** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

** **

| **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|----------------------------------------------------------------------------------------------------|
|                                                                                               |
| **For the Quarterly Period Ended  September 30, 2003**                                        |
|                                                                                               |
| **Commission File No. 0-22361**                                                                    |

 

**NETBANK, INC.**(Exact name of registrant as specified in its charter)

 
| **Georgia**                                               |   | **58-2224352**                           |
|-----------------------------------------------------------|--------|------------------------------------------|
| (State of  incorporation)                                 |   | (I.R.S.  Employer Identification Number) |
|                                                      |   |                                     |
| **11475 Great Oaks Way  Suite 100  Alpharetta, Georgia**  |   | **30022**                                |
| (Address of  principal executive offices)                 |   | (Zip Code)                               |
|                                                      |   |                                     |
| **(770) 343-6006**                                        |
| Registrant’s  telephone number, including area code: |

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. YES ý  NO o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Exchange Act Rule 12b-2):YES ý  NO o

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date:

 

| **Class**                     |   | **Shares  Outstanding At October 30, 2003** |
|-------------------------------|--------|--------------------------------------------------|
| Common  Stock, par value $.01 |   | 47,835,590                                       |

 

 

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**NETBANK, INC.****TABLE OFCONTENTS**

 
| **Part I. Financial Information**                                                                                              |   |
|--------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                           |   |
| **Item I. Financial Statements**                                                                                               |   |
|                                                                                                                           |   |
| **Consolidated balance sheets as of September 30, 2003 and  December 31, 2002**                                      | **3**  |
|                                                                                                                           |   |
| **Consolidated statements of operations for  the three and nine months ended September 30, 2003  and 2002**          | 4      |
|                                                                                                                           |   |
| **Consolidated statements of shareholders’  equity for the three and nine months endedSeptember 30,  2003 and 2002** | 5      |
|                                                                                                                           |   |
| **Consolidated statements of cash flows for  the nine months ended September 30, 2003 and 2002**                          | 7      |
|                                                                                                                           |   |
| **Notes to consolidated financial statements**                                                                                 | 8      |
|                                                                                                                           |   |
| **Item 2. Management’s Discussion and  Analysis of Financial Condition and Results of Operations**                        | 19     |
|                                                                                                                           |   |
| **Item 3. Quantitative and Qualitative  Disclosures about Market Risk**                                                        | 36     |
|                                                                                                                           |   |
| **Item 4. Controls and Procedures**                                                                                            | 37     |
|                                                                                                                           |   |
| **Part II. OTHER INFORMATION**                                                                                                 |   |
|                                                                                                                           |   |
| **Item 1. Legal Proceedings**                                                                                                  | **38** |
|                                                                                                                           |   |
| **Item 2. Changes in Securities and Use of  Proceeds**                                                                         | 40     |
|                                                                                                                           |   |
| **Item 3. Defaults Upon Senior Securities**                                                                                    | **40** |
|                                                                                                                           |   |
| **Item 4. Submission of Matters to a Vote of  Security Holders**                                                               | 40     |
|                                                                                                                           |   |
| **Item 5. Other Information**                                                                                                  | 40     |
|                                                                                                                           |   |
| **Item 6. Exhibits and Reports on Form 8-K**                                                                                   | 40     |
|                                                                                                                           |   |
| **Signature  Page**                                                                                                            | 40     |

 

2

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**Part I. Item 1.Financial Statements**

 

**NetBank,Inc.Consolidated Balance Sheets(unaudited and in 000’s except share amounts)**

 
|                                                                                                             |   | **September 30,  2003** |      | **December 31,  2002** |   |
|------------------------------------------------------------------------------------------------------------------|--------|------------------------------|-----------|-----------------------------|--------|
| **Assets**                                                                                                       |   |                         |      |                        |   |
| Cash and cash equivalents:                                                                                       |   |                         |      |                        |   |
| Cash and due from banks                                                                                          |   | $                            | 24,895    |                        | $      | 34,687 |   |
| Federal funds sold                                                                                               |   | 18,941                       |      | 76,878                      |   |
| Total cash and cash equivalents                                                                                  |   | 43,836                       |      | 111,565                     |   |
| Investment securities available for sale-at fair  value (amortized costs of $312,988 and $636,991, respectively) |   | 320,908                      |      | 654,719                     |   |
| Stock of Federal Home Loan Bank of Atlanta - at  cost                                                            |   | 68,060                       |      | 36,600                      |   |
| Loans held for sale                                                                                              |   | 2,632,631                    |      | 1,514,625                   |   |
| Loans and leases receivable - net of allowance for  credit losses of $42,671 and $42,576, respectively           |   | 1,630,271                    |      | 892,093                     |   |
| Mortgage servicing rights – net                                                                             |   | 140,905                      |      | 88,502                      |   |
| Accrued interest receivable                                                                                      |   | 17,341                       |      | 12,839                      |   |
| Furniture, equipment and capitalized software –  net                                                        |   | 51,986                       |      | 46,610                      |   |
| Goodwill and other intangibles – net                                                                        |   | 45,283                       |      | 41,696                      |   |
| Due from servicers and investors                                                                                 |   | 42,101                       |      | 70,526                      |   |
| Other assets                                                                                                     |   | 67,282                       |      | 57,777                      |   |
| **Total assets**                                                                                                 |   | $                            | 5,060,604 |                        | $      | 3,527,552 |   |
|                                                                                                             |   |                         |      |                        |   |
| **Liabilities and shareholders’  equity**                                                                   |   |                         |      |                        |   |
| **Liabilities:**                                                                                                 |   |                         |      |                        |   |
| Deposits                                                                                                         |   | $                            | 2,524,385 |                        | $      | 2,044,922 |   |
| Other borrowed funds                                                                                             |   | 1,896,065                    |      | 882,488                     |   |
| Convertible subordinated debt                                                                                    |   | —                       |      | 26,126                      |   |
| Trust preferred securities                                                                                       |   | 8,764                        |      | 4,382                       |   |
| Accrued interest payable                                                                                         |   | 9,908                        |      | 13,266                      |   |
| Loans in process                                                                                                 |   | 50,209                       |      | 45,734                      |   |
| Accounts payable and accrued liabilities                                                                         |   | 144,470                      |      | 109,044                     |   |
| Total liabilities                                                                                                |   | 4,633,801                    |      | 3,125,962                   |   |
|                                                                                                             |   |                         |      |                        |   |
| Commitments and contingencies                                                                                    |   | —                       |      | —                      |   |
|                                                                                                             |   |                         |      |                        |   |
| **Shareholders’ equity:**                                                                                   |   |                         |      |                        |   |
| Preferred stock, no par (10,000,000 shares  authorized; none outstanding)                                        |   | —                       |      | —                      |   |
| Common stock, $.01 par (100,000,000 shares  authorized,  52,830,921 and 52,674,751 shares issued, respectively)  |   | 528                          |      | 527                         |   |
| Additional paid-in capital                                                                                       |   | 432,105                      |      | 426,485                     |   |
| Retained earnings (deficit)                                                                                      |   | 35,048                       |      | (2,568                      | )      |
| Accumulated other comprehensive income, net of  taxes of $2,977 and $6,702, respectively                         |   | 4,943                        |      | 11,026                      |   |
| Treasury stock, at cost (5,064,267 and 4,024,193  shares, respectively)                                          |   | (45,821                      | )         | (33,880                     | )      |
| Total shareholders’ equity                                                                                  |   | 426,803                      |      | 401,590                     |   |
| **Total liabilities  and shareholders’ equity**                                                             |   | $                            | 5,060,604 |                        | $      | 3,527,552 |   |

 

See notes to consolidated financial statements.

 

3

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**NetBank,Inc.Consolidated Statements ofOperations(unaudited and in 000’s except per share amounts)**

 
|                                                                   |   | **Three months ended September 30,** |   | **Nine months ended September 30, 2003** |   |
|------------------------------------------------------------------------|--------|-------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                   |   | **2003**                                  |   | **2002**                                      |   | **2003** |   | **2002** |   |
|                                                                   |   |                                      |   |                                          |   |   |   |   |   |
| **Interest income:**                                                   |   |                                      |   |                                          |   |   |   |   |   |
| Loans and leases                                                       |   | $                                         | 55,159 |                                          | $      | 39,666 |   | $ | 138,323 |   | $ | 94,608 |   |
| Investment securities                                                  |   | 3,702                                     |   | 7,822                                         |   | 15,662 |   | 24,255 |   |
| Short-term investments                                                 |   | 58                                        |   | 479                                           |   | 277 |   | 2,121 |   |
| Total interest income                                                  |   | 58,919                                    |   | 47,967                                        |   | 154,262 |   | 120,984 |   |
|                                                                   |   |                                      |   |                                          |   |   |   |   |   |
| **Interest expense:**                                                  |   |                                      |   |                                          |   |   |   |   |   |
| Deposits                                                               |   | 12,293                                    |   | 13,909                                        |   | 37,273 |   | 41,692 |   |
| Other borrowed funds                                                   |   | 9,666                                     |   | 11,244                                        |   | 27,818 |   | 38,323 |   |
| Total interest expense                                                 |   | 21,959                                    |   | 25,153                                        |   | 65,091 |   | 80,015 |   |
| Net interest income                                                    |   | 36,960                                    |   | 22,814                                        |   | 89,171 |   | 40,969 |   |
| Provision for credit losses                                            |   | 2,537                                     |   | (95                                           | )      | 4,299 |   | 26,432 |   |
| Net interest income after provision for credit  losses                 |   | 34,423                                    |   | 22,909                                        |   | 84,872 |   | 14,537 |   |
|                                                                   |   |                                      |   |                                          |   |   |   |   |   |
| **Non-interest income:**                                               |   |                                      |   |                                          |   |   |   |   |   |
| Service charges and fees                                               |   | 12,017                                    |   | 10,601                                        |   | 35,795 |   | 26,559 |   |
| Gains on sales of mortgage loans and mortgage  servicing rights        |   | 75,914                                    |   | 38,972                                        |   | 184,461 |   | 74,149 |   |
| Net gain on sales of investment securities                             |   | —                                    |   | 7,638                                         |   | 11,394 |   | 5,781 |   |
| Other income                                                           |   | 8,717                                     |   | 7,622                                         |   | 14,696 |   | 8,621 |   |
| Total non-interest income                                              |   | 96,648                                    |   | 64,833                                        |   | 246,346 |   | 115,110 |   |
|                                                                   |   |                                      |   |                                          |   |   |   |   |   |
| **Non-interest expense:**                                              |   |                                      |   |                                          |   |   |   |   |   |
| Salaries and benefits                                                  |   | 37,067                                    |   | 28,024                                        |   | 98,952 |   | 61,707 |   |
| Customer service                                                       |   | 2,684                                     |   | 3,447                                         |   | 8,282 |   | 10,220 |   |
| Loan servicing                                                         |   | 550                                       |   | 1,155                                         |   | 1,711 |   | 5,312 |   |
| Marketing                                                              |   | 1,988                                     |   | 1,454                                         |   | 6,319 |   | 4,739 |   |
| Data processing                                                        |   | 3,638                                     |   | 3,453                                         |   | 11,659 |   | 9,264 |   |
| Depreciation and amortization                                          |   | 4,063                                     |   | 3,769                                         |   | 11,254 |   | 11,985 |   |
| Impairment and amortization of mortgage servicing  rights              |   | 31,195                                    |   | 10,828                                        |   | 58,530 |   | 18,332 |   |
| Office expenses                                                        |   | 2,169                                     |   | 2,4000                                        |   | 7,534 |   | 6,076 |   |
| Occupancy                                                              |   | 5,578                                     |   | 4,929                                         |   | 14,131 |   | 11,777 |   |
| Travel and entertainment                                               |   | 1,184                                     |   | 872                                           |   | 3,129 |   | 2,042 |   |
| Professional fees                                                      |   | 5,517                                     |   | 2,935                                         |   | 12,119 |   | 6,431 |   |
| Other expenses                                                         |   | 6,329                                     |   | 3,327                                         |   | 17,132 |   | 6,862 |   |
| Prepayment penalties on the early extinguishment of  debt              |   | 4,316                                     |   | 7,451                                         |   | 16,267 |   | 9,944 |   |
| Acquisition and severance                                              |   | —                                    |   | —                                        |   | — |   | 10,085 |   |
| Total non-interest expense                                             |   | 106,278                                   |   | 74,044                                        |   | 267,019 |   | 174,776 |   |
| Income (loss) before income taxes                                      |   | 24,793                                    |   | 13,698                                        |   | 64,199 |   | (45,129 | ) |
| Income tax (expense) benefit                                           |   | (9,204                                    | )      | (5,181                                        | )      | (23,695 | ) | 16,721 |   |
| Net income (loss)                                                      |   | $                                         | 15,589 |                                          | $      | 8,517 |   | $ | 40,504 |   | $ | (28,408 | ) |
|                                                                   |   |                                      |   |                                          |   |   |   |   |   |
| Net income (loss) per common and potential  common shares outstanding: |   |                                      |   |                                          |   |   |   |   |   |
| Basic                                                                  |   | $                                         | 0.33   |                                          | $      | 0.17 |   | $ | 0.84 |   | $ | (0.66 | ) |
| Diluted                                                                |   | $                                         | 0.32   |                                          | $      | 0.17 |   | $ | 0.83 |   | $ | (0.66 | ) |
|                                                                   |   |                                      |   |                                          |   |   |   |   |   |
| Weighted average common and potential  common shares outstanding:      |   |                                      |   |                                          |   |   |   |   |   |
| Basic                                                                  |   | 47,829                                    |   | 49,778                                        |   | 48,039 |   | 42,830 |   |
| Diluted                                                                |   | 48,590                                    |   | 50,141                                        |   | 48,661 |   | 42,830 |   |
|                                                                   |   |                                      |   |                                          |   |   |   |   |   |
| Dividends declared on common stock per  share                          |   | $                                         | 0.02   |                                          | $      | — |   | $ | 0.06 |   | $ | — |   |

 

See notes to consolidated financialstatements.

 

4

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**NetBank,Inc.Consolidated Statements of Shareholders’ Equity(unaudited and in 000’s)**

** **
|                                                                 |   | **Common  shares** |   | **Common  stock** |   | **Additional  paid-in capital** |   | **Retained  (deficit)  earnings** |   | **Accumulated  other  comprehensive  income** |   | **Treasury  stock** |   | **Total** |   |
|----------------------------------------------------------------------|--------|--------------------|--------|-------------------|--------|---------------------------------|--------|-----------------------------------|--------|-----------------------------------------------|--------|---------------------|--------|-----------|--------|
| Balance - December 31, 2002                                     |   | 52,675             |   | $                 | 527    |                            | $      | 426,485                           |   | $                                             | (2,568 | )                   | $      | 11,026    |   | $ | (33,880 | ) | $ | 401,590 |   |
| Comprehensive income:                                                |   |               |   |              |   |                            |   |                              |   |                                          |   |                |   |      |   |
| Net income for the three months endedMarch 31,  2003            |   | —             |   | —            |   | —                          |   | 10,702                            |   | —                                        |   | —              |   | 10,702    |   |
| Unrealized loss on securities, net of taxes                          |   | —             |   | —            |   | —                          |   | —                            |   | (2,167                                        | )      | —              |   | (2,167    | )      |
| Comprehensive income                                                 |   |               |   |              |   |                            |   |                              |   |                                          |   |                |   | 8,535     |   |
| Dividends declared on common stock                                   |   | —             |   | —            |   | —                          |   | (973                              | )      | —                                        |   | —              |   | (973      | )      |
| Purchase of shares of common stock for treasury,  net of reissuances |   | —             |   | —            |   | (3                              | )      | —                            |   | —                                        |   | (7,499              | )      | (7,502    | )      |
| Issuances of common stock                                            |   | 68                 |   | —            |   | 4,575                           |   | —                            |   | —                                        |   | —              |   | 4,575     |   |
| Balance - March 31, 2003                                        |   | 52,743             |   | $                 | 527    |                            | $      | 431,057                           |   | $                                             | 7,161  |                | $      | 8,859     |   | $ | (41,379 | ) | $ | 406,225 |   |
| Comprehensive income:                                                |   |               |   |              |   |                            |   |                              |   |                                          |   |                |   |      |   |
| Net income for the three months ended June 30,  2003            |   | —             |   | —            |   | —                          |   | 14,213                            |   | —                                        |   | —              |   | 14,213    |   |
| Unrealized gain on securities, net of taxes                          |   | —             |   | —            |   | —                          |   | —                            |   | 2,749                                         |   |                |   | 2,749     |   |
| Comprehensive income                                                 |   |               |   |              |   |                            |   |                              |   |                                          |   |                |   | 16,962    |   |
| Dividends declared on common stock                                   |   | —             |   | —            |   | —                          |   | (964                              | )      | —                                        |   | —              |   | (964      | )      |
| Purchase of shares of common stock for treasury,  net of reissuances |   | —             |   | —            |   | (16                             | )      | —                            |   | —                                        |   | (2,228              | )      | (2,244    | )      |
| Issuances of common stock                                            |   | 19                 |   | 1                 |   | 348                             |   | —                            |   | —                                        |   | —              |   | 349       |   |
| Balance - June 30, 2003                                         |   | 52,762             |   | $                 | 528    |                            | $      | 431,389                           |   | $                                             | 20,410 |                | $      | 11,608    |   | $ | (43,607 | ) | $ | 420,328 |   |
| Comprehensive income:                                                |   |               |   |              |   |                            |   |                              |   |                                          |   |                |   |      |   |
| Net income for the three months ended  September 30, 2003       |   | —             |   | —            |   | —                          |   | 15,589                            |   | —                                        |   | —              |   | 15,589    |   |
| Unrealized loss on securities, net of taxes                          |   | —             |   | —            |   | —                          |   | —                            |   | (6,665                                        | )      | —              |   | (6,665    | )      |
| Comprehensive income                                                 |   |               |   |              |   |                            |   |                              |   |                                          |   |                |   | 8,924     |   |
| Dividends declared on common stock                                   |   | —             |   | —            |   | —                          |   | (951                              | )      | —                                        |   | —              |   | (951      | )      |
| Purchase of shares of common stock for treasury,  net of reissuances |   | —             |   | —            |   | 54                              |   | —                            |   | —                                        |   | (2,214              | )      | (2,160    | )      |
| Issuances of common stock                                            |   | 69                 |   | —            |   | 662                             |   | —                            |   | —                                        |   | —              |   | 662       |   |
| Balance  - September 30, 2003                                   |   | 52,831             | *      | $                 | 528    |                            | $      | 432,105                           |   | $                                             | 35,048 |                | $      | 4,943     |   | $ | (45,821 | ) | $ | 426,803 |   |
|                                                                      |        |                    |        |                   |        |                                 |        |                                   |        |                                               |        |                     |        |           |        |  |  |  |  |  |  |  |

 

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* Note that the Company held5,064 shares in treasury as of 9/30/2003.

See notes to consolidated financial statements.

