** **

**UNITED STATES**

 

**SECURITIES AND 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 March 31,  2003** |
|----------------------------------------------------|
|                                               |
| **Commission File No. 0-22361**                    |

** **

**NETBANK, INC.**(Exact name of registrant asspecified 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 by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities ExchangeAct of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  YES ý  NO o

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined inExchange Act Rule 12b-2): YES ý  NO o

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date:

 

| **Class**                    |   | **Shares Outstanding At May 5, 2003** |
|------------------------------|--------|---------------------------------------|
| Common Stock, par value $.01 |   | 47,966,627                            |

 

 

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**NETBANK, INC.****TABLE OF CONTENTS**

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

 

2

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**Part I****.****              Item 1. FinancialStatements**

 

**NetBank, Inc.**

**Consolidated Balance Sheets**

**(unaudited and in 000’s except share amounts)**

** **
|                                                                                                            |   | **March 31,  2003** |      | **December  31,  2002** |   |
|-----------------------------------------------------------------------------------------------------------------|--------|---------------------|-----------|-------------------------|--------|
| **Assets**                                                                                                      |   |                |      |                    |   |
| Cash and cash equivalents:                                                                                      |   |                |      |                    |   |
| Cash and due from banks                                                                                         |   | $                   | 75,537    |                    | $      | 34,687 |   |
| Federal funds sold                                                                                              |   | 40,531              |      | 76,878                  |   |
| Total cash and cash equivalents                                                                                 |   | 116,068             |      | 111,565                 |   |
| Investment securities available for sale-at  fair value (amortized cost of $551,446 and $636,991, respectively) |   | 565,678             |      | 654,719                 |   |
| Stock of Federal Home Loan Bank of Atlanta  - at cost                                                           |   | 33,500              |      | 36,600                  |   |
| Loans held for sale                                                                                             |   | 1,667,638           |      | 1,514,625               |   |
| Loans and leases receivable - net of  allowance for credit losses of $41,957 and $42,576, respectively          |   | 1,019,393           |      | 892,093                 |   |
| Mortgage servicing rights - net                                                                                 |   | 105,761             |      | 88,502                  |   |
| Accrued interest receivable                                                                                     |   | 11,470              |      | 12,839                  |   |
| Furniture, equipment and capitalized  software - net                                                            |   | 49,526              |      | 46,610                  |   |
| Goodwill and other intangibles - net                                                                            |   | 44,257              |      | 41,696                  |   |
| Due from servicers and investors                                                                                |   | 54,205              |      | 70,526                  |   |
| Other assets                                                                                                    |   | 66,094              |      | 57,777                  |   |
| **Total assets**                                                                                                |   | $                   | 3,733,590 |                    | $      | 3,527,552 |   |
|                                                                                                            |   |                |      |                    |   |
| **Liabilities and Shareholders’ Equity**                                                                   |   |                |      |                    |   |
| **Liabilities:**                                                                                                |   |                |      |                    |   |
| Deposits                                                                                                        |   | $                   | 2,279,313 |                    | $      | 2,044,922 |   |
| Other borrowed funds                                                                                            |   | 838,633             |      | 882,488                 |   |
| Convertible subordinated debt                                                                                   |   | 26,169              |      | 26,126                  |   |
| Trust preferred securities                                                                                      |   | 4,382               |      | 4,382                   |   |
| Accrued interest payable                                                                                        |   | 11,187              |      | 13,266                  |   |
| Loans in process                                                                                                |   | 70,709              |      | 45,734                  |   |
| Accounts payable and accrued liabilities                                                                        |   | 96,972              |      | 109,044                 |   |
| Total liabilities                                                                                               |   | 3,327,365           |      | 3,125,962               |   |
|                                                                                                            |   |                |      |                    |   |
| Commitments and  contingencies                                                                                  |   | —              |      | —                  |   |
|                                                                                                            |   |                |      |                    |   |
| **Shareholders’ equity:**                                                                                  |   |                |      |                    |   |
| Preferred stock, no par (10,000,0000 shares  authorized; none outstanding)                                      |   | —              |      | —                  |   |
| Common stock, $.01 par (100,000,000 shares  authorized, 52,743,235 and 52,674,751 shares issued, respectively)  |   | 527                 |      | 527                     |   |
| Additional paid-in capital                                                                                      |   | 431,057             |      | 426,485                 |   |
| Retained earnings (deficit)                                                                                     |   | 7,161               |      | (2,568                  | )      |
| Accumulated other comprehensive income, net  of taxes of $5,373 and $6,702, respectively                        |   | 8,859               |      | 11,026                  |   |
| Treasury stock, at cost (4,737,738 and  4,024,193 shares, respectively)                                         |   | (41,379             | )         | (33,880                 | )      |
| Total shareholders’ equity                                                                                 |   | 406,225             |      | 401,590                 |   |
| **Total liabilities and shareholders’ equity**                                                             |   | $                   | 3,733,590 |                    | $      | 3,527,552 |   |

 

See notes to consolidatedfinancial statements.

 

3

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**NetBank, Inc.**

**Consolidated Statements of Operations**

**(unaudited and in 000’s except per shareamounts)**

 
|                                                                   |   | **Three  months ended March 31,** |   |
|------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                   |   | **2003**                          |   | **2002** |   |
| **Interest income:**                                                   |   |                              |   |   |   |
| Loans and leases                                                       |   | $                                 | 38,261 |   | $ | 27,562 |   |
| Investment securities                                                  |   | 6,609                             |   | 8,403 |   |
| Short-term investments                                                 |   | 132                               |   | 813 |   |
| Total interest income                                                  |   | 45,002                            |   | 36,778 |   |
|                                                                   |   |                              |   |   |   |
| **Interest expense:**                                                  |   |                              |   |   |   |
| Deposits                                                               |   | 12,446                            |   | 13,774 |   |
| Other borrowed funds                                                   |   | 9,053                             |   | 10,661 |   |
| Total interest expense                                                 |   | 21,499                            |   | 24,435 |   |
| Net interest income                                                    |   | 23,503                            |   | 12,343 |   |
| Provision for credit losses                                            |   | 868                               |   | 104 |   |
| Net interest income after provision for  credit losses                 |   | 22,635                            |   | 12,239 |   |
|                                                                   |   |                              |   |   |   |
| **Non-interest income:**                                               |   |                              |   |   |   |
| Service charges and fees                                               |   | 11,326                            |   | 3,385 |   |
| Gains on sales of mortgage loans and  mortgage servicing rights        |   | 48,923                            |   | 5,673 |   |
| Gain (loss) on sales of securities                                     |   | 6,332                             |   | (85 | ) |
| Other income                                                           |   | 2,563                             |   | — |   |
| Total non-interest income                                              |   | 69,144                            |   | 8,973 |   |
|                                                                   |   |                              |   |   |   |
| **Non-interest expense:**                                              |   |                              |   |   |   |
| Salaries and benefits                                                  |   | 29,810                            |   | 5,630 |   |
| Customer service                                                       |   | 2,771                             |   | 3,238 |   |
| Loan servicing                                                         |   | 606                               |   | 2,043 |   |
| Marketing                                                              |   | 2,074                             |   | 1,567 |   |
| Data processing                                                        |   | 4,150                             |   | 2,366 |   |
| Depreciation and amortization                                          |   | 3,536                             |   | 1,915 |   |
| Impairment and amortization of mortgage  servicing rights              |   | 9,801                             |   | — |   |
| Office expenses                                                        |   | 2,723                             |   | 661 |   |
| Occupancy                                                              |   | 4,313                             |   | 970 |   |
| Travel and entertainment                                               |   | 852                               |   | 142 |   |
| Professional fees                                                      |   | 2,887                             |   | 440 |   |
| Other expenses                                                         |   | 5,309                             |   | 638 |   |
| Prepayment penalties on the early  extinguishment of debt              |   | 5,976                             |   | — |   |
| Acquisition and severance costs                                        |   | —                            |   | 10,085 |   |
| Total non-interest expense                                             |   | 74,808                            |   | 29,695 |   |
| Income (loss) before income taxes                                      |   | 16,971                            |   | (8,483 | ) |
| Income tax (expense) benefit                                           |   | (6,269                            | )      | 2,845 |   |
| Net income (loss)                                                      |   | $                                 | 10,702 |   | $ | (5,638 | ) |
|                                                                   |   |                              |   |   |   |
| Net income (loss) per common and potential  common shares outstanding: |   |                              |   |   |   |
| Basic                                                                  |   | $                                 | 0.22   |   | $ | (0.19 | ) |
| Diluted                                                                |   | $                                 | 0.22   |   | $ | (0.19 | ) |
|                                                                   |   |                              |   |   |   |
| Weighted average common and potential  common shares outstanding:      |   |                              |   |   |   |
| Basic                                                                  |   | 48,324                            |   | 29,239 |   |
| Diluted                                                                |   | 48,762                            |   | 29,239 |   |
|                                                                   |   |                              |   |   |   |
| Dividends declared on common stock                                     |   | $                                 | 0.02   |   | $ | — |   |

 

See notes to consolidated financialstatements.

 

4

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**NetBank,Inc.**

**ConsolidatedStatements of Shareholders’ Equity**

**(unauditedand in 000’s except share amounts)**

 
|                                                                 |   | **Common  shares** |   | **Common  stock** |   | **Additional  paid-in  capital** |   | **Retained  (deficit)  earnings** |   | **Accumulated  other  comprehensive  income** |   | **Treasury  stock** |   | **Total** |   |
|----------------------------------------------------------------------|--------|--------------------|--------|-------------------|--------|----------------------------------|--------|-----------------------------------|--------|-----------------------------------------------|--------|---------------------|--------|-----------|--------|
| Balance - January 1, 2003                                            |   | 52,675             |   | $                 | 527    |                             | $      | 426,485                           |   | $                                             | (2,568 | )                   | $      | 11,026    |   | $ | (33,880 | ) | $ | 401,590 |   |
| Comprehensive income:                                                |   |               |   |              |   |                             |   |                              |   |                                          |   |                |   |      |   |
| Net income                                                           |   | —             |   | —            |   | —                           |   | 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    | )      |
| Exercise of stock options                                            |   | 68                 |   | —            |   | 4,575                            |   | —                            |   | —                                        |   | —              |   | 4,575     |   |
| Balance - March 31, 2003                                             |   | 52,743             |   | $                 | 527    |                             | $      | 431,057                           |   | $                                             | 7,161  |                | $      | 8,859     |   | $ | (41,379 | ) | $ | 406,225 |   |

 
|                                                                                               |   | **Common  shares** |   | **Common  stock** |   | **Additional  paid-in  capital** |   | **Retained  earnings** |   | **Accumulated  other  comprehensive  loss** |   | **Treasury  stock** |   | **Total** |   |
|----------------------------------------------------------------------------------------------------|--------|--------------------|--------|-------------------|--------|----------------------------------|--------|------------------------|--------|---------------------------------------------|--------|---------------------|--------|-----------|--------|
| Balance – January 1, 2002                                                                     |   | 31,751             |   | $                 | 318    |                             | $      | 267,004                |   | $                                           | 13,289 |                | $      | (3,648    | )      | $ | (21,509 | ) | $ | 255,454 |   |
| Comprehensive income:                                                                              |   |               |   |              |   |                             |   |                   |   |                                        |   |                |   |      |   |
| Net loss                                                                                           |   | —             |   | —            |   | —                           |   | (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   |   |
| Exercise of stock options                                                                          |   | —             |   | —            |   | 3                                |   | —                 |   | —                                      |   | —              |   | 3         |   |
| Balance - March 31, 2002                                                                           |   | 51,468             |   | $                 | 515    |                             | $      | 422,372                |   | $                                           | 7,651  |                | $      | (3,671    | )      | $ | (21,467 | ) | $ | 405,400 |   |

 

See notes to consolidatedfinancial statements.

