UNITED STATES
 SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
   *[ X ]*
Quarterly Report Under Section 13 or 15(d) of*the Securities Exchange Act of 1934**For the Quarterly Period Ended March 31, 2004**[    ]*
*Transition Report Pursuant to Section 13 or 15(d) of**the Securities Exchange Act of 1934**For the Transition Period from _________ to _________*
  Commission File Number: 0-24526
 
 Coastal Bancorp, Inc.
 (Exact name of Registrant as specified in its charter)
   Texas

76-0428727(*State or other jurisdiction of*

(*I.R.S. Employer**incorporation or organization)*

Identification No.)
 
 5718 Westheimer, Suite 600
 Houston, Texas 77057
 (Address of principal executive office)
 
 (713) 435-5000
 (Registrant's telephone number)
 
 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
  YES
X
NO
  Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). [ X ]
 
 Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date.
 
 Common Stock Outstanding: 5,297,692 as of April 23, 2004
 
  Coastal Bancorp, Inc. and Subsidiaries
 Form 10-Q
 Table of Contents
 
 
 Part I.  Financial Information
  Item 1
Financial Statements (unaudited)Consolidated Statements of Financial Condition at March 31, 2004 and December 31, 2003
1Consolidated Statements of Income for the Three-Month Periods Ended March 31, 2004 and 2003
2Consolidated Statements of Comprehensive Income for the Three-Month Periods Ended
March 31, 2004 and 2003
3Consolidated Statements of Cash Flows for the Three-Month Periods Ended March 31, 2004 and 2003
4Notes to Consolidated Financial Statements
6Item 2
Management's Discussion and Analysis of Financial Condition and Results of Operations
16Item 3
Quantitative and Qualitative Disclosures About Market Risk
20Item 4
Controls and Procedures
20 
 
 
 
 
 Part II.  Other Information
 
 
 
 Item 1
Legal Proceedings
21Item 2
Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
21Item 3
Defaults upon Senior Securities
21Item 4
Submission of Matters to a Vote of Security Holders
21Item 5
Other Information
21Item 6
Exhibits and Reports on Form 8-K
21 
 
 
 Signatures
 
 
 
 i
     Item 1. FINANCIAL STATEMENTSCOASTAL BANCORP, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF FINANCIAL CONDITION(In Thousands, except share data)March 31,


December 31,2004


2003(Unaudited)ASSETSCash and cash equivalents

$
35,389

$
40,814Federal funds sold


24,732


10,440Loans receivable held for sale


35,341


8,078Loans receivable, net (note 4)


1,967,328


1,981,924Mortgage-backed securities available-for-sale, at fair value (note 3)


501,543


504,402Other securities available-for-sale, at fair value


4,855


6,787Accrued interest receivable


8,762


9,198Property and equipment


33,174


32,563Stock in the Federal Home Loan Bank of Dallas ("FHLB")


45,641


45,471Goodwill


21,429


21,429Prepaid expenses and other assets


20,165


21,884$
2,698,359

$
2,682,990LIABILITIES AND STOCKHOLDERS' EQUITYLiabilities:Deposits (note 5)

$
1,680,116

$
1,676,131Advances from the FHLB (note 6)


801,512


799,875Subordinated debentures (note 7)


61,856


61,856Advances from borrowers for taxes and insurance


4,023


2,482Other liabilities and accrued expenses


11,066


8,954Total liabilities


2,558,573


2,549,298Commitments and contingencies (note 4)


-


-Stockholders' equity (notes 1, 3, 8, 9 and 10):Common stock, $.01 par value; authorized shares 30,000,000; 8,043,802 sharesissued and 5,297,692 shares outstanding at March 31, 2004; 7,981,434 sharesissued and 5,235,324 shares outstanding at December 31, 2003


80


80Additional paid-in capital


38,187


37,179Retained earnings


154,485


151,167Accumulated other comprehensive income (loss) - net unrealized gain (loss) onsecurities available-for-sale


664


(1,104
)Treasury stock at cost (2,746,110 shares in 2004 and 2003)


(53,630
)

(53,630
)Total stockholders' equity


139,786


133,692$
2,698,359

$
2,682,990See accompanying Notes to Consolidated Financial Statements 
 
  COASTAL BANCORP, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME(In Thousands, except per share data)Three Months EndedMarch 31,2004
2003(Unaudited)Interest income:Loans receivable




$
24,670

$
25,612Mortgage-backed securities





3,646


3,667FHLB stock, federal funds sold and other interest-earning assets





269


32528,585


29,604Interest expense:Deposits





6,806


8,048Advances from the FHLB





4,061


4,225Subordinated debentures





1,270


1,16012,137


13,433Net interest income





16,448


16,171Provision for loan losses (note 4)





450


900Net interest income after provision for loan losses





15,998


15,271Noninterest income:Service charges on deposit accounts





2,893


2,902Loan fees





244


219Gain on sale of loans receivable held for sale





18


734Gain on sale of mortgage-backed securities available-for-sale





200


-Gain (loss) on sale of real estate owned, net





114


(130
)Gain (loss) on sale of repossessed assets, net





180


(8
)Other





389


2764,038


3,993Noninterest expense:Compensation, payroll taxes and other benefits





7,834


8,008Office occupancy





2,389


2,317Data processing





479


433Advertising





314


275Postage and delivery





375


379Other





2,307


2,50813,698


13,920Income before provision for Federal income taxes





6,338


5,344Provision for Federal income taxes





2,226


1,659Net income




$
4,112

$
3,685Net income available to common stockholders




$
4,112

$
3,058Basic earnings per common share (note 8)




$
0.78

$
0.59Diluted earnings per common share (note 8)