 

5

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**NetBank, Inc.Consolidated Statements of Shareholders’ Equity(unaudited and in 000’s)**

 
|                                                                                               |   | **Common  shares** |    | **Common  stock** |   | **Additional  paid-in  capital** |   | **Retained  earnings  (deficit)** |   | **Accumulated  other  comprehensive  (loss) income** |    | **Treasury  stock** |   | **Total** |   |
|----------------------------------------------------------------------------------------------------|--------|--------------------|---------|-------------------|--------|----------------------------------|--------|-----------------------------------|--------|------------------------------------------------------|---------|---------------------|--------|-----------|--------|
| Balance - December 31, 2001                                                                   |   | 31,751             |    | $                 | 318    |                             | $      | 267,004                           |   | $                                                    | 13,289  |                | $      | (3,648    | )      | $ | (21,509 | ) | $ | 255,454 |   |
| Comprehensive loss:                                                                                |   |               |    |              |   |                             |   |                              |   |                                                 |    |                |   |      |   |
| Net loss for the three months endedMarch 31, 2002                                             |   | —             |    | —            |   | —                           |   | (5,638                            | )      | —                                               |    | —              |   | (5,638    | )      |
| Unrealized loss on securities, net of taxes                                                        |   | —             |    | —            |   | —                           |   | —                            |   | (23                                                  | )       | —              |   | (23       | )      |
| Comprehensive loss                                                                                 |   |               |    |              |   |                             |   |                              |   |                                                 |    |                |   | (5,661    | )      |
| Reissuance of shares of common stock held in  treasury                                             |   | —             |    | —            |   | —                           |   | —                            |   | —                                               |    | 42                  |   | 42        |   |
| Issuance of stock in conjunction with the  acquisition of Resource Bancshares Mortgage Group, Inc. |   | 19,717             |    | 197               |   | 155,365                          |   | —                            |   | —                                               |    | —              |   | 155,562   |   |
| Issuances of common stock                                                                          |   | —             |    | —            |   | 3                                |   | —                            |   | —                                               |    | —              |   | 3         |   |
| Balance - March 31, 2002                                                                      |   | 51,468             |    | $                 | 515    |                             | $      | 422,372                           |   | $                                                    | 7,651   |                | $      | (3,671    | )      | $ | (21,467 | ) | $ | 405,400 |   |
| Comprehensive loss:                                                                                |   |               |    |              |   |                             |   |                              |   |                                                 |    |                |   |      |   |
| Net loss for the three months endedJune 30, 2002                                              |   | —             |    | —            |   | —                           |   | (31,287                           | )      | —                                               |    | —              |   | (31,287   | )      |
| Unrealized gain on securities, net of taxes                                                        |   | —             |    | —            |   | —                           |   | —                            |   | 7,214                                                |    | —              |   | 7,214     |   |
| Comprehensive loss                                                                                 |   |               |    |              |   |                             |   |                              |   |                                                 |    |                |   | (24,073   | )      |
| Reissuance of shares of common stock held in  treasury                                             |   | —             |    | —            |   | —                           |   | —                            |   | —                                               |    | 225                 |   | 225       |   |
| Issuances of common stock                                                                          |   | 1,012              |    | 10                |   | 3,325                            |   | —                            |   | —                                               |    | —              |   | 3,335     |   |
| Balance - June 30, 2002                                                                       |   | 52,480             |    | $                 | 525    |                             | $      | 425,697                           |   | $                                                    | (23,636 | )                   | $      | 3,543     |   | $ | (21,242 | ) | $ | 384,887 |   |
| Comprehensive income:                                                                              |   |               |    |              |   |                             |   |                              |   |                                                 |    |                |   |      |   |
| Net income for the three months endedSeptember 30, 2002                                       |   |               |    |              |   |                             |   | 8,517                             |   |                                                 |    |                |   | 8,517     |   |
| Unrealized gain on securities, net of taxes                                                        |   |               |    |              |   |                             |   |                              |   | 4,701                                                |    |                |   | 4,701     |   |
| Comprehensive income                                                                               |   |               |    |              |   |                             |   |                              |   |                                                 |    |                |   | 13,218    |   |
| Purchase of common stock held in treasury, net of  reissuances                                     |   |               |    |              |   | 7                                |   |                              |   |                                                 |    | (2,429              | )      | (2,422    | )      |
| Issuances of common stock                                                                          |   | 191                |    | 15                |   | 742                              |   |                              |   |                                                 |    |                |   | 757       |   |
| Balance  - September 30, 2002                                                                 |   | 52,671             | *  | $                 | 540    |                             | $      | 426,446                           |   | $                                                    | (15,119 | )                   | $      | 8,244     |   | $ | (23,671 | ) | $ | 396,440 |   |

 

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* Note that the Company held2,935 shares in treasury as of 9/30/2002.

See notes to consolidatedfinancial statements.

 

6

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**NetBank, Inc.Consolidated Statements of Cash Flows(unaudited and in 000’s)**

 
|                                                                                                 |   | **Nine  months ended September 30,** |   |
|------------------------------------------------------------------------------------------------------|--------|-------------------------------------------|--------|
|                                                                                                 |   | **2003**                                  |   | **2002** |   |
| Operating activities:                                                                                |   |                                      |   |   |   |
| Net income (loss)                                                                                    |   | $                                         | 40,504 |   | $ | (28,408 | ) |
| Adjustments to reconcile net income (loss)  to net cash (used in) provided by operating activities:  |   |                                      |   |   |   |
| Depreciation and amortization                                                                        |   | 11,254                                    |   | 11,985 |   |
| Amortization of premiums (discounts) on  investment securities, loan and lease receivables, and debt |   | 8,185                                     |   | 29,298 |   |
| Gain on sales of fixed assets                                                                        |   | —                                    |   | (2,814 | ) |
| Origination of loans held for sale                                                                   |   | (14,615,168                               | )      | (7,024,767 | ) |
| Proceeds from sales of loans held for sale                                                           |   | 13,676,118                                |   | 7,024,412 |   |
| Net gain on sales of mortgage loans and  servicing rights                                            |   | (184,461                                  | )      | (74,149 | ) |
| Capitalization of mortgage servicing rights                                                          |   | (169,787                                  | )      | (84,683 | ) |
| Proceeds from sales of mortgage servicing  rights                                                    |   | 58,436                                    |   | 138,853 |   |
| Impairment and amortization of mortgage servicing  rights                                            |   | 58,530                                    |   | 18,332 |   |
| Provision for credit losses                                                                          |   | 4,299                                     |   | 26,432 |   |
| Changes in assets and liabilities which  provide (use) cash:                                         |   |                                      |   |   |   |
| Increase in accrued interest receivable                                                              |   | (4,502                                    | )      | (1,726 | ) |
| Decrease in other assets, due from  servicers, and intangibles                                       |   | 15,333                                    |   | 36,741 |   |
| Decrease in accrued interest payable                                                                 |   | (3,358                                    | )      | (1,929 | ) |
| Increase in loans in process                                                                         |   | 4,475                                     |   | 33,292 |   |
| Increase in accounts payable and accrued  liabilities                                                |   | 35,426                                    |   | 15,704 |   |
| Net cash (used in) provided by operating activities                                                  |   | (1,064,716                                | )      | 116,573 |   |
|                                                                                                 |   |                                      |   |   |   |
| Investing activities:                                                                                |   |                                      |   |   |   |
| Purchases of available for sale securities                                                           |   | (50,508                                   | )      | (1,758,746 | ) |
| Principal repayments on available for sale  investment securities                                    |   | 66,096                                    |   | 211,333 |   |
| Sales and maturities of available for sale  investment securities                                    |   | 318,304                                   |   | 1,741,670 |   |
| Gain on sale of investment securities                                                                |   | (11,394                                   | )      | (5,781 | ) |
| (Purchase) sale of Federal Home Loan Bank  Stock                                                     |   | (31,460                                   | )      | 22,234 |   |
| Origination and purchases of loans and  leases                                                       |   | (1,128,005                                | )      | (304,769 | ) |
| Principal repayments on loans and leases                                                             |   | 388,496                                   |   | 696,752 |   |
| Purchases of furniture, fixtures, and  equipment                                                     |   | (16,630                                   | )      | (5,803 | ) |
| Net cash acquired in business combination                                                            |   | —                                    |   | 29,762 |   |
| Net cash (used in) provided by investing  activities                                                 |   | (465,101                                  | )      | 626,652 |   |
|                                                                                                 |   |                                      |   |   |   |
| Financing activities:                                                                                |   |                                      |   |   |   |
| Increase in money market and checking  accounts                                                      |   | 576,871                                   |   | 435,756 |   |
| (Decrease) increase in certificates of  deposits                                                     |   | (97,408                                   | )      | 129,798 |   |
| Proceeds from other borrowed funds                                                                   |   | 9,865,117                                 |   | 5,805,577 |   |
| Repayments of other borrowed funds                                                                   |   | (8,851,540                                | )      | (6,880,454 | ) |
| Net proceeds from issuance of trust  preferred securities                                            |   | 4,382                                     |   | — |   |
| Repayment of convertible subordinated debt                                                           |   | (26,126                                   | )      | — |   |
| Issuances of common stock                                                                            |   | 5,586                                     |   | 4,095 |   |
| Net (purchase) issuance of treasury stock                                                            |   | (11,906                                   | )      | (2,155 | ) |
| Dividend payments on common stock                                                                    |   | (2,888                                    | )      | — |   |
| Net cash provided by (used in) financing  activities                                                 |   | 1,462,088                                 |   | (507,383 | ) |
| Net (decrease) increase in cash and cash  equivalents                                                |   | (67,729                                   | )      | 235,842 |   |
| Cash and cash equivalents:                                                                           |   |                                      |   |   |   |
| Cash, beginning of period                                                                            |   | 111,565                                   |   | 22,347 |   |
| Cash, end of period                                                                                  |   | $                                         | 43,836 |   | $ | 258,189 |   |
|                                                                                                 |   |                                      |   |   |   |
| Supplemental disclosures of cash flow  information:                                                  |   |                                      |   |   |   |
| Cash paid during the period for interest                                                             |   | $                                         | 68,449 |   | $ | 80,673 |   |
| Cash paid during the period for income  taxes                                                        |   | $                                         | 12,463 |   | $ | 1,034 |   |
|                                                                                                 |   |                                      |   |   |   |
| Non-cash investing and financing  activities:                                                        |   |                                      |   |   |   |
| Fair value of assets acquired                                                                        |   | $                                         | — |   | $ | 1,075,492 |   |
| Liabilities assumed                                                                                  |   | —                                    |   | (919,930 | ) |
| Stock issued in transaction                                                                          |   | —                                    |   | (155,562 | ) |
| Cash paid for business                                                                               |   | $                                         | — |   | $ | — |   |

 

See notes to consolidatedfinancial statements.

 

7

----

 

**NETBANK, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSSeptember 30, 2003(unaudited)**

 

**1.**                                      ORGANIZATION AND BASIS OF PRESENTATION

** **

NetBank, Inc. is a savings andloan holding company that wholly owns the outstanding stock of NetBank®,(“NetBank, FSB”), a federal savings bank; Meritage Mortgage Corporation(“Meritage”), a wholesale non-conforming mortgage provider; MG ReinsuranceCompany (“MG Reinsurance”), a captive reinsurance company; NetInsurance, Inc.,(“NetInsurance”), a licensed insurance agency; and NB Partners, Inc., acorporation formed to be involved in strategic partnering opportunities.NetBank, FSB also owns all of the outstanding stock of Market Street MortgageCorporation (“Market Street”), a retail mortgage company, and ResourceBancshares Mortgage Group, Inc. (“Resource”). Resource wholly owns RBMG, Inc.(“RBMG”), a wholesale mortgage banking company, and Republic Leasing Company,Inc. (“Republic Leasing”), a small ticket commercial financing company.

 

NetBank, Inc. acquired Resource on March 31, 2002, andsubsequently reorganized the holding company structure as described above basedon operational, licensing and funding needs. NetBank, Inc. acquired MarketStreet on June 29, 2001 and subsequently donated Market Street to NetBank,FSB. Accordingly, the financial impact of Resource and Market Street areincluded from the dates of acquisition. The entire consolidated company isreferred to herein as “NetBank” or  “theCompany”.

 

In the opinion of management, the unaudited consolidated financialstatements included herein reflect all adjustments, consisting only of normalrecurring accruals, which are necessary for the fair presentation of thefinancial condition and results of operations for the interim periodspresented. Certain information and footnote disclosures normally included infinancial statements have been condensed or omitted pursuant to applicable rulesand regulations of the Securities and Exchange Commission (“SEC”). Thefinancial statements included herein should be read in conjunction with thefinancial statements and notes thereto, included in NetBank’s Form 10-Kfiled with the SEC for the year ended December 31, 2002. The results ofoperations for the interim periods reported herein are not necessarilyindicative of results to be expected for the full year. Certain 2002 amountshave been reclassified for comparability with 2003 amounts.

 

All dollar figures are presented in thousands (000s) except per sharedata unless otherwise noted.

 

**2.**                                      ACQUISITIONS

** **

On March 31, 2002, NetBankconsummated its acquisition of Resource pursuant to an Agreement and Plan ofMerger dated November 18, 2001. In the merger, NetBank issued 1.1382shares of NetBank common stock in exchange for each outstanding share ofResource common stock, equivalent to 19.7 million shares of common stock pluscash in lieu of fractional shares. The transaction was accounted for as a purchaseand a total of $20.6 million of goodwill was recorded.

 

On June 29, 2001, NetBank, Inc. acquired all of the outstandingstock of Market Street pursuant to an agreement dated April 15, 2001, andamended as of June 29, 2001, among NetBank, Net Interim, Inc., RepublicBank, Republic Bancorp, Inc. and certain shareholders of Market Street. Theconsideration paid consisted of 1.7 million shares of NetBank common stockvalued at $8.96 per share and cash of $6.1 million. The acquisition wasaccounted for as a purchase, and approximately $20.1 million in goodwill,including transaction costs, was recorded.

 

8

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Pro-forma unaudited financial information assuming Resource wasincluded in the results of operations for the nine months endedSeptember 30, 2002 follows:

 
| Net interest income                                                       |   | $ | 54,073  |   |
|---------------------------------------------------------------------------|--------|---|---------|--------|
| Net loss                                                                  |   | $ | (29,176 | )      |
| Basic loss per share                                                      |   | $ | (0.60   | )      |
| Diluted loss per share and potential common  equivalent share outstanding |   | $ | (0.60   | )      |

** **

**OnOctober 6, 2003, NetBank announced it had reached a definitive agreementto acquire Financial Technologies, Inc. (“FTI”).  FTI is a privately held leading provider of ATM services forretail and other non-bank businesses. The transaction is expected to close within the fourth quarter of 2003and be immediately accretive to earnings. Reference is made to the current report on Form 8-K NetBank filed onOctober 6, 2003, for additional details regarding FTI and the purchaseprice.**

** **

**3.**                                      ACCOUNTING POLICIES

** **

Reference is made to the accounting policies of NetBank described inthe notes to consolidated financial statements contained in NetBank’sForm 10-K for the year ended December 31, 2002. The Company hasfollowed those policies in preparing this report.

 

*SignificantEstimates.*The preparation of the consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the amounts reported in the consolidated financialstatements and accompanying notes.  Suchestimates relate to the Company’s allowance for credit losses, the fair valuesof mortgage loans held for sale, lease receivables, servicing rights, servicinghedges and the Company’s other hedging instruments.  Because of the inherent uncertainties associated with anyestimation process and due to possible future changes in market and economicconditions that will affect fair values, it is possible that actual futureresults and realization of the underlying assets and liabilities could differsignificantly from the amounts reflected as of the balance sheet date.

 

*Stock Options.*TheCompany accounts for stock options issued under the recognition and measurementprinciples of Accounting Principles Board 25, *Accounting for Stock Issued toEmployees,*and related Interpretations. No stock option-basedemployee compensation cost is reflected in the results of operations, as alloptions granted under those plans had an exercise price equal to the marketvalue of the underlying common stock on the date of grant. The following tableillustrates the pro forma effects on the results of operations and earnings pershare if the Company had applied the fair value recognition provisions of FASBStatement 123, *Accounting for Stock-Based Compensation,*to stockoption-based employee compensation.

 

9

----

 
|                                                                                                                                         |   | **Three months ended  September 30,** |   | **Nine months ended********September 30,** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------------|--------|
|                                                                                                                                         |   | **2003**                                   |   | **2002**                                        |   | **2003** |   | **2002** |   |
| Net income (loss), as reported                                                                                                               |   | $                                          | 15,589 |                                            | $      | 8,517 |   | $ | 40,504 |   | $ | (28,408 | ) |
| Deduct:                                                                                                                                      |   |                                       |   |                                            |   |   |   |   |   |
|                                                                                                                                         |   |                                       |   |                                            |   |   |   |   |   |
| Total stock option-based employee  compensation expense determined under fair value based method for all awards,  net of related tax effects |   | (663                                       | )      | (690                                            | )      | (1,684 | ) | (1,607 | ) |
| Pro forma net income (loss)                                                                                                                  |   | $                                          | 14,926 |                                            | $      | 7,827 |   | $ | 38,820 |   | $ | (30,015 | ) |
|                                                                                                                                         |   |                                       |   |                                            |   |   |   |   |   |
| Earnings (loss) per share:                                                                                                                   |   |                                       |   |                                            |   |   |   |   |   |
| Basic –  as reported                                                                                                                    |   | $                                          | 0.33   |                                            | $      | 0.17 |   | $ | 0.84 |   | $ | (0.66 | ) |
| Basic – pro forma                                                                                                                       |   | $                                          | 0.31   |                                            | $      | 0.16 |   | $ | 0.81 |   | $ | (0.70 | ) |
|                                                                                                                                         |   |                                       |   |                                            |   |   |   |   |   |
| Diluted – as reported                                                                                                                   |   | $                                          | 0.32   |                                            | $      | 0.17 |   | $ | 0.83 |   | $ | (0.66 | ) |
| Diluted – pro forma                                                                                                                     |   | $                                          | 0.31   |                                            | $      | 0.16 |   | $ | 0.80 |   | $ | (0.70 | ) |

** **

**In addition, for the three months endedSeptember 30, 2003, and nine months ended through September 30, 2003,compensation expense of $31 and $83, respectively, related to restricted stockawards was recognized and included in net income as reported.**

** **

***New Accounting Pronouncements.***In November 2002, the FASB issuedInterpretation No. 45 (“FIN 45”), “Guarantors Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers”, to clarify accounting and disclosure requirements relating to aguarantor’s issuance of certain types of guarantees.  FIN 45 requires entities to disclose additional information aboutcertain guarantees, or groups of similar guarantees, even if the likelihood ofthe guarantor’s having to make any payments under the guarantee is remote.  The disclosure provisions are effective forfinancial statements for fiscal years ended after December 15, 2002.  For certain guarantees, the interpretationalso requires that guarantors recognize a liability equal to the fair value ofthe guarantee upon its issuance.  Thisinitial recognition and measurement provision is to be applied only on aprospective basis to guarantees issued or modified after December 31,2002.  For the nine months endedSeptember 30, 2003, NetBank recorded an additional charge of $15,947associated with the establishment of reserves for potential future losses basedon current loan sales in accordance with this new interpretation.

** **

**In January 2003, the FinancialAccounting Standards Board (“FASB”) issued FASB Interpretation(“Interpretation”) No. 46, “Consolidation of Variable Interest Entities.”Interpretation No. 46 is applied immediately to variable interest entities(“VIEs”) created after January 31, 2003, and with respect to variableinterests held before February 1, 2003, Interpretation No. 46 will applybeginning with interim and annual periods ending on or after December 15,2003. Interpretation No. 46 addresses consolidation by business enterprises ofVIEs which have one or both of the following characteristics: (1) the equityinvestment at risk is not sufficient to permit the entity to finance itsactivities without additional subordinated support from other parties, which isprovided through other interests that will absorb some or all of the expectedlosses of the entity; or (2) the equity investors lack one or more of thefollowing essential characteristics of a controlling financial interest: (a)the direct or indirect ability to make decisions about the entities’ activitiesthrough voting rights or similar rights; or (b) the obligation to absorb theexpected losses of the entity if they occur, which makes it possible for the entityto finance its activities; or (c) the right to receive the expected residualreturns of**

** **

**10**

----

** **

**the entity if they occur, which is thecompensation for the risk of absorbing the expected losses.**  The adoption of this interpretation is not expectedto have a significant impact on the financial condition or results ofoperations of the Company.

