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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

Commission File Number: 0-24526

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to section 12(g) of the Act:

Indicate by check mark whether the Registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). ý

As of February 24, 2004, the aggregate market value of the 5,295,442 shares of Common Stock of the Registrant issued and outstanding on such date, excluding 1,123,397 shares held by all directors and executive officers of the Registrant as a group, was $172,013,415. This figure is based on the closing sale price of $41.23 per share of the Registrant's Common Stock on February 24, 2004, as reported in The Wall Street Journal on February 25, 2004.

Number of shares of Common Stock outstanding as of February 24, 2004: 5,295,442

DOCUMENTS INCORPORATED BY REFERENCE

        The following documents are incorporated by reference into the noted Parts of this Form 10-K:

(1)

Portions of the Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 2003, are incorporated into Part II, Items 5-8 of this Form 10-K.

(2)

Portions of the Registrant's definitive proxy statement for its 2004 Annual Meeting of Stockholders ("the 2004 Proxy Statement") are incorporated into Part III, Items 10-14 of this Form 10-K.

PART I.

Item 1. Business

        In addition to historical information, this Annual Report on Form 10-K includes certain "forward-looking statements," as defined in the Securities Act of 1933, as amended (the "Securities Act"), and the Securities Exchange Act of 1934, as amended (the "Exchange Act"), based on current management expectations. Coastal Bancorp, Inc.'s ("Bancorp" or the "Company") actual results could differ materially from those management expectations. Such forward-looking statements include statements regarding the Company's intentions, beliefs or current expectations as well as the assumptions on which such statements are based. Stockholders and potential stockholders are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those contemplated by such forward-looking statements. Factors that could cause future results to vary from current management expectations include, but are not limited to, the failure of the Company's merger with Hibernia Corporation ("Hibernia") to be completed in accordance with the terms of the Agreement and Plan of Merger dated December 1, 2003 (the "Merger Agreement"), general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the Federal government, changes in tax policies, rates and regulations of Federal, state and local tax authorities, changes in interest rates, deposit flows, the cost of funds, demand for loan products, demand for financial services, competition, changes in the quality or composition of the Company's loan and investment portfolios, changes in accounting principles, policies or guidelines, the timing of repayments and prepayments of loans, loan default rates, changes in the volume of loan originations or purchases, interest rate margin compression and other economic, competitive, governmental and technological factors affecting the Company's operations, markets, products, services and fees. For a more detailed discussion of these risk factors, see Exhibit 99.3. The Company undertakes no obligation to update or revise any forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time.

Recent Events

        On December 2, 2003, the Company announced that it had signed a definitive merger agreement with Hibernia Corporation (NYSE:HIB) pursuant to which Hibernia would acquire Coastal Bancorp, Inc. by means of a merger and pay cash in the amount of $41.50 per share for each outstanding share of Bancorp common stock and $41.50 less the exercise price for each option to acquire a share of Bancorp common stock. The merger transaction is subject to regulatory approvals, the approval of Bancorp's shareholders and other customary conditions to closing. It is expected to close in or about the second quarter of 2004.

Coastal Bancorp, Inc.

        Coastal Bancorp, Inc. is engaged primarily in the business of serving as the parent holding company for Coastal Banc ssb (the "Bank"). The Company was incorporated in March 1994 in connection with the reorganization of Coastal Banc Savings Association, a Texas-chartered thrift institution (the "Association"), into the holding company form of organization. In connection with the reorganization, which was completed in July 1994, the Association concurrently converted into a Texas-chartered savings bank and took its present name. In November 1996, in order to minimize state taxes, the Company's corporate structure was again reorganized by forming Coastal Banc Holding Company, Inc. ("HoCo") as a Delaware holding company. HoCo became a wholly-owned subsidiary of the Company, and the Bank became a subsidiary of HoCo. Each of these reorganizations was treated for accounting purposes as combinations similar to a pooling-of-interests. The financial information and references presented herein have been restated to give effect where appropriate to the reorganizations as if they had occurred at the earliest date presented.

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        In October 1997, the Company formed Coastal Banc Capital Corp. ("CBCC") as a wholly-owned subsidiary of HoCo. CBCC is a registered broker-dealer and was originally formed to trade packages of whole loan assets, primarily for the Bank and for other institutional investors and did so until September 2002. Beginning in 2002, a corporate finance group was formed within CBCC to act as an intermediary in raising capital for business customers and to provide merger and acquisition advisory services to buyers and sellers of small to mid-sized companies. Management of the Company made the decision to discontinue the operations of CBCC effective March 31, 2003 due to the current economic climate. In July 2002, the Company formed Coastal Banc Mortgage Corp. ("CBMC") as a wholly-owned subsidiary of HoCo. CBMC was formed to continue the function of trading whole loan assets for the Bank and for other institutional investors that had been previously performed by CBCC.

        In June 2000, the Company acquired Coastal Banc Insurance Agency, Inc. ("CBIA") as a wholly-owned subsidiary of the Bank. CBIA was a former affiliate of the Bank and receives fees related to insurance and investment product sales to the Bank's deposit and loan customers.

        On June 18, 2002, Bancorp, 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 the related $51.5 million junior subordinated debentures of Bancorp, 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 with 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 the Company 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.

        On June 23, 2003, Bancorp through Coastal Capital Trust II ("CCTII"), issued to a private institutional investor, 10,000 floating rate 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 $10.3 million junior subordinated debentures of Bancorp, which were purchased by CCTII and have substantially the same payment terms as the 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%.

        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 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 of the Company through an open market repurchase program and privately negotiated repurchases, if any. As of December 31, 2003, a total of 2,752,575 shares had been repurchased under all of the authorized repurchase plans.

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        At December 31, 2003, the Company had total consolidated assets of $2.7 billion, total deposits of $1.7 billion and common stockholders' equity of $133.7 million.

        The Company is subject to examination and regulation by the Office of Thrift Supervision (the "OTS"), and the Company and the Bank are subject to examination and regulation by the Texas Savings and Loan Department (the "Department"). The Bank is subject to examination and regulation by the Federal Deposit Insurance Corporation ("FDIC") and by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). The Bank is a member of the Federal Home Loan Bank of Dallas (the "FHLB"), one of the 12 regional banks which comprise the Federal Home Loan Bank System. See "Regulation—Regulation of the Bank." The Company is also subject to various reporting and other requirements of the Securities and Exchange Commission (the "SEC"). See "Regulation—The Company."

        The Company's executive offices are located at Coastal Banc Plaza, 5718 Westheimer, Suite 600, Houston, Texas 77057-5745, and its telephone number is (713) 435-5000. The Bank operates a website on the Internet for business and marketing purposes at www.coastalbanc.com. (The website is not a part of this Form 10-K.)

