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U. S. Securities and Exchange Commission
  Form 10-K
 þ
  o
 
 Commission file number 000-33223
 Gateway Financial Holdings, Inc.
  North Carolina
    
    56-2040581(State of incorporation)
    
    (IRS Employer Identification No.)1580 Laskin Road, Virginia Beach, Virginia
    
    23451(Address of principal executive offices)
    
    (Zip code)
 (757) 422-4055
    o þ
 o þ
 þ o
 o
  o þ o
 o þ
     Document
    

Where Incorporated1.

    Proxy Statement for the Annual Meeting of Stockholders
to be held May 30, 2007 to be mailed to stockholders
within 120 days of December 31, 2006.
    
    Part III




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##### 



Form 10-K Table of Contents
  
 Index
    
    
    
    PAGEPART IItem 1.
    
    Description of Business
    
    
    3Item 1A.
    
    Risk FactorsItem 1B.
    
    Unresolved Staff CommentsItem 2.
    
    PropertiesItem 3.
    
    LegalItem 4.
    
    Submission of Matters to a Vote of Security HoldersPART IIItem 5.
    
    Market for Common Stock, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesItem 6.
    
    Selected Financial DataItem 7.
    
    Management's Discussion and Analysis of Financial Condition and Results of OperationsItem 7A.
    
    Quantitative and Qualitative Disclosures About Market RiskItem 8.
    
    Financial StatementsItem 9.
    
    Changes in and Disagreements with Accountants on Accounting and Financial DisclosureItem 9A.
    
    Controls and ProceduresItem 9B.
    
    Other Information
    
    
    .PART IIIItem 10.
    
    Directors and Executive Officers of the RegistrantItem 11.
    
    Executive CompensationItem 12.
    
    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersItem 13.
    
    Certain Relationships and Related TransactionsItem 14.
    
    Principal Accounting Fees and Services
    
    
    .PART IVItem 15.
    
    Exhibits, Financial Statement SchedulesExhibit 3.2Exhibit 10.8Exhibit 10.9Exhibit 21Exhibit 23Exhibit 31.1Exhibit 31.2Exhibit 32
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PART I
 
 ITEM 1.  DESCRIPTION OF BUSINESS
 General
     Market Area and Growth Strategy
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st th
 We emphasize personalized service, access to decision makers, and a quick turn around time on
lending decisions. Our slogan is Real People . . . Real Solutions. We have a management team
with extensive experience in our local markets. We intend to leverage the core relationships we
build by providing a variety of services to our customers. With that focus, we target:
 
    
    Small-and medium-sized businesses;
    
    Professionals and middle managers of locally based companies;
    
    Residential real estate developers; and
    
    Individual consumers.
    
    
    Emphasize relationship banking.We have been successful in building client
relationships because our regional model enables us to deliver products and services that
are comparable to that of our largest competitors and high customer service levels that are
most commonly associated with a community bank. Each of the banks four regions has its
own President whose knowledge of the region, presence in the community and ability to make
prompt credit decisions, strengthens our ability to develop local relationships. We
typically render commercial loan decisions within 48 hours and retail loans within an hour.
Localized decision making and personalized customer service form the core of our
relationship banking strategy, and we plan to maintain this approach as we continue to grow
in both our existing markets and additional markets
    
    Grow organically in our existing markets.Our markets have been subject to
significant bank consolidation. We believe there is a large customer base in our markets
that prefers doing business with a local institution and may be dissatisfied with the
service received from larger regional and super-regional banks. By providing our
customers with personalized service and a big bank product suite, we expect to continue
our strong growth. We believe the success of our strategy is evidenced by the growth of
our deposits from approximately $115.7 million at December 31, 2001 to approximately
$923.7 million at December 31, 2006, and net loans, which increased from approximately
$105.8 million at December 31, 2001 to approximately $985.2 million at December 31,
2006.
    
    Expand franchise in high growth markets.We will actively consider both acquisitions
and de novo financial center opportunities in existing and new market areas. Since
December 31, 2001, we have successfully integrated four acquired financial centers and have
opened sixteen de novo financial centers. We are focused on markets in central and eastern
Virginia and central and eastern North Carolina that
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possess favorable growth characteristics and in which we have identified experienced bankers
to help execute our strategy. For example, we have currently targeted the MSA of
Wilmington, North Carolina, for our next financial center. According to ESRI, the MSA of
Wilmington has a projected population growth of 12.3% from 2007 to 2010. In addition to the
Wilmington financial center, we currently intend to open two additional new financial
centers in 2007 in the Raleigh market area.
    
    Grow insurance agency through acquisitions.Our independent insurance agency was
created through the acquisition and integration of three independent insurance agencies.
Since December 31, 2001, we have successfully integrated the further acquisitions of five
insurance agencies, the Outer Banks business of another insurance agency, two insurance
agencies in the fourth quarter of 2006 located in Chesapeake and Newport News, Virginia and
an insurance premium finance agency. We will actively consider acquisitions in both our
existing market areas and in other growing markets in eastern Virginia and eastern North
Carolina that have favorable market demographics for our insurance agency subsidiary.
    
    Grow non-interest income through mortgage subsidiary.During 2006, we withdrew from
our relationships with third party mortgage bankers and created our own mortgage
subsidiary. We will actively seek mortgage originations in both our existing market areas
and in other growing markets in eastern Virginia and eastern and central North Carolina.
    
    Improve our core profitability.We believe as we grow our franchise that we will be
able to take advantage of the economies of scale typically enjoyed by larger organizations.
As our financial center network matures and the pace of our expansion slows, our
profitability should improve. We believe the investments we have made in our financial
center network and technology infrastructure are sufficient to support a much larger
organization, and therefore believe increases in our expense base going forward should be
lower than our proportional increase in assets and revenues.
    
    Continue our disciplined execution.We believe our success as a banking organization
depends on a disciplined approach to originating loans and monitoring the performance of
our loan portfolio. Despite our growth, we have consistently maintained strong asset
quality. We believe our strong asset quality is the result of conservative underwriting
standards, experienced loan officers and the strength of the local economies in which we
operate. At December 31, 2006, our non-performing assets as a percentage of total assets
were 0.27% and our ratio of net charge-offs to average loans was 0.03%. Our year-end
non-performing assets as a percentage of total assets have not exceeded 0.38% in any of the
past five years.
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Competition
    Other Products and Services
 Other Banking Products and Services.
  Other Financial Services.
  Employees
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SUPERVISION AND REGULATION
  Gateway Financial Holdings, Inc.
      Enforcement Authority
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Interstate Acquisitions
 Capital Adequacy
    Source of Strength for Subsidiary.
 Dividends.
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Change of Control.
 Gateway Bank & Trust Co.
  Transactions with Affiliates
 Loans to Insiders
 Regulation of Lending Activities
 Financial Centers
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Reserve Requirements.
 Community Reinvestment.
 Governmental Monetary Policies
  Dividends
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Capital Adequacy
 Changes in Management
 Enforcement Authority
 Prompt Corrective Action
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Deposit Insurance.
 Future legislation and regulations.
  
 ITEM 1A RISK FACTORS
 An investment in our common stock involves risks. Stockholders should carefully consider the risks
described below in conjunction with the other information in this Form 10K and information
incorporated by reference in this Form 10K, including our consolidated financial statements and
related notes. If any of the following risks or other risks which have not been identified or which
we may believe are immaterial or unlikely, actually occur, our business, financial condition and
results of operations could be harmed. This could cause the price of our stock to decline, and
stockholders could lose part or all of their investment. This Form 10K contains forward-looking
statements that involve risks and uncertainties, including statements about our future plans,
objectives, intentions and expectations. Many factors, including those described below, could cause
actual results to differ materially from those discussed in our forward-looking statements.
 Our business strategy includes the continuation of significant growth plans, and our financial
condition and results of operations could be negatively affected if we fail to grow or fail to
manage our growth effectively.
  Our business is subject to the success of the local economies where we operate.
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We may face risks with respect to future expansion.
  
    
    the time and costs associated with identifying and evaluating potential acquisitions and
merger partners;
    
    the estimates and judgments used to evaluate credit, operations, management and market
risks with respect to the target entity may not be accurate;
    
    the time and costs of evaluating new markets, hiring experienced local management and
opening new offices, and the time lags between these activities and the generation of
sufficient assets and deposits to support the costs of the expansion;
    
    our ability to finance an acquisition and possible ownership and economic dilution to
our current shareholders;
    
    the diversion of our managements attention to the negotiation of a transaction, and the
integration of the operations and personnel of the combining businesses;
    
    entry into new markets where we lack experience;
    
    the introduction of new products and services into our business;
    
    the incurrence and possible impairment of goodwill associated with an acquisition and
possible adverse short-term effects on our results of operations; and
    
    the risk of loss of key employees and customers.
  If the value of real estate in our core market areas were to decline materially, a significant
portion of our loan portfolio could become under-collateralized, which could have a material
adverse effect on us.
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An inadequate allowance for loan losses would reduce our earnings and capital.
   A significant part of our loan portfolio is unseasoned.
  Our reliance on time deposits, including out-of-market certificates of deposit, as a source of
funds for loans and our other liquidity needs could have an adverse effect on our operating
results.
  The building of market share through our de novo financial center strategy could cause our expenses
to increase faster than our revenues.
  Our recent results may not be indicative of our future results.
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We may be adversely affected by interest rate changes.
  Our operations and customers might be affected by the occurrence of a natural disaster or other
catastrophic event in our market area.
  Competition from financial institutions and other financial service providers may adversely affect
our profitability.
   We are subject to extensive regulation that could limit or restrict our activities.
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Our directors and executive officers own a significant portion of our common stock
  Our continued success is dependent upon the services of our management team.
  Our investment in certain derivative investments may result in volatility in our earnings and
adversely affect the market for our common stock.
  Our continued pace of growth may require us to raise additional capital in the future, but that
capital may not be available when it is needed.
  Our future capital needs could result in dilution of your investment.
  The trading volume in our common stock is low and the sale of substantial amounts of our common
stock in the public market could depress the price of our common stock.
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Our ability to pay dividends is limited and we may be unable to pay future dividends.
  Holders of our junior subordinated debentures have rights that are senior to those of our common
shareholders.
  Certain provisions under our Articles of Incorporation and applicable law may make it difficult for
others to obtain control of our corporation even if such a change in control may be favored by some
shareholders.
  The securities of Gateway Financial are not FDIC insured.
  
 ITEM 1B  UNRESOLVED STAFF COMMENTS
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ITEM 2  PROPERTIES
  Approximate Square
    
    Year Established/Office Location
    
    Footage
    
    AcquiredEdenton- 322 South Broad Street (4)
    
    
    5,400
    
    
    
    2006Elizabeth City 112 Corporate Drive (6)
    
    
    25,000
    
    
    
    2006Elizabeth City- 1145 North Road Street (1)
    
    
    9,000
    
    
    
    1999Elizabeth City- 1404 West Ehringhaus Street (3)
    
    
    2,000
    
    
    
    2003Elizabeth City- 400 West Ehringhaus Street (4)
    
    
    5,000
    
    
    
    2004Elizabeth City- 802 West Ehringhaus Street (2)
    
    
    3,200
    
    
    
    2004Hertford 147 North Church Street (2)
    
    
    2,000
    
    
    
    2002Kitty Hawk- 3600 Croatan Highway (1)
    
    
    6,500
    
    
    
    2002Kitty Hawk 5406 Croatan Highway (1)
    
    
    4,200
    
    
    
    2006Moyock- 100 Moyock Commons Drive (4)
    
    
    4,000
    
    
    
    2004Nags Head 2808 S. Croatan Highway (5)
    
    
    4,800
    
    
    
    2004Plymouth- 433 U.S. Highway 64 East (4)
    
    
    5,200
    
    
    
    2000Raleigh 2209 Century Drive (3)
    
    
    2,500
    
    
    
    2006Roper- 102 W. Buncomb Street (3)
    
    
    550
    
    
    
    2000Chesapeake- 111 Gainsbourgh Square (5)
    
    
    7,200
    
    
    
    2002Chesapeake- 575 Cedar Road (3)
    
    
    2,400
    
    
    
    2003Chesapeake 1403 Greenbrier Parkway (3)
    
    
    3,800
    
    
    
    2006Emporia 5205 Main Street (3)
    
    
    6,500
    
    
    
    2004Norfolk 539 21st Street (3)
    
    
    10,000
    
    
    
    2006Newport News 753 Thimble Shoals Blvd (2)
    
    
    2,800
    
    
    
    2006Suffolk 2825 Godwin Drive (3)
    
    
    3,200
    
    
    
    2004Virginia Beach- 4460 Corporation Lane, Suite 100 (3)
    
    
    4,000
    
    
    
    2000Virginia Beach 713 Independence Boulevard (3)
    
    
    2,200
    
    
    
    2003Virginia Beach 1580 Laskin Road (5)
    
    
    7,500
    
    
    
    2005Virginia Beach 641 Lynnhaven Parkway (3)
    
    
    20,000
    
    
    
    2006Virginia Beach 3801 Pacific Avenue (3)
    
    
    1,200
    
    
    
    2006Virginia Beach 2098 Princess Anne Road (3)
    
    
    2,500
    
    
    
    2005Virginia Beach- 3001 Shore Drive (3)
    
    
    2,000
    
    
    
    2003
 
 (1)
    
    Includes banking, investment brokerage and insurance services.(2)
    
    Insurance services only.(3)
    
    Banking services only.(4)
    
    Only banking and insurance services.(5)
    
    Only banking and investment brokerage services.(6)
    
    Operations building.  
 ITEM 3  LEGAL PROCEEDINGS
  
 ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
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PART II
 
 ITEM
5  MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL
 BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
  High
    
    
    Low
    
    
    Dividend2005
    
    First Quarter
    
    $
    15.35
    
    
    $
    12.87
    
    
    $
    0.02Second Quarter
    
    
    16.73
    
    
    
    14.07
    
    
    
    0.02Third Quarter
    
    
    16.29
    
    
    
    15.43
    
    
    
    0.02Fourth Quarter
    
    
    16.24
    
    
    
    14.51
    
    
    
    0.032006
    
    First Quarter
    
    $
    15.74
    
    
    $
    14.90
    
    
    $
    0.03Second Quarter
    
    
    15.69
    
    
    
    14.45
    
    
    
    0.03Third Quarter
    
    
    15.01
    
    
    
    14.01
    
    
    
    0.05Fourth Quarter
    
    
    14.73
    
    
    
    13.95
    
    
    
    0.05
  
 ITEM 6  SELECTED FINANCIAL DATA
  For the Years Ended December 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002(Dollars in thousands, except per share data)Operating Data:Total interest income
    
    $
    73,097
    
    
    $
    39,679
    
    
    $
    19,632
    
    
    $
    13,486
    
    
    $
    10,311Total interest expense
    
    
    36,099
    
    
    
    16,376
    
    
    
    6,691
    
    
    
    5,341
    
    
    
    4,819Net interest income
    
    
    36,998
    
    
    
    23,303
    
    
    
    12,941
    
    
    
    8,145
    
    
    
    5,492Provision for loan losses
    
    
    3,400
    
    
    
    2,200
    
    
    