** **

In May 2003,the FASB issued Statement of Financial Accounting Standards No. 150, *“Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity”*.  This statement established standards for howan issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity.  NetBank’s accounting policies were already in compliance withFASB statement No. 150 at the time of its issuance.

 

**4.**                                      LOAN AND LEASE RECEIVABLES

** **

Prior to its acquisition of Resource, NetBank’s primary loan investmentstrategy was to purchase pools of loans from other financial institutions.Generally the selling institutions retained the servicing for such loanpurchases. However, since its acquisitions of Market Street and Resource,NetBank has discontinued purchasing pools of loans from other financialinstitutions and selectively retains a portion of its originated loans forinvestment purposes.  Additionally,NetBank retains primarily all of the small ticket equipment leases itoriginates. At September 30, 2003 and December 31, 2002 the Companyhad net unamortized premiums and deferred cost on its loans and leases of$29,324 and $23,547, respectively.  Asof September 30, 2003, NetBank had commitments to fund mortgage loans of$1.4 billion, unused home equity lines of credit of $73,704 and commercialfinancing commitments of $1,063.

 

The following is a summary of NetBank’s loan and lease portfolio:

 
|                             |   | **September 30, 2003** |      | **December 31, 2002** |   |
|----------------------------------|--------|-----------------------------|-----------|----------------------------|--------|
|                             |   | **Amount**                  |      | **%**                      |   | **Amount** |   | **%** |   |
| Residential mortgages            |   | $                           | 1,246,694 |                       | 74.5   | % | $ | 545,120 |   | 58.3 | % |
| Leases                           |   | 329,975                     |      | 19.7                       | %      | 305,276 |   | 32.7 | % |
| Home equity lines                |   | 51,070                      |      | 3.1                        | %      | 82,051 |   | 8.8 | % |
| Consumer                         |   | 2,489                       |      | 0.1                        | %      | 2,025 |   | 0.2 | % |
| Construction                     |   | —                      |      | 0.0                        | %      | 188 |   | 0.0 | % |
| Auto                             |   | 42,714                      |      | 2.6                        | %      | 9 |   | 0.0 | % |
| Total                            |   | 1,672,942                   |      | 100.0                      | %      | 934,669 |   | 100.0 | % |
| Less allowance for credit losses |   | (42,671                     | )         |                       |   | (42,576 | ) |   |   |
| Total                            |   | $                           | 1,630,271 |                       |   |   | $ | 892,093 |   |   |   |

** **

**11**

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** **

**5.**                                      ALLOWANCE FOR CREDIT LOSSES

** **

The following is a summary of the allowance for credit losses:

 
|                                                                     |   | **Three months ended  September 30,** |   | **Nine months ended********September 30,** |   |
|--------------------------------------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------------------|--------|
|                                                                     |   | **2003**                                   |   | **2002**                                        |   | **2003** |   | **2002** |   |
| **Beginning balance**                                                    |   | $                                          | 41,855 |                                            | $      | 53,471 |   | $ | 42,576 |   | $ | 22,865 |   |
| Allowance recorded on purchased loan pools                               |   | —                                     |   | —                                          |   | — |   | 7,257 |   |
| Provision for credit losses                                              |   | 2,537                                      |   | (95                                             | )      | 4,299 |   | 26,432 |   |
| Allowance acquired in connection with acquisition  of Resource           |   | —                                     |   | —                                          |   | — |   | 1,828 |   |
| Allowance transferred to held for sale                                   |   | —                                     |   | —                                          |   | — |   | (3,270 | ) |
| Charge-offs:                                                             |   |                                       |   |                                            |   |   |   |   |   |
| Residential mortgages                                                    |   | (817                                       | )      | (5,563                                          | )      | (1,241 | ) | (5,929 | ) |
| Leases                                                                   |   | (1,372                                     | )      | (625                                            | )      | (4,127 | ) | (1,993 | ) |
| Home equity lines                                                        |   | (56                                        | )      | (63                                             | )      | (489 | ) | (304 | ) |
| Consumer                                                                 |   | (27                                        | )      | —                                          |   | (45 | ) | (196 | ) |
| Auto                                                                     |   | —                                     |   | —                                          |   | — |   | (10 | ) |
| Recoveries:                                                              |   |                                       |   |                                            |   |   |   |   |   |
| Residential mortgages                                                    |   | 19                                         |   | 4                                               |   | 121 |   | 65 |   |
| Leases                                                                   |   | 440                                        |   | 492                                             |   | 1,427 |   | 785 |   |
| Home equity lines                                                        |   | 89                                         |   | 72                                              |   | 147 |   | 138 |   |
| Consumer                                                                 |   | 3                                          |   | —                                          |   | 3 |   | 25 |   |
| Auto                                                                     |   | —                                     |   | —                                          |   | — |   | — |   |
| Total charge-offs, net                                                   |   | (1,721                                     | )      | (5,683                                          | )      | (4,204 | ) | (7,418 | ) |
| **Ending balance at 09/30/2003**                                         |   | $                                          | 42,671 |                                            | $      | 47,693 |   | $ | 42,671 |   | $ | 47,693 |   |
|                                                                     |   |                                       |   |                                            |   |   |   |   |   |
| Allowance for credit losses as a percentage of  average loans and leases |   | 3.1                                        | %      | 3.9                                             | %      | 3.8 | % | 3.4 | % |

 

NetBank considers a loan orlease to be impaired when it is probable that it will be unable to collect allamounts due according to the original terms of the loan or leaseagreement.  NetBank measures impairmentof a loan or lease on a loan-by-loan or lease-by-lease basis.  Amounts of impaired loans that are notprobable of collection are charged-off immediately.  As of September 30, 2003, and December 31, 2002,NetBank had $84,188 and $87,025, respectively, of non-performing loans andleases in its held for investment portfolio. The CMC lease portfolio, which is the subject of litigation as describedin Part II. Item I. Legal Proceedings included within this report, represented$80,465 and $83,769 of NetBank’s non-performing assets as of September 30,2003, and December 31, 2002, respectively.  NetBank had $2,885 and $3,485 of real estate owned resulting fromforeclosures at September 30, 2003 and December 31, 2002, respectively.  NetBank had $7,262 and $4,988 of loans thatwere restructured as of September 30, 2003, and December 31, 2002,respectively.  NetBank’s other realestate owned consists almost entirely of residential properties as a result offoreclosures.

 

12

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**6.**                                      FAIR VALUE AND IMPAIRMENT OFMORTGAGE SERVICING RIGHTS

** **

For purposes of evaluating its mortgage servicing rights portfolio forimpairment, the Company disaggregates its servicing portfolio into two primarysegments: available for sale and held for sale.

 

The segment of the portfolio designated as available for sale iscomposed of servicing rights that were purchased in bulk transactions or thatwere retained out of production pursuant to individual portfolio retentiondecisions. As of September 30, 2003, the Company is retaining the majorityof its mortgage servicing rights.  Theavailable for sale portfolio is disaggregated for purposes of measuringpotential impairments according to defined risk tranches. The Company hasdefined its risk tranches based upon interest rate band and product type. Withrespect to each such risk tranche, the fair value thereof, which is based uponan internal analysis that considers current market conditions, prevailinginterest rates, prepayment speeds, default rates and other relevant factors, iscompared to amortized carrying values of the mortgage servicing rights forpurposes of measuring potential impairment. The Company uses Constant MaturitySwap rate (CMS) floors, Constant Maturity Treasury rate (CMT) floors andcorridors, interest rate swap contracts, interest rate swaptions and interestrate caps to protect itself against interest rate and prepayment risk on itsavailable for sale portfolio.

 

The segment of the portfolio designated as held for sale is composed ofrecently produced mortgage servicing rights that are scheduled for sale andhave been allocated to specific forward servicing sales contracts. The held forsale portfolio is disaggregated for purposes of measuring possible impairmentsaccording to the specific forward sales contracts to which allocated, which theCompany has determined to be the appropriate approach to disaggregation bypredominant risk characteristic for this portfolio. For each such risk tranche,the fair value is based upon the allocated forward committed delivery price,which is compared to amortized carrying value for purposes of measuringpotential impairment.

 

As of September 30, 2003, the following amounts related toNetBank’s mortgage servicing rights portfolio:

 
|                         |   | **Available  for sale** |       | **Held********for Sale** |   |
|------------------------------|--------|-------------------------|------------|--------------------------|--------|
| UPB                          |   | $                       | 10,990,711 |                     | $      | 281,946 |   |
| Carrying value               |   | $                       | 137,285    |                     | $      | 3,620 |   |
| Carrying value / UPB         |   | 1.25                    | %          | 1.28                     | %      |
| Weighted average note rate   |   | 6.14                    | %          | 5.52                     | %      |
| Weighted average service fee |   | 0.34                    | %          | 0.32                     | %      |
| Net basis as multiple        |   | 3.67                    |       | 3.97                     |   |

 

The following table summarizeschanges in the impairment reserve for NetBank’s available for sale mortgageservicing rights:

 
| Balance as of January 1, 2003    |   | $      | 14,429 |   |
|---------------------------------------|--------|--------|--------|--------|
| Impairment expense                    |   | 38,434 |   |
| Balance as of September 30, 2003 |   | $      | 52,863 |   |

 

13

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7.                                       **DEPOSITS**

** **

The following table sets forth the dollar amount of deposits andweighted average interest rates in the various types of deposit programsoffered by the Company:

 
|                                   |   | **As of September 30, 2003** |      | **As of December 31, 2002** |   |
|----------------------------------------|--------|-----------------------------------|-----------|----------------------------------|--------|
|                                   |   | **Amount**                        |      | **Percentage**                   |   | **Current  weighted  average  interest rate** |   | **Amount** |   | **Percentage** |   | **Current  weighted  average  interest rate** |   |
| Non-interest bearing checking accounts |   | $                                 | 304,486   |                             | 12.1   | % | N/A |   | $ | 227,490 |   | 11.1 | % | N/A |   |
| Interest bearing:                      |   |                              |      |                             |   |   |   |   |   |   |   |   |   |
| Checking accounts                      |   | 204,247                           |      | 8.1                              | %      | 1.5 | % | 163,938 |   | 8.0 | % | 1.6 | % |
| Money market                           |   | 1,271,439                         |      | 50.3                             | %      | 2.0 | % | 811,873 |   | 39.7 | % | 2.3 | % |
| Certificate of deposit under $100,000  |   | 631,467                           |      | 25.0                             | %      | 3.0 | % | 720,399 |   | 35.2 | % | 3.4 | % |
| Certificate of deposit over $100,000   |   | 112,746                           |      | 4.5                              | %      | 3.0 | % | 121,222 |   | 6.0 | % | 3.4 | % |
| Total deposits                         |   | $                                 | 2,524,385 |                             | 100.0  | % |   |   | $ | 2,044,922 |   | 100.0 | % |   |   |

 

Accrued interest as of September 30, 2003, related to checking,money market and certificates of deposit accounts was $91, $829 and $5,943,respectively.  Accrued interest as ofDecember 31, 2002, related to checking, money market, and certificates ofdeposit accounts was $71, $512 and $9,318, respectively. At September 30,2003, and December 31, 2002, $639 and $641 of overdrawn deposits were classifiedas loans, respectively.

 

**8.**                                      BORROWINGS

 

A summary of borrowings andavailable borrowings, grouped by year of maturity, as of September 30,2003 follows:

 
| **Type of  Borrowing**                    |   | **Year of maturity** |   | **Range of stated  interest rates  September 30, 2003** |   | **Principal amount  outstanding  September 30, 2003** |      |
|-------------------------------------------|--------|----------------------|--------|--------------------------------------------------------------|--------|------------------------------------------------------------|-----------|
| $ 100 million warehouse line of credit    |   | 2003                 |   | 1.13                                                         | %*     | $                                                          | —    |   |
| $ 250 million master  repurchase facility |   | 2003                 |   | 2.36                                                         | %*     | 242,838                                                    |      |
| $ 625 million FHLB  warehouse line        |   | 2003                 |   | DRC + 0.50                                                   | %*     | 254,500                                                    |      |
| $ 200 million master  repurchase facility |   | 2003                 |   | 2.37                                                         | %      | 129,629                                                    |      |
| FHLB advances                             |   | 2003                 |   | 2.83%, DRC                                                   | *      | 875,300                                                    |      |
| FHLB advances                             |   | 2004                 |   | 4.45                                                         | %      | 50,000                                                     |      |
| FHLB advances                             |   | 2005                 |   | 5.63% - 7.41                                                 | %      | 126,000                                                    |      |
| FHLB advances                             |   | 2006                 |   | 5.63                                                         | %      | 20,000                                                     |      |
| FHLB advances                             |   | 2009                 |   | 4.64                                                         | %      | 25,000                                                     |      |
| NBI Trust I preferred securities          |   | 2032                 |   | LIBOR + 3.35                                                 | %      | 4,382                                                      |      |
| NBI Trust II preferred securities         |   | 2033                 |   | LIBOR + 3.25                                                 | %      | 4,382                                                      |      |
| $ 175 million master  repurchase facility |   | N/A                  |   | 1.52                                                         | %*     | 172,798                                                    |      |
|                                      |   | Total Debt           |   |                                                         |   | $                                                          | 1,904,829 |   |

 

----

* Indicates a variable rate.

 

14

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Most of the Federal Home LoanBank (“FHLB”) advances are fixed rate. Four advances, however, totaling$115,000 may be converted at the FHLB’s option to adjustable rate based on thethree month floating LIBOR.  The FHLB warehouse line is a $625,000adjustable line of credit with a floating rate based on the daily rate credit(“DRC”) plus 50 basis points used to fund mortgages originated by Market Streetand RBMG.  All of the FHLB advances andthe FHLB warehouse line are secured by investment securities or mortgageloans.  At September 30, 2003, NetBank had pledged $290,441 ofinvestment securities to the FHLB as collateral for various FHLB advances.

 

Convertible Subordinated Notes (“Notes”) were originally issued for$115,000, in a public offering during the year ended December 31,1999.  The Notes were scheduled tomature on June 1, 2004, and carried an interest rate of 4.75% payable semiannually on June 1 and December 1 of each year beginningDecember 1, 2000.  Holders of theNotes could have converted any Notes or portions of the Notes into shares ofNetBank’s common stock at a conversion price of $35.67 per share, subject toadjustment.  This is equivalent to28.0348 shares of common stock per one thousand dollars of principal amount ofthe Notes.  In July 2003, all thesubordinated notes were called at par, and the remaining unamortized discountof $145 was written off.

 

During 2002, NetBank issued $4,382 of trust preferred securities in aprivate pooled transaction through a newly formed trust, NBI Trust I. Thesecurities carry a variable rate and were initially priced at LIBOR plus 3.35%with a cap of 12.5% through January 2008. Interest payments and the resetting of the rate both occur on aquarterly basis. The securities are scheduled to mature in December 2032and cannot be redeemed by NBI Trust I for a minimum of five years.  During 2003, NetBank issued an additional$4,382 of trusted preferred securities in a private pooled transaction througha newly formed trust, NBI Trust II, under similar terms as the NBI Trust Isecurities.

 

Most of the revolving lines of credit, warehouse lines of credit (otherthan the FHLB warehouse line), the master repurchase facilities and commercialpaper conduit facility are secured by mortgage loans and are subject torestrictive covenants.  The covenantsinclude certain minimum net worth requirements, minimum tangible net worthrequirements, certain minimum financial ratios, maintenance of servicereligibility for various government agencies, a minimum balance in the mortgageservicing rights portfolio and certain minimum liquidity requirements, whichare all defined in the terms of the related debt agreements.  In addition,the covenants restrict the types of business activities in which the Companymay engage.  NetBank was in compliance with all debt covenants in place asof September 30, 2003.  Although management anticipates complyingwith all current debt covenants, there can be no assurance that NetBank or itsindividual subsidiaries will be able to comply with all debt covenants in thefuture.  Failure to comply could result in the loss of the relatedfinancing.  Short-term debt outstandingto third parties reached the highest level for the quarter onSeptember 12, 2003 with a daily short-term balance of $2,126 million.

 

**9.**                                      NET INCOME (LOSS) PER COMMONAND COMMON EQUIVALENT SHARE

** **

Basic and diluted net income(loss) per common and potential common share has been calculated based on theweighted average number of shares outstanding. The followingschedule reconciles the numerator and denominator of the basic and dilutednet income (loss) per common and potential common share for the three and ninemonths ended September 30, 2003, and for the three months ended September 30,2002.  For the nine months endedSeptember 30, 2002, there is no difference in basic and diluted shares asthe effect of options outstanding to purchase common shares would beanti-dilutive to the net loss for that period. The effect of the recently retired convertible debt securities has notbeen included in any of the periods presented because the assumed conversion ofsuch securities was anti-dilutive.

 

15

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|                                                                      |   | **Net Income  (Numerator)** |       | **Shares  (Denominator)** |       | **Per Share  Amount** |       |
|---------------------------------------------------------------------------|--------|-----------------------------|------------|---------------------------|------------|-----------------------|------------|
| **Nine months ended  September 30, 2003**                            |   |                        | ** ** |                      | ** ** |                  | ** ** |
| Basic EPS                                                                 |   | $                           | 40,504     |                      | 48,039     |                  | $          | 0.84 |   |
|                                                                      |   |                        |       |                      |       |                  |       |   |   |
| Effect of dilutive securities - option to  purchase common shares         |   | —                      |       | 622                       |       | (0.01                 | )          |
| Diluted EPS                                                               |   | $                           | 40,504     |                      | 48,661     |                  | $          | 0.83 |   |
|                                                                      |   |                        |       |                      |       |                  |       |
| **Three months ended  September 30, 2003**                           |   |                        | ** ** |                      | ** ** |                  | ** ** |
| Basic EPS                                                                 |   | $                           | 15,589     |                      | 47,829     |                  | $          | 0.33 |   |
|                                                                      |   |                        |       |                      |       |                  |       |   |   |
| Effect of dilutive securities - option to  purchase common shares         |   | —                      |       | 761                       |       | (0.01                 | )          |
| Diluted EPS                                                               |   | $                           | 15,589     |                      | 48,590     |                  | $          | 0.32 |   |
|                                                                      |   |                        | ** ** |                      | ** ** |                  | ** ** |
| **Nine months ended September 30, 2002**                             |   |                        | ** ** |                      | ** ** |                  | ** ** |
| Basic EPS                                                                 |   | $                           | (28,408    | )                         | 42,830     |                  | $          | 0.66 | ) |
| Effective of dilutive securities – option  to purchase common shares |   | —                      |       | —                    |       | —                |       |
| Diluted EPS                                                               |   | $                           | (28,408    | )                         | 42,830     |                  | $          | (0.66 | ) |
|                                                                      |   |                        |       |                      |       |                  |       |
| **Three months ended  September 30, 2002**                           |   |                        |       |                      |       |                  |       |
| Basic EPS                                                                 |   | $                           | 8,517      |                      | 49,778     |                  | $          | 0.17 |   |
|                                                                      |   |                        |       |                      |       |                  |       |   |   |
| Effect of dilutive securities - option to  purchase common shares         |   | —                      |       | 363                       |       | —                |       |
| Diluted EPS                                                               |   | $                           | 8,517      |                      | 50,141     |                  | $          | 0.17 |   |

 

 

**10.**                               BUSINESS SEGMENTS

** **

NetBank’s principal activitiesinclude retail banking and mortgage banking.  The retail banking segmentprimarily consists of offering consumer banking products such as checking,money market, and certificates of deposit. The retail bank primarily invests the funds generated through itsconsumer bank products in mortgage loans, investment securities and originatedsmall business financing loans and leases.  The mortgage banking segmentoriginates mortgage loans directly with borrowers and purchases mortgage loansfrom correspondents and/or brokers. The mortgage banking segment packages orpools such loans either inclusive or exclusive of servicing rights for saleinto the secondary market. Additionally, the Company has various strategic initiatives includingsmall business banking, personal financial planning, dealer financial servicesand NetInsurance. These initiatives as well as the revenues and expenses of theparent company are currently reported in the Other segment.