 

5

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**NetBank, Inc.**

**ConsolidatedStatements of Cash Flows**

**(unaudited and in000’s except share amounts)**

 
|                                                                                                |   | **Three  months ended March 31,** |    |
|-----------------------------------------------------------------------------------------------------|--------|-----------------------------------|---------|
|                                                                                                |   | **2003**                          |    | **2002** |   |
| Operating activities:                                                                               |   |                              |    |   |   |
| Net income (loss)                                                                                   |   | $                                 | 10,702  |   | $ | (5,638 | ) |
| Adjustments to reconcile net income (loss)  to net cash (used in) provided by operating activities: |   |                              |    |   |   |
| Depreciation and amortization                                                                       |   | 3,536                             |    | 1,915 |   |
| Amortization of premiums on loan and lease  receivables                                             |   | 543                               |    | 12,368 |   |
| Net amortization (accretion) of premiums  (discounts) on investment securities                      |   | 1,592                             |    | (426 | ) |
| Origination of loans held for sale                                                                  |   | (4,357,423                        | )       | (499,674 | ) |
| Proceeds from sales of loans held for sale                                                          |   | 4,252,301                         |    | 552,166 |   |
| Net gain on sales of mortgage loans and  servicing rights                                           |   | (48,923                           | )       | (5,673 | ) |
| Capitalization of mortgage servicing rights                                                         |   | (50,201                           | )       | (8,908 | ) |
| Proceeds from sale of mortgage servicing  rights                                                    |   | 22,795                            |    | 9,465 |   |
| Impairment and amortization of mortgage  servicing rights                                           |   | 9,801                             |    | — |   |
| Provision for credit losses                                                                         |   | 868                               |    | 104 |   |
| Changes in assets and liabilities which  provide (use) cash:                                        |   |                              |    |   |   |
| Decrease in accrued interest receivable                                                             |   | 1,369                             |    | 3,062 |   |
| Decrease in other assets, due from  servicers, and intangibles                                      |   | 5,443                             |    | 4,554 |   |
| (Decrease) increase in accrued interest  payable                                                    |   | (2,079                            | )       | 249 |   |
| (Decrease) increase in accounts payable and  accrued liabilities                                    |   | (12,072                           | )       | 15,063 |   |
| Increase in loans in process                                                                        |   | 24,975                            |    | 8,833 |   |
| Net cash (used in) provided by operating  activities                                                |   | (136,773                          | )       | 87,460 |   |
|                                                                                                |   |                              |    |   |   |
| Investing activities:                                                                               |   |                              |    |   |   |
| Purchases of available for sale securities                                                          |   | (50,508                           | )       | (490,189 | ) |
| Principal repayments on available for sale  investment securities                                   |   | 19,973                            |    | 42,671 |   |
| Sales and maturities of available for sale  investment securities                                   |   | 122,149                           |    | 536,332 |   |
| (Gain) loss on sales of available for sale  investment securities                                   |   | (6,332                            | )       | 85 |   |
| Sale of Federal Home Loan Bank Stock                                                                |   | 3,100                             |    | 15,914 |   |
| Origination and purchases of loans and  leases                                                      |   | (241,872                          | )       | (177,047 | ) |
| Principal repayments on loans and leases                                                            |   | 114,582                           |    | 166,297 |   |
| Purchases of furniture, fixtures, and  equipment                                                    |   | (6,452                            | )       | (1,379 | ) |
| Net cash acquired in business combination                                                           |   | —                            |    | 29,762 |   |
| Net cash (used in) provided by investing  activities                                                |   | (45,360                           | )       | 122,446 |   |
|                                                                                                |   |                              |    |   |   |
| Financing activities:                                                                               |   |                              |    |   |   |
| Increase in money market and checking  accounts                                                     |   | 289,145                           |    | 143,436 |   |
| (Decrease) increase in certificates of  deposits                                                    |   | (54,754                           | )       | 95,185 |   |
| Proceeds from other borrowed funds                                                                  |   | 1,642,598                         |    | — |   |
| Repayments of other borrowed funds                                                                  |   | (1,686,453                        | )       | (232,785 | ) |
| Exercise of stock options                                                                           |   | 4,575                             |    | — |   |
| Net (purchase) issuance of treasury stock                                                           |   | (7,646                            | )       | 42 |   |
| Net proceeds from the issuance of common  stock                                                     |   | 144                               |    | 4 |   |
| Dividend payments on common stock                                                                   |   | (973                              | )       | — |   |
| Net cash provided by financing activities                                                           |   | 186,636                           |    | 5,882 |   |
| Net increase in cash and cash equivalents                                                           |   | 4,503                             |    | 215,788 |   |
| Cash and cash equivalents:                                                                          |   |                              |    |   |   |
| Cash, beginning of period                                                                           |   | 111,565                           |    | 22,347 |   |
| Cash, end of period                                                                                 |   | $                                 | 116,068 |   | $ | 238,135 |   |
|                                                                                                |   |                              |    |   |   |
| Supplemental disclosures of cash flow  information:                                                 |   |                              |    |   |   |
| Cash paid during the period for interest                                                            |   | $                                 | 23,578  |   | $ | 24,186 |   |
| Cash paid during the period for income  taxes                                                       |   | $                                 | 1,734   |   | $ | 950 |   |
|                                                                                                |   |                              |    |   |   |
| Non-cash investing and financing  activities:                                                       |   |                              |    |   |   |
| Fair value of assets acquired                                                                       |   | $                                 | —  |   | $ | 1,074,621 |   |
| Liabilities assumed                                                                                 |   | —                            |    | (919,930 | ) |
| Stock issued in transaction                                                                         |   | —                            |    | (154,691 | ) |
| Cash paid for business                                                                              |   | $                                 | —  |   | $ | — |   |

 

See notes to consolidated financialstatements.

 

6

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**NETBANK,INC.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**March31, 2003**

 

**1.**                                      ORGANIZATION AND BASIS OF PRESENTATION

 

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 nonconforming 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 owns all of the outstanding stock of MarketStreet Mortgage Corporation (“Market Street”), a retail mortgage company, andResource Bancshares Mortgage Group, Inc. (“Resource”). Resource wholly ownsRBMG, Inc. (“RBMG”), a wholesale mortgage banking company, and Republic LeasingCompany, Inc. (“Republic Leasing”), a small ticket financing company.

 

NetBank, Inc. acquired Resourceon March 31, 2002, and subsequently reorganized the holding company structureas described above based on operational, licensing and funding needs. NetBank,Inc. acquired Market Street on June 29, 2001 and subsequently donated MarketStreet to NetBank, FSB. Accordingly, the financial impact of Resource andMarket Street are included from the dates of acquisition. The entireconsolidated company is referred to herein as “NetBank” or  “the Company”.

 

In theopinion of management, the unaudited consolidated financial statements includedherein reflect all adjustments, consisting only of normal recurring accruals,which are necessary for the fair presentation of the financial condition andresults of operations for the interim periods presented. Certain informationand footnote disclosures normally included in financial statements have beencondensed or omitted pursuant to applicable rules and regulations of theSecurities and Exchange Commission (“SEC”). The financial statements includedherein should be read in conjunction with the financial statements and notesthereto, included in NetBank’s Form 10-K filed with the SEC for the yearended December 31, 2002. The results of operations for the interim periodsreported herein are not necessarily indicative of results to be expected forthe full year. Certain 2002 amounts have been reclassified for comparabilitywith 2003 amounts.

 

All dollar figures arepresented in thousands (000s) except per share data unless otherwise noted.

** **

**2.**                                      ACQUISITIONS

 

On March 31, 2002, NetBank consummated its acquisition of Resourcepursuant to an Agreement and Plan of Merger dated November 18, 2001. Inthe merger, NetBank issued 1.1382 shares of NetBank common stock in exchangefor each outstanding share of Resource common stock, equivalent to 19.7 millionshares of common stock plus cash in lieu of fractional shares. The transactionwas accounted for as a purchase and a total of $20.6 million of goodwill wasrecorded.

 

On June 29, 2001, NetBank, Inc.acquired all of the outstanding stock of Market Street pursuant to an agreementdated April 15, 2001, and amended as of June 29, 2001, among NetBank, NetInterim, Inc., Republic Bank, Republic Bancorp, Inc. and certain shareholdersof Market Street. The consideration paid consisted of 1,689,000 shares ofNetBank common stock valued at $8.96 per share and cash of $6.1 million. Theacquisition was accounted for as a purchase, and approximately $20.1 million ingoodwill, including transaction costs, was recorded.

 

Pro-forma unaudited financialinformation assuming Resource was included in the results of operations for thethree  months ended March 31, 2002follows:

 
| Net interest income                                             |   | $ | 25,447 |   |
|-----------------------------------------------------------------|--------|---|--------|--------|
| Net loss                                                        |   | $ | (6,406 | )      |
| Basic loss per share                                            |   | $ | (0.13  | )      |
| Diluted loss per share and common  equivalent share outstanding |   | $ | (0.13  | )      |

** **

**7**

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**3.**                                      ACCOUNTING POLICIES

 

Reference is made to theaccounting policies of NetBank described in the notes to financial statementscontained in NetBank’s Form 10-K for the year ended December 31,2002. The Company has followed those policies in preparing this report.

* *

*SignificantEstimates.*In preparing the financial statements,management is required to make estimates based on available information thatcan affect the reported amounts of assets, liabilities and disclosures as ofthe balance sheet dates and revenues and expenses for the relatedperiods.  Such estimates relate principally to the Company’s allowance forforeclosure losses and repurchased loans, the allowance for credit losses, andthe unamortized premiums on loans and leases held for investment. Additionally, estimates concerning the fair values of mortgage loans held-for-sale,lease receivables, interest rate lock commitments, servicing rights, servicinghedges and the Company’s other hedging instruments are all relevant to ensuringthat leases and mortgage loans are carried at the lower of cost or market, thatinterest rate locks are carried at market, and that potential impairments ofservicing rights are recognized if required.  Because of the inherentuncertainties associated with any estimation process and due to possible futurechanges in the market and economic conditions that will affect fair values, itis possible that actual future results and realization of the underlying assetsand liabilities could differ significantly from the amounts reflected as of thebalance 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-based employeecompensation cost is reflected in net income, as all options granted underthose plans had an exercise price equal to the market value of the underlyingcommon stock on the date of grant. The following table illustrates the effecton net income and earnings per share if the Company had applied the fair valuerecognition provisions of FASB Statement 123, *Accounting for Stock-BasedCompensation,*to stock-based employee compensation. 

 
|                                                                                                                                  |   | **Three months ended  March 31,** |   |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                                                  |   | **2003**                          |   | **2002** |   |
| Net income (loss), as reported                                                                                                        |   | $                                 | 10,702 |   | $ | (5,638 | ) |
| Deduct:                                                                                                                               |   |                              |   |   |   |
| Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |   | (469                              | )      | (238 | ) |
| Pro forma net income (loss)                                                                                                           |   | $                                 | 10,233 |   | $ | (5,876 | ) |
|                                                                                                                                  |   |                              |   |   |   |
| Earnings (loss) per share:                                                                                                            |   |                              |   |   |   |
| Basic – as reported                                                                                                              |   | $                                 | 0.22   |   | $ | (0.19 | ) |
| Basic – pro forma                                                                                                                |   | $                                 | 0.21   |   | $ | (0.20 | ) |
|                                                                                                                                  |   |                              |   |   |   |
| Diluted – as reported                                                                                                            |   | $                                 | 0.22   |   | $ | (0.19 | ) |
| Diluted – pro forma                                                                                                              |   | $                                 | 0.21   |   | $ | (0.20 | ) |

** **

**4.**                                      NEW ACCOUNTING PRONOUNCEMENTS

 

In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”),“Guarantors Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others”, to clarify accounting anddisclosure requirements relating to a guarantor’s issuance of certain types ofguarantees.  FIN 45 requires entities todisclose additional information about certain guarantees, or groups of similarguarantees, even if the likelihood of the guarantor’s having to make anypayments under the guarantee is remote. The disclosure provisions are effective for financial statements forfiscal years ended after December 15, 2002. For certain guarantees, the interpretation also requires that guarantorsrecognize a liability equal to the fair value of the guarantee upon itsissuance.  This initial recognition andmeasurement provision is to be applied only on a prospective basis toguarantees issued or modified after December 31, 2002.  During the three months ended March 31,2003, NetBank recorded a charge of $287 as a lower of 

 

8

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cost or market adjustment associated with the establishment of reservesfor potential future losses based on current loan sales in accordance with thisnew interpretation.

** **

**5.**                                      LOAN AND LEASE RECEIVABLES

 

Prior to its acquisition ofResource, NetBank’s primary loan investment strategy was to purchase pools ofloans from other financial institutions. Generally the selling institutionsretained the servicing for such loan purchases. However, since its acquisitionsof Market Street and Resource, NetBank has discontinued purchasing pools ofloans from other financial institutions and selectively retains a portion ofits originated loans for investment purposes. Additionally, NetBank retains primarily all of the small ticketequipment leases it originates. At March 31, 2003 and December 31, 2002 theCompany had net unamortized premiums on its loans and leases of $24,612 and$23,547, respectively.