$
0.75

$
0.57See accompanying Notes to Consolidated Financial Statements
 
 
  COASTAL BANCORP, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(In Thousands)Three Months EndedMarch 31,2004
2003(Unaudited)Net income




$
4,112

$
3,685Other comprehensive income (loss), net of tax:Unrealized gains (losses) on securities available-for-salearising during period





1,638


(185
)Reclassification adjustment for gains included in net income





130


-Total comprehensive income




$
5,880

$
3,500See accompanying Notes to Consolidated Financial Statements  
 COASTAL BANCORP, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(In Thousands)Three Months EndedMarch 31,2004
2003(Unaudited)Cash flows from operating activities:Net income

$
4,112

$
3,685Adjustments to reconcile net income to net cashprovided by (used in) operating activities:Depreciation and amortization of property and equipment,mortgage servicing rights and prepaid expenses and other assets


2,864


2,302Net premium amortization


1,458


592Provision for loan losses


450


900Originations and purchases of loans receivable held for sale


(37,341
)

(92,166
)Sales of loans receivable held for sale


10,021


132,425Gain on sale of loans receivable held for sale


(18
)

(734
)Gain on sale of mortgage backed securities available-for-sale


(200
)

-Gain on sale of real estate owned, net


(114
)

130Gain on sale of repossessed assets, net


(180
)

8Stock dividends from the FHLB


(170
)

(254
)Decrease (increase) in:Accrued interest receivable


436


39Other, net


1,813


3,332Net cash provided by (used in) operating activities


(16,869
)

50,259Cash flows from investing activities:Net change in federal funds sold


(14,292
)

19,355Purchase of mortgage-backed securities available-for-sale


(75,757
)

(38,840
)Principal repayments on mortgage-backed securitiesavailable-for-sale


33,074


46,910Principal repayments on other securities available-for-sale


35


-Proceeds from maturity of other securities available-for-sale


2,000


-Proceeds from sale of mortgage-backed securities available-for-sale


47,580


-Origination of loans receivable


(188,542
)

(168,885
)Purchases of loans receivable


(39,129
)

(160,898
)Principal repayments and principal reduction of loans receivable


240,539


252,921Purchases of property and equipment, net


(1,441
)

(1,433
)Net cash provided by (used in) investing activities


4,067


(50,870
)(Table continued on next page)  
 COASTAL BANCORP, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED(In Thousands)Three Months EndedMarch 31,2004
2003(Unaudited)Cash flows from financing activities:Net change in deposits

$
3,985


$
6,719Advances from the FHLB


747,150



4,485,991Principal payments on advances from the FHLB


(745,513
)


(4,494,417
)Net increase in advances from borrowers for taxes and insurance


1,541



1,839Exercise of stock options for purchase of Common Stock


1,008



50Issuance of treasury shares


-



27Dividends paid


(794
)


(1,244
)Net cash provided by (used in) financing activities


7,377



(1,035
)Net decrease in cash and cash equivalents


(5,425
)


(1,646
)Cash and cash equivalents at beginning of period


40,814



39,766Cash and cash equivalents at end of period

$
35,389


$
38,120Supplemental schedule of cash flows-interest paid

$
12,281


$
13,835Supplemental schedule of noncash investingand financing activities:Net transfer of loans to (from) held for sale category

$
-


$
(6,175
)Real estate owned acquired through foreclosureof loans receivable


599



811See accompanying Notes to Consolidated Financial Statements 
 
 
    (1) Basis of Presentation
 
 The accompanying unaudited Consolidated Financial Statements were prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations, comprehensive income and cash flows in conformity with accounting principles generally accepted in the United States of America. All adjustments, which are, in the opinion of management, of a normal recurring nature and are necessary for a fair presentation of the interim financial statements, have been included. The results of operations for the period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the entire fiscal year or any other interim period.
 
 Recent Accounting Pronouncements
 On January 17, 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46), which addresses consolidation by business enterprises of variable interest entities. FIN 46 clarifies the application of Accounting Research Bulletin (ARB) No. 51, "Consolidated Financial Statements", to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. Coastal has two statutory business trusts, one of which was formed subsequent to January 31, 2003, for the sole purpose of issuing trust preferred securities as further described in Note 7 to the accompanying consolidated financial statements. FIN 46 was revised and reissued in December 2003.
 
 On December 31, 2003, Coastal retroactively implemented FASB Interpretation No. 46R, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, resulting in the deconsolidation of Coastal Capital Trust I and Coastal Capital Trust II, both of which were created for the sole purpose of issuing trust preferred securities. The implementation of this Interpretation resulted in Coastal Bancorp, Incs investment in the common equity of the two trusts being included in the consolidated statements of financial condition as other assets and subordinated debentures and the interest income and interest expense received from and paid to the trusts, respectively, being included in the consolidated statements of income as interest income and expense.
 
 Treasury Stock
 On August 27, 1998, December 21, 1998, February 25, 1999, April 27, 2000, July 27, 2000 and April 25, 2002, the Board of Directors authorized six separate repurchase plans for up to 500,000 shares each of the outstanding shares of common stock through an open-market repurchase program and privately negotiated repurchases, if any. As of March 31, 2004, a total of 2,752,575 shares had been repurchased under all of the authorized repurchase plans.
 
 As of March 31, 2004, 2,746,110 shares of common stock were held in treasury at an average price of $19.53 per share for a total cost of $53.6 million. Book value per common share at March 31, 2004 was $25.66.
 
 Common Stock Dividends
 On July 31, 2003, Coastal announced an increase in its quarterly common stock dividend from $0.12 to $0.15 per common share. Future dividend increases will be determined by the Board of Directors based upon Coastal's results of operations and financial condition, in addition to general economic and other factors.
 