 

The accompanying segment data includes the results of Resourcecommencing March 31, 2002, reflecting the date of acquisition. The2002 tables include the effects of certain transactions related to theacquisition of Resource, including restructuring the investment portfolio inanticipation of the Resource transaction and certain compensation chargesrelated to changes in management as a result of the transaction.  Thereader is

 

16

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directed to the management discussion and analysis and results ofoperations included within this report for additional detail regardingcomparability of period results.

 

The financial information for each business segment reflects specificidentifiable transactions or allocated transactions based on an internalallocation method. The measurement of the performance of the business segmentsis based on the management structure of NetBank and is not necessarilycomparable with similar information from any other financial institution. Theinformation presented is also not necessarily indicative of the segment’soperations if they were independent entities.

 
|                          |   | **For the three months ended September 30, 2003** |      |
|-------------------------------|--------|--------------------------------------------------------|-----------|
|                          |   | **Retail  Banking**                                    |      | **Mortgage  Banking** |   | **Other** |   | **Eliminations** |   | **Consolidated** |   |
| Interest income               |   | $                                                      | 22,111    |   | $ | 36,402 |   | $ | 372 |   | $ | 34 |   | $ | 58,919 |   |
| Intersegment interest income  |   | 13,287                                                 |      | 53 |   | 82 |   | (13,422 | ) | — |   |
| Total interest income         |   | 35,398                                                 |      | 36,455 |   | 454 |   | (13,388 | ) | 58,919 |   |
| Interest expense              |   | 19,256                                                 |      | 2,420 |   | 283 |   | — |   | 21,959 |   |
| Intersegment interest expense |   | (35                                                    | )         | 13,049 |   | 408 |   | (13,422 | ) | — |   |
| Total interest expense        |   | 19,221                                                 |      | 15,469 |   | 691 |   | (13,422 | ) | 21,959 |   |
| Net interest income           |   | 16,177                                                 |      | 20,986 |   | (237 | ) | 34 |   | 36,960 |   |
| Provision for credit losses   |   | 2,542                                                  |      | (5 | ) | — |   | — |   | 2,537 |   |
| Non-interest income           |   | 2,762                                                  |      | 96,020 |   | 248 |   | (2,382 | ) | 96,648 |   |
| Non-interest expense          |   | 18,947                                                 |      | 84,345 |   | 3,074 |   | (88 | ) | 106,278 |   |
| Pre-tax income (loss)         |   | $                                                      | (2,550    | ) | $ | 32,666 |   | $ | (3,063 | ) | $ | (2,260 | ) | $ | 24,793 |   |
|                          |   |                                                   |      |   |   |   |   |   |   |   |   |
| Total assets                  |   | $                                                      | 4,471,108 |   | $ | 2,926,477 |   | $ | 619,217 |   | $ | (2,956,198 | ) | $ | 5,060,604 |   |

 
|                          |   | **For the three months ended September 30, 2002** | ** ** |
|-------------------------------|--------|--------------------------------------------------------|------------|
|                          |   | **Retail********Banking**                              |       | **Mortgage  Banking** | ** ** | **Other** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Interest income               |   | $                                                      | 27,384     |   | $ | 20,364 |   | $ | 219 |   | $ | — |   | $ | 47,967 |   |
| Intersegment interest income  |   | 5,380                                                  |       | — |   | 317 |   | (5,697 | ) | — |   |
| Total interest income         |   | 32,764                                                 |       | 20,364 |   | 536 |   | (5,697 | ) | 47,967 |   |
| Interest expense              |   | 23,075                                                 |       | 1,714 |   | 364 |   | — |   | 25,153 |   |
| Intersegment interest expense |   | —                                                 |       | 5,380 |   | 317 |   | (5,697 | ) | — |   |
| Total interest expense        |   | 23,075                                                 |       | 7,094 |   | 681 |   | (5,697 | ) | 25,153 |   |
| Net interest income           |   | 9,689                                                  |       | 13,270 |   | (145 | ) | — |   | 22,814 |   |
| Provision for credit losses   |   | (95                                                    | )          | — |   | — |   | — |   | (95 | ) |
| Non-interest income           |   | 15,604                                                 |       | 46,957 |   | 3,167 |   | (895 | ) | 64,833 |   |
| Non-interest expense          |   | 22,529                                                 |       | 49,875 |   | 2,225 |   | (585 | ) | 74,044 |   |
| Pre-tax income (loss)         |   | $                                                      | 2,859      |   | $ | 10,352 |   | $ | 797 |   | $ | (310 | ) | $ | 13,698 |   |
|                          |   |                                                   |       |   |   |   |   |   |   |   |   |
| Total assets                  |   | $                                                      | 3,159,399  |   | $ | 1,347,013 |   | $ | 570,392 |   | $ | (1,598,485 | ) | $ | 3,478,319 |   |

 

17

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|                          |   | **For the nine months ended September 30, 2003** |      |
|-------------------------------|--------|-------------------------------------------------------|-----------|
|                          |   | **Retail********Banking**                             |      | **Mortgage  Banking** |   | **Other** |   | **Eliminations** |   | **Consolidated** |   |
| Interest income               |   | $                                                     | 61,070    |   | $ | 92,729 |   | $ | 404 |   | $ | 59 |   | $ | 154,262 |   |
| Intersegment interest income  |   | 33,110                                                |      | 135 |   | 948 |   | (34,193 | ) | — |   |
| Total interest income         |   | 94,180                                                |      | 92,864 |   | 1,352 |   | (34,134 | ) | 154,262 |   |
| Interest expense              |   | 57,807                                                |      | 6,110 |   | 1,174 |   | — |   | 65,091 |   |
| Intersegment interest expense |   | 845                                                   |      | 32,330 |   | 1,018 |   | (34,193 | ) | — |   |
| Total interest expense        |   | 58,652                                                |      | 38,440 |   | 2,192 |   | (34,193 | ) | 65,091 |   |
| Net interest income           |   | 35,528                                                |      | 54,424 |   | (840 | ) | 59 |   | 89,171 |   |
| Provision for credit losses   |   | 4,263                                                 |      | 36 |   | — |   | — |   | 4,299 |   |
| Non-interest income           |   | 20,274                                                |      | 230,485 |   | 181 |   | (4,594 | ) | 246,346 |   |
| Non-interest expense          |   | 60,825                                                |      | 199,702 |   | 6,662 |   | (170 | ) | 267,019 |   |
| Pre-tax income (loss)         |   | $                                                     | (9,286    | ) | $ | 85,171 |   | $ | (7,321 | ) | $ | (4,365 | ) | $ | 64,199 |   |
|                          |   |                                                  |      |   |   |   |   |   |   |   |   |
| Total assets                  |   | $                                                     | 4,471,108 |   | $ | 2,926,477 |   | $ | 619,217 |   | $ | (2,956,198 | ) | $ | 5,060,604 |   |

 
|                          |   | **For the nine months ended September 30, 2002** | ** ** |
|-------------------------------|--------|-------------------------------------------------------|------------|
|                          |   | **Retail********Banking**                             |       | **Mortgage  Banking** | ** ** | **Other** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Interest income               |   | $                                                     | 76,990     |   | $ | 43,750 |   | $ | 244 |   | $ | — |   | $ | 120,984 |   |
| Intersegment interest income  |   | 10,557                                                |       | — |   | 1,624 |   | (12,181 | ) | — |   |
| Total interest income         |   | 87,547                                                |       | 43,750 |   | 1,868 |   | (12,181 | ) | 120,984 |   |
| Interest expense              |   | 70,130                                                |       | 8,691 |   | 1,194 |   | — |   | 80,015 |   |
| Intersegment interest expense |   | 411                                                   |       | 10,557 |   | 1,213 |   | (12,181 | ) | — |   |
| Total interest expense        |   | 70,541                                                |       | 19,248 |   | 2,407 |   | (12,181 | ) | 80,015 |   |
| Net interest income           |   | 17,006                                                |       | 24,502 |   | (539 | ) | — |   | 40,969 |   |
| Provision for credit losses   |   | 26,432                                                |       | — |   | — |   | — |   | 26,432 |   |
| Non-interest income           |   | 19,241                                                |       | 93,425 |   | 3,775 |   | (1,331 | ) | 115,110 |   |
| Non-interest expense          |   | 63,316                                                |       | 98,377 |   | 14,104 |   | (1,021 | ) | 174,776 |   |
| Pre-tax income (loss)         |   | $                                                     | (53,501    | ) | $ | 19,550 |   | $ | (10,868 | ) | $ | (310 | ) | $ | (45,129 | ) |
|                          |   |                                                  |       |   |   |   |   |   |   |   |   |
| Total assets                  |   | $                                                     | 3,159,399  |   | $ | 1,347,013 |   | $ | 570,392 |   | $ | (1,598,485 | ) | $ | 3,478,319 |   |

** **

**11.**                               LOSS CONTINGENCY

** **

NetBank, FSB is involved inlitigation with three insurance companies who are sureties on some of NetBank,FSB’s commercial lease portfolios. NetBank, FSB has filed a claim for allprincipal and interest payments that are currently past due.  The unpaid principal balance totals $80,465.In accordance with the Office of Thrift Supervision requirements, the Companymaintains an allowance for losses against this portfolio of $21,230.  The entire portfolio has been placed onnon-accrual status pending the outcome of the litigation.  The Company did not accrue and did notreceive approximately $1.2 million and $4.1 million of interest for the threeand nine months ended September 30, 2003, respectively.  Approximately $1.4 million and $5.1 millionof was not accrued or received during the three and nine months endedSeptember 30, 2002, respectively. Additionally, NetBank incurred $198 and $670 of legal expenses relatedto this litigation for the three and nine months ended September 30,2003.  In the normal course of businessNetBank is party to various legal proceedings. As of September 30, 2003, NetBank does not consider any of theseproceedings to be material to its financial position

 

18

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or results of operations, otherthan the litigation involving the CMC lease portfolio.  Reference is made to Part II. Item I. Legalproceeding included within this report for additional information.

 

# **12.**                               GUARANTEES

# ** **

The Company has issued mortgage-backed securities under variousprograms sponsored by Ginnie Mae, Freddie Mac and Fannie Mae.  In connection with servicing mortgage-backedsecurities guaranteed by Ginnie Mae, Freddie Mac or Fannie Mae, the Companyadvances certain principal and interest payments to security holders prior totheir collection from specific mortgagors. Additionally, the Company must remit certain payments of property taxesand insurance premiums in advance of collecting them from specific mortgagorsand make certain payments of attorney’s fees and other costs related to loansin foreclosure.  These amounts areincluded in servicing advances under the caption due from servicers andinvestors in the accompanying consolidated balance sheets. Likewise, during themonth that a mortgagor pays off his/her mortgage, the Company must accept aninterest payment from the borrower that is pro-rated to the date of payoff andpass through a full month’s interest to the security holder.  The Company includes its projection of thecost of such advances, lost interest on mortgages that prepay, and the expenseof unreimbursed attorney and other costs associated with foreclosure in itsvaluation of the servicing assets.

 

**In the ordinary course of business, the Company is exposedto liability under representations and warranties made to purchasers andinsurers of mortgage loans and the purchasers of servicing rights.  Under certain circumstances, the Company maybe required to repurchase mortgage loans or indemnify the purchasers of loansor servicing rights for losses if there has been a breach of representations orwarranties.  At September 30, 2003and December 31, 2002, NetBank had $35,850 and $11,893 of reserves whichrepresent the estimated fair value of its guarantees under thesecontracts.  For the nine months endedSeptember 30, 2003, NetBank repurchased $32,135 of loans, which is lessthan two tenths of one percent of production for the same period.**

** **

**In certain sales of whole loans and sales of servicing, theCompany is contractually obligated to refund to the purchaser, certain premiumspaid to the Company on the sale of loans or servicing rights if the mortgagorprepays the mortgage during a specified period of time (generally up to 120days after sale).  The Company hadreserves for its estimated obligation of $3,475 and $1,475 as ofSeptember 30, 2003, and December 31, 2002, respectively.**

** **

**Since NetBank is not the primary servicer for many of theloans or loans underlying the mortgage servicing rights it sells, it has noknowledge as to the current status of previously sold loans and mortgageservicing rights.  Accordingly, NetBankis unable to determine its exposure, if any, under its representations andwarranties.  The maximum exposure underNetBank’s representations and warranties would be the outstanding principalbalance and any premium paid of all loans or mortgage servicing rights eversold by the Company less any loans sold servicing released or any loansunderlying mortgage servicing rights that have already prepaid or defaultedwithout a breach of representations and warranties.**

** **

**Part I. Item 2:  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

** **

*Some of the statements in this report are forward-looking statements.Forward-looking statements include statements regarding the intent, belief orcurrent expectations of NetBank or its officers and directors and can beidentified by the use of forward-looking terms such as “may,” “will,” “should,”“believe,” “expect,” “anticipate,” “estimate,” “continue,” or comparableterminology. The Company’s actual results could differ materially from thoseanticipated from the forward-looking statements, depending on various importantfactors. These factors include a possible decline in asset quality; potentialdifficulties in integrating the Company’s operations across its multiple linesof business; the cyclical nature of the mortgage banking industry generally;the evolving nature of the market for internet banking and financial servicesgenerally; the possible adverse effects of unexpected changes in the interestrate environment; increasing competition and regulatory changes; and/or adverselegal rulings, particularly in the company’s litigation over leases originatedby the Commercial Money Center, Inc. The Company’s 2002 Form 10-K filed withthe Securities and Exchange Commission,*

 

19

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*contains additional details on these and other risks that are materialto operations. All forward-looking statements in this report are based oninformation available as of the date this report was filed with the SEC. TheCompany does not undertake to update any forward-looking statements that may bemade.*

 

**General**

 

NetBank, Inc. is a savings and loan holding company that wholly ownsthe outstanding stock of NetBank®, (“NetBank, FSB”), a federal savings bank;Meritage Mortgage Corporation (“Meritage”), a wholesale non-conforming mortgageprovider; MG Reinsurance Company (“MG Reinsurance”), a captive reinsurancecompany; NetInsurance, Inc., (“NetInsurance”), a licensed insurance agency; andNB Partners, Inc., a corporation formed to be involved in strategic partneringopportunities.  NetBank, FSB also ownsall of the outstanding stock of Market Street Mortgage Corporation (“MarketStreet”), a retail mortgage company, and Resource Bancshares Mortgage Group,Inc. (“Resource”). Resource wholly owns RBMG, Inc. (“RBMG”), a wholesalemortgage banking company, and Republic Leasing Company, Inc. (“Republic Leasing”),a small ticket commercial financing company.

 

NetBank, Inc. acquired Resource on March 31, 2002, andsubsequently reorganized the holding company structure as described above basedon operational, licensing and funding needs. Accordingly, the financial impactof Resource is included from the date of acquisition. The entire consolidatedcompany is referred to herein as “NetBank” or “the Company”.

 

All dollar figures are presented in thousands (000s) except per sharedata unless otherwise noted.

 

# **FinancialCondition**

# ** **

*General.*During the nine months endedSeptember 30, 2003, the Company’s assets increased $1.5 billion or43%.  This increase was primarily due toincreases of $1.1 billion, $738 million and $52 million in loans held for sale,loan and lease receivables and mortgage servicing rights, respectively.  These large increases were offset in part byreductions of $334 million, $68 million and $28 million in investmentsecurities available for sale, cash and cash equivalents and due from servicersand investors, respectively.  Theincrease in mortgages held for sale was primarily due to the velocity of salesinto the secondary markets or retention by the retail bank segment laggingproduction by $1.3 billion.  Theincrease in loan and lease receivables was due to the retention of $1.0 billionof mortgage loans produced by the mortgage banking segment, partially offset byamortization, prepayments and sales of $285 million.  The $52 million increase in the value of the Company’smortgage servicing rights was primarily due to the $4.3 billion or 62% increasein the principal balance of mortgage loans underlying the mortgage servicingrights portfolio.  Throughout 2003 theCompany retained the majority of its originated mortgage servicing rights andexpects to continue this strategy for the foreseeable future.  The investment securities available for saleportfolio declined $334 million as the Company chose to sell certain investmentsecurities and use some of the proceeds to pay off certain fixed-rate termadvances from the Federal Home Loan Bank (“FHLB”).  This strategy will more effectively balance the Company’sinterest rate sensitivity and improve the net interest margin in futureperiods.  Cash and cash equivalentsdeclined by $68 million primarily due to the Company more effectively using itscash to support the increase in mortgage loan production.  This increase was partially offset by adecline of $28 million in due from servicers and investors related to theCompany replacing externally serviced loans with internally originated andserviced loans.  By internally servicingits portfolio of loans and leases, NetBank will accelerate its cash receipts byeliminating the delay in collection of principal and interest payments andallow the Company to expand its cross-selling efforts.

 

20

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*Average balances.*The following table contains average balances for the periods indicated.  Reference is made to the rate volumevariance tables contained in the results of operations section foradditional detail of the Company’s average interest-earning assets andinterest-bearing liabilities.

 
|                                            |   | **For the three months  ended September 30,** |      | **For the nine months ended  September 30,** |   |
|-------------------------------------------------|--------|----------------------------------------------------|-----------|---------------------------------------------------|--------|
|                                            |   | **2003**                                           |      | **2002**                                          |   | **2003** |   | **2002** |   |
| Assets                                          |   |                                               |      |                                              |   |   |   |   |   |
| Interest-earning                                |   | $                                                  | 4,233,349 |                                              | $      | 3,225,115 |   | $ | 3,725,797 |   | $ | 3,069,156 |   |
| Noninterest-earning                             |   | 326,806                                            |      | 559,813                                           |   | 482,246 |   | 513,771 |   |
| Total                                           |   | $                                                  | 4,560,155 |                                              | $      | 3,784,928 |   | $ | 4,208,043 |   | $ | 3,582,927 |   |
|                                            |   |                                               |      |                                              |   |   |   |   |   |
| Liabilities and shareholders’ equity       |   |                                               |      |                                              |   |   |   |   |   |
| Interest-bearing                                |   | $                                                  | 3,668,570 |                                              | $      | 3,004,842 |   | $ | 3,398,684 |   | $ | 2,878,452 |   |
| Noninterest-bearing                             |   | 468,019                                            |      | 384,942                                           |   | 395,622 |   | 332,397 |   |
| Total liabilities                               |   | 4,136,589                                          |      | 3,389,784                                         |   | 3,794,306 |   | 3,210,849 |   |
| Shareholders’ equity                       |   | 423,566                                            |      | 395,144                                           |   | 413,737 |   | 372,078 |   |
| Total liabilities and shareholders’ equity |   | $                                                  | 4,560,155 |                                              | $      | 3,784,928 |   | $ | 4,208,043 |   | $ | 3,582,927 |   |

 

*InvestmentSecurities.*  During the nine months endedSeptember 30, 2003, the Company sold certain investment securities at gainsof $12,188.  NetBank used the proceedsto pay off certain fixed-rate term FHLB advances.  NetBank may continue to selectively sell investment securities inorder to use the proceeds to better position its net interest margin for thebenefit of future periods. Additionally, the Company recorded impairment charges of $794 on twovariable rate, long-term corporate bonds. The bonds had traded under book value for an extended period of time dueto widening credit spreads.  Both bondscarry a Standard & Poor’s “A-rating”.

