COASTAL BANCORP INC - 10-Q Quarterly Report

Item 1	Financial Statements (unaudited)

	Consolidated Statements of Financial Condition at September 30, 2003 and December 31, 2002

	Consolidated Statements of Income for the Nine-Month Periods Ended September 30, 2003 and 2002

	Consolidated Statements of Income for the Three-Month Periods Ended September 30, 2003 and 2002

	Consolidated Statements of Comprehensive Income for the Nine-Month and Three-Month Periods Ended September 30, 2003 and 2002

	Consolidated Statements of Cash Flows for the Nine-Month Periods Ended September 30, 2003 and 2002

	Notes to Consolidated Financial Statements

Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations

Item 3	Quantitative and Qualitative Disclosures About Market Risk

Item 4	Controls and Procedures


Item 1	Legal Proceedings

Item 2	Changes in Securities and Use of Proceeds

Item 3	Defaults upon Senior Securities

Item 4	Submission of Matters to a Vote of Security Holders

Item 5	Other Information

Item 6	Exhibits and Reports on Form 8-K

Item 1. FINANCIAL STATEMENTS

COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(In Thousands, except share data)

	September 30,				December 31,
	2003				2002
	(Unaudited)
ASSETS

Cash and cash equivalents		$	35,347			$	39,766
Federal funds sold			1,490				27,755
Loans receivable held for sale			-				49,886
Loans receivable, net (note 4)			1,951,987				1,812,785
Mortgage-backed securities available-for-sale, at fair value (note 3)			527,668				475,022
Other securities available-for-sale, at fair value			2,271				1,788
Accrued interest receivable			9,466				9,781
Property and equipment			29,804				27,341
Stock in the Federal Home Loan Bank of Dallas ("FHLB")			45,243				41,221
Goodwill			21,429				21,429
Prepaid expenses and other assets			16,351				19,370

		$	2,641,056			$	2,526,144


LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities:
Deposits (note 5)		$	1,638,914			$	1,614,368
Advances from the FHLB (note 6)			792,031				696,085
Company obligated mandatorily redeemable 9.0% trust
preferred securities of Coastal Capital Trust I
(note 7)			50,000				50,000
Company obligated mandatorily redeemable variable rate
trust preferred securities of Coastal Capital Trust II
(note 7)			10,000				-
Advances from borrowers for taxes and insurance			8,304				2,407
Other liabilities and accrued expenses			10,514				10,399

Total liabilities			2,509,763				2,373,259


Commitments and contingencies (notes 4 and 9)

Stockholders' equity (notes 1, 3, 10, 12 and 13):

Preferred stock, no par value; authorized shares 5,000,000;
9.12% Cumulative, Series A, 1,100,000 shares issued
and outstanding			-				27,500
Common stock, $.01 par value; authorized shares
30,000,000; 7,929,485 shares issued and 5,182,610
shares outstanding at September 30, 2003; 7,867,029
shares issued and 5,141,010 outstanding at
December 31, 2002			79				79
Additional paid-in capital			36,475				35,736
Retained earnings			148,699				141,986
Accumulated other comprehensive income (loss) - net
unrealized gain (loss) on securities available-for-sale			(315	)			619
Treasury stock at cost (2,746,875 shares in 2003 and
2,726,019 shares in 2002)			(53,645	)			(53,035	)

Total stockholders' equity			131,293				152,885

		$	2,641,056			$	2,526,144


See accompanying Notes to Consolidated Financial Statements

COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, except per share data)

	Nine Months Ended
	September 30,
	2003			2002
	(Unaudited)
Interest income:
Loans receivable	$	74,880		$	90,357
Mortgage-backed securities		10,403			13,060
FHLB stock, federal funds sold and other interest-earning assets		829			1,203

		86,112			104,620

Interest expense:
Deposits		22,934			30,859
Advances from the FHLB		12,749			15,303
Senior Notes payable (note 8)		-			378
Company obligated mandatorily redeemable trust preferred securities		3,487			1,275

		39,170			47,815


Net interest income		46,942			56,805
Provision for loan losses (note 4)		2,700			2,700

Net interest income after provision for loan losses		44,242			54,105


Noninterest income:
Service charges on deposit accounts		8,859			6,732
Loan fees		681			888
Gain on sale of loans receivable held for sale		798			40
Gain (loss) on derivative instruments (note 9)		15			(18	)
Gain (loss) on real estate owned		(23	)		207
Gain on sale of mortgage-backed securities available-for-sale		302			-
Other		748			668

		11,380			8,517


Noninterest expense:
Compensation, payroll taxes and other benefits		22,699			23,821
Office occupancy		7,225			7,629
Data processing		1,355			1,235
Advertising		905			1,396
Postage and delivery		1,163			1,206
Other		7,343			6,128

		40,690			41,415


Income before provision for Federal income taxes and minority interest		14,932			21,207
Provision for Federal income taxes		4,735			6,289

Income before minority interest		10,197			14,918
Minority interest - preferred stock dividends of Coastal Banc ssb		-			1,507

Net income	$	10,197		$	13,411

Net income available to common stockholders	$	8,727		$	11,530

Basic earnings per common share (note 10)	$	1.69		$	2.06

Diluted earnings per common share (note 10)	$	1.62		$	1.97


See accompanying Notes to Consolidated Financial Statements

COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, except per share data)

	Three Months Ended
	September 30,
	2003		2002
	(Unaudited)
Interest income:
Loans receivable	$	24,049	$	29,649
Mortgage-backed securities		3,251		4,034
FHLB stock, federal funds sold and other interest-earning assets		250		348