 Stock Options
 Statement of Financial Accounting Standards No. 148 ("Statement 148") "Accounting for Stock-Based Compensation  Transition and Disclosure" was issued in December 2002. Statement 148 amends FASB Statement No. 123 "Accounting for Stock-Based Compensation" ("Statement 123") to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, Statement 148 amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Coastal has adopted the disclosure provisions included in Statement 148 in the notes to the consolidated financial statements for the three months ended March 31, 2004 and 2003 contained herein.
 
 As provided by Statement 123, Coastal accounts for its stock compensation programs in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Under this method, no stock-based compensation expense is reflected in net income, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effects on net income and earnings per share as if Coastal had applied the fair value recognition provisions of Statement 123 as amended by Statement 148.
 
 Three Months EndedMarch 31,2004


2003(In thousands, except per share data)Net income available to common stockholders, as reported
$
4,112

$
3,058Deduct:  Total stock-based compensation expense determinedunder the fair value based method for all awards,net of related tax effects

(30)


(49)Proforma net income available to common stockholders
$
4,082

$
3,009Earnings per common share:Basic  as reported
$
0.78

$
0.59Basic  proforma
$
0.77

$
0.58Diluted  as reported
$
0.75

$
0.57Diluted  proforma
$
0.74

$
0.56 
 
 (2)  Principles of Consolidation
 
 The accompanying unaudited Consolidated Financial Statements include the accounts of Coastal Bancorp, Inc. ("Bancorp") and its wholly-owned subsidiary, Coastal Banc Holding Company, Inc. (collectively "Coastal"). Coastal Banc Holding Company Inc.'s wholly-owned subsidiaries are Coastal Banc ssb, Coastal Banc Capital Corp. and Coastal Banc Mortgage Corp. Coastal Banc ssb's wholly-owned subsidiaries are CoastalBanc Financial Corp. and Coastal Banc Insurance Agency, Inc. (collectively, the "Bank"). All significant intercompany balances and transactions have been eliminated in consolidation.
 
 
 
 Coastal Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited) (3) Mortgage-backed Securities
 
 Mortgage-backed securities at March 31, 2004 were as follows (in thousands):
 
 Gross
GrossAmortized
Unrealized
Unrealized
FairCost
Gains
Losses
ValueAvailable-for-sale:Agency securities

$
432,288

$
1,789

$
(327
)
$
433,750CMOs  Non-agency


66,731


7


(469
)

66,269Non-agency securities


1,502


22


-


1,524$
500,521

$
1,818

$
(796
)
$
501,543 
 As overall interest rates increase, the fair value of Coastal's mortgage-backed securities could be negatively affected by decreasing any unrealized gains and possibly resulting in additional net unrealized losses in future periods.
 
 Mortgage-backed securities at December 31, 2003 were as follows (in thousands):
 
 Gross
GrossAmortized
Unrealized
Unrealized
FairCost
Gains
Losses
ValueAvailable-for-sale:Agency securities

$
432,065

$
888

$
(1,771
)
$
431,182CMOs  Non-agency


72,315


-


(721
)

71,594Non-agency securities


1,603


23


-


1,626$
505,983

$
911

$
(2,492
)
$
504,402  
 An analysis of gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2004 is as follows (in thousands):
 
 Less than 12 months
12 months or longer
TotalFair
Value
UnrealizedLoss
Fair
Value
UnrealizedLoss
Fair
Value
Unrealized
LossAgency securities

$
144,032

$
(327
)
$
--

$
--

$
144,032

$
(327
)CMOs  Non-agency


49,970


(469
)

--


--


49,970


(469
)$
194,002

$
(796
)
$
--

$
--

$
194,002

$
(796
) 
 Coastal Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited) (4) Loans Receivable
 
 Loans receivable at March 31, 2004 and December 31, 2003 were as follows (dollars in thousands):
 
 March 31, 2004
December 31, 2003Real estate mortgage loans:First-lien mortgage, primarily residential

$
968,947

$
1,007,566Commercial


380,665


360,858Multifamily


110,494


107,903Residential construction


111,992


114,445Acquisition and development


129,423


134,179Commercial construction


175,529


183,273Commercial, financial and industrial


177,512


175,869Loans secured by deposits


12,662


13,019Consumer and other loans


32,779


32,594Loans in process


(116,633
)

(132,072
)Allowance for loan losses


(19,585
)

(19,389
)Unearned interest and loan fees


(3,059
)

(3,134
)Premium on purchased loans, net


6,602


6,813$
1,967,328

$
1,981,924Weighted average yield


4.86
%

4.94
% At March 31, 2004, Coastal had outstanding commitments to originate or purchase $16.8 million of real estate mortgage and other loans and had commitments under lines of credit to originate primarily construction and other loans of approximately $158.5 million. In addition, at March 31, 2004, Coastal had $15.2 million of outstanding standby letters of credit. Management anticipates the funding of these commitments through normal operations.
 
 Standby letters of credit are written for conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The Bank's policies generally require that letters of credit arrangements contain security and debt covenants similar to those contained in loan agreements. Under the standby letters of credit, the Bank is required to make payments to the beneficiary of the letters of credit upon request by the beneficiary so long as all performance criteria have been met. At March 31, 2004, the maximum potential amount of future payments under standby letters of credit was $15.2 million. As of March 31, 2004, the fair value of these guarantees, which is the liability recorded when fees are collected, was immaterial to the consolidated financial statements.
 
 At March 31, 2004 and December 31, 2003, the carrying value of loans that were considered to be impaired totaled approximately $7.0 million and $7.3 million, respectively, and the related allowance for loan losses on those impaired loans totaled $1.9 million and $1.9 million at March 31, 2004 and December 31, 2003, respectively. Of the impaired loans outstanding, two loans with a balance of $83,000 at March 31, 2004 and three loans with a balance of $332,000 at December 31, 2003 did not have specific portions of the allowance for loan losses allocated to them at each respective date. The average recorded investment in impaired loans during the three months ended March 31, 2004 and 2003 was $7.0 million and $8.2 million, respectively.
 