Coastal Banc ssb

        The Bank is a Texas-chartered, Federally insured state savings bank. It is headquartered in Houston, Texas and operates through 43 branch offices in metropolitan Houston, Austin, Corpus Christi, the Rio Grande Valley and small cities in the southeast quadrant of Texas.

        The Bank, which was originally organized in 1954, was acquired in 1986 by an investor group (which includes a majority of the current members of the Board of Directors and the present Chairman of the Board, President and Chief Executive Officer of the Company) as a vehicle to take advantage of the failures and consolidation in the Texas banking and thrift industries. At February 28, 1986 (the date of change in ownership), the Bank had one full service office and total assets of approximately $10.7 million. Since then, the Bank has acquired deposits and branch offices in transactions with the Federal government and other private institutions, and, in 1995, acquired an independent national bank. By December 31, 2003, the Bank had total assets of $2.7 billion, total deposits of $1.7 billion and stockholders' equity of $187.1 million.

        The Bank attempts to maximize profitability through the generation of net interest income and fee income. To meet this objective, the Bank has implemented a strategy of building its core deposit base while deploying its funds in assets, which provide an attractive return with acceptable credit risk. In carrying out this strategy, and to ultimately provide an attractive rate of return to the Company's shareholders, the Bank adheres to four operating principles: (i) continuing to expand its low cost core deposit base; (ii) minimizing interest rate risk; (iii) controlling credit risk, while increasing the emphasis on commercial business lending; and (iv) maintaining a low level of general overhead expense relative to its peers. These operating principles are briefly discussed below.

        Core Deposits.    The Bank began to implement the first operating principle, developing and expanding a core deposit base, in 1988 through a series of transactions with the Federal government and competitively priced transactions with private sector financial institutions. In 1988, the Bank became the first acquiror of failed or failing savings institutions under the Federal government's "Southwest Plan." In this transaction (the "Southwest Plan Acquisition"), the Bank acquired from the Federal Savings and Loan Insurance Corporation ("FSLIC"), as receiver for four insolvent savings associations (the "Acquired Associations"), approximately $543.4 million of assets and assumed approximately $543.4 million of deposits and other liabilities. The Bank acquired an aggregate of 14 branch offices from the Acquired Associations in new and existing markets in southwest Houston, west of Houston along the Houston-San Antonio corridor and in the Rio Grande Valley.

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        Since completion of the Southwest Plan Acquisition, the Bank has entered into a series of branch office transactions (including three disposition transactions) and one whole bank acquisition. All of these transactions resulted in the net assumption of $1.8 billion of primarily retail deposits and 58 branch offices. The Bank has also opened eight de novo branches since its inception, six in the Houston metropolitan area, one in Rosenberg and one in Austin. The Bank will continue to pursue acquisitions in Texas as a vehicle for growth, although there can be no assurance that the Bank will be able to continue to do so on an accretive basis in the future, or at all.

        Interest Rate Risk.    The Bank has implemented its second operating principle, minimizing interest rate risk, by matching, to the extent possible, the repricing or maturity of its interest-earning assets to the repricing or expected terms of its interest-bearing liabilities. The Bank also tries to match the basis or index (for example, the London Interbank Offered Rate ("LIBOR") or the 11th District Federal Home Loan Bank cost of funds index ("COFI") upon which these assets and liabilities reprice. Generally this matching is achieved through management of the composition of the Bank's assets and liabilities. The Bank may also use interest rate swap and cap agreements to aid in minimizing exposure to interest rate and price fluctuations. In November 2001, to strategically restructure a portion of its asset base to make it less vulnerable to market interest rate and price fluctuations, the Company completed the sale of approximately $845 million of its mortgage-backed securities. The majority of the securities sold were Collateralized Mortgage Obligations ("CMOs") tied to COFI and contained extension risk which caused, on average, high levels of price volatility. Also in November, the Company used a portion of the proceeds of the sale to purchase approximately $512 million of primarily pass-thru mortgage-backed securities with an overall shorter expected duration. Coastal reduced borrowings with the remainder of the proceeds from the sale. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Asset and Liability Management" set forth in Item 7 hereof.

        Credit Risk.    The Bank has implemented the third operating principle, controlling credit risk, while increasing the emphasis on its commercial business lending, by (i) taking a cautious approach to its direct lending operations, including the development of commercial business lending and (ii) holding a substantial portion of its assets in primarily adjustable rate first lien (single family) residential mortgage loans and mortgage-backed securities. At December 31, 2003, the Company's total loans receivable portfolio (excluding loans held for sale) amounted to $2.0 billion or 73.9% of total assets, $1.0 billion, or 50.8%, of which were comprised of first lien single family residential mortgage loans. At December 31, 2003, of the Company's $2.7 billion in total assets, $504.4 million or 18.8% of total assets consisted of mortgage-backed securities.

        Noninterest Expense.    The Bank has implemented the fourth operating principle, maintaining a low level of general overhead expense relative to its peers, by operating an efficiently staffed operations and branch office system which is able to economically administer and deliver its products and services. The Company's ratio of noninterest expense to average total assets on a consolidated basis was 2.13% for the year ended December 31, 2003.

Lending Activities

        General.    Coastal is continuing to expand and diversify its loan portfolio in a manner consistent with the operating principles discussed above by emphasizing the origination or purchase for retention in its portfolio of only those loans determined by management to have an acceptable credit risk and which provide a positive interest rate spread over funding liabilities matched with similar maturities and other characteristics. This strategy is designed to achieve an acceptable risk adjusted rate of return, as determined and continuously evaluated by the Board of Directors and management.

        Since 1995, the Bank has attempted to re-align its lending products to compete with commercial banks in an effort to increase its net interest margin. In doing so, the Bank continues to take a cautious

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approach to the development and growth of its direct lending operations in its efforts to control credit risk. In November 1995, the Bank acquired its first commercial bank with $103.3 million in loans including first lien residential, multifamily and commercial real estate, residential construction, real estate acquisition and development, commercial, financial and industrial and consumer loans. In 1998, the Bank acquired twelve commercial bank branches (the "1998 Branch Acquisition") and designated them as the foundation for the Bank's Business Banking Centers, which focus on the Bank's commercial banking customers. In an effort to enhance its ability to service its commercial customers, during the fourth quarter of 1997 the Bank implemented a more centralized process for originating, underwriting and approving all loans over $1.0 million. The staff involved in this more centralized approach are able to incorporate more comprehensive credit information than previously reviewed by the Bank by applying Internet and network computer technology to take a loan from application to closing in less time than before.

        The following table sets forth information concerning the composition of the Company's net loans receivable portfolio by type of loan at the dates indicated.

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        Scheduled Maturities.    The following table sets forth certain information at December 31, 2003 regarding the principal amount of loans maturing in the Company's loans receivable portfolio (excluding loans held for sale) based on their contractual terms to maturity assuming no periodic amortization of principal. Demand loans, loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.