    1,425
    
    
    
    1,200
    
    
    
    480Net interest income after
provision for loan losses
    
    
    33,598
    
    
    
    21,103
    
    
    
    11,516
    
    
    
    6,945
    
    
    
    5,012Total non-interest income
    
    
    9,270
    
    
    
    8,067
    
    
    
    5,857
    
    
    
    4,485
    
    
    
    2,826Total non-interest expense
    
    
    34,974
    
    
    
    23,266
    
    
    
    14,653
    
    
    
    10,230
    
    
    
    7,211Income before income taxes
    
    
    7,894
    
    
    
    5,904
    
    
    
    2,720
    
    
    
    1,200
    
    
    
    627Provision for income taxes
    
    
    2,625
    
    
    
    1,965
    
    
    
    710
    
    
    
    -
    
    
    
    -Net income
    
    $
    5,269
    
    
    $
    3,939
    
    
    $
    2,010
    
    
    $
    1,200
    
    
    $
    627
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For the Years Ended December 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002(Dollars in thousands, except per share data)Per Share Data: (1)Net income basic
    
    $
    0.49
    
    
    $
    0.48
    
    
    $
    0.37
    
    
    $
    0.30
    
    
    $
    0.16Net income diluted
    
    
    0.47
    
    
    
    0.46
    
    
    
    0.34
    
    
    
    0.29
    
    
    
    0.16Dividends
    
    
    0.16
    
    
    
    0.09
    
    
    
    0.02
    
    
    
    -
    
    
    
    -Book value
    
    
    9.99
    
    
    
    9.46
    
    
    
    7.98
    
    
    
    6.20
    
    
    
    5.98Tangible book value
    
    
    8.84
    
    
    
    8.47
    
    
    
    6.66
    
    
    
    5.31
    
    
    
    5.41Balance Sheet Data:Total assets
    
    $
    1,207,477
    
    
    $
    883,373
    
    
    $
    535,728
    
    
    $
    314,826
    
    
    $
    231,053Loans receivable
    
    
    994,592
    
    
    
    666,652
    
    
    
    381,956
    
    
    
    231,740
    
    
    
    161,488Allowance for loan losses
    
    
    9,405
    
    
    
    6,283
    
    
    
    4,163
    
    
    
    2,759
    
    
    
    1,721Deposits
    
    
    923,725
    
    
    
    646,262
    
    
    
    406,259
    
    
    
    238,452
    
    
    
    174,663Borrowings
    
    
    166,929
    
    
    
    134,665
    
    
    
    63,926
    
    
    
    50,000
    
    
    
    31,401Stockholders equity
    
    
    109,640
    
    
    
    98,744
    
    
    
    64,318
    
    
    
    24,971
    
    
    
    23,968Selected Performance Ratios:Return on average assets
    
    
    0.51
    %
    
    
    0.58
    %
    
    
    0.49
    %
    
    
    0.43
    %
    
    
    0.32
    %Return on average equity
    
    
    5.06
    %
    
    
    5.77
    %
    
    
    5.12
    %
    
    
    4.93
    %
    
    
    2.58
    %Net interest margin (2)
    
    
    3.87
    %
    
    
    3.81
    %
    
    
    3.59
    %
    
    
    3.24
    %
    
    
    3.09
    %Net interest spread (3)
    
    
    3.35
    %
    
    
    3.44
    %
    
    
    3.33
    %
    
    
    2.98
    %
    
    
    2.68
    %Non-interest income as a percentage of
net interest income and non-interest
income
    
    
    20.04
    %
    
    
    25.72
    %
    
    
    31.16
    %
    
    
    35.51
    %
    
    
    33.97
    %Non-interest income as a percentage of
average assets
    
    
    0.89
    %
    
    
    1.19
    %
    
    
    1.44
    %
    
    
    1.61
    %
    
    
    1.46
    %Non-interest expense to average assets
    
    
    3.35
    %
    
    
    3.43
    %
    
    
    3.59
    %
    
    
    3.67
    %
    
    
    3.71
    %Efficiency ratio (4)
    
    
    75.80
    %
    
    
    74.17
    %
    
    
    77.95
    %
    
    
    81.00
    %
    
    
    86.69
    %
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For the Years Ended December 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002(Dollars in thousands, except per share data)Asset Quality Ratios:Nonperforming loans to period-end loans
    
    
    0.33
    %
    
    
    0.03
    %
    
    
    0.13
    %
    
    
    0.52
    %
    
    
    0.82
    %Allowance for loan losses to period-end
loans
    
    
    0.95
    %
    
    
    0.94
    %
    
    
    1.09
    %
    
    
    1.19
    %
    
    
    1.07
    %Allowance for loan losses to
nonperforming loans
    
    
    287.70
    %
    
    
    3079.90
    %
    
    
    849.59
    %
    
    
    228.02
    %
    
    
    129.59
    %Nonperforming assets to total assets (5)
    
    
    0.27
    %
    
    
    0.02
    %
    
    
    0.09
    %
    
    
    0.38
    %
    
    
    0.67
    %Net loan charge-offs to average
loans outstanding
    
    
    0.04
    %
    
    
    0.02
    %
    
    
    0.01
    %
    
    
    0.11
    %
    
    
    0.15
    %Capital Ratios:(6)Total risk-based capital
    
    
    12.99
    %
    
    
    15.17
    %
    
    
    17.40
    %
    
    
    12.68
    %
    
    
    12.51
    %Tier 1 risk-based capital
    
    
    12.11
    %
    
    
    14.31
    %
    
    
    16.41
    %
    
    
    11.59
    %
    
    
    11.57
    %Leverage ratio
    
    
    11.38
    %
    
    
    13.73
    %
    
    
    13.89
    %
    
    
    9.33
    %
    
    
    9.71
    %Equity to assets ratio
    
    
    9.08
    %
    
    
    10.19
    %
    
    
    12.01
    %
    
    
    7.93
    %
    
    
    10.37
    %Other Data:Number of banking offices
    
    
    24
    
    
    
    18
    
    
    
    16
    
    
    
    10
    
    
    
    7Number of full time equivalent employees
    
    
    327
    
    
    
    247
    
    
    
    191
    
    
    
    123
    
    
    
    96
 
 (1)
    
    Restated for 11 for- 10 stock split in 2006, Restated for 11 for- 10 stock split in 2005,
21-for-20 stock split in 2004, 21-for-20 stock split occurring during 2003 and 11-for-10
stock split occurring during 2002.(2)
    
    Net interest margin is net interest income divided by average interest-earning assets.(3)
    
    Net interest spread is the difference between the average yield on interest-earning assets
and the average cost of interest-bearing liabilities.(4)
    
    Efficiency ratio is non-interest expense divided by the sum of net interest income and
non-interest income.(5)
    
    Nonperforming assets consists of nonaccrual loans, restructured loans, and real estate owned,
where applicable.(6)
    
    Capital ratios are for the Company. 
 ITEM 7  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 AND
 
 ITEM 7A  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  FORWARD LOOKING STATEMENTS
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Managements discussion and analysis is intended to assist readers in the understanding and
evaluation of the financial condition and results of operations of Gateway Financial Holdings, Inc.
It should be read in conjunction with the audited consolidated financial statements and
accompanying notes included in this annual report and the supplemental financial data appearing
throughout this discussion and analysis. On April 25, 2006 the Companys Board of Directors
declared an 11 for-10 stock split effected in the form of a 10% stock dividend, which was
distributed May 15, 2006 to stockholders of record on April 28, 2006. On May 16, 2005 the Companys
Board of Directors declared an 11 for-10 stock split effected in the form of a 10% stock dividend,
which was distributed June 20, 2005 to stockholders of record on May 30, 2005. On February 17,
2004, the Companys Board of Directors declared a 21-for-20 stock split, to be effected in the form
of a 5% stock dividend, distributed April 8, 2004 to stockholders of record on March 15, 2004. All
references in this discussion and analysis to per share results and weighted average shares
outstanding have been adjusted to reflect the effects of these stock splits.
 OVERVIEW
     Page 22




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FINANCIAL CONDITION
December 31, 2006 and 2005
   Page 23




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##### Table of Contents



NET INTEREST INCOME
 
 Page 24




---



##### Table of Contents



Average Balances and Average Rates Earned and Paid.
 For the Years Ended December 31,2006
    
    
    2005
    
    
    2004Average
    
    
    
    
    
    
    Average
    
    
    Average
    
    
    
    
    
    
    Average
    
    
    Average
    
    
    
    
    
    
    AverageBalance
    
    
    Interest
    
    
    Rate
    
    
    Balance
    
    
    Interest
    
    
    Rate
    
    
    Balance
    
    
    Interest
    
    
    Rate(Dollars in thousands)Interest-earning assets:Loans
    
    $
    835,527
    
    
    $
    67,517
    
    
    
    8.08
    %
    
    $
    523,492
    
    
    $
    36,358
    
    
    
    6.95
    %
    
    $
    301,466
    
    
    $
    17,509
    
    
    
    5.81
    %Interest-earning deposits
    
    
    2,707
    
    
    
    140
    
    
    
    5.17
    %
    
    
    3,668
    
    
    
    138
    
    
    
    3.76
    %
    
    
    6,515
    
    
    
    102
    
    
    
    1.57
    %Investment securities available for sale taxable
    
    
    102,506
    
    
    
    4,632
    
    
    
    4.52
    %
    
    
    72,579
    
    
    
    2,731
    
    
    
    3.76
    %
    
    
    47,630
    
    
    
    1,835
    
    
    
    3.85
    %Investment securities available for sale tax
exempt
    
    
    6,850
    
    
    
    238
    
    
    
    3.47
    %
    
    
    6,327
    
    
    
    204
    
    
    
    3.22
    %
    
    
    1,908
    
    
    
    64
    
    
    
    3.35
    %FHLB/FRB stock
    
    
    9,175
    
    
    
    570
    
    
    
    6.21
    %
    
    
    5,038
    
    
    
    248
    
    
    
    4.92
    %
    
    
    2,936
    
    
    
    122
    
    
    
    4.16
    %Total interest-earning assets
    
    
    956,765
    
    
    
    73,097
    
    
    
    7.64
    %
    
    
    611,104
    
    
    
    39,679
    
    
    
    6.49
    %
    
    
    360,455
    
    
    
    19,632
    
    
    
    5.45
    %Other assets
    
    
    
    
    
    
    86,553
    
    
    
    
    
    
    
    
    
    
    
    67,916
    
    
    
    
    
    
    
    
    
    
    
    47,244Total assets
    
    $
    1,043,318
    
    
    
    
    
    
    
    
    
    
    $
    679,020
    
    
    
    
    
    
    
    
    
    
    $
    407,699Interest-bearing liabilities:Deposits:Savings, NOW, and money market
    
    $
    245,038
    
    
    
    7,918
    
    
    
    3.23
    %
    
    $
    178,577
    
    
    
    3,579
    
    
    
    2.00
    %
    
    $
    118,242
    
    
    
    1,553
    
    
    
    1.31
    %Time deposits
    
    
    450,786
    
    
    
    20,571
    
    
    
    4.56
    %
    
    
    267,494
    
    
    
    9,115
    
    
    
    3.41
    %
    
    
    137,440
    
    
    
    3,430
    
    
    
    2.50
    %Borrowings
    
    
    145,725
    
    
    
    7,610
    
    
    
    5.22
    %
    
    
    91,005
    
    
    
    3,682
    
    
    
    4.05
    %
    
    
    59,758
    
    
    
    1,708
    
    
    
    2.86
    %Total interest-bearing liabilities
    
    
    841,549
    
    
    
    36,099
    
    
    
    4.29
    %
    
    
    537,076
    
    
    
    16,376
    
    
    
    3.05
    %
    
    
    315,440
    
    
    
    6,691
    
    
    
    2.12
    %Demand deposits
    
    
    93,346
    
    
    
    
    
    
    
    
    
    
    
    72,369
    
    
    
    
    
    
    
    
    
    
    
    52,218Other liabilities
    
    
    4,216
    
    
    
    
    
    
    
    
    
    
    
    1,317
    
    
    
    
    
    
    
    
    
    
    
    815Stockholders equity
    
    
    104,207
    
    
    
    
    
    
    
    
    
    
    
    68,258
    
    
    
    
    
    
    
    
    
    
    
    39,226Total liabilities and stockholders equity
    
    $
    1,043,318
    
    
    
    
    
    
    
    
    
    
    $
    679,020
    
    
    
    
    
    
    
    
    
    
    $
    407,669Net interest income and interest rate spread
    
    
    
    
    
    $
    36,998
    
    
    
    3.35
    %
    
    
    
    
    
    $
    23,303
    
    
    
    3.44
    %
    
    
    
    
    
    $
    12,941
    
    
    
    3.33
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    3.87
    %
    
    
    
    
    
    
    
    
    
    
    3.81
    %
    
    
    
    
    
    
    
    
    
    
    3.59
    %Ratio of average interest-earning assets to
average interest-bearing liabilities
    
    
    113.69
    %
    
    
    
    
    
    
    
    
    
    
    113.78
    %
    
    
    
    
    
    
    
    
    
    
    114.27
    %
 Page 25




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##### Table of Contents



RATE/VOLUME ANALYSIS
  Year Ended
    
    
    Year EndedDecember 31, 2006 vs. 2005
    
    December 31, 2005 vs. 2004Increase (Decrease) Due to
    
    Increase (Decrease) Due toVolume
    
    Rate
    
    Total
    
    Volume
    
    Rate
    
    Total(Dollars in thousands)Interest income:Loans
    
    $
    23,443
    
    
    $
    7,716
    
    
    $
    31,159
    
    
    $
    14,158
    
    
    $
    4,691
    
    
    $
    18,849Interest-earning deposits
    
    
    (43
    )
    
    
    45
    
    
    
    2
    
    
    
    (76
    )
    
    
    112
    
    
    
    36Investment securities available
for saleTaxable
    
    
    1,239
    
    
    
    662
    
    
    
    1,901
    
    
    
    950
    
    
    
    (54
    )
    
    
    896Tax-exempt
    
    
    18
    
    
    
    16
    
    
    
    34
    
    
    
    145
    
    
    
    (5
    )
    
    
    140FHLB/FRB stock
    
    
    230
    
    
    
    92
    
    
    
    322
    
    
    
    95
    
    
    
    31
    
    
    
    126Total interest income
    
    
    24,887
    
    
    
    8,531
    
    
    
    33,418
    
    
    
    15,272
    
    
    
    4,775
    
    
    
    20,047Interest expense:DepositsSavings, NOW, and
money market
    
    
    1,740
    
    
    
    2,599
    
    
    
    4,339
    
    
    
    1,001
    
    
    
    1,025
    
    
    
    2,026Time deposits
    
    
    7,305
    
    
    
    4,151
    
    
    
    11,456
    
    
    
    3,839
    
    
    
    1,846
    
    
    
    5,685Borrowings
    
    
    2,701
    
    
    
    1,227
    
    
    
    3,928
    
    
    
    1,063
    
    
    
    911
    
    
    
    1,974Total interest expense
    
    
    11,746
    
    
    
    7,977
    
    
    
    19,723
    
    
    