 An analysis of activity in the allowance for loan losses for the three months ended March 31, 2004 and 2003 is as follows (in thousands):
 
 
 Three Months Ended March 31,2004
2003Balance, beginning of period




$
19,389

$
18,118Provision for loan losses





450


900Charge-offs





(392
)

(908
)Recoveries





138


191Balance, end of period




$
19,585

$
18,301 
 Coastal services for others loans receivable which are not included in the Consolidated Financial Statements. The total amounts of such loans were $166.6 million and $209.0 million at March 31, 2004 and December 31, 2003, respectively.
 Coastal Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited) (5) Deposits
 
 Deposits, their stated rates and the related weighted average interest rates, at March 31, 2004 and December 31, 2003, are summarized below (dollars in thousands). Effective January 1, 1998, Coastal implemented a program whereby a portion of the balances in noninterest-bearing and interest-bearing checking accounts is reclassified to money market demand accounts under Federal Reserve Regulation D. The amount of such reclassification, reflected in the following table, was approximately $237.0 million ($131.2 million from noninterest-bearing and $105.8 million from interest-bearing) at March 31, 2004 and $261.2 million ($151.2 million from noninterest-bearing and $110.0 million from interest-bearing) at December 31, 2003.
 
 
 Stated Rate
March 31, 2004
December 31, 2003Noninterest-bearing checking


0.00
%
$
73,023

$
60,793Interest-bearing checking


0.00 - 1.00


19,141


18,625Savings accounts


0.25 - 1.24


46,063


45,459Money market demand accounts


0.00 - 2.13


629,390


621,571767,617


746,448Certificate accounts


Less than 2.00


465,424


442,0442.00 - 2.99


236,659


275,1063.00 - 3.99


138,247


138,7794.00 - 4.99


47,124


47,1085.00 - 5.99


22,791


23,7696.00 - 6.99


2,235


2,8587.00 - 7.99


19


19912,499


929,683$
1,680,116

$
1,676,131Weighted average interest rate





1.63
%

1.64
% 
 Prior to the reclassification as discussed above, noninterest-bearing checking accounts, interest-bearing checking accounts and money market demand accounts were as follows at March 31, 2004 and December 31, 2003 (in thousands):
 
 March 31, 2004
December 31, 2003Noninterest-bearing checking

$
204,258

$
212,003Interest-bearing checking


124,928


128,610Money market demand accounts


392,368


360,376 
 The scheduled maturities of certificate accounts outstanding at March 31, 2004 were as follows (in thousands):
 
 March 31, 20040 through 12 months

$
660,58513 through 24 months


170,51625 through 36 months


17,21237 through 48 months


35,53149 through 60 months


28,558Over 60 months


97$
912,499  (6) Advances from the FHLB
 
 The weighted average interest rates on advances from the FHLB at March 31, 2004 and December 31, 2003 were 1.91% and 2.02%, respectively. The scheduled maturities and related weighted average interest rates on advances from the FHLB at March 31, 2004 are summarized as follows (dollars in thousands):
 
 WeightedDue during the year

Averageending December 31,

Interest Rate
Amount2004


1.37
%
$
262,5072005


2.01


382,5642006


1.71


115,2172007


4.38


2,8882008


3.78


10,9132009


7.97


3,0632010


4.78


4,2482011


6.62


7082012


5.76


2922013


5.23


10,5212014


5.29


3,6912015


6.65


1,5682017


5.43


1,9582018


5.05


1,3741.91
%
$
801,512
 Advances from the FHLB are secured by certain first-lien mortgage and multifamily loans and mortgage-backed securities owned by Coastal.
 
 (7) Subordinated Debentures
 
 On December 31, 2003, Coastal retroactively implemented FASB Interpretation No. 46R, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, resulting in the deconsolidation of Coastal Capital Trust I and Coastal Capital Trust II, both of which were created for the sole purpose of issuing trust preferred securities. The implementation of this Interpretation resulted in Bancorps $1.9 million investment in the common equity of the two trusts being included in the consolidated statements of financial condition as other assets and subordinated debentures and the interest income and interest expense received from and paid to the trusts, respectively, being included in the consolidated statements of income as interest income and expense. The increase to other interest income and interest expense totaled $35,000 for the three months ended March 31, 2003.
 
 On June 23, 2003, Coastal, through Coastal Capital Trust II ("CCTII"), issued to a private institutional investor, 10,000 floating rate pooled trust preferred securities ("Trust Preferred Securities II") with a liquidation preference of $1,000 per security. The Trust Preferred Securities II represent an interest in the related junior subordinated debentures of Bancorp, which were purchased by CCTII and have substantially the same payment terms as these Trust Preferred Securities II. The junior subordinated debentures are the only assets of CCTII and interest payments from the debentures finance the distributions paid on the Trust Preferred Securities II. Distributions on the debentures are payable quarterly at a variable interest rate, reset quarterly, equal to LIBOR plus 3.05% and are included in interest expense in the consolidated statements of income.
 
 The Trust Preferred Securities II are subject to mandatory redemption at the liquidation preference, in whole or in part, upon repayment of the junior subordinated debentures at maturity or their earlier redemption. The junior subordinated debentures are redeemable prior to the maturity date of June 23, 2033, at the option of Bancorp on or after June 23, 2008, in whole at any time or in part from time to time. The junior subordinated debentures are also redeemable at any time, in whole, but not in part, upon the occurrence of specific events defined within the trust indenture. Bancorp has the option to defer distributions on the junior subordinated debentures from time to time for a period not to exceed 20 consecutive quarters.
 