        The average life of loans is generally substantially less than their average contractual terms because of prepayments and, in the case of conventional mortgage loans, due-on-sale clauses, which generally give the Bank the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid. The average life of mortgage loans tends to increase when current mortgage loan rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when rates on current mortgages are substantially lower than existing mortgage loan rates (due to refinancings of adjustable-rate and fixed-rate loans at lower rates). Under the latter circumstances, the weighted average yield on loans decreases as higher yielding loans are repaid or refinanced at lower rates.

        The following table sets forth the amount of loans due after one year from December 31, 2003 by category and which have fixed or adjustable interest rates.

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        Origination, Purchase and Sale of Loans.    The following table sets forth the loan origination, purchase and sale activity of the Bank during the periods indicated. The table does not reflect the activity of loans held for sale or of mortgage loans serviced for third party investors during the periods presented. See "Mortgage Loan Servicing."

        First Lien Residential Mortgage Loan Purchases, Sales and Originations.    The Bank primarily purchases, and also originates, loans secured by first lien mortgages on completed single family residences for its own portfolio. The majority of the Bank's residential mortgage loan portfolio has been acquired through bulk purchases in the traditional secondary market and is secured by real estate located throughout the United States. During 2003, 2002 and 2001, the Bank purchased $565.7 million, $421.4 million and $250.9 million of such loans, respectively. The Bank also originates these types of loans primarily in the geographic areas surrounding the Bank's branch locations. During 2003, 2002 and 2001, the Bank originated residential mortgage loans for its portfolio totaling $22.6 million, $22.2 million and $49.5 million, respectively.

        From time to time, the Bank also sells residential mortgage loans. During 2002, the Bank's management made the decision to liquidate a portion of its mortgage loan portfolio through sales to third party investors. The first sale was in March 2002 when the Bank sold $10.8 million of under-performing mortgage loans. Prior to the sale, the Bank wrote those loans down to fair value and recorded a charge-off to the allowance for loan losses of $761,000. In addition, as of March 31, 2002, the Bank wrote down to fair value and reclassified $9.1 million of other under-performing single-family mortgage loans to the held for sale category. The loans that were reclassified to the held for sale category were written down to fair value as of March 31, 2002 through a charge-off to the allowance for loan losses of $691,000. During the second quarter of 2002, a total of $3.1 million of these under-performing loans held for sale were sold to the same third party investor. As of December 31, 2002,

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the Bank had reclassified the remaining $3.0 million of these loans held for sale back to the loans receivable portfolio.

        The second sale was in the fourth quarter of 2002 when the Bank entered into an agreement with a third party to sell approximately $77.0 million of single-family mortgage loans. As of December 31, 2002, $74.4 million of these loans had been sold, $70.1 million of which were sold servicing retained and $4.3 million (which were considered nonperforming loans) were sold servicing released. The remaining $2.6 million, which are under a contract for sale, were reclassified to the held for sale category at December 31, 2002. In connection with this sale and the reclassification of the remaining loans to the held for sale category, the loans were written down to fair value through a charge-off to the allowance for loan losses of $309,000. In addition, the Company recorded a gain of $359,000 on the sale of these loans receivable as a result of the Bank recording the estimated fair value of the mortgage servicing rights retained. See "Mortgage Loan Servicing."

        The Bank acquires first lien residential mortgage loans for its portfolio through bulk purchases when the prices of these purchases are considered to be favorable. The acquisition of first lien residential mortgage loans has been accomplished primarily through bulk purchases in the traditional secondary market (from mortgage companies, financial institutions, investment banks, CBCC and beginning in 2002, from CBMC). Bulk purchases allow the Bank to obtain these residential mortgage loans without the direct cost of origination activities. Personnel from the Bank generally analyze loan bid packages, as they become available from CBMC, CBCC (through September 2002) and from third parties, and the members of the Bank's Asset/Liability Subcommittee, along with the Bank's Chief Executive Officer, review the information in the loan packages to determine whether to bid (or make an offer) on a package and the price of such bid (or offer). The bid price with respect to such loan packages is based on a number of factors, including the ability to create spread income with a funding source of comparable maturity, the pricing of alternative investments, particularly mortgage-backed securities, which offer little or no credit risk, assumed prepayment speeds and the credit risk profile of the portfolio offered. The Bank analyzes credit risk in a whole loan package through its due diligence investigation, which is designed to provide management with basic underwriting information on each loan or group of loans, including loan-to-value, payment history, insurance and other documentation. Because the Bank is purchasing loans in bulk, the Bank prices the loan packages to take into consideration, among other things, delinquency and foreclosure assumptions based on the risk characteristics of the loan packages. The Bank intends to continue to make competitive bids on loan packages that meet the Bank's purchase criteria.

        During the fourth quarter of 2003, Coastal entered into a mortgage loan program with a large, national mortgage banking company. Under this arrangement, loans are closed in the name of Coastal by the mortgage banking company. Coastal receives a fee for the mortgage loans that are closed as a result of a referral made by a Bank officer or employee. In addition to the fee income opportunities, this mortgage program allows Coastal to better serve its existing customer base and solicit new customers by offering a wide array of very competitively priced mortgage products. The loan applications are reviewed by the mortgage company pursuant to its own underwriting guidelines and any loans closed under the referral program are typically owned by the mortgage company.

        In addition to the mortgage loan referral program, the Bank also makes available, but does not actively solicit, a variety of mortgage products designed to respond to consumer needs and competitive factors. Conventional conforming loans that are secured by first liens on completed residential real estate are generally originated for amounts up to 95% of the appraised value or selling price of the mortgaged property, whichever is less. All loans with loan-to-value ratios in excess of 80% generally require the borrower to purchase private mortgage insurance from approved third party insurers. The Bank also originates conventional non-conforming mortgage loans (i.e., loans for single family homes with an original balance in excess of the maximum loan balance amount set by the Federal National Mortgage Association ("FNMA") or the Federal Home Loan Mortgage Corporation ("FHLMC"),

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which is presently $333,700, or loans that do not otherwise meet the criteria established by FNMA or FHLMC).

        In addition to 15-year and 30-year conventional mortgages, the Bank offers special products designed to provide to its customers lower rates of interest or lower principal and interest payments. Borrowers may choose from a wide variety of combinations of interest rates and points on many products so that they may elect to pay higher points at closing and lower interest over the life of the loan, or pay a higher interest rate and reduce the points payable at closing. In addition, from time to time mortgages are offered in the following categories: those which allow the borrower to make lower monthly payments for the first one, two or three years of the loan; fixed rate mortgages; and adjustable rate mortgages having interest rate adjustments every one, five or seven years based upon a specified independent index.

        While the Bank has the general authority to originate and purchase loans secured by real estate located anywhere in the United States, the largest concentrations of its first lien residential mortgage and residential construction loan portfolios are secured by real estate located in California and Texas.