    5,903
    
    
    
    3,782
    
    
    
    9,685Net interest income
increase
    
    $
    13,141
    
    
    $
    554
    
    
    $
    13,695
    
    
    $
    9,369
    
    
    $
    993
    
    
    $
    10,362
 RESULTS OF OPERATIONS
Years Ended December 31, 2006 and 2005
 Overview.
  Page 26




---



##### Table of Contents



Net Interest Income.
  Provision for Loan Losses.
 Non-Interest Income.
  Page 27




---



##### Table of Contents



Non-Interest Expenses.
 Income Taxes.
 RESULTS OF OPERATIONS
Years Ended December 31, 2005 and 2004
 Overview.
 Net Interest Income.
  Page 28




---



##### Table of Contents



Provision for Loan Losses.
 Non-Interest Income.
 Non-Interest Expenses.
 Income Taxes.
 LIQUIDITY AND CAPITAL RESOURCES
   Page 29




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##### Table of Contents



CAPITAL RATIOS
  At December 31, 2006Actual
    
    Minimum
    
    Well-CapitalizedRatio
    
    Requirement
    
    RequirementTotal risk-based capital ratio
    
    
    12.28
    %
    
    
    8.0
    %
    
    
    10.0
    %Tier 1 risk-based capital ratio
    
    
    11.39
    %
    
    
    4.0
    %
    
    
    6.0
    %Leverage ratio
    
    
    10.62
    %
    
    
    4.0
    %
    
    
    5.0
    %
  CONTRACTUAL OBLIGATIONS AND COMMITMENTS
  Payments Due by PeriodOn DemandOr Within
    
    
    
    
    
    
    
    
    
    
    AfterContractual Obligations
    
    Total
    
    
    1 Year
    
    
    2-3 Years
    
    
    4-5 Years
    
    
    5 Years(In thousands)Federal funds purchased
    
    $
    -
    
    
    $
    -
    
    
    $
    -
    
    
    $
    -
    
    
    $
    -FHLB advances
    
    
    116,000
    
    
    
    14,500
    
    
    
    5,000
    
    
    
    76,500
    
    
    
    20,000Reverse purchase agreements
    
    
    20,000
    
    
    
    -
    
    
    
    -
    
    
    
    10,000
    
    
    
    10,000Junior subordinated debentures
    
    
    30,929
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    30,929Lease obligations
    
    
    20,291
    
    
    
    1,553
    
    
    
    2,746
    
    
    
    2,531
    
    
    
    13,461Deposits
    
    
    923,725
    
    
    
    905,999
    
    
    
    13,281
    
    
    
    4,445
    
    
    
    -Total contractual cash obligations
    
    $
    1,110,945
    
    
    $
    922,052
    
    
    $
    21,027
    
    
    $
    93,476
    
    
    $
    74,390
 Page 30




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##### Table of Contents



Amount of Commitment Expiration Per PeriodTotalAmounts
    
    
    Within
    
    
    
    
    
    
    
    
    
    
    AfterOther Commitments
    
    Committed
    
    
    1 Year
    
    
    2-3 Years
    
    
    4-5 Years
    
    
    5 Years(In thousands)Undisbursed home equity credit lines
    
    $
    53,274
    
    
    $
    53,274
    
    
    $
    -
    
    
    $
    -
    
    
    $
    -Other commitments and credit lines
    
    
    174,885
    
    
    
    174,885
    
    
    
    -
    
    
    
    -
    
    
    
    -Undisbursed portion of construction loans
    
    
    27,965
    
    
    
    27,965
    
    
    
    -
    
    
    
    -
    
    
    
    -Standby letters of credit
    
    
    6,187
    
    
    
    6,187
    
    
    
    -
    
    
    
    -
    
    
    
    -Construction projects
    
    
    16,500
    
    
    
    16,500
    
    
    
    -
    
    
    
    -
    
    
    
    -Total other commitments
    
    $
    278,811
    
    
    $
    278,811
    
    
    $
    -
    
    
    $
    -
    
    
    $
    -
  ASSET/LIABILITY MANAGEMENT
      Page 31




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##### Table of Contents



Terms to Repricing at December 31, 2006Over 3
    
    
    Total3 Months
    
    
    Months to
    
    
    Within
    
    
    Over 12or Less
    
    
    12 Months
    
    
    12 Months
    
    
    Months
    
    
    Total(Dollars in thousands)Interest-earning assets:Loans
    
    $
    478,428
    
    
    $
    56,202
    
    
    $
    534,630
    
    
    $
    459,962
    
    
    $
    994,592Interest-earning deposits
    
    
    4,717
    
    
    
    -
    
    
    
    4,717
    
    
    
    -
    
    
    
    4,717Investment securities available for sale
    
    
    7,266
    
    
    
    5,923
    
    
    
    13,189
    
    
    
    80,286
    
    
    
    93,475FHLB/FRB stock
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    10,579
    
    
    
    10,579Total interest-earning assets
    
    $
    490,411
    
    
    $
    62,125
    
    
    $
    552,536
    
    
    $
    550,827
    
    
    $
    1,103,363Percentage of total interest-earning assets
    
    
    44.44%
    
    
    
    5.64%
    
    
    
    50.08%
    
    
    
    49.92%
    
    
    
    100.00%Cumulative percentage to total interest-
earning assets
    
    
    44.44%
    
    
    
    50.08%
    
    
    
    50.08%
    
    
    
    100.00%
    
    
    
    100.00%Interest-bearing liabilities:Deposits:Savings, NOW and money market
    
    $
    268,658
    
    
    $
    -
    
    
    $
    268,658
    
    
    $
    -
    
    
    $
    268,658Time
    
    
    258,154
    
    
    
    271,181
    
    
    
    529,335
    
    
    
    17,725
    
    
    
    547,060Borrowings
    
    
    100,429
    
    
    
    -
    
    
    
    100,429
    
    
    
    66,500
    
    
    
    166,929Total interest-bearing liabilities
    
    $
    627,241
    
    
    $
    271,181
    
    
    $
    898,422
    
    
    $
    84,225
    
    
    $
    982,647Percentage of total interest-bearing liabilities
    
    
    63.83%
    
    
    
    27.60%
    
    
    
    91.43%
    
    
    
    8.57%
    
    
    
    100.00%Cumulative percentage of total interest-
bearing liabilities
    
    
    63.83%
    
    
    
    91.43%
    
    
    
    91.43%
    
    
    
    100.00%
    
    
    
    100.00%Interest sensitivity gap
    
    $
    (136,830
    )
    
    $
    (209,056
    )
    
    $
    (345,886
    )
    
    $
    466,602
    
    
    $
    120,716Cumulative interest sensitivity gap
    
    $
    (136,830
    )
    
    $
    (345,886
    )
    
    $
    (345,886
    )
    
    $
    120,716
    
    
    $
    120,716Cumulative interest sensitivity gap as a
percentage of total interest-earning assets
    
    
    (12.40)%
    
    
    
    (31.35)%
    
    
    
    (31.35)%
    
    
    
    10.94%
    
    
    
    10.94%Cumulative ratio of interest-sensitive assets
to interest-sensitive liabilities
    
    
    78.19%
    
    
    
    61.50%
    
    
    
    61.50%
    
    
    
    112.28%
    
    
    
    112.28%
  Page 32




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##### Table of Contents



CRITICAL ACCOUNTING POLICIES
   Allowance for loan losses
  Goodwill.
  Page 33




---



##### Table of Contents



Stock Compensation Plans
   OFF-BALANCE SHEET ARRANGEMENTS
  RECENT ACCOUNTING PRONOUNCEMENTS
  LENDING ACTIVITIES
 General
  Page 34




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##### Table of Contents



At December 31,2006
    
    2005Percent
    
    
    
    
    
    PercentAmount
    
    of Total
    
    Amount
    
    of Total(Dollars in thousands)Commercial & industrial
    
    $
    150,070
    
    
    
    15.1
    %
    
    $
    80,816
    
    
    
    12.1
    %Real estate  construction
    
    
    183,831
    
    
    
    18.5
    %
    
    
    114,018
    
    
    
    17.1
    %Real estate  commercial mortgage
    
    
    362,322
    
    
    
    36.4
    %
    
    
    221,526
    
    
    
    33.2
    %Real estate  1-4 family mortgage
    
    
    108,498
    
    
    
    10.9
    %
    
    
    82,987
    
    
    
    12.4
    %Consumer
    
    
    88,744
    
    
    
    8.9
    %
    
    
    98,881
    
    
    
    14.8
    %Mortgage loans held for sale
    
    
    15,576
    
    
    
    1.6
    %
    
    
    -
    
    
    
    -
    %Home equity lines of credit
    
    
    85,882
    
    
    
    8.6
    %
    
    
    69,246
    
    
    
    10.4
    %Subtotal
    
    
    994,923
    
    
    
    100.0
    %
    
    
    667,474
    
    
    
    100.0
    %Less: Allowance for loan losses
    
    
    (9,405
    )
    
    
    
    
    
    
    (6,283
    )Unamortized net deferred (fees) costs
    
    
    (331
    )
    
    
    
    
    
    
    (822
    )Net loans
    
    $
    985,187
    
    
    
    
    
    
    $
    660,369
 At December 31,2004
    
    2003Percent
    
    
    
    
    
    PercentAmount
    
    of Total
    
    Amount
    
    of Total(Dollars in thousands)Commercial & industrial
    
    $
    69,075
    
    
    
    18.0
    %
    
    $
    52,554
    
    
    
    22.7
    %Real estate  construction
    
    
    131,431
    
    
    
    34.4
    %
    
    
    55,970
    
    
    
    24.2
    %Real estate  commercial mortgage
    
    
    90,197
    
    
    
    23.6
    %
    
    
    68,094
    
    
    
    29.3
    %Real estate  1-4 family mortgage
    
    
    51,768
    
    
    
    13.5
    %
    
    
    32,191
    
    
    
    13.9
    %Consumer
    
    
    10,641
    
    
    
    2.8
    %
    
    
    10,458
    
    
    
    4.5
    %Home equity lines of credit
    
    
    29,350
    
    
    
    7.7
    %
    
    
    12,615
    
    
    
    5.4
    %Subtotal
    
    
    382,462
    
    
    
    100.0
    %
    
    
    231,882
    
    
    
    100.0
    %Less: Allowance for loan losses
    
    
    (4,163
    )
    
    
    
    
    
    
    (2,759
    )Unamortized net deferred (fees) costs
    
    
    (506
    )
    
    
    
    
    
    
    (142
    )Net loans
    
    $
    377,793
    
    
    
    
    
    
    $
    228,981
 Page 35




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##### Table of Contents



At December 31,2002PercentAmount
    
    of Total(Dollars in thousands)Commercial
    
    $
    42,767
    
    
    
    26.5
    %Real estate  construction
    
    
    22,861
    
    
    
    14.2
    %Real estate  commercial mortgage
    
    
    48,362
    
    
    
    29.9
    %Real estate  1-4 family mortgage
    
    
    31,957
    
    
    
    19.8
    %Consumer
    
    
    7,707
    
    
    
    4.7
    %Home equity lines of credit
    
    
    7,834
    
    
    
    4.9
    %Subtotal
    
    
    161,488
    
    
    
    100.0
    %Less: Allowance for loan losses
    
    
    (1,721
    )Unamortized net deferred (fees) costs
    
    
    -Net loans
    
    $
    159,767
  Within 1 Year
    
    
    1-5 Years
    
    
    After 5 Years
    
    
    Total(Dollars in thousands)Commercial and industrial
    
    $
    84,989
    
    
    $
    56,882
    
    
    $
    8,199
    
    
    $
    150,070Real estate  construction
    
    
    126,664
    
    
    
    51,201
    
    
    
    5,966
    
    
    
    183,831Total
    
    $
    211,653
    
    
    $
    108,083
    
    
    $
    14,165
    
    
    $
    333,901Fixed rate loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    66,477Variable rate loans
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    55,772$
    122,249
 Commercial & Industrial Loans.
  Real Estate Loans.
  Page 36




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##### Table of Contents



Consumer Loans and Home Equity Lines of Credits.
 Loan Approvals.
 Commitments and Contingent Liabilities
  Asset Quality
  Page 37




---



##### Table of Contents



Nonperforming Assets
  At December 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002(Dollars in thousands)Nonaccrual loans
    
    $
    3,269
    
    
    $
    204
    
    
    $
    490
    
    
    $
    1,210
    
    
    $
    1,328Restructured loans
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -Total nonperforming loans
    
    
    3,269
    
    
    
    204
    
    
    
    490
    
    
    
    1,210
    
    
    
    1,328Real estate owned
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    230Total nonperforming assets
    
    $
    3,269
    
    
    $
    204
    
    
    $
    490
    
    
    $
    1,210
    
    
    $
    1,558Accruing loans past due 90 days or more
    
    $
    -
    
    
    $
    -
    
    
    $
    -
    
    
    $
    -
    
    
    $
    -Potential problem loans
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -Allowance for loan losses
    
    
    9,405
    
    
    
    6,283
    
    
    
    4,163
    
    
    
    2,759
    
    
    
    1,721Nonperforming loans to period end loans
    
    
    0.33%
    
    
    
    0.03%
    
    
    
    0.13%
    
    
    
    0.52%
    
    
    
    0.82%Allowance for loan losses to
period end loans
    
    
    0.95%
    
    
    
    .94%
    
    
    
    1.09%
    
    
    
    1.19%
    
    
    
    1.07%Allowance for loan losses to
nonperforming loans
    
    
    287.70%
    
    
    
    3,079.90%
    
    
    
    849.59%
    
    
    
    228.02%
    
    
    
    129.59%Nonperforming assets to total assets
    
    
    0.27%
    
    
    
    0.02%
    
    
    
    0.09%
    
    
    
    0.38%
    
    
    
    0.67%
  Page 38




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##### Table of Contents



Analysis of Allowance for Loan Losses
      Page 39




---



##### Table of Contents



At December 31,2006
    
    2005% of Total
    
    
    
    
    
    % of TotalAmount
    
    Loans (1)
    
    Amount
    
    Loans (1)(Dollars in thousands)Balance applicable to:Commercial & industrial
    
    $
    1,979
    
    
    
    15.1
    %
    
    $
    881
    
    
    
    12.1
    %Real estate  construction
    
    
    3,191
    
    
    
    18.5
    %
    
    
    2,149
    
    
    
    17.1
    %Real estate  mortgage
    
    
    2,514
    
    
    
    48.9
    %
    
    
    1,724
    
    
    
    45.6
    %Consumer
    
    
    907
    
    
    
    8.9
    %
    
    
    989
    
    
    
    14.8
    %Home equity lines of credit
    
    
    814
    
    
    
    8.6
    %
    
    
    540
    
    
    
    10.4
    %Unallocated
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    9,405
    
    
    
    100.0
    %
    
    $
    6,283
    
    
    
    100.0
    %
 At December 31,2004
    
    2003% of Total
    
    
    
    
    
    % of TotalAmount
    
    Loans (1)
    
    Amount
    
    Loans (1)(Dollars in thousands)Balance applicable to:Commercial & industrial
    
    $
    667
    
    
    
    18.0
    %
    
    $
    683
    
    
    