		27,550		34,031

Interest expense:
Deposits		7,128		9,616
Advances from the FHLB		4,291		4,944
Company obligated mandatorily redeemable trust preferred securities		1,229		1,112

		12,648		15,672


Net interest income		14,902		18,359
Provision for loan losses (note 4)		900		900

Net interest income after provision for loan losses		14,002		17,459


Noninterest income:
Service charges on deposit accounts		3,013		2,599
Loan fees		259		266
Gain on sale of loans receivable held for sale		6		-
Gain on derivative instruments (note 9)		2		6
Gain (loss) on real estate owned		73		(33	)
Gain on sale of mortgage-backed securities available-for-sale		302		-
Other		226		216

		3,881		3,054


Noninterest expense:
Compensation, payroll taxes and other benefits		7,245		7,968
Office occupancy		2,505		2,408
Data processing		461		413
Advertising		336		546
Postage and delivery		406		411
Other		2,458		2,134

		13,411		13,880


Income before provision for Federal income taxes and minority interest		4,472		6,633
Provision for Federal income taxes		1,498		2,045

Income before minority interest		2,974		4,588
Minority interest - preferred stock dividends of Coastal Banc ssb		-		213

Net income	$	2,974	$	4,375

Net income available to common stockholders	$	2,758	$	3,748

Basic earnings per common share (note 10)	$	0.53	$	0.72

Diluted earnings per common share (note 10)	$	0.51	$	0.68


See accompanying Notes to Consolidated Financial Statements

COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In Thousands)



	Nine Months Ended
	September 30,
	2003			2002
	(Unaudited)

Net income	$	10,197		$	13,411

Other comprehensive income, net of tax:
Unrealized gains (losses) on securities available-for-sale arising during period		(1,130	)		1,626
Reclassification adjustment for gains included in net income		196			-

Total comprehensive income	$	9,263		$	15,037




		Three Months Ended
		September 30,
		2003			2002
		(Unaudited)

Net income	$	2,974		$	4,375

Other comprehensive income, net of tax:
Unrealized gains (losses) on securities available-for-sale arising during period		(2,065	)		1,562
Reclassification adjustment for gains included in net income		196			-

Total comprehensive income	$	1,105		$	5,937




See accompanying Notes to Consolidated Financial Statements

COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)



		Nine Months Ended
		September 30,
		2003			2002
		(Unaudited)
Cash flows from operating activities:
Net income		$	10,197		$	13,411
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization of property and equipment
and prepaid expenses and other assets			6,924			6,476
Net amortization (accretion) of premiums, discounts and loan fees			7,211			3,558
Provision for loan losses			2,700			2,700
Originations and purchases of mortgage loans held for sale			(127,784	)		(8,592	)
Sales of mortgage loans held for sale			153,443			11,758
Gain on sale of mortgage loans held for sale			(798	)		(40	)
Gain on sale of mortgage backed securities available-for-sale			(302	)		-
Stock dividends from the FHLB			(731	)		(905	)
(Gain) loss on derivative instruments			(15	)		18
Decrease (increase) in:
Accrued interest receivable			315			1,899
Other, net			6,923			4,065

Net cash provided by operating activities			58,083			34,348

Cash flows from investing activities:
Net decrease in federal funds sold			26,265			15,960
Purchase of mortgage-backed securities available-for-sale			(242,998	)		(70,138	)
Principal repayments on mortgage-backed securities available-for-sale			152,954			115,898
Sales of mortgage-backed securities available-for-sale			33,078			-
Purchase of other securities available-for-sale			(511	)		(243	)
Proceeds from maturity of other securities available-for-sale			-			41,000
Purchases of loans receivable			(452,670	)		(387,843	)
Sales of loans receivable			-			10,111
Net decrease in loans receivable			324,263			261,129
Purchase of FHLB stock			(3,291	)		-
Net purchases of property and equipment			(4,976	)		(2,861	)


Net cash provided (used) by investing activities			(167,886	)		(16,987	)




	(Table continued on next page)

COASTAL BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(In Thousands)

	Nine Months Ended
	September 30,
	2003			2002
	(Unaudited)

Cash flows from financing activities:
Net increase (decrease) in deposits	$	24,546		$	(16,705	)
Advances from the FHLB		12,606,474			15,601,400
Principal payments on advances from the FHLB		(12,510,528	)		(15,559,494	)
Proceeds from issuance of trust preferred securities		9,850			48,125
Net increase in advances from borrowers for taxes and insurance		5,897			6,109
Exercise of stock options for purchase of Common Stock, net		717			105
Purchase of treasury stock		(652	)		(21,162	)
Issuance of treasury shares		63			83
Redemption of Senior Notes payable		-			(43,875	)
Redemption of Coastal Banc ssb 9.0% Noncumulative Preferred Stock		-			(28,750	)
Redemption of 9.12% Cumulative Series A Preferred Stock		(27,500	)		-
Dividends paid		(3,483	)		(3,912	)

Net cash provided (used) by financing activities		105,384			(18,076	)

Net decrease in cash and cash equivalents		(4,419	)		(715	)
Cash and cash equivalents at beginning of period		39,766			41,537

Cash and cash equivalents at end of period	$	35,347		$	40,822


Supplemental schedule of cash flows-interest paid	$	40,066		$	49,801


Supplemental schedule of noncash investing and financing activities:
Transfer of loans to the held for sale category	$	-		$	9,075
Transfer of loans from held for sale to loans receivable		19,644			-
Foreclosures of loans receivable		2,151			4,289


See accompanying Notes to Consolidated Financial Statements

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 September 30, 2003 are not necessarily indicative of the results that may be expected for the entire fiscal year or any other interim period.