        Residential Construction Lending.    The Bank initiated a construction lending program with local builders in the latter part of 1989 which has grown considerably since its inception. At the initiation of the program, management of the Bank initially surveyed the members of the residential construction industry in the Bank's Houston market area and targeted those companies. The Bank now has expanded its residential construction lending into the Dallas, Austin and Rio Grande Valley markets.    Loans are made primarily to fund residential construction. Construction loans are made on pre-sold and speculative residential homes considered by management to be in well located, viable subdivisions and planned unit developments.

        Most of the builders with whom the Bank does business generally apply for either a non-binding short-term line of credit or for an annual line of credit (subject to covenants) from the Bank for a maximum amount of borrowing to be outstanding at any one time. Upon approval of the line of credit, the Bank issues a letter which indicates to the builder the maximum amount which will be available under the line, the term of the line of credit (typically one year), the interest rate of the loans to be offered under the line (which is generally set at a rate indexed to The Wall Street Journal prime rate or LIBOR on the outstanding monthly loan balance) and the loan fees payable. When the builder desires to draw upon a short-term line of credit, a separate loan application generally must be made under the line for a specific loan amount. Each loan commitment under a short-term line of credit is separately verified to be in compliance with the terms previously approved with the line of credit.

        The terms of the Bank's construction loans are typically for one year or less, unless extended by the Bank. If a construction loan is extended, the borrower is generally charged a loan fee for each 90 day extension period. The Bank reserves the right to extend any loan term, but generally does not permit the original term and all extensions to exceed 24 months without amortization of principal either in monthly increments or a lump sum.

        The loan-to-value ratio (applied to the underlying property that collateralizes the loan) of any residential construction loan may not exceed the lesser of 85% of appraised value or 100% of the actual cost. All individual loans are limited in dollar amount based upon the project proposed by the builder. Draws for lot purchases are generally limited to the contracted sales price of the lot (to include escalations) not to exceed 100% of the lot's appraised value. Other special conditions which the Bank attaches to its construction loans include a requirement that limits the number and dollar amount of loans which may be made based upon unsold inventory. The Bank may also, at its sole discretion, discontinue making any further loans if the builder's unsold inventory exceeds a certain level from all lending sources or if the builder fails to pay its suppliers or subcontractors in a timely manner.

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        The Bank provides construction financing for homes that generally are priced below $450,000, with most homes priced between $125,000 and $300,000. In this price range, the Bank has experienced the shortest duration of term, the highest annualized yield and the least likelihood of defaults because of the generally high number of pre-completion sales. The Bank will also make individual construction loans to builders or individuals on single homes or groups of homes on substantially the same terms and conditions as loans granted under the Bank's line of credit program.

        At December 31, 2003, the Bank had $61.6 million in outstanding residential construction loans (net of loans in process of $52.8 million) none of which were on nonaccrual status. At the present time, the Bank has approved builders primarily domiciled in the Houston, Dallas, and Austin metropolitan areas, as well as the Rio Grande Valley area, and is selectively soliciting new builders for its residential construction lending program. In addition, the Bank participates in the funding of residential construction loans with other institutions. Through a participation, one of the Bank's approved builders is authorized for the funding of loans on properties located outside the state of Texas. The Bank intends to continue to do business with the companies involved in its line of credit program and believes that it will continue to have construction loan demand from the builders with whom it currently has an established lending relationship.

        Construction financing is generally considered to involve a higher degree of risk than long-term financing on improved, occupied residential real estate, due to the lender's reliance on the borrower to add to the estimated value of the property through construction within the budget set forth in the loan application. The Bank attempts to limit its risk exposure by, among other things: limiting the number of borrowers to whom it lends and establishing specific qualification requirements for borrowers generally; continually monitoring the general economic conditions in the market, recent housing starts and sales; continually monitoring the financial position of its borrowers throughout the term of the loan; continually monitoring the progress of the development through site inspections prior to loan disbursements; utilizing only qualified, approved appraisers; and requiring that the builder maintain a pre-approved ratio (generally not greater than 60%) of speculative to pre-sold homes in the development.

        Commercial Real Estate and Multifamily Mortgage Lending.    The Bank initiated a program in 1993 to actively seek loans secured by commercial or multifamily properties. Commercial real estate and multifamily mortgage loans typically involve higher principal amounts and repayment of the loans generally depends, in large part, on sufficient cash flow being generated by the underlying properties to cover operating expenses and loan repayments. Market values may vary as a result of economic events or governmental regulations which are outside the control of the borrower or lender and which can affect the future cash flow of the properties. The loans are generally for a short to medium term of between one to five years, and have floating rates indexed to prime rate or LIBOR or fixed rates based on a spread over similarly fixed borrowings from the FHLB. The properties securing the loans originated by the Bank are primarily located in Texas. The Bank attempts to limit its risk exposure by, among other things: lending to proven developers/owners, only considering properties with existing operating performance which can be analyzed, requiring conservative debt coverage ratios and continually monitoring the operation of the collateral. At December 31, 2003, commercial real estate loans totaling $360.9 million and multifamily mortgage loans of $107.9 million were outstanding. At December 31, 2003, the Bank had commercial real estate loans totaling approximately $714,000 that were on nonaccrual status and no multifamily mortgage loans that were on nonaccrual status.

        The Bank began originating commercial real estate and multifamily construction loans in 1996 primarily for the construction or renovation of income generating facilities. The Bank generally underwrites these loans in the same way it underwrites its multifamily mortgage loans and attempts to manage the risk of such loans by lending to proven developers/owners, requiring that each builder maintain a specified amount of equity in the project, continually monitoring the progress of the development through site inspections prior to loan disbursement and by monitoring other financial

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strength requirements. At December 31, 2003, commercial and multifamily construction loans totaling $154.2 million (net of loans in process of $29.0 million) were outstanding, none of which were on nonaccrual status.

        Warehouse Lending.    Beginning in 1992 and through 2002, the Bank provided or participated in lines of credit to mortgage companies generally for their origination of single family residential loans which are typically sold no more than 90 days from origination to FNMA, FHLMC, the Government National Mortgage Association ("GNMA") or to private investors. The lines of credit were generally renewable annually. Borrowers paid interest on funds drawn at a floating rate. In addition, the Bank usually received a fee for each loan file processed under these lines of credit, the Bank (or the lead lender in a participation) held the original mortgage loan notes and other documentation as collateral until repayment of the related lines of credit, except when a third party lender was acting as the lead lender in the lending relationship.