 

The Company did not purchaseany pools of loans or leases from outside financials institutions during thethree months ended March 31, 2003. The following table displays the purchasedloan and lease pools for the three months ended March 31, 2002:

 
| **Types of Loans Purchased** |   | **Principal  Amount** |    | **Premium  Amount** |   | **Average  interest rate  of pool(s)** |   |
|------------------------------|--------|-----------------------|---------|---------------------|--------|----------------------------------------|--------|
| First Mortgages              |   | $                     | 18,770  |                | $      | (64                                    | )      | 6.24 | % |
| Second mortgages             |   | 11,393                |    | (198                | )      | 8.34-8.54                              | %      |
| Leases                       |   | 152,582               |    | —              |   | 7.00                                   | %      |
| Total                        |   | $                     | 182,745 |                | $      | (262                                   | )      |   |   |

 

The following is a summary ofNetBank’s loan and lease receivables portfolio:

 
|                             |   | **As of  March 31, 2003** |      | **As of  December 31, 2002** |   |
|----------------------------------|--------|---------------------------|-----------|------------------------------|--------|
|                             |   | **Amount**                |      | **%**                        |   | **Amount** |   | **%** |   |
| Residential mortgages            |   | $                         | 678,703   |                         | 63.9   | % | $ | 545,120 |   | 58.3 | % |
| Leases                           |   | 309,962                   |      | 29.2                         | %      | 305,276 |   | 32.7 | % |
| Home equity lines                |   | 70,336                    |      | 6.6                          | %      | 82,051 |   | 8.8 | % |
| Consumer                         |   | 2,161                     |      | 0.3                          | %      | 2,025 |   | 0.2 | % |
| Construction                     |   | 185                       |      | 0.0                          | %      | 188 |   | 0.0 | % |
| Auto                             |   | 3                         |      | 0.0                          | %      | 9 |   | 0.0 | % |
| Total                            |   | 1,061,350                 |      | 100.0                        | %      | 934,669 |   | 100.0 | % |
| Less allowance for credit losses |   | (41,957                   | )         |                         |   | (42,576 | ) |   |   |
| Total                            |   | $                         | 1,019,393 |                         |   |   | $ | 892,093 |   |   |   |

 

9

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**6.**                                      ALLOWANCE FOR CREDIT LOSSES

 

The following is a summary ofthe allowance for credit losses:

 
|                                                                                  |   | **Quarter ended March 31** |   |
|---------------------------------------------------------------------------------------|--------|----------------------------|--------|
|                                                                                  |   | **2003**                   |   | **2002** |   |
| Beginning balance                                                                     |   | $                          | 42,576 |   | $ | 22,865 |   |
| Allowance recorded in connection with the purchase of loan pools                      |   | —                     |   | 7,162 |   |
| Provision for credit losses                                                           |   | 868                        |   | 104 |   |
| Allowance aquired in connection with acquisition of Resource                          |   | —                     |   | 1,828 |   |
| Allowance transferred to held for sale                                                |   | —                     |   | (3,270 | ) |
| Charge-offs, net of recoveries:                                                       |   |                       |   |   |   |
| Residential mortgages                                                                 |   | (256                       | )      | (460 | ) |
| Leases                                                                                |   | (928                       | )      | (386 | ) |
| Home equity lines                                                                     |   | (285                       | )      | (28 | ) |
| Consumer                                                                              |   | (18                        | )      | (65 | ) |
| Auto                                                                                  |   | —                     |   | (10 | ) |
| Total charge-offs, net of recoveries                                                  |   | (1,487                     | )      | (949 | ) |
| Ending balance                                                                        |   | $                          | 41,957 |   | $ | 27,740 |   |
|                                                                                  |   |                       |   |   |   |
| Allowance for credit losses as a percent of average total loan and  lease receivables |   | 4.2                        | %      | 1.8 | % |

 

NetBank considers a loan or lease to be impaired when it is probablethat it will be unable to collect all amounts due according to the originalterms of the loan or lease agreement. NetBank measures impairment of a loan orlease on a loan-by-loan or lease-by-lease basis.  Amounts of impaired loans that are not probable of collection arecharged-off immediately. NetBank had $2,824 and $3,485 real estate ownedresulting from foreclosures at March 31, 2003, and December 31, 2002,respectively. NetBank had $4,469 and $4,988 loans that were restructured as ofMarch 31, 2003, and December 31, 2002, respectively. NetBank’s other realestate owned consists almost entirely of residential properties as a result offoreclosures.

 

The following tables detailNetBank’s loan and lease portfolio:

 
|                       |   | **March 31,  2003** |       |
|----------------------------|--------|---------------------|------------|
|                       |   | **Gross UPB**       |       | **Allowance** |   | **Non-  performing  assets (1)** |   | **Allowance  /   NPA** |   |
|                       |   |                | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Residential mortgages      |   | $                   | 678,703    |   | $ | 10,333 |   | $ | 1,326 |   | 779 | % |
| Leases                     |   | 309,962             |       | 30,271 |   | 84,914 |   | 36 | % |
| Home equity lines          |   | 70,336              |       | 1,119 |   | 411 |   | 272 | % |
| Consumer                   |   | 2,161               |       | 234 |   | 8 |   | 2925 | % |
| Construction               |   | 185                 |       | — |   | — |   | — |   |
| Auto                       |   | 3                   |       | — |   | — |   | — |   |
| Loan and lease receivables |   | $                   | 1,061,350  |   | $ | 41,957 |   | $ | 86,659 |   | 48 | % |

 

10

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|                       |   | **December  31, 2002** |       |
|----------------------------|--------|------------------------|------------|
|                       |   | **Gross UPB**          |       | **Allowance** |   | **Non-  performing   assets (1)** |   | **Allowance  /   NPA** |   |
|                       |   |                   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| Residential mortgages      |   | $                      | 545,120    |   | $ | 10,464 |   | $ | 1,851 |   | 565 | % |
| Leases                     |   | 305,276                |       | 30,237 |   | 85,174 |   | 36 | % |
| Home equity lines          |   | 82,051                 |       | 1,659 |   | — |   | — |   |
| Consumer                   |   | 2,025                  |       | 216 |   | — |   | — |   |
| Construction               |   | 188                    |       | — |   | — |   | — |   |
| Auto                       |   | 9                      |       | — |   | — |   | — |   |
| Loan and lease receivables |   | $                      | 934,669    |   | $ | 42,576 |   | $ | 87,025 |   | 49 | % |

 

----

(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 $18,927 and $30,443 of non-performing loansclassified as held for sale as of March 31, 2003, and December 31, 2002,respectively. Since loans classified as held for sale are carried at the lowerof cost or market the estimated losses that may occur would have already beenrecorded in both the balance sheet and statement of operations.

** **

**7.**                                      FAIR VALUE AND IMPAIRMENT OF MORTGAGE SERVICING RIGHTS

 

For purposes of evaluating itsmortgage servicing rights portfolio for impairment, the Company disaggregatesits servicing portfolio into two primary segments: available for sale and heldfor sale.

 

The segment of the portfoliodesignated as available for sale is composed of servicing rights that werepurchased in bulk transactions or that were retained out of production pursuantto individual portfolio retention decisions. As of March 31, 2003, the Companyis retaining the majority of its conventional mortgage servicing rights.  The available for sale portfolio isdisaggregated for purposes of measuring potential impairments according todefined risk tranches. The Company has defined its risk tranches based uponinterest rate band and product type. With respect to each such risk tranche,the fair value thereof, which is based upon an internal analysis that considerscurrent market conditions, prevailing interest rates, prepayment speeds,default rates and other relevant factors, is compared to amortized carryingvalues of the mortgage servicing rights for purposes of measuring potentialimpairment. The Company uses Constant Maturity Swap rate (CMS) floors, ConstantMaturity Treasury rate (CMT) floors and corridors, interest rate swapcontracts, interest rate caps and forward purchase contracts on FNMA mortgagebacked securities (FNMA TBA) to protect itself against interest rate andprepayment risk on its available for sale portfolio.

 

The segment of the portfoliodesignated as held for sale is composed of recently produced mortgage servicingrights that are scheduled for sale and have been allocated to specific forwardservicing sales contracts. The held for sale portfolio is disaggregated forpurposes of measuring possible impairments according to the specific forwardsales contracts to which allocated, which the Company has determined to be theappropriate approach to disaggregation by predominant risk characteristic forthis portfolio. For each such risk tranche, the fair value is based upon theallocated forward committed delivery price, which is compared to amortizedcarrying value for purposes of measuring potential impairment.

 

11

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At March 31, 2003, thefollowing amounts related to NetBank’s mortgage servicing rights portfolio:

 
|                                       |   | **Available  for   sale** |      | **Held for**

**sale** |   |
|--------------------------------------------|--------|---------------------------|-----------|------------------------|--------|
| Unpaid principal balance (“UPB”) |   | $                         | 7,666,062 |                   | $      | 391,019 |   |
| Carrying value                             |   | $                         | 99,605    |                   | $      | 6,156 |   |
| Carrying value / UPB                       |   | 1.30                      | %         | 1.57                   | %      |
| Weighted average note rate                 |   | 6.57                      | %         | 5.95                   | %      |
| Weighted average service fee               |   | 0.38                      | %         | 0.32                   | %      |
| Net basis as multiple                      |   | 3.45                      |      | 4.92                   |   |

 

The following table summarizes changes in the impairment reserve forNetBank’s available for sale mortgage servicing rights:

 
| Balance as of January 1, 2003 |   | $     | 14,429 |   |
|-------------------------------|--------|-------|--------|--------|
| Impairment expense            |   | 3,904 |   |
| Balance as of March 31, 2003  |   | $     | 18,333 |   |

** **

**8.**                                      DEPOSITS

 

The following table setsforth the dollar amount of deposits and weighted average interest rates in thevarious types of deposit programs offered by the Company:

 
|                                   |   | **As of  March 31, 2003** |      | **As of  December 31, 2002** |   |
|----------------------------------------|--------|---------------------------|-----------|------------------------------|--------|
| **($s in 000s)**                       |   | **Amount**                |      | **Percentage**               |   | **Weighted  average  interest  rate** |   | **Amount** |   | **Percentage** |   | **Weighted  average  interest  rate** |   |
| Non-interest bearing checking accounts |   | $                         | 293,375   |                         | 12.9   | % | N/A |   | $ | 227,490 |   | 11.1 | % | N/A |   |
| Interest bearing:                      |   |                      |      |                         |   |   |   |   |   |   |   |   |   |
| Checking accounts                      |   | 187,330                   |      | 8.2                          | %      | 1.6 | % | 163,938 |   | 8.0 | % | 1.6 | % |
| Money market                           |   | 1,011,741                 |      | 44.4                         | %      | 2.2 | % | 811,873 |   | 39.7 | % | 2.3 | % |
| Certificate of deposit under $100,000  |   | 670,221                   |      | 29.4                         | %      | 3.2 | % | 720,399 |   | 35.2 | % | 3.4 | % |
| Certificate of deposit over $100,000   |   | 116,646                   |      | 5.1                          | %      | 3.2 | % | 121,222 |   | 6.0 | % | 3.4 | % |
| Total deposits                         |   | $                         | 2,279,313 |                         | 100.0  | % |   |   | $ | 2,044,922 |   | 100.0 | % |   |   |

 

Accrued interest as of March31, 2003, related to checking, money market and certificates of depositaccounts was $91, $727 and $7,447, respectively. Accrued interest as of December31, 2002, related to checking, money market, and certificates of depositaccounts was $71, $512 and $9,318, respectively. At March 31, 2003, andDecember 31, 2002, $586 and $641 of overdrawn deposits were classified asloans, respectively.