 The proceeds from the issuance of the Trust Preferred Securities II were used on July 31, 2003 in the redemption of Bancorp's 9.12% Series A Cumulative Preferred Stock (Nasdaq:CBSAO).
 
 On June 18, 2002, Coastal, through Coastal Capital Trust I ("CCTI"), issued 2,000,000 trust preferred securities ("Trust Preferred Securities I") with a liquidation preference of $25 per security. The Trust Preferred Securities I represent an interest in Bancorp's junior subordinated debentures, which were purchased by CCTI. The junior subordinated debentures are the only assets of CCTI and interest payments from the debentures finance the distributions paid on the Trust Preferred Securities I. Distributions on the debentures are payable quarterly at the annual rate of 9.0% and are included in interest expense in the consolidated statements of income.
 
 The Trust Preferred Securities I are subject to mandatory redemption at the liquidation preference, in whole or in part, upon repayment of the junior subordinated debentures at maturity or their earlier redemption. The junior subordinated debentures are redeemable prior to the maturity date of June 30, 2032, at the option of Bancorp on or after June 30, 2007, in whole at any time or in part from time to time. The junior subordinated debentures are also redeemable at any time, in whole, but not in part, upon the occurrence of specific events defined within the trust indenture. Bancorp has the option to defer distributions on the junior subordinated debentures from time to time for a period not to exceed 20 consecutive quarters.
 
 A portion of the proceeds from the issuance of the Trust Preferred Securities I were used to repurchase 500,000 shares of common stock for $15.0 million from a director of Bancorp in June 2002. In addition, $28.8 million of the proceeds were used on July 15, 2002, to redeem the Bank's 9.0% Series A Noncumulative Preferred Stock (Nasdaq:CBSAP) through a capital contribution to Coastal Banc ssb.
 
 
 
 (8) Earnings Per Share
 
 The following summarizes information related to the computation of basic and diluted earnings per share ("EPS") for the three-month periods ended March 31, 2004 and 2003 (dollars in thousands, except share and per share data):
 Three Months EndedMarch 31,2004
2003Net income

$
4,112

$
3,685Preferred stock dividends


-


627Net income available to common stockholders

$
4,112

$
3,058Weighted average number of common sharesoutstanding used in basic EPS calculation


5,283,602


5,144,407Add assumed exercise of outstanding stockoptions as adjusted for dilutive securities


225,194


242,159Weighted average number of common sharesoutstanding used in diluted EPS calculation


5,508,796


5,386,566Basic EPS

$
0.78

$
0.59Diluted EPS

$
0.75

$
0.57 
 (9) Coastal Bancorp, Inc. Preferred Stock
 
 On May 11, 1999, Coastal Bancorp, Inc. ("Bancorp") issued 1,100,000 shares of 9.12% Series A Cumulative Preferred Stock, no par value, at a price of $25 per share (Nasdaq:CBSAO) to the public ("Bancorp Preferred Stock"). Dividends on the Bancorp Preferred Stock were payable quarterly at the annual rate of $2.28 per share. The preferred stock was callable on May 15, 2003 at Bancorp's option.
 
 With the proceeds from the issuance of the Trust Preferred Securities II (see note 7) and a capital distribution of $17.9 million from the Bank, Bancorp redeemed from the stockholders of record all of the 9.12% Series A Cumulative Preferred Stock on July 31, 2003. The redemption price was $25.19633 per share, which represented the stated value plus an amount equal to accrued but unpaid dividends to the date of redemption.
 
 Pursuant to Coastal's tax benefit agreement with the FRF, Coastal received a tax benefit for dividends paid on this preferred stock.  This benefit ceased upon the redemption of the Bancorp Preferred Stock. The benefit amounted to a reduction in Coastals provision for Federal income taxes of $219,000 for the three months ended March 31, 2003. The effective tax rate for the three months ended March 31, 2004 and 2003 was approximately 35%, excluding this tax benefit in 2003.
 
 
 
  (10) Statutory Capital Requirements
 
 The applicable regulations require federally insured institutions, which are not the highest rated, to have a minimum regulatory tier 1 (core) capital to total assets ratio equal to a minimum of 4.0%, a tier 1 risk-based capital to risk-weighted assets ratio of 4.0% and a total risk-based capital to risk-weighted assets ratio of 8.0%.
 
 At March 31, 2004, the Bank's regulatory capital in relation to its existing regulatory capital requirements for capital adequacy purposes was as follows (dollars in thousands):
 
 Minimum For Capital


Well-CapitalizedActual


Adequacy Purposes


RequirementsCapital Requirement

Amount
Ratio



Amount
Ratio



Amount
RatioTier 1 (core)
$
169,462
6.35
%

$
106,812
4.00
%

$
133,515
5.00
%Tier 1 risk-based

169,462
9.28



73,005
4.00



109,507
6.00Total risk-based

189,046
10.36



146,009
8.00



182,511
10.00 
 
 As of March 31, 2004, the most recent notification from the Federal Deposit Insurance Corporation ("FDIC") categorized the Bank as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum Tier 1 (core), Tier 1 risk-based and total risk-based ratios as set forth in the table above. There are no conditions or events since that notification that management believes have changed the institution's category.
 
 
 
    Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 On December 2, 2003 Coastal announced that it had signed a definitive merger agreement with Hibernia Corporation (NYSE: HIB) (Hibernia) pursuant to which Hibernia would acquire Coastal by means of a merger and pay cash in the amount of $41.50 per share for each outstanding share of Coastal common stock and $41.50 less the exercise price for each option to acquire a share of Coastal common stock. The required regulatory approvals have been granted. Coastals shareholders voted in favor of the merger at the annual meeting held on April 22, 2004. If all other customary conditions are met, the merger is expected to close on May 12, 2004.
 