        Warehouse loans were underwritten in accordance with Bank policies and procedures. Bank personnel attempted to minimize the risk of making Warehouse loans (excluding participations in loans where a third party bank is acting as the lead bank) by, among other things, (i) taking physical possession of the originator's collateral, (ii) directly receiving payment from secondary market investors when the loans are sold and remitting any balance to the borrower after deducting the amount borrowed for that particular loan, (iii) visiting the originator's office from time to time to review its financial and other records and (iv) monitoring each originator by periodically reviewing their financial statements, loan production delinquency and commitment reports and, on an annual basis, by reviewing their audited financial statements and auditor's letter to its board of directors. In loan participations where a third party bank was acting as the lead bank, the Bank relied on the lead bank to perform substantially the same procedures as noted above.

        During 1999, the Bank experienced significant loan losses in Warehouse and mortgage servicing rights ("MSR") loans (described below) due to the default of two borrowers. The first loss was related to the $10.0 million participation purchased in 1998 in a Warehouse loan aggregating $25.0 million to MCA Financial Corp., and certain of its affiliates, of Southfield, Michigan (collectively "MCA"). In late January 1999, due to a lack of liquidity, MCA ceased operations and shortly thereafter was seized by the Michigan Bureau of Financial Institutions. A conservator was appointed to take control of MCA's books and records, marshal its assets and continue its loan servicing operations. A voluntary petition under Chapter 11 of the U.S. Bankruptcy Code was filed in the U.S. Bankruptcy Court for the Eastern District of Michigan for MCA on or about February 10, 1999, by the conservator.

        Throughout 1999, the Bank worked with the lead lender and the bankruptcy trustee to determine the value of, and sell, the underlying collateral. As of December 31, 1999, the Bank had received only $1.1 million in proceeds from the MCA loan. Due to the uncertainty of the value of the remaining collateral, the Bank charged-off the remaining $8.9 million balance of this loan in 1999 resulting in the additional provision for loan losses of $6.8 million during 1999. During the years ended December 31, 2003, 2002 and 2001, Coastal received $0, $288,000 and $267,000, respectively, in proceeds from the MCA loan which was recorded as a recovery in the allowance for loan losses in the period received. The Bank will continue to work with the bankruptcy trustee to recover any funds, if possible, from the collateral or MCA.

        In the second situation, during 1999, the Bank purchased approximately $10.1 million of the underlying loans securing a $13.2 million Warehouse and servicing rights line of credit due to default by the borrower. The remaining outstanding balance of $990,000 on this Warehouse and servicing rights line of credit was charged-off during 1999.

        In 1999, the Bank began to decrease its emphasis on Warehouse lending. The Bank did not have any Warehouse loans outstanding at December 31, 2003 or 2002.

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        MSR Lending.    Beginning in 1992 and discontinued in 1999, the Bank loaned funds to mortgage companies for their purchase of mortgage servicing rights or to finance the mortgage companies' ongoing operations to originate and retain mortgage servicing. Loans of this nature generally had terms of one to five years, and were generally limited to 70.0% of the price paid by the mortgage company for servicing rights, or of the value of the originated servicing rights (subject to the regulatory maximum for loans to one borrower). MSR loans were made at adjustable rates of interest tied to LIBOR or the Bank's borrowing rate plus a spread and a commitment fee. MSR loans were collateralized by purchased or originated mortgage servicing rights to the remaining cash flows after remittance of payments to FNMA, FHLMC or other investors on the servicing portfolio. MSR loans were underwritten in substantially the same manner as Warehouse loans, where Bank personnel closely monitored MSR borrowers by, among other things, reviewing the borrower's financial condition and operations in the same manner as they did for Warehouse loans and by examining the value of the borrower's MSR portfolio (through evaluation of the estimated future net cash flows from the servicing rights) in order to ensure that the loan-to-value ratio did not exceed 75.0% during the life of the loan. During 1999, the Bank incurred a loss on a Warehouse and servicing rights line of credit due to default of the borrower as discussed previously. The Bank did not have any MSR loans outstanding at December 31, 2003 or 2002.

        Real Estate Acquisition and Development Lending.    The Bank originates loans to residential real estate builders and developers as well as to major homebuilders for the acquisition and/or development of vacant land. The proceeds of the loans are generally used to acquire the land and make the site improvements necessary to develop the land into residential lots to be sold to third parties or used by the homebuilders. The Bank generally lends only to developers with good track records and strong financial capacity and on property where a substantial number of the lots to be developed are pre-sold. The term of the loans have generally been from 18 to 36 months at a spread over the prime rate, plus an origination fee. Repayment on the loans is generally made as the lots are sold or used by homebuilders. Land acquisition and development loans involve additional risks when compared to loans on existing residential properties, however, when lending directly to a major homebuilder the risk is mitigated by the strength of the borrower. These loans typically involve relatively large loan balances to single borrowers, and the repayment experience is dependent upon the successful development of the land and the resale of the lots. These risks can be significantly impacted by supply and demand conditions and the general economic conditions in the local market area. At December 31, 2003, the Bank had $84.0 million (net of loans in process of $50.2 million) of real estate acquisition and development loans outstanding. At December 31, 2003, real estate acquisition and development loans of $5.5 million were on nonaccrual status, with two of those loans totaling $5.4 million to one borrower.

        Commercial Business Lending.    Development of a commercial business lending program continues to be a strategic goal of Bank management. The commercial bank acquisition in 1995 provided the Bank with an established commercial business lending program directed to small and medium sized companies primarily in the Houston and Austin metropolitan areas. Since that acquisition, management has continued to develop the infrastructure for commercial business lending in most of the Bank's major markets. In addition, the Bank acquired twelve commercial bank branches in the 1998 Branch Acquisition and significantly increased the Bank's commercial business loan origination capacity. The commercial, financial and industrial loans ("Commercial Business loans") are typically made to provide working capital financing or asset acquisition financing to businesses and are generally secured by the borrower's working capital assets (i.e., accounts receivable, inventory, etc.) or assets purchased by the borrower (i.e., operating assets, equipment, etc.). Commercial Business loans generally have shorter terms (one to five years) which are indexed to prime rate, LIBOR or are fixed and are of greater risk than real estate secured loans because of the type and nature of the collateral. In addition, Commercial Business loan collections are more dependent on the continuing financial stability of the borrower. The Bank intends to continue to expand its commercial business lending programs, while managing the associated credit risk by continually monitoring borrowers' financial

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position and underlying collateral securing the loans. At December 31, 2003, Commercial Business loans outstanding totaled $175.9 million, with $1.1 million of such loans on nonaccrual status.