 

12

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**9.**                                      BORROWINGS

 

A summary of borrowings and available borrowings, grouped by year ofmaturity, as of March 31, 2003 follows:

 
| **Type of borrowing**                     |   | **Year of  maturity** |   | **Range of  stated  interest rates at  March 31, 2003** |   | **Principal  amount  outstanding at  March 31, 2003** |    |
|-------------------------------------------|--------|-----------------------|--------|---------------------------------------------------------|--------|-------------------------------------------------------|---------|
| $ 100 million warehouse  line of credit   |   | 2003                  |   | 2.55                                                    | %*     | $                                                     | —  |   |
| $ 250 million master repurchase  facility |   | 2003                  |   | 2.60                                                    | %*     | 66,996                                                |    |
| $ 200 million master repurchase  facility |   | 2003                  |   | 2.59                                                    | %*     | 38,440                                                |    |
| $ 625 million FHLB warehouse line         |   | 2003                  |   | DRC + 0.50                                              | %*     | —                                                |    |
| FHLB advances                             |   | 2003                  |   | 2.50-2.83                                               | %      | 180,000                                               |    |
| FHLB advances                             |   | 2004                  |   | 2.31-4.45                                               | %      | 250,000                                               |    |
| Convertible subordinated notes            |   | 2004                  |   | 4.75                                                    | %      | 26,358                                                |    |
| FHLB advances                             |   | 2005                  |   | 5.63-7.41                                               | %      | 170,000                                               |    |
| FHLB advances                             |   | 2006                  |   | 5.63                                                    | %      | 20,000                                                |    |
| FHLB advances                             |   | 2007                  |   | 7.50                                                    | %      | 25,000                                                |    |
| FHLB advances                             |   | 2009                  |   | 4.64                                                    | %      | 25,000                                                |    |
| NBI Trust I preferred securities          |   | 2032                  |   | LIBOR + 3                                               | %*     | 4,382                                                 |    |
| $ 175 million master repurchase facility  |   | N/A                   |   | 1.57                                                    | %*     | 63,197                                                |    |
| Total                                     |   |                  |   |                                                    |   | 869,373                                               |    |
| Less unamortized discount                 |   |                  |   |                                                    |   | (189                                                  | )       |
| Total debt                                |   |                  |   |                                                    |   | $                                                     | 869,184 |   |

----

* Indicates a variable rate

 

All of the Federal Home Loan Bank (“FHLB”) advances are fixed rate;however, five advances totaling $150,000 may be converted at the FHLB’s optionto adjustable rate based on the three month floating LIBOR.  The FHLBwarehouse line is a $625,000 adjustable line of credit with a floating ratebased on the daily rate credit (“DRC”) plus 50 basis points used to fundmortgages originated by Market Street and RBMG. All of the FHLB advances andthe FHLB warehouse line are secured by investment securities or mortgageloans.  At March 31, 2003 NetBank had pledged $537,817 of investmentsecurities to the FHLB as collateral for various FHLB advances.

 

Convertible Subordinated Notes(“Notes”) were originally issued for $115,000, in a public offering during theyear ended December 31, 1999.  The Notesmature on June 1, 2004 unless previously redeemed and bear interest at 4.75%payable semi-annually on June 1 and December 1 of each year beginning December1, 2000.  Holders of the Notes mayconvert any Notes or portions of the Notes into shares of NetBank’s commonstock at a conversion price of $35.67 per share, subject to adjustment.  This is equivalent to 28.0348 shares of commonstock per one thousand dollars of principal amount of the Notes.  NetBank may redeem the Notes, in whole or inpart, at any time on or after June 4, 2002, at the declining redemption priceslisted in the indenture plus accrued interest. In the event of a change of control, under certain circumstances holdersof the Notes may require NetBank to repurchase their Notes in whole or in partat a repurchase price of 100% of the principal amount plus accruedinterest.  The Notes are unsecured andare subordinated to all of NetBank’s existing and future “senior indebtedness,”as defined in the indenture governing the Notes.

 

During 2002, NetBank issued$4,382 of trust preferred securities in a private pooled transaction through anewly formed trust, NBI Trust I. The securities carry a variable rate and wereinitially priced at LIBOR plus 3.35% with a cap of 12.5% through January2008.  Interest payments and theresetting of the rate both occur on a quarterly basis. The securities arescheduled to mature in December 2032 and cannot be redeemed by NBI Trust for aminimum of five years.

 

Most of the revolving lines ofcredit, warehouse line of credit (other than the FHLB warehouse line), themaster repurchase facilities and commercial paper conduit facility are securedby mortgage loans and are subject to restrictive covenants, such as minimum networth requirements; minimum tangible net worth requirements; certain minimumfinancial ratios, all as defined in the terms of the related debt agreements;maintenance of servicer eligibility for various government agencies; a minimumbalance in the mortgage servicing rights portfolio, and certain minimumliquidity requirements.  In addition, the covenants restrict businessactivities to those related to the mortgage banking and lending business andthe servicing of mortgage loans.  NetBank was in compliance with all debtcovenants in place as of March 31, 2003.  Although management anticipatescomplying with all current debt covenants, there can be no assurance thatNetBank or its individual subsidiaries will be able to comply with all debtcovenants in the future.  Failure to comply 

 

13

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could result in the loss of therelated financing. Short-term debt outstanding to third parties reached thehighest level for the quarter in January with an average monthly balance of$334 million.

** **

**10.**                               SHAREHOLDERS’ EQUITY

 

NetBank has authorized 100,000shares of Series A Junior Participating Preferred Stock, without par value(“Series A Stock”). Each share of Series A Stock will be entitled to 1,000votes on all matters submitted to a shareholder vote.  The Series A Stock is not redeemable or convertible into anyother security. Each share of Series A Stock will have a minimum cumulative preferredquarterly dividend rate equal to the greater of $1 per share or 1,000 times theaggregate per share amount of dividends declared on common stock in the relatedquarter. In the event of liquidation, shares of Series A Stock will be entitledto a preferential liquidation payment equal to the greater of $1,000 per shareplus any accrued and unpaid dividends or 1,000 times the payment to be made pershare of common stock. No shares of Series A Stock are presently outstanding,and no shares are expected to be issued except in connection with theshareholder rights plan referred to below.

 

Effective January 20, 2000,NetBank’s Board of Directors adopted a Shareholder Rights Plan pursuant towhich all shareholders of record on February 4, 2000, received one right topurchase a fractional (1/1000th) share of a new series of preferredstock for each share of NetBank’s common stock owned on that date. These rightswill only trade with NetBank’s common stock if certain events occur. In theevent of merger of NetBank into another entity or an acquisition of 20% ofNetBank’s common stock by any person or entity, these rights, unless previouslyredeemed by NetBank, will convert into a right to acquire at a discount price,either the stock of the acquiring entity or additional share of NetBank’scommon stock. These rights will be exercisable at $150 for each 1/1000thof a share of preferred stock and will expire on February 4, 2010.  These rights are redeemable at $.01 perright at the option of NetBank.

* *

*Common Stock –*AtMarch 31, 2003, and December 31, 2002, there were 52,743,235 and 52,674,751shares of common stock issued, respectively. The 68,484 increase is the result of option exercises.

* *

*Additional Paid-in Capital –*Duringthe three months ended March 31, 2003, additional paid-in capital increased$4,575 related to the exercise of stock options which was offset in part by adecline of $3 related to the reissuance of treasury stock related to theCompany’s employee stock purchase plan.

* *

*Retained Earning –*During the three months ended March 31, 2003, retained earning increased $9,729due to net income of $10,702, partially offset by dividends of $973.

* *

*Accumulated Other Comprehensive Income(“OCI”) –*OCI declined by $2,167 during the threemonths ended March 31, 2003, related primarily to the realization of gainsassociated with the sale of certain available for sale investment securities.

* *

*Treasury Stock**–*At March 31, 2003, NetBank had 4,737,738 shares of treasury stock compared to4,024,193 shares of treasury stock at December 31, 2002. The 713,545 increasein shares is primarily due to the repurchase of 731,000 shares during the threemonths ended March 31, 2003. This increase was in part offset by the reissuanceof 17,455 treasury shares relating to the Company’s employee stock purchaseplan.

* *

*Dividends**–*OnApril 21, 2003, NetBank’s Board of Directors declared a dividend in the amountof $.02 per share to shareholders of record on April 30, 2003. The dividendwill be paid on June 15, 2003.

** **

**11.**                               NET INCOME (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE

 

Basic and diluted net income (loss) per common and potential commonshare has been calculated based on the weighted average number of sharesoutstanding. The following schedule reconciles the numerator and denominator ofthe basic and diluted net income (loss) per common and potential common sharefor the three months ended March 31, 2003 and 2002. For the three months endedMarch 31, 2002, there is no difference in basic and diluted shares as theeffect of options outstanding to purchase common shares would be anti-dilutiveto the net loss for that period. The effect of convertible debt securitiesoutstanding has not been included in any of the periods presented because theassumed conversion of such securities would be anti-dilutive.

 

14

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|                                                             |   | **Net (loss)  income  (numerator)**   |       | **Shares  (denominator)** |       | **Per share  amount** |       |
|------------------------------------------------------------------|--------|---------------------------------------|------------|---------------------------|------------|-----------------------|------------|
|                                                             |   |                                  |       |                      |       |                  |       |
|                                                             |   | **Three months ended March 31, 2003** | ** ** |
| Basic EPS                                                        |   | $                                     | 10,702     |                      | 48,324     |                  | $          | 0.22 |   |
| Effect of  dilutive securities-options to purchase common shares |   | —                                |       | 438                       | ** ** | —                | ** ** |
| Diluted EPS                                                      |   | $                                     | 10,702     |                      | 48,762     |                  | $          | 0.22 |   |

** **
|                                                             |   | **Three months ended March 31, 2002** |   |
|------------------------------------------------------------------|--------|---------------------------------------|--------|
| Basic EPS                                                        |   | $                                     | (5,638 | ) | 29,239 |   | $ | (0.19 | ) |
| Effect of  dilutive securities-options to purchase common shares |   | —                                |   | — |   |   |   |
| Diluted EPS                                                      |   | $                                     | (5,638 | ) | 29,239 |   | $ | (0.19 | ) |

** **

**12.**                               BUSINESS SEGMENTS

 

NetBank’s principal activities include retail banking and mortgagebanking.  The retail banking segment primarily consists of offeringconsumer banking products such as checking, money market, and certificates ofdeposit and the purchase of bulk loan portfolios and securities forinvestment.  The mortgage banking segment originates mortgage loansdirectly with borrowers and purchases mortgage loans from correspondents and/orbrokers. The mortgage banking segment packages or pools such loans eitherinclusive or exclusive of servicing rights for sale into the secondary market.

 

The accompanying segment dataincludes the results of Resource commencing April 1, 2002, reflecting the date ofacquisition. The 2002 table includes the effects of certaintransactions related to the acquisition of Resource, including restructuringthe investment portfolio in anticipation of the Resource transaction andcertain compensation charges related to changes in management as a result ofthe transaction.