In November 2002, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34" ("FIN 45"). This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after D ecember 31, 2002 and did not have a material effect on Coastal's consolidated financial statements for the nine months ended September 30, 2003.

On January 17, 2003, the FASB issued FASB Interpretation No. 46 "Consolidation of Variable Interest Entities", which addresses consolidation by business enterprises of variable interest entities. FIN 46 clarifies the application of Accounting Research Bulletin 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 inte rim 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 and 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 our accompanying consolidated financial statements. Coastal currently believes the continued consolidation of these trusts is appropriate under Interpretation No. 46. However, the application of Interpretation No. 46 to these types of trusts is an emerging issue and a possible unintended consequence of Interpretation No. 46 is the deconsolidation of these types of trusts. Coastal is currently evaluating the impact that deconsolidation of these trusts would have on its consolidated financial statements.

In April 2003, the FASB issued Statement No. 149 ("Statement 149"), "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". Statement 149 amends FASB Statement No. 133 ("Statement 133"), "Accounting for Derivative Instruments and Hedging Activities" and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. Statement 149 improves financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. In particular, Statement 149 clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative, clarifies when a derivative contains a financing component, amends the defin ition of underlying to conform to the language in FIN 45 and amends certain other existing pronouncements. Statement 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. However, the provisions of Statement 149 that related to Statement 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. The adoption of Statement 149 is not expected to have a material impact on Coastal's consolidated financial statements.

In May 2003, the FASB issued Statement No. 150 ("Statement 150"), "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity". Statement 150 requires certain financial instruments that have characteristics of both liabilities and equity to be classified as a liability on the consolidated statements of financial condition. Prior to the issuance of Statement 150, Coastal classified trust preferred securities as liabilities on the consolidated statements of financial condition and the related interest cost as interest expense on the consolidated statements of income, which is consistent with the requirements of Statement 150. Statement 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. Statement 150 will be effected by reporting the cumulative effect of a change in accounting principle for contracts created before the issuance date and still existing at the beginning of that interim period. The adoption of Statement 150 did not have an impact on Coastal's consolidated financial statements.

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 and nine months ended September 30, 2003 and 2002 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 tables illustrate 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.

		Nine Months Ended
		September 30,
		2003			2002
	(In thousands, except per share data)

Net income available to common stockholders, as reported		$	8,727		$	11,530
Deduct: Total stock-based compensation expense determined under the fair value
based method for all awards, net of related tax effects			(184	)		(319	)

Proforma net income available to common stockholders		$	8,543		$	11,211

Earnings per common share:
Basic – as reported		$	1.69		$	2.06

Basic – proforma		$	1.66		$	2.00

Diluted – as reported		$	1.62		$	1.97

Diluted – proforma		$	1.59		$	1.91


		Three Months Ended
		September 30,
		2003			2002
	(In thousands, except per share data)
Net income available to common stockholders, as reported		$	2,758		$	3,748
Deduct: Total stock-based compensation expense determined under the fair value
based method for all awards, net of related tax effects			(61	)		(106	)

Proforma net income available to common stockholders		$	2,697		$	3,642

Earnings per common share:
Basic – as reported		$	0.53		$	0.72

Basic – proforma		$	0.52		$	0.70

Diluted – as reported		$	0.51		$	0.68

Diluted – proforma		$	0.50		$	0.67




Coastal Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Unaudited)

The accompanying unaudited Consolidated Financial Statements include the accounts of Coastal Bancorp, Inc. ("Bancorp") and its wholly-owned subsidiaries, Coastal Banc Holding Company, Inc., Coastal Capital Trust I and Coastal Capital Trust II (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)

	September 30, 2003			December 31, 2002

Real estate mortgage loans:
First-lien mortgage, primarily residential	$	968,608		$	855,633
Commercial		373,921			317,692
Multifamily		102,238			116,020
Residential construction		125,116			123,085
Acquisition and development		138,402			143,463
Commercial construction		189,042			241,128
Commercial, financial and industrial		176,226			135,209
Loans secured by deposits		12,839			14,465
Consumer and other loans		31,371			33,430

		2,117,763			1,980,125
Loans in process		(150,223	)		(147,769	)
Allowance for loan losses		(19,066	)		(18,118	)
Unearned interest and loan fees		(3,055	)		(2,910	)
Premium on purchased loans, net		6,568			1,457


	$	1,951,987		$	1,812,785

Weighted average yield		4.73	%		5.52	%

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 September 30, 2003, the maximum potential amount of future payments under standby letters of credit was $17.4 million. As of September 30, 2003, the fair value of these guarantees, which is the liability recorded when fees are collected, was immaterial to the consolidated financial statements.

At September 30, 2003 and December 31, 2002, the carrying value of loans that were considered to be impaired totaled approximately $6.9 million and $8.5 million, respectively, and the related allowance for loan losses on those impaired loans totaled $1.9 million and $2.4 million at September 30, 2003 and December 31, 2002, respectively. Of the impaired loans outstanding, one loan with a balance of $32,000 at September 30, 2003 and eight loans with a balance of $551,000 at December 31, 2002 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 nine months ended September 30, 2003 and 2002 was $7.8 million and $3.4 million, respectively.




