10-K

U. S. Securities and Exchange Commission

Washington, D.C. 20549

Form 10-K

þ Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934

For the fiscal year ended December 31, 2006

o Transition Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934

For the transition period from                      to                     

Commission file number 000-33223

Gateway Financial Holdings, Inc.

(Exact name of registrant as specified in its charter)

North Carolina	56-2040581
(State of incorporation)	(IRS Employer Identification No.)
1580 Laskin Road, Virginia Beach, Virginia	23451
(Address of principal executive offices)	(Zip code)

(757) 422-4055

(Registrant’s telephone number, including area code)

Securities registered under Section 12(b) of the Act: Common Stock, no par value.

Securities registered under Section 12(g) of the Act: None.

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o       No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o       No þ

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

Indicate by check mark if disclosure of delinquent filers in response 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 a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act).

large accelerated filer o             accelerated filer þ            non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined Rule 12b-2 of the Act). Yes o       No þ

State issuer’s revenues for its most recent fiscal year $82.4 million.

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $137.4 million.

As of March 12, 2007, (the most recent practicable date), the registrant had outstanding 11,034,828 shares of common stock, no par value per share.

Documents Incorporated By Reference

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

Form 10-K Table of Contents

Index		PAGE
PART I
Item 1.	Description of Business		3
Item 1A.	Risk Factors
Item 1B.	Unresolved Staff Comments
Item 2.	Properties
Item 3.	Legal
Item 4.	Submission of Matters to a Vote of Security Holders
PART II
Item 5.	Market for Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6.	Selected Financial Data
Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk
Item 8.	Financial Statements
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.	Controls and Procedures
Item 9B.	Other Information		.
PART III
Item 10.	Directors and Executive Officers of the Registrant
Item 11.	Executive Compensation
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.	Certain Relationships and Related Transactions
Item 14.	Principal Accounting Fees and Services		.
PART IV
Item 15.	Exhibits, Financial Statement Schedules
Exhibit 3.2
Exhibit 10.8
Exhibit 10.9
Exhibit 21
Exhibit 23
Exhibit 31.1
Exhibit 31.2
Exhibit 32

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PART I

ITEM 1. – DESCRIPTION OF BUSINESS

General

Gateway Financial Holdings, Inc. is a financial holding company incorporated under the laws of North Carolina to serve as the holding company for Gateway Bank & Trust Co., a North Carolina chartered commercial bank with banking and insurance agency offices in eastern and central North Carolina and eastern Virginia. The bank began operations on December 1, 1998 and, effective October 1, 2001, became our wholly owned subsidiary.

Since inception, we have aggressively pursued the primary objective of building a full-service commercial banking operation, while effectively supplementing our banking activities with other financial services intended to generate significant non-interest income. Accordingly, a key component of our growth strategy has been expanding our franchise through the opening of newly constructed financial centers and strategic financial center acquisitions. The bank serves its customers from twenty-four offices - thirteen in Virginia: Virginia Beach (7), Chesapeake (3), Suffolk, Norfolk and Emporia; and eleven in North Carolina: Elizabeth City (3), Edenton, Kitty Hawk (2), Moyock, Nags Head, Plymouth, Roper and Raleigh, and a private banking center in Raleigh. We currently intend to open three additional new financial centers in 2007, including our first financial center in Wilmington, North Carolina. In June 2006 the Company started a wholly owned loan production subsidiary named Gateway Financial Mortgage, Inc with offices in Raleigh, Elizabeth City and Kitty Hawk, North Carolina and Chesapeake, Norfolk and Virginia Beach, Virginia. On January 10, 2007 we entered into a definitive agreement to acquire The Bank of Richmond, N.A., which operates six community-banking offices in the Richmond metropolitan area and one loan production office in Charlottesville, Virginia. Consistent with our long-range strategic objectives, we will continue to consider acquisition opportunities including whole bank or financial center locations. We will also continue to explore de novo financial center opportunities in markets that we consider attractive.

The bank has three wholly-owned operating subsidiaries, each of which has contributed to our profitability. Gateway Insurance Services, Inc., an insurance agency with offices in Edenton, Hertford, Elizabeth City, Plymouth, Moyock and Kitty Hawk, North Carolina, and recently two newly acquired insurance agencies in the Hampton Roads area of Virginia to sell insurance products to businesses and individuals. Gateway Investment Services, Inc. assists bank customers in their securities brokerage activities through an arrangement with an unaffiliated broker-dealer. As prescribed by this arrangement, Gateway Investment Services earns revenue through a commission sharing arrangement with the unaffiliated broker-dealer. Gateway Financial Mortgage, Inc., provides mortgage banking services with products that are sold on the secondary market. In an ongoing effort to create significant sources of non-interest income, we will continue to look for ways to expand non-traditional banking activities in our insurance and investment services subsidiaries.

Since inception, we have concentrated our efforts on building a franchise and infrastructure that can deliver and sustain long-term profitability. We achieved our first profitable quarter during the three months ended March 31, 2001 and have now remained profitable in twenty consecutive quarters, producing net income of $2.0 million in 2004, $3.9 million in 2005, and $5.3 million during the twelve months ended December 31, 2006. While we anticipate continued profitability, future expansion activity can be expected to generate significant additional costs that can negatively impact earnings as we pursue our growth strategies.

Market Area and Growth Strategy

Our current market area consists of the following four geographic regions: (1) the Greater Metropolitan Hampton Roads area of Virginia; (2) the geographically contiguous Northeastern coastal region of North Carolina, including the Outer Banks; (3) Southeastern North Carolina (includes Wilmington); and (4) Central North Carolina (includes Raleigh). The Greater Metropolitan Hampton Roads area, which includes the cities of Norfolk, Virginia Beach, Suffolk and Chesapeake, is the second largest urban concentration in the southern United States with a 2005 population, estimated by the U.S. Census Bureau, of over 1.64 million. Additionally, Virginia Beach is the largest city, as measured by population, in the Commonwealth of Virginia. The Northeastern coastal region of North Carolina is a bedroom community for the Greater Metropolitan Hampton Roads area and the Outer Banks includes such prime vacation areas as Corolla, Duck, Kitty Hawk, Kill Devil Hills, Manteo, Nags Head, and Southern Shores. According to the Environmental Systems Research Institute (“ESRI”), a leading national demographic forecaster, the projected population growth from 2005 to 2010 in the Greater Hampton Roads and Northeastern North Carolina banking markets is 7.8% compared to 6.3% for the entire United States.

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The Raleigh-Cary Metropolitan area is the 51^st largest metropolitan area in the United States with a 2005 population, estimated by the U.S. Census Bureau, of almost 950 thousand. According to ESRI, the MSA of Raleigh has a projected population growth of 15.8% from 2005 to 2010. Richmond, Virginia, the market area for the Bank of Richmond, is the 45^th largest metropolitan area in the United States with a 2005 population, estimated by the U.S. Census Bureau, of almost 1.18 million.

We emphasize personalized service, access to decision makers, and a quick turn around time on lending decisions. Our slogan is “Real People . . . Real Solutions.” We have a management team with extensive experience in our local markets. We intend to leverage the core relationships we build by providing a variety of services to our customers. With that focus, we target:

• Small-and medium-sized businesses;

• Professionals and middle managers of locally based companies;

• Residential real estate developers; and

• Individual consumers.

We believe that these segments are the most under-served by local financial centers of regional and super-regional financial institutions. We also intend to continue to diversify our revenue in order to continue to generate significant non-interest income. We presently offer investment brokerage and insurance services, and we originate mortgage loans for sale in the secondary market.

We believe that economic growth and bank consolidation have created a growing number of businesses and consumers in need of high quality banking and other financial services delivered with personalized attention. Consolidation in the banking market has dislocated experienced and talented management and lending personnel. As a result, we believe we have a substantial opportunity to attract experienced management, loan officers and banking customers both within our current markets and other markets in which we might expand in Virginia and North Carolina. Our business plan is to capitalize on this opportunity by developing a financial center network in growing areas within Virginia and North Carolina where we can hire experienced bankers with a loyal following of deposit and loan customers. Our plan has been to start new financial centers after we have identified either an experienced banker who will have responsibility for that market or an existing office in a location with favorable growth characteristics that is being sold by another bank. We believe that it takes a combination of an attractive location and experienced, talented people to be successful in expanding our franchise. We intend to build upon existing relationships and create new relationships and new markets by de novo expansion, further financial center acquisitions, or potential whole bank acquisitions which make strategic and economic sense.

We intend to achieve our primary goal of maximizing long-term returns to stockholders by focusing on the following objectives:

• Emphasize relationship banking. We have been successful in building client relationships because our regional model enables us to deliver products and services that are comparable to that of our largest competitors and high customer service levels that are most commonly associated with a community bank. Each of the bank’s four regions has its own President whose knowledge of the region, presence in the community and ability to make prompt credit decisions, strengthens our ability to develop local relationships. We typically render commercial loan decisions within 48 hours and retail loans within an hour. Localized decision making and personalized customer service form the core of our relationship banking strategy, and we plan to maintain this approach as we continue to grow in both our existing markets and additional markets

• Grow organically in our existing markets. Our markets have been subject to significant bank consolidation. We believe there is a large customer base in our markets that prefers doing business with a local institution and may be dissatisfied with the service received from larger regional and super-regional banks. By providing our customers with personalized service and a big bank product suite, we expect to continue our strong growth. We believe the success of our strategy is evidenced by the growth of our deposits from approximately $115.7 million at December 31, 2001 to approximately $923.7 million at December 31, 2006, and net loans, which increased from approximately $105.8 million at December 31, 2001 to approximately $985.2 million at December 31, 2006.

• Expand franchise in high growth markets. We will actively consider both acquisitions and de novo financial center opportunities in existing and new market areas. Since December 31, 2001, we have successfully integrated four acquired financial centers and have opened sixteen de novo financial centers. We are focused on markets in central and eastern Virginia and central and eastern North Carolina that

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	possess favorable growth characteristics and in which we have identified experienced bankers to help execute our strategy. For example, we have currently targeted the MSA of Wilmington, North Carolina, for our next financial center. According to ESRI, the MSA of Wilmington has a projected population growth of 12.3% from 2007 to 2010. In addition to the Wilmington financial center, we currently intend to open two additional new financial centers in 2007 in the Raleigh market area.
•	Grow insurance agency through acquisitions. Our independent insurance agency was created through the acquisition and integration of three independent insurance agencies. Since December 31, 2001, we have successfully integrated the further acquisitions of five insurance agencies, the Outer Banks business of another insurance agency, two insurance agencies in the fourth quarter of 2006 located in Chesapeake and Newport News, Virginia and an insurance premium finance agency. We will actively consider acquisitions in both our existing market areas and in other growing markets in eastern Virginia and eastern North Carolina that have favorable market demographics for our insurance agency subsidiary.
•	Grow non-interest income through mortgage subsidiary. During 2006, we withdrew from our relationships with third party mortgage bankers and created our own mortgage subsidiary. We will actively seek mortgage originations in both our existing market areas and in other growing markets in eastern Virginia and eastern and central North Carolina.
•	Improve our core profitability. We believe as we grow our franchise that we will be able to take advantage of the economies of scale typically enjoyed by larger organizations. As our financial center network matures and the pace of our expansion slows, our profitability should improve. We believe the investments we have made in our financial center network and technology infrastructure are sufficient to support a much larger organization, and therefore believe increases in our expense base going forward should be lower than our proportional increase in assets and revenues.
•	Continue our disciplined execution. We believe our success as a banking organization depends on a disciplined approach to originating loans and monitoring the performance of our loan portfolio. Despite our growth, we have consistently maintained strong asset quality. We believe our strong asset quality is the result of conservative underwriting standards, experienced loan officers and the strength of the local economies in which we operate. At December 31, 2006, our non-performing assets as a percentage of total assets were 0.27% and our ratio of net charge-offs to average loans was 0.03%. Our year-end non-performing assets as a percentage of total assets have not exceeded 0.38% in any of the past five years.

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Competition

Our subsidiary bank faces considerable competition in its market areas for deposits and loans from other depository institutions. Many of the bank’s depository institution competitors have substantially greater resources, broader geographic markets, and higher lending limits than the bank and are also able to provide more services and make greater use of media advertising. In recent years, intense market demands, economic pressures, and increased customer awareness of products and services, and the availability of electronic services have forced banks to diversify their services and become more cost-effective. Also, with the elimination of restrictions on interstate banking, our bank may be required to compete with out-of-state financial institutions that are not presently in its market area. Our bank presently faces strong competition in attracting and retaining deposits and loans. Based upon FDIC data as of June 30, 2006, in the Greater Hampton Roads Metropolitan Statistical Area, there were 368 financial centers operated by 33 banking institutions with approximately $17.4 billion in deposits. Our bank’s total deposits were approximately $403.9 million in the Virginia market and $422.75 in the eastern and central North Carolina markets on that date. Based upon FDIC data as of June 30, 2006, in the Raleigh-Cary Metropolitan Statistical Area, there were 265 financial centers operated by 29 banking institutions with approximately $14.2 billion in deposits. On that date, the FDIC data indicates that the Richmond market had 376 financial centers operated by 39 banking institutions with over $36.1 billion in deposits and Bank of Richmond had almost $141.9 million in deposits on that date.

The bank also competes with credit unions, brokerage firms, insurance companies, money market mutual funds, consumer finance companies, mortgage companies and other financial companies, some of which are not subject to the same degree of regulation and restrictions as the bank in attracting deposits and making loans. Interest rates on deposit accounts, convenience of facilities, products and services, and marketing are all significant factors in the competition for deposits. Competition for loans comes from other commercial banks, savings institutions, insurance companies, consumer finance companies, credit unions, mortgage banking firms and other institutional lenders. We primarily compete for loan originations through our handling of loans and the overall quality of service. Competition is affected by the availability of lendable funds, general and local economic conditions, interest rates, and other factors that are not readily predictable.

We expect competition will continue in the future due to statewide financial center laws and the entry of additional bank and nonbank competitors in our markets.

Other Products and Services

Other Banking Products and Services.

To enable our bank to offer more personalized service to its customers, we offer a range of products and services, including 24-hour internet banking, direct deposit, travelers’ checks, safe deposit boxes, United States savings bonds and automatic account transfers. We earn fees for most of these services. We also receive ATM transaction fees from transactions performed by our customers participating in a shared network of automated teller machines and a debit card system that our customers can use throughout our market areas and in other states.

Other Financial Services.

Through its subsidiary, Gateway Investment Services, Inc., our bank uses a networking arrangement to make available securities brokerage products to its customers. We also offer property, casualty, life and health insurance products to businesses and individuals through our bank’s insurance subsidiary, Gateway Insurance Services, Inc. Gateway Insurance Services is an independent insurance agency that does not engage in insurance underwriting. It has offices in Edenton, Hertford, Elizabeth City, Moyock, Plymouth and Kitty Hawk, North Carolina and Chesapeake and Newport News, Virginia. Our mortgage banking subsidiary, Gateway Financial Mortgage, Inc., offers our customers a range of mortgage products that are sold on the secondary market with offices in Raleigh, Elizabeth City and Kitty Hawk, North Carolina and Chesapeake, Norfolk and Virginia Beach, Virginia.

Employees

The Company had 327 full-time equivalent employees at December 31, 2006. None of the Company’s employees are covered by a collective bargaining agreement. The Company considers its relations with its employees to be good.

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SUPERVISION AND REGULATION

Banking is a complex, highly regulated industry. The primary goals of the bank regulatory scheme are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress has created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies and the banking industry. The descriptions of and references to the statutes and regulations below are brief summaries and do not purport to be complete. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed.

Gateway Financial Holdings, Inc.

GFH is a bank holding company that has elected to be treated as a financial holding company. As a bank holding company under the Bank Holding Company Act of 1956, as amended, GFH is registered with and subject to regulation by the Federal Reserve. GFH is required to file annual and other reports with, and furnish information to, the Federal Reserve. The Federal Reserve conducts periodic examinations of GFH and may examine any of its subsidiaries, including the Bank.

The Bank Holding Company Act provides that a bank holding company must obtain the prior approval of the Federal Reserve for the acquisition of more than five percent of the voting stock or substantially all the assets of any bank or bank holding company. In addition, the Bank Holding Company Act restricts the extension of credit to any bank holding company by its subsidiary bank. The Bank Holding Company Act also provides that, with certain exceptions, a bank holding company may not engage in any activities other than those of banking or managing or controlling banks and other authorized subsidiaries or own or control more than five percent of the voting shares of any company that is not a bank. The Federal Reserve has deemed limited activities to be closely related to banking and therefore permissible for a bank holding company.

However, with the passage of the Gramm-Leach-Bliley Financial Services Modernization Act of 1999, the types of activities in which a bank holding company may engage were significantly expanded. Subject to various limitations, the Modernization Act generally permits a bank holding company to elect to become a “financial holding company.” A financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are “financial in nature.” Among the activities that are deemed “financial in nature” are, in addition to traditional lending activities, securities underwriting, dealing in or making a market in securities, sponsoring mutual funds and investment companies, insurance underwriting and agency activities, certain merchant banking activities as well as activities that the Federal Reserve considers to be closely related to banking.

A bank holding company may become a financial holding company under the Modernization Act if each of its subsidiary banks is “well-capitalized” under the Federal Deposit Insurance Corporation Improvement Act prompt corrective action provisions, is well managed and has at least a satisfactory rating under the Community Reinvestment Act. In addition, the bank holding company must file a declaration with the Federal Reserve that the bank holding company wishes to become a financial holding company. A bank holding company that falls out of compliance with these requirements may be required to cease engaging in some of its activities.

Under the Modernization Act, the Federal Reserve serves as the primary “umbrella” regulator of financial holding companies, with supervisory authority over each parent company and limited authority over its subsidiaries. Expanded financial activities of financial holding companies generally will be regulated according to the type of such financial activity: banking activities by banking regulators, securities activities by securities regulators and insurance activities by insurance regulators. The Modernization Act also imposes additional restrictions and heightened disclosure requirements regarding private information collected by financial institutions.

Enforcement Authority. GFH will be required to obtain the approval of the Federal Reserve prior to engaging in or, with certain exceptions, acquiring control of more than 5% of the voting shares of a company engaged in, any new activity. Prior to granting such approval, the Federal Reserve must weigh the expected benefits of any such new activity to the public (such as greater convenience, increased competition, or gains in efficiency) against the risk of possible adverse effects of such activity (such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices). The Federal Reserve has cease-and-desist powers over bank holding companies and their nonbanking subsidiaries where their actions would constitute a serious threat to the safety, soundness or stability of a subsidiary bank. The Federal Reserve also has authority to regulate debt obligations (other than commercial paper) issued by bank holding companies. This authority includes the power to

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impose interest ceilings and reserve requirements on such debt obligations. A bank holding company and its subsidiaries are also prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.

Interstate Acquisitions. Federal banking law generally provides that a bank holding company may acquire or establish banks in any state of the United States, subject to certain aging and deposit concentration limits. In addition, North Carolina banking laws permit a bank holding company which owns stock of a bank located outside North Carolina to acquire a bank or bank holding company located in North Carolina. Federal banking law will not permit a bank holding company to own or control banks in North Carolina if the acquisition would exceed 20% of the total deposits of all federally-insured deposits in North Carolina.

Capital Adequacy. The Federal Reserve has promulgated capital adequacy regulations for all bank holding companies with assets in excess of $150 million. The Federal Reserve’s capital adequacy regulations are based upon a risk-based capital determination, whereby a bank holding company’s capital adequacy is determined in light of the risk, both on- and off-balance sheet, contained in the company’s assets. Different categories of assets are assigned risk weightings and are counted at a percentage of their book value.

The regulations divide capital between Tier 1 capital (core capital) and Tier 2 capital. For a bank holding company, Tier 1 capital consists primarily of common stock, related surplus, noncumulative perpetual preferred stock, minority interests in consolidated subsidiaries and a limited amount of qualifying cumulative preferred securities. Goodwill and certain other intangibles are excluded from Tier 1 capital. Tier 2 capital consists of an amount equal to the allowance for loan and lease losses up to a maximum of 1.25% of risk-weighted assets, limited other types of preferred stock not included in Tier 1 capital, hybrid capital instruments and term subordinated debt. Investments in and loans to unconsolidated banking and finance subsidiaries that constitute capital of those subsidiaries are excluded from capital. The sum of Tier 1 and Tier 2 capital constitutes qualifying total capital. The Tier 1 component must comprise at least 50% of qualifying total capital.

Every bank holding company has to achieve and maintain a minimum Tier 1 capital ratio of at least 4.0% and a minimum total capital ratio of at least 8.0%. In addition, banks and bank holding companies are required to maintain a minimum leverage ratio of Tier 1 capital to average total consolidated assets (leverage capital ratio) of at least 3.0% for the most highly-rated, financially sound banks and bank holding companies and a minimum leverage ratio of at least 4.0% for all other banks. The Federal Deposit Insurance Corporation and the Federal Reserve define Tier 1 capital for banks in the same manner for both the leverage ratio and the risk-based capital ratio. However, the Federal Reserve defines Tier 1 capital for bank holding companies in a slightly different manner. As of December 31, 2006, GFH’s Tier 1 leverage capital ratio and total capital were 11.38% and 12.99%, respectively.

The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory level, without significant reliance on intangible assets. The guidelines also indicate that the Federal Reserve will continue to consider a “Tangible Tier 1 Leverage Ratio” in evaluating proposals for expansion or new activities. The Tangible Tier 1 Leverage Ratio is the ratio of Tier 1 capital, less intangibles not deducted from Tier 1 capital, to quarterly average total assets. As of December 31, 2006, the Federal Reserve had not advised GFH of any specific minimum Tangible Tier 1 Leverage Ratio applicable to it.

Source of Strength for Subsidiary. Bank holding companies are required to serve as a source of financial strength for their depository institution subsidiaries, and, if their depository institution subsidiaries become undercapitalized, bank holding companies may be required to guarantee the subsidiaries’ compliance with capital restoration plans filed with their bank regulators, subject to certain limits.

Dividends. As a holding company that does not, as an entity, currently engage in separate business activities of a material nature, our ability to pay cash dividends depends upon the cash dividends received from our subsidiary bank and management fees paid by the bank. We must pay our operating expenses from funds we receive from the bank. Therefore, stockholders may receive cash dividends from us only to the extent that funds are available after payment of operating expenses. In addition, the Federal Reserve generally prohibits bank holding companies from paying cash dividends except out of operating earnings, provided that the prospective rate of earnings retention appears consistent with the bank holding company’s capital needs, asset quality and overall financial condition. As a North Carolina corporation, our payment of cash dividends is subject to the restrictions under North Carolina law on the declaration of cash dividends. Under such provisions, cash dividends may not be paid if a corporation will not be able to pay its debts as they become due in the usual course of business after paying such a cash dividend or if the corporation’s total assets would be less than the sum of its total liabilities plus the amount that would be needed

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to satisfy certain liquidation preferential rights.

Change of Control. State and federal banking law restricts the amount of voting stock of a bank that a person may acquire without the prior approval of banking regulators. The Bank Holding Company Act requires that a bank holding company obtain the approval of the Federal Reserve before it may merge with a bank holding company, acquire a subsidiary bank, acquire substantially all of the assets of any bank, or before it may acquire ownership or control of any voting shares of any bank or bank holding company if, after such acquisition, it would own or control, directly or indirectly, more than 5% of the voting shares of that bank or bank holding company. The overall effect of such laws is to make it more difficult to acquire GFH by tender offer or similar means than it might be to acquire control of another type of corporation. Consequently, GFH stockholders may be less likely to benefit from rapid increases in stock prices that often result from tender offers or similar efforts to acquire control of other types of companies.

Gateway Bank & Trust Co.

The Bank is subject to various requirements and restrictions under the laws of the United States and the State of North Carolina. As a North Carolina bank, the Bank is subject to regulation, supervision and regular examination by the North Carolina Banking Commission. As a member of the Federal Reserve, the Bank is subject to regulation, supervision and regular examination by the Federal Reserve. The North Carolina Banking Commission and the Federal Reserve have the power to enforce compliance with applicable banking statutes and regulations. These requirements and restrictions include requirements to maintain reserves against deposits, restrictions on the nature and amount of loans that may be made and the interest that may be charged thereon and restrictions relating to investments and other activities of the Bank.

Transactions with Affiliates. The Bank may not engage in specified transactions (including, for example, loans) with its affiliates unless the terms and conditions of those transactions are substantially the same or at least as favorable to the Bank as those prevailing at the time for comparable transactions with or involving other nonaffiliated entities. In the absence of comparable transactions, any transaction between the Bank and its affiliates must be on terms and under circumstances, including credit standards, which in good faith would be offered or would apply to nonaffiliated companies. In addition, transactions referred to as “covered transactions” between the Bank and its affiliates may not exceed 10% of the Bank’s capital and surplus per affiliate and an aggregate of 20% of its capital and surplus for covered transactions with all affiliates. Certain transactions with affiliates, such as loans, also must be secured by collateral of specific types and amounts. The Bank also is prohibited from purchasing low-quality assets from an affiliate. Every company under common control with the Bank, including GFH, is deemed to be an affiliate of the Bank.

Loans to Insiders. Federal law also constrains the types and amounts of loans that the Bank may make to its executive officers, directors and principal stockholders. Among other things, these loans are limited in amount, must be approved by the Bank’s board of directors in advance, and must be on terms and conditions as favorable to the Bank as those available to an unrelated person.

Regulation of Lending Activities. Loans made by the Bank are also subject to numerous federal and state laws and regulations, including the Truth-In-Lending Act, Federal Consumer Credit Protection Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act and adjustable rate mortgage disclosure requirements. Remedies to the borrower or consumer and penalties to the Bank are provided if the Bank fails to comply with these laws and regulations. The scope and requirements of these laws and regulations have expanded significantly in recent years.

Financial Centers. All banks located in North Carolina are authorized to establish financial centers statewide. Accordingly, a bank located anywhere in North Carolina has the ability, subject to regulatory approval, to establish financial center facilities near any of our facilities and within our market area. If other banks were to establish financial center facilities near our facilities, it is uncertain whether these financial center facilities would have a material adverse effect on our business.

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Federal law provides for nationwide interstate banking, and subject to certain aging and deposit concentration limits that may be imposed under applicable state laws. Applicable North Carolina statutes permit regulatory authorities to approve de novo financial center in North Carolina by institutions located in states that would permit North Carolina institutions to financial center on a de novo basis into those states. Federal regulations prohibit an out-of-state bank from using interstate financial center authority primarily for the purpose of deposit production. These regulations include guidelines to insure that interstate financial centers operated by an out-of-state bank in a host state are reasonably helping to meet the credit needs of the host state communities served by the out-of-state bank.

Pursuant to a regulatory agreement between the state banking regulatory authorities in North Carolina and Virginia, we are permitted to open and operate financial centers in Virginia. The Virginia banking regulator has the opportunity to comment on our operations in Virginia, but the bank’s Virginia operations are subject to regulation, supervision and regular examination by the North Carolina Commissioner of Banks.

Reserve Requirements. Pursuant to regulations of the Federal Reserve, the bank must maintain average daily reserves against its transaction accounts. During 2006, no reserves were required to be maintained on the first $7.8 million of transaction accounts, but reserves equal to 3.0% were required to be maintained on the aggregate balances of those accounts between $7.8 million and $48.3 million, and additional reserves were required to be maintained on aggregate balances in excess of $48.3 million in an amount equal to 10.0% of the excess. These percentages are subject to annual adjustment by the Federal Reserve, which has advised that for 2007, no reserves will be required to be maintained on the first $8.5 million of transaction accounts, but reserves equal to 3.0% must be maintained on the aggregate balances of those accounts between $8.5 million and $45.8 million, and additional reserves are required on aggregate balances in excess of $45.8 million in an amount equal to 10.0% of the excess. Because required reserves must be maintained in the form of vault cash or in a non-interest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution’s interest-earning assets. As of December 31, 2006, the Bank met its reserve requirements.

Community Reinvestment. Under the Community Reinvestment Act (“CRA”), as implemented by regulations of the federal bank regulatory agencies, an insured bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for banks, nor does it limit a bank’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the federal bank regulatory agencies, in connection with their examination of insured banks, to assess the banks’ records of meeting the credit needs of their communities, using the ratings of “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of certain applications by those banks. All banks are required to make public disclosure of their CRA performance ratings. The Bank received a “satisfactory” rating in its most recent CRA examination.

Governmental Monetary Policies. The commercial banking business is affected not only by general economic conditions but also by the monetary policies of the Federal Reserve. Changes in the discount rate on member bank borrowings, control of borrowings, open market transactions in United States government securities, the imposition of and changes in reserve requirements against member banks and deposits and assets of foreign financial centers, and the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates are some of the monetary policies available to the Federal Reserve. Those monetary policies influence to a significant extent the overall growth of all bank loans, investments and deposits and the interest rates charged on loans or paid on time and savings deposits in order to mitigate recessionary and inflationary pressures. These techniques are used in varying combinations to influence overall growth and distribution of bank loans, investments, and deposits, and their use may also affect interest rates charged on loans or paid for deposits.

The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of changing conditions in the national economy and money markets, as well as the effect of actions by monetary and fiscal authorities, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the Bank.

Dividends. All dividends paid by the Bank are paid to GFH, the sole stockholder of the Bank. The general dividend policy of the Bank is to pay dividends at levels consistent with maintaining liquidity and preserving applicable capital ratios and servicing obligations. The dividend policy of the Bank is subject to the discretion of the board of directors of the Bank and will depend upon such factors as future earnings, financial condition, cash needs, capital adequacy, compliance with applicable statutory and regulatory requirements and general business conditions.

Page 10

The ability of the Bank to pay dividends is restricted under applicable law and regulations. Under North Carolina banking law, dividends must be paid out of retained earnings and no cash dividends may be paid if payment of the dividend would cause the Bank’s surplus to be less than 50% of its paid-in capital. Also, under federal banking law, no cash dividend may be paid if the Bank is undercapitalized or insolvent or if payment of the cash dividend would render the Bank undercapitalized or insolvent, and no cash dividend may be paid by the Bank if it is in default of any deposit insurance assessment due to the Federal Deposit Insurance Corporation.

The exact amount of future dividends on the stock of the Bank will be a function of the profitability of the Bank in general and applicable tax rates in effect from year to year. The Bank’s ability to pay dividends in the future will directly depend on its future profitability, which cannot be accurately estimated or assured.

Capital Adequacy. The capital adequacy regulations which apply to state banks, such as the Bank, are similar to the Federal Reserve requirements promulgated with respect to bank holding companies discussed above.

Changes in Management. Any depository institution that has been chartered less than two years, is not in compliance with the minimum capital requirements of its primary federal banking regulator, or is otherwise in a troubled condition must notify its primary federal banking regulator of the proposed addition of any person to the board of directors or the employment of any person as a senior executive officer of the institution at least 30 days before such addition or employment becomes effective. During this 30-day period, the applicable federal banking regulatory agency may disapprove of the addition of such director or employment of such officer. The Bank is not subject to any such requirements.

Enforcement Authority. The federal banking laws also contain civil and criminal penalties available for use by the appropriate regulatory agency against certain “institution-affiliated parties” primarily including management, employees and agents of a financial institution, as well as independent contractors such as attorneys and accountants and others who participate in the conduct of the financial institution’s affairs and who caused or are likely to cause more than minimum financial loss to or a significant adverse affect on the institution, who knowingly or recklessly violate a law or regulation, breach a fiduciary duty or engage in unsafe or unsound practices. These practices can include the failure of an institution to timely file required reports or the submission of inaccurate reports. These laws authorize the appropriate banking agency to issue cease and desist orders that may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnification or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets or take other action as determined by the primary federal banking agency to be appropriate.

Prompt Corrective Action. Banks are subject to restrictions on their activities depending on their level of capital. Federal “prompt corrective action” regulations divide banks into five different categories, depending on their level of capital. Under these regulations, a bank is deemed to be “well-capitalized” if it has a total risk-based capital ratio of 10% or more, a core capital ratio of six percent or more and a leverage ratio of five percent or more, and if the bank is not subject to an order or capital directive to meet and maintain a certain capital level. Under these regulations, a bank is deemed to be “adequately capitalized” if it has a total risk-based capital ratio of eight percent or more, a core capital ratio of four percent or more and a leverage ratio of four percent or more (unless it receives the highest composite rating at its most recent examination and is not experiencing or anticipating significant growth, in which instance it must maintain a leverage ratio of three percent or more). Under these regulations, a bank is deemed to be “undercapitalized” if it has a total risk-based capital ratio of less than eight percent, a core capital ratio of less than four percent or a leverage ratio of less than three percent. Under these regulations, a bank is deemed to be “significantly undercapitalized” if it has a risk-based capital ratio of less than six percent, a core capital ratio of less than three percent and a leverage ratio of less than three percent. Under such regulations, a bank is deemed to be “critically undercapitalized” if it has a leverage ratio of less than or equal to two percent. In addition, the applicable federal banking agency has the ability to downgrade a bank’s classification (but not to “critically undercapitalized”) based on other considerations even if the bank meets the capital guidelines. If a state member bank, such as the Bank, is classified as undercapitalized, the bank is required to submit a capital restoration plan to the Federal Reserve. An undercapitalized bank is prohibited from increasing its assets, engaging in a new line of business, acquiring any interest in any company or insured depository institution, or opening or acquiring a new financial center office, except under certain circumstances, including the acceptance by the Federal Reserve of a capital restoration plan for that bank.

If a state member bank is classified as undercapitalized, the Federal Reserve may take certain actions to correct the capital position of the bank. If a state member bank is classified as significantly undercapitalized, the Federal Reserve would be required to take one or more prompt corrective actions. These actions would include, among other

Page 11

things, requiring sales of new securities to bolster capital, changes in management, limits on interest rates paid, prohibitions on transactions with affiliates, termination of certain risky activities and restrictions on compensation paid to executive officers. If a bank is classified as critically undercapitalized, the bank must be placed into conservatorship or receivership within 90 days, unless the Federal Deposit Insurance Corporation determines otherwise.

The capital classification of a bank affects the frequency of examinations of the bank and impacts the ability of the bank to engage in certain activities and affects the deposit insurance premiums paid by the bank. The Federal Reserve is required to conduct a full-scope, on-site examination of every member bank at least once every twelve months.

Banks also may be restricted in their ability to accept brokered deposits, depending on their capital classification. “Well-capitalized” banks are permitted to accept brokered deposits, but all banks that are not well-capitalized are not permitted to accept such deposits. The Federal Reserve may, on a case-by-case basis, permit member banks that are adequately capitalized to accept brokered deposits if the Federal Reserve determines that acceptance of such deposits would not constitute an unsafe or unsound banking practice with respect to the bank.

Deposit Insurance. The Bank’s deposits are insured up to $100,000 per insured non-IRA account and up to $250,000 per IRA account by the Bank Insurance Fund of the Federal Deposit Insurance Corporation. During 2006, the FDIC approved a new risk-based assessment system for deposit insurance. It is expected that all banks will pay assessments under this revised system, while under the previous system, certain banks deemed not to pose a threat to the deposit insurance system did not pay any assessments. The FDIC determines the Bank’s deposit insurance assessment rates on the basis of four risk categories. Under the revised assessment rate schedule, the Bank’s assessment will range from 0.02 to 0.04% at the lowest assessment category up to a maximum assessment of 0.40% of the Bank’s average deposit base, with the exact assessment determined by the Bank’s assets, its capital and the FDIC’s supervisory opinion of its operations. The insurance assessment rate may change periodically. Increases in the assessment rate may have an adverse effect on the Bank’s operating results. The FDIC has the authority to terminate deposit insurance.

Future legislation and regulations.

GFH’s management and the Bank’s management cannot predict what other legislation might be enacted or what other regulations might be adopted or the effects thereof. Any change in applicable law or regulation, state or federal, may have a material adverse effect on their business.

ITEM 1A – RISK FACTORS

An investment in our common stock involves risks. Stockholders should carefully consider the risks described below in conjunction with the other information in this Form 10K and information incorporated by reference in this Form 10K, including our consolidated financial statements and related notes. If any of the following risks or other risks which have not been identified or which we may believe are immaterial or unlikely, actually occur, our business, financial condition and results of operations could be harmed. This could cause the price of our stock to decline, and stockholders could lose part or all of their investment. This Form 10K contains forward-looking statements that involve risks and uncertainties, including statements about our future plans, objectives, intentions and expectations. Many factors, including those described below, could cause actual results to differ materially from those discussed in our forward-looking statements.

Our business strategy includes the continuation of significant growth plans, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.

We intend to continue pursuing a significant growth strategy for our business. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in significant growth stages of development. We cannot assure you we will be able to expand our market presence in our existing markets or successfully enter new markets or that any such expansion will not adversely affect our results of operations. Failure to manage our growth effectively could have a material adverse effect on our business, future prospects, financial condition or results of operations, and could adversely affect our ability to successfully implement our business strategy. Also, if our growth occurs more slowly than anticipated or declines, our operating results could be materially adversely affected.

Our business is subject to the success of the local economies where we operate.

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Our success significantly depends upon the growth in population, income levels, deposits and housing starts in our primary and secondary markets. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may not succeed. Adverse economic conditions in our specific market area could reduce our growth rate, affect the ability of our customers to repay their loans to us and generally affect our financial condition and results of operations. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Moreover, we cannot give any assurance we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.

Any adverse market or economic conditions in Virginia and North Carolina may disproportionately increase the risk that our borrowers will be unable to make their loan payments. In addition, the market value of the real estate securing loans as collateral could be adversely affected by unfavorable changes in market and economic conditions. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in Virginia and North Carolina could adversely affect the value of our assets, our revenues, results of operations and financial condition.

We may face risks with respect to future expansion.

As a strategy, we have sought to increase the size of our franchise by aggressively pursuing business development opportunities, and we have grown rapidly since our incorporation. We have purchased a number of banking offices of other financial institutions as a part of that strategy and have acquired a number of insurance agencies. We may acquire other financial institutions and insurance agencies or parts of those entities in the future. Acquisitions and mergers involve a number of risks, including:

• the time and costs associated with identifying and evaluating potential acquisitions and merger partners;

• the estimates and judgments used to evaluate credit, operations, management and market risks with respect to the target entity may not be accurate;

• the time and costs of evaluating new markets, hiring experienced local management and opening new offices, and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;

• our ability to finance an acquisition and possible ownership and economic dilution to our current shareholders;

• the diversion of our management’s attention to the negotiation of a transaction, and the integration of the operations and personnel of the combining businesses;

• entry into new markets where we lack experience;

• the introduction of new products and services into our business;

• the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on our results of operations; and

• the risk of loss of key employees and customers.