 

The financial information foreach business segment reflects specific identifiable transactions or allocatedtransactions based on an internal allocation method. The measurement of theperformance of the business segments is based on the management structure ofNetBank and is not necessarily comparable with similar information from anyother financial institution. The information presented is also not necessarilyindicative of the segment’s operations if they were independent entities.

 
|                          |   | **For the  three months ended March 31, 2003** |      |
|-------------------------------|--------|------------------------------------------------|-----------|
|                          |   | **Retail  Banking**                            |      | **Mortgage  Banking** |   | **Other** |   | **Eliminations** |   | **Consolidated** |   |
| Interest income               |   | $                                              | 19,500    |   | $ | 25,495 |   | $ | — |   | $ | 7 |   | $ | 45,002 |   |
| Intersegment interest income  |   | 8,509                                          |      | — |   | 506 |   | (9,015 | ) | — |   |
| Total interest income         |   | 28,009                                         |      | 25,495 |   | 506 |   | (9,008 | ) | 45,002 |   |
| Interest expense              |   | 19,427                                         |      | 1,660 |   | 412 |   | — |   | 21,499 |   |
| Intersegment interest expense |   | 485                                            |      | 8,221 |   | 309 |   | (9,015 | ) | — |   |
| Total interest expense        |   | 19,912                                         |      | 9,881 |   | 721 |   | (9,015 | ) | 21,499 |   |
| Net interest income           |   | 8,097                                          |      | 15,614 |   | (215 | ) | 7 |   | 23,503 |   |
| Provision for credit losses   |   | 849                                            |      | 19 |   | — |   | — |   | 868 |   |
| Non-interest income           |   | 9,557                                          |      | 60,532 |   | 2 |   | (947 | ) | 69,144 |   |
| Non-interest expense          |   | 21,185                                         |      | 52,157 |   | 1,496 |   | (30 | ) | 74,808 |   |
| Income before income taxes    |   | $                                              | (4,380    | ) | $ | 23,970 |   | $ | (1,709 | ) | $ | (910 | ) | $ | 16,971 |   |
|                          |   |                                           |      |   |   |   |   |   |   |   |   |
| Total assets                  |   | $                                              | 3,498,051 |   | $ | 1,908,539 |   | $ | 578,981 |   | $ | (2,251,981 | ) | $ | 3,733,590 |   |

 

15

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|                          |   | **For the  three months ended March 31, 2002** |      |
|-------------------------------|--------|------------------------------------------------|-----------|
|                          |   | **Retail  Banking**                            |      | **Mortgage  Banking** |   | **Other** |   | **Eliminations** |   | **Consolidated** |   |
| Interest income               |   | $                                              | 32,151    |   | $ | 4,620 |   | $ | 7 |   | $ | — |   | $ | 36,778 |   |
| Intersegment interest income  |   | 1,091                                          |      | — |   | 411 |   | (1,502 | ) | — |   |
| Total interest income         |   | 33,242                                         |      | 4,620 |   | 418 |   | (1,502 | ) | 36,778 |   |
| Interest expense              |   | 23,070                                         |      | 988 |   | 377 |   | — |   | 24,435 |   |
| Intersegment interest expense |   | 411                                            |      | 1,091 |   | — |   | (1,502 | ) | — |   |
| Total interest expense        |   | 23,481                                         |      | 2,079 |   | 377 |   | (1,502 | ) | 24,435 |   |
| Net interest income           |   | 9,761                                          |      | 2,541 |   | 41 |   | — |   | 12,343 |   |
| Provision for credit losses   |   | 104                                            |      | — |   | — |   | — |   | 104 |   |
| Non-interest income           |   | 2,953                                          |      | 5,895 |   | 125 |   | — |   | 8,973 |   |
| Non-interest expense          |   | 15,654                                         |      | 4,475 |   | 9,566 |   | — |   | 29,695 |   |
| Income before income taxes    |   | $                                              | (3,044    | ) | $ | 3,961 |   | $ | (9,400 | ) | $ | — |   | $ | (8,483 | ) |
|                          |   |                                           |      |   |   |   |   |   |   |   |   |
| Total assets                  |   | $                                              | 2,712,260 |   | $ | 1,366,927 |   | $ | 425,054 |   | $ | (524,809 | ) | $ | 3,979,432 |   |

** **

**13.**                               LOSS CONTINGENCY

 

NetBank, FSB is involved in litigation with three insurance companieswho are sureties on some of NetBank, FSB’s commercial lease portfolios.NetBank, FSB has filed a claim for all principal and interest payments that arecurrently past due.  The unpaidprincipal balance and unpaid interest balance total $83,769. In accordance withthe Office of Thrift Supervision requirements, the Company maintains anallowance for losses against this portfolio of $21,228.  The entire portfolio has been placed onnon-accrual status pending outcome of the litigation.  For the three months ended March 31, 2003 the Company did notreceive and did not accrue interest of $1,539 and incurred $151 of legalexpenses related to this litigation.

# ** **

# **14.**                            GUARANTEES

 

The Company has issuedmortgage-backed securities under programs sponsored by Ginnie Mae, Freddie Macand Fannie Mae.  In connection withservicing mortgage-backed securities guaranteed by Ginnie Mae, Freddie Mac orFannie Mae, the Company advances certain principal and interest payments tosecurity holders prior to their collection from specific mortgagors.  Additionally, the Company must remit certainpayments of property taxes and insurance premiums in advance of collecting themfrom specific mortgagors and make certain payments of attorney’s fees and othercosts related to loans in foreclosure. These amounts are included in servicing advances under the captionreceivables in the accompanying consolidated balance sheets. Likewise, duringthe month that a mortgagor pays off his/her mortgage, the Company must acceptan interest payment from the borrower that is pro-rated to the date of payoffand pass 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 its valuationof the servicing assets.

** **

**In the ordinary course of business,the Company is exposed to liability under representations and warranties madeto purchasers and insurers of mortgage loans and the purchasers of servicingrights.  Under certain circumstances,the Company may be required to repurchase mortgage loans or indemnify thepurchasers of loans or servicing rights for losses if there has been a breachof representations or warranties.  Forthe three months ended March 31, 2003, NetBank repurchased $9,751 ofloans.  Repurchased loans are carried atthe lower of cost or net realizable value.** At March 31,2003, and December 31, 2002, NetBank had $15,941 and $11,893 of reservesresulting from the estimation of the net realizable value associated withrepurchased loans, respectively.

** **

**In certain sales of whole loans andsales of servicing, the Company is contractually obligated to refund to thepurchaser, certain premiums paid to the Company on the sale of loans orservicing rights if the mortgagor prepays the mortgage during a specifiedperiod of time (generally from 60 to 120 days after sale).  The Company had reserves for its estimatedobligation of $1,385 and $1,475 as of March 31, 2003, and December 31, 2002,respectively.**

** **

**16**

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** **

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

*** ***

***Some of the statements in this report are forward-lookingstatements. Forward-looking statements include statements regarding the intent,belief or current expectations of NetBank or its officers and directors and canbe identified by the use of forward-looking terms such as “may,” “will,”“should,” “believe,” “expect,” “anticipate,” “estimate,” “continue,” orcomparable terminology. The Company’s actual results could differ materiallyfrom those anticipated from the forward-looking statements, depending onvarious important factors. These factors include a possible decline in assetquality, potential difficulties in integrating the Company’s operations withthose of companies acquired, the cyclical nature of the mortgage bankingindustry generally, the evolving nature of the market for internet banking andfinancial services generally, the possible adverse effects of unexpectedchanges in the interest rate environment, and increasing competition andregulatory changes. The Company’s 2002 Form 10-K filed with the Securities andExchange Commission, contains additional details on these and other risks thatare material to operations. All forward-looking statements in this report arebased on information available as of the date this report was filed with theSEC. The Company does not undertake to update any forward-looking statementsthat may be made.***

** **

**General**

 

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 theoutstanding stock of Market Street Mortgage Corporation (“Market Street”), aretail mortgage company, and Resource Bancshares Mortgage Group, Inc.(“Resource”). Resource wholly owns RBMG, Inc. (“RBMG”), a wholesale mortgagebanking company, and Republic Leasing Company, Inc. (“Republic Leasing”), asmall ticket financing company.

 

NetBank, Inc. acquired Resourceon March 31, 2002, and subsequently reorganized the holding company structureas described above based on operational, licensing and funding needs. NetBank,Inc. acquired Market Street on June 29, 2001, and subsequently donated MarketStreet to NetBank, FSB. Accordingly, the financial impact of Resource andMarket Street are included from the dates of acquisition. The entireconsolidated company is referred to herein as “NetBank” or  “the Company”.

 

All dollar figures arepresented in thousands (000s) except per share data unless otherwise noted.

 

# **FinancialCondition**

* *

*General.*Totalassets for the three months ended March 31, 2003, increased $206,038 or 5.84%to $3.7 billion.  This increase isprimarily due to the level of production in the mortgage banking segmentoutpacing the velocity of its sales into the secondary markets resulting in a$153,013 increase in loans held for sale. Further, the Company chose to retain$215,037 of mortgage loans to replace the $87,737 of loans that ran off duringthe quarter resulting in an increase of $127,300 in loan and lease receivables.Additionally, the Company’s mortgage servicing rights portfolio increased$17,259 as the Company continued to retain primarily all of its originatedconventional mortgage servicing rights. These increases were offset in part bya reduction of $89,041 in the investment securities available for saleportfolio as the Company chose to sell certain investment securities and usethe proceeds to pay off certain fixed-rate term advances from the Federal HomeLoan Bank (“FHLB”) which will more effectively balance its interest ratesensitivity and improve the net interest margin going forward. Receivables fromservicers and investors also decreased by $16,321 as receipts from fourthquarter 2002 sales outpaced the establishment of receivables associated withcurrent quarter sales of mortgage loans.

* *

*Investment Securities.* During the three months ended March 31, 2003, the Company opportunisticallysold approximately $100,000 of its investment securities at a gain of$6,332.  NetBank used the proceeds topurchase $50,000 of new securities and to pay off certain fixed-rate term FHLBadvances.  The $6,332 gain on the salemore than offset the $5,976 of prepayment penalties incurred on the earlyextinguishments of the debt. Eliminating the yield differential

 

17

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between the investmentsecurities sold and the extinguished FHLB advances will increase net interestincome by approximately $100 per month. Should the opportunity present itself,NetBank will continue to selectively sell investment securities in order to usethe proceeds to better position its net interest margin for the benefit offuture periods.

 

The following tables set forthcertain information relating to the Company’s available for sale securities atMarch 31, 2003, and December 31, 2002:

* *
| **As of March 31, 2003**            |   | **Amortized  cost** |    | **Unrealized  gains** |   | **Unrealized  losses** |   | **Estimated  fair value** |   |
|-------------------------------------|--------|---------------------|---------|-----------------------|--------|------------------------|--------|---------------------------|--------|
| Mortgage pool securities            |   | $                   | 155,258 |                  | $      | 3,208                  |   | $                         | 2      |   | $ | 158,464 |   |
| Collateralized mortgage obligations |   | 2,374               |    | 56                    |   | —                 |   | 2,430                     |   |
| U.S. government agencies            |   | 380,621             |    | 11,678                |   | —                 |   | 392,299                   |   |
| Corporate bonds                     |   | 9,683               |    | —                |   | 963                    |   | 8,720                     |   |
| Habitat bonds and other             |   | 3,510               |    | 255                   |   | —                 |   | 3,765                     |   |
| Total                               |   | $                   | 551,446 |                  | $      | 15,197                 |   | $                         | 965    |   | $ | 565,678 |   |

* *
| **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 |   |

* *

*Loan and Lease Receivables.* NetBank is actively replacing its purchased loan and lease receivablesportfolio with internally originated loans and leases so it can capitalize oncross-selling opportunities, internally service the assets and more effectivelycontrol its credit and interest rate risk. The Company’s loan and leasereceivables grew by $127,300 for the three months ended March 31, 2003, as theCompany retained $215,037 of its originated mortgage loans to replace therunoff or sale of previously purchased loan and lease pools.

18

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*Asset Quality and Non-performing Assets.*The Company periodically reviews the performance of its loan and leasereceivables portfolio by reviewing charge-offs, delinquency statistics, andindustry statistics on a pool-by-pool basis for its purchased portfolio and anindividual basis for its originated loans and leases. If a decline in creditquality for a specific pool or individual loan or lease is noted, the Companyrecords additional allowance through a charge to the provision for creditlosses. The allowance for credit losses is maintained at a level estimated tobe adequate to provide for inherent losses in the loan and lease receivablesportfolio. 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 declined from 9.31% to 8.16% during the three months endedMarch 31, 2003.  This same measurementexcluding the CMC lease portfolio reflects a drop from 0.38% to 0.29%.

* *

*Liabilities.* Totalliabilities for the three months ended March 31, 2003, increased $201,403.  This increase was due primarily to the$234,391 increase in deposits as the Company added 9,798 new deposit customersand increased the average account balance to $10 from $9 during the threemonths ended March 31, 2003. This increase was slightly offset by the $43,855decrease in other borrowed funds related to the reduction of FHLB advances.

* *

*Deposits.* As ofMarch 31, 2003, deposits represented over 72% of total funding sources. FHLBadvances, warehouse lines of credit and repurchase agreements representedalmost 27%, and convertible subordinated debt and trust preferred securitiesrepresented less than 1%. During the three months ended March 31, 2003, NetBankwas able to further lower its cost of funds by replacing $54,754 of higher costcertificates of deposits with $289,145 of money market, checking andnon-interest bearing checking accounts. NetBank will continue to emphasizetransactional accounts as its primary long-term funding source.