    22.7
    %Real estate  construction
    
    
    1,577
    
    
    
    34.4
    %
    
    
    672
    
    
    
    24.2
    %Real estate  mortgage
    
    
    1,477
    
    
    
    37.1
    %
    
    
    1,102
    
    
    
    43.2
    %Consumer
    
    
    128
    
    
    
    2.8
    %
    
    
    125
    
    
    
    4.5
    %Home equity lines of credit
    
    
    294
    
    
    
    7.7
    %
    
    
    139
    
    
    
    5.4
    %Unallocated
    
    
    20
    
    
    
    
    
    
    
    38
    
    
    
    Total
    
    $
    4,163
    
    
    
    100.0
    %
    
    $
    2,759
    
    
    
    100.0
    %
 Page 40




---



##### Table of Contents



At December 31,2002% of TotalAmount
    
    
    Loans (1)(Dollars in thousands)Balance applicable to:Commercial
    
    $
    482
    
    
    
    26.5
    %Real estate  construction
    
    
    229
    
    
    
    14.2
    %Real estate  mortgage
    
    
    803
    
    
    
    49.7
    %Consumer
    
    
    77
    
    
    
    4.7
    %Home equity lines of credit
    
    
    78
    
    
    
    4.9
    %Unallocated
    
    
    52
    
    
    
    -Total
    
    $
    1,721
    
    
    
    100.0
    %
 (1)
  At or for the Years Ended December 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002(Dollars in thousands)Balance at beginning of period
    
    $
    6,283
    
    
    $
    4,163
    
    
    $
    2,759
    
    
    $
    1,721
    
    
    $
    1,435Charge-offs:Commercial
    
    
    (42
    )
    
    
    -
    
    
    
    -
    
    
    
    (195
    )
    
    
    (146
    )Real estate
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    (18
    )Consumer
    
    
    (263
    )
    
    
    (87
    )
    
    
    (174
    )
    
    
    (20
    )
    
    
    (30
    )Home equity lines of credit
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -Total charge-offs
    
    
    (305
    )
    
    
    (87
    )
    
    
    (174
    )
    
    
    (215
    )
    
    
    (194
    )Recoveries:Commercial
    
    
    3
    
    
    
    -
    
    
    
    125
    
    
    
    1
    
    
    
    -Real estate
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -Consumer
    
    
    24
    
    
    
    7
    
    
    
    28
    
    
    
    -
    
    
    
    -Home equity lines of credit
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -Total recoveries
    
    
    27
    
    
    
    7
    
    
    
    153
    
    
    
    1
    
    
    
    -Net charge-offs
    
    
    (278
    )
    
    
    (80
    )
    
    
    (21
    )
    
    
    (214
    )
    
    
    (194
    )Allowance for loan losses on
loans purchased
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    52
    
    
    
    -Provision for loan losses charged
to operations
    
    
    3,400
    
    
    
    2,200
    
    
    
    1,425
    
    
    
    1,200
    
    
    
    480Balance at end of period
    
    $
    9,405
    
    
    $
    6,283
    
    
    $
    4,163
    
    
    $
    2,759
    
    
    $
    1,721Ratio of net loan charge-offs to
average loans outstanding
    
    
    0.04
    %
    
    
    0.02
    %
    
    
    0.01
    %
    
    
    0.11
    %
    
    
    0.15
    %
 INVESTMENT ACTIVITIES
  Page 41




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##### Table of Contents



Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    MarketCost
    
    
    Gains
    
    
    Losses
    
    
    Value(Dollars in thousands)December 31, 2005U.S. government agencies
    
    $
    36,900
    
    
    $
    -
    
    
    $
    922
    
    
    $
    35,978Corporate debt/equity securities
    
    
    8,415
    
    
    
    403
    
    
    
    10
    
    
    
    8,808Mortgage-backed securities
    
    
    42,748
    
    
    
    9
    
    
    
    616
    
    
    
    42,141Municipal securities
    
    
    6,612
    
    
    
    14
    
    
    
    78
    
    
    
    6,548$
    94,675
    
    
    $
    426
    
    
    $
    1,626
    
    
    $
    93,475December 31, 2005U.S. government agencies
    
    $
    42,555
    
    
    $
    -
    
    
    $
    1,327
    
    
    $
    41,228Corporate debt/equity securities
    
    
    6,619
    
    
    
    1,373
    
    
    
    117
    
    
    
    7,875Mortgage-backed securities
    
    
    67,935
    
    
    
    13
    
    
    
    581
    
    
    
    67,367Municipal securities
    
    
    7,372
    
    
    
    18
    
    
    
    87
    
    
    
    7,303$
    124,481
    
    
    $
    1,404
    
    
    $
    2,112
    
    
    $
    123,773December 31, 2004U.S. government agencies
    
    $
    43,709
    
    
    $
    6
    
    
    $
    471
    
    
    $
    43,244Corporate debt/equity securities
    
    
    2,613
    
    
    
    49
    
    
    
    1
    
    
    
    2,661Mortgage-backed securities
    
    
    40,408
    
    
    
    146
    
    
    
    86
    
    
    
    40,468Municipal securities
    
    
    6,239
    
    
    
    17
    
    
    
    21
    
    
    
    6,235$
    92,969
    
    
    $
    218
    
    
    $
    579
    
    
    $
    92,608
  WeightedAmortized
    
    
    Fair
    
    
    AverageCost
    
    
    Value
    
    
    YieldSecurities available for sale:
    
    (Dollars in thousands)U.S. Government agencies:Due within one year
    
    $
    6,002
    
    
    $
    5,923
    
    
    
    3.51
    %Due after one but within five years
    
    
    30,898
    
    
    
    30,055
    
    
    
    3.58
    %36,900
    
    
    
    35,978
    
    
    
    3.57
    %Corporate debt/equity securities:Due within one year
    
    
    6,862
    
    
    
    7,266
    
    
    
    5.68
    %Due after one but within five years
    
    
    1,553
    
    
    
    1,542
    
    
    
    5.81
    %8,415
    
    
    
    8,808
    
    
    
    5.70
    %Mortgage-backed securities:Due after one but within five years
    
    
    996
    
    
    
    967
    
    
    
    3.09
    %Due after ten years
    
    
    41,752
    
    
    
    41,174
    
    
    
    5.09
    %42,748
    
    
    
    42,141
    
    
    
    5.04
    %Municipal securities:Due after one but within five years
    
    
    1,814
    
    
    
    1,768
    
    
    
    3.75
    %Due after five but within ten years
    
    
    1,432
    
    
    
    1,418
    
    
    
    4.99
    %Due after ten years
    
    
    3,366
    
    
    
    3,362
    
    
    
    5.85
    %6,612
    
    
    
    6,548
    
    
    
    5.10
    %Total securities available for sale:Due within one year
    
    
    12,864
    
    
    
    13,189
    
    
    
    4.71
    %Due after one but within five years
    
    
    35,261
    
    
    
    34,332
    
    
    
    3.68
    %Due after five but within ten years
    
    
    1,432
    
    
    
    1,418
    
    
    
    4.99
    %Due after ten years
    
    
    45,118
    
    
    
    44,536
    
    
    
    5.15
    %$
    94,675
    
    
    $
    93,475
    
    
    
    4.54
    %
 Page 42




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##### Table of Contents



SOURCES OF FUNDS
 Deposit Activities
   At December 31,2006

    
    2005

    
    2004Average
    
    
    Average

    
    Average
    
    
    Average

    
    Average
    
    
    AverageBalance
    
    
    Rate

    
    Balance
    
    
    Rate

    
    Balance
    
    
    Rate(Dollars in thousands)Interest-bearing NOW, money
market and savings accounts
    
    $
    245,038
    
    
    
    3.23
    %
    
    $
    178,577
    
    
    
    2.00
    %
    
    $
    118,242
    
    
    
    1.31
    %Time deposits
    
    
    450,786
    
    
    
    4.56
    %
    
    
    267,494
    
    
    
    3.41
    %
    
    
    137,440
    
    
    
    2.50
    %Total interest-bearing deposits
    
    
    695,824
    
    
    
    4.09
    %
    
    
    446,071
    
    
    
    2.85
    %
    
    
    255,682
    
    
    
    1.95
    %Demand and other non-interest-bearing
deposits
    
    
    93,346
    
    
    
    
    
    
    
    79,901
    
    
    
    
    
    
    
    52,218Total average deposits
    
    $
    789,170
    
    
    
    3.61
    %
    
    $
    525,972
    
    
    
    2.41
    %
    
    $
    307,900
    
    
    
    1.62
    %
  At December 31, 2006(Dollars in thousands)Remaining maturity:Less than three months
    
    $
    76,844Over three months through six months
    
    
    73,336Over six months through one year
    
    
    50,515Over one year through three years
    
    
    3,232Over three years through five years
    
    
    1,525Total
    
    $
    205,452
 Page 43




---



##### Table of Contents



Borrowings
  InterestMaturity
    
    Rate

    
    2006
    
    
    2005February 27, 2006
    
    
    5.45
    %
    
    $
    -
    
    
    $
    200,000March 17, 2010
    
    
    5.71
    %
    
    
    1,500,000
    
    
    
    1,500,000November 10, 2010
    
    
    5.43
    %
    
    
    5,000,000
    
    
    
    5,000,000January 24, 2012
    
    
    3.88
    %
    
    
    -
    
    
    
    5,500,000October 23, 2006
    
    
    3.89
    %
    
    
    -
    
    
    
    5,000,000April 21, 2008
    
    
    4.22
    %
    
    
    5,000,000
    
    
    
    5,000,000April 25, 2012
    
    
    4.85
    %
    
    
    10,000,000
    
    
    
    10,000,000May 19, 2010
    
    
    3.88
    %
    
    
    -
    
    
    
    10,000,000June 24, 2010
    
    
    3.88
    %
    
    
    -
    
    
    
    10,000,000July 23, 2012
    
    
    4.85
    %
    
    
    10,000,000
    
    
    
    10,000,000November 22, 2006
    
    
    4.58
    %
    
    
    -
    
    
    
    52,000,000October 4, 2011
    
    
    4.35
    %
    
    
    20,000,000
    
    
    
    -October 24, 2011
    
    
    4.35
    %
    
    
    5,000,000
    
    
    
    -August 8, 2011
    
    
    4.56
    %
    
    
    35,000,000
    
    
    
    -November 23, 2007
    
    
    5.50
    %
    
    
    14,500,000
    
    
    
    -September 1, 2011
    
    
    4.49
    %
    
    
    10,000,000
    
    
    
    -$
    116,000,000
    
    
    $
    114,200,000
     Page 44




---



##### Table of Contents



ITEM 8  FINANCIAL STATEMENTS
 GATEWAY FINANCIAL HOLDINGS, INC. & SUBSIDIARY
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS
 Page No.Report of Independent Registered Public Accounting Firm
    
    39Consolidated Balance Sheets as of December 31, 2006 and 2005
    
    40Consolidated Statements of Operations
for the years ended December 31, 2006, 2005 and 2004
    
    41Consolidated Statements of Comprehensive Income
for the years ended December 31, 2006, 2005 and 2004
    
    42Consolidated Statements of Changes in Stockholders Equity
for the years ended December 31, 2006, 2005 and 2004
    
    43Consolidated Statements of Cash Flows
for the years ended December 31, 2006, 2005 and 2004
    
    44Notes to Consolidated Financial Statements
    
    45
 Page 45




---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
     Greenville, North Carolina
March 14, 2007
 Page 46




---



##### Table of Contents



GATEWAY
FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
 
 CONSOLIDATED BALANCE SHEETS
December 31, 2006 and 2005
 2006
    
    
    2005ASSETS
    
    
    
    
    
    (In thousands, except share data)Cash and due from banks
    
    
    
    
    
    $
    22,077
    
    
    $
    18,475Interest-earning deposits in other banks
    
    
    
    
    
    
    4,717
    
    
    
    3,668Investment securities available for sale, at fair value (Note C)
    
    
    
    
    
    
    93,475
    
    
    
    123,773Loans (Note D)
    
    
    
    
    
    
    994,592
    
    
    
    666,652Allowance for loan losses (Note D)
    
    
    
    
    
    
    (9,405
    )
    
    
    (6,283
    )NET LOANS
    
    
    985,187
    
    
    
    660,369Accrued interest receivable
    
    
    
    
    
    
    8,742
    
    
    
    5,883Stock in Federal Reserve Bank, at cost
    
    
    
    
    
    
    3,609
    
    
    
    2,097Stock in Federal Home Loan Bank of Atlanta, at cost
    
    
    
    
    
    
    6,970
    
    
    
    6,208Premises and equipment, net (Note E)
    
    
    
    
    
    
    38,456
    
    
    
    29,551Intangible assets, net (Note Q)
    
    
    
    
    
    
    4,163
    
    
    
    2,891Goodwill (Notes N and Q)
    
    
    
    
    
    
    8,452
    
    
    
    7,456Bank-owned life insurance
    
    
    
    
    
    
    25,051
    
    
    
    17,187Other assets
    
    
    
    
    
    
    6,578
    
    
    
    5,815TOTAL ASSETS
    
    $
    1,207,477
    
    
    $
    883,373LIABILITIES AND STOCKHOLDERS EQUITYDepositsDemand
    
    
    
    
    
    $
    108,007
    
    
    $
    89,162Savings
    
    
    
    
    
    
    7,249
    
    
    
    8,347Money market and NOW
    
    
    
    
    
    
    261,409
    
    
    
    181,337Time (Note F)
    
    
    
    
    
    
    547,060
    
    
    
    367,416TOTAL DEPOSITS
    
    
    923,725
    
    
    
    646,262Short term borrowings (Note G)
    
    
    
    
    
    
    14,500
    
    
    
    62,000Long term borrowings (Note G)
    
    
    
    
    
    
    152,429
    
    
    
    72,665Accrued expenses and other liabilities
    
    
    
    
    
    
    7,183
    
    
    
    3,702TOTAL LIABILITIES
    
    
    1,097,837
    
    
    
    784,629Commitments (Notes D and K)Stockholders Equity (Notes J and M)Preferred stock, 1,000,000 shares authorized, none issued
    
    
    
    
    
    
    
    
    
    
    Common stock, no par value, 20,000,000 shares authorized,
10,978,014 and 9,493,440 shares issued and
outstanding at December 31, 2006 and 2005, respectively
    
    
    
    
    
    
    101,669
    
    
    
    94,109Retained earnings
    
    
    
    
    
    
    8,708
    
    
    
    5,113Deferred compensation  restricted stock
    
    
    
    
    
    
    
    
    
    
    (43
    )Accumulated other comprehensive loss
    
    
    
    
    
    
    (737
    )
    
    
    (435
    )TOTAL STOCKHOLDERS' EQUITY
    
    
    109,640
    
    
    
    98,744TOTAL LIABILITIES ANDSTOCKHOLDERS' EQUITY
    
    $
    1,207,477
    
    
    $
    883,373
 Page 47




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##### Table of Contents



GATEWAY
FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2006, 2005 and 2004
 2006
    
    
    2005
    
    
    2004(Amounts in thousands, exceptper share data)INTEREST INCOMEInterest and fees on loans
    