 

The following tables set forth certain information relating to theCompany’s available for sale securities at September 30, 2003, andDecember 31, 2002:

 
| **As of  September 30, 2003**  |   | **Amortized  cost** |    | **Unrealized  gains** |   | **Unrealized  losses** |   | **Estimated  fair value** |   |
|-------------------------------------|--------|---------------------|---------|-----------------------|--------|------------------------|--------|---------------------------|--------|
| Mortgage pool securities            |   | $                   | 43,462  |                  | $      | 1,201                  |   | $                         | 12     |   | $ | 44,651 |   |
| Collateralized mortgage obligations |   | 1,537               |    | 125                   |   | —                 |   | 1,662                     |   |
| U.S. government agencies            |   | 255,523             |    | 6,231                 |   | —                 |   | 261,754                   |   |
| Corporate bonds                     |   | 8,900               |    | 141                   |   | 14                     |   | 9,027                     |   |
| Habitat bonds and other             |   | 3,566               |    | 248                   |   | —                 |   | 3,814                     |   |
| Total                               |   | $                   | 312,988 |                  | $      | 7,946                  |   | $                         | 26     |   | $ | 320,908 |   |

 
| **As of  December 31, 2002**   |   | **Amortized  cost** | ** ** | **Unrealized  gains** | ** ** | **Unrealized  losses** | ** ** | **Estimated  fair value** | ** ** |
|-------------------------------------|--------|---------------------|------------|-----------------------|------------|------------------------|------------|---------------------------|------------|
| Mortgage pool securities            |   | $                   | 121,868    |                  | $          | 3,222                  |       | $                         | —     |   | $ | 125,090 |   |
| Collateralized mortgage obligations |   | 8,774               |       | 159                   |       | 9                      |       | 8,924                     |       |
| U.S. government agencies            |   | 493,159             |       | 15,079                |       | —                 |       | 508,238                   |       |
| Corporate bonds                     |   | 9,679               |       | —                |       | 971                    |       | 8,708                     |       |
| Habitat bonds and other             |   | 3,511               |       | 248                   |       | —                 |       | 3,759                     |       |
| Total                               |   | $                   | 636,991    |                  | $          | 18,708                 |       | $                         | 980        |   | $ | 654,719 |   |

 

21

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*Loan and LeaseReceivables.*  NetBank is actively replacing itspurchased loan and lease receivables portfolio with internally originated loansand leases so it can capitalize on cross-selling opportunities, internallyservice the assets and more effectively control its credit and interest raterisk.  The Company’s loan and leasereceivables grew by $738 million for the nine months ended September 30,2003, as the Company selectively retained $1.0 billion of ARM, second and jumbomortgage loans to replace the runoff or sale of previously purchased loan andlease pools.  The Company expects tocontinue retaining the majority of the ARM, second and jumbo mortgage loansoriginated by the mortgage banking segment. As a result of the strategic retention of internally originated mortgageloans, the Company has increased its percentage of residential mortgage loansto total loans and leases to 75% as of September 30, 2003, compared to 58%as of December 31, 2002.

 

*Asset Quality andNon-performing Assets.* The Company periodicallyreviews the performance of its loan and lease receivables portfolio byreviewing charge-offs, delinquency statistics, and various other industrystatistics.  Large non-homogeneouscredits are reviewed on a loan-by-loan or lease-by-lease basis, whereasrelatively small credits with similar risk characteristic are reviewed on apool-by-pool basis.  If a decline incredit quality for a specific pool or individual loan or lease is noted, theCompany records additional allowance through a charge to the provision forcredit losses.  The allowance for creditlosses is maintained at a level estimated to be adequate to provide for probablelosses in the loan and lease receivables portfolio.  The Company determines the adequacy of the allowance based uponreviews of individual loans and leases, recent loss experience, currenteconomic conditions, the risk characteristics of the various categories ofloans and leases and other pertinent factors. NetBank’s non-performing assets as a percentage of gross unpaidprincipal balance (UPB) improved from 9.3% at December 31, 2002, to 5.0%at September 30, 2003, as the level of non-performing assets held constantrelative to an increase of $742 million or 80% in gross UPB.  This same measurement excluding the CMClease portfolio reflects a drop from 0.4% to 0.2%.  As gross UPB continues to increase from the retention ofresidential mortgage loans, the Company expects these ratios may continue toimprove.

 

The following tables detail NetBank’s held for investment loan andlease portfolio, the associated allowance for credit losses and non-performingassets:

 
|                             |   | **September 30, 2003** |      |
|----------------------------------|--------|-----------------------------|-----------|
|                             |   | **Gross UPB**               |      | **Allocated  allowance** |   | **(1) Non-  performing** |   | **Allowance /  NPA** |   | **NPA /********Gross UPB** |   |
| Residential mortgages            |   | $                           | 1,246,694 |   | $ | 9,779 |   | $ | 2,126 |   | 460.0 | % | 0.2 | % |
| Leases                           |   | 249,510                     |      | 10,057 |   | 1,218 |   | 825.7 | % | 0.5 | % |
| Home equity lines                |   | 51,070                      |      | 880 |   | 379 |   | 232.2 | % | 0.7 | % |
| Consumer                         |   | 2,489                       |      | 266 |   | — |   | n/a |   | 0.0 | % |
| Construction                     |   | —                      |      | — |   | — |   | n/a |   | n/a |   |
| Auto                             |   | 42,714                      |      | 459 |   | — |   | n/a |   | 0.0 | % |
| Loan and lease receivables       |   | 1,592,477                   |      | 21,441 |   | 3,723 |   | 575.9 | % | 0.2 | % |
| CMC leases (2)                   |   | 80,465                      |      | 21,230 |   | 80,465 |   | 26.4 | % | 100.0 | % |
| Total loan and lease receivables |   | $                           | 1,672,942 |   | $ | 42,671 |   | $ | 84,188 |   | 50.7 | % | 5.0 | % |

 

22

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|                       |   | **December 31, 2002** |    |
|----------------------------|--------|----------------------------|---------|
|                       |   | **Gross UPB**              |    | **Allocated  allowance** |   | **(1) Non-  performing** |   | **Allowance /  NPA** |   | **NPA /  Gross UPB** |   |
| Residential mortgages      |   | $                          | 545,120 |   | $ | 10,464 |   | $ | 1,851 |   | 565.3 | % | 0.3 | % |
| Leases                     |   | 221,507                    |    | 9,009 |   | 1,405 |   | 641.2 | % | 0.6 | % |
| Home equity lines          |   | 82,051                     |    | 1,659 |   | — |   | n/a |   | 0.0 | % |
| Consumer                   |   | 2,025                      |    | 216 |   | — |   | n/a |   | 0.0 | % |
| Construction               |   | 188                        |    | — |   | — |   | n/a |   | n/a |   |
| Auto                       |   | 9                          |    | — |   | — |   | n/a |   | 0.0 | % |
| Loan and lease receivables |   | 850,900                    |    | 21,348 |   | 3,256 |   | 655.7 | % | 0.4 | % |
| CMC leases (2)             |   | 83,769                     |    | 21,228 |   | 83,769 |   | 25.3 | % | 100.0 | % |
| Loan and lease receivables |   | $                          | 934,669 |   | $ | 42,576 |   | $ | 87,025 |   | 48.9 | % | 9.3 | % |

 

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(1)            Non-performing assets (“NPA”) include allloans and leases that are 90 days or more delinquent or on non-accrual status.The tables above do not include $24,212 and $30,443 of non-performing loansclassified as held for sale as of September 30, 2003, andDecember 31, 2002, respectively. Since loans classified as held for sale arecarried at the lower of cost or market, the estimated losses that may occurhave already been recorded in both the balance sheet and statement ofoperations.

 

(2)            The reader is directed to Part II. Item 1. Legal Proceedings containedwithin this report for additional detail regarding the CMC lease portfolio andthe associated litigation.

 

*Mortgage ServicingRights.*  The value of NetBank’s mortgage servicingrights (“MSRs”) increased $52,403 or 59% during the nine months endedSeptember 30, 2003.  The $52,403increase in value was primarily driven by the $4.3 billion or 62% increase inthe portfolio of mortgage loans underlying its MSRs during the period.  Beginning in late 2002, NetBank adopted astrategy of retaining primarily all of its originated conventional MSRs inorder to achieve the necessary critical mass the servicing division requires toeventually become operationally profitable. NetBank will continue to retain the majority of its originated MSRs forthe foreseeable future.  In addition toscheduled amortization and valuation impairments due to acceleratedprepayments, the value of the MSRs portfolio was negatively impacted by $9.7million due to implementation of a more robust, dynamic prepayment assumptionmethodology and recognition of a higher cost to service certain loan productsin the company’s portfolio.

 

*Liabilities.* Total liabilities for the nine months endedSeptember 30, 2003, increased $1.5 billion.  This increase was due primarily to increases of $0.5 billion indeposits and $1.0 billion in other borrowed funds.  The increase in deposits is the result of adding 12,907 newcustomers, which is part of NetBank’s overall strategy of increasing itstransactional deposit base.  Theincrease in other borrowed funds was necessary to support the $1.1 billionincrease in loans held for sale and $0.7 billion increase in loan and leasereceivables.  In April 2003, theCompany completed its second trust preferred securities offering which alsoincreased total liabilities by $4,382. Additionally, accounts payable and accrued liabilities increased by$35,426 primarily due to the increase in current tax liabilities associatedwith significant higher earnings year over year.  These increases were offset in part by a $26,126 decline inconvertible subordinated debt, which was retired in July 2003.

 

*Deposits.*  As of September 30, 2003, depositsrepresented 57% of total interest-bearing liabilities (including deposits,other borrowed funds, convertible subordinated notes and trust preferredsecurities) outstanding.  FHLB advances,warehouse lines of credit and repurchase agreements represented approximately42%, and trust preferred securities represented less than 1%.  During the nine months endedSeptember 30, 2003, NetBank was able to increase its deposits and lowerits cost of funds by replacing $97,408 of higher cost certificates of depositswith $76,996 of non-interest bearing transactional accounts and $499,875 ofmoney market and interest-bearing checking accounts.  Deposits as a percentage of total interest-bearing liabilitiesfell from 69% to 57% during the nine months ended September 30, 2003.  NetBank would expect this trend to reverseas the level of other borrowed funds, which primarily supports loans held forsale, should decline in

 

23

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proportion to expected declines in mortgage loan production.  The expected decline in mortgage loanproduction is based on the October 22, 2003, Mortgage Bankers Associationforecast of residential mortgage loan originations.  NetBank will continue to emphasize transactional accounts as itsprimary long-term funding source. Reference is made to the detailed deposit information contained withinnote 7 of the notes to consolidated financial statements for additionaldetails.

 

*Shareholders’Equity.*  Totalshareholders’ equity increased $25,213 for the nine months endedSeptember 30, 2003.  The increaseis primarily due to a $37,616 increase in retained earnings resulting from$40,504 of net income, offset in part by the payment of dividends of$2,888.  Additional paid-in capitalincreased by $5,620 primarily related to the tax benefit of non-qualifiedoption exercises.  Accumulated other comprehensiveincome (OCI) decreased $6,083 related to the change in fair value of availablefor sale investment securities and the realization of $12,188 in gains due tothe sale of certain investment securities offset in part by $794 of realizedimpairment on certain securities. Treasury stock increased $11,941 due to the repurchase of 1,201,200shares of common stock at a weighted average cost of $11.12 per share offset inpart by the reissuance of 116,126 shares under the employee stock purchaseplan, for the exercise of employee stock options and the reissuance of 45,000shares of restricted stock.  NetBankwill continue to repurchase shares periodically in the public market or throughprivate transactions.

 

**Results of Operations– Three months ended September 30, 2003, compared to the three monthsended September 30, 2002**

 

*General.* Net income for the three months ended September 30, 2003, was $15,589 or$0.32 per share, compared to net income of $8,517 or $0.17 per share, for thesame period in 2002.  The $7,072 or 83%increase in net income was primarily driven by the continued strong performanceof the mortgage banking segment. NetBank had record mortgage production of $5.7 billion and record salesof $4.9 billion for the three months ended September 30, 2003, compared toproduction of $3.6 billion and sales of $3.4 billion for the same period of2002.

 

*Interest Income*. NetBank’s interest income for the three months ended September 30, 2003,was $58,919 compared to $47,967 for the same period in 2002.  As detailed in the following rate volumevariance table, NetBank lowered the average balance of its short-terminvestments and investment securities available for sale by $395,972 andincreased the average balance of its loans held for sale by $1.2 billion andloan and lease receivables by $154,305. This repositioning has allowed theCompany to earn long-term yields on a greater percentage of itsinterest-earning assets while effectively holding short-term held for saleassets.  During the current quarterNetBank retained $543,466 of internally originated mortgage loans and approximately$42 million of internally originated auto loans.  As the Company continues to selectively retain internallyoriginated loans, the average balance of loan and lease receivables willincrease as a percentage of total interest-earning assets.  The expected increase in loan and leasereceivables as a percentage of total interest-earning assets will be compoundedby the expected decline in the average balance of loans held for sale.  This decline is based on the October 22,2003, Mortgage Bankers Association’s forecast of residential mortgageoriginations being 53% lower in 2004 than in 2003.  As discussed in note 11 of the consolidated financial statementsincluded within this report, the Company has not accrued and has not receivedapproximately $1.2 million of interest related to the CMC lease portfolioduring the three months ended September 30, 2003.  See Part II. Item 1. Legal Proceedingswithin this report for a more in depth discussion of the CMC lease portfolioand associated litigation.

 

*Interest Expense*.Total interest expense for the three months ended September 30, 2003, was$21,959 compared to $25,153 for the same period of 2002.  The $3,194 decline is primarily due to the96 basis-point reduction in the average cost of funds, offset in part by theimpact of an increase of $663,728 in the average balance of interest-bearingliabilities.  For the three months endedSeptember 30, 2003, there was $12,293 of interest expense on deposits(including checking, money market and certificates of deposits) as compared to$13,909 for the three months ended September 30, 2002.  The $1,616net decrease in interest expense on deposits was the result of a 63 basis-pointdecline in the average rate paid on deposits resulting in a positive $1,870rate variance,

 

24

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partially offset by a negative volume variance of $254 due to increasedaverage interest-bearing deposit balances of $233,792.  For the three months endedSeptember 30, 2003, interest expense on other borrowed funds (includingshort-term debt, FHLB advances, trust preferred and convertible subordinateddebt) was $9,666 compared to $11,244 for the same period of 2002.  The $1,578 decline in interest expenserelated to other borrowed funds is the result of a 159 basis-point decline inthe average cost of funds, partially offset by an increase of $429,936 in theaverage outstanding balance.  The 159basis-point reduction in the average cost of other borrowed funds is primarilydue to fixed-rate term FHLB advances being prepaid and replaced with variablerate advances. NetBank reduced its overall cost of funds during the period byreallocating its sources of funds to rely more heavily on deposits with anaverage cost of 229 basis points as opposed to other borrowed funds with anaverage cost of 255 basis points.

 

*Net InterestIncome. *Netinterest income is determined by interest rate spread, which is the differencebetween the yields earned on interest-earning assets and the rates paid oninterest-bearing liabilities, and the relative amounts of interest-earningassets and interest-bearing liabilities. Net interest income was $36,960, or 3.49% of average interest-earningassets for the three months ended September 30, 2003, compared to $22,814,or 2.83% of average interest-earning assets for the three months endedSeptember 30, 2002.

 

The following table details therelative interest rates and average balances of NetBank’s interest-earningassets and interest-bearing liabilities for the three months ended September 30,2003, and 2002:

 
| **Average Balance** |      | **Average Yield / Rate** |       |      |       | **Interest** |       |                                |   | **Variance attributable to**                   |       |
|---------------------|-----------|--------------------------|------------|-----------|------------|--------------|------------|-------------------------------------|--------|------------------------------------------------|------------|
| **2003**            |      | **2002**                 | ** ** | **2003**  | ** ** | **2002**     | ** ** |                                |   | **2003**                                       | ** ** | **2002** | ** ** | **Variance** | ** ** | **Rate** |   | **Volume  (3)** |   |
|                |      |                     |       |      |       |         |       | **Interest-earning assets:**        |   |                                           |       |   |   |   |   |   |   |   |   |
| $                   | 25,251    |                     | $          | 73,026    |       | 0.92         | %          | 2.62                                | %      | Short-term  investments                        |       | $ | 58 |   | $ | 479 |   | $ | (421 | ) | $ | (311 | ) | $ | (110 | ) |
| 394,350             |      | 742,547                  |       | 3.76      | %          | 4.21         | %          | Investment  securities (1)          |   | 3,702                                          |       | 7,822 |   | (4,120 | ) | (851 | ) | (3,269 | ) |
| 2,449,955           |      | 1,200,054                |       | 6.08      | %          | 7.13         | %          | Loans  held for sale (2)            |   | 37,235                                         |       | 21,394 |   | 15,841 |   | (3,155 | ) | 18,996 |   |
| 1,363,793           |      | 1,209,488                |       | 5.26      | %          | 6.04         | %          | Loans  and leases receivable (2)    |   | 17,924                                         |       | 18,272 |   | (348 | ) | (2,376 | ) | 2,028 |   |
| 4,233,349           |      | 3,225,115                |       | 5.57      | %          | 5.95         | %          | Total  interest-earning assets      |   | 58,919                                         |       | 47,967 |   | 10,952 |   | (6,693 | ) | 17,645 |   |
|                |      |                     |       |      |       |         |       |                                |   |                                           |       |   |   |   |   |   |   |   |   |
|                |      |                     |       |      |       |         |       | **Interest-bearing liabilities:**   |   |                                           |       |   |   |   |   |   |   |   |   |
| 191,016             |      | 147,282                  |       | 1.50      | %          | 1.64         | %          | Checking  accounts                  |   | 715                                            |       | 603 |   | 112 |   | (52 | ) | 164 |   |
| 1,213,121           |      | 678,766                  |       | 1.98      | %          | 2.67         | %          | Money  market                       |   | 6,018                                          |       | 4,536 |   | 1,482 |   | (1,169 | ) | 2,651 |   |
| 747,359             |      | 1,091,656                |       | 2.98      | %          | 3.21         | %          | Certificates  of deposit            |   | 5,560                                          |       | 8,770 |   | (3,210 | ) | (649 | ) | (2,561 | ) |
| 1,114,973           |      | 403,300                  |       | 1.78      | %          | 2.47         | %          | Short-term  debt                    |   | 4,969                                          |       | 2,494 |   | 2,475 |   | (697 | ) | 3,172 |   |
| 391,233             |      | 656,522                  |       | 4.51      | %          | 5.13         | %          | FHLB  advances                      |   | 4,414                                          |       | 8,422 |   | (4,008 | ) | (1,015 | ) | (2,993 | ) |
| 8,764               |      | —                   |       | 5.61      | %          | 0.00         | %          | Trust  Preferred                    |   | 123                                            |       | — |   | 123 |   | — |   | 123 |   |
| 2,104               |      | 27,316                   |       | 30.42     | %          | 4.80         | %          | Convertible  subordinate debt       |   | 160                                            |       | 328 |   | (168 | ) | 1,749 |   | (1,917 | ) |
| 3,668,570           |      | 3,004,842                |       | 2.39      | %          | 3.35         | %          | Total  interest-bearing liabilities |   | 21,959                                         |       | 25,153 |   | (3,194 | ) | (1,833 | ) | (1,361 | ) |
|                |      |                     |       |      |       |         |       |                                |   |                                           |       |   |   |   |   |   |   |   |   |
| —              |      | —                   |       | 3.18      | %          | 2.60         | %          | Net  interest margin                |   | 36,960                                         |       | 22,814 |   | 14,146 |   | (4,860 | ) | 19,006 |   |
| 564,779             |      | 220,273                  |       | 0.31      | %          | 0.23         | %          | Interest  free sources              |   | —                                         |       | — |   | — |   | — |   | — |   |
| $                   | 4,233,349 |                     | $          | 3,225,115 |       | 3.49         | %          | 2.83                                | %      | Net interest income to interest-earning assets |       | $ | 36,960 |   | $ | 22,814 |   | $ | 14,146 |   | $ | (4,860 | ) | $ | 19,006 |   |

 

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(1) Based on amortized cost; changes in fair value are not considered.