 

19

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The following table sets forththe dollar amount of deposits and weighted average interest rates in thevarious types of deposit programs offered by the Company:

 
|                                   |   | **As of  March 31, 2003** |      | **As of  December 31, 2002** |   |
|----------------------------------------|--------|---------------------------|-----------|------------------------------|--------|
|                                   |   | **Amount**                |      | **Percentage**               |   | **Weighted  average  interest  rate** |   | **Amount** |   | **Percentage** |   | **Weighted  average  interest  rate** |   |
| Non-interest bearing checking accounts |   | $                         | 293,375   |                         | 12.9   | % | N/A |   | $ | 227,490 |   | 11.1 | % | N/A |   |
| Interest bearing:                      |   |                      |      |                         |   |   |   |   |   |   |   |   |   |
| Checking accounts                      |   | 187,330                   |      | 8.2                          | %      | 1.6 | % | 163,938 |   | 8.0 | % | 1.6 | % |
| Money market                           |   | 1,011,741                 |      | 44.4                         | %      | 2.2 | % | 811,873 |   | 39.7 | % | 2.3 | % |
| Certificate of deposit under $100,000  |   | 670,221                   |      | 29.4                         | %      | 3.2 | % | 720,399 |   | 35.2 | % | 3.4 | % |
| Certificate of deposit over $100,000   |   | 116,646                   |      | 5.1                          | %      | 3.2 | % | 121,222 |   | 6.0 | % | 3.4 | % |
| Total deposits                         |   | $                         | 2,279,313 |                         | 100.0  | % |   |   | $ | 2,044,922 |   | 100.0 | % |   |   |

* *

*Shareholders’ Equity.*  Total shareholders’ equity increased $4,635for the three months ended March 31, 2003. The increase is primarily due to a $9,729 increase in retained earningresulting from $10,702 of net income, offset in part by the payment ofdividends of $973. Additional paid-in capital increased by $4,572 primarilyrelated to the tax benefit of non-qualified option exercises.  These increases were partially offset by a$7,499 increase in treasury stock due to the repurchase of 731,000 shares at aweighted average cost of $10.46 per share, and a $2,167 decline in accumulatedother comprehensive income associated with realization of gains on investmentsecurities available for sale that were sold during the three months endedMarch 31, 2003.  As of April 30, 2003,the Company had authorization to repurchase up to 4 million shares of theCompany’s outstanding common stock, of which 2,131,600 shares have beenrepurchased at an average price of $9.90 per share. NetBank will continue torepurchase shares periodically in the public market or through privatetransactions.

** **

**Results of Operations – Three months ended March31, 2003 compared to the three months ended March 31, 2002**

* *

*General.* Netincome for the three months ended March 31, 2003, was $10,702 or $0.22 pershare, compared to a net loss of $5,638 or ($0.19) per share, for the sameperiod in 2002.  The $5,638 net loss in2002 included $10,085 of acquisition and severance costs related to theacquisition of Resource on March 31, 2002. Additionally, the prior period netloss does not include the operating results of Resource since its acquisitionwas not completed until March 31, 2002. The increase in net income for thethree months ended March 31, 2003, was driven by the strong performance of themortgage banking segment as it capitalized on high production and sales levelsassociated with the low interest rate environment. NetBank had mortgageproduction of $4.4 billion and sales of $4.2 billion for the three months endedMarch 31, 2003, compared to only $500 million of production and sales for thesame period of 2002.

* *

*Interest Income*. NetBank’sinterest income for the three months ended March 31, 2003, was $45,002 comparedto $36,778 for the same period in 2002. As detailed in the proceeding ratevolume variance table, NetBank lowered the average balance of its short-terminvestments, investment securities available for sale and loan and leasereceivables by $608,446 and increased the average balance of its loans held forsale by $1,333,125. This allowed the Company to earn long-term yields on agreater percentage of its interest-earning assets while effectively holdingshort-term held for sale assets. Utilization of this strategy limited NetBank’sdecline in average yield to 29 basis points compared to a 110 basis pointdecline in the average cost of funds. Interest income was negatively impacted by approximately $1,539 and$1,200 for the three months ended March 31, 2003 and 2002, respectively, as aresult of the non-accrual status of the CMC lease portfolio.  See Part II Item 1 of this report or Note 13of the consolidated financial statements included in this report for a more indepth discussion of the CMC leases and associated litigation.

* *

*Interest Expense*.Total interest expense for the three months ended March 31, 2003, was $21,499compared to $24,435 for the same period of 2002.  The $2,936 decline is primarily due to the net 110 basis-pointreduction in the average cost of funds, offset in part by the $553,584 declinein the average balance of interest-bearing liabilities. For the three monthsended March 31, 2003, there was $12,446 in interest expense on deposits(checking, money market and certificates of deposits) as compared to $13,774for the three months ended March 31, 2002.  The $1,328 net decrease ininterest

 

20

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expense on deposits was theresult of a 107 basis-point decline in the average rate paid on depositsresulting in a positive $4,171 rate variance, partially offset by the negativevolume variance of $2,844 due to increased average deposit balances of$492,236. The increase in the average balance of short-term debt reflects theincreased use of short-term debt by the mortgage banking segment to support theincreased volume of mortgage loans produced during the three months ended March31, 2003, as compared to the same period of 2002. Short-term debt includeswarehouse lines of credit and repurchase agreements entered into by RBMG andMeritage with various other lenders. The decline in long-term debt reflects theincreased use of deposits and short-term debt as opposed to more expensivelong-term FHLB advances.

* *

*Net Interest Income.*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 $23,503, or2.90% of average interest-earning assets for the three months ended March 31,2003, compared to $12,343, or 1.96% of average interest-earning assets for thethree months ended March 31, 2002.

 

The following table details the relative interest rates and averagebalances of NetBank’s interest-earning assets and interest-bearing liabilitiesfor the three months ended March 31, 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:**      |   |                                           |   |   |   |   |   |   |   |   |   |
| $                    | 37,674    |                       | $      | 199,398   |   | 1.41         | %      | 1.63                               | %      | Short-term investments                         |   | $ | 132 |   | $ | 813 |   | $ | (681 | ) | $ | (113 | ) | $ | (568 | ) |
| 653,372              |      | 667,505                    |   | 4.05      | %      | 5.04         | %      | Investment  securities (1)         |   | 6,609                                          |   | 8,403 |   | (1,794 | ) | (1,651 | ) | (143 | ) |
| 1,557,071            |      | 223,946                    |   | 6.54      | %      | 8.25         | %      | Loans held for sale (2)            |   | 25,477                                         |   | 4,620 |   | 20,857 |   | (956 | ) | 21,813 |   |
| 996,712              |      | 1,429,301                  |   | 5.13      | %      | 6.42         | %      | Loans and leases receivable (2)    |   | 12,784                                         |   | 22,942 |   | (10,158 | ) | (4,609 | ) | (5,549 | ) |
| 3,244,829            |      | 2,520,150                  |   | 5.55      | %      | 5.84         | %      | Total interest-earning assets      |   | 45,002                                         |   | 36,778 |   | 8,224 |   | (7,329 | ) | 15,553 |   |
|                 |      |                       |   |      |   |         |   |                               |   |                                           |   |   |   |   |   |   |   |   |   |
|                 |      |                       |   |      |   |         |   | **Interest-bearing  liabilities:** |   |                                           |   |   |   |   |   |   |   |   |   |
| 168,126              |      | 132,908                    |   | 1.55      | %      | 1.72         | %      | Checking accounts                  |   | 650                                            |   | 571 |   | 79 |   | (58 | ) | 137 |   |
| 906,564              |      | 587,528                    |   | 2.25      | %      | 2.66         | %      | Money market                       |   | 5,099                                          |   | 3,901 |   | 1,198 |   | (596 | ) | 1,794 |   |
| 1,011,636            |      | 873,654                    |   | 2.65      | %      | 4.26         | %      | Certificates of deposit            |   | 6,697                                          |   | 9,302 |   | (2,605 | ) | (3,518 | ) | 913 |   |
| 335,069              |      | 140,592                    |   | 2.29      | %      | 2.46         | %      | Short-term debt                    |   | 1,921                                          |   | 865 |   | 1,056 |   | (59 | ) | 1,115 |   |
| 601,178              |      | 739,997                    |   | 4.47      | %      | 5.12         | %      | Long-term debt                     |   | 6,720                                          |   | 9,468 |   | (2,748 | ) | (1,197 | ) | (1,551 | ) |
| 4,382                |      | —                     |   | 4.76      | %      | 0.00         | %      | Trust Preferred                    |   | 52                                             |   | — |   | 52 |   | — |   | 52 |   |
| 28,624               |      | 27,316                     |   | 5.03      | %      | 4.80         | %      | Convertible subordinate debt       |   | 360                                            |   | 328 |   | 32 |   | 16 |   | 16 |   |
| 3,055,579            |      | 2,501,995                  |   | 2.81      | %      | 3.91         | %      | Total interest-bearing liabilities |   | 21,499                                         |   | 24,435 |   | (2,936 | ) | (5,412 | ) | 2,476 |   |
|                 |      |                       |   |      |   |         |   |                               |   |                                           |   |   |   |   |   |   |   |   |   |
| —               |      | —                     |   | 2.74      | %      | 1.93         | %      | Net interest margin                |   | 23,503                                         |   | 12,343 |   | 11,160 |   | (1,917 | ) | 13,077 |   |
| 189,250              |      | 18,155                     |   | 0.16      | %      | 0.03         | %      | Interest free sources              |   | —                                         |   | — |   | — |   | — |   | — |   |
| $                    | 3,244,829 |                       | $      | 2,520,150 |   | 2.90         | %      | 1.96                               | %      | Net interest income to interest-earning assets |   | $ | 23,503 |   | $ | 12,343 |   | $ | 11,160 |   | $ | (1,917 | ) | $ | 13,077 |   |
|                      |           |                            |        |           |        |              |        |                                    |        |                                                |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

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

(3) Variances attributable tothe rate and volume mix are included in the volume variances

* *

*Provision for Credit Losses.* The provision for credit losses was $868 for the three months ended March 31,2003, compared to $104 for the same period of 2002.  The increase in provision expense is related primarily to theCompany’s strategy of retaining internally originated assets as opposed topurchasing pools of loans or leases.

* *

*Non-interest Income.* Non-interest income increased $60,171 to $69,144 for the three months endedMarch 31, 2003, compared to $8,973 for the three months ended March 31,2002.  Of this increase, gains on sales of mortgage loans andmortgage servicing rights accounted for $43,250, of which $38,696 isattributable to the mortgage subsidiaries from the acquisition of Resource onMarch 31, 2002, which were not included in the 2002 results.  All of the mortgage subsidiaries’ improvedresults were attributable to a lower interest rate environment resulting inhigher production and more favorable pricing conditions.  Service charges and fees increased by $7,941to $11,326 for the three months ended March 31, 2003, from $3,385 in the sameperiod of 2002. $7,826 of the increase is attributable to the addition ofResource’s mortgage servicing operations. Select investment securities weresold at a gain of $6,332 during the three months ended March 31, 2003, comparedto a loss of $85 on the sale of certain investment securities during the same 

 

21

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period in 2002. Other incomewas $2,563 for the three months ended March 31, 2003. Other income consisted of$898 of gains associated with fair value adjustments for assets accounted forunder SFAS No. 133, $599 of revenues from MG Reinsurance, $496 from Republicleasing and $570 of other miscellaneous items.

* *

*Non-interest Expense.* Non-interest expense includes all operating expenses such as salaries andbenefits, marketing and general and administrative expenses.  Non-interest expense increased by $45,113 to$74,808 for the three months ended March 31, 2003, from $29,695 for the threemonths ended March 31, 2002.  The$74,808 of non-interest expense for the three months ended March 31, 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 $29,695 of non-interest expense for the period ended March31, 2002, includes $10,085 of acquisition and severance costs associated withthe acquisition of Resource on March 31, 2002. Additionally, during the quarterended March 31, 2003, the Company incurred $5,976 of prepayment penalty fees onthe early extinguishments of $100,000 of fixed-rate FHLB advances.  Net of these items, non-interest expensesincreased by $5,238 primarily related to increased variable expenses associatedwith the 35% higher volume of retail mortgage loans produced and from expensesrelated to investments in new initiatives such as NetInsurance, dealerfinancial services and small business banking.