    
    
    
    
    $
    67,517
    
    
    $
    36,358
    
    
    $
    17,509Investment securities available for saleTaxable
    
    
    
    
    
    
    4,632
    
    
    
    2,731
    
    
    
    1,835Tax-exempt
    
    
    
    
    
    
    238
    
    
    
    204
    
    
    
    64Interest-earning bank deposits
    
    
    
    
    
    
    140
    
    
    
    138
    
    
    
    102Other interest and dividends
    
    
    
    
    
    
    570
    
    
    
    248
    
    
    
    122TOTAL INTEREST INCOME
    
    
    73,097
    
    
    
    39,679
    
    
    
    19,632INTEREST EXPENSEMoney market, NOW and savings deposits
    
    
    
    
    
    
    7,918
    
    
    
    3,579
    
    
    
    1,553Time deposits (Note F)
    
    
    
    
    
    
    20,571
    
    
    
    9,115
    
    
    
    3,430Short-term borrowings
    
    
    
    
    
    
    2,429
    
    
    
    1,140
    
    
    
    404Long-term borrowings
    
    
    
    
    
    
    5,181
    
    
    
    2,542
    
    
    
    1,304TOTAL INTEREST EXPENSE
    
    
    36,099
    
    
    
    16,376
    
    
    
    6,691NET INTEREST INCOME
    
    
    36,998
    
    
    
    23,303
    
    
    
    12,941PROVISION FOR LOAN LOSSES (Note D)
    
    
    
    
    
    
    3,400
    
    
    
    2,200
    
    
    
    1,425NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
    
    
    33,598
    
    
    
    21,103
    
    
    
    11,516NON-INTEREST INCOMEService charges on deposit accounts
    
    
    
    
    
    
    3,294
    
    
    
    2,308
    
    
    
    1,500Mortgage operations
    
    
    
    
    
    
    1,584
    
    
    
    836
    
    
    
    872Insurance operations
    
    
    
    
    
    
    2,883
    
    
    
    2,388
    
    
    
    1,832Brokerage operations
    
    
    
    
    
    
    744
    
    
    
    656
    
    
    
    463Gain on sale of securities
    
    
    
    
    
    
    842
    
    
    
    282
    
    
    
    159Loss on disposition of premises & equipment
    
    
    
    
    
    
    (292
    )
    
    
    
    
    
    
    Gain on sale of membership interest in mortgage company
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    281Loss and net cash settlement on economic hedge (Note R)
    
    
    
    
    
    
    (1,918
    )
    
    
    
    
    
    
    Income from bank-owned life insurance
    
    
    
    
    
    
    864
    
    
    
    679
    
    
    
    401Other service charges and fees
    
    
    
    
    
    
    1,019
    
    
    
    623
    
    
    
    259Other
    
    
    
    
    
    
    250
    
    
    
    295
    
    
    
    90TOTAL NON-INTEREST INCOME
    
    
    9,270
    
    
    
    8,067
    
    
    
    5,857NON-INTEREST EXPENSEPersonnel costs
    
    
    
    
    
    
    17,287
    
    
    
    11,583
    
    
    
    7,838Occupancy and equipment
    
    
    
    
    
    
    6,865
    
    
    
    4,592
    
    
    
    2,884Data processing fees
    
    
    
    
    
    
    1,652
    
    
    
    941
    
    
    
    606Other (Note I)
    
    
    
    
    
    
    9,170
    
    
    
    6,150
    
    
    
    3,325TOTAL NON-INTEREST EXPENSE
    
    
    34,974
    
    
    
    23,266
    
    
    
    14,653INCOME BEFORE INCOME TAXES
    
    
    7,894
    
    
    
    5,904
    
    
    
    2,720INCOME TAXES (Note H)
    
    
    
    
    
    
    2,625
    
    
    
    1,965
    
    
    
    710NET INCOME
    
    $
    5,269
    
    
    $
    3,939
    
    
    $
    2,010NET INCOME PER COMMON SHAREBasic
    
    
    
    
    
    $
    .49
    
    
    $
    .48
    
    
    $
    .37Diluted
    
    
    
    
    
    $
    .47
    
    
    $
    .46
    
    
    $
    .34
 See accompanying notes.
 Page 48




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##### Table of Contents



GATEWAY
FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
 
 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2006, 2005 and 2004
 2006
    
    
    2005
    
    
    2004(Amounts in thousands)Net income
    
    $
    5,269
    
    
    $
    3,939
    
    
    $
    2,010Other comprehensive income (loss):Securities available for sale:Unrealized holding gains (losses) on available-for-sale
securities
    
    
    351
    
    
    
    (67
    )
    
    
    (489
    )Tax effect
    
    
    (127
    )
    
    
    26
    
    
    
    188Reclassification of gains recognized in net income
    
    
    (842
    )
    
    
    (282
    )
    
    
    (159
    )Tax effect
    
    
    316
    
    
    
    109
    
    
    
    62Total other comprehensive loss
    
    
    (302
    )
    
    
    (214
    )
    
    
    (398
    )Comprehensive income
    
    $
    4,967
    
    
    $
    3,725
    
    
    $
    1,612
 See accompanying notes.
 Page 49




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
 
 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
Years Ended December 31, 2006, 2005 and 2004
 
 Deferred
    
    
    AccumulatedRetained
    
    
    Compensation
    
    
    Other
    
    
    TotalCommon Stock
    
    
    Earnings
    
    
    - Restricted
    
    
    Comprehensive
    
    
    StockholdersShares
    
    
    Amount
    
    
    (Deficit)
    
    
    Stock
    
    
    Income (Loss)
    
    
    Equity(Amounts in thousands, except share data)Balance at December 31, 2003
    
    
    3,167,542
    
    
    $
    24,896
    
    
    $
    (102
    )
    
    $
    -
    
    
    $
    177
    
    
    $
    24,971Net income
    
    
    
    
    
    
    -
    
    
    
    2,010
    
    
    
    
    
    
    
    -
    
    
    
    2,010Other comprehensive loss
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    (398
    )
    
    
    (398
    )Shares issued in exercise of
common stock warrants
    
    
    1,320,817
    
    
    
    12,111
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    12,111Shares issued in subsidiary
acquisition
    
    
    38,013
    
    
    
    503
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    503Shares issued from options exercise
    
    
    39,517
    
    
    
    311
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    311Issuance of common stock
    
    
    1,932,000
    
    
    
    24,915
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    24,915Shares issued in 21-for-20 stock
split effected as a 5% stock
dividend
    
    
    161,184
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -Cash dividends ($.02 per share)
    
    
    -
    
    
    
    -
    
    
    
    (95
    )
    
    
    -
    
    
    
    -
    
    
    
    (95
    )Cash paid for fractional shares
    
    
    -
    
    
    
    (10
    )
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    (10
    )Balance at December 31, 2004
    
    
    6,659,073
    
    
    
    62,726
    
    
    
    1,813
    
    
    
    -
    
    
    
    (221
    )
    
    
    64,318Net income
    
    
    -
    
    
    
    -
    
    
    
    3,939
    
    
    
    -
    
    
    
    -
    
    
    
    3,939Other comprehensive loss
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    (214
    )
    
    
    (214
    )Restricted stock awards
    
    
    10,230
    
    
    
    133
    
    
    
    -
    
    
    
    (133
    )
    
    
    -
    
    
    
    -Unearned compensation
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    90
    
    
    
    -
    
    
    
    90Issuance of shares pursuant to
dividend reinvestment plan
    
    
    9,025
    
    
    
    147
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    147Shares issued from options exercise
    
    
    142,159
    
    
    
    1,225
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    1,225Issuance of common stock
    
    
    2,000,000
    
    
    
    29,855
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    29,855Shares issued in 11-for-10 stock split
effected as a 10% stock dividend
    
    
    671,740
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -Tax benefits from the exercise
of options
    
    
    -
    
    
    
    12
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    12Sale of common stock
    
    
    1,213
    
    
    
    11
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    11Cash dividends ($0.09 per share)
    
    
    -
    
    
    
    -
    
    
    
    (631
    )
    
    
    -
    
    
    
    -
    
    
    
    (631
    )Cash paid for fractional shares
    
    
    -
    
    
    
    -
    
    
    
    (8
    )
    
    
    -
    
    
    
    -
    
    
    
    (8
    )Balance at December 31, 2005
    
    
    9,493,440
    
    
    
    94,109
    
    
    
    5,113
    
    
    
    (43
    )
    
    
    (435
    )
    
    
    98,744Net income
    
    
    -
    
    
    
    -
    
    
    
    5,269
    
    
    
    -
    
    
    
    -
    
    
    
    5,269Other comprehensive loss
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    (302
    )
    
    
    (302
    )Issuance of restricted stock awards
    
    
    12,500
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -Stock based compensation
related to restricted stock
    
    
    -
    
    
    
    171
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    171Stock based compensation
related to stock options
    
    
    -
    
    
    
    51
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    51Adjustment to deferred
compensation for the adoption
of SFAS No. 123 (R)
    
    
    -
    
    
    
    (43
    )
    
    
    -
    
    
    
    43
    
    
    
    -
    
    
    
    -Issuance of shares pursuant to
dividend reinvestment plan
    
    
    32,573
    
    
    
    515
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    515Shares issued for subsidiary
acquisitions
    
    
    143,966
    
    
    
    2,088
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    2,088Shares issued from options exercise
    
    
    13,763
    
    
    
    102
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    102Shares issued upon exercise
of overallotment option
    
    
    300,000
    
    
    
    4,383
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    4,383Shares issued in 11 for 10 stock split
effected as a 10% stock dividend
    
    
    981,772
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -Tax benefits from the exercise
of options
    
    
    -
    
    
    
    293
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    293Cash dividends ($0.16 per share)
    
    
    -
    
    
    
    -
    
    
    
    (1,674
    )
    
    
    -
    
    
    
    -
    
    
    
    (1,674
    )Balance at December 31, 2006
    
    
    10,978,014
    
    
    $
    101,669
    
    
    $
    8,708
    
    
    $
    -
    
    
    $
    (737
    )
    
    $
    109,640
 See accompanying notes.
 Page 50




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2006, 2005 and 2004
 
 2006
    
    
    2005
    
    
    2004(Amounts in thousands)CASH FLOWS FROM OPERATING ACTIVITIESNet income
    
    $
    5,269
    
    
    $
    3,939
    
    
    $
    2,010Adjustments to reconcile net income to net
cash provided by operating activities:Amortization of intangibles
    
    
    361
    
    
    
    379
    
    
    
    130Depreciation and amortization
    
    
    2,444
    
    
    
    1,761
    
    
    
    1,310Loss on market value of economic hedge
    
    
    1,225
    
    
    
    -
    
    
    
    -Deferred income taxes
    
    
    (1,319
    )
    
    
    (185
    )
    
    
    (308
    )Realized gain on available-for-sale securities
    
    
    (842
    )
    
    
    (282
    )
    
    
    (159
    )Income from bank-owned life insurance
    
    
    (864
    )
    
    
    (680
    )
    
    
    (401
    )Realized gain on sale of loans
    
    
    (56
    )
    
    
    (127
    )
    
    
    -Proceeds from sale of loans
    
    
    799
    
    
    
    2,536
    
    
    
    -Proceeds from sale of mortgage loans held for sale
    
    
    58,593
    
    
    
    -
    
    
    
    -Mortgage loan originations held for sale
    
    
    (74,169
    )
    
    
    -
    
    
    
    -Realized loss on sale of foreclosed real estate
    
    
    -
    
    
    
    -
    
    
    
    -Realized (gain) loss on sale of premises and equipment
    
    
    292
    
    
    
    (6
    )
    
    
    14Provision for loan losses
    
    
    3,400
    
    
    
    2,200
    
    
    
    1,425Stock based compensation
    
    
    222
    
    
    
    -
    
    
    
    -Deferred
compensation  restricted stock
    
    
    -
    
    
    
    90
    
    
    
    -Change in assets and liabilities:(Increase) decrease in accrued interest receivable
    
    
    (2,859
    )
    
    
    (3,186
    )
    
    
    (1,396
    )(Increase) decrease in other assets
    
    
    (171
    )
    
    
    (1,360
    )
    
    
    92Increase in accrued expenses and other liabilities
    
    
    2,594
    
    
    
    1,526
    
    
    
    (252
    )NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES
    
    
    (5,081
    )
    
    
    6,605
    
    
    
    2,465CASH FLOWS FROM INVESTING ACTIVITIESPurchases of available-for-sale securities
    
    
    (7,621
    )
    
    
    (58,113
    )
    
    
    (87,212
    )Maturities and calls of available-for-sale securities
    
    
    15,055
    
    
    
    5,106
    
    
    
    3,685Proceeds from sale of available-for-sale securities
    
    
    23,133
    
    
    
    21,540
    
    
    
    33,935Net increase in loans from originations and repayments
    
    
    (313,385
    )
    
    
    (287,185
    )
    
    
    (149,605
    )Proceeds from sale of bank premises and equipment
    
    
    6
    
    
    
    234
    
    
    
    209Purchase of premises and equipment
    
    
    (11,528
    )
    
    
    (12,408
    )
    
    
    (6,033
    )Purchase of Federal Reserve Bank stock
    
    
    (1,512
    )
    
    
    (1,375
    )
    
    
    -Purchase of Federal Home Loan Bank stock
    
    
    (762
    )
    
    
    (3,887
    )
    
    
    (271
    )Purchase of bank owned life insurance
    
    
    (7,000
    )
    
    
    -
    
    
    
    (9,000
    )Net cash received in financial center and subsidiary acquisitions
    
    
    -
    
    
    
    -
    
    
    
    117,361NET CASH USED BY INVESTING ACTIVITIES
    
    
    (303,614
    )
    
    
    (336,088
    )
    
    
    (96,931
    )CASH FLOWS FROM FINANCING ACTIVITIESIncrease in deposits
    
    
    277,463
    
    
    
    240,003
    
    
    
    41,001Net increase (decrease) in short-term borrowings
    
    
    (47,500
    )
    
    
    21,339
    
    
    
    1,600Net increase (decrease) in long term borrowings
    
    
    64,300
    
    
    
    49,400
    
    
    
    4,861Proceeds from issuance of junior subordinated debentures
    
    
    15,464
    
    
    
    -
    
    
    
    7,217Proceeds from exercise of stock options
    
    
    102
    
    
    
    1,237
    
    
    
    311Proceeds from issuance of common stock
    
    
    4,383
    
    
    
    29,866
    
    
    
    24,915Proceeds from the conversion of common stock warrants
    
    
    -
    
    
    
    -
    
    
    
    12,111Proceeds from dividend reinvestment
    
    
    515
    
    
    
    147
    
    
    
    -Cash paid for dividends
    
    
    (1,674
    )
    
    
    (631
    )
    
    
    (95
    )Tax benefit from the exercise of stock options
    
    
    293
    
    
    
    -
    
    
    
    -Cash paid for fractional shares
    
    
    -
    
    
    
    (8
    )
    
    
    (10
    )NET CASH PROVIDED BY FINANCING ACTIVITIES
    
    
    313,346
    
    
    
    341,353
    
    
    
    91,911NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    4,651
    
    
    