(2) No separate treatment has been made for non-accrual loans.

(3) Variances attributable to the rate and volume mix are included inthe volume variances

 

*Provision for CreditLosses.*  The provision for credit losses was$2,537 for the three months ended September 30, 2003, compared to $(95)for the same period of 2002.  During thethree months ended September 30, 2003, NetBank began retaining itsoriginated auto loans and recorded 110 basis points or $459 of provisionexpense.  The remaining $2,078 ofprovision expense is related to the retention of $544 million of mortgage and$36 million of originated leases.  The$95 recapture of provision expense during the 2002 period was the result of theloan and lease receivables portfolio declining by $174,664 due to highprepayments and sales of certain

 

25

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loans as the Company was beginning to reposition the portfolio afterits acquisition of Resource in March 2002.  Reference is made to the asset quality and non-performing assetssection in the financial condition section contained within thisreport for additional detail concerning the determination of provision expenserelated to maintaining the proper level of allowance for credit losses.

 

*Non-interest Income.* Non-interest income increased $31,815 to $96,648 for the three months endedSeptember 30, 2003, compared to $64,833 for the same period of2002.  Gain on sales of mortgage loans and mortgage servicing rightsaccounted for $36,942 of the period-over-period increase, which was primarilydue to the $1.5 billion increase in sales of mortgage loans period overperiod.  This increase was partiallyoffset by a decline of $7,638 in gains on sales of investment securities as theCompany sold certain investment securities for gains of $7,638 in thecorresponding period of 2002.  For thethree months ended September 30, 2003, other income increased $1,095compared to the same period of 2002. Other income for the three months ended September 30, 2003,consisted of $5,181 of gains associated with fair value adjustments for assetsaccounted for under SFAS No. 133, $323 of revenues from MG Reinsurance, $478 ofrevenues from Republic Leasing and $2,735 of ancillary fees and income.

 

*Non-interestExpense.*  Non-interest expense includes alloperating expenses such as salaries and benefits, marketing and general andadministrative expenses.  Non-interestexpense increased by $32,234 to $106,278 for the three months endedSeptember 30, 2003, from $74,044 for the three months endedSeptember 30, 2002.  The largestpart of the increase was impairment and amortization of mortgage servicingrights, which totaled $31,195, an increase of $20,367 period over period.  This large increase was primarily due tonear record high actual prepayment speeds and the implementation of a moredynamic prepayment assumption methodology, which accounted for $9.7 million ofthe increase.  Additionally, salariesand benefits increased $9,043 for the three months ended September 30,2003, compared to the same period of 2002. This increase is primarily related to the $2.0 billion increase inmortgage loan production during the current period.  Slightly offsetting these increases, NetBank incurred $4,316 ofprepayment fees on the early extinguishments of certain fixed-rate FHLBadvances, a reduction of $3,135 compared to $7,451 in the same period of2002.  Additionally, customer serviceand loan servicing expenses declined by $763 and $605, respectively, due toincreased efficiency and a reduction of loans being serviced by third parties.  As the bank continues to replace third partyserviced loans with internally originated loans, loan servicing expenses shouldcontinue to decline.

 

26

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# ***Retail Bank Operations***

 

The table below provides an overview of the results of operations forthe retail bank segment:

 
|                                                                  |   | **RETAIL BANK OPERATIONS  Three months ended September 30,** |      |
|-----------------------------------------------------------------------|--------|-------------------------------------------------------------------|-----------|
|                                                                  |   | **2003**                                                          |      | **2002** |   | **Change** |   |
| Net interest income                                                   |   | $                                                                 | 16,177    |   | $ | 9,689 |   | $ | 6,488 |   |
| Provision for credit losses                                           |   | (2,542                                                            | )         | 95 |   | (2,637 | ) |
| Net interest income after provision for credit  losses                |   | 13,635                                                            |      | 9,784 |   | 3,851 |   |
| Gain on sale of loans                                                 |   | 30                                                                |      | 3,701 |   | (3,671 | ) |
| Service charges and fees                                              |   | 2,732                                                             |      | 4,265 |   | (1,533 | ) |
| Total revenues                                                        |   | 16,397                                                            |      | 17,750 |   | (1,353 | ) |
| Total non-interest expenses                                           |   | 14,631                                                            |      | 15,078 |   | (447 | ) |
| Pre-tax income before net (loss) gain on  securities and prepaid debt |   | 1,766                                                             |      | 2,672 |   | (906 | ) |
| Net (loss) gain on securities and prepaid debt                        |   | (4,316                                                            | )         | 187 |   | (4,503 | ) |
| Pre-tax (loss) income                                                 |   | $                                                                 | (2,550    | ) | $ | 2,859 |   | $ | (5,409 | ) |
|                                                                  |   |                                                              |      |   |   |   |   |
| Earning assets                                                        |   | $                                                                 | 4,189,997 |   | $ | 2,821,486 |   | $ | 1,368,511 |   |
|                                                                  |   |                                                              |      |   |   |   |   |
| Net interest income to earning assets                                 |   | 1.54                                                              | %         | 1.37 | % | 0.17 | % |
| Net interest income after provision to earning  assets                |   | 1.30                                                              | %         | 1.39 | % | (0.09 | )% |
| Service charges and fees to earning assets                            |   | 0.26                                                              | %         | 0.60 | % | (0.34 | )% |
| Expenses to earning assets                                            |   | 1.40                                                              | %         | 2.14 | % | (0.74 | )% |

 

The retail bank segment lost$2,550 for the three months ended September 30, 2003, compared to incomeof $2,859 for the three months ended September 30, 2002.  As illustrated in the table above, theretail bank segment would have been profitable had it not incurred $4,316 ofprepayment fees for the early extinguishments of certain fixed-rate FHLBadvances during the current period.  Forthe three months ended September 30, 2003, compared to the same period of2002, the retail bank was able to lower its non-interest expenses whilesupporting a $1.4 billion increase in interest-earning assets.  The cost savings were achieved throughstrict cost controls, effective outsourcing and consolidation of redundantfunctions as a result of the acquisition of Resource in 2002.  The retail bank will continue to selectivelyretain loans originated by the mortgage banking segment as it strives toincrease its interest-earning assets and improve its net interest income.  This expected increase may be offset in partby a decline in the warehouse line of credit the retail bank extends to themortgage banking segment, as the level of loans held for sale in the mortgagebanking segment is expected to decrease in proportion to any declines inproduction over future periods. Additionally, the retail bank will retain themajority of the auto loans originated through the Company’s new indirect autolending unit, Dealer Financial Services, which totaled approximately $42million for the three months ended September 30, 2003.

 

27

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*MortgageBanking*

 

The following table highlightsthe mortgage banking segment production and sales activities:

 
|                                     |   | **Mortgage banking segment  Three months ended September 30,** |      |
|------------------------------------------|--------|---------------------------------------------------------------------|-----------|
|                                     |   | **2003**                                                            |      | **2002** |   | **Change** |   |
| **Mortgage loan production:**            |   |                                                                |      |   |   |   |   |
| Retail                                   |   | $                                                                   | 874,406   |   | $ | 628,669 |   | $ | 245,737 |   |
| Correspondent                            |   | 2,678,439                                                           |      | 1,686,094 |   | 992,345 |   |
| Wholesale/broker                         |   | 1,298,672                                                           |      | 810,528 |   | 488,144 |   |
| RMS                                      |   | 240,973                                                             |      | 67,184 |   | 173,789 |   |
| Total agency-eligible                    |   | 5,092,490                                                           |      | 3,192,475 |   | 1,900,015 |   |
| Nonconforming                            |   | 589,033                                                             |      | 433,559 |   | 155,474 |   |
| Total                                    |   | $                                                                   | 5,681,523 |   | $ | 3,626,034 |   | $ | 2,055,489 |   |
|                                     |   |                                                                |      |   |   |   |   |
| **Mortgage loan sales:**                 |   |                                                                |      |   |   |   |   |
| Conforming or agency-eligible sales      |   | $                                                                   | 5,131,811 |   | $ | 2,964,043 |   | $ | 2,167,768 |   |
| Non-conforming sales                     |   | 332,697                                                             |      | 476,554 |   | (143,857 | ) |
| Mortgage banking sales                   |   | 5,464,508                                                           |      | 3,440,597 |   | 2,023,911 |   |
| Sold to retail bank                      |   | (543,466                                                            | )         | (12,115 | ) | (531,351 | ) |
| Sales to third parties                   |   | $                                                                   | 4,921,042 |   | $ | 3,428,482 |   | $ | 1,492,560 |   |
|                                     |   |                                                                |      |   |   |   |   |
| Production revenues                      |   | $                                                                   | 117,011   |   | $ | 60,227 |   | $ | 56,784 |   |
| Production expenses                      |   | 84,345                                                              |      | 49,875 |   | 34,470 |   |
| Pre-tax margin                           |   | $                                                                   | 32,666    |   | $ | 10,352 |   | $ | 22,314 |   |
|                                     |   |                                                                |      |   |   |   |   |
| Production revenues in bps to sales      |   | 214                                                                 |      | 175 |   | 39 |   |
| Production expenses in bps to production |   | 148                                                                 |      | 138 |   | 10 |   |
| Net production margin in bps             |   | 66                                                                  |      | 37 |   | 29 |   |

 

Note: Production revenues in bps to sales is based on mortgage bankingsales, which includes intersegment sales to the retail bank segment.

 

For the three months ended September 30, 2003, the mortgagebanking segment posted a record pre-tax margin of $32,666 compared to $10,352for the same period of 2002.  Theincrease in pre-tax margin for the three months ended September 30, 2003,compared with the same period of 2002 relates primarily to record mortgage loanproduction of $5.7 billion and record sales of $5.5 billion compared toproduction of $3.6 billion and sales of $3.4 billion for the 2002 period.  The mortgage banking segment achieved recordproduction and sales in both the conforming and non-conforming channels duringthe 2003 period.  Additionally, duringthe three months ended September 30, 2003, pricing pressures eased asindustry pipelines neared full capacity resulting in a 39 bps increase inproduction revenues.  Productionexpenses decreased by 10 basis points period over period.  The decline in expenses was partially offsetby increased impairment and amortization charges of $20.4 million.  Net of this increase, production expenses wouldhave declined by 25 basis points due to the mortgage banking segment leveragingits fixed costs against higher production levels.

 

28

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*Other Segment*

 

For the three months ended September 30,2003, the other segment recorded a pre-tax loss of $3,063 compared to pre-taxincome of $797 for the same period of 2002. The loss includes NetBank’s strategic initiatives and holding companyexpenses, including Dealer Financial Services, NetInsurance, NetBank, Inc.,Resource Bancshares Mortgage Group, Inc. and NetBank Partners.  The 2002 pre-tax income of $797 includes aone-time gain of $2.8 million on the sale of Resource’s former headquarters.

 

**Results of Operations– Nine months ended September 30, 2003, compared to the nine months endedSeptember 30, 2002**

 

*General.* Net income for the nine months ended September 30, 2003, was a record$40,504 or $0.83 per share, compared to a net loss of $28,408 or $0.66 pershare for the same period of 2002.  The2002 loss included $10.1 million, pre-tax, of acquisition and severance chargesand $59.9 million pre-tax, of charges associated with the integration andrepositioning of the Company’s balance sheet as NetBank implemented itsfinancial intermediary strategy following its acquisition of Resource inMarch 2002.  Additionally, theprior period net loss only includes the operating results of Resource for thesix months ended September 30, 2002, since its acquisition was not completeduntil March 31, 2002.  The recordnet income for the nine months ended September 30, 2003, was primarilydriven by the strong performance of the mortgage banking segment as itcapitalized on record production of $15.6 billion and record sales to thirdparties of $13.3 billion compared to $7.0 billion of production and $6.9billion of sales for the same period in 2002. The low interest rate environment and the addition of Resource’smortgage banking operations fueled the increase in production and sales.

 

*Interest Income*. NetBank’s interest income for the nine months ended September 30, 2003,was $154,262 compared to $120,984 for the same period in 2002.  Interest income for the 2002 period wasnegatively impacted by approximately $12,500 related to impairment of premiumson purchased loan pools that had experienced accelerated prepayments in early2002.  As detailed in the following ratevolume variance table, NetBank lowered the average balance of its short-terminvestments by $94,332, investment securities available for sale by $238,086and loan and lease receivables by $247,468. These declines were offset by a $1.2 billion increase in the averagebalance of loans held for sale.  Thisrepositioning allowed the Company to earn higher long-term yields on a greaterpercentage of its interest-earning assets while effectively holding short-termheld for sale assets.  Utilization ofthis strategy limited NetBank’s decline in average yield, adjusted for the 2002impairment, to 28 basis points compared to a 116 basis-point decline in theaverage cost of funds.  As discussed innote 11 of the consolidated financial statements included within this report,the Company has not accrued and has not received approximately $4.1 million ofinterest related to the CMC lease portfolio for the nine months ended September 30,2003.  See Part II. Item 1. LegalProceedings within this report for a more in depth discussion of the CMC leaseportfolio and associated litigation.

 

*Interest Expense*.  Total interest expense for the nine monthsended September 30, 2003, was $65,091 compared to $80,015 for the sameperiod of 2002.  The $14,924 decline isprimarily due to the 116 basis-point reduction in the average cost of funds,offset in part by the impact of an increase of $520,232 in the average balanceof interest-bearing liabilities. For the nine months ended September 30,2003, there was $37,273 of interest expense on deposits (including checking,money market and certificates of deposits) compared to $41,692 for the ninemonths ended September 30, 2002.  The $4,419 net decrease in interestexpense on deposits was the result of a 89 basis-point decline in the averagerate paid on deposits resulting in a positive $19,381 rate variance, partiallyoffset by a negative volume variance of $14,962 due to an increase in averagedeposit balances of $431,666.  For thenine months ended September 30, 2003, interest expense on other borrowedfunds (including short-term debt, FHLB advances, trust preferred andconvertible subordinated debt) was $27,818 compared to $38,323 for the same periodof 2002.  The net $10,505 decline ininterest expense related to other borrowed funds is the result of a 148basis-point decline in the average cost of funds, partially offset by anegative volume variance of $5,329 due to the $88,566 increase in the averageoutstanding balance.  NetBank reducedits overall cost of funds during the period by reallocating its sources offunds to rely more heavily on

 

29

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deposits with an average cost of 228 basis points as opposed to otherborrowed funds with an average cost of 305 basis points.

 

*Net InterestIncome. *Netinterest income is determined by interest rate spread, which is the differencebetween the yields earned on interest-earning assets and the rates paid on interest-bearingliabilities, and the relative amounts of interest-earning assets andinterest-bearing liabilities. Net interest income was $89,171, or 3.19% ofaverage interest-earning assets for the nine months ended September 30,2003, compared to $40,969, or 1.78% of average interest-earning assets for thenine months ended September 30, 2002.

 

The following table details therelative interest rates and average balances of NetBank’s interest-earningassets and interest-bearing liabilities for the nine months endedSeptember 30, 2003, and 2002:

 
| **Average Balance** |      | **Average Yield /  Rate** |   |      |   | **Interest** |   |                                |   | **Variance attributable to**                   |   |
|---------------------|-----------|---------------------------|--------|-----------|--------|--------------|--------|-------------------------------------|--------|------------------------------------------------|--------|
| **2003**            |      | **2002**                  |   | **2003**  |   | **2002**     |   |                                |   | **2003**                                       |   | **2002** |   | **Variance** |   | **Rate** |   | **Volume  (3)** |   |
|                |      |                      |   |      |   |         |   | **Interest-earning assets:**        |   |                                           |   |   |   |   |   |   |   |   |   |
| $                   | 32,627    |                      | $      | 126,959   |   | 1.13         | %      | 2.23                                | %      | Short-term investments                         |   | $ | 277 |   | $ | 2,121 |   | $ | (1,844 | ) | $ | (1,854 | ) | $ | 10 |   |
| 534,644             |      | 772,730                   |   | 3.91      | %      | 4.19         | %      | Investment  securities (1)          |   | 15,662                                         |   | 24,255 |   | (8,593 | ) | (2,877 | ) | (5,716 | ) |
| 2,022,616           |      | 786,089                   |   | 6.26      | %      | 7.45         | %      | Loans  held for sale (2)            |   | 95,020                                         |   | 43,913 |   | 51,107 |   | (12,415 | ) | 63,522 |   |
| 1,135,910           |      | 1,383,378                 |   | 5.08      | %      | 4.89         | %      | Loans  and leases receivable (2)    |   | 43,303                                         |   | 50,695 |   | (7,392 | ) | 3,630 |   | (11,022 | ) |
| 3,725,797           |      | 3,069,156                 |   | 5.52      | %      | 5.26         | %      | Total  interest-earning assets      |   | 154,262                                        |   | 120,984 |   | 33,278 |   | (13,516 | ) | 46,794 |   |
|                |      |                      |   |      |   |         |   |                                |   |                                           |   |   |   |   |   |   |   |   |   |
|                |      |                      |   |      |   |         |   | **Interest-bearing liabilities:**   |   |                                           |   |   |   |   |   |   |   |   |   |
| 180,969             |      | 141,495                   |   | 1.53      | %      | 1.65         | %      | Checking  accounts                  |   | 2,076                                          |   | 1,753 |   | 323 |   | (231 | ) | 554 |   |
| 1,065,963           |      | 622,281                   |   | 2.11      | %      | 2.73         | %      | Money  market                       |   | 16,903                                         |   | 12,754 |   | 4,149 |   | (5,132 | ) | 9,281 |   |
| 936,350             |      | 987,840                   |   | 2.61      | %      | 3.67         | %      | Certificates  of deposit            |   | 18,294                                         |   | 27,185 |   | (8,891 | ) | (14,018 | ) | 5,127 |   |
| 682,166             |      | 438,714                   |   | 1.95      | %      | 3.07         | %      | Short-term  debt                    |   | 9,988                                          |   | 10,112 |   | (124 | ) | (6,557 | ) | 6,433 |   |
| 507,050             |      | 660,806                   |   | 4.40      | %      | 5.50         | %      | FHLB  advances                      |   | 16,725                                         |   | 27,234 |   | (10,509 | ) | (9,666 | ) | (843 | ) |
| 7,157               |      | —                    |   | 5.07      | %      | 0.00         | %      | Trust  Preferred                    |   | 272                                            |   | — |   | 272 |   | — |   | 272 |   |
| 19,029              |      | 27,316                    |   | 5.84      | %      | 4.77         | %      | Convertible  subordinate debt       |   | 833                                            |   | 977 |   | (144 | ) | 389 |   | (533 | ) |
| 3,398,684           |      | 2,878,452                 |   | 2.55      | %      | 3.71         | %      | Total  interest-bearing liabilities |   | 65,091                                         |   | 80,015 |   | (14,924 | ) | (35,215 | ) | 20,291 |   |
|                |      |                      |   |      |   |         |   |                                |   |                                           |   |   |   |   |   |   |   |   |   |
| —              |      | —                    |   | 2.97      | %      | 1.55         | %      | Net  interest margin                |   | 89,171                                         |   | 40,969 |   | 48,202 |   | 21,699 |   | 26,503 |   |
| 327,111             |      | 190,704                   |   | 0.22      | %      | 0.23         | %      | Interest  free sources              |   | —                                         |   | — |   | — |   | — |   | — |   |
| $                   | 3,725,797 |                      | $      | 3,069,156 |   | 3.19         | %      | 1.78                                | %      | Net interest income to interest-earning assets |   | $ | 89,171 |   | $ | 40,969 |   | $ | 48,202 |   | $ | 21,699 |   | $ | 26,503 |   |
|                     |           |                           |        |           |        |              |        |                                     |        |                                                |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1) Based on amortized cost; changes in fair value are not considered.