# *** ***

# ***Retail BankOperations***

 

The table below provides anoverview of the results of operations for the retail bank segment:

 
|                                                                                                   |   | **For the  three months ended  March 31,** |   |
|--------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|--------|
|                                                                                                   |   | **2003**                                   |   | **2002** |   | **Change** | ** ** |
| Net interest income                                                                                    |   | $                                          | 8,097  |   | $ | 9,761 |   | $ | (1,664 | ) |
| Provision for credit losses                                                                            |   | (849                                       | )      | (103 | ) | (746 | ) |
| Gains on sales of loans                                                                                |   | 183                                        |   | — |   | 183 |   |
| Service charges and fees                                                                               |   | 3,042                                      |   | 3,038 |   | 4 |   |
| Total revenues                                                                                         |   | 10,473                                     |   | 12,696 |   | (2,223 | ) |
|                                                                                                   |   |                                       |   |   |   |   |   |
| Non-interest expenses                                                                                  |   | 15,209                                     |   | 15,654 |   | (445 | ) |
| Pre-tax loss before gains on securities                                                                |   | (4,736                                     | )      | (2,958 | ) | (1,778 | ) |
| Gains (losses) on sales of securities, net  of prepayment penalties on the extinguishments of debt (1) |   | 356                                        |   | (85 | ) | 441 |   |
| Pre-tax loss                                                                                           |   | $                                          | (4,380 | ) | $ | (3,043 | ) | $ | (1,337 | ) |

----

(1)          For presentation purposes $5,976 ofprepayment penalties on the early extinguishments of debt has been deductedfrom non-interest expenses as reported in the statement of operations andoffset against the $6,332 of gains on sales of investment securities.

 

Netinterest income declined $1,664 for the three months ended March 31, 2003,compared to same period of 2002 primarily related to the $608,446 decline inthe average balance of interest-earning assets held for investment by theretail banking segment. The provision for credit losses increased $746 due tothe retention of $215,037 of originated mortgage loans during the three monthsended March 31, 2003, compared the purchase of loan and lease pools during2002. During the three months ended March 31, 2002, the Company established theappropriate allowance for credit losses by adjusting the premium on purchasedloan or lease pools. Service charges and fees remained flat period-to-period.Non-interest expenses declined $445 during the three months ended March 31,2003, compared to the same period of 2002. The three months ended March 31,2003, include $1,760 of expenses related to the acquired leasing operations ofResource which were not included in the 2002 results.  The three months ended March 31, 2002, included $729 of acquisitionand severance costs and $797 of salaries and benefit expense related to theaccelerated vesting of retirement plans. Excluding these costs, non-interestexpenses would have declined $679 primarily related to declines of $1,437 inloan servicing fees and $467 in customer service expenses, offset in part byincreases of $609 in salaries and benefits and $775 in data processingexpenses. As externally serviced purchased loan and lease receivables run offand are replaced with internally serviced originated loans and leases the loanservicing fees paid to third parties will continue to decline.  More effective customer service policies andprocedures have allowed the bank to reduce its customer service expenses by$467 primarily related to a $350 reduction in cash item lossesperiod-over-period.  Reinvestment in newproduct lines such as

 

22

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smallbusiness banking and dealer financial services primarily drove the increases of$609 in salaries and benefits and $775 in data processing expenses.

* *

*Mortgage Banking*

 

The following table highlights the mortgage banking segment productionand sales activities:

 
|                                              |   | **For the three months ended  March 31,** |      | **Change** |   |
|---------------------------------------------------|--------|-------------------------------------------|-----------|------------|--------|
|                                              |   | **2003**                                  |      | **2002**   |   |   |   |
| **Mortgage loan production:**                     |   |                                      |      |       |   |   |   |
| Retail                                            |   | $                                         | 674,649   |       | $      | 499,658 |   | $ | 174,991 |   |
| Correspondent                                     |   | 1,867,755                                 |      | —     |   | 1,867,755 |   |
| Wholesale/broker                                  |   | 1,357,119                                 |      | —     |   | 1,357,119 |   |
| Total agency-eligible                             |   | 3,899,523                                 |      | 499,658    |   | 3,399,865 |   |
| Nonconforming                                     |   | 457,900                                   |      | —     |   | 457,900 |   |
| Total                                             |   | $                                         | 4,357,423 |       | $      | 499,658 |   | $ | 3,857,765 |   |
|                                              |   |                                      |      |       |   |   |   |
| **Mortgage loan sales:**                          |   |                                      |      |       |   |   |   |
| Conforming or agency-eligible sales               |   | $                                         | 3,663,154 |       | $      | 528,008 |   | $ | 3,135,146 |   |
| Non-conforming sales                              |   | 482,362                                   |      | —     |   | 482,362 |   |
| Total                                             |   | $                                         | 4,145,516 |       | $      | 528,008 |   | $ | 3,617,508 |   |
|                                              |   |                                      |      |       |   |   |   |
| Production revenues                               |   | $                                         | 76,127    |       | $      | 8,435 |   | $ | 67,692 |   |
| Production expenses                               |   | 52,157                                    |      | 4,475      |   | 47,682 |   |
| Pre-tax profit                                    |   | $                                         | 23,970    |       | $      | 3,960 |   | $ | 20,010 |   |
|                                              |   |                                      |      |       |   |   |   |
| Production revenues in basis points to sales      |   | 184                                       |      | 160        |   | 24 |   |
| Production expenses in basis points to production |   | 120                                       |      | 90         |   | 30 |   |
| Net production margin in basis points             |   | 64                                        |      | 70         |   | (6 | ) |

 

For the three months endedMarch 31, 2003, the mortgage banking segment posted record earnings of $23,970compared to $3,960 for the same period of 2002 and $22,272 for the three monthsended December 31, 2002. The increase in earnings for the three months endedMarch 31, 2003, compared with the same period of 2002 relates primarily to theacquisition of Resource’s mortgage operations on March 31, 2002, which were notincluded in the 2002 results. The $1,698 increase over the three months endedDecember 31, 2002, is primarily attributable to a $2,105 improvement in nethedge results related to the mortgage servicing rights portfolio as the declineof mortgage rates slowed during the current period.

 

# **Liquidity and Capital Resources**

* *

*Liquidity.*NetBank’s liquidity, represented by cash and cashequivalents, is a product of its operating, investing, and financingactivities. NetBank’s primary sources of funds are deposits, borrowings,prepayments and maturities of outstanding loans, sales of loans, maturities ofinvestment securities and other short-term investments, and funds provided fromoperations. While scheduled loan payments and maturing investment securitiesand short-term investments are relatively predictable sources of funds, depositflows and loan prepayments are greatly influenced by general interest rates,economic conditions, and competition. NetBank invests excess funds in overnightdeposits and other short-term interest-earning assets. NetBank can use cashgenerated through the retail deposit market, its traditional funding source, tooffset the cash utilized in investing activities. NetBank’s available for salesecurities and short-term interest-earning assets can also be used to provideliquidity for lending and other operational requirements.  For the three months ended March 31, 2003,NetBank had positive cash flow of $4,503 compared to positive cash flow of$215,788 for the same period of 2002. Cash

 

23

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flows forthe three months ended March 31, 2002, were unusually high related to theaccumulation of cash in anticipation of settling Resource’s existing lines ofcredit after its acquisition. As an additional source of funds, NetBank hadavailable under existing lines of credit agreements $1.2 billion at March 31,2003 (see Note 9 of the consolidated financial statements included as part ofthis report for additional details of the available lines of credit).  As of March 31, 2003, NetBank had commitmentsto fund mortgage loans of $2.4 billion, unused home equity lines of credits of$81,541 and commercial financing commitments of $9,012.

 

The Company uses deposits as its principal source of funds.  For the three months ended March 31, 2003,deposits increased by $234,391 to $2.3 billion from $2.0 billion as of December31, 2002. NetBank’s deposit products include checking, money market accountsand certificates of deposit accounts. Deposit account terms vary, with theprincipal differences being the minimum balance required, the time periods thefunds must remain on deposit and the interest rate. NetBank is competitive in the types of accounts,services and ranges of interest rates offered on deposit products. Althoughmarket demand generally dictates which deposit maturities and rates will beaccepted by the public, NetBank intends to continue to promote checking, moneymarket and certificates of deposit to the extent possible consistent with assetand liability management goals.

* *

*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 guidelinesand the regulatory framework for prompt corrective action, NetBank, FSB mustmeet specific capital guidelines that involve quantitative measures of NetBank,FSB’s assets, liabilities, and certain off-balance sheet items as calculatedunder regulatory accounting practices. NetBank, FSB’s capital amounts andclassifications are also subject to qualitative judgments by the regulatorsabout components, risk weightings and other factors. In addition, underregulatory guidelines, NetBank, FSB may not pay a dividend to NetBank, Inc. ifdoing so would cause NetBank, FSB to be less than adequately capitalized, asdefined below. During the quarter ended March 31, 2003, NetBank’s Board ofDirectors declared a dividend in the amount of $.02 to shareholders of recordon April 30, 2003. The dividend will be paid on June 15, 2003. As of April 30,2003, the Company had authorization to repurchase up to 4 million shares of theCompany’s outstanding common stock, of which 2,131,600 shares have beenrepurchased at an average price of $9.90 per share.

 

Quantitativemeasures established by regulation to ensure capital adequacy require NetBank,FSB to maintain minimum amounts and ratios set forth in the following table.NetBank, FSB’s regulatory agency, the Office of Thrift Supervision (“OTS”),requires NetBank, FSB to maintain minimum ratios of tangible capital to tangibleassets of 1.5%, core capital to tangible assets of 4.0%, and total capital torisk-weighted assets of 8.0%.  As ofMarch 31, 2003, NetBank, FSB met all the capital adequacy requirements to whichit is subject.  

 
|                                     |   | **Actual** |       | **For  capital adequacy  purposes** |       | **To be  categorized as  Well Capitalized under  prompt corrective  action plan** |       |
|------------------------------------------|--------|------------|------------|-------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
|                                     |   | **Amount** | ** ** | **Ratio**                           | ** ** | **Amount**                                                                        | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **March 31, 2003**                       |   |       |       |                                |       |                                                                              |       |   |   |   |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)  |   | $          | 280,094    |                                | 12.93      | %                                                                                 | $          | 173,243 |   | 8.00 | % | $ | 216,623 |   | 10.00 | % |
| Core capital (to tangible assets)        |   | $          | 247,776    |                                | 7.13       | %                                                                                 | $          | 139,047 |   | 4.00 | % | $ | 173,756 |   | 5.00 | % |
| Tangible capital (to tangible assets)    |   | $          | 247,776    |                                | 7.13       | %                                                                                 | $          | 52,127 |   | 1.50 | % | N/A |   | N/A |   |
| Tier I capital (to risk-weighted assets) |   | $          | 247,776    |                                | 11.44      | %                                                                                 | N/A        |   | N/A |   | $ | 129,952 |   | 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 tangible assets)        |   | $          | 240,725    |                                | 7.47       | %                                                                                 | $          | 129,104 |   | 4.00 | % | $ | 161,128 |   | 5.00 | % |
| Tangible capital (to tangible 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 | % |

 

As of March 31, 2003, themost recent notification from the OTS categorized NetBank, FSB as wellcapitalized under the regulatory framework for prompt corrective action. To bewell capitalized, NetBank must maintain minimum Total risk-based, Tier Irisk-based, and Tier I leverage ratios as set forth in the table. There are noconditions or events since that notification that management believes wouldhave changed the institution’s category.

 

24

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In addition, Market Street,RBMG, Republic and Meritage are required to maintain minimum amounts of networth to maintain their approved status with certain government agencies,investors and lenders.  Failure to meetthese requirements could have a material impact on the consolidated results ofNetBank.  As of March 31, 2003, all ofthe capital requirements placed upon NetBank and its subsidiaries were met andthere have been no subsequent events that would lead management to believe thatcontinued compliance will not be met in the future.