        Consumer and Other Lending.    The Bank makes available traditional consumer loans, such as home improvement, home equity, home equity lines of credit "(HELOC"), new and used car financing, new and used boat and recreational vehicle financing and loans secured by savings deposits to consumers in the markets served by its retail branches and business banking centers. For competitive reasons, the Bank's strategic emphasis has been on home equity loans and more recently, HELOCs. Texas voters approved HELOCs in September of 2003 along with certain other changes to home equity law as set forth in the Texas Constitution. At December 31, 2003, the Bank had $32.6 million in consumer and other loans outstanding, with $68,000 of such loans on nonaccrual status. Of the consumer and other loans outstanding, $18.1 million, or 55.6%, are second liens or home equity loans or lines of credit, secured by residential property. The Bank had $13.0 million in loans secured by deposits outstanding at December 31, 2003. The interest rate on loans secured by savings deposits is typically set at a rate above that paid on the underlying account and adjusts if the rate on the account changes.

        Consumer loans (other than deposit secured loans) generally have shorter terms and higher interest rates than mortgage loans, but usually involve greater credit risk than mortgage loans because of the type and nature of the collateral. In addition, consumer lending collections are dependent on the borrower's continuing financial stability, and are thus likely to be adversely affected by job loss, changes in marital status, illness and personal bankruptcy. In many cases, repossessed collateral for a defaulted consumer loan will not provide an adequate source of repayment of the outstanding loan balance because of depreciation of the underlying collateral. The Bank believes that the generally higher yields earned on consumer loans compensate for the increased credit risk associated with such loans and that consumer loans are important to its efforts to serve the credit needs of the communities that it serves. See "Regulation of the Bank—Community Reinvestment Act."

        Loans Receivable Held for Sale.    From time to time, the Bank has loans classified as held for sale. These loans are generally single-family loans purchased with the original intent to resell them or loans that have been reclassified from the loans receivable portfolio to held for sale due to the intent to sell. Loans receivable held for sale are carried at the lower of cost or market value. At December 31, 2003, the Bank had $8.1 million in loans receivable held for sale, due to a loan package purchased in December 2003 with the intent to sell the package to third party investors in the first quarter of 2004. The sale of this loan package to a third party investor was completed in February of 2004.

        Asset Quality.    The Bank, like all financial institutions, is exposed to certain credit risks related to the value of the collateral which secures loans held in its portfolio and the ability of borrowers to repay their loans during the term thereof. Management of the Bank monitors the loan portfolio and the Bank's real estate acquired as a result of foreclosure ("REO") for potential problems on a weekly basis and reports to the Board of Directors on a monthly basis. When a borrower fails to make a required loan payment or other weaknesses are detected in a borrower's financial condition, the Bank determines an appropriate course of action including contacting the borrower. Delinquencies are cured promptly in most cases. If the delinquency on a mortgage loan exceeds 90 days and is not cured through the Bank's normal collection procedures, or an acceptable arrangement is not worked out with the borrower, the Bank will institute measures to remedy the default, usually including commencing a foreclosure action. As a matter of policy, the Bank generally does not accept from the mortgagor a voluntary deed of the secured property in lieu of foreclosure. If foreclosure is effected, the property is sold at a public auction in which the Bank may participate as a bidder. If the Bank is the successful bidder, the foreclosed real estate is then included in the Bank's REO portfolio until it is sold.

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        Upon acquisition, REO is recorded at the lower of unpaid principal balance adjusted for any remaining acquisition premiums or discounts less any applicable valuation allowance or estimated fair value, based on an appraisal, less estimated selling costs. Subsequent to foreclosure, real estate owned is carried at the lower of the new cost basis or fair value, with any further declines in fair value charged to operations. All costs incurred from the date of acquisition forward relating to maintaining the property are recorded as a current period expense.

        It is the Bank's general policy to stop accruing interest income and place the recognition of interest on a cash basis when a loan is past due more than 90 days. When a loan is placed on nonaccrual status, previously accrued but unpaid interest is generally reversed against current interest income. A loan is returned to an accrual basis when all amounts due are reasonably assured of repayment within a reasonable period and when the borrower has demonstrated payment performance history. On a loan-by-loan basis, Bank management may continue to accrue interest on loans that are past due more than 90 days, particularly if management believes that the individual loan is well secured, in the process of collection or renewal and the interest is fully collectible.

        The following table sets forth information regarding the Bank's nonperforming assets as of the dates shown.

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        Nonperforming loans are those loans on nonaccrual status as well as those loans greater than ninety (90) days delinquent and still accruing interest. At December 31, 2003, the Bank's nonperforming loans increased slightly, when compared to December 31, 2002, by $1.7 million or 9.3%, to $20.3 million.

        At December 31, 2003, nonperforming assets included REO with an aggregate book value of $2.5 million. At such date, the Bank's REO consisted of 17 single family residential properties totaling $1.0 million, 6 commercial properties totaling $1.5 million and 1 residential construction property totaling $9,000. The Bank actively markets the REO properties held. The Bank has historically incurred minimal losses on the sale of single family REO properties.

        For the year ended December 31, 2003, approximately $633,000 in additional interest income would have been recorded on the above loans accounted for on a nonaccrual basis if such loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination if held for part of the period. Net income for 2003 included $471,000 in interest income for these same loans prior to the time they were placed on nonaccrual status.

        The Bank considers a loan to be impaired when, based upon current information and events, it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. In determining impairment, the Bank considers, among other things, large non-homogeneous loans which may include nonaccrual loans or troubled debt restructurings and performing loans which exhibit, among other characteristics, high loan-to-value ratios, low debt coverage ratios or indications that the borrowers are experiencing increased levels of financial difficulty. The Bank bases the measurements of collateral-dependent impaired loans on the fair value of their collateral. The amount by which the recorded investment in the loan exceeds the measure of the fair value of the collateral securing the loan is recognized by recording a valuation allowance. At December 31, 2003, the carrying value of impaired loans totaled approximately $7.3 million and the related allowance for loan losses on those impaired loans totaled $1.9 million. Of these impaired loans outstanding at December 31, 2003, three loans with a total balance of $332,000 did not have a specific portion of the allowance for loan losses allocated to them at such date. The average balance of impaired loans during the year ended December 31, 2003 was approximately $7.6 million. For the year ended December 31, 2003, the Bank did not recognize interest income on loans considered impaired.

        The Bank had loaned $114.4 million at December 31, 2003, under its residential construction lending program to multiple borrowers who are engaged in similar activities. Certain of these borrowers could be similarly impacted by economic conditions in the Houston metropolitan area. See "Residential Construction Lending." The Bank had no other loan concentrations.

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        Allowance for Loan Losses.    Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses in the appropriate provision required to maintain an adequate allowance to absorb probable losses on its loans receivable portfolio. The following table summarizes activity in the Bank's allowance for loan losses during the periods indicated.

        The following table sets forth the charge-offs by type of loan during the periods indicated.

(1)

In 2002, includes charge-offs totaling $1.8 million related to the Bank's decision to liquidate a portion of the mortgage loan portfolio. See "First Lien Residential Mortgage Loan Purchases, Sales and Originations."

(2)

In 1999, includes the charge-off of an $8.9 million warehouse loan to one borrower. See "Warehouse Lending."