Coastal Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Unaudited)

Deposits, their stated rates and the related weighted average interest rates, at September 30, 2003 and December 31, 2002, 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 $247.4 million ($138.9 million from noninterest-bearing and $108.5 million from interest-bearing) at September 30, 2003 and $250.9 million ($131.3 million from noninterest-bearing and $119.6 million from interest-bearing) at December 31, 2002.

		Stated Rate			September 30, 2003			December 31, 2002

Noninterest-bearing checking			0.00	%	$	55,292		$	51,029
Interest-bearing checking			0.00 - 1.00			13,990			14,353
Savings accounts			0.25 - 1.24			44,730			44,603
Money market demand accounts			0.00 - 2.13			594,795			530,659

						708,807			640,644


Certificate accounts
	Less than 2.00					388,378			104,358
		2.00 - 2.99				328,875			558,337
		3.00 - 3.99				137,187			206,645
		4.00 - 4.99				47,641			63,234
		5.00 - 5.99				24,812			34,447
		6.00 - 6.99				3,194			6,524
		7.00 - 7.99				19			106
		8.00 - 8.99				1			73

						930,107			973,724

					$	1,638,914		$	1,614,368

Weighted average interest rate						1.69	%		2.12	%




Coastal Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Unaudited)




Coastal Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Unaudited)

On June 23, 2003, Bancorp, through Coastal Capital Trust II (a consolidated trust subsidiary) ("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 the CCTII and have substantially the same payment terms as these Trust Preferred Securities II. The junior subordinated notes are the only assets of the CCTII and interest payments from the notes finance the distributions paid on the Trust Preferred Securities II. Distributions on the securities are payable quarterly at a variable interest rate, reset quarterly, equal t o LIBOR plus 3.05%, and are included in interest expense in the consolidated statements of income. Interest was paid on the Trust Preferred Securities II at the rate of 4.0775% for the quarter ended September 30, 2003. Effective October 1, 2003 the rate reset at 4.19% for the fourth quarter of 2003.

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.

On June 18, 2002, Coastal, through Coastal Capital Trust I (a consolidated trust subsidiary) ("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 the CCTI. The junior subordinated debentures are the only assets of the CCTI and interest payments from the debentures finance the distributions paid on the Trust Preferred Securities I. Distributions on the securities 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.




Coastal Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Unaudited)

On June 30, 1995, Coastal issued $50.0 million of 10.0% Senior Notes due June 30, 2002. The Senior Notes became redeemable at Coastal's option, in whole or in part, on June 30, 2000, at par, plus accrued interest to the redemption date. Interest on the Senior Notes was payable quarterly. During 2001 and 1999, Coastal repurchased in the open market $3.0 and $3.1 million, respectively, of the Senior Notes outstanding at par. On February 1, 2002, Coastal redeemed all of the remaining Senior Notes outstanding ($43.9 million) at par plus accrued interest to the redemption date.

Coastal is a party to derivative instruments in the normal course of business to reduce its exposure to fluctuations in interest rates. These derivative instruments have included interest rate swap agreements where Coastal makes fixed interest payments and receives payments based on a floating index and interest rate cap agreements, as described below. For the nine months ended September 30, 2003 and 2002, Coastal recorded a fair value gain (loss) on these derivative instruments of $15,000 and ($18,000), respectively. As of September 30, 2003 and December 31, 2002, interest rate cap agreements were Coastal's only derivative instruments and were recorded at fair value.

Payments on the interest rate cap agreements are based on the notional principal amount of the agreements; no funds were actually borrowed or are to be repaid. No payments are required to be made upon the expiration of the agreements. The fair value of the interest rate cap agreements was zero at September 30, 2003 and December 31, 2002, which is the recorded book value of the agreements at such dates. The interest rate cap agreements are used to alter the interest rate sensitivity of a portion of Coastal's mortgage-backed securities and loans receivable portfolios. As such, the amortization of any purchase price and interest income from the interest rate cap agreements is recorded in interest income in the accompanying consolidated statements of income, as applicable. The net decrease in in terest income related to the interest rate cap agreements for the nine months ended September 30, 2003 and 2002 was approximately $15,000 and $19,000, respectively. No payments were made to Coastal under the interest rate cap agreements during the nine months ended September 30, 2003 or 2002. As of September 30, 2003, Coastal had one interest rate cap agreement with a third party with a notional amount totaling $4.3 million. The current agreement provides for the third party to make payments to Coastal whenever a defined floating rate exceeds 9.0%. This agreement expires in 2003.

Market risk, or the risk of loss due to movement in market prices or rates, is quantified by Coastal through a risk monitoring process of marking to market its assets and liabilities to expected market level changes in an instantaneous shock of plus and minus 200 basis points on a quarterly basis. This process discloses the effects on market values of the assets and liabilities, unrealized gains and losses, including off-balance sheet items, as well as potential changes in net interest income.