We may incur substantial costs to expand, and we can give no assurance such expansion will result in the levels of profits we seek. There can be no assurance integration efforts for any future mergers or acquisitions will be successful. Also, we may issue equity securities, including common stock, and securities convertible into shares of our common stock in connection with future acquisitions, which could cause ownership and economic dilution to our current shareholders. There is no assurance that, following any future mergers or acquisition, our integration efforts will be successful or our company, after giving effect to the acquisition, will achieve profits comparable to or better than our historical experience.

If the value of real estate in our core market areas were to decline materially, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on us.

With most of our loans concentrated in the Greater Metropolitan Hampton Roads area of Virginia and the coastal and eastern Piedmont region of North Carolina, a decline in local economic conditions could adversely affect the values of our real estate collateral. Consequently, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse.

In addition to the financial strength and cash flow characteristics of the borrower in each case, the bank often secures loans with real estate collateral. At December 31, 2006, approximately 86.3% of the bank’s loans have real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate

Page 13

source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.

An inadequate allowance for loan losses would reduce our earnings and capital.

Our loan losses could exceed the allowance for loan losses we have set aside. Our average loan size continues to increase. Reliance on historic loan loss experience may not be indicative of future loan losses. Approximately 70.0% of our loan portfolio is composed of construction, commercial mortgage and commercial loans. Repayment of such loans is generally considered more subject to market risk than residential mortgage loans. Industry experience shows that a portion of loans will become delinquent and a portion of the loans will require partial or entire charge-off. Regardless of the underwriting criteria we utilize, losses may be experienced as a result of various factors beyond our control, including, among other things, changes in market conditions affecting the value of our loan collateral and problems affecting the credit of our borrowers.

Management makes various assumptions and judgments about the ultimate collectibility of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and for specific loans when their ultimate collectibility is considered questionable. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb losses, or if the bank regulatory authorities require the bank to increase the allowance for loan losses as a part of their examination process, the bank’s earnings and capital could be significantly and adversely affected.

A significant part of our loan portfolio is unseasoned.

Since the end of 2004, our loan portfolio has grown by approximately $613 million. It is difficult to assess the future performance of this part of our loan portfolio due to the recent origination of these loans. Industry experience shows that it takes several years for loan difficulties to become apparent. We can give no assurance that these loans will not become non-performing or delinquent, which could adversely affect our future performance.

Our reliance on time deposits, including out-of-market certificates of deposit, as a source of funds for loans and our other liquidity needs could have an adverse effect on our operating results.

Among other sources of funds, we rely heavily on deposits for funds to make loans and provide for our other liquidity needs. However, our loan demand has exceeded the rate at which we have been able to build core deposits so we have relied heavily on time deposits, including out-of-market certificates of deposit, as a source of funds. Those deposits may not be as stable as other types of deposits and, in the future, depositors may not renew those time deposits when they mature, or we may have to pay a higher rate of interest to attract or keep them or to replace them with other deposits or with funds from other sources. Not being able to attract those deposits or to keep or replace them as they mature would adversely affect our liquidity. Paying higher deposit rates to attract, keep or replace those deposits could have a negative effect on our interest margin and operating results.

The building of market share through our de novo financial center strategy could cause our expenses to increase faster than our revenues.

We intend to continue to build market share through our de novo financial center strategy. We currently intend to open three additional new financial centers in 2007, including our first financial center in Wilmington, North Carolina. There are considerable costs involved in opening financial centers. New financial centers generally do not generate sufficient revenues to offset their costs until they have been in operation for at least a year or more. Accordingly, our new financial centers can be expected to negatively impact our earnings for some period of time until the financial centers reach certain economies of scale. Our expenses could be further increased if we encounter delays in the opening of any of our new financial centers. Finally, we have no assurance our new financial centers will be successful even after they have been established.

Our recent results may not be indicative of our future results.

We may not be able to sustain our historical rate of growth or may not even be able to grow our business at all. In addition, our recent and rapid growth may distort some of our historical financial ratios and statistics. Various factors, such as economic conditions, regulatory and legislative considerations and competition, may also impede or prohibit our ability to expand our market presence. If we experience a significant decrease in our historical rate of growth, our results of operations and financial condition may be adversely affected due to a high percentage of our

Page 14

operating costs being fixed expenses.

We may be adversely affected by interest rate changes.

Changes in interest rates may affect our level of interest income, the primary component of our gross revenue, as well as the level of our interest expense, our largest recurring expenditure. Net interest income is the difference between income from interest-earning assets, such as loans, and the expense of interest-bearing liabilities, such as deposits and our borrowings, including our outstanding junior subordinated debentures. We may not be able to effectively manage changes in what we charge as interest on our earning assets and the expense we must pay on interest-bearing liabilities, which may significantly reduce our earnings. Since rates charged on loans often tend to react to market conditions faster than do rates paid on deposit accounts, these rate changes may have a negative impact on our earnings until we can make appropriate adjustments in our deposit rates. In addition, there are costs associated with our risk management techniques, and these costs could be material. Fluctuations in interest rates are not predictable or controllable and, therefore, there can be no assurances of our ability to continue to maintain a consistent positive spread between the interest earned on our earning assets and the interest paid on our interest-bearing liabilities.

Our operations and customers might be affected by the occurrence of a natural disaster or other catastrophic event in our market area.

Because substantially all of our loans are with customers and businesses located in the coastal areas of Virginia and the coastal and eastern Piedmont region of North Carolina, catastrophic events, including natural disasters, such as hurricanes which historically have struck the east coast of the United States with some regularity, or terrorist attacks, could disrupt our operations. Any of these natural disasters or other catastrophic events could have a negative impact on most or all of our offices and customer base, as well as the strength of our loan portfolio. Even though we carry business interruption insurance policies, make contingency plans and typically have provisions in our contracts that protect us in certain events, we might suffer losses as a result of business interruptions that exceed the coverage available under our insurance policies or for which we do not have coverage. Any natural disaster or catastrophic event affecting us could have a significant negative impact on our operations.

Competition from financial institutions and other financial service providers may adversely affect our profitability.

The banking business is highly competitive and we experience competition in each of our markets from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national and international financial institutions that operate offices in our primary market areas and elsewhere.

We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in our primary markets, we may face a competitive disadvantage as a result of our smaller size, lack of geographic diversification and inability to spread our marketing costs across a broader market. Although we compete by concentrating our marketing efforts in our primary markets with local advertisements, personal contacts, and greater flexibility and responsiveness in working with local customers, we can give no assurance this strategy will be successful.

We are subject to extensive regulation that could limit or restrict our activities.

We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various federal and state agencies. Our compliance with these regulations is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth.

The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank and financial holding companies, our cost of compliance could adversely affect our ability to operate profitably. The Sarbanes-Oxley Act of 2002, and the related

Page 15

rules and regulations promulgated by the Securities and Exchange Commission and the Nasdaq Stock Market that are applicable to us, have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices. As a result, we may experience greater compliance costs.

Our directors and executive officers own a significant portion of our common stock

Our directors and executive officers, as a group, beneficially owned approximately 16.0% of our outstanding common stock as of December 31, 2006 (24.0% upon the exercise of outstanding vested options). As a result of their ownership, the directors and executive officers will have the ability, by voting their shares in concert, to significantly influence the outcome of all matters submitted to our shareholders for approval, including the election of directors.

Our continued success is dependent upon the services of our management team.

Our future success and profitability is substantially dependent upon the management and banking abilities of our senior executives. We believe that our continued growth and future results will depend in part upon our attracting and retaining highly skilled and qualified management and sales and marketing personnel. Competition for such personnel is intense, and we cannot assure you that we will be successful in attracting or retaining such personnel. We also cannot guarantee that members of our executive management team will remain with us. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition and results of operations.

Our investment in certain derivative investments may result in volatility in our earnings and adversely affect the market for our common stock.

We have a stand-alone derivative financial instrument in the form of an interest rate swap agreement, which derives its value from underlying interest rates. Accounting rules require that changes in the fair value of derivative financial instruments that do not qualify as hedging instruments be reported as an economic gain or loss in non-interest income. Our interest rate swap was determined not to qualify as a hedging instrument. For the three months ended September 30, 2006 a gain of approximately $1.9 million was included in non-interest income related to the change in the fair value of the interest rate swap agreement. For the three months ended December 31, 2006, a loss of approximately $212,000 was included in non-interest income related to the change in the fair value of the interest rate swap agreement. Fair value changes in this derivative can be volatile from quarter to quarter, and are primarily driven by changes in interest rates. Because the market for our common stock is affected by our earnings, the resulting volatility in our earnings may have an adverse effect on the market for our common stock.

Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We have conducted two public stock offerings since October 2004 to support our continued growth. We may at some point need to again raise additional capital to support our continued growth. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital if needed on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth and acquisitions could be materially impaired.

Our future capital needs could result in dilution of your investment.

Our board of directors may determine from time to time there is a need to obtain additional capital through the issuance of additional shares of our common stock or other securities. These issuances would likely dilute the ownership interests of existing shareholders and may dilute the per share book value of our common stock. New investors may also have rights, preferences and privileges senior to our current shareholders which may adversely impact our current shareholders.

The trading volume in our common stock is low and the sale of substantial amounts of our common stock in the public market could depress the price of our common stock.

The average daily trading volume of our shares on The Nasdaq Global Market for the three months ended March 12, 2007 was approximately 13,000 shares. Lightly traded stock can be more volatile than stock trading in an active

Page 16

public market. We cannot predict the extent to which an active public market for our common stock will develop or be sustained after this transaction. In recent years, the stock market has experienced a high level of price and volume volatility, and market prices for the stock of many companies have experienced wide price fluctuations that have not necessarily been related to their operating performance. Therefore, our shareholders may not be able to sell their shares at the volumes, prices, or times that they desire.

We cannot predict the effect, if any, that future sales of our common stock in the market, or availability of shares of our common stock for sale in the market, will have on the market price of our common stock. We therefore can give no assurance that sales of substantial amounts of our common stock in the market, or the potential for large amounts of sales in the market, would not cause the price of our common stock to decline or impair our ability to raise capital through sales of our common stock.

Our ability to pay dividends is limited and we may be unable to pay future dividends.

Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient consolidated capital. The ability of our bank subsidiary to pay dividends to us is limited by their obligations to maintain sufficient capital and by other general restrictions on their dividends under federal and state bank regulatory requirements. If we do not satisfy these regulatory requirements, we will be unable to pay dividends on our common stock.

Holders of our junior subordinated debentures have rights that are senior to those of our common shareholders.

We have supported our continued growth through the issuance of trust preferred securities from special purpose trusts and accompanying junior subordinated debentures. At December 31, 2006, we had outstanding trust preferred securities and accompanying junior subordinated debentures totaling $30.9 million and currently intend to issue additional trust preferred securities and accompanying junior subordinated debentures to fund all or a portion of the cash portion of the transaction consideration. Payments of the principal and interest on the trust preferred securities of these special purpose trusts are conditionally guaranteed by us. Further, the accompanying junior subordinated debentures we issued to these special purpose trusts are senior to our shares of common stock. As a result, we must make payments on the junior subordinated debentures before any dividends can be paid on our common stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the junior subordinated debentures must be satisfied before any distributions can be made on our common stock. We have the right to defer distributions on our junior subordinated debentures (and the related trust preferred securities) for up to five years, during which time no dividends may be paid on our common stock.

Certain provisions under our Articles of Incorporation and applicable law may make it difficult for others to obtain control of our corporation even if such a change in control may be favored by some shareholders.

Certain provisions in our Articles of Incorporation and applicable North Carolina corporate and banking law may have the effect of discouraging a change of control of Gateway Financial even if such a transaction is favored by some of our shareholders and could result in shareholders receiving a substantial premium over the current market price of our shares. The primary purpose of these provisions is to encourage negotiations with our management by persons interested in acquiring control of our corporation. These provisions may also tend to perpetuate present management and make it difficult for shareholders owning less than a majority of the shares to be able to elect even a single director.

The securities of Gateway Financial are not FDIC insured.

The securities of Gateway Financial are not savings or deposit accounts or other obligations of any bank, and are not insured by the Federal Deposit Insurance Corporation, or any other governmental agency and are subject to investment risk, including the possible loss of principal.

ITEM 1B – UNRESOLVED STAFF COMMENTS

None.

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ITEM 2 – PROPERTIES

The Company currently operates out of the banking and insurance offices as set forth below:

	Approximate Square		Year Established/
Office Location	Footage		Acquired
Edenton - 322 South Broad Street (4)		5,400		2006
Elizabeth City – 112 Corporate Drive (6)		25,000		2006
Elizabeth City - 1145 North Road Street (1)		9,000		1999
Elizabeth City - 1404 West Ehringhaus Street (3)		2,000		2003
Elizabeth City - 400 West Ehringhaus Street (4)		5,000		2004
Elizabeth City - 802 West Ehringhaus Street (2)		3,200		2004
Hertford – 147 North Church Street (2)		2,000		2002
Kitty Hawk - 3600 Croatan Highway (1)		6,500		2002
Kitty Hawk – 5406 Croatan Highway (1)		4,200		2006
Moyock - 100 Moyock Commons Drive (4)		4,000		2004
Nags Head – 2808 S. Croatan Highway (5)		4,800		2004
Plymouth - 433 U.S. Highway 64 East (4)		5,200		2000
Raleigh – 2209 Century Drive (3)		2,500		2006
Roper - 102 W. Buncomb Street (3)		550		2000
Chesapeake - 111 Gainsbourgh Square (5)		7,200		2002
Chesapeake - 575 Cedar Road (3)		2,400		2003
Chesapeake – 1403 Greenbrier Parkway (3)		3,800		2006
Emporia – 5205 Main Street (3)		6,500		2004
Norfolk – 539 21st Street (3)		10,000		2006
Newport News – 753 Thimble Shoals Blvd (2)		2,800		2006
Suffolk – 2825 Godwin Drive (3)		3,200		2004
Virginia Beach - 4460 Corporation Lane, Suite 100 (3)		4,000		2000
Virginia Beach – 713 Independence Boulevard (3)		2,200		2003
Virginia Beach – 1580 Laskin Road (5)		7,500		2005
Virginia Beach – 641 Lynnhaven Parkway (3)		20,000		2006
Virginia Beach – 3801 Pacific Avenue (3)		1,200		2006
Virginia Beach – 2098 Princess Anne Road (3)		2,500		2005
Virginia Beach - 3001 Shore Drive (3)		2,000		2003

(1)	Includes banking, investment brokerage and insurance services.
(2)	Insurance services only.
(3)	Banking services only.
(4)	Only banking and insurance services.
(5)	Only banking and investment brokerage services.
(6)	Operations building.

The properties we own, including land, buildings and improvements, furniture, equipment and vehicles, had a net book value at December 31, 2006 of $38.5 million. In the opinion of the Company’s management, such properties are adequately covered by insurance, are in good operating condition, ordinary wear and tear excepted, and are adequate and suitable for the ordinary and regular conduct and operation of our business.

ITEM 3 – LEGAL PROCEEDINGS

The Company is aware of no material legal proceeding to which the Company or any of its subsidiaries is a party or of which any of their properties is subject.

ITEM 4 – SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

Page 18

PART II

ITEM 5 – MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL
BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on the Nasdaq Global Market under the symbol “GBTS”. The following table sets forth the high and low published closing prices for shares of our common stock for the periods indicated. Where appropriate, prices have been adjusted for the effects of an 11-for-10 stock split in the form of a 10% stock dividend distributed June 20, 2005 to stockholders of record on May 30, 2005 and an 11-for-10 stock split in the form of a 10% stock dividend payable May 15, 2006 to holders of record as of the close of business on April 28, 2006. The last reported sales price of the common stock on March 12, 2007 was $14.43 per share. As of December 31, 2006, Gateway Bank had approximately 4,600 stockholders of record.

		High		Low		Dividend
2005	First Quarter	$	15.35	$	12.87	$	0.02
	Second Quarter		16.73		14.07		0.02
	Third Quarter		16.29		15.43		0.02
	Fourth Quarter		16.24		14.51		0.03
2006	First Quarter	$	15.74	$	14.90	$	0.03
	Second Quarter		15.69		14.45		0.03
	Third Quarter		15.01		14.01		0.05
	Fourth Quarter		14.73		13.95		0.05

As a holding company, we are dependent upon our subsidiary, Gateway Bank, to provide funding for our operating expenses and dividends. North Carolina banking law will permit the payment of dividends only out of retained earnings and will prohibit the payment of cash dividends if payment of the dividend would cause Gateway Bank’s surplus to be less than 50% of its paid-in capital. Also, under federal banking law, no cash dividend may be paid if Gateway Bank is undercapitalized or insolvent or if payment of the cash dividend would render Gateway Bank undercapitalized or insolvent, and no cash dividend may be paid by Gateway Bank if it is in default of any deposit insurance assessment due to the FDIC. Subject to these restrictions, our Board of Directors will consider the payment of dividends when it is deemed prudent to do so.

ITEM 6 – SELECTED FINANCIAL DATA

The information presented below is derived in part from the audited consolidated financial statements and notes thereto of the Company. This information presented below does not purport to be complete and should be read in conjunction with the Company’s consolidated financial statements appearing elsewhere in this annual report.

	For the Years Ended December 31,
	2006		2005		2004		2003		2002
	(Dollars in thousands, except per share data)
Operating Data:
Total interest income	$	73,097	$	39,679	$	19,632	$	13,486	$	10,311
Total interest expense		36,099		16,376		6,691		5,341		4,819
Net interest income		36,998		23,303		12,941		8,145		5,492
Provision for loan losses		3,400		2,200		1,425		1,200		480
Net interest income after provision for loan losses		33,598		21,103		11,516		6,945		5,012
Total non-interest income		9,270		8,067		5,857		4,485		2,826
Total non-interest expense		34,974		23,266		14,653		10,230		7,211
Income before income taxes		7,894		5,904		2,720		1,200		627
Provision for income taxes		2,625		1,965		710		-		-
Net income	$	5,269	$	3,939	$	2,010	$	1,200	$	627

Page 19

	For the Years Ended December 31,
	2006			2005			2004			2003			2002
	(Dollars in thousands, except per share data)
Per Share Data: (1)
Net income basic	$	0.49		$	0.48		$	0.37		$	0.30		$	0.16
Net income diluted		0.47			0.46			0.34			0.29			0.16
Dividends		0.16			0.09			0.02			-			-
Book value		9.99			9.46			7.98			6.20			5.98
Tangible book value		8.84			8.47			6.66			5.31			5.41
Balance Sheet Data:
Total assets	$	1,207,477		$	883,373		$	535,728		$	314,826		$	231,053
Loans receivable		994,592			666,652			381,956			231,740			161,488
Allowance for loan losses		9,405			6,283			4,163			2,759			1,721
Deposits		923,725			646,262			406,259			238,452			174,663
Borrowings		166,929			134,665			63,926			50,000			31,401
Stockholders’ equity		109,640			98,744			64,318			24,971			23,968
Selected Performance Ratios:
Return on average assets		0.51	%		0.58	%		0.49	%		0.43	%		0.32	%
Return on average equity		5.06	%		5.77	%		5.12	%		4.93	%		2.58	%
Net interest margin (2)		3.87	%		3.81	%		3.59	%		3.24	%		3.09	%
Net interest spread (3)		3.35	%		3.44	%		3.33	%		2.98	%		2.68	%
Non-interest income as a percentage of net interest income and non-interest income		20.04	%		25.72	%		31.16	%		35.51	%		33.97	%
Non-interest income as a percentage of average assets		0.89	%		1.19	%		1.44	%		1.61	%		1.46	%
Non-interest expense to average assets		3.35	%		3.43	%		3.59	%		3.67	%		3.71	%
Efficiency ratio (4)		75.80	%		74.17	%		77.95	%		81.00	%		86.69	%

Page 20

	For the Years Ended December 31,
	2006			2005			2004			2003			2002
	(Dollars in thousands, except per share data)
Asset Quality Ratios:
Nonperforming loans to period-end loans		0.33	%		0.03	%		0.13	%		0.52	%		0.82	%
Allowance for loan losses to period-end loans		0.95	%		0.94	%		1.09	%		1.19	%		1.07	%
Allowance for loan losses to nonperforming loans		287.70	%		3079.90	%		849.59	%		228.02	%		129.59	%
Nonperforming assets to total assets (5)		0.27	%		0.02	%		0.09	%		0.38	%		0.67	%
Net loan charge-offs to average loans outstanding		0.04	%		0.02	%		0.01	%		0.11	%		0.15	%
Capital Ratios: (6)
Total risk-based capital		12.99	%		15.17	%		17.40	%		12.68	%		12.51	%
Tier 1 risk-based capital		12.11	%		14.31	%		16.41	%		11.59	%		11.57	%
Leverage ratio		11.38	%		13.73	%		13.89	%		9.33	%		9.71	%
Equity to assets ratio		9.08	%		10.19	%		12.01	%		7.93	%		10.37	%
Other Data:
Number of banking offices		24			18			16			10			7
Number of full time equivalent employees		327			247			191			123			96

(1)	Restated for 11 –for- 10 stock split in 2006, Restated for 11 –for- 10 stock split in 2005, 21-for-20 stock split in 2004, 21-for-20 stock split occurring during 2003 and 11-for-10 stock split occurring during 2002.
(2)	Net interest margin is net interest income divided by average interest-earning assets.
(3)	Net interest spread is the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(4)	Efficiency ratio is non-interest expense divided by the sum of net interest income and non-interest income.
(5)	Nonperforming assets consists of nonaccrual loans, restructured loans, and real estate owned, where applicable.
(6)	Capital ratios are for the Company.

ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

AND

ITEM 7A — QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The purpose of this discussion is to focus on significant changes in the financial condition and results of operation of the company during the past three years. The discussion and analysis are intended to supplement and highlight information contained in the accompanying consolidated financial statements and the selected financial data presented elsewhere in this Annual Report on Form 10-K. Prior period information has been restated as applicable in order to provide the reader a better comparison between periods.

FORWARD LOOKING STATEMENTS

Statements contained in this annual report, which are not historical facts, are forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Amounts herein could vary as a result of market and other factors. Such forward-looking statements are subject to risks and uncertainties which could cause actual results to differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in documents filed by the Company with the Securities and Commission and the Bank with the Federal Reserve Bank from time to time. Such forward-looking statements may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” and “potential.” Examples of forward-looking statements include, but are not limited to, estimates with respect to the financial condition, expected or anticipated revenue, results of operations and business of the Company that are subject to various

Page 21

factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to, general economic conditions, changes in interest rates, deposit flows, loan demand, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulations; and other economic, competitive, governmental, regulatory, and technological factors affecting the Company’s operations, pricing, products and services.

Management’s discussion and analysis is intended to assist readers in the understanding and evaluation of the financial condition and results of operations of Gateway Financial Holdings, Inc. It should be read in conjunction with the audited consolidated financial statements and accompanying notes included in this annual report and the supplemental financial data appearing throughout this discussion and analysis. On April 25, 2006 the Company’s Board of Directors declared an 11– for-10 stock split effected in the form of a 10% stock dividend, which was distributed May 15, 2006 to stockholders of record on April 28, 2006. On May 16, 2005 the Company’s Board of Directors declared an 11– for-10 stock split effected in the form of a 10% stock dividend, which was distributed June 20, 2005 to stockholders of record on May 30, 2005. On February 17, 2004, the Company’s Board of Directors declared a 21-for-20 stock split, to be effected in the form of a 5% stock dividend, distributed April 8, 2004 to stockholders of record on March 15, 2004. All references in this discussion and analysis to per share results and weighted average shares outstanding have been adjusted to reflect the effects of these stock splits.

OVERVIEW

Gateway Financial Holdings, Inc. is a financial holding company incorporated under the laws of North Carolina to serve as the holding company for Gateway Bank & Trust Co., a North Carolina chartered commercial bank with banking and insurance agency offices in Northeastern North Carolina, including the Outer Banks, and the Greater Hampton Roads area of Virginia. The bank began operations on December 1, 1998 and, effective October 1, 2001, became our wholly owned subsidiary.

Since inception, we have aggressively pursued the primary objective of building a full-service commercial banking operation, while effectively supplementing our banking activities with other financial services intended to generate significant non-interest income. Accordingly, a key component of our growth strategy has been expanding our franchise through the opening of newly constructed financial centers and strategic financial center acquisitions. The bank serves its customers from twenty four full-service financial centers located in Elizabeth City (3), Kitty Hawk (2), Edenton, Moyock, Nags Head, Plymouth, Raleigh and Roper, North Carolina, and Virginia Beach (7), Emporia, Norfolk, Suffolk and Chesapeake (3), Virginia. We opened two full-service financial centers in Virginia Beach during the first half of 2005. During 2006, we opened one newly constructed financial center in Kitty Hawk, North Carolina and our first financial center in Raleigh, North Carolina and we opened our first branch in Norfolk, Virginia. We also opened three full-service financial centers in our Virginia footprint, one in Virginia Beach’s oceanfront section, one in Chesapeake’s Greenbrier section, and one in the Lynnhaven section of Virginia Beach, Virginia. Consistent with our long-range strategic objectives, we will continue to consider acquisition opportunities including whole bank or financial center locations. We will also continue to explore de novo financial center opportunities in markets that we consider attractive.

The bank has three wholly-owned operating subsidiaries, which have contributed to our market presence. Gateway Insurance Services, Inc., an insurance agency with offices in Edenton, Hertford, Elizabeth City, Plymouth, Moyock, and Kitty Hawk, North Carolina and two newly acquired locations in Virginia, one in Chesapeake and one in Newport News, which sells insurance products to businesses and individuals. Gateway Investment Services, Inc. assists customers in their securities brokerage activities through an arrangement with an unaffiliated broker-dealer. As prescribed by this arrangement, Gateway Investment Services earns revenue through a commission sharing arrangement with the unaffiliated broker-dealer. In June 2006 we opened a wholly owned mortgage origination company with offices in Raleigh, Elizabeth City and Kitty Hawk, North Carolina and Norfolk and Virginia Beach, Virginia. In an ongoing effort to create significant sources of non-interest income, we will continue to look for ways to expand non-traditional banking activities in our insurance, mortgage and investment services subsidiaries.

Since inception, we have concentrated our efforts on building a franchise and infrastructure that can deliver and sustain long-term profitability. Toward that objective, and consistent with our business plans, we incurred significant operating losses from the date of our opening through December 31, 2000. We achieved our first profitable quarter during the three months ended March 31, 2001 and have now remained profitable in twenty consecutive quarters, producing net income for the past three years of $2.0 million in 2004, $3.9 million in 2005 and $5.3 million for the

Page 22

twelve months ended December 31, 2006. While we anticipate continued profitability, future expansion activity can be expected to generate significant additional costs that can negatively impact earnings as we pursue our growth strategies.

In addition to our banking activities, the Bank has focused on insurance, mortgage and brokerage services to develop sustainable and growth-oriented sources of non-interest income. The Bank acquired the Dowd & Twiddy Insurance Agency in January 2000 and Fidelity Insurance in January 2001. These agencies were combined to form Gateway Insurance Services, Inc., which sells insurance products to businesses and individuals. Gateway Insurance Services. maintains offices in Elizabeth City, Edenton, Hertford, Moyock, Plymouth and Kitty Hawk, North Carolina. In May 2004, Gateway Insurance Services purchased Whitehurst Insurance Agency with three financial centers in Elizabeth City, Edenton and Moyock, North Carolina. In June 2004, Gateway Insurance Services purchased Insurance Express Premium Finance to provide specialized financing of insurance premiums. In the fourth quarter of 2006 Gateway Insurance Services acquired two agencies in Virginia (The Insurance Center and C D West & Company) opening the door for further expansion in the Hampton Roads area of Virginia. In addition, the Bank organized Gateway Investment Services in September 1999 to assist customers in their securities brokerage activities through a networking arrangement with an unaffiliated broker-dealer. Through this arrangement, Gateway Investment Services earns revenues through commission sharing from the unaffiliated broker-dealer. In June 2006 we opened our wholly owned mortgage origination company in Raleigh, North Carolina with offices also in Elizabeth City, and Kitty Hawk, North Carolina and offices in Norfolk and Virginia Beach, Virginia. The Bank will continue to look for ways to expand non-traditional banking activities in its insurance subsidiary and securities networking arrangement, which create significant sources of non-interest income.

FINANCIAL CONDITION
December 31, 2006 and 2005

The Company continued its pattern of strong growth during 2006, with total assets increasing by $324.1 million, or 36.7%, to $1.2 billion at year end. This growth was principally reflected in increased loans. Total loans increased by $327.9 million, or 49.2%, from $666.7 million at the beginning of the year to $994.6 million at year end. The increase in loans was comprised principally of increases of $140.8 million, $69.3 million, $69.8 million, $16.6 million and $41.1 million, respectively, in commercial real estate loans, commercial and industrial loans, construction loans, home equity lines of credit and 1-4 family mortgage – areas of lending that the Company targets. There was a decrease in consumer loans in 2006 of $10.1 million. As of December 31, 2006, 70% of our loan portfolio was represented by commercial, industrial, real estate and construction loans. The Company maintained liquidity at what it believes to be an appropriate level, as liquid assets, consisting of cash and due from banks, interest-earning deposits in other banks and investment securities available for sale, decreased $25.6 million in the aggregate to $120.3 million, representing 10.0% of total assets, at December 31, 2006. The cash surrender value of bank owned life insurance totaled $25.1 million, or 2.1% of total assets at December 31, 2006, an increase of $7.9 million in 2006, the majority of which was related to purchasing $7.0 million additional bank owned life insurance during the third quarter. Additionally, the Company’s investment in premises and equipment increased by $8.9 million as a result of growth and expansion and costs incurred associated with opening a new operations center in Elizabeth City, a full service financial center in Kitty Hawk, North Carolina and a facility on Lynnhaven Parkway in Virginia Beach and four leased facilities in Raleigh, North Carolina and Norfolk and Virginia Beach (2), Virginia. Goodwill and other intangibles increased $2.3 million due to the acquisitions of two insurance agencies in Virginia less scheduled amortization.

Funding for the growth in assets and loans was provided by increases of $277.5 million and $32.3 million, respectively, in deposit accounts and total borrowings. Total deposit accounts increased 42.9%, from $646.3 million at December 31, 2005 to $923.7 million at December 31, 2006. Non-interest-bearing demand accounts increased by $18.8 million, or 21.1%, from $89.2 million at the beginning of the period to $108.0 million at the end of the period. Savings, money market and NOW accounts increased to $268.7 million, representing a total increase of $79.0 million or 41.6% over the $189.7 million reported at December 31, 2005. The increases in these transaction type accounts were attributable to the branch expansion under taken during 2006, the Haberfeld High Performance checking program utilized throughout the year, and the introduction of highly successful retail money market and commercial DDA sweep accounts in 2006. The Company’s product mix of demand, savings, money market, and NOW accounts of $376.7 million at December 31, 2006 represented 40.8% of total deposits at that date, down from 43.1% of total deposits at December 31, 2005. The decrease in percentage was primarily the result of increased jumbo and brokered CDs during 2006. Time deposits totaled $547.1 million at December 31, 2006 as compared to $367.4 million at December 31, 2005. Large denomination time deposits of more than $100,000 were $205.5 million, or 22.2% of total deposits at December 31, 2006 as compared with $151.4 million, or 23.5% of total deposits at December 31, 2005. The Company

Page 23

continues to use brokered deposits to fund growth, with such deposits increasing from $10.0 million to $95.2 million during the year, comprising 10.3% of total deposits at December 31, 2006. Brokered deposits have been used primarily to fund loans in our Wilmington loan production office and Raleigh private banking center. Although advances from the Federal Home Loan Bank of Atlanta only increased from $114.2 million to $116.0 million during the twelve months, short term borrowings decreased by $42.5 million and long term borrowings increased by $44.3 million. The refinancing of Federal Home Loan Bank advances during the year was done to take advantage of lower rates offered on the long-term advances to help curtail funding costs during the inverted yield curve environment in 2006. Federal funds purchased decreased from $5.0 million to $0.0 million during the same time period. In addition, during 2006 the Company issued $15.0 million of trust preferred securities, which provided further funding to support the franchise expansion while enhancing the regulatory capital position of the Company and its bank subsidiary.

Total stockholders’ equity increased by $10.9 million during the year, primarily due to net income for the current year of $5.3 million, proceeds of $4.4 million from the stock offering over allotment option from the prior year offering, and $2.1 million from shares issued for the acquisition of two insurance agencies, partially offset by cash dividend payment in the amount of $1.7 million. Stockholders’ equity totaled $109.6 million at December 31, 2006. Its capital ratios continue to place the Bank in excess of the minimums required to be deemed well-capitalized by regulatory measures.

NET INTEREST INCOME

Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between interest income, principally from loan and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as levels of non-interest-bearing liabilities. During the years ended December 31, 2006, 2005, and 2004, average interest-earning assets were $956.8 million, $611.1 million, and $360.5 million, respectively. During these same years, the Company’s net interest margins were 3.87%, 3.81%, and 3.59%, respectively.

Page 24

Average Balances and Average Rates Earned and Paid. The following table sets forth, for the periods indicated, information with regard to average balances of assets and liabilities, as well as the total dollar amounts of interest income from interest-earning assets and interest expense on interest-bearing liabilities, resultant yields or costs, net interest income, net interest spread, net interest margin, and ratio of average interest-earning assets to average interest-bearing liabilities. In preparing the table, nonaccrual loans are included in the average loan balance.

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

Page 25

RATE/VOLUME ANALYSIS

The following table analyzes the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table distinguishes between (i) changes attributable to volume (changes in volume multiplied by the prior period’s rate), (ii) changes attributable to rate (changes in rate multiplied by the prior period’s volume), and (iii) net change (the sum of the previous columns). The change attributable to both rate and volume (changes in rate multiplied by changes in volume) has been allocated equally to both the changes attributable to volume and the changes attributable to rate.

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

RESULTS OF OPERATIONS
Years Ended December 31, 2006 and 2005

Overview. The Company reported net income of $5.3 million or $.47 per diluted share for the year ended December 31, 2006, as compared with net income of $3.9 million or $.46 per diluted share for 2005, an increase of $1.3 million or 33.8% in net income, and an increase of $.01 or 2.1% in net income per diluted share. The results from operations were negatively affected during the year by the change in market value of its interest rate swap that was entered into in December 2005 to hedge the interest rate of its variable loan portfolio. The change in the fair market value of this economic hedge reduced non-interest income by $1.2 million, and in total the loss and net cash settlement on the economic hedge was $1.9 million for the year. This loss (net of taxes using a 37.5 % blended rate) reduced net income by $1.2 million or $0.11 per diluted share. The market value of the interest rate swap can be volatile from quarter to quarter, and thus can effect net income positively or negatively depending on interest rate conditions and other factors.

The Company’s primary focus continues to be on growth and development of its financial center network and subsidiary operations, sacrificing some profitability in the near term. The Bank opened our first financial center in Raleigh, North Carolina in January 2006 and Norfolk, Virginia in February 2006. In March 2006 the Bank opened another financial center in Virginia Beach, Virginia and opened a newly constructed financial center in Kitty Hawk, North Carolina in April 2006. In addition, we opened two financial centers in August, one in Chesapeake and Virginia Beach adding to our presence in those markets. These new locations increased the number of full-service financial centers to twenty four. The Company has incurred additional non-interest expenses both as a result of growth from period to period, and also as a result of staff additions and other costs incurred as a result of the financial center expansion during 2006. In 2004 interest rates obtained at or near forty year historical lows and steadily rose until June

Page 26

2006. During 2006, Wall Street Journal Prime increased from 7.25% at December 31, 2005 to 8.25% at the end of June and has remained at 8.25% through December 31, 2006. The Company’s interest rate spread has increased primarily due to the Bank’s management of the interest rates on its loan and deposit portfolios while maintaining an upward growth trend. The current trend with interest rates is a flat rate environment for the first part of 2007 with uncertainty as to which direction interest rates will take later in the year.

Net Interest Income. Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between interest income, principally from loan and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread, and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of non-interest-bearing liabilities and capital.

Net interest income increased to $37.0 million for the year ended December 31, 2006, a $13.7 million or 58.8% increase from the $23.3 million earned during 2005. Total interest income benefited from growth in the level of average earning assets during the year. Asset growth combined with higher asset yields caused by the increase in market interest rates during periods reported contributed to this rise in income. Average total interest-earning assets increased $345.7 million, or 56.6%, for 2006 as compared to 2005, while the average yield increased by 115 basis points from 6.49% to 7.64%. Average total interest-bearing liabilities increased by $304.5 million, or 56.7% for 2006 as compared to 2005, while the average cost of interest-bearing liabilities increased by 124 basis points from 3.05% to 4.29%. Our cost of funds increased at a higher pace than our yield on interest-earning assets as a result of deposits steadily repricing at higher rates throughout the entire year, while the yield on our loan and investment portfolio has remained relatively flat for the last half of 2006 since the last increase in the fed funds in June 2006. This resulted in a 9 basis point decrease in interest rate spread. However, despite the decrease in interest rate spread, because we were able increase our interest earning assets by $41.2 million more than our interest bearing liabilities (primarily as a result of $21.0 million increase in average demand deposit accounts), our interest rate margin improved during 2006 by 6 basis points. For the year ended December 31, 2006, the net interest rate spread was 3.35% and the net interest margin was 3.87%. For the year ended December 31, 2005, the net interest spread was 3.44% and the net interest margin was 3.81%.

Provision for Loan Losses. The Company recorded a $3.4 million provision for loan losses in 2006, representing an increase of $1.2 million from the $2.2 million provision made in 2005. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by Management. In evaluating the allowance for loan losses, Management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions, and other relevant factors. In both 2006 and 2005 the provision for loan losses was made principally in response to growth in loans, as total loans outstanding increased by $327.9 million in 2006 and by $284.7 million in 2005. Additionally, the 2006 provision was also increased as a result of the increase in impaired loans. At December 31, the allowance for loan losses was $9.4 million for 2006 and $6.3 million for 2005, representing .95% and .94%, respectively, of loans outstanding.

Non-Interest Income. Non-interest income totaled $9.3 million for the year ended December 31, 2006 as compared with $8.1 million for 2006, an increase of $1.2 million, or 14.9%. Since inception, the Company has actively pursued additional non-interest income sources outside of traditional banking operations, including income from insurance, mortgage banking, and brokerage networking operations. Non-interest income was negatively affected in 2006 by the loss and net cash settlement on economic hedge of $1.9 million. Of this loss, $1.2 million was related to the drop in fair market value of the economic hedge that resulted from the rise in rates primarily during the first half of 2006. The market value of the economic hedge can be volatile from quarter to quarter and thus effect non-interest income either positively or negatively depending on interest rate conditions and other factors. Excluding the effect of the economic hedge, non-interest income was $11.2 million which represented a $3.1 million or 38.7% increase during 2005.

