      | % |  | 250 BPS                                   |  | $ | 1,669,345                            |  | $ | 188,152                                      |  |  | 11.27               | %
|No change                    |  | 6.00                                      | % |  |                                           |  | $ | 1,688,941                            |  | $ | 197,978                                      |  |  | 11.72               | %
|100 basis point decline      |  | 6.00                                      | % |  | 250 BPS                                   |  | $ | 1,705,282                            |  | $ | 203,981                                      |  |  | 11.96               | %
|200 basis point decline      |  | 6.00                                      | % |  | 300 BPS                                   |  | $ | 1,716,400                            |  | $ | 203,938                                      |  |  | 11.88               | %
|300 basis point decline      |  | 6.00                                      | % |  | 350 BPS                                   |  |   | N/A                                  |  |   | N/A                                          |  |  | N/A                 |  

|29
|--



|The preceding table indicates that at June 30, 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 increase minimally. A value for the 300 basis point decline is not indicated
due to the level of interest rates at June 30, 2006. At June 30, 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 June 30, 2006 that has materially
affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.
PART II. OTHER INFORMATIONCOASTAL FINANCIAL CORPORATION AND SUBSIDIARIES
Item 1. Legal Proceedings
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.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

| |  | 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

|30
|--



| |  | 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 carryout our strategies is often lengthy. Our success depends, to a significant degree, upon our
  ability to attract and retain qualified management, loan origination, finance, administrative, marketing
  and technical personnel. We are dependent upon a number of key executives who are integral to implementing
  our business plan. The loss of the services of any one of our senior executive management team or
  other key executives could have a material adverse effect on our business, financial condition, results
  of operations and cash flows.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

| |  | Provisions in our articles of incorporation and Delaware law may discourage or prevent takeover attempts,
  and these provisions may have the effect of reducing the market price of our stock.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                                

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

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

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

|31
|--



| |  | 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.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                        

| |  | 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
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|32
|--



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

|33
|--



|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
Not Applicable.
Item 6.  Exhibits
Exhibits
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                

| | 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.                    

|34
|--



| | (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.          

|35
|--



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

| |                |  | COASTAL FINANCIAL CORPORATION         | 
| | -------------- |  | ------------------------------------- | 
| |                |  |                                       | 
| | August 9, 2006 |  | /s/ Michael C. Gerald                 | 
| |                |  |                                       | 
| |                |  | Michael C. Gerald                     | 
| |                |  | President and Chief Executive Officer | 
| |                |  |                                       | 

| | August 9, 2006 |  | /s/ Jerry L. Rexroad         | 
| | -------------- |  | ---------------------------- | 
| | Date           |  |                              | 
| |                |  | Jerry L. Rexroad             | 
| |                |  | Executive Vice President and | 
| |                |  | Chief Financial Officer      | 

|36
|--