Coastal Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Unaudited)


	Nine Months Ended
	September 30,
	2003		2002

Net income	$	10,197	$	13,411
Preferred stock dividends		1,470		1,881

Net income available to common stockholders	$	8,727	$	11,530

Weighted average number of common shares outstanding used in basic EPS calculation		5,159,564		5,596,525
Add assumed exercise of outstanding stock options as adjusted for dilutive securities		229,003		262,176

Weighted average number of common shares outstanding used in diluted EPS
calculation		5,388,567		5,858,701

Basic EPS	$	1.69	$	2.06

Diluted EPS	$	1.62	$	1.97



	Three Months Ended
	September 30,
		2003		2002

Net income	$	2,974	$	4,375
Preferred stock dividends		216		627

Net income available to common stockholders	$	2,758	$	3,748

Weighted average number of common shares outstanding used in basic EPS calculation		5,168,964		5,226,334

Add assumed exercise of outstanding stock options as adjusted for dilutive securities		218,383		248,101

Weighted average number of common shares outstanding used in diluted
EPS calculation		5,387,347		5,474,435

Basic EPS	$	0.53	$	0.72

Diluted EPS	$	0.51	$	0.68

On October 21, 1993, the Bank issued 1,150,000 shares of 9.0% Noncumulative Preferred Stock, no par value, Series A, at a price of $25 per share to the public (Nasdaq:CBSAP). Dividends on the Preferred Stock were payable quarterly at the annual rate of $2.25 per share, when, as and if declared by the Board of Directors of the Bank. At any time on or after December 15, 1998, the Preferred Stock could be redeemed in whole or in part only at the Bank's option at $25 per share plus unpaid dividends (whether or not earned or declared) for the then current dividend period to the date fixed for redemption.

Pursuant to Coastal's tax benefit agreement with the FDIC, Coastal received a tax benefit for dividends paid on this Bancorp Preferred Stock. This benefit ceased upon the redemption of the Bancorp Preferred Stock. The benefit amounted to a reduction in Coastal's effective tax rate of approximately 3% for the nine months ended September 30, 2003 and 2002. Excluding this tax benefit and the tax benefit for the minority interest expense in 2002, the effective tax rate for the nine months ended September 30, 2003 and 2002 was approximately 35%.

As of September 30, 2003, 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.

Total assets increased by $114.9 million from December 31, 2002 to September 30, 2003. The net increase was primarily due to increases of $139.2 million in loans receivable and $52.6 million in mortgage-backed securities available-for-sale, somewhat offset by decreases of $49.9 million in loans receivable held for sale and $26.3 million in federal funds sold when comparing the two periods. There were also small changes in other asset categories. The increase in loans receivable was primarily due to the purchase of $452.7 million in single-family mortgage loans, offset by principal payments received on mortgage and other types of loans. The increase in mortgage-backed securities was due to the purchase of $243.0 million of securities, offset by sales of $33.1 million and principal payments re ceived. The decrease in loans receivable held for sale was due primarily to the sale to third party investors in January 2003 of a loan package purchased in November of 2002, the majority of which was intended to be sold.

From December 31, 2002 to September 30, 2003, total liabilities increased by $136.5 million primarily to fund asset purchases and due to the issuance of Trust Preferred Securities II to partially fund the redemption of the 9.12% Series A Preferred Stock. When comparing the two periods, advances from the FHLB increased $95.9 million and deposits increased $24.5 million. During the nine months ended September 30, 2003, Coastal issued $10.0 million in Trust Preferred Securities II through a consolidated trust subsidiary (see note 7 to the Consolidated Financial Statements). Stockholders' equity decreased 14.1% or $21.6 million from December 31, 2002 to September 30, 2003 primarily as a result of the redemption of the 9.12% Series A Cumulative Preferred Stock (see note 12 to the Consol idated Financial Statements). Other changes included net income, offset by dividends declared and increases of $934,000 and $610,000 in accumulated other comprehensive loss and Treasury Stock, respectively.

For the nine months ended September 30, 2003, net income was $10.2 million compared to $13.4 million for the nine months ended September 30, 2002. The decrease was primarily due to a $9.9 million decrease in net interest income, as a result of a 0.56% decrease in net interest margin, to 2.54%, and a $9.6 million decrease in average net interest-earning assets when comparing the first nine months of 2003 to the same period in 2002. This decrease in net interest income was somewhat offset by a $2.9 million increase in noninterest income, a $725,000 decrease in noninterest expense, a $1.6 million decrease in the provision for Federal income taxes and a $1.5 million decrease in the expense for minority interest (related to preferred stock of Coastal Banc ssb which was redeemed on July 15, 2002).

Due primarily to principal paydowns, amortization of related premiums and the replacement of assets at lower yields (interest rates), interest income decreased $18.5 million to $86.1 million for the nine months ended September 30, 2003 from $104.6 million for the nine months ended September 30, 2002. The decrease was comprised of a $15.5 million decrease in interest income on loans receivable, a $2.7 million decrease in interest income on mortgage-backed securities and a $374,000 decrease in interest income on FHLB stock, federal funds sold and other interest-earning assets.

When comparing the two periods, average interest-earning assets increased $18.2 million while the average yield decreased 1.05% from 5.72% in 2002 to 4.67% in 2003. The $18.2 million increase in average interest-earning assets consisted primarily of a $23.8 million increase in the average balance of mortgage-backed securities available-for-sale, offset by an $8.4 million decrease in other securities available-for-sale. The 1.05% decrease in the average yield was primarily due to decreases of 1.11% and 0.90% in the average yield on loans receivable and mortgage-backed securities, respectively, due to significant principal paydowns and the replacement of assets at lower yields (interest rates) during the nine months ended September 30, 2003.

During 2003, Coastal has 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 its mortgage assets. The paydowns, on an annualized basis, were approximately 43% on mortgage-backed securities and 50% on single-family mortgage loans during the nine months ended September 30, 2003. Because the majority of Coastal's single-family mortgage assets have been acquired through bulk purchases, the significant paydowns Coastal has experienced have resulted in greater premium amortization (and therefore a lower yield) on those purchased assets. In addition, due to the lower interest rate environment, Coastal is replacing these paid down assets with lower yielding assets, again with many being purchased at a premium.