(3)

In 2001, includes the charge-off of an $818,000 commercial overdraft loan ($450,000 of which was subsequently recovered through insurance proceeds) and $754,000 of charged-off purchased automobile loans, in addition to the charge-offs of other consumer type loans.

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        The following table sets forth the allocation of the allowance for loan losses by type of loan outstanding at the dates indicated.

        The following table sets forth the allocation of the provision or the reduction of allowance for loan losses by loan type during the periods indicated.

(1)

From December 31, 2002 to December 31, 2003, the amount of allowance allocated to and provision recorded for commercial real estate loans increased primarily due to an increase in the specific reserve allocated to particular loans in addition to higher balances of this loan type.

(2)

From December 31, 2002 to December 31, 2003, the amount of allowance allocated to and provision recorded for commercial construction loans decreased primarily due to a decrease in the specific reserve allocated to particular loans in addition to decreased balances of this loan type.

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        Estimating the allowance for loan losses is a critical accounting policy. It is subjective in nature and requires 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, industry standards, regulatory policies and other factors related to the collectibility of Coastal's loan portfolio. Management's calculation of the appropriate total allowance for loan losses addresses both performing and nonperforming loans. For performing loans, a stratification of the portfolio is done to group together loans of the same type. An appropriate allowance percentage is then assigned to those groups based upon the level of risk of the various loan types or groups. This aggregate analysis is based upon industry standards as well as Coastal's historical experience and includes an unallocated amount in the allowance calculation to provide for the inherently subjective nature of the estimate. For nonperforming loans or otherwise adversely classified loans with balances that exceed $500,000, an appropriate allowance percentage or dollar amount is identified on a case-by-case basis. This analysis specifically addresses the particular risk characteristics or weaknesses that are affecting the collectibility of the loan being reviewed. In addition, management also conducts an ongoing analysis of Coastal's actual loss experience on single-family mortgage loans to substantiate the adequacy of the allowance policy for such loans. 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 to recognize losses on loans, there can be no assurance that future additions to the allowance will not be necessary. When comparing 2003 and 2002, the changes in the provision for loan losses are due to management's continuing evaluation of the overall allowance for loan losses. The decrease in the provision for loan losses in 2003 was based upon the current level of unallocated reserves required to adhere to our loan policy described above. The increase in the provision for loan losses in 2002 (in the fourth quarter of 2002) was due to management's reevaluation of the allowance for loan losses given the current economic conditions, the decision in 2002 to sell loans which resulted in charge-offs totaling $1.8 million to writedown such loans to fair value, and the changes that have occurred within the mix of Coastal's loan portfolio, in addition to certain specific loans in the portfolio that have warranted greater attention and specific allocations of the allowance for loan losses. While management believes that it has adequately provided for loan losses and that the allowance for loan losses is adequate at December 31, 2003, it will continue to monitor the loan portfolio and make adjustments to its allowance for loan losses as it considers necessary. At December 31, 2003, the Bank's ratio of the allowance for loan losses to nonperforming loans was 95.66% and the ratio of the allowance for loan losses to total loans receivable was 0.98%.

        The Board of Directors of the Bank reviews its Asset Classification and Allowance Policy ("ACAP") at least annually. The policy provides that the Bank at least annually will establish a monthly provision amount to be added to the allowance for loan losses and the resultant allowance will be "tested" monthly for adequacy based on policy guidelines. Management maintains the allowance for loan losses at a level considered adequate to cover probable losses on the loans receivable portfolio. This allowance covers all loans, including loans deemed to be impaired, loans not impaired and loans excluded from the impairment test. The adequacy of the allowance is based on management's periodic evaluation of the loan portfolio, which considers, among other things, the size, quality and risk of loans in the portfolio, identification of any adverse situations which may affect the ability of borrowers to repay, assessment of current and future economic conditions, regulatory policies and the estimated value of the underlying collateral, if any.

        The Bank's management believes that its present allowance for loan losses is adequate based upon, among other considerations, the factors discussed above, its existing nonperforming loans and the underlying collateral value on those loans and its historical and peer group loss experience. Management continues to review its loan portfolio to determine whether its ACAP should be altered in

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light of current conditions and to make any additional provisions which may be deemed necessary. While management uses the best information available to make such determinations, additional provisions for loan losses may be required to be established in the future should economic or other conditions change substantially. In addition, the FDIC and the Texas Savings and Loan Department, as an integral part of their examination processes, periodically review the Bank's allowance for loan losses. These agencies may require the Bank to increase the allowance for loan losses, based on their respective judgments of the information available at the time of the examinations.

        Mortgage Loan Servicing.    The Bank services residential real estate loans for others, including FNMA, FHLMC and other private investors. Loan servicing for others includes collecting and remitting loan payments, accounting for principal and interest, making advances to cover delinquent payments, making inspections as required of mortgaged premises, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults and generally administering the loans.

        Due to the Bank's declining servicing for others portfolio (with an average remaining loan life of approximately seven years), in the first quarter of 2000 management decided to sell its entire servicing rights portfolio based on the then current market conditions for loan servicing rights and the expected declining income benefits of that servicing portfolio on an ongoing basis. Effective March 31, 2000, the Bank sold, to a third party, its rights to service approximately $389.1 million of mortgage loans for third party investors, primarily FNMA and FHLMC, pursuant to a purchase and sale agreement. The Bank subserviced those mortgage loans until the transfer to the purchaser was completed in the second quarter of 2000. The Bank recorded a $2.2 million gain on the sale of the above mentioned mortgage servicing rights in 2000.

        In December 2002, Coastal sold $70.1 million of mortgage loans with servicing retained to a third party investor and recognized the estimated fair value of those servicing rights retained of $359,000, which is recorded in prepaid expenses and other assets in the Company's Consolidated Statement of Financial Condition at December 31, 2002.

        In December 2003, Coastal purchased the servicing rights applicable to $160.5 million of mortgage loans for $1.7 million. As of December 31, 2003, Coastal serviced for others approximately $209.0 million of such loans. See "First Lien Residential Mortgage Loan Purchases, Sales and Originations."

        The Bank receives fees for servicing mortgage loans for others, which generally range from 0.25% to 0.50% per annum on the declining principal balance of mortgage loans. Such fees serve to compensate the Bank for the costs of performing the servicing function. Other sources of loan servicing revenues include late charges and other ancillary fees. Servicing fees are collected out of the monthly mortgage payments made by borrowers and are recorded net of the amortization of mortgage servicing rights. For the year ended 2003, the Bank earned $69,000 in conjunction with its loan servicing.

        The Bank's servicing portfolio was subject to reduction by normal principal amortization, by prepayment or by foreclosure of outstanding loans. The following table sets forth certain information regarding the mortgage loans serviced for others portfolio for period indicated.