The 2006 increases were broad based and include $986,000 in service charges on deposit accounts, $495,000 in income from insurance operations, $88,000 in income from brokerage operations, $185,000 from bank owned life insurance, $748,000 from mortgage operations, $560,000 from gain on the sale of securities and $396,000 from other service fee income. The increase in service charges was a direct result of the increase in the number of deposit accounts opened during 2006 that came from the financial center expansion and Haberfeld High Performance Checking program. The increase in insurance operations resulted also from the franchise expansion, growth in lines of business, and the two insurance company acquisitions made in the fourth quarter of 2006. The increase in brokerage revenues resulted from expanding our brokerage services into Virginia during the first quarter with the hiring of an experienced broker in

Page 27

Virginia Beach. The increase in income from bank owned life insurance was the result of purchasing an additional $7.0 million of bank owned life insurance during the third quarter of 2006. During mid 2006 the bank dissolved its 49% ownership of Gateway First Mortgage, LLC (“Gateway First”) which provided mortgage banking services to the Bank and to other lenders and replaced it with our wholly owned mortgage subsidiary, Gateway Financial Mortgage, Inc., which accounted for the increase in mortgage revenues in 2006 as compared with the prior year.

Non-Interest Expenses. Non-interest expenses totaled $35.0 million for the year ended December 31, 2006, an increase of $11.7 million or 50.3% over the $23.3 million reported for 2005. In comparison, total assets averaged $1.0 billion for 2006, an increase of 53.7% over average total assets of $679.0 million for the year ended December 31, 2005. Substantially all of the increase in non-interest expenses resulted from the Company’s growth and franchise expansion, and reflects the additional expenses in the current year associated with the opening of six new financial centers, increasing the number of full-service banking locations to twenty four; a private banking center, launching a new mortgage subsidiary, opening a new state of the art operations center, starting two new loan production offices, and making two insurance agency acquisitions. Eighteen of the twenty four financial centers were fully operational throughout 2006 and sixteen of the eighteen financial centers were fully operational throughout all of 2005. As a result of such expansion, personnel costs increased by $5.7 million, or 49.2%, the costs of occupancy, data processing and equipment costs increased by $3.0 million or 53.9%, and other non-interest expenses increased by $3.0 million or 49.1%. The increase in other expense included $1.03 million of expenses related to the Haberfeld High Performance Checking account program in 2006 (there were none of these expenses in 2005), and an increase of $237,000 related to other promotional and advertising costs, increased franchise taxes related to Virginia financial center expansion of $500,000, increased consulting and professional costs of $318,000, and increased travel and business development expenses of $340,000. Despite these higher expenses as a percentage of average total assets, total non-interest expenses decreased to 3.35% for 2006 from 3.43% for 2005.

Income Taxes. Income tax expense was $2.6 million for 2006 as compared with $2.0 million for 2005. The Company’s effective tax rate for both tax years was approximately 33.3%. As a result of the Company’s sustained pattern of profitability we expect our tax rate to remain near this level in 2007. Deferred taxes increased primarily due to increases in our allowance for loan losses and the unrealized loss related to our economic hedge.

RESULTS OF OPERATIONS
Years Ended December 31, 2005 and 2004

Overview. The Company reported net income of $3.9 million or $.46 per diluted share for the year ended December 31, 2005, as compared with net income of $2.0 million or $.34 per diluted share for 2004, an increase of $1.9 million or 96.0% in net income, and an increase of $.12 or 35.3% in net income per diluted share. The Company’s primary focus continues to be on growth and development of its financial center network and subsidiary operations, sacrificing some profitability in the near term. During 2005 the Bank opened two new financial centers, one located on Laskin Road and the other on Princess Anne Road in Virginia Beach, Virginia in March and April, respectively. The Bank also opened a newly constructed financial center in Moyock, North Carolina in December 2004. In October 2004 the Bank purchased three financial centers in Emporia and Suffolk, Virginia and Elizabeth City, North Carolina from Provident Bank of Maryland. These new locations increased the number of full-service financial centers to eighteen. The Company has incurred additional non-interest expenses both as a result of growth from period to period, and also as a result of staff additions and other costs incurred as a result of the financial center expansion during 2005. In 2004 interest rates obtained at or near forty year historical lows. During 2005, Wall Street Journal Prime increased from 5.25% at December 31, 2004 to 7.25% at December 31, 2005. The Company’s interest rate spread has increased primarily due to the Bank’s management of the interest rates on its loan and deposit portfolios while maintaining an upward growth trend.

Net Interest Income. Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between interest income, principally from loan and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread, and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by levels of non-interest-bearing liabilities and capital.

Net interest income increased to $23.3 million for the year ended December 31, 2005, a $10.4 million or 80.1% increase from the $12.9 million earned during 2004. Total interest income benefited from strong growth in the level of average earning assets during the year. Asset growth combined with higher asset yields caused by the increase in market interest rates during periods reported contributed to this rise in income. Average total interest-earning assets increased $250.6 million, or 69.5%, for 2005 as compared to 2004, while the average yield increased by 104 basis

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points from 5.45% to 6.49%. Average total interest-bearing liabilities increased by $221.6 million, or 70.3% for 2005 as compared to 2004, while the average cost of interest-bearing liabilities increased by 93 basis points from 2.12% to 3.05%. This resulted in an 11 basis point improvement in interest rate spread and also resulted in an improvement in interest rate margin. For the year ended December 31, 2005, the net interest rate spread was 3.44% and the net interest margin was 3.81%. For the year ended December 31, 2004, the net interest spread was 3.33% and the net interest margin was 3.59%.

Provision for Loan Losses. The Company recorded a $2.2 million provision for loan losses in 2005, representing an increase of $775,000 from the $1.4 million provision made in 2004. Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by Management. In evaluating the allowance for loan losses, Management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions, and other relevant factors. In both 2005 and 2004 the provision for loan losses was made principally in response to growth in loans, as total loans outstanding increased by $284.7 million in 2005 and by $150.2 million in 2004. At December 31, the allowance for loan losses was $6.3 million for 2005 and $4.2 million for 2004, representing .94% and 1.09%, respectively, of loans outstanding.

Non-Interest Income. Non-interest income totaled $8.1 million for the year ended December 31, 2005 as compared with $5.9 million for 2004, an increase of $2.2 million, or 37.7%. Since inception, the Company has actively pursued additional non-interest income sources outside of traditional banking operations, including income from insurance, mortgage banking, and brokerage networking operations. The 2005 increases were broad based and include $808,000 in service charges on deposit accounts, $556,000 in income from insurance operations, $193,000 in income from brokerage operations, $278,000 from bank owned life insurance, and $364,000 in income from other service fee income. The Bank owned a 49% of Gateway First Mortgage, LLC (“Gateway First”) which provided mortgage banking services to the Bank and to other lenders. The increases in income from insurance and brokerage operations resulted from growth in those lines of business.

Non-Interest Expenses. Non-interest expenses totaled $23.3 million for the year ended December 31, 2005, an increase of $8.6 million or 58.8% over the $14.7 million reported for 2004. In comparison, total assets averaged $679.0 million for 2005, an increase of 66.5% over average total assets of $407.7 million for the year ended December 31, 2004. Substantially all of the increase in non-interest expenses resulted from the Company’s growth and development, and reflects the additional expenses in the current year associated with the opening of new financial centers in March and April 2005, increasing the number of full-service banking locations to eighteen. Sixteen of the eighteen financial centers were fully operational throughout 2005 and ten of the sixteen financial centers were fully operational throughout all of 2004. As a result of such expansion, personnel costs increased by $3.7 million, or 47.8%, the costs of occupancy and equipment increased by $1.7 million or 59.2%, and other non-interest expenses increased by $2.8 million or 85.0%. The Company’s data processing increased by $335,000 or 55.3%. As a percentage of average total assets, total non-interest expenses decreased to 3.43% for 2005 from 3.59% for 2004.

Income Taxes. Income tax expense was $2.0 million for 2005 and $710,000 for 2004 as a result of the recognition of deferred tax assets, generated in prior years, that had previously been offset by a valuation allowance. During the years ended December 31, 2004, the Company utilized all remaining net operating loss carryforwards created during our first three fiscal years.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s sources of funds are customer deposits, cash and demand balances due from other banks, interest-earning deposits in other banks and investment securities available for sale. These funds, together with loan repayments, are used to make loans and to fund continuing operations. In addition, at December 31, 2006, the Bank had credit availability with the Federal Home Loan Bank of Atlanta (“FHLB”) of approximately $230.0 million, with $116.0 million outstanding secured by commercial loans and federal funds lines of credit with five other financial institutions in the aggregate amount of $61.5 million of which there were no advances. The Company also utilizes the wholesale brokered CD market to fund liquidity on an as needed basis.

Total deposits were $923.7 million and $646.3 million at December 31, 2006 and 2005, respectively. As a result of the Company’s loan demand exceeding the rate at which core deposits have been built, the Company has relied significantly on time deposits as a source of funds. Certificates of deposit are the only deposit accounts that have stated maturity dates. Such deposits are generally considered to be rate sensitive. At December 31, 2006, time deposits represented 59.2% of the Company’s total deposits, up from 56.9% of total deposits at December 31, 2005. Certificates

Page 29

of deposit of $100,000 or more represented 22.2% and 23.5%, respectively, of the Bank’s total deposits at December 31, 2006 and 2005. At December 31, 2006, the Company had $95.2 million in brokered time deposits, representing 10.3% of total deposits at that date, up from 1.5% of total deposits at December 31, 2005. The bank has primarily used brokered deposits to fund its loan production offices and private banking center. While the Company will need to pay competitive rates to retain these deposits at their maturities, there are other subjective factors that will determine their continued retention. Based upon prior experience, the Company anticipates that a substantial portion of outstanding certificates of deposit will renew upon maturity.

Management anticipates that the Company will rely primarily upon customer deposits, loan repayments, current earnings, brokered deposits, and as necessary, additional borrowings, to provide liquidity, and will use funds thus generated to make loans and to purchase securities, primarily securities issued by the federal government and its agencies, corporate securities, and mortgage-backed securities.

At December 31, 2006 and 2005, the Company’s tangible equity to asset ratio was 8.04% and 10.0%, respectively. All capital ratios place the Bank in excess of the minimum required to be deemed a well-capitalized bank by regulatory measures. The regulatory capital position of both the Company and the Bank was enhanced during December 2005 with the issuance of $30.0 million in common stock and the over allotment exercised in 2006 by the underwriter resulting in an additional $4.4 million in capital. In May 2006, the Company issued $15.0 million of trust preferred securities that qualify, subject to certain limitations, as Tier 1 capital. The Company’s Tier 1 capital ratio at
December 31, 2006 and 2005 was 12.11% and 14.31%, respectively.

CAPITAL RATIOS

The Bank is subject to minimum capital requirements. See “SUPERVISION AND REGULATION.” As the following table indicates, at December 31, 2006, the Bank exceeded regulatory capital requirements.

	At December 31, 2006
	Actual			Minimum			Well-Capitalized
	Ratio			Requirement			Requirement
Total risk-based capital ratio		12.28	%		8.0	%		10.0	%
Tier 1 risk-based capital ratio		11.39	%		4.0	%		6.0	%
Leverage ratio		10.62	%		4.0	%		5.0	%

Management expects that the Bank will remain “well-capitalized” for regulatory purposes, although there can be no assurance that additional capital will not be required in the near future due to greater-than-expected growth, or otherwise.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

     In the normal course of business there are various outstanding contractual obligations of the Company that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit that may or may not require future cash outflows. The following table reflects contractual obligations of the Company outstanding as of December 31, 2006.

	Payments Due by Period
			On Demand
			Or Within						After
Contractual Obligations	Total		1 Year		2-3 Years		4-5 Years		5 Years
	(In thousands)
Federal funds purchased	$	-	$	-	$	-	$	-	$	-
FHLB advances		116,000		14,500		5,000		76,500		20,000
Reverse purchase agreements		20,000		-		-		10,000		10,000
Junior subordinated debentures		30,929		-		-		-		30,929
Lease obligations		20,291		1,553		2,746		2,531		13,461
Deposits		923,725		905,999		13,281		4,445		-
Total contractual cash obligations	$	1,110,945	$	922,052	$	21,027	$	93,476	$	74,390

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The following table reflects other commitments of the company outstanding as of December 31, 2006.

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

In the normal course of business, the Company may enter into purchase agreements for goods or services. In management’s opinion, the dollar amount of such agreements at December 31, 2006 is not material and has not been included in the above table.

ASSET/LIABILITY MANAGEMENT

The Company’s results of operations depend substantially on its net interest income. Like most financial institutions, the Bank’s interest income and cost of funds are affected by general economic conditions and by competition in the market place. The purpose of asset/liability management is to provide stable net interest income growth by protecting the Company’s earnings from undue interest rate risk, which arises from volatile interest rates and changes in the balance sheet mix, and by managing the risk/return relationships between liquidity, interest rate risk, market risk, and capital adequacy. The Company maintains, and has complied with, a Board approved asset/liability management policy that provides guidelines for controlling exposure to interest rate risk by utilizing the following ratios and trend analysis: liquidity, equity, volatile liability dependence, portfolio maturities, maturing assets and maturing liabilities. The Company’s policy is to control the exposure of its earnings to changing interest rates by generally endeavoring to maintain a position within a narrow range around an “earnings neutral position,” which is defined as the mix of assets and liabilities that generate a net interest margin that is least affected by interest rate changes.

When suitable lending opportunities are not sufficient to utilize available funds, the Company has generally invested such funds in securities, primarily U.S. Treasury securities, securities issued by governmental agencies, mortgage-backed securities and corporate obligations. The securities portfolio contributes to the Company’s profits and plays an important part in the overall interest rate management. However, management of the securities portfolio alone cannot balance overall interest rate risk. The securities portfolio must be used in combination with other asset/liability techniques to actively manage the balance sheet. The primary objectives in the overall management of the securities portfolio are safety, liquidity, yield, asset/liability management (interest rate risk), and investing in securities that can be pledged for public deposits.

In reviewing the needs of the Company with regard to proper management of its asset/liability program, the Company’s management estimates its future needs, taking into consideration historical periods of high loan demand and low deposit balances, estimated loan and deposit increases (due to increased demand through marketing), and forecasted interest rate changes. A number of measures are used to monitor and manage interest rate risk, including income simulations and interest sensitivity (gap) analyses. An income simulation model is the primary tool used to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Key assumptions in the model include prepayment speeds on mortgage-related assets, cash flows and maturities of other investment securities, loan and deposit volumes and pricing. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.

Based on the results of the income simulation model as of November 30, 2006, the Company would expect a decrease in net interest income of $1.4 million if interest rates increase from current rates by 200 basis points and a decrease in net interest income of $2.1 million if interest rates decrease from current rates by 200 basis points.

The analysis of an institution’s interest rate gap (the difference between the repricing of interest-earning assets and interest-bearing liabilities during a given period of time) is another standard tool for the measurement of the exposure

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to interest rate risk. The Company believes that because interest rate gap analysis does not address all factors that can affect earnings performance, it should be used in conjunction with other methods of evaluating interest rate risk.

The following table sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 2006 which are projected to reprice or mature in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown which reprice or mature within a particular period were determined in accordance with the contractual terms of the assets or liabilities. Loans with adjustable rates are shown as being due at the end of the next upcoming adjustment period. Money market deposit accounts and negotiable order of withdrawal or other transaction accounts are assumed to be subject to immediate repricing and depositor availability and have been placed in the shortest period. In making the gap computations, none of the assumptions sometimes made regarding prepayment rates and deposit decay rates have been used for any interest-earning assets or interest-bearing liabilities. In addition, the table does not reflect scheduled principal payments which will be received throughout the lives of the loans. The interest rate swap with a notional value of $150 million and an expiration in December 2008, has been shown in the over 12 month column. The interest rate sensitivity of the Company’s assets and liabilities illustrated in the following table would vary substantially if different assumptions were used or if actual experience differs from that indicated by such assumptions.

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

The table illustrates that if assets and liabilities reprice in the time intervals indicated in the table, the Company is liability sensitive within twelve months, and asset sensitive thereafter. As stated above, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market

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interest rates. For instance, while the table is based on the assumption that interest-bearing demand accounts, money market accounts and savings accounts are immediately sensitive to movements in rates, the Company expects that in a changing rate environment the amount of the adjustment in interest rates for such accounts would be less than the adjustment in categories of assets which are considered to be immediately sensitive. Additionally, certain assets have features which restrict changes in the interest rates of such assets both on a short-term basis and over the lives of such assets. Further, in the event of a change in market interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability of many borrowers to service their adjustable-rate debt may decrease in the event of an increase in market interest rates. Due to these shortcomings, the Company places primary emphasis on its income simulation model when managing its exposure to changes in interest rates.

CRITICAL ACCOUNTING POLICIES

The preparation of the Company’s audited consolidated financial statements and the information included in management’s discussion and analysis is governed by policies that are based on accounting principles generally accepted in the United States of America and general practices within the banking industry. Among the more significant policies are those that govern accounting for loans and allowance for loan losses, stock based compensation, derivatives and goodwill. These policies are discussed in Note B of the “Notes To Consolidated Financial Statements” included in this Annual Report.

A critical accounting policy is one that is both very important to the portrayal of the Company’s financial condition and results, and requires a difficult, subjective or complex judgment by management. What makes these judgments difficult, subjective and/or complex is the need to make estimates about the effects of matters that are inherently uncertain. Estimates and judgments are integral to our accounting for certain items, and those estimates and judgments affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. The Company periodically evaluates its estimates, including those related to the allowance for loan losses and goodwill. While we base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, actual results may differ from these estimates under different assumptions or conditions. Further information regarding the accounting policies that we consider to be critical is provided below.

Allowance for loan losses. The Company’s most significant critical accounting policy is the determination of its allowance for loan losses. The allowance for loan losses reflects the estimated losses that will result from the inability of our customers to make required payments. The allowance for loan losses results from management’s evaluation of the risk characteristics of the loan portfolio under current economic conditions and considers such factors as the financial condition of the borrower, fair market value of collateral and other items that, in our opinion, deserve current recognition in estimating possible credit losses. Our evaluation process is based on historical evidence and current trends among delinquencies, defaults and nonperforming assets. Our estimate of the allowance for loan losses does not include the impact of events that might occur in the future.

Management considers the established allowance adequate to absorb losses that relate to loans outstanding at December 31, 2006, although future additions to the allowance may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses. Such agencies may require adjustments to the allowance based on their judgments of information available to them at the time of their examination. If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, our estimates would be updated, and additional provisions may be required. For further information on the allowance for loan losses, see “Financial Condition” in Management’s Discussion and Analysis and Note D of the “Notes to Consolidated Financial Statements” included in this Annual Report.

Goodwill. Goodwill is not amortized but is tested annually for impairment or at any time an event occurs or circumstances change that may trigger a decline in the value of the reporting unit. Examples of such events or circumstances include adverse changes in legal factors, business climate, unanticipated competition, change in regulatory environment or loss of key personnel.

The Company tests for impairment in accordance with SFAS No. 142. Potential impairment of goodwill exists when the carrying amount of a reporting unit exceeds its fair value. The fair value of a reporting unit is computed using one or a combination of the following three methods: income, market value or cost method. The income method uses a discounted cash flow analysis to determine fair value by considering a reporting unit’s capital structure and applying a risk-adjusted discount rate to forecast earnings based on a capital asset pricing model. The market value

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method uses recent transaction analysis or publicly traded comparable analysis for similar assets and liabilities to determine fair value. The cost method assumes the net assets of a recent business combination accounted for under the purchase method of accounting will be recorded at fair value if no event or circumstance has occurred triggering a decline in the value. To the extent a reporting unit’s carrying amount exceeds its fair value, an indication exists that the reporting unit’s goodwill may be impaired, and a second step of impairment test will be performed. In the second step, the implied fair value of the reporting unit’s goodwill, determined by allocating the reporting unit’s fair value to all of its assets (recognized and unrecognized) and liabilities as if the reporting unit had been acquired in a business combination at the date of the impairment test. If the implied fair value of reporting unit goodwill is lower than its carrying amount, goodwill is impaired and is written down to its implied fair value. The loss recognized is limited to the carrying amount of goodwill. Once an impairment loss is recognized, future increases in fair value will not result in the reversal of previously recognized losses.

Stock Compensation Plans. Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment,” (“SFAS No. 123R”) which was issued by the FASB in December 2004. SFAS No. 123R revises SFAS No. 123 “Accounting for Stock Based Compensation,” and supersedes APB No. 25, “Accounting for Stock Issued to Employees,” (APB No. 25) and its related interpretations. SFAS No. 123R requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period). SFAS No. 123R also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. SFAS No. 123R also amends SFAS No. 95 “Statement of Cash Flows,” to require that excess tax benefits be reported as financing cash inflows flows, rather than as a reduction of taxes paid, which is included within operating cash flows.

The Company adopted SFAS No. 123R using the modified prospective application as permitted under SFAS No. 123R. Accordingly, prior period amounts have not been restated. Under this application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption.

Prior to the adoption of SFAS No. 123R, the Company used the intrinsic value method as prescribed by APB No. 25 and thus recognized no compensation expense for options granted with exercise prices equal to the fair market value of the Company’s common stock on the date of the grant.

OFF-BALANCE SHEET ARRANGEMENTS

Information about the Company’s off-balance sheet risk exposure is presented in Note K to the accompanying consolidated financial statements. As part of its ongoing business, the Company does not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as special purpose entities (SPEs), which generally are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of December 31, 2006, except as otherwise disclosed in Note G to the accompanying consolidated financial statements, the Company is not involved in any unconsolidated SPE transactions.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note B to the consolidated financial statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.

LENDING ACTIVITIES

General. The Company provides to its customers a full range of short- to medium-term commercial and industrial, real estate, agricultural, Small Business Administration guaranteed, Farmers Home Administration guaranteed, mortgage, construction and consumer loans, both secured and unsecured.

The Company’s loan policies and procedures establish the basic guidelines governing its lending operations. Generally, the guidelines address the types of loans that the Company seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the

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borrower’s total outstanding indebtedness to the Company, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by the Board of Directors of the Company. The Company supplements its own supervision of the loan underwriting and approval process with periodic loan audits by internal loan examiners and outside professionals experienced in loan review work. The Company has focused its portfolio lending activities on typically higher yielding commercial, construction and consumer loans rather than lower yielding 1-4 family mortgages which the Company typically sells in the secondary market. The following table sets forth at the dates indicated the Company’s loan portfolio composition by type of loan:

	At December 31,
	2006						2005
				Percent						Percent
	Amount			of Total			Amount			of Total
	(Dollars in thousands)
Commercial & industrial	$	150,070			15.1	%	$	80,816			12.1	%
Real estate – construction		183,831			18.5	%		114,018			17.1	%
Real estate – commercial mortgage		362,322			36.4	%		221,526			33.2	%
Real estate – 1-4 family mortgage		108,498			10.9	%		82,987			12.4	%
Consumer		88,744			8.9	%		98,881			14.8	%
Mortgage loans held for sale		15,576			1.6	%		-			-	%
Home equity lines of credit		85,882			8.6	%		69,246			10.4	%
Subtotal		994,923			100.0	%		667,474			100.0	%
Less: Allowance for loan losses		(9,405	)					(6,283	)
Unamortized net deferred (fees) costs		(331	)					(822	)
Net loans	$	985,187					$	660,369

	At December 31,
	2004						2003
				Percent						Percent
	Amount			of Total			Amount			of Total
	(Dollars in thousands)
Commercial & industrial	$	69,075			18.0	%	$	52,554			22.7	%
Real estate – construction		131,431			34.4	%		55,970			24.2	%
Real estate – commercial mortgage		90,197			23.6	%		68,094			29.3	%
Real estate – 1-4 family mortgage		51,768			13.5	%		32,191			13.9	%
Consumer		10,641			2.8	%		10,458			4.5	%
Home equity lines of credit		29,350			7.7	%		12,615			5.4	%
Subtotal		382,462			100.0	%		231,882			100.0	%
Less: Allowance for loan losses		(4,163	)					(2,759	)
Unamortized net deferred (fees) costs		(506	)					(142	)
Net loans	$	377,793					$	228,981

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	At December 31,
	2002
				Percent
	Amount			of Total
	(Dollars in thousands)
Commercial	$	42,767			26.5	%
Real estate – construction		22,861			14.2	%
Real estate – commercial mortgage		48,362			29.9	%
Real estate – 1-4 family mortgage		31,957			19.8	%
Consumer		7,707			4.7	%
Home equity lines of credit		7,834			4.9	%
Subtotal		161,488			100.0	%
Less: Allowance for loan losses		(1,721	)
Unamortized net deferred (fees) costs		-
Net loans	$	159,767

The following table presents, at December 31, 2006, (i) the aggregate maturities or repricings of loans in the named categories of the Company’s loan portfolio and (ii) the aggregate amounts of such loans maturing or repricing after one year by fixed and variable rates:

	Within 1 Year		1-5 Years		After 5 Years		Total
	(Dollars in thousands)
Commercial and industrial	$	84,989	$	56,882	$	8,199	$	150,070
Real estate – construction		126,664		51,201		5,966		183,831
Total	$	211,653	$	108,083	$	14,165	$	333,901
Fixed rate loans							$	66,477
Variable rate loans								55,772
							$	122,249

Commercial & Industrial Loans. Commercial business lending is a primary focus of the Company’s lending activities. At December 31, 2006, the Company’s commercial loan portfolio equaled $150.1 million or 15.1% of total loans, as compared with $80.8 million or 12.1% of total loans at December 31, 2005. Commercial and industrial loans include both secured and unsecured loans for working capital, expansion, and other business purposes. Short-term working capital loans generally are secured by accounts receivable, inventory and/or equipment. The Company also makes term commercial loans secured by equipment and real estate. Lending decisions are based on an evaluation of the financial strength, management and credit history of the borrower, and the quality of the collateral securing the loan. With few exceptions, the Company requires personal guarantees and secondary sources of repayment.

Commercial loans generally provide greater yields and reprice more frequently than other types of loans, such as real estate loans. More frequent repricing means that yields on our commercial loans adjust with changes in interest rates.

Real Estate Loans. Real estate loans are made for purchasing, constructing and refinancing one to four family, five or more family and commercial properties. The Company offers fixed and adjustable rate options. The Company provides customers access to long-term conventional real estate loans through its mortgage loan department which makes Federal National Mortgage Association (“FNMA”) – conforming loans for the account of third parties.

At December 31, 2006, the Company’s residential one to four family loans amounted to $108.5 million or 10.9% of total loans as compared with $83.0 million or 12.4% of total loans at December 31, 2005. The Company’s residential mortgage loans are secured by properties located within the Company’s market area. Some of the one to four family residential mortgage loans that the Company makes are originated for the account of third parties, either through the Bank or Gateway Financial Mortgage. Such loans are booked as loans held for resale until the loan is

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sold. At December 31, 2006 such loans aggregated $15.6 million or 1.6% of total loans. The Company receives a fee for each such loan originated, with such fees included in income from mortgage operations which aggregated $1.6 million for the year ended December 31, 2006 and $836,000 for the year ended December 31, 2005. The Company anticipates that it will continue to be an active originator of residential loans.

The Company has made, and anticipates continuing to make, commercial real estate loans. Commercial real estate loans equaled $362.3 or 36.4% of total loans at December 31, 2006 and $221.5 million or 33.2% of total loans at December 31, 2005. This lending has involved loans secured principally by commercial buildings for office, storage and warehouse space, and by agricultural properties. Generally in underwriting commercial real estate loans, the Company requires the personal guaranty of borrowers and a demonstrated cash flow capability sufficient to service the debt. Loans secured by commercial real estate may be in greater amount and involve a greater degree of risk than one to four family residential mortgage loans. Payments on such loans are often dependent on successful operation or management of the properties.

The Company originates one to four family residential construction loans for the construction of custom homes (where the home buyer is the borrower) and provides financing to builders and consumers for the construction of pre-sold homes. Real estate construction loans amounted to $183.8 million or 18.5% of total loans at December 31, 2006 and $114.0 million or 17.1% of total loans at December 31, 2005. The Company generally receives a pre-arranged permanent financing commitment from an outside entity prior to financing the construction of pre-sold homes. The Company lends to builders who have demonstrated a favorable record of performance and profitable operations and who are building in markets that management believes it understands and in which it is comfortable with the economic conditions. The Company also makes commercial real estate construction loans, generally for owner-occupied properties. The Company further endeavors to limit its construction lending risk through adherence to established underwriting procedures. Also, the Company generally requires documentation of all draw requests and utilizes loan officers to inspect the project prior to paying any draw requests from the builder. With few exceptions, the Company requires personal guarantees and secondary sources of repayment on construction loans.

Consumer Loans and Home Equity Lines of Credits. Loans to individuals include automobile loans, boat and recreational vehicle financing, home equity and home improvement loans and miscellaneous secured and unsecured personal loans. Consumer loans generally can carry significantly greater risks than other loans, even if secured, if the collateral consists of rapidly depreciating assets such as automobiles and equipment. Repossessed collateral securing a defaulted consumer loan may not provide an adequate source of repayment of the loan. Consumer loan collections are sensitive to job loss, illness and other personal factors. The Company attempts to manage the risks inherent in consumer lending by following established credit guidelines and underwriting practices designed to minimize risk of loss.

Loan Approvals. The Company’s loan policies and procedures establish the basic guidelines governing its lending operations. Generally, the guidelines address the type of loans that the Company seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness to the Company, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by the Board of Directors of the Company. The Company supplements its own supervision of the loan underwriting and approval process with periodic loan audits by independent, outside professionals experienced in loan review work.

Commitments and Contingent Liabilities

In the ordinary course of business, the Company enters into various types of transactions that include commitments to extend credit that are not included in loans receivable, net, presented on the Company’s consolidated balance sheets. The Company applies the same credit standards to these commitments as it uses in all its lending activities and has included these commitments in its lending risk evaluations. The Company’s exposure to credit loss under commitments to extend credit is represented by the amount of these commitments. See “NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.”

Asset Quality

The Company considers asset quality to be of primary importance, and employs a formal internal loan review process to ensure adherence to the Lending Policy as approved by the Board of Directors. It is the responsibility of each lending officer to assign an appropriate risk grade to every loan originated. Credit Administration, through the loan review process, validates the accuracy of the initial risk grade assessment. In addition, as a given loan’s credit

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quality improves or deteriorates, it is Credit Administration’s responsibility to change the borrower’s risk grade accordingly. The function of determining the allowance for loan losses is fundamentally driven by the risk grade system. In determining the allowance for loan losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to historical loan loss experience, the value and adequacy of collateral, economic conditions in the Company’s market area and other factors. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The allowance for loan losses represents management’s estimate of the appropriate level of reserve to provide for probable losses inherent in the loan portfolio.

The Company’s policy regarding past due loans normally requires a prompt charge-off to the allowance for loan losses following timely collection efforts and a thorough review. Further efforts are then pursued through various means available. Loans carried in a non-accrual status are generally collateralized and probable losses are considered in the determination of the allowance for loan losses.

Nonperforming Assets

The table sets forth, for the period indicated, information with respect to the Company’s nonaccrual loans, restructured loans, total nonperforming loans (nonaccrual loans plus restructured loans), and total nonperforming assets.

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

Our consolidated financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans, unless we place a loan on nonaccrual basis. We account for loans on a nonaccrual basis when we have serious doubts about the collectibility of principal or interest. Generally, our policy is to place a loan on nonaccrual status when the loan becomes past due 90 days. We also place loans on nonaccrual status in cases where we are uncertain whether the borrower can satisfy the contractual terms of the loan agreement. Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected. Restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal, have been granted due to the borrower’s weakened financial condition. We accrue interest on restructured loans at the restructured rates when we anticipate that no loss of original principal will occur. Potential problem loans are loans which are currently performing and are not included in nonaccrual or restructured loans above, but about which we have serious doubts as to the borrower’s ability to comply with present repayment terms. These loans are likely to be included later in nonaccrual, past due or restructured loans, so they are considered by management in assessing the adequacy of our allowance for loan losses. At December 31, 2006, we had $3.3 million of nonaccrual loans. Real estate owned

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consists of foreclosed, repossessed and idled properties. At December 31, 2006 the Company had no real estate owned.

Analysis of Allowance for Loan Losses

Our allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. We increase our allowance for loan losses by provisions charged to operations and by recoveries of amounts previously charged off, and we reduce our allowance by loans charged off. We evaluate the adequacy of the allowance at least quarterly. In addition, on a quarterly basis our board of directors reviews our loan portfolio, conducts an evaluation of our credit quality and reviews our computation of the loan loss provision, recommending changes as may be required. In evaluating the adequacy of the allowance, we consider the growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors deriving from our limited history of operations. Because we have a limited history of our own, we also consider the loss experience and allowance levels of other similar banks and the historical experience encountered by our management and senior lending officers prior to joining us. In addition, regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to make adjustments to the allowance based upon judgments different from those of our management.

We use our risk grading program, as described under “Asset Quality,” to facilitate our evaluation of probable inherent loan losses and the adequacy of the allowance for loan losses. In this program, risk grades are initially assigned by loan officers and reviewed by Credit Administration, and tested as part of the periodic loan audit by independent, outside professionals experienced in loan review work. The testing program includes an evaluation of a sample of new loans, large loans, loans that are identified as having potential credit weaknesses, loans past due 90 days or more, and nonaccrual loans. We strive to maintain our loan portfolio in accordance with conservative loan underwriting policies that result in loans specifically tailored to the needs of our market area. Every effort is made to identify and minimize the credit risks associated with such lending strategies. We have no foreign loans and we do not engage in significant lease financing or highly leveraged transactions.

We follow a loan review program designed to evaluate the credit risk in our loan portfolio. Through this loan review process, we maintain an internally classified watch list that helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. In establishing the appropriate classification for specific assets, management considers, among other factors, the estimated value of the underlying collateral, the borrower’s ability to repay, the borrower’s payment history and the current delinquent status. As a result of this process, certain loans are categorized as substandard, doubtful or loss. Reserves are allocated based on management’s judgment and historical experience.

Loans classified as “substandard” are those loans with clear and defined weaknesses such as unfavorable financial ratios, uncertain repayment sources or poor financial condition that may jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some losses if the deficiencies are not corrected. Loans classified as “doubtful” are those loans that have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable. Loans classified as “loss” are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value but rather it is not practical or desirable to defer writing off this asset even though partial recovery may be achieved in the future. As a practical matter, when loans are identified as loss, the estimated loss is calculated and charged off against the allowance for loan losses. In addition to the above classification categories, we also categorize loans based upon risk grade and loan type, estimating an allowance allocation based upon each homogenous loan pool.

Growth in loans outstanding has, throughout our history, been the primary reason for increases in our allowance for loan losses and the resultant provisions for loan losses necessary to provide for those increases. This growth has been spread among our major loan categories. Between December 31, 1999 and December 31, 2006, the range of each major category of loans as a percentage of total loans outstanding is as follows: real estate secured mortgage loans – 6.6% to 48.9%; construction loans – 8.4% to 34.4%; commercial and industrial loans –15.1% to 57.2%; loans to individuals – 2.8% to 14.8%; and home equity lines of credit – 4.9% to 10.3%. For all fiscal years through 2006, our net loan charge-offs in each year were no more than .15% of average loans outstanding. Because of this sustained trend of low loss experience, and based upon our assessment of probable loss, we have set our allowance for loan losses at December 31, 2006 at $9.4 million, representing .95% of total loans outstanding, which is consistent with .94% at December 31, 2005.

Page 39

The allowance for loan losses represents management’s estimate of an amount adequate to provide for known and inherent losses in the loan portfolio in the normal course of business. We make specific allowances that are allocated to certain individual loans and pools of loans based on risk characteristics, as discussed below. A portion of allowance assigned to each pool of loans contains estimated components based on historical data, economic trends, peer group analysis, past due analysis, interest rate trends, unemployment trends, inflation rates and the unseasoned segment of the loan portfolio. A portion of the allowance is intended to reserve for the inherent risk in the portfolio and the intrinsic inaccuracies associated with the estimation of the allowance for loan losses and its allocation to specific loan categories. While management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established the allowance for loan losses in conformity with generally accepted accounting principles (SFAS 5 and SFAS 114) in conjunction with guidance issued by the Securities Exchange Commission (i.e. SAB 102), there can be no assurance that regulators, in reviewing our portfolio, will not require an increase or decrease in our allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed herein. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.

The following table shows the allocation of the allowance for loan losses at the dates indicated. The allocation is based on an evaluation of defined loan problems, historical ratios of loan losses and other factors that may affect future loan losses in the categories of loans shown.

	At December 31,
	2006					2005
			% of Total					% of Total
	Amount		Loans (1)			Amount		Loans (1)
	(Dollars in thousands)
Balance applicable to:
Commercial & industrial	$	1,979		15.1	%	$	881		12.1	%
Real estate – construction		3,191		18.5	%		2,149		17.1	%
Real estate – mortgage		2,514		48.9	%		1,724		45.6	%
Consumer		907		8.9	%		989		14.8	%
Home equity lines of credit		814		8.6	%		540		10.4	%
Unallocated		–		–			–		–
Total	$	9,405		100.0	%	$	6,283		100.0	%

	At December 31,
	2004					2003
			% of Total					% of Total
	Amount		Loans (1)			Amount		Loans (1)
	(Dollars in thousands)
Balance applicable to:
Commercial & industrial	$	667		18.0	%	$	683		22.7	%
Real estate – construction		1,577		34.4	%		672		24.2	%
Real estate – mortgage		1,477		37.1	%		1,102		43.2	%
Consumer		128		2.8	%		125		4.5	%
Home equity lines of credit		294		7.7	%		139		5.4	%
Unallocated		20		–			38		–
Total	$	4,163		100.0	%	$	2,759		100.0	%

Page 40

	At December 31,
	2002
			% of Total
	Amount		Loans (1)
	(Dollars in thousands)
Balance applicable to:
Commercial	$	482		26.5	%
Real estate – construction		229		14.2	%
Real estate – mortgage		803		49.7	%
Consumer		77		4.7	%
Home equity lines of credit		78		4.9	%
Unallocated		52		-
Total	$	1,721		100.0	%

⁽¹⁾ Represents total of all outstanding loans in each category as a percent of total loans outstanding.