Interest expense on interest-bearing liabilities was $39.2 million for the nine months ended September 30, 2003, as compared to $47.8 million for the same period in 2002. The decrease in interest expense was again primarily due to the lower overall market rates of interest that declined throughout 2002 and have continued to decline during the first nine months of 2003, offset by the increase in interest expense due to the 9.0% Trust Preferred Securities I issued in June of 2002 and the floating rate Trust Preferred Securities II issued in June of 2003.

When comparing the two periods, the average rate paid on interest-bearing liabilities decreased to 2.38% for the nine months ended September 30, 2003 from 2.94% for the same period in 2002 and average interest-bearing liabilities increased by $27.8 million. The 0.56% decrease in the average rate paid on interest-bearing liabilities was due primarily to a 0.69% decrease in the average rates paid on advances from the FHLB and a 0.64% decrease in the average rate paid on interest-bearing deposits. The increase in average interest-bearing liabilities consisted primarily of a $50.4 million increase in advances from the FHLB and a $34.4 million increase in the average balance of Trust Preferred Securities due to the issuance of $50.0 million of the Trust Preferred Securities I on June 18, 2002 at 9.0% and $10.0 million of the Trust Preferred Securities II on June 23, 2003 at a floating rate (LIBOR plus 3.05). These increases were somewhat offset by a $52.1 million decrease in average interest-bearing deposits (primarily due to the sale of the Hill Country branches in December 2002) and a $5.0 million decrease in the average balance of Senior Notes due to their redemption on February 1, 2002.

Net interest income was $46.9 million for the nine months ended September 30, 2003 and $56.8 million for the same period in 2002. As discussed above, the decrease 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 2.54% for the nine months ended September 30, 2003 compared to 3.10% for the nine months ended September 30, 2002. 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 2.29% for the nine months ended September 30, 2003 from 2.78% for the nine months ended September 30, 2002. Management also calculates an alternative Spread which incl udes noninterest-bearing deposits. Under this calculation, the alternative Spreads for the nine months ended September 30, 2003 and 2002 were 2.47% and 2.99%, 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 $18.2 million and average interest-bearing liabilities increased $27.8 million.

The provision for loan losses was $2.7 million for the nine months ended September 30, 2003 and for the nine months ended September 30, 2002. At September 30, 2003, Coastal had nonperforming loans totaling $15.4 million, which was a decrease of $3.1 million, or 17%, when compared to December 31, 2002. This decrease was primarily a result of the decrease in nonperforming first lien residential (single-family) mortgage loans due to management's increased focus on ongoing collection efforts. Nonperforming loans are those loans on nonaccrual status as well as those loans greater than ninety days delinquent and still accruing interest. The ratio of nonperforming assets to total assets was 0.70% at September 30, 2003, compared to 0.91% at December 31, 2002. At September 30, 2003 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 123.8% compared to 97.7% at December 31, 2002.

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.

For the nine months ended September 30, 2003, noninterest income increased $2.9 million to $11.4 million, compared to $8.5 million for the nine months ended September 30, 2002. The $2.9 million increase in noninterest income was primarily due to a $2.1 million increase in service charges on deposit accounts, a $758,000 gain on the sale of loans receivable held for sale and a $302,000 gain on the sale of mortgage-backed securities available-for-sale. The increased income from service charges on deposit accounts is due to Coastal's continued focus on increasing transaction-type accounts and the related fee income, including Coastal's Free Checking and Bounce Protection features on retail checking accounts introduced during August 2002. The increase in the gain on the sale of mortgage loans hel d for sale was due to routine sales transactions by Coastal Banc ssb (the "Bank"), which were facilitated by Coastal Banc Mortgage Corp. ("CBMC"), an affiliate of the Bank. The loans sold were purchased by the Bank in packages with the intention to resell all or part of the loans in the packages to third party investors. CBMC was formed during the third quarter of 2002 for the purpose of facilitating the purchase and sale of whole loans and participations to third parties. These increases in other noninterest income were somewhat offset by a $230,000 decrease in the gain on the sale of real estate owned and a $207,000 decrease in loan fees. The decrease in loan fees was due to decreased construction loan activity, no warehouse activity in 2003 and decreased single-family mortgage loan fees due to the fact that the number of Coastal's mortgage loans that are being serviced by Coastal has decreased.

For the nine months ended September 30, 2003, noninterest expense decreased $725,000 from the nine months ended September 30, 2002. When comparing the nine months ended September 30, 2003 to the same period in 2002, the $725,000 net decrease in noninterest expense was comprised primarily of a decrease in compensation, payroll taxes and benefits of $1.1 million, a decrease of $404,000 in office occupancy and a $491,000 decrease in advertising, somewhat offset by a $1.2 million increase in other noninterest expense. The $1.1 million decrease in compensation related expense is primarily comprised of the following: a $555,000 decrease in incentive and bonus expense because of the overall lower net income results, a $444,000 decrease due to the sale of the five Hill Country branches in December 2 002, a $373,000 decrease due to the outsourcing of the internal audit department in September of 2002, offset by a $281,000 increase in compensation paid to CBMC employees including brokerage commissions related to the loan sales mentioned previously. The decrease in office occupancy was due to various assets becoming fully depreciated in 2002 and in 2003 and to the sale of the five Hill Country branches in December of 2002. The decrease in advertising expense was due to management's decision to reduce this spending in 2003. The increase in other noninterest expense was primarily comprised of the following: a $349,000 increase in audit and accounting fees, a $353,000 increase in legal fees and insurance premiums, a $122,000 increase in the provision for losses on deposit accounts and a $379,000 increase in expenses related to loans, repossessed assets and real estate owned.