 Financial Condition
 
 Total assets increased slightly by $15.4 million from December 31, 2003 to March 31, 2004. The net increase was primarily due to increases of $27.3 million in loans receivable held for sale and $14.3 million in federal funds sold, offset by decreases of $14.6 million in loans receivable and $5.4 million in cash and cash equivalents when comparing the two periods. There were also small changes in other asset categories. The increase in loans receivable held for sale was due to the purchase of $35.0 million in mortgage loans held for sale in March of 2004, offset by the sale in February 2004 of $8.0 million of mortgage loans held for sale purchased in December of 2003. The decrease in loans receivable was due to principal payments received that more than offset the purchases and production during the period.
 
 From December 31, 2003 to March 31, 2004, total liabilities increased by $9.3 million primarily due to deposit growth and borrowing to fund asset purchases. When comparing the two periods, deposits increased $4.0 million and advances from the FHLB increased $1.6 million. There were also small changes in other liability categories. Stockholders' equity increased $6.1 million from December 31, 2003 to March 31, 2004 primarily as a result of net income, offset by dividends declared, and a $1.8 million increase in accumulated other comprehensive gain on securities available-for-sale.
 
 Results of Operations for the Three Months Ended March 31, 2004 and 2003
 
 General
 
 For the three months ended March 31, 2004, net income available to common stockholders was $4.1 million compared to $3.1 million for the three months ended March 31, 2003. The $1.0 million increase was primarily due to the following: a $277,000 increase in net interest income, a $450,000 decrease in the provision for loan losses, a $222,000 decrease in noninterest expense and a $45,000 increase in noninterest income, offset by a $567,000 increase in the provision for Federal income taxes. In addition, dividends on preferred stock decreased $627,000 due to the July 31, 2003 redemption of the 9.12% Series A Cumulative Preferred Stock of Coastal Bancorp, Inc.
 
 Interest Income
 
 Interest income decreased $1.0 million to $28.6 million for the three months ended March 31, 2004 from $29.6 million for the three months ended March 31, 2003. This decrease was due primarily to principal paydowns, amortization of related premiums and the replacement of assets at lower yields (interest rates). The decrease was comprised of a $942,000 decrease in interest income on loans receivable, a $21,000 decrease in interest income on mortgage-backed securities and a $56,000 decrease in interest income on FHLB stock, federal funds sold and other interest-earning assets.
 
 When comparing the quarter ended March 31, 2004 to the same period in 2003, average interest-earning assets increased $209.6 million while the average yield decreased 0.58% to 4.39% in 2004 from 4.97% in 2003. The $209.6 million increase in average interest-earning assets consisted primarily of a $142.2 million increase in the average balance of loans receivable and a $53.4 million increase in the average balance of mortgage-backed securities available-for-sale. The 0.58% decrease in the average yield was primarily due to decreases of 0.60% and 0.34% in the average yield on loans receivable and mortgage-backed securities, respectively. The average yield on loans receivable decreased to 4.90% from 5.50% and the average yield on mortgage-backed securities available-for-sale decreased to 2.80% from 3.14%, when comparing the quarter ended March 31, 2004 to the same period in 2003.
 
 During 2003, Coastal experienced significant principal paydowns on its mortgage-backed securities and single-family mortgage loans receivable portfolios due to the continuing low market rates of interest and the resulting refinancings of mortgage assets. Since the majority of Coastal's single-family mortgage assets have been acquired primarily through bulk purchases at a premium, the significant paydowns resulted in greater premium amortization (and therefore a lower yield) on those purchased assets. While Coastal purchased mortgage-backed securities and single-family mortgage loans receivable to replace the paid down assets, the purchased assets were at lower interest rates due to the lower market rates of interest.
 
 Interest Expense
 
 Interest expense on interest-bearing liabilities was $12.1 million for the three months ended March 31, 2004, as compared to $13.4 million for the same period in 2003. The decrease in interest expense was again primarily due to the lower overall market rates of interest, offset by the increase in interest expense due to increased liabilities.
 
 When comparing the two periods, the average rate paid on interest-bearing liabilities decreased 0.46% to 2.07% for the three months ended March 31, 2004 from 2.53% for the same period in 2003 while average interest-bearing liabilities increased by $208.4 million. The 0.46% decrease in the average rate paid on interest-bearing liabilities was due primarily to a 0.43% decrease in the average rate paid on deposits and a 0.56% decrease in the average rate paid on advances from the FHLB. The increase in average interest-bearing liabilities consisted primarily of increases of $153.2 million in advances from the FHLB to fund purchases of mortgage loans and mortgage-backed securities, $44.9 million in the average balance of deposits due to deposit growth and $10.3 million in subordinated debentures due to the issuance in June of 2003.
 
 Net Interest Income
 
 Net interest income was $16.4 million for the three months ended March 31, 2004 compared to $16.2 million for the same period in 2003. As discussed above, the increase was due primarily to principal paydowns, amortization of related premiums and the replacement of assets at lower yields (interest rates). Net interest margin ("Margin") was 2.53% for the three months ended March 31, 2004 compared to 2.71% for the three months ended March 31, 2003. Margin represents net interest income as a percentage of average interest-earning assets. Net interest spread ("Spread"), defined to exclude noninterest-bearing deposits, decreased to 2.32% for the three months ended March 31, 2004 from 2.44% for the three months ended March 31, 2003. Management also calculates an alternative Spread which includes noninterest-bearing deposits. Under this calculation, the alternative Spreads for the three months ended March 31, 2004 and 2003 were 2.48% and 2.63%, respectively. Margin and Spread are affected by the changes in the amount and composition of interest-earning assets and interest-bearing liabilities. When comparing the two periods, average interest-earning assets increased $209.6 million and average interest-bearing liabilities increased $208.4 million in the 2004 period.
 