The following table sets forth for the periods indicated information regarding changes in the Company’s allowance for loan losses:

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

INVESTMENT ACTIVITIES

The Company’s portfolio of investment securities, all of which are available for sale, consists primarily of U.S. Treasury and government agency securities, and mortgage-backed securities. Securities to be held for indefinite periods of time and not intended to be held to maturity are classified as available for sale and carried at fair value with any unrealized gains or losses reflected as an adjustment to stockholders’ equity. Securities held for indefinite periods of time include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in interest rates and/or significant prepayment risks. It is the Company’s policy to classify all investment securities as available for sale. The following table summarizes the amortized costs, gross unrealized gains and losses and the resulting market value of securities available for sale:

Page 41

			Gross		Gross
	Amortized		Unrealized		Unrealized		Market
	Cost		Gains		Losses		Value
	(Dollars in thousands)
December 31, 2005
U.S. government agencies	$	36,900	$	-	$	922	$	35,978
Corporate debt/equity securities		8,415		403		10		8,808
Mortgage-backed securities		42,748		9		616		42,141
Municipal securities		6,612		14		78		6,548
	$	94,675	$	426	$	1,626	$	93,475
December 31, 2005
U.S. government agencies	$	42,555	$	-	$	1,327	$	41,228
Corporate debt/equity securities		6,619		1,373		117		7,875
Mortgage-backed securities		67,935		13		581		67,367
Municipal securities		7,372		18		87		7,303
	$	124,481	$	1,404	$	2,112	$	123,773
December 31, 2004
U.S. government agencies	$	43,709	$	6	$	471	$	43,244
Corporate debt/equity securities		2,613		49		1		2,661
Mortgage-backed securities		40,408		146		86		40,468
Municipal securities		6,239		17		21		6,235
	$	92,969	$	218	$	579	$	92,608

The following table summarizes the amortized costs, fair values and weighted average yields, based on amortized cost, of securities available-for-sale at December 31, 2006, by contractual maturity groups:

					Weighted
	Amortized		Fair		Average
	Cost		Value		Yield
Securities available for sale:	(Dollars in thousands)
U.S. Government agencies:
Due within one year	$	6,002	$	5,923		3.51	%
Due after one but within five years		30,898		30,055		3.58	%
		36,900		35,978		3.57	%
Corporate debt/equity securities:
Due within one year		6,862		7,266		5.68	%
Due after one but within five years		1,553		1,542		5.81	%
		8,415		8,808		5.70	%
Mortgage-backed securities:
Due after one but within five years		996		967		3.09	%
Due after ten years		41,752		41,174		5.09	%
		42,748		42,141		5.04	%
Municipal securities:
Due after one but within five years		1,814		1,768		3.75	%
Due after five but within ten years		1,432		1,418		4.99	%
Due after ten years		3,366		3,362		5.85	%
		6,612		6,548		5.10	%
Total securities available for sale:
Due within one year		12,864		13,189		4.71	%
Due after one but within five years		35,261		34,332		3.68	%
Due after five but within ten years		1,432		1,418		4.99	%
Due after ten years		45,118		44,536		5.15	%
	$	94,675	$	93,475		4.54	%

Page 42

The Company does not engage in, nor does it presently intend to engage in, securities trading activities and therefore does not maintain a trading account. At December 31, 2006 there were no securities of any issuer (other than governmental agencies) that exceeded 10% of the Company’s stockholders’ equity.

SOURCES OF FUNDS

Deposit Activities

The Company provides a range of deposit services, including non-interest-bearing checking accounts, interest-bearing checking and savings accounts, money market accounts and certificates of deposit. These accounts generally earn interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. The Company has used brokered deposits as a funding source. However, it strives to establish customer relations to attract core deposits in non-interest-bearing transactional accounts and thus to reduce its costs of funds.

The following table sets forth for the periods indicated the average balances outstanding and average interest rates for each major category of deposits.

	At December 31,
	2006					2005					2004
	Average		Average			Average		Average			Average		Average
	Balance		Rate			Balance		Rate			Balance		Rate
						(Dollars in thousands)
Interest-bearing NOW, money market and savings accounts	$	245,038		3.23	%	$	178,577		2.00	%	$	118,242		1.31	%
Time deposits		450,786		4.56	%		267,494		3.41	%		137,440		2.50	%
Total interest-bearing deposits		695,824		4.09	%		446,071		2.85	%		255,682		1.95	%
Demand and other non-interest-bearing deposits		93,346					79,901					52,218
Total average deposits	$	789,170		3.61	%	$	525,972		2.41	%	$	307,900		1.62	%

The following table sets forth at the dates indicated the amounts and maturities of certificates of deposit with balances of $100,000 or more at December 31, 2006:

	At December 31, 2006
	(Dollars in thousands)
Remaining maturity:
Less than three months	$	76,844
Over three months through six months		73,336
Over six months through one year		50,515
Over one year through three years		3,232
Over three years through five years		1,525
Total	$	205,452

Page 43

Borrowings

As additional sources of funding, the Company uses advances from the Federal Home Loan Bank of Atlanta under a line of credit equal to 25% of the Bank’s total assets ($301.9 million at December 31, 2006). Outstanding advances at December 31, 2006 were as follows:

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

Pursuant to collateral agreements with the Federal Home Loan Bank, at December 31, 2006 advances are secured by investment securities available for sale with a fair value of $24.1 million and by loans with a carrying amount of $205.6 million, which approximates market value. The Company has a maximum borrowing availability from FHLB equal to 25% of total assets.

In addition, the Company may purchase federal funds through five unsecured federal funds lines of credit with correspondent banks aggregating $61.5 million. These lines are intended for short-term borrowings and are subject to restrictions limiting the frequency and term of advances. These lines of credit are payable on demand and bear interest based upon the daily federal funds rate (5.50% at December 31, 2006). The Company had no balance outstanding at December 31, 2006 and $5.0 million outstanding on these lines of credit as of December 31, 2005. The maximum amounts outstanding under these lines of credit at any month-end during 2006 and 2005 were $35.0 million and $17.5 million, respectively. The average amounts outstanding under these lines of credit were $11.0 million for 2006 and $4.3 million for 2005.

We also entered into two reverse repurchase agreements in 2006 pursuant to a master repurchase agreement. Each repurchase agreement is for $10.0 million, and is collateralized with mortgage backed securities with a similar fair market value. The first repurchase agreement, dated August 1, 2006 has a five year term. The interest rate on this agreement was 4.49% from August 1, 2006 through November 1, 2006. The interest rate was fixed at 4.99% on November 1, 2006 until it is repurchased by the counterparty on August 1, 2011. The agreement is callable by the counterparty on a quarterly basis. The second repurchase agreement, dated August 1, 2006 has a seven year term with a repurchase date of August 1, 2013. The interest rate of this agreement was 4.55% from August 1, 2006 through February 1, 2007, at which time it will adjust to a variable rate of 9.85% minus three month LIBOR, not to exceed 5.85%, for the duration of the contract. The agreement is callable by the counterparty on a quarterly basis.

In August of 2003, $8.0 million of trust preferred securities were placed through Gateway Capital Statutory Trust I (the “Trust”). The Trust issuer has invested the total proceeds from the sale of the Trust Preferred in Junior Subordinated Deferrable Interest Debentures (the “Junior Subordinated Debentures”) issued by the Company. The trust preferred securities pay cumulative cash distributions quarterly at an annual rate, reset quarterly, equal to LIBOR plus 3.10%. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible for income tax purposes. The trust preferred securities are redeemable on or after September 17, 2008, in whole or in part. Redemption is mandatory at September 17, 2033. The Company has fully and unconditionally guaranteed the trust preferred securities through the combined operation of the debentures and

Page 44

other related documents. The Company’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company.

In June of 2004, $7.0 million of trust preferred securities were placed through Gateway Capital Statutory Trust II (the “Trust”). The Trust issuer has invested the total proceeds from the sale of the Trust Preferred Securities in Junior Subordinated Deferrable Interest Debentures (the “Junior Subordinated Debentures”) issued by the Company. The trust preferred securities pay cumulative cash distributions quarterly at an annual rate, reset quarterly, equal to the 3 month LIBOR plus 2.65%. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible for income tax purposes. The trust preferred securities are redeemable on or after June 17, 2009, in whole or in part. Redemption is mandatory at June 17, 2034. The Company has fully and unconditionally guaranteed the trust preferred securities through the combined operation of the debentures and other related documents. The Company’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company.

In May of 2006, $15.0 million of trust preferred securities were placed through Gateway Capital Statutory Trust III (the “Trust”). The Trust issuer has invested the total proceeds from the sale of the Trust Preferred Securities in Junior Subordinated Deferrable Interest Debentures (the “Junior Subordinated Debentures”) issued by the Company. The trust preferred securities pay cumulative cash distributions quarterly at an annual rate, reset quarterly, equal to the 3 month LIBOR plus 1.50%. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible for income tax purposes. The trust preferred securities are redeemable on or after May 30, 2011, in whole or in part. Redemption is mandatory at May 30, 2036. The Company has fully and unconditionally guaranteed the trust preferred securities through the combined operation of the debentures and other related documents. The Company’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company.

The trust preferred securities presently qualify as Tier 1 regulatory capital and are reported in Federal Reserve regulatory reports as a minority interest in a consolidated subsidiary. The junior subordinated debentures do not qualify as Tier 1 regulatory capital. On March 1, 2005, the Board of Governors of the Federal Reserve issued a final rule stating that trust preferred securities will continue to be included in Tier 1 capital, subject to stricter quantitative and qualitative standards. For Bank Holding Companies, trust preferred securities will continue to be included in Tier 1 capital up to 25% of core capital elements (including trust preferred securities) net of goodwill less any associated deferred tax liability.

ITEM 8 – FINANCIAL STATEMENTS

GATEWAY FINANCIAL HOLDINGS, INC. & SUBSIDIARY
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS

	Page No.
Report of Independent Registered Public Accounting Firm	39
Consolidated Balance Sheets as of December 31, 2006 and 2005	40
Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004	41
Consolidated Statements of Comprehensive Income for the years ended December 31, 2006, 2005 and 2004	42
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2006, 2005 and 2004	43
Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004	44
Notes to Consolidated Financial Statements	45

Page 45

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and the Board of Directors
Gateway Financial Holdings, Inc.
Virginia Beach, Virginia

We have audited the accompanying consolidated balance sheets of Gateway Financial Holdings, Inc. and subsidiary as of December 31, 2006 and 2005, and the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Gateway Financial Holdings, Inc.’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 14, 2007, expressed unqualified opinions on both management’s assessment of the Company’s internal control over financial reporting and the effectiveness of the Company’s internal control over financial reporting.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Gateway Financial Holdings, Inc. and subsidiary at December 31, 2006 and 2005 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.

Greenville, North Carolina
March 14, 2007

Page 46

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS
December 31, 2006 and 2005

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

Page 47

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2006, 2005 and 2004

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

See accompanying notes.

Page 48

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2006, 2005 and 2004

	2006			2005			2004
	(Amounts in thousands)
Net income	$	5,269		$	3,939		$	2,010
Other comprehensive income (loss):
Securities available for sale:
Unrealized holding gains (losses) on available-for-sale securities		351			(67	)		(489	)
Tax effect		(127	)		26			188
Reclassification of gains recognized in net income		(842	)		(282	)		(159	)
Tax effect		316			109			62
Total other comprehensive loss		(302	)		(214	)		(398	)
Comprehensive income	$	4,967		$	3,725		$	1,612

See accompanying notes.

Page 49

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2006, 2005 and 2004

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

See accompanying notes.

Page 50

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2006, 2005 and 2004

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

See accompanying notes.

Page 51

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE A - ORGANIZATION AND OPERATIONS

Gateway Bank & Trust Co. (the “Bank”) was incorporated November 24, 1998 and began banking operations on December 1, 1998. Effective October 1, 2001, the Bank became a wholly-owned subsidiary of Gateway Financial Holdings, Inc. (the “Company”), a financial holding company whose principal business activity consists of the ownership of the Bank, Gateway Capital Statutory Trust I, and Gateway Capital Statutory Trust II, and Gateway Capital Statutory Trust III.

The Bank is engaged in general commercial and retail banking in Northeastern North Carolina and in the Tidewater area of Southeastern Virginia, operating under state banking laws and the rules and regulations of the Federal Reserve System and the North Carolina Commissioner of Banks. The Bank undergoes periodic examinations by those regulatory authorities.

The Bank has three wholly-owned subsidiaries, Gateway Investment Services, Inc., whose principal activity is to engage in brokerage services as an agent for non-bank investment products and services, Gateway Insurance Services, Inc., an independent insurance agency with offices in Edenton, Hertford, Elizabeth City, Moyock, Plymouth and Kitty Hawk, North Carolina and Chesapeake and Newport News, Virginia and Gateway Financial Mortgage, Inc. with offices in Raleigh, Elizabeth City and Kitty Hawk, North Carolina and Norfolk and Virginia Beach, Virginia.

The Company formed Gateway Capital Statutory Trust I in 2003, Gateway Capital Statutory Trust II in 2004 and Gateway Capital Statutory Trust III in 2006, all of which are wholly owned by the Company, to facilitate the issuance of trust preferred securities totaling $8.0 million, $7.0 million and $15.0 million, respectively. Adoption of FASB Interpretation No. (FIN) 46, Consolidation of Variable Interest Entities resulted in the deconsolidation of these trust preferred subsidiaries. Upon deconsolidation, the junior subordinated debentures issued by the Company to the trusts were included in long-term borrowings and the Company’s equity interest in the trusts was included in other assets. The deconsolidation of the trusts did not materially impact net income.

The trust preferred securities presently qualify as Tier 1 regulatory capital and are reported in Federal Reserve regulatory reports as a minority interest in a consolidated subsidiary. The junior subordinated debentures do not qualify as Tier 1 regulatory capital. On March 1, 2005, the Board of Governors of the Federal Reserve issued the final rule that would retain the inclusion of trust preferred securities in Tier 1 capital of bank holding companies, but with stricter quantitative limits and clearer qualitative standards. Under the new rule, after a three-year transition period, the aggregate amount of trust preferred securities and certain other capital elements would be limited to 25 percent of tier 1 capital elements, net of goodwill less any associated deferred tax liability. The amount of trust preferred securities and certain other elements in excess of the limit could be included in tier 2 capital, subject to restrictions. The Company believes that the Bank would remain “well capitalized” under the new Federal Reserve Board guidelines.

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of Gateway Financial Holdings, Inc. and Gateway Bank & Trust Co., and its three wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses.

Page 52

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Cash and Cash Equivalents

For the purpose of presentation in the statement of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet captions “Cash and due from banks” and “Interest-earning deposits in other banks.”

Investment Securities Held to Maturity

Investment securities that management has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity.

Investment Securities Available for Sale

Investment securities available for sale are reported at fair value and consist of debt instruments that are not classified as either trading securities or as held to maturity securities. Unrealized holding gains and losses, net of deferred income tax, on available for sale securities are reported as a net amount in other comprehensive income. Gains and losses on the sale of investment securities available for sale are determined using the specific-identification method. Declines in the fair value of individual held to maturity and investment securities available for sale below their cost that are other than temporary would result in write-downs of the individual securities to their fair value. Such write-downs would be included in earnings as realized losses. Premiums and discounts are recognized in interest income using the interest method over the period to maturity.

Mortgage Loans Held for Sale

The Company originates single family, residential first mortgage loans on a pre-sold basis. Loans held for sale are carried at the lower of cost or fair value in the aggregate as determined by outstanding commitments from investors. The Company issues a rate lock commitment to a customer and concurrently “locks in” with a secondary market investor under a best efforts delivery system. Within several weeks of closing, these loans, together with their servicing rights, are sold to other financial institutions under prearranged terms. The Company recognizes certain origination and service release fees upon the sale, which are included in mortgage operations which is part of non-interest income in the consolidated statement of operations.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at their outstanding principal adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. When loans become classified as non-accrual loans interest accrual is discontinued.

Page 53

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Allowance for Loan Losses

The provision for loan losses is based upon management’s estimate of the amount needed to maintain the allowance for loan losses at an adequate level. In making the evaluation of the adequacy of the allowance for loan losses, management gives consideration to current economic conditions, statutory examinations of the loan portfolio by regulatory agencies, delinquency information and management’s internal review of the loan portfolio. Loans are considered impaired when it is probable amounts will not be collected in accordance to the contractual terms of the loan agreement. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, or upon the fair value of the collateral if collateral dependent. If the recorded investment in the loan (including accrued and unpaid interest) exceeds the measure of fair value, a valuation allowance is established as a component of the allowance for loan losses. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, regulatory examiners may require the Bank to recognize adjustments to the allowance for loan losses based on their judgments about information available to them at the time of their examination.

Foreclosed Real Estate

Real estate acquired through, or in lieu of, loan foreclosure is initially recorded at fair value less estimated cost to sell at the date of foreclosure establishing a new cost basis. After foreclosure, valuations of the property are periodically performed by management and the real estate is carried at the lower of cost or fair value minus estimated cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other non-interest expense.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated on the straight-line method over the estimated useful asset lives of 3 - 10 years for furniture and equipment, 5 years for vehicles, and 40 years for bank premises. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Repairs and maintenance costs are charged to operations as incurred and additions and improvements to premises and equipment are capitalized. Upon sale or retirement, the cost and related accumulated depreciation are removed from the accounts and any gains or losses are reflected in current operations.

Federal Home Loan Bank and Federal Reserve Bank Stock

As a requirement for membership, the Company invests in stock of the Federal Home Loan Bank of Atlanta (“FHLB”) and the Federal Reserve Bank (“FRB”). These investments are carried at cost. Due to the redemption provisions of these entities, the Company estimated that fair value equals cost and that these investments were not impaired at December 31, 2006.

Intangible Assets

Intangible assets include goodwill and other identifiable assets, such as core deposit premiums, resulting from acquisitions. Core deposit premiums are amortized primarily on a straight-line basis over a ten-year life based upon historical studies of core deposits. Intangible assets related to insurance agency acquisitions are amortized over the expected life of the book of business acquired. Goodwill is not amortized but is tested annually for impairment or at any time an event occurs or circumstances change that may trigger a decline in the value of the reporting unit. Examples of such events or circumstances include adverse changes in legal factors, business climate, unanticipated competition, change in regulatory environment or loss of key personnel.

Page 54

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Intangible Assets (Continued)

The Company tests for impairment in accordance with SFAS No. 142. Potential impairment of goodwill exists when the carrying amount of a reporting unit exceeds its fair value. The fair value of a reporting unit is computed using one or a combination of the following three methods: income, market value or cost method. The income method uses a discounted cash flow analysis to determine fair value by considering a reporting unit’s capital structure and applying a risk-adjusted discount rate to forecast earnings based on a capital asset pricing model. The market value method uses recent transaction analysis or publicly traded comparable analysis for similar assets and liabilities to determine fair value. The cost method assumes the net assets of a recent business combination accounted for under the purchase method of accounting will be recorded at fair value if no event or circumstance has occurred triggering a decline in the value. To the extent a reporting unit’s carrying amount exceeds its fair value, an indication exists that the reporting unit’s goodwill may be impaired, and a second step of impairment test will be performed. In the second step, the implied fair value of the reporting unit’s goodwill, determined by allocating the reporting unit’s fair value to all of its assets (recognized and unrecognized) and liabilities as if the reporting unit had been acquired in a business combination at the date of the impairment test. If the implied fair value of reporting unit goodwill is lower than its carrying amount, goodwill is impaired and is written down to its implied fair value. The loss recognized is limited to the carrying amount of goodwill. Once an impairment loss is recognized, future increases in fair value will not result in the reversal of previously recognized losses.

Income Taxes

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred tax assets are also recognized for operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized.

Comprehensive Income

The Company reports as comprehensive income all changes in stockholders’ equity during the year from sources other than stockholders. Other comprehensive income refers to all components (revenues, expenses, gains, and losses) of comprehensive income that are excluded from net income. The Company’s only component of other comprehensive income is unrealized gains and losses on investment securities available for sale.

Mortgage Operations

The Bank originates single family, residential first mortgage loans on a presold basis. For a portion of the year, such loans were closed by a third party and therefore are not shown in the Company’s consolidated financial statements. The Bank recognizes certain origination and service release fees upon the sale, which are included in non-interest income on the statements of operations under the caption “Mortgage operations.” Also included under this caption is income derived from investments in certain mortgage companies. During the year the bank ceased using a third party to close such loans after it opened its wholly owned mortgage subsidiary, Gateway Financial Mortgage, Inc. These originations were closed by our mortgage company with the related fees and expenses recorded in the consolidated financial statements.

Page 55

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE B – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Stock Compensation Plans

Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment,” (“SFAS No. 123R”) which was issued by the FASB in December 2004. SFAS No. 123R revises SFAS No. 123 “Accounting for Stock Based Compensation,” and supersedes APB No. 25, “Accounting for Stock Issued to Employees,” (APB No. 25) and its related interpretations. SFAS No. 123R requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (usually the vesting period). SFAS No. 123R also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. SFAS No. 123R also amends SFAS No. 95 “Statement of Cash Flows,” to require that excess tax benefits be reported as financing cash inflows flows, rather than as a reduction of taxes paid, which is included within operating cash flows.

The Company adopted SFAS No. 123R using the modified prospective application as permitted under SFAS No. 123R. Accordingly, prior period amounts have not been restated. Under this application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption.

Prior to the adoption of SFAS No. 123R, the Company used the intrinsic value method as prescribed by APB No. 25 and thus recognized no compensation expense for options granted with exercise prices equal to the fair market value of the Company’s common stock on the date of the grant.

The Company has three share-based compensation plans in effect at December 31, 2006. The compensation cost that has been charged against income for those plans was approximately $222,000 for the twelve months ended December 31, 2006. During 2006 the Company recorded tax benefits totaling $293,000 related to options exercises.

The adoption of SFAS 123R and its fair market value cost recognition provisions are different from the provisions used SFAS 123 and the intrinsic value method for compensation cost allowed under APB 25. The effect (increase (decrease)) of the adoption of 123R is presented below:

	2005		2004
	(Amounts in thousands,
	except per share data)
Net income:
As reported	$	3,939	$	2,010
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects		1,748		1,429
Pro forma	$	2,191	$	581
Basic net income per share:
As reported	$	0.48	$	0.37
Pro forma		0.27		0.11
Diluted net income per share:
As reported	$	0.46	$	0.34
Pro forma		0.26		0.10

For purposes of this pro-forma disclosure, the value of the options is estimated using the Black-Scholes option pricing model and amortized to expense over the options’ vesting periods.

Page 56

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Per Share Results

Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options and are determined using the treasury stock method.

The basic and diluted weighted average shares outstanding are as follows:

	2006		2005		2004
Weighted average outstanding shares used for basic EPS		10,811,980		8,214,118		5,419,300
Plus incremental shares from assumed exercise of:
Stock options		293,166		339,275		272,411
Restricted stock		16,557		2,619		-
Warrants		-		-		216,359
Weighted average outstanding shares used for diluted EPS		11,121,703		8,556,012		5,908,070

On February 27, 2004, the Company’s Board of Directors declared a 21-for-20 stock split, effected in the form of a 5% stock dividend, which was distributed April 8, 2004 to stockholders of record on March 15, 2004. On May 16, 2005, the Company’s Board of Directors declared a 11-for-10 stock split, effected in the form of a 10% stock dividend, which was distributed June 20, 2005 to stockholders of record on May 30, 2005 This year our Board of Directors declared an 11-for-10 stock split, effected in the form of a 10% stock dividend, which was distributed May 15, 2006 to stockholders of record on April 28, 2006. All references to per share results and weighted average common and common equivalent shares outstanding have been adjusted to reflect the effects of these stock splits.

There were no adjustments required to be made to net income in the computation of diluted earnings per share. For the years ended December 31, 2006, 2005 and 2004, there were 162,250, 126,000, and 464,000 options, respectively, that were antidilutive since the exercise price for these options exceeded the average market price of the Company’s common stock for the year.

Derivative financial instruments

For asset/liability management purposes, the Company uses interest rate swap agreements to hedge various exposures or to modify interest rate characteristics of various balance sheet accounts. Such derivatives are used as part of the asset/liability management process and are linked to specific assets or liabilities, and have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period.

The Company utilizes interest rate swap agreements to convert a portion of its variable rate loans to a fixed rate economic hedge. Interest rate swaps are contracts in which a series of interest rate flows are exchanged over a prescribed period. The notional amount on which the interest payments are based is not exchanged.

Under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” requires that changes in the fair market value of derivative financial instruments that do not qualify for hedge accounting treatment be reported as an economic gain or loss in non-interest income.

Page 57

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recent Accounting Pronouncements

In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 155, “Accounting for Certain Hybrid Financial Instruments -an amendment of FASB Statements No. 133 and 140,” which simplifies accounting for certain hybrid financial instruments by permitting fair value remeasurement for any hybrid instrument that contains an embedded derivative that otherwise would require bifurcation and eliminates a restriction on the passive derivative instruments that a qualifying special-purpose entity may hold. SFAS No. 155 is effective for all financial instruments acquired, issued or subject to a remeasurement (new basis) event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not expect the adoption of this new standard to have a material effect on the Company’s consolidated results of operations or consolidated financial position.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140,” which establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities by requiring that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable and permits the entity to choose either the amortization method or fair value method for subsequent measurement. SFAS No. 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. We are currently evaluating the impact of this new standard on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the impact of this new standard on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 123(R),” which requires a business entity to recognize the overfunded or underfunded status of a single-employer defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in comprehensive income in the year in which the changes occur. SFAS No. 158 also requires a business entity to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. The provisions of this statement are effective as of the end of the first fiscal year ending after December 15, 2006. We have determined that the impact of this new standard on our consolidated financial statements does not have a material effect.

In June 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109,” which establishes that the financial statement effects of a tax position taken or expected to be taken in a tax return are to be recognized in the financial statements when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. FIN 48 is effective for fiscal years beginning after December 15, 2006. We have determined that the impact of our tax liability is immaterial to our consolidated financial statements.

Page 58

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recent Accounting Pronouncements (Continued)

In 2006 the Emerging Issues Task Force issued EITF Issue 06-4 “Accounting for Deferred Compensation and Postretirement Benefits Aspects of Endorsement Split-Dollar Life Insurance Arrangements” requires the recognition of a liability related to the postretirement benefits covered by an endorsement split-dollar life insurance arrangement. The employer (who is also the policyholder) has a liability for the benefit it is providing to its employee. As such, if the policyholder has agreed to maintain the insurance policy in force for the employee’s benefit during his or her retirement, then the liability recognized during the employee’s active service period should be based on the future cost of insurance to be incurred during the employee’s retirement. Alternatively, if the policyholder has agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized by following the guidance in Statement 106 or Opinion 12, as appropriate. This issue is applicable for interim or annual reporting periods beginning after December 15, 2007. The Company is currently evaluating the impact that this pronouncement will have on the consolidated financial statements.

SAB 108 – In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statements misstatements.

Traditionally, there have been two widely-recognized methods for quantifying the effects of financial statement misstatements the “roll-over” method and the “iron curtain” method. The roll-over method focuses primarily on the impact of a misstatement on the income statement – including the reversing effect of prior year misstatements – but its use can lead to the accumulation of misstatements in the balance sheet. The iron-curtain method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. We currently use the roll-over method for quantifying identified financial statement misstatements.

In SAB 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the Company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron curtain and the roll-over-methods.

SAB 108 permits existing public companies to initially apply its provisions either by (i) restating prior financial statements as if the “dual approach” had always been used or (ii) recording the cumulative effect of initially applying the “dual approach” as adjustments to the carrying values of assets and liabilities as of October 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings. Use the “cumulative effect” transition method requires detailed disclosure of the nature and amount of each individual error being corrected through the cumulative adjustment and how and when it arose. The effects of adopting the provisions of SAB 108 does not have a material impact on our consolidated financial statements.

EITF 06-5 – The EITF reached a consensus at its September 2006 meeting regarding EITF 06-5, Accounting for Purchases of Life Insurance Determining the Amount That Could be Realized in Accordance with FASB Technical Bulletin No. 85-4. The scope of EITF 06-5 is limited to the determination of net cash surrender value of a life insurance contract in accordance with Technical Bulletin 85-4. This EITF outlines when contractual limitations of the policy should be considered when determining the net realizable value of the contract. EITF 06-5 is effective for fiscal years beginning after December 15, 2006, with earlier application permitted. The Company has not yet evaluated the effects of this EITF.

From time to time, the FASB issues exposure drafts for proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.

Page 59

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Reclassifications

Certain amounts in the 2005 and 2004 consolidated financial statements have been reclassified to conform to the 2006 presentation. The reclassifications had no effect on net income or stockholders’ equity as previously reported.

NOTE C - INVESTMENT SECURITIES

The following is a summary of the securities portfolio by major classification:

	December 31, 2006
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
	(Amounts in thousands)
Securities available-for-sale:
U. S. government securities and obligations of U.S. government agencies	$	36,900	$	-	$	922	$	35,978
Corporate debt/equity securities		8,415		403		10		8,808
Mortgage-backed securities		42,748		9		616		42,141
Municipal securities		6,612		14		78		6,548
	$	94,675	$	426	$	1,626	$	93,475

	December 31, 2005
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
			(Amounts in thousands)
Securities available-for-sale:
U. S. government securities and obligations of U.S. government agencies	$	42,555	$	-	$	1,327	$	41,228
Corporate debt/equity securities		6,619		1,373		117		7,875
Mortgage-backed securities		67,935		13		581		67,367
Municipal securities		7,372		18		87		7,303
	$	124,481	$	1,404	$	2,112	$	123,773

The following tables show our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at December 31, 2006 and December 31, 2005. For available for sale securities, the unrealized losses relate to fifteen U.S. government securities and obligations of U.S. government agencies, three corporate debt securities, seventeen municipal securities and eleven mortgage-backed securities. All investment securities with unrealized losses are considered by management to be temporarily impaired given the credit ratings on these investment securities and management’s intent and ability to hold these securities until recovery. Should the Company decide in the future to sell securities in an unrealized loss position, or determine that impairment of any securities is other than temporary, irrespective of a decision to sell, an impairment loss would be recognized in the period such determination is made.

Page 60

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE C - INVESTMENT SECURITIES (Continued)

	2006
	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	value		losses		value		losses		value		losses
Securities available for sale:
U.S. government securities and obligations of U.S. government agencies	$	-	$	-	$	35,978	$	922	$	35,978	$	922
Corporate		-		-		1,542		10		1,542		10
Mortgage-backed securities		21,749		302		7,989		314		29,738		616
Municipal securities		1,313		12		2,924		66		4,237		78
Total temporarily impaired securities	$	23,062	$	314	$	48,433	$	1,312	$	71,495	$	1,626

	2005
	Less Than 12 Months				12 Months or More				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	value		losses		value		losses		value		losses
Securities available for sale:
U.S. government securities and obligations of U.S. government agencies	$	-	$	-	$	40,727	$	1,327	$	40,727	$	1,327
Corporate		981		58		472		59		1,453		117
Mortgage-backed securities		9,216		260		8,545		321		17,761		581
Municipal securities		3,937		52		2,089		35		6,026		87
Total temporarily impaired securities	$	14,134	$	370	$	51,833	$	1,742	$	65,967	$	2,112

Proceeds from maturities, sales and calls of investment securities during the years ended December 31, 2006, 2005 and 2004 were $38.2 million, $26.6 million and $37.6 million, respectively. From those transactions, the Company realized gross gains of $842,000, $333,000 and $171,000 and gross losses of $0, $52,000 and $12,000 in 2006, 2005 and 2004, respectively.

The amortized cost and fair values of securities available-for-sale at December 31, 2006 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized		Fair
	Cost		Value
	(Dollars in thousands)
Due within one year	$	12,864	$	13,190
Due after one year through five years		35,261		34,331
Due after five years through ten years		1,432		1,418
Due after ten years		45,118		44,536
	$	94,675	$	93,475

Page 61

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE C - INVESTMENT SECURITIES (Continued)

For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of underlying collateral. The mortgage-backed securities may mature earlier than their weighted-average contractual maturities because of principal prepayments.

Securities with an amortized cost of $51.2 million and a fair value of $50.3 million were pledged to secure FHLB advances and public monies on deposit as required by law at December 31, 2006.

NOTE D - LOANS

A summary of the balances of loans follows:

	December 31,
	2006			2005
	(Dollars in thousands)
Commercial	$	150,070		$	80,816
Real estate – construction		183,831			114,018
Real estate – commercial mortgage		362,322			221,526
Mortgage loans held for sale		15,576			—
Real estate – 1-4 family mortgage		108,498			82,987
Consumer		88,744			98,881
Home equity lines of credit		85,882			69,246
Subtotal		994,923			667,474
Less: Allowance for loan losses		(9,405	)		(6,283	)
Unamortized net deferred fees		(331	)		(822	)
Net loans	$	985,187		$	660,369

Loans are primarily made in central and eastern North Carolina and the Tidewater area of Southeastern Virginia. Real estate loans can be affected by the condition of the local real estate market. Commercial and industrial loans and loans to individuals can be affected by the local economic conditions. Non-accrual loans, all of which are considered to be impaired, at December 31, 2006 and 2005 consisted of loans of approximately $3.3 million and $204,000, respectively, that were more than 90 days delinquent and on which the accrual of interest had ceased. The average recorded investment in non-accrual loans was approximately $1.3 million, $252,000 and $840,000 for the years ended December 31, 2006, 2005 and 2004, respectively. Interest income that would have been recorded on non-accrual loans totaled $70,000 $141,000 and $138,000 for the years ended December 31, 2006, 2005 and 2004. The total amount of impaired loans as of December 31, 2006 and 2005 was $4.1 million and $318,000, respectively. The allowance for loan losses allocated to these impaired loans was $902,000 and $120,000.

The Company grants loans to directors and executive officers of the Bank and their related interests. Such loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other borrowers and, in management’s opinion, do not involve more than the normal risk of collectibility. All loans to directors and executive officers or their related interests are submitted to the Board of Directors for approval.

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GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE D - LOANS (Continued)

A summary of related party loan transactions is as follows (in thousands):

	2006
Balance at beginning of year	$	35,464
Additions		33,402
Loan repayments		(18,492	)
Balance at end of year	$	50,374

At December 31, 2006, commitments to extend credit to directors, executive officers and their related interests consisted of unused lines of credit totaling $16.0 million.

An analysis of the allowance for loan losses follows:

	2006			2005			2004
	(Amounts in thousands)
Balance at beginning of year	$	6,283		$	4,163		$	2,759
Provision charged to operations		3,400			2,200			1,425
Allowance for loan losses on loans purchased		-			-			-
Charge-offs		(305	)		(87	)		(174	)
Recoveries		27			7			153
Net charge-offs		(278	)		(80	)		(21	)
Balance at end of year	$	9,405		$	6,283		$	4,163

     NOTE E - PREMISES AND EQUIPMENT

Following is a summary of premises and equipment at December 31, 2006 and 2005:

	2006			2005
	(Amounts in thousands)
Land	$	4,799		$	2,942
Furniture and equipment		9,692			6,692
Vehicles		763			617
Buildings and improvements		25,942			14,927
Construction in progress		3,135			8,350
Accumulated depreciation		(5,875	)		(3,977	)
Total	$	38,456		$	29,551

Depreciation and amortization amounting to $2.4 million, $1.5 million and $970,000 for the years ended December 31, 2006, 2005 and 2004, respectively, is included in occupancy and equipment expense.

The Company leases, under separate agreements, land on which the permanent headquarters and adjacent parking lot are located. The Company also leases land on which its Chesapeake, Virginia financial center is located, as well as, its operations facility and financial center facilities in Norfolk, Chesapeake and Virginia Beach, Virginia and Elizabeth City, Raleigh, Kitty Hawk and Nags Head, North Carolina. These leases expire at various dates through January 31, 2034. Future rentals under these leases are as follows (in thousands):

Page 63

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE E – PREMISES AND EQUIPMENT (Continued)

2007	$	1,554
2008		1,442
2009		1,330
2010		1,309
2011		1,227
Thereafter		14,148
	$	21,010

Rental expense amounted to $1.5 million, $819,000 and $655,000 during the years ended December 31, 2006, 2005 and 2004, respectively.

Certain leases contain options to extend for up to three consecutive five-year terms. The Company has an option to purchase the land on which its permanent headquarters are affixed at the end of the twenty-year lease term for a cost of $300,000.

Gateway Bank & Trust Co. leases its Nags Head and one of its Kitty Hawk branch offices from a director, Billy G. Roughton, and his wife for monthly payments of approximately $6,000 and $15,875, respectively. The term of the Nags Head lease is for five years, with one five-year renewal. Kitty Hawk is a land lease that commenced in April 2006 for a term of for twenty years, with three five-year renewals.

Our commitment for construction projects as of December 31, 2006 is approximately $16.5 million.

NOTE F – DEPOSITS

The weighted average cost of time deposits was 4.56%, 3.85% and 2.69% at December 31, 2006, 2005 and 2004, respectively.

Time deposits in denominations of $100,000 or more were $205.5 million and $151.4 million at December 31, 2006 and 2005, respectively. Interest expense on such deposits aggregated $10.2 million in 2006 and $9.1 million in 2005. At December 31, 2006, the scheduled maturities of time deposits are as follows (in thousands):

	$100,000		Under
	and Over		$100,000		Total
2007	$	200,695	$	328,639	$	529,334
2008		2,923		7,897		10,820
2009		309		2,152		2,461
2010		1,525		1,039		2,564
2011		–		1,881		1,881
2012		–		–		–
Total	$	205,452	$	341,608	$	547,060

Page 64

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE G – BORROWINGS

A summary of the balances of borrowings follows:

	December 31,
	2006		2005
	(Dollars in thousands)
Federal fund purchased	$	–	$	5,000
Federal Home Loan Bank		14,500		57,000
Total short-term borrowings	$	14,500	$	62,000
Federal Home Loan Bank	$	101,500	$	57,200
Reverse repurchase agreements		20,000		–
Junior Subordinated Debentures		30,929		15,465
Total long-term borrowings	$	152,429	$	72,665

Advances from the Federal Home Loan Bank of Atlanta consisted of the following at December 31, 2006 and 2005:

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

Pursuant to collateral agreements with the Federal Home Loan Bank, at December 31, 2006 advances are secured by investment securities available for sale with a fair value of $24.1 million and by loans with a carrying amount of $205.6 million, which approximates market value. The Company has a maximum borrowing availability from FHLB equal to 25% of total assets.