The provision for Federal income taxes for the nine months ended September 30, 2003 was $4.7 million compared to $6.3 million for the nine months ended September 30, 2002. The $1.6 million decrease was due to the lower amount of income before provision for Federal income taxes and minority interest, with the effective tax rate for the periods being approximately 32% for the nine months ended September 30, 2003 and 32% for the same period in 2002 (when taking into account the tax benefit for the minority interest expense in 2002). 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 includes benefits of $514,000 and $658,000 for the nine months ended September 30, 2003 and 2002, respectively. This benefit ceased upon redemption of the Bancorp Preferred Stock on July 31, 2003.

For the three months ended September 30, 2003, net income was $3.0 million compared to $4.4 million for the three months ended September 30, 2002. The decrease was primarily due to a $3.5 million decrease in net interest income, as a result of a 0.63% decrease in net interest margin when comparing the third quarter of 2003 to the same period in 2002. This decrease in net interest income was partially offset by an $827,000 increase in noninterest income, a $469,000 decrease in noninterest expense, a $547,000 decrease in the provision for Federal income taxes and a $213,000 decrease in the expense for minority interest (related to the preferred stock of Coastal Banc ssb which was redeemed on July 15, 2002).

Due primarily to principal paydowns, amortization of related premiums and the replacement of assets at lower yields (interest rates), interest income decreased $6.5 million to $27.6 million for the three months ended September 30, 2003 from $34.0 million for the three months ended September 30, 2002. The decrease was comprised of a $5.6 million decrease in interest income on loans receivable, a $783,000 decrease in interest income on mortgage-backed securities and a $98,000 decrease in interest income on FHLB stock, federal funds sold and other interest-earning assets.

When comparing the two periods, average interest-earning assets increased $78.0 million while the average yield decreased 1.19% from 5.49% in 2002 to 4.30% in 2003. The $78.0 million increase in average interest-earning assets consisted primarily of a $74.4 million increase in the average balance of mortgage-backed securities. The 1.19% decrease in the average yield was primarily due to decreases of 1.14% and 1.12% in the average yield on loans receivable and mortgage-backed securities, respectively, due to significant principal paydowns and the replacement of assets at lower yields (interest rates).

During 2003, Coastal has 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 its mortgage assets. These paydowns, on an annualized basis, were approximately 49% on mortgage-backed securities and over 60% on single-family mortgage loans during the three months ended September 30, 2003. Because the majority of Coastal’s single-family mortgage assets have been acquired through bulk purchases, the significant paydowns Coastal has experienced have resulted in greater premium amortization (and therefore a lower yield) on those purchased assets. In addition, due to the lower interest rate environment, Coastal is replacing these pai d down assets with lower yielding assets, again with many being purchased at a premium.

Interest expense on interest-bearing liabilities was $12.6 million for the three months ended September 30, 2003, as compared to $15.7 million for the same period in 2002. The decrease in interest expense was again primarily due to the lower overall market rates of interest that declined throughout 2002 and have continued to decline during the first nine months of 2003, offset by the increase in interest expense due to the floating rate Trust Preferred Securities II issued in June of 2003.

When comparing the two periods, the average rate paid on interest-bearing liabilities decreased to 2.19% for the three months ended September 30, 2003 from 2.81% for the same period in 2002 and average interest-bearing liabilities increased $78.6 million. The 0.62% decrease in the average rate paid on interest-bearing liabilities was due primarily to a 0.75% decrease in the average rate paid on advances from the FHLB and a 0.59% decrease in the average rate paid on interest-bearing deposits. The increase in average interest-bearing liabilities consisted primarily of a $120.5 million increase in the average balance of FHLB advances and an increase in Trust Preferred Securities due to the issuance of $10.0 million of the Trust Preferred Securities II on June 23, 2003 at a floating rate (LIBOR plus 3.05%). These increases were somewhat offset by a $51.9 million decrease in average interest-bearing deposits, primarily due to the December 2002 branch sale.

Net interest income was $14.9 million for the three months ended September 30, 2003 and $18.4 million for the same period in 2002. As discussed above, the decrease 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 2.34% for the three months ended September 30, 2003 compared to 2.97% for the three months ended September 30, 2002. 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 2.11% for the three months ended September 30, 2003 from 2.68% for the three months ended September 30, 2002. Management also calculates an alternative Spread which includes noninterest-bearing deposits. Under this calculation, the alternative Spreads for the three months ended September 30, 2003 and 2002 were 2.27% and 2.88%, 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 $78.0 million and average interest-bearing liabilities increased $78.6 million.

The provision for loan losses was $900,000 for the three months ended September 30, 2003 and for the three months ended September 30, 2002. At September 30, 2003, Coastal had nonperforming loans totaling $15.4 million, which was a decrease of $3.1 million, or 17%, when compared to December 31, 2002. This decrease was primarily a result of the decrease in nonperforming first lien residential (single-family) mortgage loans due to management's increased focus on ongoing collection efforts. Nonperforming loans are those loans on nonaccrual status as well as those loans greater than ninety days delinquent and still accruing interest. The ratio of nonperforming assets to total assets was 0.70% at September 30, 2003, compared to 0.91% at December 31, 2002. At September 30, 2003 the allowance for lo an 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 123.8% compared to 97.7% at December 31, 2002.