    11,870
    
    
    
    (2,555
    )CASH AND CASH EQUIVALENTS, BEGINNING
    
    
    22,143
    
    
    
    10,273
    
    
    
    12,828CASH AND CASH EQUIVALENTS, ENDING
    
    $
    26,794
    
    
    $
    22,143
    
    
    $
    10,273SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATIONInterest paid
    
    $
    34,656
    
    
    $
    15,689
    
    
    $
    6,788Income taxes paid
    
    $
    3,723
    
    
    $
    748
    
    
    $
    1,220SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING ACTIVITIESUnrealized holding gains (losses) on available-for-sale
securities, net
    
    $
    (302
    )
    
    $
    (214
    )
    
    $
    (398
    )Deconsolidation of grantor trust
    
    $
    -
    
    
    $
    -
    
    
    $
    248Fair value of assets acquired through business combinations
    
    $
    2,740
    
    
    $
    -
    
    
    $
    127,523Fair value of common stock issued in business combinations
    
    $
    2,088
    
    
    $
    -
    
    
    $
    503
 See accompanying notes.
 Page 51




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE
A - ORGANIZATION AND OPERATIONS
    Consolidation of
Variable Interest Entities
  NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Principles of Consolidation
  Use of Estimates
  Page 52




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 Cash and Cash Equivalents
  Investment Securities Held to Maturity
  Investment Securities Available for Sale
  Mortgage Loans Held for Sale
  Loans
  Page 53




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 Allowance for Loan Losses
  Foreclosed Real Estate
  Premises and Equipment
  Federal Home Loan Bank and Federal Reserve Bank Stock
  Intangible Assets
  Page 54




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 Intangible Assets (Continued)
  Income Taxes
  Comprehensive Income
  Mortgage Operations
  Page 55




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE
B  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 Stock Compensation Plans
      2005
    
    
    2004(Amounts in thousands,except per share data)Net income:As reported
    
    $
    3,939
    
    
    $
    2,010Deduct: Total stock-based employee compensation
expense determined under fair value method
for all awards, net of related tax effects
    
    
    1,748
    
    
    
    1,429Pro forma
    
    $
    2,191
    
    
    $
    581Basic net income per share:As reported
    
    $
    0.48
    
    
    $
    0.37Pro forma
    
    
    0.27
    
    
    
    0.11Diluted net income per share:As reported
    
    $
    0.46
    
    
    $
    0.34Pro forma
    
    
    0.26
    
    
    
    0.10
  Page 56




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 Per Share Results
   2006
    
    
    2005
    
    
    2004Weighted average outstanding shares used for
basic EPS
    
    
    10,811,980
    
    
    
    8,214,118
    
    
    
    5,419,300Plus incremental shares from assumed exercise of:Stock options
    
    
    293,166
    
    
    
    339,275
    
    
    
    272,411Restricted stock
    
    
    16,557
    
    
    
    2,619
    
    
    
    -Warrants
    
    
    -
    
    
    
    -
    
    
    
    216,359Weighted average outstanding shares
used for diluted EPS
    
    
    11,121,703
    
    
    
    8,556,012
    
    
    
    5,908,070
   Derivative financial instruments
    Page 57




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 Recent Accounting Pronouncements
      Page 58




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 Recent Accounting Pronouncements (Continued)
        Page 59




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE
B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 Reclassifications
  NOTE
C - INVESTMENT SECURITIES
  December 31, 2006Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    Value(Amounts in thousands)Securities available-for-sale:U. S. government securities
and obligations of U.S.
government agencies
    
    $
    36,900
    
    
    $
    -
    
    
    $
    922
    
    
    $
    35,978Corporate debt/equity securities
    
    
    8,415
    
    
    
    403
    
    
    
    10
    
    
    
    8,808Mortgage-backed securities
    
    
    42,748
    
    
    
    9
    
    
    
    616
    
    
    
    42,141Municipal securities
    
    
    6,612
    
    
    
    14
    
    
    
    78
    
    
    
    6,548$
    94,675
    
    
    $
    426
    
    
    $
    1,626
    
    
    $
    93,475
 December 31, 2005Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    FairCost
    
    
    Gains
    
    
    Losses
    
    
    Value(Amounts in thousands)Securities available-for-sale:U. S. government securities
and obligations of U.S.
government agencies
    
    $
    42,555
    
    
    $
    -
    
    
    $
    1,327
    
    
    $
    41,228Corporate debt/equity securities
    
    
    6,619
    
    
    
    1,373
    
    
    
    117
    
    
    
    7,875Mortgage-backed securities
    
    
    67,935
    
    
    
    13
    
    
    
    581
    
    
    
    67,367Municipal securities
    
    
    7,372
    
    
    
    18
    
    
    
    87
    
    
    
    7,303$
    124,481
    
    
    $
    1,404
    
    
    $
    2,112
    
    
    $
    123,773
  Page 60




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE C - INVESTMENT SECURITIES (Continued)
 2006Less Than 12 Months
    
    
    12 Months or More
    
    
    TotalFair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealizedvalue
    
    
    losses
    
    
    value
    
    
    losses
    
    
    value
    
    
    lossesSecurities available for sale:U.S. government securities
and obligations of U.S.
government agencies
    
    $
    -
    
    
    $
    -
    
    
    $
    35,978
    
    
    $
    922
    
    
    $
    35,978
    
    
    $
    922Corporate
    
    
    -
    
    
    
    -
    
    
    
    1,542
    
    
    
    10
    
    
    
    1,542
    
    
    
    10Mortgage-backed securities
    
    
    21,749
    
    
    
    302
    
    
    
    7,989
    
    
    
    314
    
    
    
    29,738
    
    
    
    616Municipal securities
    
    
    1,313
    
    
    
    12
    
    
    
    2,924
    
    
    
    66
    
    
    
    4,237
    
    
    
    78Total temporarily impaired
securities
    
    $
    23,062
    
    
    $
    314
    
    
    $
    48,433
    
    
    $
    1,312
    
    
    $
    71,495
    
    
    $
    1,626
 2005Less Than 12 Months
    
    
    12 Months or More
    
    
    TotalFair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealizedvalue
    
    
    losses
    
    
    value
    
    
    losses
    
    
    value
    
    
    lossesSecurities available for sale:U.S. government securities
and obligations of U.S.
government agencies
    
    $
    -
    
    
    $
    -
    
    
    $
    40,727
    
    
    $
    1,327
    
    
    $
    40,727
    
    
    $
    1,327Corporate
    
    
    981
    
    
    
    58
    
    
    
    472
    
    
    
    59
    
    
    
    1,453
    
    
    
    117Mortgage-backed securities
    
    
    9,216
    
    
    
    260
    
    
    
    8,545
    
    
    
    321
    
    
    
    17,761
    
    
    
    581Municipal securities
    
    
    3,937
    
    
    
    52
    
    
    
    2,089
    
    
    
    35
    
    
    
    6,026
    
    
    
    87Total temporarily impaired
securities
    
    $
    14,134
    
    
    $
    370
    
    
    $
    51,833
    
    
    $
    1,742
    
    
    $
    65,967
    
    
    $
    2,112
   Amortized
    
    
    FairCost
    
    
    Value(Dollars in thousands)Due within one year
    
    $
    12,864
    
    
    $
    13,190Due after one year through five years
    
    
    35,261
    
    
    
    34,331Due after five years through ten years
    
    
    1,432
    
    
    
    1,418Due after ten years
    
    
    45,118
    
    
    
    44,536$
    94,675
    
    
    $
    93,475
 Page 61




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  December 31, 2006, 2005 and 2004
 
 NOTE C - INVESTMENT SECURITIES (Continued)
   NOTE D - LOANS
  December 31,2006
    
    
    2005(Dollars in thousands)Commercial
    
    $
    150,070
    
    
    $
    80,816Real estate  construction
    
    
    183,831
    
    
    
    114,018Real estate  commercial mortgage
    
    
    362,322
    
    
    
    221,526Mortgage loans held for sale
    
    
    15,576
    
    
    
    Real estate  1-4 family mortgage
    
    
    108,498
    
    
    
    82,987Consumer
    
    
    88,744
    
    
    
    98,881Home equity lines of credit
    
    
    85,882
    
    
    
    69,246Subtotal
    
    
    994,923
    
    
    
    667,474Less: Allowance for loan losses
    
    
    (9,405
    )
    
    
    (6,283
    )Unamortized net deferred fees
    
    
    (331
    )
    
    
    (822
    )Net loans
    
    $
    985,187
    
    
    $
    660,369
   Page 62




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE D - LOANS (Continued)
  2006Balance at beginning of year
    
    
    
    
    
    $
    35,464Additions
    
    
    
    
    
    
    33,402Loan repayments
    
    
    
    
    
    
    (18,492
    )Balance at end of year
    
    
    
    
    
    $
    50,374
   2006
    
    
    2005
    
    
    2004(Amounts in thousands)Balance at beginning of year
    
    $
    6,283
    
    
    $
    4,163
    
    
    $
    2,759Provision charged to operations
    
    
    3,400
    
    
    
    2,200
    
    
    
    1,425Allowance for loan losses on loans purchased
    
    
    -
    
    
    
    -
    
    
    
    -Charge-offs
    
    
    (305
    )
    
    
    (87
    )
    
    
    (174
    )Recoveries
    
    
    27
    
    
    
    7
    
    
    
    153Net charge-offs
    
    
    (278
    )
    
    
    (80
    )
    
    
    (21
    )Balance at end of year
    
    $
    9,405
    
    
    $
    6,283
    
    
    $
    4,163
 NOTE E - PREMISES AND EQUIPMENT
  2006
    
    
    2005(Amounts in thousands)Land
    
    $
    4,799
    
    
    $
    2,942Furniture and equipment
    
    
    9,692
    
    
    
    6,692Vehicles
    
    
    763
    
    
    
    617Buildings and improvements
    
    
    25,942
    
    
    
    14,927Construction in progress
    
    
    3,135
    
    
    
    8,350Accumulated depreciation
    
    
    (5,875
    )
    
    
    (3,977
    )Total
    
    $
    38,456
    
    
    $
    29,551
   Page 63




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE E  PREMISES AND EQUIPMENT (Continued)
 2007
    
    $
    1,5542008
    
    
    1,4422009
    
    
    1,3302010
    
    
    1,3092011
    
    
    1,227Thereafter
    
    
    14,148$
    21,010
     NOTE F  DEPOSITS
   $100,000
    
    
    Underand Over
    
    
    $100,000
    
    
    Total2007
    
    $
    200,695
    
    
    $
    328,639
    
    
    $
    529,3342008
    
    
    2,923
    
    
    
    7,897
    
    
    
    10,8202009
    
    
    309
    
    
    
    2,152
    
    
    
    2,4612010
    
    
    1,525
    
    
    
    1,039
    
    
    
    2,5642011
    
    
    
    
    
    
    1,881
    
    
    
    1,8812012
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    205,452
    
    
    $
    341,608
    
    
    $
    547,060
 Page 64




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS  December 31, 2006, 2005 and 2004
 
 NOTE G  BORROWINGS
  December 31,2006
    
    
    2005(Dollars in thousands)Federal fund purchased
    
    $
    
    
    
    $
    5,000Federal Home Loan Bank
    
    
    14,500
    
    
    
    57,000Total short-term borrowings
    
    $
    14,500
    
    
    $
    62,000Federal Home Loan Bank
    
    $
    101,500
    
    
    $
    57,200Reverse repurchase agreements
    
    
    20,000
    
    
    
    Junior Subordinated Debentures
    
    
    30,929
    
    
    
    15,465Total long-term borrowings
    
    $
    152,429
    
    
    $
    72,665
  InterestMaturity
    
    Rate
    
    
    2006
    
    
    2005February 27, 2006
    
    
    5.45
    %
    
    
    
    
    
    
    200,000March 17, 2010
    
    
    5.71
    %
    
    
    1,500,000
    
    
    
    1,500,000November 10, 2010
    
    
    5.43
    %
    
    
    5,000,000
    
    
    
    5,000,000January 24, 2012
    
    
    3.88
    %
    
    
    
    
    
    
    5,500,000October 23, 2006
    
    
    3.89
    %
    
    
    
    
    
    
    5,000,000April 21, 2008
    
    
    4.22
    %
    
    
    5,000,000
    
    
    
    5,000,000April 25, 2012
    
    
    4.85
    %
    
    
    10,000,000
    
    
    
    10,000,000May 19, 2010
    
    
    3.88
    %
    
    
    
    
    
    
    10,000,000June 24, 2010
    
    
    3.88
    %
    
    
    
    
    
    
    10,000,000July 23, 2012
    
    
    4.85
    %
    
    
    10,000,000
    
    
    
    10,000,000November 22, 2006
    
    
    4.58
    %
    
    
    
    
    
    
    52,000,000October 4, 2011
    
    
    4.35
    %
    
    
    20,000,000
    
    
    
    October 24, 2011
    
    
    4.35
    %
    
    
    5,000,000
    
    
    
    August 8, 2011
    
    
    4.56
    %
    
    
    35,000,000
    
    
    
    November 23, 2007
    
    
    5.50
    %
    
    
    14,500,000
    
    
    
    September 1, 2011
    
    
    4.49
    %
    
    
    10,000,000
    
    
    
    $
    116,000,000
    
    
    $
    114,200,000
   Page 65




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
G-BORROWINGS (Continued)
      Page 66




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
H-INCOME TAXES
  2006
    
    
    2005
    
    
    2004(In thousands)Current tax provision:Federal
    
    $
    3,373
    
    
    $
    1,841
    
    
    $
    837State
    
    
    571
    
    
    
    309
    
    
    
    1813,944
    
    
    
    2,150
    
    
    
    1,018Deferred tax provision:Federal
    
    
    (1,130
    )
    
    
    (181
    )
    
    
    (65
    )State
    
    
    (189
    )
    
    
    (4
    )
    
    
    (16
    )(1,319
    )
    
    
    (185
    )
    
    
    (81
    )Provision for income tax expense before
adjustment to deferred tax asset valuation
allowance
    
    
    2,625
    
    
    
    1,965
    
    
    
    937Decrease in valuation allowance
    
    
    -
    
    
    
    -
    
    
    
    (227
    )Net provision for income taxes
    
    $
    2,625
    
    
    $
    1,965
    
    
    $
    710
  2006
    
    
    2005
    
    
    2004(In thousands)Tax computed at the statutory federal rate
    
    $
    2,684
    
    
    $
    2,007
    
    
    $
    925Increase (decrease) resulting from:State income taxes, net of federal benefit
    
    
    253
    
    
    
    184
    
    
    
    109Adjustment to deferred tax asset valuation allowance
    
    
    -
    
    
    
    -
    
    
    
    (227
    )Non-taxable interest income
    
    
    (65
    )
    
    
    (59
    )
    
    
    (17
    )Non-taxable income from bank owned life insurance
    
    
    (294
    )
    
    
    (231
    )
    
    
    (137
    )Other permanent differences
    
    
    47
    
    
    
    64
    
    
    
    57Provision for income taxes
    
    $
    2,625
    
    
    $
    1,965
    
    
    $
    710
  Page 67




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
H-INCOME TAXES (Continued)
 2006
    