The Company may purchase federal funds through five unsecured federal funds lines of credit aggregating $61.5 million. These lines are intended for short-term borrowings and are subject to restrictions limiting the frequency and term of advances. These lines of credit are payable on demand and bear interest based upon the daily federal funds rate (5.50% at December 31, 2006). The Company had $0 million and $5.0 million outstanding on these lines of credit as of December 31, 2006 and 2005, respectively. The maximum amounts outstanding under these lines of credit at any month-end during 2006 and 2005 were $35.0 million and $17.5 million, respectively. The average amounts outstanding under these lines of credit were $11.0 million for 2006 and $4.3 million for 2005.

Page 65

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE G-BORROWINGS (Continued)

The Company entered into two reverse repurchase agreements in 2006 pursuant to a master repurchase agreement. Each repurchase agreement is for $10.0 million, and is collateralized with mortgage backed securities with a similar fair market value. The first repurchase agreement, dated August 1, 2006 has a five year term. The interest rate on this agreement was 4.49% from August 1, 2006 through November 1, 2006. The interest rate was fixed at 4.99% on November 1, 2006 until it is repurchased by the counterparty on August 1, 2011. The agreement is callable by the counterparty on a quarterly basis. The second repurchase agreement, dated August 1, 2006 has a seven year term with a repurchase date of August 1, 2013. The interest rate of this agreement was 4.55% from August 1, 2006 through February 1, 2007, at which time it will adjust to a variable rate of 9.85% minus three month LIBOR, not to exceed 5.85%, for the duration of the contract. The agreement is callable by the counterparty on a quarterly basis.

In August of 2003, $8.0 million of trust preferred securities were placed through Gateway Capital Statutory Trust I (the “Trust”). The Trust issuer has invested the total proceeds from the sale of the Trust Preferred in Junior Subordinated Deferrable Interest Debentures (the “Junior Subordinated Debentures”) issued by the Company. The trust preferred securities pay cumulative cash distributions quarterly at an annual rate, reset quarterly, equal to LIBOR plus 3.10%. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible for income tax purposes. The trust preferred securities are redeemable on or after September 17, 2008, in whole or in part. Redemption is mandatory at September 17, 2033. The Company has fully and unconditionally guaranteed the trust preferred securities through the combined operation of the debentures and other related documents. The Company’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company.

In June of 2004, $7.0 million of trust preferred securities were placed through Gateway Capital Statutory Trust II (the “Trust”). The Trust issuer has invested the total proceeds from the sale of the Trust Preferred Securities in Junior Subordinated Deferrable Interest Debentures (the “Junior Subordinated Debentures”) issued by the Company. The trust preferred securities pay cumulative cash distributions quarterly at an annual rate, reset quarterly, equal to the 3 month LIBOR plus 2.65%. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible for income tax purposes. The trust preferred securities are redeemable on or after June 17, 2009, in whole or in part. Redemption is mandatory at June 17, 2034. The Company has fully and unconditionally guaranteed the trust preferred securities through the combined operation of the debentures and other related documents. The Company’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company.

In May of 2006, $15.0 million of trust preferred securities were placed through Gateway Capital Statutory Trust III (the “Trust”). The Trust issuer has invested the total proceeds from the sale of the Trust Preferred Securities in Junior Subordinated Deferrable Interest Debentures (the “Junior Subordinated Debentures”) issued by the Company. The trust preferred securities pay cumulative cash distributions quarterly at an annual rate, reset quarterly, equal to the 3 month LIBOR plus 1.50%. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible for income tax purposes. The trust preferred securities are redeemable on or after May 30, 2011, in whole or in part. Redemption is mandatory at May 30, 2036. The Company has fully and unconditionally guaranteed the trust preferred securities through the combined operation of the debentures and other related documents. The Company’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company.

The trust preferred securities presently qualify as Tier 1 regulatory capital and are reported in Federal Reserve regulatory reports as a minority interest in a consolidated subsidiary. The junior subordinated debentures do not qualify as Tier 1 regulatory capital. On March 1, 2005, the Board of Governors of the Federal Reserve issued a final rule stating that trust preferred securities will continue to be included in Tier 1 capital, subject to stricter quantitative and qualitative standards. For Bank Holding Companies, trust preferred securities will continue to be included in Tier 1 capital up to 25% of core capital elements (including trust preferred securities) net of goodwill less any associated deferred tax liability.

Page 66

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE H-INCOME TAXES

The significant components of the provision for income taxes for the years ended December 31, 2006, 2005 and 2004.

	2006			2005			2004
	(In thousands)
Current tax provision:
Federal	$	3,373		$	1,841		$	837
State		571			309			181
		3,944			2,150			1,018
Deferred tax provision:
Federal		(1,130	)		(181	)		(65	)
State		(189	)		(4	)		(16	)
		(1,319	)		(185	)		(81	)
Provision for income tax expense before adjustment to deferred tax asset valuation allowance		2,625			1,965			937
Decrease in valuation allowance		-			-			(227	)
Net provision for income taxes	$	2,625		$	1,965		$	710

The difference between the provision for income taxes and the amounts computed by applying the statutory federal income tax rate of 34% to income before income taxes is summarized below:

	2006			2005			2004
	(In thousands)
Tax computed at the statutory federal rate	$	2,684		$	2,007		$	925
Increase (decrease) resulting from:
State income taxes, net of federal benefit		253			184			109
Adjustment to deferred tax asset valuation allowance		-			-			(227	)
Non-taxable interest income		(65	)		(59	)		(17	)
Non-taxable income from bank owned life insurance		(294	)		(231	)		(137	)
Other permanent differences		47			64			57
Provision for income taxes	$	2,625		$	1,965		$	710

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred taxes at December 31, 2006 and 2005 are as follows:

Page 67

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE H-INCOME TAXES (Continued)

	2006			2005
	(In thousands)
Deferred tax assets relating to:
Allowance for loan losses	$	3,464		$	2,285
Equity investment basis difference		6			10
Unrealized loss on economic hedge		460			—
Unrealized loss on securities available for sale		462			273
Other		187			40
Total deferred tax assets		4,579			2,608
Deferred tax liabilities relating to:
Premises and equipment		(545	)		(527	)
Deferred loan costs		(709	)		(383	)
Intangible assets		(1,026	)		(253	)
Prepaid expenses		(248	)		(259	)
Total deferred tax liabilities		(2,528	)		(1,422	)
Net recorded deferred tax assets	$	2,051		$	1,186

It is management’s opinion that realization of the net deferred tax asset is more likely than not based on the Company’s history of taxable income and estimates of future taxable income.

NOTE I - OTHER NON-INTEREST EXPENSE

The major components of other non-interest expense for the years ended December 31, 2006, 2005 and 2004 are as follows:

	2006		2005		2004
	(Dollars in thousands)
Professional services	$	1,535	$	1,399	$	643
Postage, printing and office supplies		1,504		1,355		847
Advertising and promotion		1,814		541		478
Amortization of intangibles		323		380		130
Other		3,994		2,475		1,227
Total	$	9,170	$	6,150	$	3,325

NOTE J-REGULATORY MATTERS

The Company is subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios, as set forth in the table below. Management believes, as of December 31, 2006, that the Company meets all capital adequacy requirements to which it is subject. At December 31, 2006, the Company’s total risk-based capital, Tier I risk-based capital, and leverage ratios were 12.99%, 12.11% and 11.38%, respectively.

Page 68

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE J-REGULATORY MATTERS (Continued)

As of December 31, 2006, the most recent notification from the 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 amounts and ratios, as set forth in the table below. There are no conditions or events since that notification that management believes have changed the Bank’s category. The Bank’s actual capital amounts and ratios are also presented in the table below:

											Minimum to be Well
											Capitalized under
						Minimum for Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
As of December 31, 2006:
Total Capital (to Risk-Weighted Assets)	$	130,191		12.28	%	$	84,814		8.00	%	$	106,018		10.00	%
Tier I Capital (to Risk-Weighted Assets)		120,786		11.39	%		42,407		4.00	%		63,611		6.00	%
Tier I Capital (to Average Assets)		120,786		10.62	%		45,929		4.00	%		57,411		5.00	%
As of December 31, 2005:
Total Capital (to Risk-Weighted Assets)	$	100,659		14.00	%	$	58,111		8.00	%	$	72,639		10.00	%
Tier I Capital (to Risk-Weighted Assets)		94,376		13.13	%		29,055		4.00	%		43,583		6.00	%
Tier I Capital (to Average Assets)		94,376		12.47	%		30,271		4.00	%		37,839		5.00	%

The Bank may not declare or pay a cash dividend, or repurchase any of its capital stock, if the effect would cause the regulatory net worth of the Bank to fall to an amount which is less than the minimum required by the FDIC and the North Carolina Office of the Commissioner of Banks.

NOTE K - OFF-BALANCE SHEET RISK

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank, upon extension of credit is based on management’s credit evaluation of the borrower. Collateral obtained varies but may include real estate, stocks, bonds, and certificates of deposit.

Page 69

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE K-OFF-BALANCE SHEET RISK (Continued)

A summary of the contract amount of the Company’s exposure to off-balance sheet risk as of December 31, 2006 is as follows (in thousands):

Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit	$	18,651
Undisbursed lines of credit		237,473
Standby letters of credit		6,187
Construction commitments		16,500

NOTE L-DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS

Financial instruments include cash and due from banks, interest-earning deposits with banks, investments, loans, stock in the Federal Reserve Bank and the Federal Home Loan Bank of Atlanta, deposit accounts and borrowings. Fair value estimates are made at a specific moment in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no active market readily exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Due from Banks and Interest-Earning Deposits in Other Banks

The carrying amounts for cash and due from banks and interest-earning deposits in other banks approximate fair value because of the short maturities of those instruments.

Investment Securities

Fair value for investment securities equals quoted market price if such information is available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

Loans

For certain homogenous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The carrying amount of loans held for sale is a reasonable estimate of fair value since they will be sold in a short period.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

Page 70

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE L-DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)

Stock in Federal Reserve Bank and Federal Home Loan Bank of Atlanta

The fair value for FRB and FHLB stock approximates carrying value, based on the redemption provisions of the Federal Reserve Bank and Federal Home Loan Bank.

Bank Owned Life Insurance

The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.

Deposits

The fair value of demand, savings, money market and NOW account deposits is the amount payable on demand at the reporting date. The fair value of time deposits is estimated based on discounting expected cash flows using the rates currently offered for instruments of similar remaining maturities.

Borrowings

The fair values are based on discounting expected cash flows at the interest rate for debt with the same or similar remaining maturities and collateral requirements.

Financial Instruments with Off-Balance Sheet Risk

With regard to financial instruments with off-balance sheet risk discussed in Note L, it is not practicable to estimate the fair value of future financing commitments.

The carrying amounts and estimated fair values of the Company’s financial instruments, none of which are held for trading purposes, are as follows at December 31, 2006 and 2005:

	2006				2005
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
	(In thousands)
Financial assets:
Cash and due from banks	$	22,077	$	22,077	$	18,475	$	18,475
Interest-earning deposits in other banks		4,717		4,717		3,668		3,668
Investment securities		93,475		93,475		123,773		123,773
Accrued interest receivable		8,742		8,742		5,883		5,883
Federal Reserve Bank stock		3,609		3,609		2,097		2,097
Federal Home Loan Bank stock		6,970		6,970		6,208		6,208
Loans		994,592		989,650		666,652		669,600
Bank owned life insurance		25,051		25,051		17,187		17,187
Financial liabilities:
Deposits		923,725		931,413		646,262		647,704
Borrowings		166,929		167,846		134,665		129,606
Accrued interest payable		2,569		2,569		1,126		1,126

Page 71

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE M-EMPLOYEE AND DIRECTOR BENEFIT PLANS

401(k) Retirement Plan

The Company has a 401(k) retirement plan that contains provisions for specified matching contributions by the Bank. The Company funds contributions as they accrue. Total 401(k) expense was $520,000, $388,000 and $265,000 during the years ended December 31, 2006, 2005 and 2004, respectively.

Stock Based Compensation

During 1999 the Bank adopted, with stockholder approval, an Employee Stock Option Plan (the “Employee Plan”) and a Director Stock Option Plan (the “Director Plan”). During 2002 and 2001 the Company increased the number of shares available under these option plans. On November 24, 2004, the Company adopted the 2005 Omnibus Stock Ownership And Long Term Incentive Plan (the “Omnibus Plan”) subject to stockholder approval at the 2005 stockholder meeting, and made certain grants of nonstatutory options pursuant to the Omnibus Plan. On November 24, 2004, the Company increased, by 556,600, the number of options that were subject to stockholder approval at the 2005 stockholder meeting, and made certain grants of these options. All options granted prior to November 2004 to non-employee directors vested immediately at the time of grant, while other options from this pool vest over a four-year period with 20% vesting on the grant date and 20% vesting annually thereafter. Options granted from the pool of shares made available on November 24, 2004 to non-employee directors vested immediately at the time of the grant, while options from this pool granted to employees vest 50% in at the time of grant and 50% the following year. In May 2005, the Company increased the number of options available for grant by 726,000. During the year ended December 31, 2005 the Company granted 162,250 nonstatutory options which vested immediately. On August 28, 2006 and October 25, 2006 the Company granted 152,500 and 14,000, respectively, nonstatutory options which will vest at 20% per year beginning the month following the quarter in which the Company achieves a ROA of 1%. For purposes of the ROA calculation, the gain or loss from the fair market value of the economic hedge are excluded. All unexercised options expire ten years after the date of grant. All references to options have been adjusted to reflect the effects of stock splits. The exercise price of all options granted to date under these plans range from $5.62 to $16.53. At December 31, 2006 the number of shares available for grant under Omnibus plan was 420,223.

The fair market value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The Company has assumed a volatility rate of 19.06%, a expected life of 7 years, interest rate of 4.75% and a dividend yield of 1.50% in the Black Scholes computation related to the options granted in 2006.. The Company granted 166,500 nonqualifying stock options during the twelve months ended December 31, 2006. During the twelve months ended December 31, 2005, the Company granted 162,250 options, respectively.

Page 72

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE M-EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)

Stock Based Compensation (Continued)

A summary of the Company’s option plans as of and for the years ended December 31, 2006, 2005 and 2004 is as follows:

							Outstanding Options					Exercisable Options
				Shares						Weighted					Weighted
				Available						Average					Average
	Shares			for Future			Number			Exercise		Number			Exercise
	in Plans			Grants			Outstanding			Price		Outstanding			Price
At December 31, 2003		872,189			25,585			846,604		$	6.55		729,132		$	6.61
Options authorized		556,600			556,600			-			-		-			-
Options granted/vested		-			(579,867	)		579,867			13.08		512,182			12.25
Options exercised		(47,816	)		-			(47,816	)		6.59		(47,816	)		6.59
Options forfeited		-			5,877			(5,877	)		6.50		(5,877	)		6.50
At December 31, 2004		1,380,973			8,195			1,372,778			9.31		1,187,621			9.04
Options authorized		726,000			726,000			-					-
Options granted/vested		-			(162,250	)		162,250			16.05		335,199			16.02
Options exercised		(163,156	)		-			(163,156	)		7.50		(163,156	)		7.50
Options forfeited		-			10,890			(10,890	)		11.72		(10,890	)		11.72
At December 31, 2005		1,943,817			582,835			1,360,982			10.31		1,348,774			10.33
Options authorized		-			-			-					-
Options granted/vested		-			(166,500	)		166,500			14.62		9,031			8.47
Options exercised		(13,897	)		-			(13,897	)		7.36		(13,897	)		7.36
Options forfeited		-			3,888			(3,888	)		9.39		(3,888	)		9.39
At December 31, 2006		1,929,920			420,223			1,509,697		$	10.82		1,340,020		$	10.35

Outstanding options include 1,509,697 options with exercise prices ranging from $5.62 to $16.53 per share, of which 1,340,020 are exercisable at December 31, 2006. The weighted average remaining life of total options outstanding and options exercisable as of December 31, 2006 is 6.31 years and 5.89 years, respectively. The weighted average fair value of options granted in 2006, 2005 and 2004 was $3.68, $4.90 and $6.05, respectively, and was determined as of the date of grant using the Black-Scholes option pricing model, assuming a dividend growth rate ranging from 0% to 5% for each period; expected volatility of 16.42%, 24.26% and 26.40%; risk-free interest rates ranging from 3.0% to 4.84%; and expected lives of 7 years for new grants during the years ended December 31, 2006, 2005 and 2004, respectively.

For the year ended December 31, 2006, the intrinsic value of options exercised and fair value of options vested amounted to $103,254 and $133,568, respectively. The aggregate intrinsic value of options outstanding and exercisable at December 31, 2006 amounted to $5.9 million and $5.2 million, respectively.

Cash received from option exercises under all share-based payment arrangements for the year ended December 31, 2006 was $102,000. The actual tax benefit realized for tax deductions from option exercise of the share-based payment arrangements totaled $293,000 for the year ended December 31, 2006.

Page 73

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE M-EMPLOYEE AND DIRECTOR BENEFIT PLANS (Continued)

Stock Based Compensation (Continued)

A summary of restricted stock outstanding (split adjusted) during the year is presented below:

			Weighted
			Average
			Grant Date
	Shares		Fair Value
Non-vested outstanding at December 31, 2005		6,050	$	13.21
Granted		13,750		15.26
Vested		6,050		-
Forfeited		-		-
Non-vested outstanding at December 31, 2006		13,750	$	15.26

The total fair value of restricted stock grants issued during the year ended December 31, 2006 was $210,000. The fair value of restricted stock grants vested during the period was $110,000.

As of December 31, 2006, there was $648,000 of unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the plans. That cost is expected to be recognized over a weighted average period of 2.6 years.

Employment Contracts

The Company has entered into employment agreements with its chief executive officer and seventeen other officers to ensure a stable and competent management base. The agreements provide for a three-year term, but the agreements may be extended for an additional year at the end of the first year and annually thereafter. The agreements provide for benefits as spelled out in the contracts and cannot be terminated by the Board of Directors, except for cause, without prejudicing the officers’ rights to receive certain vested rights, including compensation. In the event of a change in control of the Bank and in certain other events, as defined in the agreements, the Bank or any successor to the Company will be bound to the terms of the contracts.

Salary Continuation Agreements

The Company in October 2006 entered into Salary Continuation Agreements with its chief executive officer and one other executive officer. These Salary Continuation Agreements provide for benefits to be paid for 15 years to each executive with the payment amounts varying upon different retirement scenarios, such as normal retirement, early termination, disability, or change in control. The Company has purchased life insurance policies on the participating officers in order to provide future funding of benefit payments. Provisions of $85,628 in 2006 were expensed for future benefits to be provided under these plans. The corresponding liability related to this plan was also $85,628 as of December 31, 2006.

The Company also has a deferred compensation plan for its directors. Expense provided under the plan totaled $175,000, $106,400 and $74,400 for the years ended December 31, 2006, 2005 and 2004, respectively. Since 2003, directors have had the option to invest amounts deferred in Company common stock that is held in a rabbi trust established for that purpose. At December 31, 2006 and 2005, the trust held 31,984 and 18,361 shares of Company common stock, respectively.

Page 74

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE N-ACQUISITIONS

During October 2006, Gateway Insurance Services, Inc., completed the acquisition of Insurance Center, Inc., an independent insurance agency located in Chesapeake, Virginia. This transaction was accounted for as a purchase. A summary, in thousands, of the purchase price and the assets acquired is as follows.

	(Amounts in Thousands)
Purchase price:
Issuance of common stock		$	588
Total purchase price		$	588
Assets acquired:
Other intangibles		$	588
Goodwill			226
Total assets acquired		$	814
Liabilities Assumed:
Deferred taxes		$	226
Total liabilities assumed		$	226

During December 2006, Gateway Insurance Services, Inc., completed the acquisition of C D West, III, Inc an independent insurance agency located in Newport News, Virginia. This transaction was accounted for as a purchase. A summary, in thousands, of the purchase price and the assets acquired is as follows.

Purchase price:
Issuance of common stock	$	1,500
Total purchase price	$	1,500
Assets acquired:
Property and equipment	$	36
Accounts receivable		75
Goodwill		770
Other intangibles		1,045
Total assets acquired	$	1,926
Liabilities Assumed:
Accounts payable	$	34
Deferred taxes		392
Total liabilities assumed	$	426

Page 75

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE N-ACQUISITIONS (Continued)

During May 2004, Gateway Insurance Services, Inc., completed the acquisition of Whitehurst Insurance Agency, Inc., an independent insurance agency with offices located in Elizabeth City, Moyock and Edenton, North Carolina. This transaction was accounted for as a purchase. A summary, of the purchase price and the assets acquired is as follows.

	(Amounts in Thousands)
Purchase price:
Portion paid in cash		$	69
Issuance of common stock			503
Total purchase price		$	572
Assets acquired:
Property and equipment		$	123
Goodwill			337
Other intangibles			112
Total assets acquired		$	572

During June 2004, Gateway Insurance Services, Inc., completed the acquisition of Insurance Express Premium Finance, an insurance premium finance agency located in Plymouth, North Carolina. This transaction was accounted for as a purchase. A summary, in thousands, of the purchase price and the assets acquired is as follows.

Purchase price:
Portion paid in cash	$	71
Total purchase price	$	71
Assets acquired:
Property and equipment	$	10
Goodwill		31
Loans		30
Total assets acquired	$	71

On October 15, 2004, the Bank completed its acquisition of three financial center offices in a business combination transaction accounted for as a purchase. The financial centers were located in Emporia and Suffolk, Virginia and Elizabeth City, North Carolina. This acquisition was made to expand the Company’s market share in Southeastern Virginia and Northeastern North Carolina and because the financial centers acquired fit well within the Company’s strategic objectives.

A summary of assets acquired, and liabilities assumed, is set forth below (in thousands):

Assets Acquired:
Cash and cash equivalents	$	117,501
Loans		602
Premises and equipment		1,955
Core deposit intangibles		2,692
Goodwill		4,130
Total assets acquired	$	126,880
Liabilities Assumed:
Deposits	$	126,806
Other liabilities		74
Total liabilities assumed	$	126,880

Page 76

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE N-ACQUISITIONS (Continued)

The goodwill related to the acquisitions of C D West, III, Inc., Insurance Center, Inc. and Whitehurst Insurance Agency, Inc. is not tax deductible. The goodwill related to the acquisitions of Insurance Express and the three financial centers is tax deductible.

The pro-forma impact of the acquisitions presented above as though they had been made at the beginning of the periods presented is not considered material to the Company’s consolidated financial statements.

NOTE O-PARENT COMPANY FINANCIAL DATA

Gateway Financial Holdings, Inc. became the holding company for Gateway Bank & Trust Co. effective October 1, 2001. Following are condensed financial statements of Gateway Financial Holdings, Inc. as of December 31, 2006 and 2005 and for the years ended December 31, 2006, 2005 and 2004, presented in thousands.

Condensed Balance Sheets
December 31, 2006 and 2005

	2006			2005
Asset:
Cash on deposit in subsidiary	$	1,679		$	3,909
Investment in securities available for sale		7,266			6,421
Investment in subsidiaries		131,653			103,808
Other assets		192			640
Total assets	$	140,790		$	114,778
Liabilities:
Junior subordinated debentures	$	30,929		$	15,465
Other liabilities		221			569
Total liabilities		31,150			16,034
Stockholders’ equity:
Common stock		101,669			94,109
Retained earnings		8,708			5,113
Deferred Compensation — restricted stock		-			(43	)
Accumulated other comprehensive loss		(737	)		(435	)
Total stockholders’ equity		109,640			98,744
Total liabilities and stockholders’ equity	$	140,790		$	114,778

Condensed Statements of Operations
Years Ended December 31, 2006, 2005 and 2004

	2006			2005			2004
Equity in income of subsidiary	$	6,499		$	4,716		$	2,584
Interest income		34			18			19
Gain on sale of securities		653			199			-
Interest expense		(1,831	)		(939	)		(541	)
Other expense		(86	)		(55	)		(52	)
	$	5,269		$	3,939		$	2,010

Page 77

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE O-PARENT COMPANY FINANCIAL DATA (Continued)

Condensed Statements of Cash Flows
Years Ended December 31, 2006, 2005 and 2004

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

Page 78

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE P - BUSINESS SEGMENT REPORTING

In addition to its banking operations, the Bank has three other reportable segments, Gateway Investment Services, Inc., whose principal activity is to engage in brokerage services as an agent for non-bank investment products and services, Gateway Financial Mortgage, Inc., a mortgage company which began operations during the second quarter of 2006 and Gateway Insurance Services, Inc., an independent insurance agency. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. Set forth below is certain financial information for each segment and in total (in thousands):

	At or for the Year Ended December 31, 2006
	Consolidated		Adjustments			Banking		Brokerage		Insurance		Mortgage
Total interest income	$	73,097	$	-		$	72,940	$	-	$	21	$	136
Total interest expense		36,099		(149	)		36,099		-		-		149
Net interest income		36,998		-			36,841		-		21		(13	)
Provision for loan losses		3,400		-			3,400		-		-		-
Net interest income after provision for loan losses		33,598		-			33,441		-		21		(13	)
Non-interest income		9,270		(676	)		5,135		744		2,873		1,194
Non-interest expense		34,974		-			30,682		590		2,195		1,507
Income before income taxes		7,894		(676	)		7,894		154		699		(326	)
Provision for income taxes		2,625		-			2,625		-		-		-
Net income	$	5,269	$	(676	)	$	5,269	$	154	$	699	$	(326	)
Period end total assets	$	1,207,477	$	(22,548	)	$	1,207,477	$	645	$	6,132	$	15,771

	At or for the Year Ended December 31, 2005
	Consolidated		Adjustments			Banking		Brokerage		Insurance		Mortgage
Total interest income	$	39,679	$	-		$	39,646	$	-	$	33	$	-
Total interest expense		16,376		-			16,376		-		-		-
Net interest income				23,303			-		23,270		-		33
Provision for loan losses		2,200		-			2,200		-		-		-
Net interest income after provision for loan losses		21,103		-			21,070		-		33		-
Non-interest income		8,067		(713	)		5,736		656		2,388		-
Non-interest expense		23,266		-			20,902		464		1,900		-
Income before income taxes		5,904		(713	)		5,904		192		521		-
Provision for income taxes		1,965		-			1,965		-		-		-
Net income	$	3,939	$	(713	)	$	3,939	$	192	$	521	$	-
Period end total assets	$	883,373	$	(3,837	)	$	884,198	$	488	$	2,524	$

	At or for the Year Ended December 31, 2004
	Consolidated		Adjustments			Banking		Brokerage		Insurance		Mortgage
Total interest income	$	19,632	$	-		$	19,609	$	-	$	23	$	-
Total interest expense		6,691		-			6,691		-		-		-
Net interest income		12,941		-			12,918		-		23		-
Provision for loan losses		1,425		-			1,425		-		-		-
Net interest income after provision for loan losses		11,516		-			11,493		-		23		-
Non-interest income		5,857		(562	)		3,963		463		1,993		-
Non-interest expense		14,653		(161	)		12,736		400		1,678		-
Income before income taxes		2,720		(401	)		2,720		63		338		-
Provision for income taxes		710		-			710
Net income	$	2,010	$	(401	)	$	2,010	$	63	$	338	$	-
Period end total assets	$	535,728	$	(2,219	)	$	535,751	$	286	$	1,910	$	-

Page 79

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE Q - INTANGIBLE ASSETS

The following is a summary of intangible assets as of December 31, 2006, 2005 and 2004.

	2006			2005			2004
	(In thousands)
Intangibles assets subject to future amortization:
Core intangibles - gross	$	3,497		$	3,497		$	3,497
Less accumulated amortization		(1,027	)		(707	)		(328	)
Core intangible Net		2,470			2,790			3,169
Intangibles - book of business	$	1,821		$	188		$	188
Less accumulated amortization		(128	)		(87	)		(56	)
		1,693			101			132
Intangibles - net	$	4,163		$	2,891		$	3,301
Intangible assets not subject to future amortization:
Goodwill - banking segment	$	6,454		$	6,454		$	6,471
Goodwill - insurance segment		1,998			1,002			1,002
	$	8,452		$	7,456		$	7,473

The following table presents the estimated amortization expense (in thousands) for intangible assets for each of the five years ending December 31, 2011 and the estimated amount amortizable thereafter. These estimates are subject to change in future periods to the extent management determines it is necessary to make adjustments to the carrying value or estimated useful life of amortizing intangible assets.

2007	$	472
2008		472
2009		472
2010		432
2011		414
Thereafter		1,901
	$	4,163

NOTE R - DERIVATIVES

The Company has a stand-alone derivative financial instrument which it entered into on December 30, 2005, in the form of an interest rate swap agreement, which derives its value from underlying interest rates. These transactions involve both credit and market risk. The notional amount is the amount on which calculations, payments and the value of the derivative are based. Notional amounts do not represent direct credit exposures. Direct credit exposure is limited to the net difference between the calculated amounts to be received and paid. SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” requires that changes in the fair value of derivative financial instruments that do not qualify as hedging instruments be reported as an economic gain or loss in non-interest income. For the year ended December 31, 2006 a loss of $1.2 million was included in non-interest income related to the change in the fair value of the interest rate swap agreement. Fair value changes in this derivative can be volatile from quarter to quarter, and are primarily driven by changes in interest rates. Net cash monthly settlements are recorded as non-interest income in the period to which they relate. For the year ended December 31, 2006 the interest rate swap cash settlements decreased non-interest income by $693,000.

Page 80

GATEWAY FINANCIAL HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006, 2005 and 2004

NOTE R — DERIVATIVES (Continued)

The Company is exposed to credit related losses in the event of nonperformance by the counterparty to this agreement. The Company controls the credit risk of its financial contracts through credit approvals, limits and monitoring procedures, and does not expect the counterparty to fail their obligations.

At December 31, 2006 the information pertaining to the outstanding interest rate swap agreement used to economically hedge variable rate loans is as follows (amounts in thousands):

Notional amount	$	150,000
Weighted average pay rate		7.95	%
Weighted average receive rate		7.50	%
Weighted average maturity in years		2.0
Unrealized gain (loss) relating to the interest rate swap	$	(1,226	)

This agreement requires the Company to make monthly payments at a variable rate determined by a specified index (prime rate as stated in Publication H-15) in exchange for receiving payments at a fixed rate.

The Company has been required to provide collateral in the form of U. S Treasury Securities of $2.0 million to the counterparty based on the evaluation of the market value of the agreement. The counterparty does not have the right and ability to redeem the collateral or prohibit the Company from selling the asset used as collateral. However, the counterparty may require the Company to provide another asset as collateral to replace the asset the Company has decided to sell.

NOTE S - SUBSEQUENT EVENTS

On January 10, 2007, Gateway Financial Holdings, Inc. announced that its board of directors approved the execution of, and the parties have executed, a definitive agreement in which Gateway Financial Holdings will acquire The Bank of Richmond, N.A. (OTC Bulletin Board: BRCH). Gateway Financial Holdings will acquire all of the outstanding shares of The Bank of Richmond for a total purchase price of approximately $55.8 million. Under the terms of the merger agreement, The Bank of Richmond stockholders will receive either $30.05 per share in cash or Gateway Financial Holdings common stock of comparable value, subject to certain collar provisions, as determined by a pricing period. Pursuant to the terms of the merger agreement, stockholders of The Bank of Richmond will have the opportunity to elect to receive cash, shares of Gateway Financial Holdings common stock, or a combination of cash and shares of Gateway Financial Holdings common stock subject to the allocation and proration procedures set forth in the merger agreement which are intended to ensure that, in the aggregate, 50% of the total merger consideration will be cash and 50% of the total merger consideration will be Gateway Financial Holdings common stock. The transaction will provide Gateway Financial Holdings entrance into the demographically attractive Richmond market area and will significantly add to Gateway Financial Holdings’ existing Virginia footprint.

The Bank of Richmond, founded in 1999 and headquartered in Richmond, Virginia, operates six community banking offices in the Richmond metropolitan area and one loan production office in Charlottesville, Virginia. As of September 30, 2006, The Bank of Richmond had total assets of $168.4 million, deposits of $149.1 million, net loans of $146.1 million, and stockholders’ equity of $18.3 million.

The merger is anticipated to close on May 31, 2007 and is conditioned on receiving the requisite regulatory and stockholder approvals. Pursuant to the terms of the merger agreement, The Bank of Richmond will merge with and into Gateway Bank & Trust Co. with Gateway Bank & Trust Co. as the surviving bank.

On January 31, 2007, the bank purchased substantially all of the assets and liabilities of Breen Title & Settlement, Inc. in Newport News, Virginia (“Breen Title”) for approximately $850,000. The acquisition was paid with a combination of $425,000 cash and 29,502 shares of common stock for substantially all of the assets and liabilities.

Page 81

ITEM 9 – CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A – CONTROLS AND PROCEDURES

The Company’s management, with the participation of its Chief Executive Officer and the Chief Financial Officer has evaluated the effectiveness of the Company’s disclosure controls and procedures as of December 31, 2006. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2006. There were no material changes in the Company’s internal controls over financial reporting during the fourth quarter of 2006.

Management’s Report On Internal Control Over Financial Reporting

The management of Gateway Financial Holdings, Inc. and Subsidiary (the “Company”) is responsible for preparing the Company’s annual consolidated financial statements and for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control system was designed to provide reasonable assurance to management and board of directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control – Integrated Framework. Based on that assessment, we believe that, as of December 31, 2006, the Company’s internal control over financial reporting is effective based on those criteria.

The Company’s registered public accounting firm that audited the Company’s consolidated financial statements included in this annual report has issued an attestation report on management’s assessment of internal control over financial reporting.

March 14, 2007

/s/ D. Ben Berry	/s/ Theodore L. Salter
D. Ben Berry	Theodore L. Salter
Chairman, President and Chief Executive Officer	Senior Executive Vice President and Chief Financial Officer

Page 82

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
Gateway Financial Holdings, Inc. and Subsidiary

We have audited management’s assessment, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting, that Gateway Financial Holdings, Inc. and Subsidiary (the “Company”) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A Company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Page 83

In our opinion, management’s assessment that Gateway Financial Holdings, Inc. and Subsidiary maintained effective internal control over financial reporting as of December 31 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, Gateway Financial Holdings, Inc. and Subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements of Gateway Financial Holdings, Inc. and Subsidiary as of and for the year ended December 31, 2006, and our report dated March 14, 2007, expressed an unqualified opinion on those consolidated financial statements.

Greenville, North Carolina
March 14, 2007

Page 84

ITEM 9B – OTHER INFORMATION

None.

PART III

     ITEM 10 – DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; COMPLIANCE WITH SECTION 16(a)

     Incorporated by reference from the Company’s definitive proxy statement, to be mailed to stockholders and filed with the Securities and Exchange Commission within 120 days of December 31, 2006.

ITEM 11 – EXECUTIVE COMPENSATION

     Incorporated by reference from the Company’s definitive proxy statement, to be mailed to stockholders and filed with the Securities and Exchange Commission within 120 days of December 31, 2006.

ITEM 12 – SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     Incorporated by reference from the Company’s definitive proxy statement, to be mailed to stockholders and filed with the Securities and Exchange Commission within 120 days of December 31, 2006.

The following table sets forth equity compensation plan information at December 31, 2006.

Equity Compensation Plan Information
						Number of securities
		Number of securities				remaining available for
		to be issued		Weighted-average		future issuance under
		upon exercise of		exercise price of		equity compensation plans
		outstanding options		outstanding options		(excluding securities
	Plan Category					reflected in column(a))
		(a)		(b)		(c)
	Equity compensation plans approved by security holders		1,359,665		$11.31		420,223
	Equity compensation plans not approved by security holders		150,032		$6.14		–
	Total		1,509,697		$10.82		420,223

A description of the Company’s equity compensation plans is presented in Note M to the accompanying consolidated financial statements.

The 2001 Nonstatutory Stock Option Plan (“NSSO Plan”) was not approved by security holders. Options granted under the NSSO Plan do not qualify as “incentive stock options” within the meaning of Section 422A of the Internal Revenue Code and do not afford favorable tax treatment to recipients. Options granted under the NSSO Plan do result in tax deductions to the Company. The NSSO Plan is administered by the Executive Committee. Directors and employees of the Company are eligible to receive options under the NSSO Plan at no cost to them other than the option exercise price. The options must be exercised within ten years from the date of grant. In the event that a participant ceases to serve as a director or employee of the Company due to disability or retirement, as defined in the NSSO Plan, an exercisable stock option will continue to be exercisable upon the terms and conditions contained in the grant. In the event of the death of a participant during service, an exercisable stock option will continue to be exercisable for 12 months from the date of death to the extent it was exercisable by the participant immediately prior to death. In the event that a participant ceases to serve as a director or employee of the Company for any other reason, the options will terminate.

Page 85

ITEM 13 – CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Incorporated by reference from the Company’s definitive proxy statement, to be mailed to stockholders and filed with the Securities and Exchange Commission within 120 days of December 31, 2006.

ITEM 14 – PRINCIPAL ACCOUNTANT FEES AND SERVICES

     Incorporated by reference from the Company’s definitive proxy statement, to be mailed to stockholders and filed with the Securities and Exchange Commission within 120 days of December 31, 2006.

PART IV

ITEM 15 – EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a)(3)Exhibits. The exhibits required by Item 601 of Regulation S-K are listed below.