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Mortgage-Backed Securities

        The Bank maintains a substantial portfolio of mortgage-backed securities as a means of investing in housing-related mortgage instruments without the costs associated with originating mortgage loans for portfolio retention. At December 31, 2003, the Company's mortgage-backed securities available-for-sale portfolio amounted to $504.4 million, or 18.8%, of total assets. Effective September 30, 2001, Coastal transferred all of its mortgage-backed securities to the available-for-sale category. This was due to management's intent to restructure a portion of the asset base to make it less vulnerable to market interest rate fluctuations. In late November 2001, Coastal completed the sale of approximately $845 million of its mortgage-backed securities and recorded a gain of $169,000. The majority of the securities sold were CMOs tied to COFI and contained extension risk which caused, on average, higher levels of price volatility. Also in November 2001, Coastal used a portion of the proceeds of the sale to purchase approximately $512 million of primarily pass-thru mortgage-backed securities. A consequence of this 2001 securities sale was that any securities purchased by Coastal for approximately two years thereafter were required to be placed in either the available-for-sale or trading category. Securities available-for-sale are securities other than those held-to-maturity or for trading purposes and are recorded at fair value, with unrealized gains and losses excluded from earnings and recorded net of tax as other comprehensive income (loss) in stockholders' equity until realized. Realized gains and losses on securities are recorded in earnings in the year of sale based on the specific identification of each individual security sold. Premiums and discounts on mortgage-backed securities are amortized or accreted as a yield adjustment over the life of the securities using the interest method, with the amortization or accretion being adjusted when the prepayments are received.

        The following table sets forth the composition of the Company's mortgage-backed securities portfolio at the dates indicated.

        The mortgage-backed securities which the Company purchases and maintains in its portfolio can include FNMA, FHLMC and GNMA certificates, certain privately issued, credit-enhanced mortgage-backed securities which are rated "AAA" or better by the national securities rating agencies and certain types of CMOs. The FNMA, FHLMC and GNMA certificates ("Agency Securities") are modified pass-thru mortgage-backed securities, which represent undivided interests in underlying pools of fixed-rate, or certain types of adjustable rate, single family residential mortgages issued by these quasi-governmental (GNMA) and private (FNMA and FHLMC) corporations. FNMA and GNMA provide to the certificate holder a guarantee (which is backed by the full faith and credit of the U.S. government in the case of GNMA certificates) of timely payments of interest and scheduled principal payments, whether or not they have been collected. FHLMC guarantees the timely payment of interest and the full (though not necessarily timely) payment of principal. The guarantees of FNMA and FHLMC are not backed by the full faith and credit of the U.S. government. The mortgage-backed securities acquired by the Company that have been pooled and sold by private issuers, generally large

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investment banking firms, provide for the timely payments of principal and interest either through insurance issued by a reputable insurer or the right to receive certain payments thereunder is subordinated in a manner which is sufficient to have such mortgage-backed securities generally earn a credit rating of "AAA" or better from one or more of the national securities rating agencies.

        A CMO is a special type of pay-thru debt obligation in which the stream of principal and interest payments on the underlying mortgages or mortgage-backed securities is used to create classes with different maturities and, in some cases, amortization schedules and a residual class of the CMO security being sold, with each such class possessing different risk characteristics. The residual interest sold represents any residual cash flows which result from the excess of the monthly receipts generated by principal and interest payments on the underlying mortgage collateral and any reinvestment earnings thereon, less the cash payments to the CMO holders and any administrative expenses. As a matter of policy, due to the risk associated with residual interests, the Bank does not intend to invest in residual interests in CMOs.

        Mortgage-backed securities generally yield less than the loans which underlie such securities because of their payment guarantees or credit enhancements which reduce credit risk. In addition, mortgage-backed securities are more liquid than individual mortgage loans and may be used to collateralize obligations of the Bank. Mortgage-backed securities issued or guaranteed by FNMA or FHLMC (except interest-only securities or the residual interests in CMOs) are weighted at no more than 20% for risk-based capital purposes, compared to a weight of 50% to 100% for residential loans. See "Regulation—Regulatory Capital Requirements."

The following table sets forth the Company's activities with respect to mortgage-backed securities (including held-to-maturity and available-for-sale) during the periods indicated.

Investment Activities

        Under the Texas Savings Bank Act (the "Act"), the Bank is permitted to invest in obligations of, or guaranteed as to principal and interest by, the United States or the State of Texas, in the stock or in any obligations or consolidated obligations of the FHLB and in various other specified instruments. The Bank holds investment securities from time to time to help meet its liquidity requirements and as temporary investments until funds can be utilized to purchase residential mortgage loans, mortgage-backed securities or to originate other loans for the Bank's portfolio. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources."

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Sources of Funds

        General.    Advances from the FHLB, deposits, sales of securities under agreements to repurchase, as well as maturities of and principal repayments on loans and mortgage-backed securities have been the major sources of funds for use in the Bank's lending and investments and for other general business purposes. Management of the Bank closely monitors rates and terms of competing sources of funds on at least a weekly basis and utilizes the source which is the most cost effective.

        Deposits.    The Bank attracts a majority of its deposits through its 43 branch offices in metropolitan Houston, Austin, Corpus Christi, the Rio Grande Valley and small cities in the southeast quadrant of Texas. The Bank also obtains deposits through acquisitions. The Bank offers a variety of traditional retail deposit products which currently includes interest-bearing checking, noninterest-bearing checking, savings, money market demand accounts and certificates of deposit which generally range in terms from three to 60 months. Included among these deposit products are individual retirement account certificates. Beginning in 1995 with the acquisition of Texas Capital, the Bank's management has pursued a commercial banking strategy related to deposits designed to increase the level of lower cost transaction and commercial deposit accounts. The Bank offers a range of products for commercial businesses including Small Business Checking, Business Interest Checking, Analysis Checking and Commercial Money Market Accounts. The acquisitions and marketing efforts have resulted in the outstanding balances of demand deposit accounts increasing to 44.5% of total deposits at December 31, 2003 from 32.1% at December 31, 1998.

        Effective January 1, 1998, the Company implemented a program whereby a portion of the balance 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 $261.2 million ($151.2 million from noninterest bearing and $110.0 million from interest-bearing) at December 31, 2003, $250.9 million ($131.3 million from noninterest-bearing and $119.6 million from interest-bearing) at December 31, 2002, and $243.3 million ($113.0 million from noninterest-bearing and $130.3 million from interest-bearing) at December 31, 2001. The following table shows the distribution of and certain other information relating to the Company's deposits by type at the dates indicated.

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        Prior to the reclassification as discussed above, noninterest-bearing checking accounts, interest-bearing checking accounts and money market demand accounts were as follows at December 31, 2003, 2002 and 2001:

        The following table sets forth the average balance of each deposit type and the average rate paid on each deposit type for the periods indicated.