For the three months ended September 30, 2003, noninterest income increased $827,000 to $3.9 million, compared to $3.0 million for the three months ended September 30, 2002. The $827,000 increase in noninterest income was primarily due to a $414,000 increase in service charges on deposit accounts, a $302,000 gain on the sale of mortgage-backed securities available-for-sale and a $106,000 increase in the gain on the sale of real estate owned. The increased income from service charges on deposit accounts is due to Coastal's continued focus on increasing transaction-type accounts and the related fee income, including Coastal's Free Checking and Bounce Protection features on retail checking accounts introduced during August 2002.

For the three months ended September 30, 2003, noninterest expense decreased $469,000 from the three months ended September 30, 2002. When comparing the third quarter of 2003 to the same period in 2002, the $469,000 net decrease in noninterest expense was comprised primarily of a decrease in compensation, payroll taxes and benefits of $723,000 and a decrease of $210,000 in advertising. These decreases were somewhat offset by a $324,000 increase in other noninterest expense, and increases of $97,000 and $48,000 in office occupancy and in data processing, respectively. The decrease in compensation related expenses was primarily comprised of the following: decreased incentive and bonus expense of $298,000 because of the overall lower net income results, a $121,000 decrease due to the outsourcin g of the internal audit department in September of 2002, a $151,000 decrease due to the sale of the five Hill Country branches in December 2002, in addition to other overall staffing changes to gain efficiencies throughout Coastal. The decrease in advertising expense was due to management's decision to reduce this spending in 2003. The $324,000 increase in other noninterest expense was primarily comprised of a $114,000 increase in audit and accounting fees related to the outsourcing of the internal audit department and a $251,000 increase in expenses related to loans, repossessed assets and real estate owned.

The provision for Federal income taxes for the three months ended September 30, 2003 was $1.5 million compared to $2.0 million for the three months ended September 30, 2002. The $547,000 decrease was primarily due to the lower amount of income before provision for Federal income taxes and minority interest, with the effective tax rate for the periods being approximately 33% for the quarter ended September 30, 2003 and 32% for the same period in 2002 (when taking into account the tax benefit for the minority interest expense in 2002). 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 includes the tax benefit recei ved from the dividends on the Series A Preferred Stock of Coastal Bancorp, Inc. of $76,000 and $219,000 for the quarters ended September 30, 2003 and 2002, respectively. This benefit ceased upon redemption of the Bancorp Preferred Stock on July 31, 2003.

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 September 30, 2003, Coastal had binding commitments to originate or purchase loans totaling approximately $16.6 million and had $150.2 millio n of undisbursed loans in process. Scheduled maturities of certificates of deposit during the 12 months following September 30, 2003, totaled $694.4 million at September 30, 2003. Management believes that Coastal has adequate resources to fund all of its commitments.

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 ar e 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, Coastal's acquisition strategy, including risks of adversely changing results of operations and factors affecting Coastal's ability to consummate further acquisitions; risks involved in Coastal's ability to quickly and efficiently integrate the operations of acquired entities with those of Coastal; changes in business strategies, changes in general 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, 2002, as filed with the SEC on March 25, 2003.

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.

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 September 30, 2003 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.

On June 23, 2003, Bancorp, through the CCTII, issued to a private institutional investor, 10,000 floating rate 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 the CCTII and have substantially the same payment terms as these Trust Preferred Securities II. The junior subordinated notes are the only assets of the CCTII and interest payments from the notes finance the distributions paid on the Trust Preferred Securities II. Distributions on the securities 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 .

Texas		76-0428727
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value

Available-for-sale:
Agency securities	$	445,018	$	1,132	$	(978	)	$	445,172
CMOs – Non-agency		81,429		-		(672	)		80,757
Non-agency securities		1,709		30		-			1,739

	$	528,156	$	1,162	$	(1,650	)	$	527,668

	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value

Available-for-sale:
Agency securities	$	387,636	$	1,983	$	(470	)	$	389,149
CMOs – Non-agency		84,376		67		(644	)		83,799
Non-agency securities		2,060		14		-			2,074

	$	474,072	$	2,064	$	(1,114	)	$	475,022

	September 30, 2003		December 31, 2002

Noninterest-bearing checking	$	194,206	$	182,290
Interest-bearing checking		122,444		134,034
Money market demand accounts		347,427		279,717

	September 30, 2003

0 through 12 months		$	694,369
13 through 24 months			163,843
25 through 36 months			13,080
37 through 48 months			29,528
49 through 60 months			29,142
Over 60 months			145

		$	930,107


	Weighted
	Average
Due during the year ending December 31,	Interest Rate			Amount

2003		3.83	%	$	3,452
2004		1.64			295,400
2005		2.04			356,025
2006		1.70			105,754
2007		4.38			2,999
2008		3.85			5,562
2009		7.99			3,244
2010		5.38			2,055
2011		6.64			729
2012		5.76			292
2013		5.46			8,671
2014		5.44			2,869
2015		6.66			1,601
2017		5.43			1,973
2018		5.05			1,405

		1.99	%	$	792,031


						Minimum For Capital				Well-Capitalized
		Actual				Adequacy Purposes				Requirements

Capital Requirement		Amount	Ratio			Amount	Ratio			Amount	Ratio

Tier 1 (core)	$	164,765	6.29	%	$	104,696	4.00	%	$	130,870	5.00	%
Tier 1 risk-based		164,765	9.21			71,561	4.00			107,342	6.00
Total risk-based		183,831	10.28			143,123	8.00			178,904	10.00