Exhibit No.	Description
Exhibit 3.1:	Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 10.1 to the Annual Report on Form 10K for the year ended December 31, 2005)
Exhibit 3.2:	Bylaws
Exhibit 4.1:	Specimen Certificate for Common Stock of Gateway Financial Holdings, Inc. (incorporated by reference to Exhibit 4.1 of Amendment No. 1 to the Registration Statement on Form S-3 filed September 20, 2001)
Exhibit 10.1:	1999 Incentive Stock Option Plan of Gateway Financial Holdings, Inc. (incorporated by reference to Exhibit 10.1 to the Annual Report on Form 10K for the year ended December 31, 2001 (“2001 Annual Report”))
Exhibit 10.2:	1999 Non-Statutory Stock Option Plan of Gateway Financial Holdings, Inc. (incorporated by reference to Exhibit 10.2 to the 2001 Annual Report)
Exhibit 10.3:	2001 Non-Statutory Stock Option Plan of Gateway Financial Holdings, Inc. (incorporated by reference to Exhibit 10.3 to the 2001 Annual Report)
Exhibit 10.4	Employment Agreement with D. Ben Berry (incorporated by reference to Exhibit 10.1 to the Quarterly Report on form 10Q for the quarter ended March 31, 2006)
Exhibit 10.5	Employment Agreement with David R. Twiddy (incorporated by reference to Exhibit 10.2 to the Quarterly Report on form 10Q for the quarter ended March 31, 2006)
Exhibit 10.6	2005 Omnibus Stock Ownership And Long Term Incentive Plan (incorporated by reference to Exhibit 10.6 to the Annual Report on Form 10K for the year ended December 31, 2005)
Exhibit 10.7	Employment Agreement with Theodore L. Salter (incorporated by reference to Exhibit 10.3 to the Quarterly Report on form 10Q for the quarter ended March 31, 2006)
Exhibit 10.8	Salary Continuation Agreement with D. Ben Berry
Exhibit 10.9	Salary Continuation Agreement with David R. Twiddy
Exhibit 21:	Subsidiaries of the Registrant
Exhibit 23:	Consent of Dixon Hughes PLLC
Exhibit 31.1:	Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer
Exhibit 31.2:	Rule 13a-14(a)/15d-14(a) Certification by Chief Financial Officer
Exhibit 32:	Section 1350 Certifications

Page 86

SIGNATURES

Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on behalf of the undersigned, thereunto duly authorized.

	GATEWAY FINANCIAL HOLDINGS, INC.
Date: March 16, 2007	By:	/s/ D. Ben Berry
		D. Ben Berry
		Chairman, President and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

NAME	TITLE	DATE
/s/ D. Ben Berry
D. Ben Berry	Chairman, President and CEO	March 16, 2007
/s/ Theodore L. Salter
Theodore L. Salter	Chief Financial Officer	March 16, 2007
/s/ Mark A. Jeffries
Mark A. Jeffries	Controller	March 16, 2007
/s/ H. Spencer Barrow
H. Spencer Barrow	Director	March 16, 2007
/s/ William Brumsey III
William Brumsey III	Director	March 16, 2007
/s/ Jimmie Dixon, Jr.
Jimmie Dixon, Jr.	Director	March 16, 2007
/s/ James H. Ferebee, Jr.
James H. Ferebee, Jr.	Director	March 16, 2007
/s/ Charles R. Franklin, Jr.
Charles R. Franklin, Jr.	Director	March 16, 2007
/s/ Robert Y. Green, Jr.
Robert Y. Green, Jr.	Director	March 16, 2007
/s/ W. Taylor Johnson, Jr.
W. Taylor Johnson, Jr.	Director	March 16, 2007
/s/ Robert Willard Luther, III
Robert Willard Luther, III	Director	March 16, 2007
/s/ Frances Morrisette Norrell
Frances Morrisette Norrell	Director	March 16, 2007
/s/ W. C. Owens, Jr.
W. C. Owens, Jr.	Director	March 16, 2007
/s/ Billy G. Roughton
Billy G. Roughton	Director	March 16, 2007
/s/ Ollin B. Sykes
Ollin B. Sykes	Director	March 16, 2007
/s/ Frank T. Williams
Frank T. Williams	Director	March 16, 2007
/s/ Jerry T. Womack
Jerry T. Womack	Director	March 16, 2007

Page 87

EX-3.2

Exhibit 3.2

AMENDED AND RESTATED

BYLAWS

GATEWAY FINANCIAL HOLDINGS, INC.

1

BYLAWS
OF
GATEWAY FINANCIAL HOLDINGS, INC.

Index

ARTICLE I

Offices

Section 1.	Principal Offices
Section 2.	Registered Office
Section 3.	Other Offices
	ARTICLE II
	Meetings of Shareholders
Section 1.	Annual Meeting
Section 2.	Substitute Annual Meeting
Section 3.	Special Meetings
Section 4.	Place of Meetings
Section 5.	Notice of Meetings
Section 6.	Waiver of Notice
Section 7.	Voting Lists
Section 8.	Quorum
Section 9.	Voting
Section 10.	Proxies
	ARTICLE III
	Board of Directors
Section 1.	General Powers
Section 2.	Number, Term of Office and Qualifications
Section 3.	Election of Directors
Section 4.	Directors’ Immunity
Section 5.	Removal of Directors
Section 6.	Vacancies
Section 7.	Compensation of Directors
Section 8.	Committees
Section 9.	Chairman and Vice Chairman of Board
Section 10.	Nominations

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	ARTICLE IV
	Meetings of Directors
Section 1.	Regular Meetings
Section 2.	Special Meetings
Section 3.	Place of Meetings
Section 4.	Notice of Meetings
Section 5.	Quorum; Manner of Acting
Section 6.	Presumption of Assent
Section 7.	Informal Action of Directors
Section 8.	Resignations
Section 9.	Minutes
	ARTICLE V
	Officers
Section 1.	Number of Officers
Section 2.	Election, Term of Office and Qualifications
Section 3.	Subordinate Officers and Agents
Section 4.	Removal
Section 5.	Resignations
Section 6.	Vacancies
Section 7.	President
Section 8.	Vice President
Section 9.	Secretary
Section 10.	Assistant Secretary
Section 11.	Treasurer
Section 12.	Duties of Officers May Be Delegated
Section 13.	Salaries of Officers
Section 14.	Bonds
	ARTICLE VI
	Contracts, Loans, Deposits, Checks, Drafts, Etc.
Section 1.	Contracts
Section 2.	Loans
Section 3.	Deposits
Section 4.	Checks, Drafts, Etc.
	ARTICLE VII
	Share Certificates and Their Transfer
Section 1.	Share Certificates
Section 2.	Transfers of Shares
Section 3.	Lost or Destroyed Certificates
Section 4.	Regulations
Section 5.	Fixing Record Date

ii

Section 6.	Holder of Record
Section 7.	Reacquired Shares
	ARTICLE VIII
	General Provisions
Section 1.	Corporate Seal
Section 2.	Distributions
Section 3.	Fiscal Year
Section 4.	Waiver of Notice
Section 5.	Amendments
Section 6.	Indemnification
Section 7.	Interpretation of Bylaws

iii

CODE OF BYLAWS

GATEWAY FINANCIAL HOLDINGS, INC.

ARTICLE I

Offices

     Section 1. Principal Office. The Corporation’s principal office shall be located in Elizabeth City, North Carolina, or at such other place(s) as the Board may designate from time to time.

     Section 2. Registered Office. The Corporation’s registered office, which by law is required to be maintained within the State, shall be located at such place or places within the State of North Carolina as the Board may designate from time to time.

     Section 3. Other Offices. The Corporation may have offices at such places, either within or outside the State, as the Board may determine from time to time.

ARTICLE II

Meeting of Shareholders

     Section 1. Annual Meeting. The annual meeting of shareholders shall be held within 150 days of the close of the fiscal year, as set by the Board, for the purpose of electing directors of the Corporation and for the transaction of such other business as properly may be brought before the meeting.

     Section 2. Substitute Annual Meeting. If the annual meeting shall not be held on the day designated by these Bylaws, a substitute annual meeting may be called in the manner provided for the call of a special meeting in accordance with the provisions of Section 3 of this Article and a substitute annual meeting so called shall be designated as and shall be treated, for all purposes, as the annual meeting.

     Section 3. Special Meetings. Special meetings of the shareholders may be called at any time by (a) the President of the Corporation, (b) the Chairman of the Corporation, (c) the Secretary of the Corporation or (d) the Board.

     Section 4. Place of Meetings. All meetings of shareholders shall be held at the principal office of the Corporation or at such other place, either within or without the State of North Carolina, as shall be designated in the notice of the meeting or agreed upon by a majority of the shareholders entitled to vote thereat.

     Section 5. Notice of Meetings. Written or printed notice stating the time and place of a shareholders’ meeting shall be delivered, personally or by mail, by or at the direction of the President, the Board or by such other person or persons calling such meeting, to each shareholder of record entitled to vote at such meeting, not less than ten or more than sixty days prior to the date of such meeting. If mailed, such notice shall be deemed to be delivered when deposited in the United States mail addressed to the shareholder to the address determined in the manner indicated below, with postage thereon prepaid. A statement of the business to be transacted at an annual or substitute annual meeting of shareholders need

1

not be set forth in the notice of such meeting except that if any matter is to be considered or acted upon, other than the election of directors, on which the vote of shareholders is required under the provisions of the Act then a specific statement thereof shall be set forth in such notice. In the case of a special meeting, the notice shall set forth the nature of the business to be transacted. If any meeting of shareholders is adjourned to a different date, time, or place, notice need not be given of the new date, time, or place if the new date, time, or place is announced at the meeting before adjournment and if a new record date is not fixed for the adjourned meeting. If a new record date for the adjourned meeting is or must be fixed pursuant to the Act, notice of the adjourned meeting must be given as provided in this Section to persons who are shareholders as of the new record date. Any notice which shall be mailed shall be directed to each shareholder at its address as set forth on the Corporation’s share books, except that if any shareholder shall have filed with the Secretary a written request that notices intended for such shareholder be mailed to some other address, then notice to such shareholder shall be mailed to the address set forth in such written request.

     Section 6. Waiver of Notice. Any shareholder may waive notice of any meeting before or after the meeting. The waiver must be in writing, signed by the shareholder, and delivered to the Corporation for inclusion in the minutes or filing with the corporate records. A shareholder’s attendance, in person or by proxy, at a meeting (a) waives objection to lack of notice or defective notice of the meeting, unless the shareholder or the shareholder’s proxy at the beginning of the meeting objects to holding the meeting or transacting business thereat, and (b) waives objection to consideration of a particular matter at the meeting that is not within the purpose or purposes described in the meeting notice, unless the shareholder or the shareholder’s proxy objects to considering the matter before it is voted upon.

     Section 7. Voting Lists. No later than two days after notice of a shareholder is given, the Secretary shall prepare an alphabetical list of the shareholders entitled to notice of such meeting. The Secretary shall maintain such list and make it available as provided by the Act.

     Section 8. Quorum. Except as otherwise provided by the Act, the Articles or these Bylaws, the presence in person or by proxy of holders of record of a majority of the shares entitled to vote shall be necessary to constitute a quorum for action on such matters; provided, however, that at any substitute annual shareholders’ meeting called in accordance with Section 2 of this Article, the shares entitled to vote there represented, in person or by proxy, shall constitute a quorum. In the absence of a quorum, a majority of the shares entitled to vote there represented, in person or by proxy, may adjourn the meeting from time to time. At any such adjourned meeting, at which a quorum shall be present, any business may be transacted which might have been transacted at the meeting as originally called if a quorum had been there present. Once a share is represented for any purpose at a meeting, it is deemed present for quorum purposes for the remainder of the meeting and for any adjournment of that meeting unless a new record date is or must be set for that adjourned meeting.

     Section 9. Voting. At each shareholders’ meeting, every holder of record of shares entitled to vote shall be entitled to one vote for every share standing in his name on the Corporation’s books, unless otherwise provided by the terms of such shares, and all questions, except as otherwise provided by the Act, the Articles, or these Bylaws, shall be determined by a majority of the votes so cast. Any provision in these Bylaws prescribing the vote required for any purpose as permitted by law may not itself be amended by a vote less than the vote prescribed therein. Persons holding shares in a fiduciary capacity shall be entitled to vote the shares so held. Shares owned by the Corporation, directly or indirectly, through a subsidiary corporation or otherwise, or held directly or indirectly in a fiduciary capacity by it or by a subsidiary corporation, shall not be voted at any shareholders’ meeting and shall not be counted in

2

determining the total number of outstanding shares at a given time entitled to vote, except to the extent permitted by the Act. Voting on all matters, except the election of Directors, shall be by voice vote or by show of hands except that if prior to voting on any particular matter demand shall be made by or on behalf of the holders of not less than one-tenth (1/10th) of the shares represented, in person or by proxy, at such meeting and entitled to vote on such matter that the vote thereon be taken by ballot, then the vote on such matter shall be taken by ballot.

     Section 10. Proxies. Any shareholder entitled to vote may vote by proxy, provided that the instrument authorizing such proxy to act shall have been executed in writing by the shareholder or his duly authorized attorney. No proxy shall be valid after the expiration of eleven months from the date of its execution, unless the person executing it shall have specified therein the length of time it is to continue in force or limits its use to a particular meeting. Each instrument designating a proxy shall be exhibited to the Secretary and shall be filed with the Corporation’s records.

ARTICLE III

Board of Directors

     Section 1. General Powers. All corporate powers shall be exercised by or under the authority of and the business and affairs of the Corporation manage under the direction of, the Board, except as otherwise provided in the Articles.

     Section 2. Number, Term of Office and Qualifications.(a) The number of directors shall be not less than seven (7) nor more than fifteen (15) shareholders. The exact number of directors, within the minimum and maximum limitations of the preceding sentence, shall be fixed from time to time by the Board pursuant to a resolution adopted by a majority of the entire Board prior to the annual meeting of shareholders at which such directors are to be elected. In addition to the foregoing relating to the determination of the number and election of directors, the shareholders, at any meeting thereof, may authorize not more than two (2) additional directorships, which may be left unfilled by the shareholders at such meeting, to be filled in the discretion of the directors during the interval between meetings of the shareholders.

     (b) At the first annual meeting of shareholders, the Board shall be divided into three classes, containing as nearly equal a number of directors as possible, with the term of office for the first class to expire at the first annual meeting of shareholders after their election, the term of office for the second class to expire at the second annual meeting of shareholders after their election, and the term of office for the third class to expire at the third annual meeting of the shareholders after their election. At each annual meeting of shareholders following such initial classification and election, directors elected to succeed those directors whose terms expire shall be selected for a term of office to expire the third succeeding annual meeting of shareholders after their election. In the event of any increase or decrease in the number of directors, the additional or eliminated directorships shall be so classified or chosen so that all classes of directors shall remain and become as nearly equal in number as possible. Each director shall continue in office until the expiration of his term as specified above and until his successor shall have been elected and qualified, or until his death or until the director shall resign or shall have become disqualified or shall have been removed in the manner hereinafter provided. No director shall serve past the annual meeting after reaching the age of seventy five (75) regardless of the number of years remaining in his or her term; provided that any such director may continue to serve as an honorary director; further provided that any director serving at the date of adoption of these bylaws who had attained the age of seventy (70) may

3

serve until the completion of the term during which the director reaches the age of seventy seven (77). An honorary director may attend meetings of the Board, but may not vote, serve as an officer of the Board, or receive any fee or other benefit of Board membership.

     Section 3. Election of Directors. Except as provided in Section 6 of this Article, the Directors shall be elected at the shareholders’ annual meeting of shareholders and the persons who shall receive the highest number of votes shall be the elected directors. If prior to voting for the election of Directors demand therefor shall be made by or on behalf of any share entitled to vote at such meeting, the election of directors shall be by ballot.

     Section 4. Directors’ Immunity. To the fullest extent permitted by law, each Director shall be immune from personal liability of each Director arising out of an action whether by or in the right of the Corporation or otherwise for monetary damages for breach of any duty as a Director.

     Section 5. Removal of Directors. Any director may be removed from office at any time with or without cause by either (i) a two-thirds (2/3) vote of all the directors or (ii) a vote of shareholders whenever the number of votes cast in favor of removal of the director exceeds the number of votes cast against such removal. A director may not be removed by the shareholders at a meeting unless the notice of the meeting states that the purpose, or one of the purposes, of the meeting is removal of the director. If any directors are so removed, new directors may be elected at the same meeting to fill the unexpired term of the removed director.

     Section 6. Vacancies. Except as provided in Section 2 of this Article, a vacancy in the Board created by an increase in the authorized number of Directors shall be filled only by election at an annual meeting of shareholders or at a special meeting of shareholders called for that purpose; provided, however, that prior to the issuance of the Corporation’s shares any such vacancy may be filled by the then existing Board. Any vacancy in the Board created other than by an increase in the authorized number of Directors may be filled by a majority of the remaining Directors, even though less than a quorum, or by the sole remaining Director. The shareholders may elect a Director at any time to fill any vacancy not filled by the Directors. In the event of the resignation of a Director to take effect at a future date either the Board or the shareholders, at any time after tender of such resignation, may elect a successor to such Director to take office as of the effective date of such resignation. Any Director elected to fill a vacancy shall be elected for the unexpired term of his predecessor.

     Section 7. Compensation of Directors. The Board may cause the Corporation to compensate Directors for their services as Directors and may provide for the payment by the Corporation of all expenses incurred by directors in attending regular and special meetings of the Board.

     Section 8. Committees. The Board, by resolution of a majority of the number of directors in office, may designate three or more directors to constitute an Executive Committee and such other committees as the Board shall deem advisable, each of which, to the extent authorized by law and provided in such resolution, shall have and may exercise all of the authority of the Board in the management of the Corporation. The designation of any committee and the delegation thereto of authority shall not operate to relieve the Board, or any member thereof, of any responsibility or liability imposed upon the Board, or any member thereof, by law.

4

     Section 9. Chairman and Vice Chairman of Board. The Directors shall elect a Chairman and may elect a Vice Chairman from their number at any meeting of the Board. The Chairman shall preside at all meetings of the Board and perform such other duties as the Board may direct.

     Section 10. Nominations. Only persons who are nominated in accordance with the provisions set forth in these bylaws shall be eligible to be elected as directors at an annual or special meeting of shareholders. Nomination for election to the Board shall be made by or at the direction of the Nominating Committee appointed by the Board. Nomination for election of any person to the Board may also be made by a shareholder entitled to vote on such election if written notice of the nomination of such person shall have been received by the Secretary of the Corporation at the principal office of the Corporation on a day which is at least seven business days and not more than 60 days prior to the date of the meeting. Each such notice shall set forth: (a) the name and address of the shareholder who intends to make the nomination; (b) a representation that such shareholder is a holder of the record of shares of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (c) as to each person to be nominated (i) such person’s name and address, employment history for the past five years, affiliations, if any, with the Corporation and other corporations, the number of shares of the Corporation that are owned of record or beneficially by such person and information concerning any transactions in such shares within the prior 60 days, whether such person has been convicted in a criminal preceding (excluding traffic violations or similar misdemeanors) within the past five years and the details thereof, whether such person has been a party to any proceeding or subject to any judgment, decree or final order with respect to violations of federal or state securities laws within the past five years and the details thereof, and the details of any contract, arrangement, understanding or relationships with any person with respect to any securities of the Corporation; (ii) such person’s written consent to being named as a nominee and to serving as a director if elected; and (iii) a description of all arrangements or understanding between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made by the shareholder. The person or persons, as the case may be, presiding over the meeting may refuse to acknowledge the nomination of any person not made in compliance with the foregoing procedure, and upon the presiding person’s instruction, the voting inspectors may disregard all votes cast for each such nominee.

ARTICLE IV

Meetings of Directors

     Section 1. Regular Meetings. A regular annual meeting of the Board may be held immediately after the shareholders’ annual meeting and if not then held shall be held within a reasonable time thereafter. In addition, the Board may provide, by resolution, the time and place, within or without the State, for the holding of additional regular meetings. The Board shall meet at least quarterly, including the regular meeting to be held immediately or shortly after the annual meeting of shareholders.

     Section 2. Special Meetings. Special Board meetings may be called by or at the request of the President or any two Directors.

     Section 3. Place of Meetings. All Board meetings shall be held at the Corporation’s principal office except that such meetings may be held at such other place, within or without the State, as may be

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designated by the President or in a duly executed waiver of notice of such meeting or as may be otherwise agreed upon in advance of the meeting by a majority of Directors.

     Section 4. Notice of Meetings. Regular meetings of the Board may be held without notice. Special meetings shall be called on not less than three (3) days’ prior notice. Notice of a special meeting need not state the purpose thereof, unless otherwise required by the Act or these Bylaws, and such notice shall be directed to each Director at his residence or usual place of business by mail, cable or telegram, or may be delivered personally. A Director’s presence at a meeting shall constitute a waiver of notice of that meeting except when such Director attends the meeting solely for the purpose of objecting to the transaction of any business thereat, on the grounds that the meeting has not been lawfully called, and does not otherwise participate in such meeting.

     Section 5. Quorum; Manner of Acting. A majority of the number of Directors then authorized as the number of Directors of the Corporation shall constitute a quorum for the transaction of any business at any meeting. Except as otherwise expressly provided in the Articles or these Bylaws, the act of a majority of the Directors present at a meeting at which a quorum is present shall be the act of the Board. The vote of a majority of the Directors then holding office shall be required to adopt, amend or repeal a Bylaw or to dissolve the Corporation pursuant to the Act without shareholder consent.

     Section 6. Presumption of Assent. A Director who is present at a Board meeting at which action on any matter is taken shall be presumed to have assented to the action taken on any such matter unless (a) his contrary vote is recorded or his dissent or abstention is otherwise entered in the minutes of the meeting, (b) the Director files his written dissent or abstention to such action with a person acting as the secretary of the meeting before the adjournment thereof or (c) the Director forwards such dissent or abstention by registered mail to such secretary immediately after the adjournment of the meeting. Such right to dissent or abstention shall not apply to a Director who voted in favor of such action.

     Section 7. Informal Action of Directors. Action taken without a meeting shall constitute action of the Board if written consent to the action in question is signed by a majority of (or of a committee appointed by the Board in accordance with these Bylaws) the Directors then holding office or members of the committee, as the case may be, and filed with the minutes of the proceedings of the Board or such committee, whether done before or after the action so taken. Any one or more Directors may participate in any Board or committee meeting by means of a conference telephone or similar communications device which allows all persons participating in the meeting simultaneously to hear each other, and such participation in a meeting shall be deemed presence in person at such meeting.

     Section 8. Resignations. A Director may resign at any time by communicating his resignation to the Board, its chairman, or the Corporation. A resignation is effective when it its communicated unless it specifies in writing a later effective date or subsequent event upon which it will become effective. Unless otherwise specified therein, the acceptance of any such resignation shall not be necessary to make it effective.

     Section 9. Minutes. The Secretary or an Assistant Secretary shall keep minutes of all Board meetings, and the same shall be recorded in a book or books which shall be kept for that purpose, which book of books shall be kept on file in the Corporation. The minutes shall show a record of all action taken by the Board concerning the Corporation’s conduct, management, and welfare. The minutes of any meeting of a Board committee, showing the actions taken by such committee since the last meeting, shall

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be submitted to the Board at each Board meeting. All minutes must be signed by either the chairman or the secretary of the meeting.

ARTICLE V

Officers

     Section 1. Number of Officers. The Corporation’s officers shall be a President, one or more Vice Presidents, a Secretary and a Treasurer, and such other officers as may be appointed in accordance with the provisions of Section 3 of this Article. Any two offices or more may be held by one person, except the offices of President and Secretary, but no officer shall sign or execute any document in more than one capacity.

     Section 2. Election, Term of Office and Qualifications. Each officer, except such officers as may be appointed in accordance with the provisions of Section 3 of this Article, shall be nominated by the President and elected by the Board and shall hold office until the annual meeting of the Board held next after his election or until his successor shall have been duly elected and qualified or until his death or until he shall resign or shall have been disqualified or shall have been removed from office.

     Section 3. Subordinate Officers and Agents. From time to time, the Board of Directors may appoint other officers or agents to hold office for a period, have the authority, and perform duties as the Board of Directors from time to time may determine. The President shall appoint such officers upon notice to the Board. The Board of Directors may delegate to any officer or agent the power to appoint any subordinate officer or agent and to prescribe authority and duties

     Section 4. Removal. The officers specifically designated in Section 1 of this Article may be removed, either with or without cause, by vote of a majority of the whole Board at a special meeting of the Board called for that purpose, or by any officer upon whom the Board may confer such power of removal. The officers appointed in accordance with the provisions of Section 3 of this Article may be removed, either with or without cause, by the President. The removal of any person from office shall be without prejudice to the contract rights, if any, of the person so removed..

     Section 5. Resignations. Subject to any contract obligations or provisions in this regard, any officer may resign at any time by giving written notice to the Board or to the President or Secretary, or if he were appointed by an officer or agent in accordance with Section 3 of this Article, by giving written notice to the officer or agent who appointed him. Any such resignation shall take effect upon its being accepted by the Board or by the officer or agent appointing the person so resigning.

     Section 6. Vacancies. A vacancy in any office because of death, resignation, removal, or disqualification, or any other cause, shall be filled for the unexpired portion of the term in the manner prescribed by these Bylaws for regular appointments or elections to such offices.

     Section 7. President. The President shall be the Corporation’s chief executive officer and, subject to the Board’s instructions, shall have general charge of the Corporation’s business, affairs and property and control over its other officers, agents and employees. He shall preside at all meetings of shareholders at which he may be present. The President shall sign, with the Secretary, an Assistant Secretary, or any other proper officer of the Corporation thereunto authorized by the Board, certificates for shares of the Corporation, any deeds, mortgages, bonds, contracts, or other instruments which the Board has authorized

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to be executed, except in cases where the signing and execution thereof shall be expressly delegated by the Board or by these Bylaws to some other officer or agent of the Corporation, or shall be required by law to be otherwise signed or executed. The President shall do and perform such other duties as the Board may from time to time assign to him.

     Section 8. Vice President. At the President’s request, or in the President’s absence or disability, the Vice President, and if there be more than one (1) Vice President, the Vice President designated by the Board, or in the absence of such designation, the Vice President designated by the President, or absent such designation, in order of length of service, shall perform all the duties of the President and when so acting shall have all the powers of and be subject to all the restrictions upon the President. The Vice Presidents shall perform such other duties and have such authority as the Board may from time to time assign to them.

     Section 9. Secretary. The Secretary shall keep the minutes of the meetings of shareholders and of the Board, and shall see that all notices are duly given in accordance with the provisions of these Bylaws or the Act. He shall be custodian of the Corporation’s records, books, reports, statements, certificates and other documents and of the Corporation’s seal, and see that the seal is affixed to all share certificates prior to their issuance and to all documents requiring such seal. In general, he shall perform all duties and possess all authority incident to the office of Secretary, and he shall perform such other duties and have such other authority as the Board may from time to time assign to him.

     Section 10. Assistant Secretary. In the absence of the Secretary or in the event of his death, inability, or refusal to act, any Assistant Secretary, if such an officer is appointed by the Board, shall, unless otherwise determined by the Board, perform the duties of the Secretary, and when so acting shall have all the powers of and be subject to all the restrictions upon the Secretary. An Assistant Secretary shall perform such other duties as may be assigned to him by the Secretary, by the President, or by the Board. Any Assistant Secretary may sign, with the President or Vice President, certificates for shares of the Corporation.

     Section 11. Treasurer. The Treasurer shall have supervision over the Corporation’s funds, securities, receipts and disbursements of the Corporation. He shall keep full and accurate accounts of the Corporation’s finances in books especially provided for that purpose, and he shall cause a true statement of its assets and liabilities, as of the close of each fiscal year, and of the results of its operations and of changes in surplus for such fiscal year, all in reasonable detail, to be made and filed at the Corporation’s principal office within four months after the end of such fiscal year. The statement so filed shall be kept available for inspection by any shareholder for a period of ten years and the Treasurer shall mail or otherwise deliver a copy of the latest such statement to any shareholder upon his written request for the same. He shall in general perform all duties and have all authority incident to the office of Treasurer and shall perform such other duties and have such other authority as the Board may from time to time assign or grant to him.

     Section 12. Duties of Officers May Be Delegated. In case of the absence of any officer of the Corporation or for any other reason that the Board may deem sufficient, the Board may delegate the powers or duties of such officer to any other officer or to any Director for the time being provided a majority of the entire Board concurs therein.

     Section 13. Salaries of Officers. No officer shall be prevented from receiving a salary as such officer or from voting thereon by reason of the fact that he is also a Director. The Compensation

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Committee of the Board shall from time to time fix the salary of the President, subject to ratification by the Board. The President shall recommend the salaries of the Corporation’s other officers specifically designated in Section 1, which are subject to approval of the Compensation Committee of the Board. The Board may delegate to any officer who has been given power to appoint subordinate officers or agents, as provided in Section 3 of this Article, the authority to fix the salaries or other compensation of any such officers or agents appointed by him.

     Section 14. Bonds. Each officer and employee of the Corporation shall give bond to the Corporation, in a suitable amount to be approved by the Board, conditioned upon the faithful performance of the duties of his respective office or position, and to comply with such other conditions as may from time to time be required by the Board.

ARTICLE VI

Contracts, Loans, Deposits, Checks, Drafts, Etc.

     Section 1. Contracts. The Board may authorize any officer or officers, agent or agents to enter into any contract or to execute or deliver any instrument on behalf of the Corporation, and such authority may be general or confined to specific instances.

     Section 2. Loans. No loans shall be contracted on the Corporation’s behalf and no evidences of indebtedness shall be issued in its name, unless and except as authorized by resolution of the Board. Any officer or agent of the Corporation thereunto so authorized may effect loans or advances for the Corporation and for such loans and advances may make, execute and deliver promissory notes, bonds, or other evidences of indebtedness of the Corporation. Any such officer or agent, when thereunto so authorized, may mortgage, pledge, hypothecate or transfer as security for the payment of any and all loans, advances, indebtedness and liabilities of the Corporation any real property and all stocks, bonds, other securities and other personal property at any time held by the Corporation, and to that end may endorse, assign and deliver the same, and do every act and thing necessary or proper in connection therewith. Such authority may be general or confined to specific instances.

     Section 3. Deposits. All corporate funds shall be deposited from time to time to the Corporation’s credit in such banks or trust companies or with such bankers or other depositories as the Board may select, or as may be selected by any corporate officer or officers, agent or agents to whom the Board may give such power from time to time.

     Section 4. Checks, Drafts, Etc. All notes, drafts, acceptances, checks and endorsements or other evidences of indebtedness shall be signed by the President or a Vice President and by the Secretary or the Treasurer, or in such other manner as the Board from time to time may determine. Endorsements for deposit to the Corporation’s credit in any of its duly authorized depositories shall be made by the President or Treasurer or by any officer or agent who may be designated by Board resolution in such manner as such resolution may provide.

ARTICLE VII

Share Certificates and Their Transfer

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     Section 1. Share Certificates. Share certificates of the Corporation shall be in such form as the Board may approve from time to time. The Corporation shall issue and deliver to each shareholder certificates representing all fully paid shares owned by him. They shall be signed by the President or a Vice President and by the Secretary, Assistant Secretary, or the Treasurer and sealed with the Corporation’s seal, which seal may be a facsimile, engraved or printed. All shares shall be consecutively numbered or otherwise identified.

     Section 2. Transfers of Shares. The Secretary shall keep books containing the names, alphabetically arranged, of all shareholders of the Corporation, and showing their address, the number and class of shares held by them respectively, the date of issue of such shares, the time when they respectively became the owners thereof and the amount paid thereon. Transfers of the Corporation’s shares shall be made on such books at the direction of the record holder thereof or his attorney thereunto duly authorized by a power of attorney thereunto duly executed and filed with the Secretary, or with the transfer agent, if any, for such shares, and the surrender of the certificate or certificates for such shares properly endorsed.

     Section 3. Lost or Destroyed Certificates. The Board may authorize the issuance of a new share certificate in place of a certificate theretofore issued by the Corporation claimed to have been lost or destroyed, upon receipt of an affidavit to such fact from the person claiming the loss or destruction. The Board in its discretion may require the owner of the certificate alleged to have been lost, destroyed, stolen or mutilated, or his legal representative, to give the Corporation and its transfer agent and its registrar, if any, before the issuance of such new certificate, a bond of indemnity in such sum and in such form and with such surety or sureties as the Board may direct or the Board, by resolution reciting that the circumstances justify such action, may authorize the issuance of such new certificate without requiring such bond.

     Section 4. Regulations. The Board may make such rules and regulations as it may deem expedient concerning the issuance and transfer of certificates for the Corporation’s shares and may appoint transfer agents or registrars, or both, and may require all certificates of stock to bear the signature of either or both.

     Section 5. Fixing Record Date. (a) The Board may fix a future date as the record date in order to determine (i) the shareholders entitled to notice of a meeting of shareholders, (ii) the shareholders entitled to demand a special meeting, (iii) the shareholders entitled to vote, or (iv) the shareholders entitled to take any other action. A record date fixed under this Section may not be more than seventy (70) days before the meeting or action requiring a determination of shareholders.

     (b) A determination of shareholders entitled to notice of or to vote at a meeting of shareholders is effective for any adjournment of the meeting unless the Board fixes a new record date for the adjourned meeting, which it must do if the meeting is adjourned to a date more than one hundred twenty (120) days after the date fixed for the original meeting.

     Section 6. Holder of Record. The Corporation may treat as absolute owner of shares the person in whose name the shares stand of record on its books just as if that person has full competency, capacity and authority to exercise all rights of ownership irrespective of any knowledge or notice to the contrary or any description indicating a representative, pledge or other fiduciary relation or any reference to any other instrument or to the rights of any other person appearing upon its record or upon the share certificate, except that any person furnishing to the Corporation proof of his appointment as a fiduciary shall be

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treated as if he were a holder of record of its shares, and except as may otherwise by expressly provided by the laws of the State.

     Section 7. Reacquired Shares. Shares of the Corporation that have been issued and thereafter reacquired by the Corporation shall constitute authorized but unissued shares.

ARTICLE VIII

General Provisions

     Section 1. Corporate Seal. The corporate seal shall be in such form as the Board may approve from time to time.

     Section 2. Distributions. The Board from time to time may authorize, and the Corporation may pay, distributions and share dividends on the Corporation’s outstanding shares in the manner and upon the terms and conditions provided by law and by the Articles.

     Section 3. Fiscal Year. The Corporation’s fiscal year shall be the year ending December 31 of each year.

     Section 4. Waiver of Notice. Whenever any notice is required to be given to any shareholder or director under the Act, the Articles or these Bylaws, a waiver thereof in writing signed by the person or persons entitled to such notice, whether before or after the time stated therein, shall be equivalent to the giving of such notice.

     Section 5. Amendments. Except as otherwise herein provided, these Bylaws may be amended or repealed and new Bylaws may be adopted by the affirmative vote of a majority of the directors then holding office at any regular or special Board meeting. The Board shall not have power to adopt a Bylaw: (a) requiring more than a majority of the voting shares for a quorum at a shareholders’ meeting or more than a majority of the votes cast to constitute action by the shareholders, except where higher percentages are required by law; or (b) providing for the management of the Corporation other than by the Board or its Executive Committee. The shareholders may make, alter, amend or repeal the Corporation’s Bylaws at any annual meeting or at a special meeting called for such purpose, and Bylaws adopted by the directors may be altered or repealed by the shareholders. No Bylaw adopted or amended by the shareholders shall be altered or repealed by the Board, unless specific authority to do so is provided to the Board by the shareholders.

     Section 6. Indemnification. The Corporation shall, to the fullest extent from time to time permitted by law, indemnify (a) all directors, officers, employees or agents of the Corporation and (b) any person who, at the Corporation’s request, is or was serving as a director, officer, partner, trustee, employee or agent of another Corporation, partnership, joint venture, trust or other enterprise or as a trustee or administrator under an employee benefit plan, against liability and expenses in any proceeding (including without limitation a proceeding brought by or on behalf of the Corporation itself) arising out of their status as such or their activities in any of the foregoing capacities (“Indemnified Person”); provided, however, that the Corporation shall not indemnify or agree to indemnify an Indemnified Person against liability or expenses he may incur on account of his activities which were at the time taken known or believed by him to be clearly in conflict with the Corporation’s best interests.

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     The term “Indemnified Person” shall specifically include all persons who were initial directors, officers or employees of the Corporation prior to its incorporation and the Corporation shall, to the fullest extent from time to time permitted by law, indemnify such Indemnified Persons against liability and expenses in any proceeding arising out of their status as such or their activities on behalf of the Corporation prior to its incorporation.

     The Corporation may pay in advance expenses incurred by an Indemnified Person in defending a proceeding in advance of the final disposition of such proceeding as authorized by the Board in the specific case or as authorized or required under any provision in the Articles or these bylaws or by any applicable resolution or contract, upon receipt of an undertaking by or on behalf of such Indemnified Person to repay such amount unless it shall ultimately be determined that he is entitled to be indemnified by the Corporation against such expenses.

     The Corporation shall also pay or indemnify an Indemnified Person for such person’s reasonable costs, expenses and reasonable attorney’s fees in connection with the enforcement of rights to indemnification granted herein.

     The Board shall take all such action as may be necessary and appropriate to authorize the Corporation to pay the indemnification required by this bylaw, including without limitation a determination by a majority vote of disinterested directors that the activities giving rise to the liability or expense for which indemnification is requested were not, at the time taken, known or believed by the person requesting indemnification to be clearly in conflict with the best interests of the Corporation.

     The Corporation may purchase and maintain insurance on behalf of an Indemnified Person against liability asserted against or incurred by him in that capacity or arising from his status, whether or not the Corporation would have the power to indemnify him against the same liability under any provision of these Bylaws.

     The provisions of this section are subject to the following provisions:

     (a) the termination of any action, suit, or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that any such Indemnified Person did not meet any requisite standard of conduct imposed by law in order to be entitled to such indemnification;

     (b) in the event of such Indemnified Person’s death, the rights to indemnification hereunder shall extend to his or her legal representative; and

     (c) the rights to indemnification hereunder shall be in addition to and not exclusive of any other rights to which any such Indemnified Person may be entitled under any statute, agreement, insurance policy, or otherwise.

     For the purposes of this section, “liability” means any obligation to pay a judgment, settlement, penalty, fine (including an excise tax assessed with respect to an employee benefit plan), or reasonable expenses incurred with respect to a proceeding, “expenses” means expenses of every kind incurred in defending a proceeding, including counsel fees, and “proceeding” means any threatened, pending, or

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completed action, suit or proceeding, whether civil, criminal, administrative or investigative and whether formal or informal.

     Section 7. Interpretation of Bylaws.

     (a) All references in these Bylaws to directors, officers, shares and shareholders are references to directors, officers, shares and shareholders of the Corporation and the Board, unless the context clearly indicates otherwise.

     (b) The following terms, as used in these Bylaws, shall have the following meanings, unless the context clearly indicates otherwise:

     “Act” means the North Carolina Business Corporation Act, North

     Carolina General Statutes, Chapter 55.

     “Articles” means the Corporation’s Articles of Incorporation.

     “Corporation” shall mean Gateway Financial Holdings, Inc., a North

     Carolina corporation.

     “Board” means the Corporation ‘s Board of Directors.

     “State” shall mean the state of North Carolina.