 Management's overall goal is to continue to improve the asset/liability composition to be less vulnerable to market interest rate fluctuations, primarily through the addition of loans tied to variable rates such as LIBOR and local and regional prime rates. Management attempts to mitigate margin compression in a declining interest rate environment by requiring interest rate floors on certain variable rate loans.
 
 Provision for Loan Losses and the Allowance for Loan Losses - Critical Accounting Policy
 
 During the quarter ended March 31, 2004, Coastal recorded a provision for loan losses of $450,000 compared to $900,000 for the same period in 2003. The provision recorded in the first quarter of 2004 is less than the amount recorded in the first quarter of 2003 based upon the current level of unallocated reserves and the decrease in nonperforming loans. At March 31, 2004, the allowance for loan losses as a percentage of total loans (excluding loans held for sale which are recorded at the lower of cost or fair value) was 1.00% compared to 0.98% at December 31, 2003. At March 31, 2004, Coastal had nonperforming loans totaling $14.9 million, which was a decrease of $5.3 million, or 26%, when compared to December 31, 2003. This decrease was primarily a result of the decrease in nonperforming first lien residential (single-family) mortgage loans. Nonperforming loans are those loans on nonaccrual status as well as those loans greater than ninety days delinquent and still accruing interest. At March 31, 2004, nonperforming assets (which include nonperforming loans, real estate owned and repossessed assets) were $17.4 million and the ratio of nonperforming assets to total assets was 0.64%, compared to 0.85% at December 31, 2003. At March 31, 2004, the allowance for loan losses as a percentage of nonperforming loans (excluding nonperforming loans held for sale which are recorded at the lower of cost or fair value) was 131.07% compared to 95.66% at December 31, 2003.
 
 Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain an adequate allowance. Estimating the allowance for loan losses is a critical accounting policy. It is subjective in nature and requires material estimates that may be subject to revision as facts and circumstances warrant. In assessing the adequacy of the allowance, management reviews the type, size, quality and risk of loans in the portfolio and considers such factors as specific known risks, historical and peer group experience, the existing nonperforming loans and the underlying collateral value on those loans, general economic conditions, particularly as they relate to Coastal's lending areas and other factors related to the collectibility of Coastal's loan portfolio. Based on the ongoing assessment by management, provisions for loan losses are charged to earnings to bring the total allowance for loan losses to a level deemed appropriate by management based on probable losses in the loan portfolio. While management uses the best information available at the time to recognize losses on loans, there can be no assurance that future additions to the allowance will not be necessary.
 
 Noninterest Income
 
 For the three months ended March 31, 2004, noninterest income amounted to $4.0 million, a slight increase of $45,000, when compared to the three months ended March 31, 2003. The $45,000 increase in noninterest income was comprised of the following: a $244,000 increase in the gain on sale of real estate owned, a $200,000 increase in the gain on sale of mortgage-backed securities available for sale, a $188,000 increase in the gain on sale of repossessed assets due to the sale of one asset during the first quarter of 2004, a $113,000 increase in other noninterest income and a $25,000 increase in loan fees, largely offset by a $716,000 decrease in the gain on sale of loans held for sale, due to gains of $734,000 in the quarter ended March 31, 2003, compared to $18,000 in the quarter ended March 31, 2004 and a $9,000 decrease in service charges on deposit accounts. The $734,000 gain on sale of loans held for sale during the first quarter of 2003 was due to the sale of mortgage loans held for sale that were purchased in packages with the intention to resell all or part of the loans to third party investors.
 
 Noninterest Expense
 
 For the three months ended March 31, 2004, noninterest expense decreased $222,000 to $13.7 million from $13.9 million for the three months ended March 31, 2003. When comparing the three months ended March 31, 2004 to the same period in 2003, the $222,000 net decrease in noninterest expense was comprised of a decrease in compensation, payroll taxes and benefits of $174,000, a decrease of $201,000 in other noninterest expense, due largely to a decrease of $119,0000 in expenses related to loans, repossessed assets and real estate owned and a $4,000 decrease in postage and delivery expense. These decreases were somewhat offset by increases of $72,000 in office occupancy, $46,000 in data processing and $39,000 in advertising.
 
 Provision for Federal Income Taxes
 
 The provision for Federal income taxes for the three months ended March 31, 2004 was $2.2 million compared to $1.7 million for the three months ended March 31, 2003. The $567,000 increase was due to the increased amount of income before provision for Federal income taxes, with the effective tax rate for the periods being approximately 35% for three months ended March 31, 2004 and 31% for the same period in 2003. As discussed in the notes to the Consolidated Financial Statements, Coastal received a tax benefit for the dividends paid on the Bancorp Preferred Stock pursuant to an agreement with the FDIC. The provision for Federal income taxes for the quarter ended March 31, 2003 included a tax benefit of $219,0000. This benefit ceased upon redemption of the Bancorp Preferred Stock on July 31, 2003.
 
 Liquidity and Capital Resources
 
 Coastal's primary sources of funds consist of deposits bearing market rates of interest, advances from the FHLB, principal payments on loans receivable and mortgage-backed securities and other types of borrowings. Coastal uses its funding resources principally to meet its ongoing commitments to fund maturing deposits and deposit withdrawals, repay borrowings, purchase loans receivable and mortgage-backed securities, fund existing and continuing loan commitments, maintain its liquidity, meet operating expenses and fund dividends and stock purchases and acquisitions of other banks and thrifts, either on a branch office or whole bank acquisition basis. At March 31, 2004, Coastal had binding commitments to originate or purchase loans totaling approximately $16.8 million and had $116.6 million of undisbursed loans in process. The scheduled maturities of certificates of deposit during the 12 months following March 31, 2004, totaled $660.6 million at March 31, 2004. Management believes that Coastal has adequate resources to fund all of its commitments.
 