    
    2005(In thousands)Deferred tax assets relating to:Allowance for loan losses
    
    $
    3,464
    
    
    $
    2,285Equity investment basis difference
    
    
    6
    
    
    
    10Unrealized loss on economic hedge
    
    
    460
    
    
    
    Unrealized loss on securities available for sale
    
    
    462
    
    
    
    273Other
    
    
    187
    
    
    
    40Total deferred tax assets
    
    
    4,579
    
    
    
    2,608Deferred tax liabilities relating to:Premises and equipment
    
    
    (545
    )
    
    
    (527
    )Deferred loan costs
    
    
    (709
    )
    
    
    (383
    )Intangible assets
    
    
    (1,026
    )
    
    
    (253
    )Prepaid expenses
    
    
    (248
    )
    
    
    (259
    )Total deferred tax liabilities
    
    
    (2,528
    )
    
    
    (1,422
    )Net recorded deferred tax assets
    
    $
    2,051
    
    
    $
    1,186
  NOTE
I - OTHER NON-INTEREST EXPENSE
  2006
    
    
    2005
    
    
    2004(Dollars in thousands)Professional services
    
    $
    1,535
    
    
    $
    1,399
    
    
    $
    643Postage, printing and office supplies
    
    
    1,504
    
    
    
    1,355
    
    
    
    847Advertising and promotion
    
    
    1,814
    
    
    
    541
    
    
    
    478Amortization of intangibles
    
    
    323
    
    
    
    380
    
    
    
    130Other
    
    
    3,994
    
    
    
    2,475
    
    
    
    1,227Total
    
    $
    9,170
    
    
    $
    6,150
    
    
    $
    3,325
 NOTE
J-REGULATORY MATTERS
  Page 68




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
J-REGULATORY MATTERS (Continued)
  Minimum to be WellCapitalized underMinimum for Capital

    
    Prompt CorrectiveActual

    
    Adequacy Purposes

    
    Action ProvisionsAmount
    
    
    Ratio

    
    Amount

    
    Ratio

    
    Amount

    
    Ratio(Dollars in thousands)As of December 31, 2006:Total Capital (to Risk-Weighted Assets)
    
    $
    130,191
    
    
    
    12.28
    %
    
    $
    84,814
    
    
    
    8.00
    %
    
    $
    106,018
    
    
    
    10.00
    %Tier I Capital (to Risk-Weighted Assets)
    
    
    120,786
    
    
    
    11.39
    %
    
    
    42,407
    
    
    
    4.00
    %
    
    
    63,611
    
    
    
    6.00
    %Tier I Capital (to Average Assets)
    
    
    120,786
    
    
    
    10.62
    %
    
    
    45,929
    
    
    
    4.00
    %
    
    
    57,411
    
    
    
    5.00
    %As of December 31, 2005:Total Capital (to Risk-Weighted Assets)
    
    $
    100,659
    
    
    
    14.00
    %
    
    $
    58,111
    
    
    
    8.00
    %
    
    $
    72,639
    
    
    
    10.00
    %Tier I Capital (to Risk-Weighted Assets)
    
    
    94,376
    
    
    
    13.13
    %
    
    
    29,055
    
    
    
    4.00
    %
    
    
    43,583
    
    
    
    6.00
    %Tier I Capital (to Average Assets)
    
    
    94,376
    
    
    
    12.47
    %
    
    
    30,271
    
    
    
    4.00
    %
    
    
    37,839
    
    
    
    5.00
    %
  NOTE
K - OFF-BALANCE SHEET RISK
   Page 69




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
K-OFF-BALANCE SHEET RISK (Continued)
  Financial instruments whose contract
amounts represent credit risk:Commitments to extend credit
    
    $
    18,651Undisbursed lines of credit
    
    
    237,473Standby letters of credit
    
    
    6,187Construction commitments
    
    
    16,500
 NOTE
L-DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
   Cash and Due from Banks and Interest-Earning Deposits in Other Banks
  Investment Securities
  Loans
  Accrued Interest
  Page 70




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
L-DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)
 Stock in Federal Reserve Bank and Federal Home Loan Bank of Atlanta
  Bank Owned Life Insurance
  Deposits
  Borrowings
  Financial Instruments with Off-Balance Sheet Risk
   2006
    
    
    2005Carrying
    
    
    Estimated
    
    
    Carrying
    
    
    EstimatedAmount
    
    
    Fair Value
    
    
    Amount
    
    
    Fair Value(In thousands)Financial assets:Cash and due from banks
    
    $
    22,077
    
    
    $
    22,077
    
    
    $
    18,475
    
    
    $
    18,475Interest-earning deposits in other banks
    
    
    4,717
    
    
    
    4,717
    
    
    
    3,668
    
    
    
    3,668Investment securities
    
    
    93,475
    
    
    
    93,475
    
    
    
    123,773
    
    
    
    123,773Accrued interest receivable
    
    
    8,742
    
    
    
    8,742
    
    
    
    5,883
    
    
    
    5,883Federal Reserve Bank stock
    
    
    3,609
    
    
    
    3,609
    
    
    
    2,097
    
    
    
    2,097Federal Home Loan Bank stock
    
    
    6,970
    
    
    
    6,970
    
    
    
    6,208
    
    
    
    6,208Loans
    
    
    994,592
    
    
    
    989,650
    
    
    
    666,652
    
    
    
    669,600Bank owned life insurance
    
    
    25,051
    
    
    
    25,051
    
    
    
    17,187
    
    
    
    17,187Financial liabilities:Deposits
    
    
    923,725
    
    
    
    931,413
    
    
    
    646,262
    
    
    
    647,704Borrowings
    
    
    166,929
    
    
    
    167,846
    
    
    
    134,665
    
    
    
    129,606Accrued interest payable
    
    
    2,569
    
    
    
    2,569
    
    
    
    1,126
    
    
    
    1,126
 Page 71




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
M-EMPLOYEE AND DIRECTOR BENEFIT PLANS
 4 01(k) Retirement Plan
  Stock Based Compensation
   Page 72




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE M-EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)
 Stock Based Compensation (Continued)
  Outstanding Options
    
    
    Exercisable OptionsShares
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAvailable
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageShares
    
    
    for Future
    
    
    Number
    
    
    Exercise
    
    
    Number
    
    
    Exercisein Plans
    
    
    Grants
    
    
    Outstanding
    
    
    Price
    
    
    Outstanding
    
    
    PriceAt December 31, 2003
    
    
    872,189
    
    
    
    25,585
    
    
    
    846,604
    
    
    $
    6.55
    
    
    
    729,132
    
    
    $
    6.61Options authorized
    
    
    556,600
    
    
    
    556,600
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -Options granted/vested
    
    
    -
    
    
    
    (579,867
    )
    
    
    579,867
    
    
    
    13.08
    
    
    
    512,182
    
    
    
    12.25Options exercised
    
    
    (47,816
    )
    
    
    -
    
    
    
    (47,816
    )
    
    
    6.59
    
    
    
    (47,816
    )
    
    
    6.59Options forfeited
    
    
    -
    
    
    
    5,877
    
    
    
    (5,877
    )
    
    
    6.50
    
    
    
    (5,877
    )
    
    
    6.50At December 31, 2004
    
    
    1,380,973
    
    
    
    8,195
    
    
    
    1,372,778
    
    
    
    9.31
    
    
    
    1,187,621
    
    
    
    9.04Options authorized
    
    
    726,000
    
    
    
    726,000
    
    
    
    -
    
    
    
    
    
    
    
    -Options granted/vested
    
    
    -
    
    
    
    (162,250
    )
    
    
    162,250
    
    
    
    16.05
    
    
    
    335,199
    
    
    
    16.02Options exercised
    
    
    (163,156
    )
    
    
    -
    
    
    
    (163,156
    )
    
    
    7.50
    
    
    
    (163,156
    )
    
    
    7.50Options forfeited
    
    
    -
    
    
    
    10,890
    
    
    
    (10,890
    )
    
    
    11.72
    
    
    
    (10,890
    )
    
    
    11.72At December 31, 2005
    
    
    1,943,817
    
    
    
    582,835
    
    
    
    1,360,982
    
    
    
    10.31
    
    
    
    1,348,774
    
    
    
    10.33Options authorized
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    
    
    
    
    -Options granted/vested
    
    
    -
    
    
    
    (166,500
    )
    
    
    166,500
    
    
    
    14.62
    
    
    
    9,031
    
    
    
    8.47Options exercised
    
    
    (13,897
    )
    
    
    -
    
    
    
    (13,897
    )
    
    
    7.36
    
    
    
    (13,897
    )
    
    
    7.36Options forfeited
    
    
    -
    
    
    
    3,888
    
    
    
    (3,888
    )
    
    
    9.39
    
    
    
    (3,888
    )
    
    
    9.39At December 31, 2006
    
    
    1,929,920
    
    
    
    420,223
    
    
    
    1,509,697
    
    
    $
    10.82
    
    
    
    1,340,020
    
    
    $
    10.35
    Page 73




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
M-EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)
 Stock Based Compensation (Continued)
  WeightedAverageGrant DateShares
    
    
    Fair ValueNon-vested outstanding at December 31, 2005
    
    
    6,050
    
    
    $
    13.21Granted
    
    
    13,750
    
    
    
    15.26Vested
    
    
    6,050
    
    
    
    -Forfeited
    
    
    -
    
    
    
    -Non-vested outstanding at December 31, 2006
    
    
    13,750
    
    
    $
    15.26
   Employment Contracts
  Salary Continuation Agreements
   Page 74




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
N-ACQUISITIONS
  (Amounts in Thousands)Purchase price:Issuance of common stock
    
    $
    588Total purchase price
    
    $
    588Assets acquired:Other intangibles
    
    $
    588Goodwill
    
    
    226Total assets acquired
    
    $
    814Liabilities Assumed:Deferred taxes
    
    $
    226Total liabilities assumed
    
    $
    226
  Purchase price:Issuance of common stock
    
    $
    1,500Total purchase price
    
    $
    1,500Assets acquired:Property and equipment
    
    $
    36Accounts receivable
    
    
    75Goodwill
    
    
    770Other intangibles
    
    
    1,045Total assets acquired
    
    $
    1,926Liabilities Assumed:Accounts payable
    
    $
    34Deferred taxes
    
    
    392Total liabilities assumed
    
    $
    426
 Page 75




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
N-ACQUISITIONS (Continued)
  (Amounts in Thousands)Purchase price:Portion paid in cash
    
    $
    69Issuance of common stock
    
    
    503Total purchase price
    
    $
    572Assets acquired:Property and equipment
    
    $
    123Goodwill
    
    
    337Other intangibles
    
    
    112Total assets acquired
    
    $
    572
  Purchase price:Portion paid in cash
    
    $
    71Total purchase price
    
    $
    71Assets acquired:Property and equipment
    
    $
    10Goodwill
    
    
    31Loans
    
    
    30Total assets acquired
    
    $
    71
   Assets Acquired:Cash and cash equivalents
    
    $
    117,501Loans
    
    
    602Premises and equipment
    
    
    1,955Core deposit intangibles
    
    
    2,692Goodwill
    
    
    4,130Total assets acquired
    
    $
    126,880Liabilities Assumed:Deposits
    
    $
    126,806Other liabilities
    
    
    74Total liabilities assumed
    
    $
    126,880
 Page 76




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
N-ACQUISITIONS (Continued)
   NOTE
O-PARENT COMPANY FINANCIAL DATA
  Condensed Balance Sheets
December 31, 2006 and 2005
 2006
    
    
    2005Asset:Cash on deposit in subsidiary
    
    $
    1,679
    
    
    $
    3,909Investment in securities available for sale
    
    
    7,266
    
    
    
    6,421Investment in subsidiaries
    
    
    131,653
    
    
    
    103,808Other assets
    
    
    192
    
    
    
    640Total assets
    
    $
    140,790
    
    
    $
    114,778Liabilities:Junior subordinated debentures
    
    $
    30,929
    
    
    $
    15,465Other liabilities
    
    
    221
    
    
    
    569Total liabilities
    
    
    31,150
    
    
    
    16,034Stockholders equity:Common stock
    
    
    101,669
    
    
    
    94,109Retained earnings
    
    
    8,708
    
    
    
    5,113Deferred Compensation  restricted stock
    
    
    -
    
    
    
    (43
    )Accumulated other comprehensive loss
    
    
    (737
    )
    
    
    (435
    )Total stockholders equity
    
    
    109,640
    
    
    
    98,744Total liabilities and stockholders equity
    
    $
    140,790
    
    
    $
    114,778
 Condensed Statements of Operations
Years Ended December 31, 2006, 2005 and 2004
 2006
    
    
    2005
    
    
    2004Equity in income of subsidiary
    
    $
    6,499
    
    
    $
    4,716
    
    
    $
    2,584Interest income
    
    
    34
    
    
    
    18
    
    
    
    19Gain on sale of securities
    
    
    653
    
    
    
    199
    
    
    
    -Interest expense
    
    
    (1,831
    )
    
    
    (939
    )
    
    
    (541
    )Other expense
    
    
    (86
    )
    
    
    (55
    )
    
    
    (52
    )$
    5,269
    
    
    $
    3,939
    
    
    $
    2,010
 Page 77




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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
O-PARENT COMPANY FINANCIAL DATA (Continued)
 Condensed Statements of Cash Flows
Years Ended December 31, 2006, 2005 and 2004
 2006
    
    
    2005
    
    
    2004Operating activities:Net income
    
    $
    5,269
    
    
    $
    3,939
    
    
    $
    2,010Equity in income of subsidiary
    
    
    (6,499
    )
    
    
    (4,716
    )
    
    
    (2,584
    )Amortization of debt issuance costs
    
    
    55
    
    
    
    55
    
    
    
    52Realized gain on sale of available-for-sale securities
    
    
    (653
    )
    
    
    (199
    )
    
    
    -Deferred Compensation
    
    
    222
    
    
    
    90
    
    
    
    -(Increase) decrease in other assets
    
    
    392
    
    
    
    (482
    )
    
    
    (35
    )Increase in other liabilities
    
    
    25
    
    
    
    6
    
    
    
    20(1,189
    )
    
    
    (1,307
    )
    
    
    (537
    )Investing activities:Purchases of available-for-sale securities
    
    
    (6,619
    )
    
    
    (5,102
    )
    
    
    (513
    )Investment in subsidiaries
    
    
    (23,464
    )
    
    
    (30,000
    )
    
    
    (37,323
    )Proceeds from the sale of securities
    
    
    5,459
    
    
    
    766
    
    
    
    -Upstream dividend received from the Bank
    
    
    4,500
    
    
    
    -
    
    
    
    105(20,124
    )
    
    
    (34,336
    )
    
    
    (37,731
    )Financing activities:Proceeds from issuance of junior subordinated
debentures
    
    
    15,464
    
    
    
    -
    
    
    
    7,217Proceeds from the conversion of common
stock warrants
    
    
    -
    
    
    
    -
    
    
    
    12,111Proceeds from issuance of common stock
    
    
    4,383
    
    
    
    29,855
    
    
    
    24,915Proceeds from options exercise
    
    
    102
    
    
    