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EX-10.8

SALARY CONTINUATION AGREEMENT

          THIS SALARY CONTINUATION AGREEMENT (this “Agreement”) is entered into as of this first day of October 1, 2006, by and between GATEWAY BANK & TRUST CO., a North Carolina banking corporation (hereinafter referred to as the “Bank” or “Employer”) and D. BEN BERRY, an individual resident of Virginia (hereinafter referred to as the “Executive”).

          WHEREAS, the Executive has contributed substantially to the success of the Employer and the Employer desires that the Executive continue in its employ;

          WHEREAS, to encourage the Executive to remain an employee of the Employer, the Employer is willing to provide salary continuation benefits to the Executive, payable out of the Employer’s general assets; and

          WHEREAS, the parties hereto intend that this Agreement shall be considered an unfunded arrangement maintained primarily to provide supplemental retirement benefits for the Executive, and shall be considered a plan described in Section 301(a)(3) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).

          NOW THEREFORE, in consideration of the foregoing premises and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows.

ARTICLE 1
DEFINITIONS

          Whenever used in this Agreement, the following terms have the meanings specified —

          1.1 “Accrual Balance” means the liability that should be accrued by the Employer under accounting principles generally accepted in the United States (“GAAP”) for the Employer’s obligation to the Executive under this Agreement, by applying Accounting Principles Board Opinion No. 12, as amended by Statement of Financial Accounting Standards No. 106, and the calculation method and discount rate specified hereinafter. The Accrual Balance shall be determined by the liability accrued by the bank as of the Effective Date. The projected Accrual Balance is detailed on Schedule A including annual accruals. The Accrual Balance shall be calculated assuming a level principal amount and interest as the discount rate is accrued each period. The principal accrual is determined such that when it is credited with interest each month, the Accrual Balance at Normal Retirement Age equals the present value of the normal retirement benefits described in Section 2.1.1(a) and (b). At the end of each Plan Year, the Accrual Balance shall be adjusted to reflect the Employer’s obligation under Sections 2.1.1(a) in terms of the Executive’s actual base salary for that Plan Year. The discount rate means the rate used by the Plan Administrator for determining the Accrual Balance. The rate is based on the yield on a 20-year corporate bond rated Aa by Moody’s, rounded to the nearest ¹/4%, or as otherwise determined by the governing Regulatory body. The initial discount rate is 5.75%. In its sole discretion, the Plan Administrator may adjust the discount rate to maintain the rate within reasonable standards according to GAAP and consistent with the Interagency Advisory on Accounting for Deferred Compensation Agreements which states that the “cost of those benefits shall be accrued over that period of the employee’s service in a systematic and rational manner.”

          1.2 “Beneficiary” means each designated person, or the estate of the deceased Executive, entitled to benefits, if any, upon the death of the Executive, determined according to Article 4.

          1.3 “Beneficiary Designation Form” means the form established from time to time by the Plan Administrator that the Executive completes, signs, and returns to the Plan Administrator to designate one or more Beneficiaries.

          1.4 “Change in Control” For the purposes of this Agreement, the term Change in Control shall mean a change in control as defined in Section 409A of the Code, including any of the following events:

     (i) Any person or group acquires beneficial ownership of representing more than fifty percent (50%) of the fair market value or voting power of the Bank’s securities; or

     (ii) During any period of twelve consecutive months, any person or persons acting in concert acquires beneficial ownership of representing thirty-five percent (35%) or more of any class of voting securities of the Bank, or a majority of the Bank’s board of directors is replaced by individuals who have not been appointed, or whose election has not been endorsed in advance, by a majority the Bank’s board of directors;

     (iii) During any period of twelve consecutive months, any person or persons acting in concert acquire more than forty percent (40%) of the assets of the Bank.

Notwithstanding the other provisions of this Section 1.4, a transaction or event shall not be considered a Change in Control if, prior to the consummation or occurrence of such transaction or event, Executive and Bank agree in writing that the same shall not be treated as a Change in Control for purposes of this Agreement.

          1.4A “Code”means the Internal Revenue Code of 1986, as amended.

          1.5 “Disability” means the Executive suffers a sickness, accident or injury that is determined by the carrier of any individual or group disability insurance policy covering the Executive to be a disability rendering the Executive totally and permanently disabled, as certified by a physician chosen by the Employer and reasonably acceptable to the Executive, or as later defined by the Internal Revenue Service in IRS Notice 2005 — 1.

          1.6 “Early Retirement Date” means the date of the Executive’s Termination of Employment with the Employer for reasons other than death, Disability, Termination for Cause, termination under Article 5 of this Agreement, or within twenty-four (24) months after a Change in Control, provided, however, that an Early Retirement Date may only occur following the later of the date the Executive attains age sixty-two (62) or the date the Executive has been continuously employed by the Employer for ten (10) years.

          1.7 “Effective Date” means October 1, 2006.

          1.8 “Final Average Salary” means the Executive’s average annual base salary for the three year period ending at Executive’s Normal Retirement Date.

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          1.9 “Good Reason” shall mean any of the following events:

     (i) Executive is assigned any duties and/or responsibilities that, in Executive’s reasonable determination, are inconsistent with or constitute a demotion or reduction in the Executive’s position, duties, responsibilities or status as such existed at the time of the Change in Control or with his reporting responsibilities or titles with the Bank in effect at such time, regardless of Executive’s resulting position; or

     (ii) Executive’s annual base salary rate is reduced below the annual amount in effect as of the effective date of a Change in Control or as the same shall have been increased from time to time following such effective date; or

     (iii) Executive’s life insurance, medical or hospitalization insurance, disability insurance, stock options plans, stock purchase plans, deferred compensation plans, management retention plans, retirement plans or similar plans or benefits being provided by the Bank to the Executive as of the effective date of the Change in Control are reduced in their level, scope or coverage, or any such insurance, plans or benefits are eliminated, unless such reduction or elimination applies proportionately to all salaried employees of the Bank who participated in such benefits prior to such Change in Control; or

     (iv) Executive is transferred to a location which is more than 15 miles from his current principal work location without the Executive’s express written consent.

          1.10 “Normal Retirement Age” means age sixty-five (65).

          1.11 “Normal Retirement Date” means the date of the Executive’s Termination of Employment on or after the Executive reaches Normal Retirement Age, other than a Termination of Employment due to the Executive’s death or due to a Termination for Cause.

          1.12 “Person” means an individual, corporation, partnership, trust, association, joint venture, pool, syndicate, sole proprietorship, unincorporated organization or other entity.

          1.13 “Plan Administrator” means the plan administrator described in Article 8.

          1.14 “Plan Year” means a twelve-month period commencing on January 1, and ending on December 31 of each year. The initial Plan Year shall commence on the Effective Date of this Agreement and end on December 31 of the year in which occurs the Effective Date.

          1.15 “Regulatory Body” refers to The Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision (OTS), also known as “the agencies”.

          1.16 “Termination for Cause” and “Cause” shall have the same definition specified in any effective severance or employment agreement existing on the date hereof or hereafter entered into between the Executive and the Bank. If the Executive is not a party to a severance or employment agreement containing a definition of termination for cause, Termination for Cause means the Bank terminates the Executive’s employment because of:

          (a) the Executive’s gross negligence or gross neglect of duties or intentional and material failure to perform stated duties after written notice thereof, or

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          (b) disloyalty or dishonesty by the Executive in the performance of his duties, or a breach of the Executive’s fiduciary duties for personal profit, in any case whether in his capacity as a director or officer, or

          (c) intentional wrongful damage by the Executive to the business or property of the Bank or its affiliates, including without limitation the reputation of the Bank, which in the judgment of the Bank causes material harm to the Bank or affiliates, or

          (d) a willful violation by the Executive of any applicable law or significant policy of the Bank or an affiliate that, in the Bank’s judgment, results in an adverse effect on the Bank or the affiliate, regardless of whether the violation leads to criminal prosecution or conviction. For purposes of this Agreement, applicable laws include any statute, rule, regulatory order, statement of policy, or final cease-and-desist order of any governmental agency or body having regulatory authority over the Bank, or

          (e) the occurrence of any event that results in the Executive being excluded from coverage, or having coverage limited for the Executive as compared to other executives of the Bank, under the Bank’s blanket bond or other fidelity or insurance policy covering its directors, officers, or employees, or

          (f) the Executive is removed from office or permanently prohibited from participating in the Bank’s affairs by an order issued under section 8(e) (4) or section 8(g) (1) of the Federal Deposit Insurance Act, 12 U.S.C. 1818(e) (4) or (g)(1), or

          (g) conviction of the Executive for or plea of nolo contendere to a felony or conviction of or plea of nolo contendere to a misdemeanor involving moral turpitude, or the actual incarceration of the Executive for 45 consecutive days or more.

          1.17 “Termination of Employment” with the Employer means that the Executive shall have ceased to be employed by the Employer for any reason whatsoever, excepting a leave of absence approved by the Employer. For purposes of this Agreement, if there is a dispute over the employment status of the Executive or the date of termination of the Executive’s employment, the Employer shall have the sole and absolute right to decide the dispute.

ARTICLE 2
RETIREMENT BENEFITS

          2.1 Normal Retirement Benefit. Upon the Executive’s Termination of Employment on or after Normal Retirement Age for reason other than death, the Executive shall be eligible to receive the benefit described in this Section 2.1 in lieu of any other benefit under Article 2 of this Agreement provided no Change in Control benefit or Termination benefit has been paid as specified in Section 2.6.

2.1.1. Amount of Benefit. The amount of the annual benefit shall be equal to the following:

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(a)

Fixed Benefit. The annual benefit under this Section 2.1(a) is an amount equal to the benefit detailed on Schedule A payable annually for fifteen (15) years commencing upon the first month after attaining age 65.

(b)

Variable Benefit. Variable Benefit. The variable benefit under this Section 2.1 (b) is an amount equal to seventy percent (70%) of the Executive’s Final Average Salary, less the Fixed Benefit detailed on Schedule A, payable annually for fifteen (15) years commencing upon the first month after attaining age 65. If the benefit due under this Section 2.1 (b) is less than zero (0), then no benefit is payable under this Section 2.1 (b).

2.1.2. Payment of Benefit. The Employer shall pay the aggregate annual benefit described in Section 2.1.1 to the Executive over the remaining term in twelve (12) equal monthly installments payable on the first day of each month, beginning with the month after the Executive’s Normal Retirement Date.

          2.2 Early Retirement Benefit. Upon the Executive’s Early Retirement Date, the Executive shall be eligible to receive the benefit described in this Section 2.2 in lieu of any other benefit under Article 2 of this Agreement.

2.2.1.	Amount of Benefit. The annual benefit under this Section 2.2 is an amount equal to the Accrual Balance earned as of the last day of the Plan Year immediately preceding the Executive’s Early Retirement Date.
2.2.2.	Payment of Benefit. The Employer shall pay the early retirement benefit to the Executive over fifteen (15) years in twelve (12) equal monthly installments payable annually on the first day of each month, beginning with the month after the Executive reaches his Normal Retirement Age.

          2.3 Disability Benefit. Upon the Executive’s Termination of Employment due to a Disability before reaching Normal Retirement Age, the Executive shall be eligible to receive the benefit described in this Section 2.3 in lieu of any other benefit under this Agreement.

2.3.1.	Amount of Benefit. The annual benefit under this Section 2.3 is an amount equal to the Accrual Balance earned as of the last day of the Plan Year immediately preceding the effective date of the Executive’s Termination of Employment.
2.3.2.	Payment of Benefit. The Employer shall pay the Disability benefit to the Executive over fifteen (15) years in twelve (12) equal monthly installments payable on the first day of each month, beginning with the month after the Executive’s Normal Retirement Age.

          2.4 Change in Control Benefit. If, within twenty-four (24) months after a Change in Control, the Employer terminates the Executive’s employment other than for Cause or as described in Section 5.2 hereof or if the Executive terminates employment for Good Reason, the Executive shall be eligible to receive the benefit described in this Section 2.4 instead of any other benefit under Article 2 of this Agreement.

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2.41 Amount of Benefit. The annual benefit under this Section 2.4 is an amount equal to seventy percent (70%) of the Executive’s final annual salary at the Executive’s Termination of Employment, or the benefit detailed on Schedule A, whichever is greater, payable annually for fifteen (15) years commencing as of the last day of the Plan Month preceding the effective date of the Executive’s Termination of Employment.

2.41.1

Payment of Benefit. The Employer shall pay the Change in Control benefit under Section 2.4 of this Agreement to the Executive over fifteen (15) years in twelve (12) equal monthly installments payable on the first day of each month, beginning with the month after the Executive’s Termination of Employment.

2.41.2

Change in Control Payout of Normal Retirement Benefit, Early Retirement Benefit, or Disability Benefit Being Paid to the Executive at the Time of a Change in Control. If a Change in Control occurs at any time during the period in which the Executive is receiving payment of the benefit under Section 2.1, 2.2, or 2.3, the Employer shall pay the remaining benefits due to the Executive under the applicable section to the Executive in a single lump sum payment within thirty (30) days after the Change in Control.

          2.5 Termination Benefit. Upon the Executive’s Termination without Cause by the Employer, the Executive shall be eligible to receive the benefit described in this Section 2.5 in lieu of any other benefit under Article 2 of this Agreement.

2.5.1	Amount of Benefit. The annual benefit under this Section 2.5 is an amount equal to the benefit detailed on Schedule A payable annually for fifteen (15) years commencing upon the first month after attaining age 65.
2.5.2	Payment of Benefit. The Employer shall pay the benefit under this Section 2.5 to the Executive over fifteen (15) years in twelve (12) equal monthly installments payable annually on the first day of each month, beginning with the month after the Executive reaches his Normal Retirement Age.

          2.6 Petition for Lump Sum Payment of Benefit. If the Executive is entitled to a benefit under Section 2.1, Section 2.2, Section 2.3, Section 2.4 or Section 2.5, the Executive may petition the Board of Directors of the Employer to have the Present Value of the Benefit, determined as of the date the Executive becomes entitled to a benefit under Section 2.1, Section 2.2, Section 2.3, Section 2.4 or Section 2.5, as applicable, paid to the Executive in a single lump sum. The Board of Directors of the Employer may, in its sole and absolute discretion, pay the Present Value of the Benefit to the Executive in a single lump sum. If the Present Value of the Benefit is paid to the Executive in a single lump sum, the Employer shall have no further obligations under this Agreement.

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          2.7 Excess Parachute Payment. If the Executive receives the payment pursuant to Section 2.4 and acceleration of benefits under any other benefit, compensation, or incentive plan or arrangement with the Bank or its parent corporation (collectively, the “Total Benefits”), and if any part of the Total Benefits is subject to an excise tax under Section 280G and Section 4999 of the Code (the “Excise Tax”), the Bank shall pay to the Executive the following additional amounts, consisting of (x) a payment equal to the Excise Tax payable by the Executive under section 4999 on the Total Benefits (the “Excise Tax Payment”) and (y) a payment equal to the amount necessary to provide the Excise Tax Payment net of all income, payroll, and excise taxes. Together, the additional amounts described in clauses (x) and (y) are referred to in this Agreement as the “Gross-Up Payment Amount.” Payment of the Gross-Up Payment Amount shall be made in addition to the amount set forth in Section 2.4 above.

          2.8 Total Benefits Subject to Excise Tax. For purposes of determining whether any of the Total Benefits will be subject to the Excise Tax and for purposes of determining the amount of the Excise Tax, any other payments or benefits received or to be received by the Executive in connection with a Change in Control or the Executive’s termination of employment following a Change in Control (whether under the terms of this Agreement or any other agreement or any other benefit plan or arrangement with the Bank or its parent corporation) shall be treated as “parachute payments” within the meaning of section 280G(b)(2) of the Code, and all “excess parachute payments” within the meaning of section 280G(b)(1) shall be treated as subject to the Excise Tax, unless in the opinion of the certified public accounting firm that is retained by the Bank as of the date immediately before the Change in Control (the “Accounting Firm”), such other payments or benefits do not constitute (in whole or in part) parachute payments, or such excess parachute payments represent (in whole or in part) reasonable compensation for services actually rendered within the meaning of section 280G(b)(4) of the Code in excess of the “base amount” (as defined in section 280G(b)(3) of the Code), or are otherwise not subject to the Excise Tax. The value of any noncash benefits or any deferred payment or benefit shall be determined by the Accounting Firm in accordance with the principles of sections 280G(d)(3) and (4) of the Code.

          2.9 Gross Up Payment Amount. For purposes of determining the Gross-Up Payment Amount, the Executive shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar years in which the Gross-Up Payment Amount is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive’s residence on the date of termination of employment, net of the reduction in federal income taxes that can be obtained from deduction of such state and local taxes (calculated by assuming that any reduction under section 68 of the Code in the amount of itemized deductions allowable to the Executive applies first to reduce the amount of such state and local income taxes that would otherwise be deductible by the Executive, and applicable federal FICA and Medicare withholding taxes).

          2.10 Determination by Accounting Firm. All determinations required to be made under Section 2.7, Section 2.8 and Section 2.9, including whether and when a Gross-Up Payment Amount is required, the amount of the Gross-Up Payment Amount and the assumptions to be used to arrive at the determination (collectively, the “Determination”), shall be made by the Accounting Firm, which shall provide detailed supporting calculations both to the Bank and the Executive within 15 business days after receipt of notice from the Bank or the Executive that there has been a Gross-Up Payment Amount, or such earlier time as is requested by the Bank.

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All fees and expenses of the Accounting Firm shall be borne solely by the Bank. The Bank shall enter into any reasonable agreement requested by the Accounting Firm in connection with the performance of its services hereunder. If the Accounting Firm determines that no Excise Tax is payable by the Executive, the Accounting Firm shall furnish the Executive with a written opinion to that effect, and to the effect that failure to report an Excise Tax, if any, on the Executive’s applicable federal income tax return will not result in the imposition of a negligence or similar penalty. The Determination by the Accounting Firm shall be binding on the Bank and the Executive. If, after a Determination by the Accounting Firm, the Executive is required to make a payment of additional Excise Tax (“Underpayment”), the Accounting Firm shall determine the amount of the Underpayment that has occurred. The Underpayment (together with interest at the rate provided in section 1274(d)(2)(B) of the Code) shall be paid promptly by the Bank to or for the benefit of the Executive. If the Gross-Up Payment Amount exceeds the amount necessary to reimburse the Executive for his Excise Tax (“Overpayment”), the Accounting Firm shall determine the amount of the Overpayment that has been made. The Overpayment (together with interest at the rate provided in section 1274(d)(2)(B) of the Code) shall be paid promptly by the Executive to or for the benefit of the Bank. Provided that his expenses are reimbursed by the Bank, the Executive shall cooperate with any reasonable requests by the Bank in any contests or disputes with the Internal Revenue Service relating to the Excise Tax. If the Accounting Firm is serving as accountant or auditor for the individual, entity, or group effecting the Change in Control, the Executive, in his sole discretion, may appoint another nationally recognized public accounting firm to make the Determinations required hereunder (in which case the term “Accounting Firm” as used in this Agreement shall be deemed to refer to the accounting firm appointed by the Executive under this Section).

          2.11 Contradiction in Terms of Agreement and Schedule A. If there is a contradiction in the terms of this Agreement and Schedule A attached hereto concerning the actual amount of a particular benefit amount due the Executive under Sections 2.2, 2.3, 2.4 or 2.5 hereof, then the actual amount of the benefit set forth in the Agreement shall control.

          2.12 One Benefit Only. Despite any contrary provision of this Agreement, the Executive and Beneficiary are entitled to one benefit only under Article 2 of this Agreement, which shall be determined by the first event to occur that is dealt with by Article 2 of this Agreement. Subsequent occurrence of events dealt with by this Article 2 shall not entitle the Executive or the Executive’s Beneficiary to other or additional benefits under Article 2.

          2.13 Savings Clause Relating to Compliance with Code Section 409A. Despite any contrary provision of this Agreement, if when the Executive’s employment terminates the Executive is a specified employee, as defined in Code section 409A, and if any payments under Article 2 of this Agreement will result in additional tax or interest to the Executive because of section 409A, the Executive will not be entitled to the payments under Article 2 until the earliest of (a) the date that is at least six months after termination of the Executive’s employment for reasons other than the Executive’s death, (b) the date of the Executive’s death, or (c) any earlier date that does not result in additional tax or interest to the Executive under section 409A. If any provision of this Agreement would subject the Executive to additional tax or interest under section 409A, the Bank shall reform the provision. However, the Bank shall maintain to the maximum extent practicable the original intent of the applicable provision without subjecting the Executive to additional tax or interest, and the Bank shall not be required to incur any additional compensation expense as a result of the reformed provision. References in this Agreement to

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Code section 409A include rules, regulations, and guidance of general application issued by the Department of the Treasury under Code section 409A.

3
DEATH BENEFITS

          3.1 Death During Active Service. If the Executive dies while employed by the Employer, instead of any benefits payable under Article 2 of this Agreement the Employer shall pay to the Executive’s Beneficiary the present value of the amount necessary to provide the full benefit described in section 2.1.1 and identified on Schedule A. The Employer shall pay the death benefit under this Section 3.1 within thirty (30) days after the Executive’s death.

          3.2 Death During Benefit Period. If the Executive dies after benefit payments under Article 2 of this Agreement commences but before receiving all such payments, or if the Executive is entitled to benefit payments under Article 2 but dies before payments commence, the remaining Accrual Balance shall be payable to the Executive’s Beneficiary in accordance with the applicable payment provisions of Article 2, until fully disbursed. Payments shall be made in the same amounts they would have been made to the Executive had the Executive survived.

4
BENEFICIARIES

          4.1 Beneficiary Designations. The Executive shall have the right to designate at any time a Beneficiary to receive any benefits payable under this Agreement upon the death of the Executive. The Beneficiary designated under this Agreement may be the same as or different from the beneficiary designation under any other benefit plan of the Employer in which the Executive participates.

          4.2 Beneficiary Designation: Change. The Executive shall designate a Beneficiary by completing and signing the Beneficiary Designation Form and delivering it to the Plan Administrator or its designated agent. The Executive’s Beneficiary designation shall be deemed automatically revoked if the Beneficiary predeceases the Executive or if the Executive names a spouse as Beneficiary and the marriage is subsequently dissolved. The Executive shall have the right to change a Beneficiary by completing, signing, and otherwise complying with the terms of the Beneficiary Designation Form and the Plan Administrator’s rules and procedures, as in effect from time to time. Upon the acceptance by the Plan Administrator of a new Beneficiary Designation Form, all Beneficiary designations previously filed shall be cancelled. The Plan Administrator shall be entitled to rely on the last Beneficiary Designation Form filed by the Executive and accepted by the Plan Administrator before the Executive’s death.

          4.3 Acknowledgment. No designation or change in designation of a Beneficiary shall be effective until received in writing by the Plan Administrator or its designated agent.

          4.4 No Beneficiary Designation. If the Executive dies without a valid beneficiary designation, or if all designated Beneficiaries predecease the Executive, then the Executive’s spouse shall be the designated Beneficiary. If the Executive has no surviving spouse, the benefits shall be distributed to the personal representative of the Executive’s estate.

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          4.5 Facility of Payment. If a benefit is payable to a minor, to a person declared incapacitated, or to a person incapable of handling the disposition of his or her property, the Employer may pay such benefit to the guardian, legal representative, or person having the care or custody of the minor, incapacitated person, or incapable person. The Employer may require proof of incapacity, minority, or guardianship as it may deem appropriate before distribution of the benefit. Distribution shall completely discharge the Employer from all liability for the benefit.

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GENERAL LIMITATIONS

          5.1 Termination for Cause. If the Executive experiences a Termination of Employment which is a Termination for Cause, notwithstanding any provision of this Agreement to the contrary, this Agreement and the Employer’s obligations under this Agreement shall terminate as of the effective date of the Termination for Cause.

          5.2 Suicide or Misstatement No benefits shall be paid under this Agreement if the Executive commits suicide within two years after the Effective Date of this Agreement or if the Executive makes any material misstatement of fact on any application for life insurance purchased by the Bank.

          5.3 Removal. Despite any contrary provision of this Agreement, if the Executive is removed from office or permanently prohibited from participating in the Bank’s affairs by an order issued under section 8(e) (4) or (g) (1) of the Federal Deposit Insurance Act, 12 U.S.C. 1818(e) (4) or (g) (1), all obligations of the Bank under this Agreement shall terminate as of the effective date of the order.

          5.4 Default Despite any contrary provision of this Agreement, if the Bank is in “default” or “in danger of default”, as those terms are defined in of section 3(x) of the Federal Deposit Insurance Act, 12 U.S.C. 1813(x), all obligations under this Agreement shall terminate.

          5.5 FDIC Open-Bank Assistance. All obligations under this Agreement shall be terminated, except to the extent determined that continuation of the contract is necessary for the continued operation of the Bank, at the time the Federal Deposit Insurance Corporation enters into an agreement to provide assistance to or on behalf of the Bank under the authority contained in section 13(c) of the Federal Deposit Insurance Act. 12 U.S.C. 1823(c).

6
CLAIMS AND REVIEW PROCEDURES

          6.1 Claims Procedure. A person or beneficiary (a “claimant”) who has not received benefits under the Agreement that he or she believes should be paid shall make a claim for such benefits as follows –

6.1.1 Initiation — Written Claim. The claimant initiates a claim by submitting to the Employer a written claim for the benefits. If the claim relates to the contents of a notice received by the claimant, the claim must be made within 60 days after the notice was received by the claimant. All other claims must be made within 180

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	days after the date of the event that caused the claim to arise. The claim must state with particularity the determination desired by the claimant.
6.1.2	Timing of Employer Response. The Employer shall respond to such claimant within ninety (90) days after receiving the claim. If the Employer determines that special circumstances require additional time for processing the claim, the Employer can extend the response period by an additional ninety (90) days by notifying the claimant in writing, prior to the end of the initial ninety (90)-day period, that an additional period is required. The notice of extension must set forth the special circumstances and the date by which the Employer expects to render its decision.
6.1.3	Notice of Decision. If the Employer denies part or all of the claim, the Employer shall notify the claimant in writing of such denial. The Employer shall write the notification in a manner calculated to be understood by the claimant. The notification shall set forth:

6.1.3.1	The specific reasons for the denial,
6.1.3.2	A reference to the specific provisions of the Agreement on which the denial is based,
6.1.3.3	A description of any additional information or material necessary for the claimant to perfect the claim and an explanation of why it is needed,
6.1.3.4	An explanation of the Agreement’s review procedures and the time limits applicable to such procedures, and
6.1.3.5	A statement of the claimant’s right to bring a civil action under ERISA section 502(a) following an adverse benefit determination on review.

          6.2 Review Procedure. If the Employer denies part or all of the claim, the claimant shall have the opportunity for a full and fair review by the Employer of the denial, as follows

6.2.1	Initiation — Written Request. To initiate the review, the claimant, within 60 days after receiving the Employer’s notice of denial, must file with the Employer a written request for review.
6.2.2	Additional Submissions — Information Access. The claimant shall then have the opportunity to submit written comments, documents, records and other information relating to the claim. The Employer shall also provide the claimant, upon request and free of charge, reasonable access to, and copies of, all documents, records and other information relevant (as defined in applicable ERISA regulations) to the claimant’s claim for benefits.
6.2.3	Considerations on Review. In considering the review, the Employer shall take into account all materials and information the claimant submits relating to the claim,

11

	without regard to whether such information was submitted or considered in the initial benefit determination.
6.2.4	Timing of Employer Response. The Employer shall respond in writing to such claimant within sixty (60) days after receiving the request for review. If the Employer determines that special circumstances require additional time for processing the claim, the Employer can extend the response period by an additional sixty (60) days by notifying the claimant in writing, prior to the end of the initial sixty (60)-day period, that an additional period is required. The notice of extension must set forth the special circumstances and the date by which the Employer expects to render its decision.
6.2.5	Notice of Decision. The Employer shall notify the claimant in writing of its decision on review. The Employer shall write the notification in a manner calculated to be understood by the claimant. The notification shall set forth –

6.2.5.1	The specific reasons for the denial,
6.2.5.2	A reference to the specific provisions of the Agreement on which the denial is based,
6.2.5.3	A statement that the claimant is entitled to receive, upon request and free of charge, reasonable access to, and copies of, all documents, records and other information relevant (as defined in applicable ERISA regulations) to the claimant’s claim for benefits, and
6.2.5.4	A statement of the claimant’s right to bring a civil action under ERISA Section 502(a).

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MISCELLANEOUS

          7.1 Amendments and Termination. Subject to Section 7.13 of this Agreement, (a) this Agreement may be amended solely by a written agreement signed by the Employer and by the Executive, and (b) except for termination occurring under Article 5, this Agreement may be terminated solely by a written agreement signed by the Employer and by the Executive.

          7.2 Binding Effect. This Agreement shall bind the Executive and the Employer and their beneficiaries, survivors, executors, successors, administrators, and transferees.

          7.3 No Guarantee of Employment. This Agreement is not an employment policy or contract. It does not give the Executive the right to remain an employee of the Employer, nor does it interfere with the Employer’s right to discharge the Executive. It also does not require the Executive to remain an employee nor interfere with the Executive’s right to terminate employment at any time.

          7.4 Non-Transferability. Benefits under this Agreement cannot be sold, transferred, assigned, pledged, attached, or encumbered in any manner.

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          7.5 Tax Withholding. The Employer shall withhold any taxes that are required to be withheld from the benefits provided under this Agreement.

          7.6 Applicable Law. Except to the extent preempted by the laws of the United States of America, the validity, interpretation, construction, and performance of this Agreement shall be governed by and construed in accordance with the laws of the State of North Carolina, without giving effect to the principles of conflict of laws of such state.

          7.7 Unfunded Arrangement. The Executive and the Executive’s Beneficiary are general unsecured creditors of the Employer for the payment of benefits under this Agreement. The benefits represent the mere promise by the Employer to pay such benefits. The rights to benefits are not subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment, or garnishment by creditors. Any insurance on the Executive’s life is a general asset of the Employer to which the Executive and Beneficiary have no preferred or secured claim.

          7.8 Severability. If any provision of this Agreement is held invalid, such invalidity shall not affect any other provision of this Agreement, and each such other provision shall continue in full force and effect to the full extent consistent with law. If any provision of this Agreement is held invalid in part, such invalidity shall not affect the remainder of the provision, and the remainder of such provision together with all other provisions of this Agreement shall continue in full force and effect to the full extent consistent with law.

          7.9 Headings. The headings of sections herein are included solely for convenience of reference and shall not affect the meaning or interpretation of any provision of this Agreement.

          7.10 Notices. All notices, requests, demands, and other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered by hand or mailed, certified or registered mail, return receipt requested, with postage prepaid. Unless otherwise changed by notice, notice shall be properly addressed to the Executive if addressed to the address of the Executive on the books and records of the Employer at the time of the delivery of such notice, and properly addressed to the Employer if addressed to the Board of Directors, at 1145 North Road Street, Elizabeth City, North Carolina 27909.

          7.11 Entire Agreement. This Agreement constitutes the entire agreement between the Employer and the Executive concerning the subject matter hereof. No rights are granted to the Executive under this Agreement other than those specifically set forth herein.

          7.12 Payment of Legal Fees. In the event litigation ensues between the parties concerning the enforcement of the obligations of the parties under this Agreement, the Employer shall pay all costs and expenses in connection with such litigation until such time as a final determination (excluding any appeals) is made with respect to the litigation. If the Employer prevails on the substantive merits of the each material claim in dispute in such litigation, the Employer shall be entitled to receive from the Executive all reasonable costs and expenses, including without limitation attorneys’ fees, incurred by the Employer on behalf of the Executive in connection with such litigation, and the Executive shall pay such costs and expenses to the Employer promptly upon demand by the Employer.

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          7.13 Termination or Modification of Agreement Because of Changes in Law, Rules or Regulations. The Employer is entering into this Agreement on the assumption that certain existing tax laws, rules, and regulations will continue in effect in their current form. If that assumption materially changes and the change has a material detrimental effect on this Agreement, then the Employer reserves the right to terminate or modify this Agreement accordingly, subject to the written consent of the Executive, which shall not be unreasonably withheld. This Section 7.13 shall become null and void effective immediately if a Change in Control occurs.

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ADMINISTRATION OF AGREEMENT

          8.1 Plan Administrator Duties. This Agreement shall be administered by a Plan Administrator consisting of the Board of Directors of the Employer or such committee or person(s) as the Board of Directors of the Employer shall appoint. In accordance with the rules applicable for companies listed on the Nasdaq Stock Market and the Employer’s corporate governance procedures, the Executive shall not serve as a member of the Plan Administrator. The Plan Administrator shall also have the discretion and authority to (a) make, amend, interpret, and enforce all appropriate rules and regulations for the administration of this Agreement and (b) decide or resolve any and all questions, including interpretations of this Agreement, as may arise in connection with the Agreement.

          8.2 Agents. In the administration of this Agreement, the Plan Administrator may employ agents and delegate to them such administrative duties as it sees fit (including acting through a duly appointed representative) and may from time to time consult with counsel, who may be counsel to the Employer.

          8.3 Binding Effect of Decisions. The decision or action of the Plan Administrator with respect to any question arising out of or in connection with the administration, interpretation, and application of the Agreement and the rules and regulations promulgated hereunder shall be final and conclusive and binding upon all persons having any interest in the Agreement. No Executive or Beneficiary shall be deemed to have any right, vested or nonvested, regarding the continued use of any previously adopted assumptions, including but not limited to the discount rate and calculation method described in Section 1.1.

          8.4 Indemnity of Plan Administrator. The Plan Administrator shall not be liable to any person for any action taken or omitted in connection with the interpretation and administration of this Agreement, unless such action or omission is attributable to the willful misconduct of the Plan Administrator or any of its members. The Employer shall indemnify and hold harmless the members of the Plan Administrator against any and all claims, losses, damages, expenses, or liabilities arising from any action or failure to act with respect to this Agreement, except in the case of willful misconduct by the Plan Administrator or any of its members.

          8.5 Employer Information. To enable the Plan Administrator to perform its functions, the Employer shall supply full and timely information to the Plan Administrator on all matters relating to the date and circumstances of the retirement, Disability, death, or Termination of Employment of the Executive and such other pertinent information as the Plan

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Administrator may reasonably require.

      IN WITNESS WHEREOF, the Executive and a duly authorized Executive of the Company and the Bank have signed this Agreement as of the date first written above.

THE EXECUTIVE:	THE BANK: Gateway Bank & Trust Co.
	By:	/s/ David Twiddy
/s/ D. Ben Berry
D. Ben Berry
	Its:	President & C.O.O.

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BENEFICIARY DESIGNATION
SALARY CONTINUATION AGREEMENT

I,                                         ., designate the following as beneficiary of any death benefits under this Salary Continuation Agreement –

Primary:
	.
Contingent:
	.

Note: To name a trust as beneficiary, please provide the name of the trustee(s) and the exact name and date of the trust agreement.

I understand that I may change these beneficiary designations by filing a new written designation with the Employer. I further understand that the designations will be automatically revoked if the beneficiary predeceases me, or if I have named my spouse as beneficiary and our marriage is subsequently dissolved.

Signature:
	Daniel Berry
Date:		, 2006
Accepted by the Employer this                                            day of                                                             , 2006.
By:
Print Name:
Title:

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SCHEDULE A

					Termination
					without				Change in
					Cause		Disability		Control
					annual		annual		Annual
					benefit		benefit		Benefit
	Plan Year		Annual		payable at		payable at		Payable at
	ending		Retirement		Normal		Normal		Normal				Premature
Plan	December		Fixed		Retirement		Retirement		Retirement		Accrual		Death
Year	31,		Benefit		Age		Age		Age		Balance		Benefit
1		2006		367,500		651,282		0		651,282		60,777		2,936,040
2		2007		384,038		651,282		30,824		651,282		321,824		3,104,862
3		2008		401,319		651,282		58,760		651,282		613,484		3,283,392
4		2009		419,379		651,282		89,886		651,282		938,461		3,472,187
5		2010		438,251		651,282		124,483		651,282		1,299,674		3,671,837
6		2011		457,972		651,282		162,852		651,282		1,700,266		3,882,968
7		2012		478,581		651,282		205,317		651,282		2,143,631		4,106,239
8		2013		500,117		651,282		252,229		651,282		2,633,421		4,342,348
9		2014		522,622		651,282		303,965		651,282		3,173,573		4,592,033
10		2015		546,140		651,282		360,931		651,282		3,768,327		4,856,074
11		2016		570,716		651,282		423,564		651,282		4,422,247		5,135,299
12		2017		596,398		651,282		492,334		651,282		5,140,247		5,430,578
13		2018		623,236		651,282		567,748		651,282		5,927,613		5,742,837
	1-Dec			651,282										6,073,050

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EX-10.9

SALARY CONTINUATION AGREEMENT

     THIS SALARY CONTINUATION AGREEMENT (this “Agreement”) is entered into as of this first day of October 1, 2006 by and between GATEWAY BANK & TRUST CO., a North Carolina banking corporation (hereinafter referred to as the “Bank” or “Employer”) and DAVID R. TWIDDY, an individual resident of North Carolina (hereinafter referred to as the “Executive”).

     WHEREAS, the Executive has contributed substantially to the success of the Employer and the Employer desires that the Executive continue in its employ;

     WHEREAS, to encourage the Executive to remain an employee of the Employer, the Employer is willing to provide salary continuation benefits to the Executive, payable out of the Employer’s general assets; and

     WHEREAS, the parties hereto intend that this Agreement shall be considered an unfunded arrangement maintained primarily to provide supplemental retirement benefits for the Executive, and shall be considered a plan described in Section 301(a)(3) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).

     NOW THEREFORE, in consideration of the foregoing premises and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows.

ARTICLE 1
DEFINITIONS

     Whenever used in this Agreement, the following terms have the meanings specified —

     1.1 “Accrual Balance” means the liability that should be accrued by the Employer under accounting principles generally accepted in the United States (“GAAP”) for the Employer’s obligation to the Executive under this Agreement, by applying Accounting Principles Board Opinion No. 12, as amended by Statement of Financial Accounting Standards No. 106, and the calculation method and discount rate specified hereinafter. The Accrual Balance shall be determined by the liability accrued by the Bank as of the Effective Date. The projected Accrual Balance is detailed on Schedule A including annual accruals. The Accrual Balance shall be calculated assuming a level principal amount and interest as the discount rate is accrued each period. The principal accrual is determined such that when it is credited with interest each month, the Accrual Balance at Normal Retirement Age equals the present value of the normal retirement benefits described in Section 2.1.1(a) and (b). At the end of each Plan Year, the Accrual Balance shall be adjusted to reflect the Employer’s obligation under Sections 2.1.1(a) in terms of the Executive’s actual base salary for that Plan Year. The discount rate means the rate used by the Plan Administrator for determining the Accrual Balance. The rate is based on the yield on a 20-year corporate bond rated Aa by Moody’s, rounded to the nearest ¹/4%, or as otherwise determined by the governing Regulatory body. The initial discount rate is 5.75%. In its sole discretion, the Plan Administrator may adjust the discount rate to maintain the rate within reasonable standards according to GAAP and consistent with the Interagency Advisory on Accounting for Deferred Compensation Agreements which states that the “cost of those benefits shall be accrued over that period of the employee’s service in a systematic and rational manner.”