 During the three months ended March 31, 2004, Coastal opened a new branch in The Woodlands, Texas. As of March 31, 2004, Coastal operated 44 retail banking offices in Texas cities, including Houston, Austin, Corpus Christi, the Rio Grande Valley and small cities in the southeast quadrant of Texas.
 
 Forward-Looking Information
 
 The Management's Discussion and Analysis of Financial Condition and Results of Operations set forth in this Form 10-Q should be read in conjunction with the information contained in the Consolidated Financial Statements and the Notes thereto.
 
 The statements contained in this Quarterly Report on Form 10-Q which are not historical facts contain forward looking information with respect to plans, projections or future performance of Coastal, the occurrence of which involve certain risks and uncertainties detailed in Coastal's filings with the Securities and Exchange Commission ("SEC"). Such discussion contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"), and is subject to the safe harbor created by that Reform Act. The words "estimate," "project," "anticipate," "expect," "intend," "believe," "plans," and similar expressions are intended to identify forward-looking statements. Because such forward-looking statements involve risks and uncertainties, there are important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. Factors, all of which are difficult to predict and many of which are beyond the control of Coastal, that could cause actual results to differ materially include, but are not limited to: risks related to changes in market rates of interest, changes in our loan portfolio, including the risks associated with our non-traditional lending (loans other than single-family residential mortgage loans such as multifamily, real estate acquisition and development, commercial real estate, commercial business and commercial construction loans), the possibility that Coastal's allowance for loan losses proves to be inadequate, Coastal's ability to attract core deposits, the concentration of Coastal's loan portfolio in Texas and California to the extent that the economies of those states experience problems, the risk that the merger with Hibernia will not be completed, continuing interest margin compression, changes in the volume of loan originations or purchases, the timing of repayments and prepayments of loans, changes in business strategies, changes in general market rates of interest and in economic and business conditions and changes in the laws and regulations applicable to Coastal; and other factors as discussed in Coastal's Annual Report on Form 10-K for the year ended December 31, 2003, as filed with the SEC on March 12, 2004.
 
  Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
 There have been no material changes in Coastal's interest rate risk position since December 31, 2003. Coastal's principal market risk exposure is to interest rates.
 
 Item 4. Controls and Procedures
 
 Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Coastal's management has reviewed the disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) of Coastal or caused such disclosure controls and procedures to be designed under management's supervision, particularly during the period in which this quarterly report was being prepared. Disclosure controls and procedures are the controls and other procedures of Coastal that are designed to ensure that the information required to be disclosed by Coastal in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by Coastal in its reports filed under the Exchange Act is accumulated and communicated to Coastal's management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. Management believes that such disclosure controls and procedures as of the end of the period covered by this report were adequate to ensure that material information relating to Coastal, including its consolidated subsidiaries, is made known to management by others within Coastal and its consolidated subsidiaries. To management's knowledge, there were no significant changes in internal control over financial reporting or in other factors that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting.
 
 Coastal intends to continually review and evaluate the design and effectiveness of its disclosure controls and procedures and to improve its controls and procedures over time and to correct any deficiencies that it may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning Coastal's business. While Coastal believes that the present design of its disclosure controls and procedures is effective to achieve this goal, further events affecting its business may cause Coastal to modify its disclosure controls and procedures.
 
  PART II - OTHER INFORMATION
 
 Item 1. Legal Proceedings
 
 Coastal is, and has been involved, from time to time, in various claims, complaints, proceedings and litigation relating to activities arising from the normal course of its operations. Based on the facts currently available to management, management believes that the matters pending at March 31, 2004 are without merit, or will be covered by insurance and any other matters are of such amounts, which upon resolution, are not likely to have a material adverse effect on Coastal's consolidated financial condition, results of operations or cash flows.
 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
 
 Not applicable.
 
 Item 3. Defaults Upon Senior Securities
 
 Not applicable.
 
 Item 4. Submission of Matters to a Vote of Security Holders
 
 Not applicable.
 
 Item 5. Other Information
 
 Not applicable.
 
 Item 6. Exhibits and Reports on Form 8-K
 
 Reports on Form 8-K.
 1) Form 8-K filed with the SEC on January 16, 2004 concerning the announcement that Coastal Bancorp, Inc. issued a press release after the market closed on January 15, 2004 regarding the results of operations and financial condition for the quarterly period ended December 31, 2003.
 
 2) Form 8-K/A filed with the SEC on January 16, 2004 concerning the announcement that Coastal Bancorp, Inc. issued a press release after the market closed on January 15, 2004 regarding the results of operations and financial condition for the quarterly period ended December 31, 2003.
 
 3) Form 8-K filed with the SEC on January 20, 2004 concerning the announcement that the Company held a web cast on January 16, 2004 to discuss the press release issued after the market close on January 15, 2004 regarding the results of operations and financial condition for the quarterly period ended December 31, 2003.
 
 Exhibits.
 31.1 Certification of the Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley Act of 2002.
 
 31.2 Certification of the Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley Act of 2002.
 
 32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 99.1 Statement of Factors Under Private Securities Litigation Reform Act of 1995.
 
    Signatures
 
 
 Pursuant to the requirement of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
 Dated: 4/30/04       By  /s/ Manuel J. Mehos
 Manuel J. Mehos
 Chairman of the Board
 Chief Executive Officer
 (Principal Executive Officer)
 
 
 
 
 
 
 
 
 
 Dated: 4/30/04        By  /s/ Catherine N. Wylie
 Catherine N. Wylie
 Chief Financial Officer
 (Principal Financial and
 Accounting Officer)