(2) No separate treatment has been made for non-accrual loans.

(3) Variances attributable to the rate and volume mix are included inthe volume variances

 

*Provision for CreditLosses.*  The provision for credit losses was$4,299 for the nine months ended September 30, 2003, compared to $26,432for the same period of 2002.  The 2002figure contained $20.1 million of provision specifically for the CMC leaseportfolio.  See Part II. Item 1. LegalProceedings within this report for a more in depth discussion of the CMC leaseportfolio and associated litigation. Reference is made to the asset quality and non-performing assetssubsection in the Financial Condition section contained within thisreport for additional detail related to the determination of provision expensefor maintaining the proper level of allowance for credit losses.

 

*Non-interest Income.* Non-interest income increased $131,236 to $246,346 for the nine months endedSeptember 30, 2003, compared to $115,110 for the nine months endedSeptember 30, 2002.  Of this increase, gain on sales of mortgageloans and mortgage servicing rights accounted for $110,312.  This large increase was primarilyattributable to the strong performance in the mortgage banking segment andResource’s mortgage subsidiaries not being included in the first three monthsof 2002.  The mortgage subsidiaries’improved results were attributable to a lower interest rate environmentresulting in higher production and more favorable pricing conditions.  Service charges and fees increased by $9,236to $35,795 for the nine months ended September 30,

 

30

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2003, from $26,559 in the same period of 2002.  $7,826 of the increase is attributable tothe addition of Resource’s mortgage servicing operation.  The Company recorded $12,188 of gains oninvestment securities as certain investment securities were sold during thenine months ended September 30, 2003, compared to $5,781 during the sameperiod in 2002.  Current period gains of$12,188 were offset in part by impairment charges of $794 on two variable,long-term corporate bonds.  The bondshad traded under book value for an extended period of time due to wideningcredit spreads.  Both bonds carry aStandard & Poor’s “A-” rating. Other income was $14,696 for the nine months ended September 30,2003, compared to $8,621 for the comparable 2002 period. Other income consistedof $7,077 of gains associated with fair value adjustments for assets accountedfor under SFAS No 133, $1,504 of revenues from MG Reinsurance, $1,462 ofrevenues from Republic Leasing and $4,653 of ancillary fees and income.

 

*Non-interestExpense.*  Non-interest expense includes alloperating expenses such as salaries and benefits, marketing and general andadministrative expenses.  Non-interestexpense increased by $92,243 to $267,019 for the nine months endedSeptember 30, 2003, from $174,776 for the nine months endedSeptember 30, 2002.  The $267,019of non-interest expense for the nine months ended September 30, 2003,includes $43,984 of non-interest expense associated with operations acquired aspart of the Resource acquisition, which were not included in the comparableperiod of 2002. The $174,776 of non-interest expense for the period endedSeptember 30, 2002, included $10,085 of acquisition and severancecosts.  Additionally, during the ninemonths ended September 30, 2003, the Company incurred $16,267 ofprepayment fees on the early extinguishments of certain fixed-rate FHLB advances,compared to $9,944 of prepayment fees during the nine months endedSeptember 30, 2002.  Excluding theitems listed above, non-interest expense increased $52,021 for the nine monthsended September 30, 2003, compared to the same period of 2002.  The majority of the increase is due to the$30,786 increase in impairment and amortization of mortgage servicing rightsand the $17,566 increase in salaries and wages.  The high level of refinance activity during the first nine monthsof 2003, associated with the low interest rate environment, drove the increasein amortization and impairment of mortgage servicing rights.  The increase in salaries and wages wasprimarily driven by the $4.9 billion, on a comparable basis, increase inproduction during the nine months ended September 30, 2003, compared tothe same period of 2002.  Theseincreases were partially offset by declines in loan servicing expenses of$3,601, which should continue to decline as NetBank replaces externallyserviced loans with internally originated and serviced loans; and depreciationand amortization of $2,137, which contained a one-time charge of $2,469 for thewrite down of a core deposit intangible in 2002.

 

31

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# ***Retail Bank Operations***

# ** **

The table below provides an overview of the results of operations forthe retail bank segment:

 
|                                                                         |   | **RETAIL BANK OPERATIONS  Nine months ended September 30,** |      |
|------------------------------------------------------------------------------|--------|------------------------------------------------------------------|-----------|
|                                                                         |   | **2003**                                                         |      | **2002** |   | **Change** |   |
| Net interest income                                                          |   | $                                                                | 35,528    |   | $ | 17,006 |   | $ | 18,522 |   |
| Provision for credit losses                                                  |   | (4,263                                                           | )         | (26,431 | ) | 22,168 |   |
| Net interest income after provision for credit  losses                       |   | 31,265                                                           |      | (9,425 | ) | 40,690 |   |
| Gain on sale of loans                                                        |   | 26                                                               |      | 2,236 |   | (2,210 | ) |
| Service charges and fees                                                     |   | 8,854                                                            |      | 11,223 |   | (2,369 | ) |
| Total revenues                                                               |   | 40,145                                                           |      | 4,034 |   | 36,111 |   |
| Total non-interest expenses                                                  |   | 44,558                                                           |      | 53,372 |   | (8,814 | ) |
| Pre-tax income (loss) before net gain (loss) on  securities and prepaid debt |   | (4,413                                                           | )         | (49,338 | ) | 44,925 |   |
| Net gain (loss) on securities and prepaid debt                               |   | (4,873                                                           | )         | (4,163 | ) | (710 | ) |
| Pre-tax gain (loss)                                                          |   | $                                                                | (9,286    | ) | $ | (53,501 | ) | $ | 44,215 |   |
|                                                                         |   |                                                             |      |   |   |   |   |
| Earning assets                                                               |   | $                                                                | 3,738,264 |   | $ | 2,580,570 |   | $ | 1,157,694 |   |
|                                                                         |   |                                                             |      |   |   |   |   |
| Net interest income to earning assets                                        |   | 1.27                                                             | %         | 0.88 | % | 0.39 | % |
| Net interest income after provision to earning  assets                       |   | 1.12                                                             | %         | (0.49 | )% | 1.61 | % |
| Service charges and fees to earning assets                                   |   | 0.32                                                             | %         | 0.58 | % | (0.26 | )% |
| Expenses to earning assets                                                   |   | 1.59                                                             | %         | 2.76 | % | (1.17 | )% |

 

Net interest income increased$18,522 for the nine months ended September 30, 2003, to $35,528, comparedto $17,006 for the nine months ended September 30, 2002.  Net interest income for the 2002 period wasnegatively impacted by approximately $12,500 related to the impairment ofpremiums on purchased loan pools that had experienced accelerated prepaymentsin early 2002.  Net interest income forthe 2003 period is lower than would be expected due to the retail bank lendinga large portion of its funds at warehouse rates to the mortgage bankingoperations to support its record production levels.  As the retail bank reallocates its portfolio to include morelong-term investments, primarily single-family first mortgage loans, as opposedto providing relatively lower rate short-term warehouse lines of credit, itsinterest income should significantly improve. The 2002 provision for creditlosses included $20,100 of provision specifically for the CMC leaseportfolio.  See Part II. Item 1. LegalProceedings within this report for a more in depth discussion of the CMC leaseportfolio and associated litigation.  Whilenon-interest expenses declined $8,814 period over period, the 2002 period includedapproximately $7,494 of charges associated with the integration of Resource’sleasing operations and the repositioning of the segment to align with theCompany’s financial intermediary strategy. The 2003 period includes $1,760 of expenses associated with the leasingoperations, which would not have been included in the 2002 period.  Adjusted for these two items, non-interestexpenses declined by $3,080 period over period.  This decline is primarily due to a decrease of $4,186 in externalloan servicing fees and a decline of $1,535 in customer service expenses.  These declines were offset in part byincreases of $1,101 in salaries and benefits and $1,185 in data processing.

 

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*Mortgage Banking*

 

The following table highlightsthe mortgage banking segment production and sales activities:

 
|                                     |   | **Mortgage banking segment********Nine months ended September 30,** |       |
|------------------------------------------|--------|--------------------------------------------------------------------------|------------|
|                                     |   | **2003**                                                                 |       | **2002** |   | **Change** |   |
| **Mortgage loan production:**            |   |                                                                     |       |   |   |   |   |
| Retail                                   |   | $                                                                        | 2,484,502  |   | $ | 1,636,097 |   | $ | 848,405 |   |
| Correspondent                            |   | 7,074,378                                                                |       | 2,978,448 |   | 4,095,930 |   |
| Wholesale/broker                         |   | 3,926,407                                                                |       | 1,398,825 |   | 2,527,582 |   |
| RMS                                      |   | 599,915                                                                  |       | 103,402 |   | 496,513 |   |
| Total agency-eligible                    |   | 14,085,202                                                               |       | 6,116,772 |   | 7,968,430 |   |
| Nonconforming                            |   | 1,555,274                                                                |       | 908,113 |   | 647,161 |   |
| Total                                    |   | $                                                                        | 15,640,476 |   | $ | 7,024,885 |   | $ | 8,615,591 |   |
|                                     |   |                                                                     |       |   |   |   |   |
| **Mortgage loan sales:**                 |   |                                                                     |       |   |   |   |   |
| Conforming or agency-eligible sales      |   | $                                                                        | 13,039,254 |   | $ | 5,976,100 |   | $ | 7,063,154 |   |
| Non-conforming sales                     |   | 1,320,210                                                                |       | 973,465 |   | 346,745 |   |
| Mortgage banking sales                   |   | 14,359,464                                                               |       | 6,949,565 |   | 7,409,899 |   |
| Sold to retail bank                      |   | (1,023,180                                                               | )          | (12,115 | ) | (1,011,065 | ) |
| Sales to third parties                   |   | $                                                                        | 13,336,284 |   | $ | 6,937,450 |   | $ | 6,398,834 |   |
|                                     |   |                                                                     |       |   |   |   |   |
| Production revenues                      |   | $                                                                        | 284,873    |   | $ | 117,927 |   | $ | 166,946 |   |
| Production expenses                      |   | 199,702                                                                  |       | 98,377 |   | 101,325 |   |
| Pre-tax margin                           |   | $                                                                        | 85,171     |   | $ | 19,550 |   | $ | 65,621 |   |
|                                     |   |                                                                     |       |   |   |   |   |
| Production revenues in bps to sales      |   | 198                                                                      |       | 170 |   | 28 |   |
| Production expenses in bps to production |   | 128                                                                      |       | 140 |   | (12 | ) |
| Net production margin in bps             |   | 70                                                                       |       | 30 |   | 40 |   |

 

For the nine months endedSeptember 30, 2003, the mortgage banking segment had a record pre-taxmargin of $85,171, compared to $19,550 for the nine months endedSeptember 30, 2002.  The $65,621increase is driven primarily by increases of $8.6 billion in production and$6.4 billion in sales and the addition of Resource’s mortgage operations onMarch 31, 2002, which would only be included in six of the nine monthsduring the 2002 period.  Additionally,as industry pipelines approached capacity during the 2003 period, pricingpressures eased resulting in a 28 basis-point increase in production revenues.

 

*Other Segment*

 

For the nine months endedSeptember 30, 2003, the other segment recorded a pre-tax loss of $7,321compared to a pre-tax loss of $10,868 for the same period of 2002.  The loss includes NetBank’s strategicinitiatives and holding company expenses, including Dealer Financial Services,NetInsurance, NetBank, Inc., Resource Bancshares Mortgage Group, Inc. and NetBankPartners.  The 2002 loss included chargesassociated with the acquisition of Resource on March 31, 2002.

 

33

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###### **CriticalAccounting Policies**

###### ** **

As indicated in NetBank’s Annual Report on Form 10-K for the year endedDecember 31, 2002, NetBank has identified its policies for the valuationof its mortgage servicing rights and the maintenance of its allowance forcredit losses and repurchase reserves as being its most critical accountingpolicies. These policies require management to make judgments, estimates andassumptions concerning future events, which materially underpin the currentperiod accounting for these items. Given the effect such judgments, estimatesand assumptions can have on NetBank’s balance sheet and statement of operationsthese policies are regularly reviewed by management, the Company’s auditcommittee and the Company’s independent auditor.  Management believes that given current information, itsjudgments, estimates and assumptions used in these policies areappropriate.  For further informationregarding NetBank’s critical accounting policies, refer to its Annual Report onForm 10-K for the year ended December 31, 2002.

 

# **Liquidityand Capital Resources**

# ** **

*Liquidity. *NetBank’sliquidity, represented by cash and cash equivalents, is a product of itsoperating, investing, and financing activities.  NetBank’s primary sources of funds are deposits, borrowings,prepayments and maturities of outstanding loans, sales of loans, sales ormaturities of investment securities and other short-term investments, and fundsprovided from operations.  Whilescheduled loan payments and maturing investment securities and short-terminvestments are relatively predictable sources of funds, deposit flows and loanprepayments are greatly influenced by general interest rates, economicconditions, and competition.  NetBankcan use cash generated through the retail deposit market, its traditionalfunding source, to offset the cash utilized in investing activities.  NetBank’s available for sale securities andshort-term interest-earning assets can also be used to provide liquidity forlending and other operational requirements. For the nine months ended September 30, 2003, NetBank had negativecash flow of $67,729 compared to positive cash flow of $235,842 for the sameperiod of 2002.  The net cash out flowprimarily related to the $1.1 billion increase in loans held for sale and $0.7billion increase in loan and lease receivables.  The increase in loansheld for sale was primarily due to the $15.6 billion record level of productionin the mortgage banking segment outpacing the $13.3 billion record level ofsales into the secondary markets. The Company expects this situation to reverse once the velocity of loansales exceeds that of production.  Cashflows for the nine months ended September 30, 2002, were unusually highrelated to the accumulation of cash in anticipation of settling Resource’spre-existing lines of credit after its acquisition.  As an additional source of funds, NetBank had available underexisting lines of credit agreements $0.6 billion at September 30, 2003,(see Note 8 of the consolidated financial statements included as part of thisreport for additional details of the available lines of credit).  As of September 30, 2003, NetBank hadcommitments to fund mortgage loans of $1.4 billion, unused home equity lines ofcredit of $73,704 and commercial financing commitments of $1,063.

 

The Company uses deposits as its principalsource of funds.  For the nine monthsended September 30, 2003, deposits increased by $479,463 to $2.5 billionfrom $2.0 billion as of December 31, 2002.  NetBank’s deposit products include checking, money marketaccounts and certificates of deposit accounts. Deposit account terms vary, with the principal differences being the minimumbalance required, the time periods the funds must remain on deposit and theinterest rate.  NetBank is competitivein the types of accounts, services and ranges of interest rates offered ondeposit products.  Although marketdemand generally dictates which deposit maturities and rates will be acceptedby the public, NetBank intends to continue to promote checking, money marketand certificates of deposit to the extent possible consistent with asset andliability management goals. Additionally, NetBank increased its other borrowed funds, which includeFHLB advances, repurchase agreements and warehouse lines of credit, by $1.0billion during the nine months ended September 30, 2003.  This increase was primarily to support the$1.1 billion increase in loans held for sale as a result of record mortgageloan production.  The Company alsoraised approximately $4,382 as a result of its second trust preferredsecurities offering completed in April 2003.

 

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*Capital Resources.*  NetBank and NetBank, FSB are subject tovarious regulatory capital requirements administered by the federal bankingagencies. Failure of either company to meet minimum capital requirements caninitiate certain mandatory and possibly additional discretionary actions byregulators that, if undertaken, could have a direct material effect onNetBank’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for promptcorrective action, NetBank, FSB must meet specific capital guidelines thatinvolve quantitative measures of NetBank, FSB’s assets, liabilities, andcertain off-balance sheet items as calculated under regulatory accountingpractices. NetBank, FSB’s capital amounts and classifications are also subjectto qualitative judgments by the regulators about components, risk weightingsand other factors. In addition, under regulatory guidelines, NetBank, FSB maynot pay a dividend to NetBank, Inc. if doing so would cause NetBank, FSB to beless than adequately capitalized, as defined below. During the quarter endedSeptember 30, 2003, NetBank’s Board of Directors declared a dividend inthe amount of $.02 per share to shareholders of record on November 15,2003. The dividend will be paid on December 15, 2003.  During the nine months endedSeptember 30, 2003, NetBank repurchased 1,201,200 shares at a weightedaverage cost of $11.12, and management had authorization to repurchase up to anadditional 1,464,700 shares of its common stock through open market or privatetransactions.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require NetBank, FSB tomaintain minimum amounts and ratios as set forth in the following table.  NetBank, FSB’s regulatory agency, the Officeof Thrift Supervision (“OTS”), requires NetBank, FSB to maintain minimum ratiosof tangible capital to tangible assets of 1.5%, core capital to tangible assetsof 4.0% and total capital to risk-weighted assets of 8.0%. Additionally,NetBank, Inc., since its acquisition of Resource on March 31, 2002, has aside letter agreement with the OTS, which requires NetBank, Inc. to maintain aminimum 10% total capital to total assets and NetBank, FSB to maintain 6% corecapital and 12% total risk-based capital ratios. The 10% total capital minimumwas amended during the three months ended September 30, 2003, to allow theminimum capital held against forward sold conforming mortgages to be thegreater of 5% or $50,000 and in no event allow the total capital to totalassets to fall below 8%. As of September 30, 2003, NetBank, FSB wascategorized as Well Capitalized as indicated in the following table; however,primarily due to the $1.1 billion increase in loans held for sale, NetBank, FSBfailed to meet the 12% total risk-based capital requirement.  The Company has notified the OTS of thisdeficiency and intends to cure it as soon as possible.  The following table presents informationrelated to NetBank, FSB along with capital requirements mandated by the OTS:

 
|                                        |   | **Actual** |       | **For capital adequacy  purposes** |       | **To be categorized as Well  Capitalized under prompt********corrective action plan** |       |
|---------------------------------------------|--------|------------|------------|------------------------------------|------------|---------------------------------------------------------------------------------------|------------|
|                                        |   | **Amount** |       | **Ratio**                          | ** ** | **Amount**                                                                            | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **September 30, 2003**                 |   |       | ** ** |                               | ** ** |                                                                                  | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Total capital (to risk-weighted assets)     |   | $          | 319,530    |                               | 10.01      | %                                                                                     | $          | 255,371 |   | 8.00 | % | $ | 319,209 |   | 10.00 | % |
| Core capital (to adjusted total assets)     |   | $          | 276,009    |                               | 6.11       | %                                                                                     | $          | 180,621 |   | 4.00 | % | $ | 225,867 |   | 5.00 | % |
| Tangible capital (to adjusted total assets) |   | $          | 276,009    |                               | 6.11       | %                                                                                     | $          | 67,760 |   | 1.50 | % | N/A |   | N/A |   |
| Tier I capital (to risk-weighted assets)    |   | $          | 276,009    |                               | 8.65       | %                                                                                     | N/A        |   | N/A |   | $ | 191,451 |   | 6.00 | % |
| **December 31, 2002**                  |   |       |       |                               |       |                                                                                  |       |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)     |   | $          | 270,732    |                               | 15.42      | %                                                                                     | $          | 140,447 |   | 8.00 | % | $ | 175,572 |   | 10.00 | % |
| Core capital (to adjusted total assets)     |   | $          | 240,725    |                               | 7.47       | %                                                                                     | $          | 129,104 |   | 4.00 | % | $ | 161,128 |   | 5.00 | % |
| Tangible capital (to adjusted total assets) |   | $          | 240,725    |                               | 7.47       | %                                                                                     | $          | 48,338 |   | 1.50 | % | N/A |   | N/A |   |
| Tier I capital (to risk-weighted assets)    |   | $          | 240,725    |                               | 13.71      | %                                                                                     | N/A        |   | N/A |   | $ | 105,350 |   | 6.00 | % |

 

In addition, Market Street, RBMG, Republic and Meritage are required tomaintain minimum amounts of net worth to maintain their approved status withcertain government agencies, investors and lenders.  Failure to meet these requirements could have a material impacton the consolidated results of NetBank. Other than the side letter deficiency as described previously, atSeptember 30, 2003, all of the capital requirements placed upon NetBankand its subsidiaries were met, and there have been no subsequent events thatwould lead management to believe that continued compliance would not be met inthe future.