      1.2 “Beneficiary” means each designated person, or the estate of the deceased Executive, entitled to benefits, if any, upon the death of the Executive, determined according to Article 4.

      1.3 “Beneficiary Designation Form” means the form established from time to time by the Plan Administrator that the Executive completes, signs, and returns to the Plan Administrator to designate one or more Beneficiaries.

      1.4 “Change in Control” For the purposes of this Agreement, the term Change in Control shall mean a change in control as defined in Section 409A of the Code, including any of the following events:

(i) Any person or group acquires beneficial ownership of representing more than fifty percent (50%) of the fair market value or voting power of the Bank’s securities; or

(ii) During any period of twelve consecutive months, any person or persons acting in concert acquires beneficial ownership of representing thirty-five percent (35%) or more of any class of voting securities of the Bank, or a majority of the Bank’s board of directors is replaced by individuals who have not been appointed, or whose election has not been endorsed in advance, by a majority the Bank’s board of directors;

(iii) During any period of twelve consecutive months, any person or persons acting in concert acquire more than forty percent (40%) of the assets of the Bank.

Notwithstanding the other provisions of this Section 1.4, a transaction or event shall not be considered a Change in Control if, prior to the consummation or occurrence of such transaction or event, Executive and Bank agree in writing that the same shall not be treated as a Change in Control for purposes of this Agreement.

     1.4A “Code”means the Internal Revenue Code of 1986, as amended.

      1.5 “Disability” means the Executive suffers a sickness, accident or injury that is determined by the carrier of any individual or group disability insurance policy covering the Executive to be a disability rendering the Executive totally and permanently disabled, as certified by a physician chosen by the Employer and reasonably acceptable to the Executive, or as later defined by the Internal Revenue Service in IRS Notice 2005 — 1.

      1.6 “Early Retirement Date” means the date of the Executive’s Termination of Employment with the Employer for reasons other than death, Disability, Termination for Cause, termination under Article 5 of this Agreement, or within twenty-four (24) months after a Change in Control, provided, however, that an Early Retirement Date may only occur following the later of the date the Executive attains age sixty-two (62) or the date the Executive has been continuously employed by the Employer for ten (10) years.

      1.7 “Effective Date” means October 1, 2006.

      1.8 “Final Average Salary” means the Executive’s average annual base salary for the three year period ending at Executive’s Normal Retirement Date.

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     1.9 “Good Reason” shall mean any of the following events:

     (i) Executive is assigned any duties and/or responsibilities that, in Executive’s reasonable determination, are inconsistent with or constitute a demotion or reduction in the Executive’s position, duties, responsibilities or status as such existed at the time of the Change in Control or with his reporting responsibilities or titles with the Bank in effect at such time, regardless of Executive’s resulting position; or

     (ii) Executive’s annual base salary rate is reduced below the annual amount in effect as of the effective date of a Change in Control or as the same shall have been increased from time to time following such effective date; or

     (iii) Executive’s life insurance, medical or hospitalization insurance, disability insurance, stock options plans, stock purchase plans, deferred compensation plans, management retention plans, retirement plans or similar plans or benefits being provided by the Bank to the Executive as of the effective date of the Change in Control are reduced in their level, scope or coverage, or any such insurance, plans or benefits are eliminated, unless such reduction or elimination applies proportionately to all salaried employees of the Bank who participated in such benefits prior to such Change in Control; or

     (iv) Executive is transferred to a location which is more than 15 miles from his current principal work location without the Executive’s express written consent.

      1.10 “Normal Retirement Age” means age sixty-five (65).

      1.11 “Normal Retirement Date” means the date of the Executive’s Termination of Employment on or after the Executive reaches Normal Retirement Age, other than a Termination of Employment due to the Executive’s death or due to a Termination for Cause.

      1.12 “Person” means an individual, corporation, partnership, trust, association, joint venture, pool, syndicate, sole proprietorship, unincorporated organization or other entity.

      1.13 “Plan Administrator” means the plan administrator described in Article 8.

      1.14 “Plan Year” means a twelve-month period commencing on January 1, and ending on December 31 of each year. The initial Plan Year shall commence on the Effective Date of this Agreement and end on December 31 of the year in which occurs the Effective Date.

      1.15 “Regulatory Body” refers to The Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision (OTS), also known as “the agencies”.

      1.16 “Termination for Cause” and “Cause” shall have the same definition specified in any effective severance or employment agreement existing on the date hereof or hereafter entered into between the Executive and the Bank. If the Executive is not a party to a severance or employment agreement containing a definition of termination for cause, Termination for Cause means the Bank terminates the Executive’s employment because of:

     (a) the Executive’s gross negligence or gross neglect of duties or intentional and material failure to perform stated duties after written notice thereof, or

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     (b) disloyalty or dishonesty by the Executive in the performance of his duties, or a breach of the Executive’s fiduciary duties for personal profit, in any case whether in his capacity as a director or officer, or

     (c) intentional wrongful damage by the Executive to the business or property of the Bank or its affiliates, including without limitation the reputation of the Bank, which in the judgment of the Bank causes material harm to the Bank or affiliates, or

     (d) a willful violation by the Executive of any applicable law or significant policy of the Bank or an affiliate that, in the Bank’s judgment, results in an adverse effect on the Bank or the affiliate, regardless of whether the violation leads to criminal prosecution or conviction. For purposes of this Agreement, applicable laws include any statute, rule, regulatory order, statement of policy, or final cease-and-desist order of any governmental agency or body having regulatory authority over the Bank, or

     (e) the occurrence of any event that results in the Executive being excluded from coverage, or having coverage limited for the Executive as compared to other executives of the Bank, under the Bank’s blanket bond or other fidelity or insurance policy covering its directors, officers, or employees, or

     (f) the Executive is removed from office or permanently prohibited from participating in the Bank’s affairs by an order issued under section 8(e) (4) or section 8(g) (1) of the Federal Deposit Insurance Act, 12 U.S.C. 1818(e) (4) or (g)(1), or

     (g) conviction of the Executive for or plea of nolo contendere to a felony or conviction of or plea of nolo contendere to a misdemeanor involving moral turpitude, or the actual incarceration of the Executive for 45 consecutive days or more.

     1.17 “Termination of Employment” with the Employer means that the Executive shall have ceased to be employed by the Employer for any reason whatsoever, excepting a leave of absence approved by the Employer. For purposes of this Agreement, if there is a dispute over the employment status of the Executive or the date of termination of the Executive’s employment, the Employer shall have the sole and absolute right to decide the dispute.

ARTICLE 2
RETIREMENT BENEFITS

     2.1 Normal Retirement Benefit. Upon the Executive’s Termination of Employment on or after Normal Retirement Age for reason other than death, the Executive shall be eligible to receive the benefit described in this Section 2.1 in lieu of any other benefit under Article 2 of this Agreement provided no Change in Control benefit or Termination benefit has been paid as specified in Section 2.6.

2.1.1. Amount of Benefit. The amount of the annual benefit shall be equal to the following:

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(a) Fixed Benefit. The annual benefit under this Section 2.1(a) is an amount equal to the benefit detailed on Schedule A payable annually for fifteen (15) years commencing upon the first month after attaining age 65.

(b) Variable Benefit. The variable benefit under this Section 2.1 (b) is an amount equal to seventy percent (70%) of the Executive’s Final Average Salary, less the Fixed Benefit detailed on Schedule A, payable annually for fifteen (15) years commencing upon the first month after attaining age 65. If the benefit due under this Section 2.1 (b) is less than zero (0), then no benefit is payable under this Section 2.1 (b).

2.1.2. Payment of Benefit. The Employer shall pay the aggregate annual benefit described in Section 2.1.1 to the Executive over the remaining term in twelve (12) equal monthly installments payable on the first day of each month, beginning with the month after the Executive’s Normal Retirement Date.

     2.2 Early Retirement Benefit. Upon the Executive’s Early Retirement Date, the Executive shall be eligible to receive the benefit described in this Section 2.2 in lieu of any other benefit under Article 2 of this Agreement.

2.2.1. Amount of Benefit. The annual benefit under this Section 2.2 is an amount equal to the Accrual Balance earned as of the last day of the Plan Year immediately preceding the Executive’s Early Retirement Date.

2.2.2. Payment of Benefit. The Employer shall pay the early retirement benefit to the Executive over fifteen (15) years in twelve (12) equal monthly installments payable annually on the first day of each month, beginning with the month after the Executive reaches his Normal Retirement Age.

     2.3 Disability Benefit. Upon the Executive’s Termination of Employment due to a Disability before reaching Normal Retirement Age, the Executive shall be eligible to receive the benefit described in this Section 2.3 in lieu of any other benefit under this Agreement.

2.3.1. Amount of Benefit. The annual benefit under this Section 2.3 is an amount equal to the Accrual Balance earned as of the last day of the Plan Year immediately preceding the effective date of the Executive’s Termination of Employment.

2.3.2. Payment of Benefit. The Employer shall pay the Disability benefit to the Executive over fifteen (15) years in twelve (12) equal monthly installments payable on the first day of each month, beginning with the month after the Executive’s Normal Retirement Age.

     2.4 Change in Control Benefit. If, within twenty-four (24) months after a Change in Control, the Employer terminates the Executive’s employment other than for Cause or as described in Section 5.2 hereof or if the Executive terminates employment for Good Reason, the Executive shall be eligible to receive the benefit described in this Section 2.4 instead of any other benefit under Article 2 of this Agreement.

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2.41 Amount of Benefit. The annual benefit under this Section 2.4 is an amount equal to seventy percent (70%) of the Executive’s final annual salary at the Executive’s Termination of Employment, or the benefit detailed on Schedule A, whichever is greater, payable annually for fifteen (15) years commencing as of the last day of the Plan Month preceding the effective date of the Executive’s Termination of Employment.

2.41.1 Payment of Benefit. The Employer shall pay the Change in Control benefit under Section 2.4 of this Agreement to the Executive over fifteen (15) years in twelve (12) equal monthly installments payable on the first day of each month, beginning with the month after the Executive’s Termination of Employment.

2.41.2 Change in Control Payout of Normal Retirement Benefit, Early Retirement Benefit, or Disability Benefit Being Paid to the Executive at the Time of a Change in Control. If a Change in Control occurs at any time during the period in which the Executive is receiving payment of the benefit under Section 2.1, 2.2, or 2.3, the Employer shall pay the remaining benefits due to the Executive under the applicable section to the Executive in a single lump sum payment within thirty (30) days after the Change in Control.

     2.5 Termination Benefit. Upon the Executive’s Termination without Cause by the Employer, the Executive shall be eligible to receive the benefit described in this Section 2.5 in lieu of any other benefit under Article 2 of this Agreement.

2.5.1 Amount of Benefit. The annual benefit under this Section 2.5 is an amount equal to the benefit detailed on Schedule A payable annually for fifteen (15) years commencing upon the first month after attaining age 65.

2.5.2 Payment of Benefit. The Employer shall pay the benefit under this Section 2.5 to the Executive over fifteen (15) years in twelve (12) equal monthly installments payable annually on the first day of each month, beginning with the month after the Executive reaches his Normal Retirement Age.

     2.6 Petition for Lump Sum Payment of Benefit. If the Executive is entitled to a benefit under Section 2.1, Section 2.2, Section 2.3, Section 2.4 or Section 2.5, the Executive may petition the Board of Directors of the Employer to have the Present Value of the Benefit, determined as of the date the Executive becomes entitled to a benefit under Section 2.1, Section 2.2, Section 2.3, Section 2.4 or Section 2.5, as applicable, paid to the Executive in a single lump sum. The Board of Directors of the Employer may, in its sole and absolute discretion, pay the Present Value of the Benefit to the Executive in a single lump sum. If the Present Value of the Benefit is paid to the Executive in a single lump sum, the Employer shall have no further obligations under this Agreement.

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     2.7 Excess Parachute Payment. If the Executive receives the payment pursuant to Section 2.4 and acceleration of benefits under any other benefit, compensation, or incentive plan or arrangement with the Bank or its parent corporation (collectively, the “Total Benefits”), and if any part of the Total Benefits is subject to an excise tax under Section 280G and Section 4999 of the Code (the “Excise Tax”), the Bank shall pay to the Executive the following additional amounts, consisting of (x) a payment equal to the Excise Tax payable by the Executive under section 4999 on the Total Benefits (the “Excise Tax Payment”) and (y) a payment equal to the amount necessary to provide the Excise Tax Payment net of all income, payroll, and excise taxes. Together, the additional amounts described in clauses (x) and (y) are referred to in this Agreement as the “Gross-Up Payment Amount.” Payment of the Gross-Up Payment Amount shall be made in addition to the amount set forth in Section 2.4 above.

     2.8 Total Benefits Subject to Excise Tax. For purposes of determining whether any of the Total Benefits will be subject to the Excise Tax and for purposes of determining the amount of the Excise Tax, any other payments or benefits received or to be received by the Executive in connection with a Change in Control or the Executive’s termination of employment following a Change in Control (whether under the terms of this Agreement or any other agreement or any other benefit plan or arrangement with the Bank or its parent corporation) shall be treated as “parachute payments” within the meaning of section 280G(b)(2) of the Code, and all “excess parachute payments” within the meaning of section 280G(b)(1) shall be treated as subject to the Excise Tax, unless in the opinion of the certified public accounting firm that is retained by the Bank as of the date immediately before the Change in Control (the “Accounting Firm”), such other payments or benefits do not constitute (in whole or in part) parachute payments, or such excess parachute payments represent (in whole or in part) reasonable compensation for services actually rendered within the meaning of section 280G(b)(4) of the Code in excess of the “base amount” (as defined in section 280G(b)(3) of the Code), or are otherwise not subject to the Excise Tax. The value of any noncash benefits or any deferred payment or benefit shall be determined by the Accounting Firm in accordance with the principles of sections 280G(d)(3) and (4) of the Code.

     2.9 Gross Up Payment Amount. For purposes of determining the Gross-Up Payment Amount, the Executive shall be deemed to pay federal income taxes at the highest marginal rate of federal income taxation in the calendar years in which the Gross-Up Payment Amount is to be made and state and local income taxes at the highest marginal rate of taxation in the state and locality of the Executive’s residence on the date of termination of employment, net of the reduction in federal income taxes that can be obtained from deduction of such state and local taxes (calculated by assuming that any reduction under section 68 of the Code in the amount of itemized deductions allowable to the Executive applies first to reduce the amount of such state and local income taxes that would otherwise be deductible by the Executive, and applicable federal FICA and Medicare withholding taxes).

     2.10 Determination by Accounting Firm. All determinations required to be made under Section 2.7, Section 2.8 and Section 2.9, including whether and when a Gross-Up Payment Amount is required, the amount of the Gross-Up Payment Amount and the assumptions to be used to arrive at the determination (collectively, the “Determination”), shall be made by the Accounting Firm, which shall provide detailed supporting calculations both to the Bank and the Executive within 15 business days after receipt of notice from the Bank or the Executive that there has been a Gross-Up Payment Amount, or such earlier time as is requested by the Bank.

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All fees and expenses of the Accounting Firm shall be borne solely by the Bank. The Bank shall enter into any reasonable agreement requested by the Accounting Firm in connection with the performance of its services hereunder. If the Accounting Firm determines that no Excise Tax is payable by the Executive, the Accounting Firm shall furnish the Executive with a written opinion to that effect, and to the effect that failure to report an Excise Tax, if any, on the Executive’s applicable federal income tax return will not result in the imposition of a negligence or similar penalty. The Determination by the Accounting Firm shall be binding on the Bank and the Executive. If, after a Determination by the Accounting Firm, the Executive is required to make a payment of additional Excise Tax (“Underpayment”), the Accounting Firm shall determine the amount of the Underpayment that has occurred. The Underpayment (together with interest at the rate provided in section 1274(d)(2)(B) of the Code) shall be paid promptly by the Bank to or for the benefit of the Executive. If the Gross-Up Payment Amount exceeds the amount necessary to reimburse the Executive for his Excise Tax (“Overpayment”), the Accounting Firm shall determine the amount of the Overpayment that has been made. The Overpayment (together with interest at the rate provided in section 1274(d)(2)(B) of the Code) shall be paid promptly by the Executive to or for the benefit of the Bank. Provided that his expenses are reimbursed by the Bank, the Executive shall cooperate with any reasonable requests by the Bank in any contests or disputes with the Internal Revenue Service relating to the Excise Tax. If the Accounting Firm is serving as accountant or auditor for the individual, entity, or group effecting the Change in Control, the Executive, in his sole discretion, may appoint another nationally recognized public accounting firm to make the Determinations required hereunder (in which case the term “Accounting Firm” as used in this Agreement shall be deemed to refer to the accounting firm appointed by the Executive under this Section).

     2.11 Contradiction in Terms of Agreement and Schedule A. If there is a contradiction in the terms of this Agreement and Schedule A attached hereto concerning the actual amount of a particular benefit amount due the Executive under Sections 2.2, 2.3, 2.4 or 2.5 hereof, then the actual amount of the benefit set forth in the Agreement shall control.

     2.12 One Benefit Only. Despite any contrary provision of this Agreement, the Executive and Beneficiary are entitled to one benefit only under Article 2 of this Agreement, which shall be determined by the first event to occur that is dealt with by Article 2 of this Agreement. Subsequent occurrence of events dealt with by this Article 2 shall not entitle the Executive or the Executive’s Beneficiary to other or additional benefits under Article 2.

     2.13 Savings Clause Relating to Compliance with Code Section 409A. Despite any contrary provision of this Agreement, if when the Executive’s employment terminates the Executive is a specified employee, as defined in Code section 409A, and if any payments under Article 2 of this Agreement will result in additional tax or interest to the Executive because of section 409A, the Executive will not be entitled to the payments under Article 2 until the earliest of (a) the date that is at least six months after termination of the Executive’s employment for reasons other than the Executive’s death, (b) the date of the Executive’s death, or (c) any earlier date that does not result in additional tax or interest to the Executive under section 409A. If any provision of this Agreement would subject the Executive to additional tax or interest under section 409A, the Bank shall reform the provision. However, the Bank shall maintain to the maximum extent practicable the original intent of the applicable provision without subjecting the Executive to additional tax or interest, and the Bank shall not be required to incur any additional compensation expense as a result of the reformed provision. References in this Agreement to

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Code section 409A include rules, regulations, and guidance of general application issued by the Department of the Treasury under Code section 409A.

9

3
DEATH BENEFITS

     3.1 Death During Active Service. If the Executive dies while employed by the Employer, instead of any benefits payable under Article 2 of this Agreement the Employer shall pay to the Executive’s Beneficiary the present value of the amount necessary to provide the full benefit described in section 2.1.1 and identified on Schedule A. The Employer shall pay the death benefit under this Section 3.1 within thirty (30) days after the Executive’s death.

     3.2 Death During Benefit Period. If the Executive dies after benefit payments under Article 2 of this Agreement commences but before receiving all such payments, or if the Executive is entitled to benefit payments under Article 2 but dies before payments commence, the remaining Accrual Balance shall be payable to the Executive’s Beneficiary in accordance with the applicable payment provisions of Article 2, until fully disbursed. Payments shall be made in the same amounts they would have been made to the Executive had the Executive survived.

4
BENEFICIARIES

     4.1 Beneficiary Designations. The Executive shall have the right to designate at any time a Beneficiary to receive any benefits payable under this Agreement upon the death of the Executive. The Beneficiary designated under this Agreement may be the same as or different from the beneficiary designation under any other benefit plan of the Employer in which the Executive participates.

     4.2 Beneficiary Designation: Change. The Executive shall designate a Beneficiary by completing and signing the Beneficiary Designation Form and delivering it to the Plan Administrator or its designated agent. The Executive’s Beneficiary designation shall be deemed automatically revoked if the Beneficiary predeceases the Executive or if the Executive names a spouse as Beneficiary and the marriage is subsequently dissolved. The Executive shall have the right to change a Beneficiary by completing, signing, and otherwise complying with the terms of the Beneficiary Designation Form and the Plan Administrator’s rules and procedures, as in effect from time to time. Upon the acceptance by the Plan Administrator of a new Beneficiary Designation Form, all Beneficiary designations previously filed shall be cancelled. The Plan Administrator shall be entitled to rely on the last Beneficiary Designation Form filed by the Executive and accepted by the Plan Administrator before the Executive’s death.

     4.3 Acknowledgment. No designation or change in designation of a Beneficiary shall be effective until received in writing by the Plan Administrator or its designated agent.

     4.4 No Beneficiary Designation. If the Executive dies without a valid beneficiary designation, or if all designated Beneficiaries predecease the Executive, then the Executive’s spouse shall be the designated Beneficiary. If the Executive has no surviving spouse, the benefits shall be distributed to the personal representative of the Executive’s estate.

     4.5 Facility of Payment. If a benefit is payable to a minor, to a person declared incapacitated, or to a person incapable of handling the disposition of his or her property, the Employer may pay such benefit to the guardian, legal representative, or person having the care or

10

custody of the minor, incapacitated person, or incapable person. The Employer may require proof of incapacity, minority, or guardianship as it may deem appropriate before distribution of the benefit. Distribution shall completely discharge the Employer from all liability for the benefit.

5
GENERAL LIMITATIONS

     5.1 Termination for Cause. If the Executive experiences a Termination of Employment which is a Termination for Cause, notwithstanding any provision of this Agreement to the contrary, this Agreement and the Employer’s obligations under this Agreement shall terminate as of the effective date of the Termination for Cause.

     5.2 Suicide or Misstatement No benefits shall be paid under this Agreement if the Executive commits suicide within two years after the Effective Date of this Agreement or if the Executive makes any material misstatement of fact on any application for life insurance purchased by the Bank.

     5.3 Removal. Despite any contrary provision of this Agreement, if the Executive is removed from office or permanently prohibited from participating in the Bank’s affairs by an order issued under section 8(e) (4) or (g) (1) of the Federal Deposit Insurance Act, 12 U.S.C. 1818(e) (4) or (g) (1), all obligations of the Bank under this Agreement shall terminate as of the effective date of the order.

     5.4 Default Despite any contrary provision of this Agreement, if the Bank is in “default” or “in danger of default”, as those terms are defined in of section 3(x) of the Federal Deposit Insurance Act, 12 U.S.C. 1813(x), all obligations under this Agreement shall terminate.

     5.5 FDIC Open-Bank Assistance. All obligations under this Agreement shall be terminated, except to the extent determined that continuation of the contract is necessary for the continued operation of the Bank, at the time the Federal Deposit Insurance Corporation enters into an agreement to provide assistance to or on behalf of the Bank under the authority contained in section 13(c) of the Federal Deposit Insurance Act. 12 U.S.C. 1823(c).

     5.6 Non-Competition. All obligations under this Agreement shall be terminated, if during the period of one year after Termination of Employment, the Executive, within the “Restricted Area,” directly or indirectly, engages in any business that competes with the Bank or any of its subsidiaries without the prior written consent of the Bank; provided, however, that the provisions of this Section shall not apply following Termination for Cause, or in the event the Executive terminates his employment with the Bank for Good Cause following a Change of Control. The Restricted Area covers the following divisible list of territories: Camden, Chowan, Currituck, Dare, Pasquotank, and Perquimans Counties, North Carolina and Chesapeake and Virginia Beach, Virginia, and within 15 miles of any Bank office operated during the term of this Agreement. Notwithstanding the foregoing, the Executive shall be free, without such consent, to purchase or hold as an investment or otherwise, up to five percent of the outstanding stock or other security of any corporation which has its securities publicly traded on any recognized securities exchange or in any over-the counter market.

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6
CLAIMS AND REVIEW PROCEDURES

     6.1 Claims Procedure. A person or beneficiary (a “claimant”) who has not received benefits under the Agreement that he or she believes should be paid shall make a claim for such benefits as follows —

6.1.1	Initiation — Written Claim. The claimant initiates a claim by submitting to the Employer a written claim for the benefits. If the claim relates to the contents of a notice received by the claimant, the claim must be made within 60 days after the notice was received by the claimant. All other claims must be made within 180 days after the date of the event that caused the claim to arise. The claim must state with particularity the determination desired by the claimant.
6.1.2	Timing of Employer Response. The Employer shall respond to such claimant within ninety (90) days after receiving the claim. If the Employer determines that special circumstances require additional time for processing the claim, the Employer can extend the response period by an additional ninety (90) days by notifying the claimant in writing, prior to the end of the initial ninety (90)-day period, that an additional period is required. The notice of extension must set forth the special circumstances and the date by which the Employer expects to render its decision.
6.1.3	Notice of Decision. If the Employer denies part or all of the claim, the Employer shall notify the claimant in writing of such denial. The Employer shall write the notification in a manner calculated to be understood by the claimant. The notification shall set forth:

6.1.3.1	The specific reasons for the denial,
6.1.3.2	A reference to the specific provisions of the Agreement on which the denial is based,
6.1.3.3	A description of any additional information or material necessary for the claimant to perfect the claim and an explanation of why it is needed,
6.1.3.4	An explanation of the Agreement’s review procedures and the time limits applicable to such procedures, and
6.1.3.5	A statement of the claimant’s right to bring a civil action under ERISA section 502(a) following an adverse benefit determination on review.

     6.2 Review Procedure. If the Employer denies part or all of the claim, the claimant shall have the opportunity for a full and fair review by the Employer of the denial, as follows

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6.2.1	Initiation — Written Request. To initiate the review, the claimant, within 60 days after receiving the Employer’s notice of denial, must file with the Employer a written request for review.
6.2.2	Additional Submissions — Information Access. The claimant shall then have the opportunity to submit written comments, documents, records and other information relating to the claim. The Employer shall also provide the claimant, upon request and free of charge, reasonable access to, and copies of, all documents, records and other information relevant (as defined in applicable ERISA regulations) to the claimant’s claim for benefits.
6.2.3	Considerations on Review. In considering the review, the Employer shall take into account all materials and information the claimant submits relating to the claim, without regard to whether such information was submitted or considered in the initial benefit determination.
6.2.4	Timing of Employer Response. The Employer shall respond in writing to such claimant within sixty (60) days after receiving the request for review. If the Employer determines that special circumstances require additional time for processing the claim, the Employer can extend the response period by an additional sixty (60) days by notifying the claimant in writing, prior to the end of the initial sixty (60)-day period, that an additional period is required. The notice of extension must set forth the special circumstances and the date by which the Employer expects to render its decision.
6.2.5	Notice of Decision. The Employer shall notify the claimant in writing of its decision on review. The Employer shall write the notification in a manner calculated to be understood by the claimant. The notification shall set forth —

6.2.5.1	The specific reasons for the denial,
6.2.5.2	A reference to the specific provisions of the Agreement on which the denial is based,
6.2.5.3	A statement that the claimant is entitled to receive, upon request and free of charge, reasonable access to, and copies of, all documents, records and other information relevant (as defined in applicable ERISA regulations) to the claimant’s claim for benefits, and
6.2.5.4	A statement of the claimant’s right to bring a civil action under ERISA Section 502(a).

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7
MISCELLANEOUS

     7.1 Amendments and Termination. Subject to Section 7.13 of this Agreement, (a) this Agreement may be amended solely by a written agreement signed by the Employer and by the Executive, and (b) except for termination occurring under Article 5, this Agreement may be terminated solely by a written agreement signed by the Employer and by the Executive.

     7.2 Binding Effect. This Agreement shall bind the Executive and the Employer and their beneficiaries, survivors, executors, successors, administrators, and transferees.

     7.3 No Guarantee of Employment. This Agreement is not an employment policy or contract. It does not give the Executive the right to remain an employee of the Employer, nor does it interfere with the Employer’s right to discharge the Executive. It also does not require the Executive to remain an employee nor interfere with the Executive’s right to terminate employment at any time.

     7.4 Non-Transferability. Benefits under this Agreement cannot be sold, transferred, assigned, pledged, attached, or encumbered in any manner.

     7.5 Tax Withholding. The Employer shall withhold any taxes that are required to be withheld from the benefits provided under this Agreement.

     7.6 Applicable Law. Except to the extent preempted by the laws of the United States of America, the validity, interpretation, construction, and performance of this Agreement shall be governed by and construed in accordance with the laws of the State of North Carolina, without giving effect to the principles of conflict of laws of such state.

     7.7 Unfunded Arrangement. The Executive and the Executive’s Beneficiary are general unsecured creditors of the Employer for the payment of benefits under this Agreement. The benefits represent the mere promise by the Employer to pay such benefits. The rights to benefits are not subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment, or garnishment by creditors. Any insurance on the Executive’s life is a general asset of the Employer to which the Executive and Beneficiary have no preferred or secured claim.

     7.8 Severability. If any provision of this Agreement is held invalid, such invalidity shall not affect any other provision of this Agreement, and each such other provision shall continue in full force and effect to the full extent consistent with law. If any provision of this Agreement is held invalid in part, such invalidity shall not affect the remainder of the provision, and the remainder of such provision together with all other provisions of this Agreement shall continue in full force and effect to the full extent consistent with law.

     7.9 Headings. The headings of sections herein are included solely for convenience of reference and shall not affect the meaning or interpretation of any provision of this Agreement.

     7.10 Notices. All notices, requests, demands, and other communications hereunder shall be in writing and shall be deemed to have been duly given if delivered by hand or mailed,

14

certified or registered mail, return receipt requested, with postage prepaid. Unless otherwise changed by notice, notice shall be properly addressed to the Executive if addressed to the address of the Executive on the books and records of the Employer at the time of the delivery of such notice, and properly addressed to the Employer if addressed to the Board of Directors, at 1145 North Road Street, Elizabeth City, North Carolina 27909.

     7.11 Entire Agreement. This Agreement constitutes the entire agreement between the Employer and the Executive concerning the subject matter hereof. No rights are granted to the Executive under this Agreement other than those specifically set forth herein.

     7.12 Payment of Legal Fees. In the event litigation ensues between the parties concerning the enforcement of the obligations of the parties under this Agreement, the Employer shall pay all costs and expenses in connection with such litigation until such time as a final determination (excluding any appeals) is made with respect to the litigation. If the Employer prevails on the substantive merits of the each material claim in dispute in such litigation, the Employer shall be entitled to receive from the Executive all reasonable costs and expenses, including without limitation attorneys’ fees, incurred by the Employer on behalf of the Executive in connection with such litigation, and the Executive shall pay such costs and expenses to the Employer promptly upon demand by the Employer.

     7.13 Termination or Modification of Agreement Because of Changes in Law, Rules or Regulations. The Employer is entering into this Agreement on the assumption that certain existing tax laws, rules, and regulations will continue in effect in their current form. If that assumption materially changes and the change has a material detrimental effect on this Agreement, then the Employer reserves the right to terminate or modify this Agreement accordingly, subject to the written consent of the Executive, which shall not be unreasonably withheld. This Section 7.13 shall become null and void effective immediately if a Change in Control occurs.

8
ADMINISTRATION OF AGREEMENT

     8.1 Plan Administrator Duties. This Agreement shall be administered by a Plan Administrator consisting of the Board of Directors of the Employer or such committee or person(s) as the Board of Directors of the Employer shall appoint. In accordance with the rules applicable for companies listed on the Nasdaq Stock Market and the Employer’s corporate governance procedures, the Executive shall not serve as a member of the Plan Administrator. The Plan Administrator shall also have the discretion and authority to (a) make, amend, interpret, and enforce all appropriate rules and regulations for the administration of this Agreement and (b) decide or resolve any and all questions, including interpretations of this Agreement, as may arise in connection with the Agreement.

     8.2 Agents. In the administration of this Agreement, the Plan Administrator may employ agents and delegate to them such administrative duties as it sees fit (including acting through a duly appointed representative) and may from time to time consult with counsel, who may be counsel to the Employer.

     8.3 Binding Effect of Decisions. The decision or action of the Plan Administrator with respect to any question arising out of or in connection with the administration,

15

interpretation, and application of the Agreement and the rules and regulations promulgated hereunder shall be final and conclusive and binding upon all persons having any interest in the Agreement. No Executive or Beneficiary shall be deemed to have any right, vested or nonvested, regarding the continued use of any previously adopted assumptions, including but not limited to the discount rate and calculation method described in Section 1.1.

     8.4 Indemnity of Plan Administrator. The Plan Administrator shall not be liable to any person for any action taken or omitted in connection with the interpretation and administration of this Agreement, unless such action or omission is attributable to the willful misconduct of the Plan Administrator or any of its members. The Employer shall indemnify and hold harmless the members of the Plan Administrator against any and all claims, losses, damages, expenses, or liabilities arising from any action or failure to act with respect to this Agreement, except in the case of willful misconduct by the Plan Administrator or any of its members.

     8.5 Employer Information. To enable the Plan Administrator to perform its functions, the Employer shall supply full and timely information to the Plan Administrator on all matters relating to the date and circumstances of the retirement, Disability, death, or Termination of Employment of the Executive and such other pertinent information as the Plan Administrator may reasonably require.

     IN WITNESS WHEREOF, the Executive and a duly authorized Executive of the Company and the Bank have signed this Agreement as of the date first written above.

THE EXECUTIVE:	THE BANK:
	Gateway Bank & Trust Co.
/s/ David Twiddy	By:	/s/ Ben Berry
David Twiddy
	Its:	Chairman and CEO

16

BENEFICIARY DESIGNATION
SALARY CONTINUATION AGREEMENT

I,                                         ., designate the following as beneficiary of any death benefits under this Salary Continuation Agreement –

Primary:
	.
Contingent:
	.

     Note: To name a trust as beneficiary, please provide the name of the trustee(s) and the exact name and date of the trust agreement.

     I understand that I may change these beneficiary designations by filing a new written designation with the Employer. I further understand that the designations will be automatically revoked if the beneficiary predeceases me, or if I have named my spouse as beneficiary and our marriage is subsequently dissolved.

Signature:
	David Twiddy
Date:		,	2006
Accepted by the Employer this		day of		,	2006.
By:
Print Name:
Title:

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SCHEDULE A

		Termination		Change in
		without	Disability	Control
		Cause annual	annual	Annual
		benefit	benefit	Benefit
Plan Year	Annual	payable at	payable at	Payable at
ending	Retirement	Normal	Normal	Normal		Premature
December	fixed	Retirement	Retirement	Retirement	Accrual	Death
31,	Benefit	Age	Age	Age	Balance	Benefit
2006	192,500	389,306	0	389,306	24,851	1,462,831
2007	201,163	389,306	5,506	389,306	131,591	1,546,944
2008	210,215	389,306	27,569	389,306	250,849	1,635,893
2009	219,674	389,306	49,697	389,306	383,730	1,729,957
2010	229,560	389,306	71,889	389,306	531,426	1,829,430
2011	239,890	389,306	94,146	389,306	695,226	1,934,622
2012	250,685	389,306	116,468	389,306	876,514	2,045,862
2013	261,966	389,306	138,854	389,306	1,076,785	2,163,500
2014	273,754	389,306	161,305	389,306	1,297,649	2,287,901
2015	286,073	389,306	183,821	389,306	1,540,839	2,419,455
2016	298,947	389,306	206,403	389,306	1,808,222	2,558,574
2017	312,399	389,306	229,049	389,306	2,101,806	2,705,692
2018	326,457	389,306	251,762	389,306	2,423,754	2,861,269
2019	341,148	389,306	274,540	389,306	2,776,391	3,025,792
2020	356,499	389,306	297,384	389,306	3,162,219	3,199,775
2021	372,542	389,306	320,293	389,306	3,583,927	3,383,762
1-Oct	389,306				3,578,328	3,578,328

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EX-21

Exhibit 21
Subsidiaries

Name	State of Incorporation
Gateway Bank & Trust Co.		North Carolina
Gateway Capital Statutory Trust I		Connecticut
Gateway Capital Statutory Trust II		Delaware
Gateway Capital Statutory Trust III		Delaware

EX-23

Exhibit 23

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors
Gateway Financial Holdings, Inc. and Subsidiary
Virginia Beach, Virginia

We consent to the incorporation by reference in the registration statements (Nos. 333-98027, 333-98025, 333-98021, and 333-127978) on Forms S-8 and the registration statement (No. 333-126709) on Form S-3 of Gateway Financial Holdings, Inc. and Subsidiary of our reports dated March 14, 2007, with respect to the consolidated financial statements of Gateway Financial Holdings, Inc. and Subsidiary, management’s assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting, which reports appear in Gateway Financial Holdings, Inc. and Subsidiary 2006 Annual Report on Form 10-K.

Greenville, North Carolina
March 14, 2007

EX-31.1

Exhibit 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

Pursuant to Rule 13a-14(d)/15d-14(d)

I, D. Ben Berry, certify that:

(1) I have reviewed this annual report on Form 10-K of Gateway Financial Holdings, Inc., a North Carolina corporation (the “registrant”);

(2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

(3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

(4) The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

(5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 16, 2007	By:	/s/ D. Ben Berry
		D. Ben Berry
		President and Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

Pursuant to Rule 13a-14(d)/15d-14(d)

I, Theodore L. Salter, certify that:

(1) I have reviewed this annual report on Form 10-K of Gateway Financial Holdings, Inc., a North Carolina corporation (the “registrant”);

(2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

(3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

(4) The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

(5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

(a)	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b)	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 16, 2007	By:	/s/ Theodore L. Salter
		Theodore L. Salter
		Senior Executive Vice President and Chief Financial Officer

EX-32

Exhibit 32

Section 1350 Certifications

Each of the undersigned hereby certifies that, to his knowledge, (i) the Form 10-K filed by Gateway Financial Holdings, Inc. (the “Issuer”) for the year ended December 31, 2006, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and (ii) the information contained in that report fairly presents, in all material respects, the financial condition and results of operations of the Issuer on the dates and for the periods presented therein.

	GATEWAY FINANCIAL HOLDINGS, INC.
Date: March 16, 2007	By:	/s/ D. Ben Berry
		D. Ben Berry
		President and Chief Executive Officer

Date: March 16, 2007	By:	/s/ Theodore L. Salter
		Theodore L. Salter
		Senior Executive Vice President and Chief Financial Officer