    1,237
    
    
    
    311Proceeds from dividend reinvestment
    
    
    515
    
    
    
    147
    
    
    
    -Cash dividends paid
    
    
    (1,674
    )
    
    
    (631
    )
    
    
    (95
    )Tax benefit from exercise of stock options
    
    
    293
    
    
    
    -
    
    
    
    -Cash paid for fractional shares
    
    
    -
    
    
    
    (8
    )
    
    
    (10
    )19,083
    
    
    
    30,600
    
    
    
    44,449Net increase (decrease) in cash
    
    
    (2,230
    )
    
    
    (5,043
    )
    
    
    6,181Cash, beginning of year
    
    
    3,909
    
    
    
    8,952
    
    
    
    2,771Cash, end of year
    
    $
    1,679
    
    
    $
    3,909
    
    
    $
    8,952
 Page 78




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE
P - BUSINESS SEGMENT REPORTING
  At or for the Year Ended December 31, 2006Consolidated
    
    
    Adjustments
    
    
    Banking
    
    
    Brokerage
    
    
    Insurance
    
    
    MortgageTotal interest income
    
    $
    73,097
    
    
    $
    -
    
    
    $
    72,940
    
    
    $
    -
    
    
    $
    21
    
    
    $
    136Total interest expense
    
    
    36,099
    
    
    
    (149
    )
    
    
    36,099
    
    
    
    -
    
    
    
    -
    
    
    
    149Net interest income
    
    
    36,998
    
    
    
    -
    
    
    
    36,841
    
    
    
    -
    
    
    
    21
    
    
    
    (13
    )Provision for loan losses
    
    
    3,400
    
    
    
    -
    
    
    
    3,400
    
    
    
    -
    
    
    
    -
    
    
    
    -Net interest income after
provision for loan losses
    
    
    33,598
    
    
    
    -
    
    
    
    33,441
    
    
    
    -
    
    
    
    21
    
    
    
    (13
    )Non-interest income
    
    
    9,270
    
    
    
    (676
    )
    
    
    5,135
    
    
    
    744
    
    
    
    2,873
    
    
    
    1,194Non-interest expense
    
    
    34,974
    
    
    
    -
    
    
    
    30,682
    
    
    
    590
    
    
    
    2,195
    
    
    
    1,507Income before income taxes
    
    
    7,894
    
    
    
    (676
    )
    
    
    7,894
    
    
    
    154
    
    
    
    699
    
    
    
    (326
    )Provision for income taxes
    
    
    2,625
    
    
    
    -
    
    
    
    2,625
    
    
    
    -
    
    
    
    -
    
    
    
    -Net income
    
    $
    5,269
    
    
    $
    (676
    )
    
    $
    5,269
    
    
    $
    154
    
    
    $
    699
    
    
    $
    (326
    )Period end total assets
    
    $
    1,207,477
    
    
    $
    (22,548
    )
    
    $
    1,207,477
    
    
    $
    645
    
    
    $
    6,132
    
    
    $
    15,771
 At or for the Year Ended December 31, 2005Consolidated
    
    
    Adjustments
    
    
    Banking
    
    
    Brokerage
    
    
    Insurance
    
    
    MortgageTotal interest income
    
    $
    39,679
    
    
    $
    -
    
    
    $
    39,646
    
    
    $
    -
    
    
    $
    33
    
    
    $
    -Total interest expense
    
    
    16,376
    
    
    
    -
    
    
    
    16,376
    
    
    
    -
    
    
    
    -
    
    
    
    -Net interest income
    
    
    
    
    
    
    23,303
    
    
    
    -
    
    
    
    23,270
    
    
    
    -
    
    
    
    33Provision for loan losses
    
    
    2,200
    
    
    
    -
    
    
    
    2,200
    
    
    
    -
    
    
    
    -
    
    
    
    -Net interest income after
provision for loan losses
    
    
    21,103
    
    
    
    -
    
    
    
    21,070
    
    
    
    -
    
    
    
    33
    
    
    
    -Non-interest income
    
    
    8,067
    
    
    
    (713
    )
    
    
    5,736
    
    
    
    656
    
    
    
    2,388
    
    
    
    -Non-interest expense
    
    
    23,266
    
    
    
    -
    
    
    
    20,902
    
    
    
    464
    
    
    
    1,900
    
    
    
    -Income before income taxes
    
    
    5,904
    
    
    
    (713
    )
    
    
    5,904
    
    
    
    192
    
    
    
    521
    
    
    
    -Provision for income taxes
    
    
    1,965
    
    
    
    -
    
    
    
    1,965
    
    
    
    -
    
    
    
    -
    
    
    
    -Net income
    
    $
    3,939
    
    
    $
    (713
    )
    
    $
    3,939
    
    
    $
    192
    
    
    $
    521
    
    
    $
    -Period end total assets
    
    $
    883,373
    
    
    $
    (3,837
    )
    
    $
    884,198
    
    
    $
    488
    
    
    $
    2,524
    
    
    $
 At or for the Year Ended December 31, 2004Consolidated
    
    
    Adjustments
    
    
    Banking
    
    
    Brokerage
    
    
    Insurance
    
    
    MortgageTotal interest income
    
    $
    19,632
    
    
    $
    -
    
    
    $
    19,609
    
    
    $
    -
    
    
    $
    23
    
    
    $
    -Total interest expense
    
    
    6,691
    
    
    
    -
    
    
    
    6,691
    
    
    
    -
    
    
    
    -
    
    
    
    -Net interest income
    
    
    12,941
    
    
    
    -
    
    
    
    12,918
    
    
    
    -
    
    
    
    23
    
    
    
    -Provision for loan losses
    
    
    1,425
    
    
    
    -
    
    
    
    1,425
    
    
    
    -
    
    
    
    -
    
    
    
    -Net interest income after
provision for loan losses
    
    
    11,516
    
    
    
    -
    
    
    
    11,493
    
    
    
    -
    
    
    
    23
    
    
    
    -Non-interest income
    
    
    5,857
    
    
    
    (562
    )
    
    
    3,963
    
    
    
    463
    
    
    
    1,993
    
    
    
    -Non-interest expense
    
    
    14,653
    
    
    
    (161
    )
    
    
    12,736
    
    
    
    400
    
    
    
    1,678
    
    
    
    -Income before income taxes
    
    
    2,720
    
    
    
    (401
    )
    
    
    2,720
    
    
    
    63
    
    
    
    338
    
    
    
    -Provision for income taxes
    
    
    710
    
    
    
    -
    
    
    
    710Net income
    
    $
    2,010
    
    
    $
    (401
    )
    
    $
    2,010
    
    
    $
    63
    
    
    $
    338
    
    
    $
    -Period end total assets
    
    $
    535,728
    
    
    $
    (2,219
    )
    
    $
    535,751
    
    
    $
    286
    
    
    $
    1,910
    
    
    $
    -
 Page 79




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 NOTE Q - INTANGIBLE ASSETS
  2006
    
    
    2005
    
    
    2004(In thousands)Intangibles assets subject to future amortization:Core intangibles - gross
    
    $
    3,497
    
    
    $
    3,497
    
    
    $
    3,497Less accumulated amortization
    
    
    (1,027
    )
    
    
    (707
    )
    
    
    (328
    )Core intangible Net
    
    
    2,470
    
    
    
    2,790
    
    
    
    3,169Intangibles - book of business
    
    $
    1,821
    
    
    $
    188
    
    
    $
    188Less accumulated amortization
    
    
    (128
    )
    
    
    (87
    )
    
    
    (56
    )1,693
    
    
    
    101
    
    
    
    132Intangibles - net
    
    $
    4,163
    
    
    $
    2,891
    
    
    $
    3,301Intangible assets not subject to future amortization:Goodwill - banking segment
    
    $
    6,454
    
    
    $
    6,454
    
    
    $
    6,471Goodwill - insurance segment
    
    
    1,998
    
    
    
    1,002
    
    
    
    1,002$
    8,452
    
    
    $
    7,456
    
    
    $
    7,473
  2007
    
    $
    4722008
    
    
    4722009
    
    
    4722010
    
    
    4322011
    
    
    414Thereafter
    
    
    1,901$
    4,163
 NOTE R - DERIVATIVES
  Page 80




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##### Table of Contents



GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004
 
 NOTE R  DERIVATIVES (Continued)
   Notional amount
    
    $
    150,000Weighted average pay rate
    
    
    7.95
    %Weighted average receive rate
    
    
    7.50
    %Weighted average maturity in years
    
    
    2.0Unrealized gain (loss) relating to the interest rate swap
    
    $
    (1,226
    )
   NOTE
S - SUBSEQUENT EVENTS
     Page 81




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##### Table of Contents



ITEM 9  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
  
 ITEM 9A  CONTROLS AND PROCEDURES
  Managements Report On Internal Control Over Financial Reporting
   Internal Control 
Integrated Framework
   /s/ D. Ben Berry
    
    /s/ Theodore L. SalterD. Ben Berry
    
    Theodore L. SalterChairman, President and Chief Executive Officer
    
    Senior Executive Vice President and Chief Financial Officer
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 Internal ControlIntegrated Framework
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##### Table of Contents



Internal ControlIntegrated
Framework Internal ControlIntegrated Framework
  Greenville, North Carolina
March 14, 2007
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ITEM 9B  OTHER INFORMATION
  
 PART III
 
 ITEM 10  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; COMPLIANCE WITH SECTION 16(a)
  
 ITEM 11  EXECUTIVE COMPENSATION
  
 ITEM 12  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
   Equity Compensation Plan InformationNumber of securitiesNumber of securities
    
    
    
    
    
    
    
    remaining available forto be issued
    
    
    Weighted-average
    
    
    future issuance underupon exercise of
    
    
    exercise price of
    
    
    equity compensation plansoutstanding options
    
    
    outstanding options
    
    
    (excluding securitiesPlan Category
    
    
    
    
    
    
    
    
    
    
    
    
    reflected in column(a))(a)
    
    
    (b)
    
    
    (c)Equity compensation
plans approved by
security holders
    
    
    
    1,359,665
    
    
    
    
    $11.31
    
    
    
    
    420,223Equity compensation
plans not approved
by security holders
    
    
    
    150,032
    
    
    
    
    $6.14
    
    
    
    
    Total
    
    
    
    1,509,697
    
    
    
    
    $10.82
    
    
    
    
    420,223
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ITEM 13  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
  
 ITEM 14  PRINCIPAL ACCOUNTANT FEES AND SERVICES
  
 PART IV
 
 ITEM 15  EXHIBITS, FINANCIAL STATEMENT SCHEDULES
  Exhibit
No.
    
    DescriptionExhibit 3.1:
    
    Amended and Restated Articles of Incorporation (incorporated by reference to
Exhibit 10.1 to the Annual Report on Form 10K for the year ended December 31, 2005)Exhibit 3.2:
    
    BylawsExhibit 4.1:
    
    Specimen Certificate for Common Stock of Gateway Financial Holdings, Inc.
(incorporated by reference to Exhibit 4.1 of Amendment No. 1 to the Registration
Statement on Form S-3 filed September 20, 2001)Exhibit 10.1:
    
    1999 Incentive Stock Option Plan of Gateway Financial Holdings, Inc. (incorporated
by reference to Exhibit 10.1 to the Annual Report on Form 10K for the year ended
December 31, 2001 (2001 Annual Report))Exhibit 10.2:
    
    1999 Non-Statutory Stock Option Plan of Gateway Financial Holdings, Inc.
(incorporated by reference to Exhibit 10.2 to the 2001 Annual Report)Exhibit 10.3:
    
    2001 Non-Statutory Stock Option Plan of Gateway Financial Holdings, Inc.
(incorporated by reference to Exhibit 10.3 to the 2001 Annual Report)Exhibit 10.4
    
    Employment Agreement with D. Ben Berry (incorporated by reference to Exhibit 10.1
to the Quarterly Report on form 10Q for the quarter ended March 31, 2006)Exhibit 10.5
    
    Employment Agreement with David R. Twiddy (incorporated by reference to Exhibit
10.2 to the Quarterly Report on form 10Q for the quarter ended March 31, 2006)Exhibit 10.6
    
    2005 Omnibus Stock Ownership And Long Term Incentive Plan (incorporated by
reference to Exhibit 10.6 to the Annual Report on Form 10K for the year ended
December 31, 2005)Exhibit 10.7
    
    Employment Agreement with Theodore L. Salter (incorporated by reference to Exhibit
10.3 to the Quarterly Report on form 10Q for the quarter ended March 31, 2006)Exhibit 10.8
    
    Salary Continuation Agreement with D. Ben BerryExhibit 10.9
    
    Salary Continuation Agreement with David R. TwiddyExhibit 21:
    
    Subsidiaries of the RegistrantExhibit 23:
    
    Consent of Dixon Hughes PLLCExhibit 31.1:
    
    Rule 13a-14(a)/15d-14(a) Certification by Chief Executive OfficerExhibit 31.2:
    
    Rule 13a-14(a)/15d-14(a) Certification by Chief Financial OfficerExhibit 32:
    
    Section 1350 Certifications
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SIGNATURES
  GATEWAY FINANCIAL HOLDINGS, INC.Date: March 16, 2007
    By:
    /s/ D. Ben BerryD. Ben BerryChairman, President and Chief Executive Officer  NAME
    
    TITLE
    
    DATE/s/ D. Ben BerryD. Ben Berry
    
    Chairman,
President and CEO
    
    March
16,  2007/s/ Theodore L. SalterTheodore L. Salter
    
    Chief
Financial Officer
    
    March
16, 2007/s/ Mark A. JeffriesMark A. Jeffries
    
    Controller
    
    March
16, 2007/s/ H. Spencer BarrowH. Spencer Barrow
    
    Director
    
    March
16, 2007/s/ William Brumsey IIIWilliam Brumsey III
    
    Director
    
    March
16, 2007/s/ Jimmie Dixon, Jr.Jimmie Dixon, Jr.
    
    Director
    
    March
16, 2007/s/ James H. Ferebee, Jr.James H. Ferebee, Jr.
    
    Director
    
    March
16, 2007/s/ Charles R. Franklin, Jr.Charles R. Franklin, Jr.
    
    Director
    
    March
16, 2007/s/ Robert Y. Green, Jr.Robert Y. Green, Jr.
    
    Director
    
    March
16, 2007/s/ W. Taylor Johnson, Jr.W. Taylor Johnson, Jr.
    
    Director
    
    March
16, 2007/s/ Robert Willard Luther, IIIRobert Willard Luther, III
    
    Director
    
    March
16, 2007/s/ Frances Morrisette NorrellFrances Morrisette Norrell
    
    Director
    
    March
16, 2007/s/ W. C. Owens, Jr.W. C. Owens, Jr.
    
    Director
    
    March
16, 2007/s/ Billy G. RoughtonBilly G. Roughton
    
    Director
    
    March
16, 2007/s/ Ollin B. SykesOllin B. Sykes
    
    Director
    
    March
16, 2007/s/ Frank T. WilliamsFrank T. Williams
    
    Director
    
    March
16, 2007/s/ Jerry T. WomackJerry T. Womack
    
    Director
    
    March
16, 2007
 Page 87