 

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# **Part I. Item 3:Quantitative and Qualitative Disclosures about Market Risk**

# ** **

*Interest RateSensitivity.*The Company measures interest ratesensitivity as the difference between amounts of interest–earning assets andinterest–bearing liabilities that mature, reprice, or repay within a givenperiod of time. The difference, or the interest rate sensitivity “gap,”provides an indication of the extent to which an institution’s interest ratespread will be affected by changes in interest rates. A gap is consideredpositive when the amount of interest-rate sensitive assets exceeds the amountof interest-rate sensitive liabilities and is considered negative when theamount of interest-rate sensitive liabilities exceeds the amount ofinterest-rate sensitive assets. In a rising rate environment, an institutionwith a positive gap would see an increase in net interest income, where an institutionwith a negative gap would see a decrease. During a period of falling interestrates the reverse is true. The following table sets forth the interest ratesensitivity of the Company’s assets and liabilities as of September 30,2003:

 
|                                                                       |   | **Less than  Three  Months**                 |       | **Over three  months  through one  year** |       | **Over one  year through  five years** |       | **Over five  years and  insensitive** |       | **Total** |       |
|----------------------------------------------------------------------------|--------|----------------------------------------------|------------|-------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|-----------|------------|
|                                                                       |   | **Term to Repricing, Repayment or Maturity** |       |
|                                                                       |   |                                         | ** ** |                                      | ** ** |                                   | ** ** |                                  | ** ** |      | ** ** |
| Interest-Earning Assets:                                                   |   |                                         |       |                                      |       |                                   |       |                                  |       |      |       |
| Cash and cash equivalents                                                  |   | $                                            | 24,895     |                                      | $          | —                                 |       | $                                     | —     |      | $          | — |   | $ | 24,895 |   |
| Federal funds sold                                                         |   | 18,941                                       |       | —                                    |       | —                                 |       | —                                |       | 18,941    |       |
| Investment securities                                                      |   | 5,803                                        |       | 11,444                                    |       | 18,445                                 |       | 285,216                               |       | 320,908   |       |
| Stock of Federal Home Loan Bank of Atlanta                                 |   | 68,060                                       |       | —                                    |       | —                                 |       | —                                |       | 68,060    |       |
| Loans held for sale                                                        |   | 2,632,631                                    |       | —                                    |       | —                                 |       | —                                |       | 2,632,631 |       |
| Loan and lease receivables                                                 |   | 245,129                                      |       | 349,669                                   |       | 975,772                                |       | 59,701                                |       | 1,630,271 |       |
| Total interest-earning assets                                              |   | 2,995,459                                    |       | 361,113                                   |       | 994,217                                |       | 344,917                               |       | 4,695,706 |       |
| Non interest-earning assets                                                |   | —                                       |       | —                                    |       | —                                 |       | 364,898                               |       | 364,898   |       |
| Total assets                                                               |   | $                                            | 2,995,459  |                                      | $          | 361,113                                |       | $                                     | 994,217    |      | $          | 709,815 |   | $ | 5,060,604 |   |
|                                                                       |   |                                         |       |                                      |       |                                   |       |                                  |       |      |       |
| Interest-Bearing Liabilities:                                              |   |                                         |       |                                      |       |                                   |       |                                  |       |      |       |
| Interest-bearing deposits                                                  |   | $                                            | 137,151    |                                      | $          | 1,091,090                              |       | $                                     | 809,612    |      | $          | 182,046 |   | $ | 2,219,899 |   |
| Trust preferred securities                                                 |   | 8,764                                        |       | —                                    |       | —                                 |       | —                                |       | 8,764     |       |
| Other borrowed funds                                                       |   | 1,765,065                                    |       | —                                    |       | 131,000                                |       | —                                |       | 1,896,065 |       |
| Total interest-bearing liabilities                                         |   | 1,910,980                                    |       | 1,091,090                                 |       | 940,612                                |       | 182,046                               |       | 4,124,728 |       |
| Interest-free deposits                                                     |   | —                                       |       | —                                    |       | —                                 |       | 304,486                               |       | 304,486   |       |
| Other interest-free liabilities and equity                                 |   | —                                       |       | —                                    |       | —                                 |       | 631,390                               |       | 631,390   |       |
| Total liabilities and equity                                               |   | $                                            | 1,910,980  |                                      | $          | 1,091,090                              |       | $                                     | 940,612    |      | $          | 1,117,922 |   | $ | 5,060,604 |   |
|                                                                       |   |                                         |       |                                      |       |                                   |       |                                  |       |      |       |
| Net interest rate sensitivity gap                                          |   | $                                            | 1,084,479  |                                      | $          | (729,977                               | )          | $                                     | 53,605     |      | $          | 162,871 |   | $ | 570,978 |   |
| Cumulative gap                                                             |   | $                                            | 1,084,479  |                                      | $          | 354,502                                |       | $                                     | 408,107    |      | $          | 570,978 |   | N/A |   |
| Net interest rate sensitivity gap as a percent of  interest-earning assets |   | 36.20                                        | %          | (202.15                                   | )%         | 5.39                                   | %          | 47.22                                 | %          | 12.16     | %          |
| Cumulative gap as a percent of cumulative  interest-earning assets         |   | 36.20                                        | %          | 10.56                                     | %          | 9.38                                   | %          | 12.16                                 | %          | N/A       |       |
|                                                                            |        |                                              |            |                                           |            |                                        |            |                                       |            |           |            |  |  |  |  |  |  |

 

As the table above displays, over the next 12 months $354,502 moreinterest-earning assets than interest-bearing liabilities are projected toreprice at least once, indicating an asset sensitive position. Gap analysis,however, is only one tool that management uses to measure ratesensitivity.  The interest ratesensitive position displayed above is somewhat exaggerated by the current highlevel of loans held for sale.  The Companywould

 

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expect this position to moderate over the next few quarters as sales ofloans held for sale begin to outpace production resulting in a lower balance ofinterest rate sensitive assets.

 

*Market Risk.*NetBank’s principal businesses are retail banking and the origination andpurchase of mortgage loans.  Thesebusinesses are funded by customer deposits and, to the extent necessary, otherborrowed funds. Consequently, a significant portion of NetBank’s assets andliabilities are monetary in nature and fluctuations in interest rates willaffect NetBank’s future net interest income and cash flows. This interest raterisk is NetBank’s primary market risk exposure. For the nine months endedSeptember 30, 2003, the only derivative financial instruments that NetBankentered into were associated with hedging activities related to the portfolioof mortgage loans held for sale, the pipeline of mortgage loans for which theinterest rate has been locked, the owned mortgage servicing rights portfolioand the mortgage servicing rights which NetBank intends to retain associatedwith the pipeline of mortgage loans for which the interest rate has alreadybeen locked. NetBank has no market risk-sensitive instruments held for tradingpurposes. NetBank’s exposure to market risk is reviewed on a regular basis byNetBank’s management.

 

NetBank, FSB, like other banks, measures interest rate risk based onNet Portfolio Value (“NPV”) analysis. NPV equals the present value of expected net cash flows from existingassets minus the present value of expected net cash flows from existingliabilities.  A NPV ratio is determinedby dividing NPV by the present value of assets.  The following table sets forth the estimated percentage change inNetBank, FSB’s NPV ratios as of September 30, 2003, and December 31,2002, assuming rate shocks of +300 to -100 basis points:

 

##### **Limits and current NPV ratios for NetBank,FSB**

 
| **Rate shock********(in basis points)** |   | **As of  9/30/2003** |   | **As of  12/31/2002** |   | **Minimum as of  9/30/2003** |   |
|-----------------------------------------|--------|----------------------|--------|-----------------------|--------|------------------------------|--------|
| **+300**                                |   | 6.59                 | %      | 9.60                  | %      | 4.00                         | %      |
| **+200**                                |   | 7.06                 | %      | 9.74                  | %      | 6.00                         | %      |
| **+100**                                |   | 7.55                 | %      | 9.81                  | %      | 6.00                         | %      |
| **Flat**                                |   | 7.80                 | %      | 9.31                  | %      | 6.00                         | %      |
| **–100**                           |   | 8.23                 | %      | 9.47                  | %      | 6.00                         | %      |

 

Computation of prospective effects of hypothetical rate changes isbased on many assumptions, including relative levels of market interest rates,loan prepayments and deposit decay. They should not be relied upon as indicative of actual results. Further,the computations do not contemplate certain actions management could undertakein response to changes in interest rates.

 

**PartI. Item 4:  Controls and Procedures**

 

As of the end of the period covered by this report, the Company carriedout an evaluation, under the supervision and with the participation of theCompany’s management, including the Company’s Chief Executive Officer and ChiefFinancial Executive, of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures pursuant to the Exchange Act Rule13a-15.  Based upon that evaluation, theCompany’s Chief Executive Officer and Chief Financial Executive concluded thatthe Company’s disclosure controls and procedures are effective in timelyalerting them to material information relating to the Company (including itsconsolidated subsidiaries) that is required to be in the Company’s periodicfilings with the Securities and Exchange Commission.  There have been no significant changes in the Company’s internalcontrols or, to the Company’s knowledge, in other factors that couldsignificantly affect those internal controls subsequent to the date the Companycarried out its evaluation, and there have been no corrective actions withrespect to significant deficiencies and material weaknesses.

 

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**Part II. Item 1:  Legal Proceedings**

 

Illinois Union Insurance Co. v. Commercial MoneyCenter, Inc., et al., Case No. CV-01-0685-KJD-RJJ (District Court ofNevada) and related cases now pending in *In re Commercial Money Center, Inc.Equipment Lease Litigation in the United States District Court for the NorthernDistrict of Ohio, Eastern Division, MDL Case No. 1:02-CV-16000*,the pending bankruptcy proceedings of Commercial Money Center, Inc. and Inre Commercial Money Center, Inc., Debtor (Kipperman v. NetBank, FSB),Bankruptcy No. 02-09721; In the United States Bankruptcy Court for the SouthernDistrict of California

 

As reported in previous filings, NetBank, FSB, filed a complaint inJanuary 2002 against Commercial Money Center, Inc. (“CMC”), theoriginator, seller, and subservicer of equipment leases purchased by NetBank,FSB, and Illinois Union Insurance Company (“Illinois Union”), Safeco InsuranceCompany of America (“Safeco”), and Royal Indemnity Company (“Royal,” withIllinois Union, Safeco and Royal, collectively, referred to as the “Sureties”),the insurance companies that issued surety bonds and insurance policiesguaranteeing payment of the income stream from the leases and that also servedas master servicers of the leases.  TheNetBank, FSB action alleges several claims, including claims for breach ofcontract, fraud, and bad faith, and seeks, among other things, payment underand enforcement of surety bonds and insurance policies issued by the insuranceand surety companies.  The Judicial Panel on Multi-District Litigation hasconsolidated the actions involving NetBank, FSB with more than 35 other casespending around the country involving other banks and financial institutionsthat were seeking to enforce surety bonds and insurance policies relating toleases sold by CMC.  The consolidationwill result in all pre-trial activity being held in the United States DistrictCourt for the Northern District of Ohio (the “MDL Court”).

 

As reported in previous filings, NetBank, FSB has joined with the otherclaimants in a motion for judgment on the pleadings, which motion is currentlypending before the MDL Court. Meanwhile, discovery is proceeding in the action.  The Company believes that based on the overallfacts and circumstances, the defenses asserted by the Sureties will fail as amatter of law and that NetBank, FSB will ultimately prevail on its claims.

 

Also, as reported in previous filings, on May 30, 2002, CMC filedfor bankruptcy protection in the United States Bankruptcy Court for theSouthern District of Florida.  The FloridaBankruptcy Court ordered that all collections by the servicers andsub-servicers under the leases be paid in escrow to the bankruptcy trusteepending final resolution of rights to those collections.  On September 18, 2002, that bankruptcyproceeding was transferred to the United States Bankruptcy Court for theSouthern District of California and is not part of the consolidation of casesin Ohio. On February 5, 2003, NetBank and the bankruptcy trustee (the“Trustee”) entered into a proposed settlement agreement, subject to BankruptcyCourt approval, that would have settled and resolved all of the CMC bankruptcyestate’s claims against NetBank, FSB. On February 19, 2003, the Trustee in the bankruptcy action filed amotion with the Bankruptcy Court requesting approval of the settlementagreement.  However, the Trusteesubsequently entered into a competing agreement with Royal.

 

On June 11, 2003, the California Bankruptcy Court approved anamended settlement agreement (the “Amended NetBank Agreement”) among NetBank,FSB, Lakeland Bank and the Trustee.  TheAmended NetBank Agreement resolves all claims of the Trustee with respect tothe lease payments that were guaranteed by surety bonds and insurance policiesissued by Safeco and Illinois Union, as well as all claims related to thesurety bonds and insurance policies. The Amended NetBank Agreement did not settle the Trustee’s allegedclaims relating to the lease payments that were guaranteed with surety bondsissued by Royal or its claim related to those specific bonds.  These claims are based on the Trustee’sassertion that NetBank, FSB’s interests in the leases were not properlyperfected and that Royal could avoid those interests, as well as NetBank, FSB’sinterests in the related surety bonds, under the Bankruptcy Code.  NetBank, FSB disputes these claims, butcontends that, in any event, it was the responsibility of CMC, as well as theSureties to make sure that NetBank, FSB’s interests were properly perfected.

 

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The Company believes that the approval of theAmended NetBank Agreement enhances its position in the separate proceeding nowbefore the MDL Court since the agreement resolves any conflicts previouslypresented by the Trustee’s assertion of claims relating to the Safeco andIllinois Union leases and surety bonds. NetBank, FSB intends to seek recovery against the Sureties for theamounts paid pursuant to the bankruptcy settlement.

 

In addition to approving the Amended NetBank Agreement, the CaliforniaBankruptcy Court approved a settlement agreement between the Trustee and Royal(the “Amended Royal Agreement’).  Underthe Amended Royal Agreement, Royal has agreed, among other things, to fundlitigation by the Trustee against NetBank, FSB to avoid its interests in theleases that were guaranteed by surety bonds issued by Royal, as well asNetBank, FSB’s interests in the surety bonds themselves.

 

On September 4, 2003, the Trustee filed a Complaint against NetBank,FSB as contemplated by the Amended Royal Agreement., seeking to avoid NetBank,FSB’s interest in the leases and surety bonds relating to the Royal guaranteedlease pools.  NetBank, FSB has tenderedthe Complaint to Royal with a demand for indemnification pursuant to the Salesand Servicing Agreement under which Royal acted as servicer for theleases.  NetBank, FSB intends tovigorously defend these claims and to pursue recovery from Royal for alldamages suffered and costs incurred as a result of Royal’s financing of theseclaims.

 

In addition, NetBank, FSB intends to vigorously pursue its claimsagainst the insurance companies, including any potential losses associated withthe claims brought by the Trustee against NetBank, FSB, and has sought leave tosupplement its complaint against Royal Indemnity Company to add claims relatingto Royal’s attempt to undermine NetBank, FSB’s interests in the leases andsurety bonds, including claims for breach of contract, breach of fiduciaryduty, and tortious interference with contract. At this time, we are unable to express an opinion as to the likelihoodof loss, or the amount or range of potential loss, with regard to this matter.

 

Clayton v. Commercial Money Center, Inc., Case No. BC 253169 (CA Sup,Ct., Los Angeles County)

 

On June 27, 2001, several lessees of equipment leased from CMCfiled suit in Los Angeles Superior Court against CMC and several John Doedefendants alleging that the leases violated California usury laws, theCalifornia Financial Code, and the California Unfair Business Practices Act.  The plaintiffs are seeking to rescind orreform their obligations under the leases and are seeking to recover statutorydamages and attorney’s fees.  Theplaintiffs amended their complaint to name NetBank, FSB, several other investorbanks, and several surety companies as co-defendants in the action.  After CMC filed for bankruptcy, the actionwas removed to the bankruptcy court in the Central District of California, butthe plaintiffs have subsequently agreed to withdraw their claims against CMCand were successful in their motion to remand the case back to statecourt.  NetBank, FSB intends tovigorously defend the case and to pursue recovery against Safeco InsuranceCompany, Royal Indemnity Company, and Illinois Union Insurance Company for anydamages and costs incurred in this case. At this time, we are unable to expressan opinion as to the likelihood of loss, or the amount or range of potentialloss, with regard to this matter.

 

*inter*stateNetBank v. NetBank, Inc. and NetBank, Case No. 1:01-CV-1324(JBS) (District ofNew Jersey)

 

On June 27, 2001, the Company was served with a complaint for adeclaratory judgment filed by interState NetBank in the District of New Jerseychallenging the “NETBANK®” service mark.  The Company answered andcounterclaimed for trademark infringement on July 13, 2001. Discovery was stayed pending a ruling on interState NetBank’s November 19,2001 motion for summary judgment, which claimed that “NETBANK” is generic forall banking services delivered over the Internet.  On September 22, 2002, the District Court ruled that“NETBANK” is generic but did not cancel the Company’s existing service markregistration.  The Company filed amotion for reconsideration of the District Court’s decision, which was deniedby order of the court filed on June 23, 2003.  The Court has now set a preliminary discovery schedule.  The Company intends to vigorously defendagainst interState NetBank’s challenge of the “NETBANK®” service mark and willcontinue to pursue its counterclaims for trademark infringement and unfaircompetition in the case. In addition, the Company may appeal the DistrictCourt’s decision that “NETBANK” is generic. While there is a possibility of a final adverse outcome for the Companyon one or more of its claims, at this stage of the matter, we cannot

 

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fairly determine the likelihood of a final, adverse outcome. However, in the event of a final, adverse outcome, it is unlikely that therewould be a monetary loss aside from the loss in value of the intellectualproperty rights in the NETBANK® registration.

 

**Part II. Item 2:  Changes in Securities and Use of Proceeds**

 

**None**

 

**Part II. Item 3:  Defaults Upon Senior Securities**

 

**None**

 

**Part II. Item4:  Submission of Matters to a Vote ofSecurity Holders**

** **

**None**

** **

**Part II. Item 5:  Other Information**

** **

**None**

** **

**Part II. Item 6:  Exhibits and Reports on Form 8-K**

 

(a)          Exhibits

 

31.1                           Chief Executive Officer’scertification under Section 302 of the Sarbanes-Oxley Act

 

31.2                           Chief Financial Executive’scertification under Section 302 of the Sarbanes-Oxley Act

 

32                                    Certificationspursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(b)         Reports on Form 8-K

 

i.                  NetBank filed a Current Report onForm 8-K on July 30, 2003, furnishing information to be provided bymanagement to various interested parties.

 

#### **SIGNATURE**

#### ** **

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                          | NETBANK, INC. |
|-------------------------------|---------------|
|                          |          |
|                          | By:           | /s/ Steven F. Herbert |
|                          |          | Steven F. Herbert |
|                          |          |   |
| Dated: November 12, 2003 |          | *Chief Financial Executive and  Chief Accounting Officer* |

 

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