 

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

* *

*Interest Rate Sensitivity.*The Company measures interest rate sensitivity asthe difference between amounts of interest—earning assets and interest–bearingliabilities that mature, reprice, or repay within a given period of time. Thedifference, or the interest rate sensitivity “gap,” provides an indication ofthe extent to which an institution’s interest rate spread will be affected bychanges in interest rates. A gap is considered positive when the amount ofinterest-rate sensitive assets exceeds the amount of interest-rate sensitiveliabilities and is considered negative when the amount of interest-ratesensitive liabilities exceeds the amount of interest-rate sensitive assets. Ina rising rate environment, an institution with a positive gap would see anincrease in net interest income, where an institution with a negative gap wouldsee a decrease. During a period of falling interest rates the reverse is true.The following table sets forth the interest rate sensitivity of the Company’sassets and liabilities as of March 31, 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                                                  |   | $                                             | 75,537     |                                      | $      | —                                 |   | $                                     | —    |      | $      | — |   | $ | 75,537 |   |
| Federal funds sold                                                         |   | 40,531                                        |       | —                                    |   | —                                 |   | —                                |      | 40,531    |   |
| Investment securities                                                      |   | 28,785                                        |       | 46,065                                    |   | 246,887                                |   | 243,941                               |      | 565,678   |   |
| Stock of Federal Home Loan Bank of Atlanta                                 |   | 33,500                                        |       | —                                    |   | —                                 |   | —                                |      | 33,500    |   |
| Loans held for sale                                                        |   | 1,667,638                                     |       | —                                    |   | —                                 |   | —                                |      | 1,667,638 |   |
| Loan and lease receivables                                                 |   | 199,621                                       |       | 245,022                                   |   | 494,246                                |   | 80,504                                |      | 1,019,393 |   |
| Total interest-earning assets:                                             |   | 2,045,612                                     |       | 291,087                                   |   | 741,133                                |   | 324,445                               |      | 3,402,277 |   |
| Non interest-earning assets                                                |   | —                                        |       | —                                    |   | —                                 |   | 331,313                               |      | 331,313   |   |
| Total assets                                                               |   | 2,045,612                                     |       | 291,087                                   |   | 741,133                                |   | 655,758                               |      | 3,733,590 |   |
|                                                                       |   |                                          |       |                                      |   |                                   |   |                                  |      |      |   |
| Interest-Bearing Liabilities:                                              |   |                                          |       |                                      |   |                                   |   |                                  |      |      |   |
| Interest-bearing deposits                                                  |   | 176,308                                       |       | 953,601                                   |   | 667,706                                |   | 188,323                               |      | 1,985,938 |   |
| Convertible subordinated debt                                              |   | —                                        |       | —                                    |   | 26,169                                 |   | —                                |      | 26,169    |   |
| Trust preferred securities                                                 |   | 4,382                                         |       | —                                    |   | —                                 |   | —                                |      | 4,382     |   |
| Other borrowed funds                                                       |   | 338,633                                       |       | 10,000                                    |   | 465,000                                |   | 25,000                                |      | 838,633   |   |
| Total interest-bearing liabilities:                                        |   | 519,323                                       |       | 963,601                                   |   | 1,158,875                              |   | 213,323                               |      | 2,855,122 |   |
| Interest-free deposits                                                     |   | —                                        |       | —                                    |   | —                                 |   | 293,375                               |      | 293,375   |   |
| Other interest-free liabilities and equity                                 |   | —                                        |       | —                                    |   | —                                 |   | 585,093                               |      | 585,093   |   |
| Total liabilities and equity                                               |   | $                                             | 519,323    |                                      | $      | 963,601                                |   | $                                     | 1,158,875 |      | $      | 1,091,791 |   | $ | 3,733,590 |   |
|                                                                       |   |                                          |       |                                      |   |                                   |   |                                  |      |      |   |
| Net interest rate sensitivity gap                                          |   | $                                             | 1,526,289  |                                      | $      | (672,514                               | )      | $                                     | (417,742  | )         | $      | 111,122 |   | $ | 547,155 |   |
| Cumulative gap                                                             |   | $                                             | 1,526,289  |                                      | $      | 853,775                                |   | $                                     | 436,033   |      | $      | 547,155 |   | N/A |   |
| Net interest rate sensitivity gap as a percent  of interest-earning assets |   | 74.61                                         | %          | -231.04                                   | %      | -56.37                                 | %      | 34.25                                 | %         | 16.08     | %      |
| Cumulative gap as a percent of cumulative  interest-earning assets         |   | 74.61                                         | %          | 36.54                                     | %      | 14.17                                  | %      | 16.08                                 | %         | N/A       |   |

 

25

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As the table above displays,over the next 12 months $854 million more interest-earning assets thaninterest-bearing liabilities are projected to reprice at least once, indicatingan asset sensitive position. Gap analysis, however, is only one tool thatmanagement uses to measure rate sensitivity

* *

*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 three months endedMarch 31, 2003, the only derivative financial instruments that NetBank enteredinto were associated with hedging activities related to the portfolio ofmortgage 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 on Net Portfolio Value (“NPV”) analysis.  NPV equals the present value of expected netcash flows from existing assets minus the present value of expected net cashflows from existing liabilities. A NPV ratio is determined by dividing NPV bythe present value of assets. The following table sets forth the estimatedpercentage change in NetBank, FSB’s NPV ratios as of March 31, 2003, andDecember 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  03/31/2003** |   | **As of  12/31/2002** |   | **Minimum as  of  12/31/2002** |   |
|-----------------------------------|--------|-----------------------|--------|-----------------------|--------|--------------------------------|--------|
| +300                              |   | 9.13                  | %      | 9.60                  | %      | 4.00                           | %      |
| +200                              |   | 9.40                  | %      | 9.74                  | %      | 6.00                           | %      |
| +100                              |   | 9.50                  | %      | 9.81                  | %      | 6.00                           | %      |
| Flat                              |   | 9.44                  | %      | 9.31                  | %      | 6.00                           | %      |
| -100                              |   | 9.15                  | %      | 9.47                  | %      | 6.00                           | %      |

 

Computation of prospectiveeffects of hypothetical rate changes is based on many assumptions, includingrelative levels of market interest rates, loan prepayments and deposit decay.They should not be relied upon as indicative of actual results. Further, thecomputations do not contemplate certain actions management could undertake inresponse to changes in interest rates.

** **

**Part I.****             ****Item 4:****Controls and Procedures**

 

Within 90days prior to the date of this report, the Company carried out an evaluation,under the supervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of the Company’s disclosure andcontrols and procedures pursuant to the Exchange Act Rule 13a-14.  Based upon that evaluation, the Company’sChief Executive Office and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures are effective in timely alerting them tomaterial information relating to the Company (including its consolidatedsubsidiaries) that is required to be in the Company’s periodic filings with theSecurities 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.

** **

**PartII.****          Item1:  LegalProceedings**

 

Illinois UnionInsurance Co. v. Commercial Money Center, Inc., et al., Case No.CV-01-0685-KJD-RJJ (District Court of Nevada) andrelated cases now pending in *In re Commercial Money Center, Inc. Equipment LeaseLitigation in the United States District Court for the Northern District ofOhio, Eastern Division, MDL Case No. 1:02-CV-16000*, and thepending bankruptcy proceedings of Commercial Money Center, Inc.

 

26

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As reported in previousfilings, NetBank, FSB, filed a complaint in January 2002   against Commercial Money Center, Inc.(“CMC”), the originator, seller, and subservicer of equipment leases purchasedby NetBank, FSB, and Illinois Union Insurance Company, Safeco Insurance Companyof America, and Royal Indemnity Company (the “Sureties”), the insurancecompanies that issued surety bonds and insurance policies guaranteeing paymentof the income stream from the leases and that also served as master servicersof the leases.  The NetBank, FSB actionalleges several claims, including claims for breach of contract, fraud, and badfaith, and seeks, among other things, payment under and enforcement of suretybonds and insurance policies issued by the insurance and suretycompanies.  The Judicial Panel on Multi-District Litigation has consolidatedthe actions involving NetBank, FSB with more than 35 other cases pending aroundthe country involving other investors who were seeking to enforce surety bondsand insurance policies relating to leases sold by CMC.  The consolidation will result in allpre-trial activity being held in the United States District Court for theNorthern District of Ohio (the “MDL Court”).

 

As reported in previousfilings, NetBank, FSB has joined with the other claimants in a motion forjudgment on the pleadings currently pending before the MDL Court. The Companybelieves that based on the overall facts and circumstances, the defensesasserted by the Sureties will fail as a matter of law and that NetBank, FSBwill ultimately prevail on its claims.

 

As reported in previousfilings, on May 30, 2002, CMC filed for bankruptcy protection in the UnitedStates Bankruptcy Court for the Southern District of Florida.  The Florida Bankruptcy Court ordered thatall collections by the servicers and sub-servicers under the leases be paid inescrow to the bankruptcy trustee pending final resolution of rights to thosecollections.  On September 18, 2002,that bankruptcy proceeding was transferred to the United States BankruptcyCourt for the Southern District of California and is not part of theconsolidation of cases in Ohio. On February 5, 2003, NetBank and the bankruptcytrustee (the “Trustee”) entered into a proposed settlement agreement, subjectto Bankruptcy Court approval, that will settle and resolve all of the CMCbankruptcy estate’s claims against NetBank, FSB.  On February 19, 2003, the trustee in the bankruptcy action (the“Trustee”) filed a motion with the Bankruptcy Court requesting approval of thesettlement agreement.  The Trusteesubsequently entered into a competing agreement with Royal.  The Bankruptcy Court is expected to hold ahearing on the two agreements within the next several weeks.  The Bankruptcy Court could approve one orthe other or neither.

 

As reported in previousfilings, NetBank, FSB believes that its proposed settlement would result ingreater economic benefit and recovery to the creditors of the CMC bankruptcyestate than the proposed Royal agreement. In addition, the proposed NetBank settlement would advance public policyin favor of settlements by resolving litigation, whereas the proposed Royalagreement, contrary to public policy, would create and perpetuatelitigation.  NetBank, FSB also believesthat the Royal’s proposed settlement is not in the best interests of thecreditors.  Accordingly, NetBank, FSBintends to vigorously oppose approval of the proposed Royal agreement andrequest that the Bankruptcy Court approve the proposed NetBank settlement.  If the Bankruptcy Court neverthelessapproves the proposed Royal agreement, NetBank will vigorously defend itsinterests in any litigation with the Trustee.

 

NetBank, FSB intends tovigorously pursue its claims against the insurance companies, including anypotential losses associated with the claims brought by the Trustee againstNetBank, FSB, and will seek leave to supplement its complaint against RoyalIndemnity Company to add claims relating to Royal’s attempt to undermineNetBank, FSB’s interests in the leases and surety bonds, including claims forbreach of contract, breach of fiduciary duty, and tortious interference withcontract.  At this time, we are unableto express an opinion as to the likelihood of loss, or the amount or range ofpotential loss, with regard to this matter.

 

In reCommercial Money Center, Inc./Clayton v. Commercial Money Center, Inc., Case No02-24068 BKC RBR (Bankr. C.D. CA)

 

On June 27, 2001, severallessees of equipment leased from CMC filed suit in Los Angeles Superior Courtagainst CMC and several John Doe defendants alleging that the leases violatedCalifornia usury laws, the California Financial Code, and the California UnfairBusiness Practices Act.  The plaintiffsare seeking to rescind or reform their obligations under the leases and areseeking to recover statutory damages and attorney’s fees.  The plaintiffs amended their complaint toname NetBank, FSB, several other investor banks, and several surety companiesas co-defendants in the action.  AfterCMC filed for bankruptcy, the action was removed to the bankruptcy court in theCentral District of California, but the plaintiffs have subsequently agreed towithdraw their claims against CMC and were successful in their motion to remandthe case back to state court.  NetBank,FSB intends to vigorously defend the case and to pursue recovery against SafecoInsurance Company, Royal Indemnity Company, and Illinois Union InsuranceCompany for any damages and costs

 

27

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incurred in this case. At thistime, we are unable to express an opinion as to the likelihood of loss, or theamount or range of potential loss, 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 Companywas served with a complaint for a declaratory judgment filed by *inter*StateNetBank in the District of New Jersey challenging the “NETBANK®” servicemark.  The Company answered and counterclaimed for trademark infringementon July 13, 2001.  Discovery was stayed pending a ruling on *inter*StateNetBank’s November 19, 2001 motion for summary judgment, which claimedthat “NETBANK” is generic for all banking services delivered over the Internet.On September 22, 2002, the District Court ruled that “NETBANK” is generic butdid not cancel the Company’s existing service mark registration.   The Company filed a motion forreconsideration of the District Court’s decision and is still waiting for thejudge to issue a decision on that motion. The Company intends to vigorously defend against *inter*State NetBank’schallenge of the “NETBANK®” service mark and will pursue its counterclaims fortrademark infringement, cyberpiracy and unfair competition. While there is apossibility of an adverse outcome for the Company, at this stage of the matter,we cannot fairly determine the likelihood of an adverse outcome.  However,in the event of an adverse outcome, it is unlikely that there would be amonetary loss aside from the loss in value of the intellectual property rightsin the NETBANK® registration.

 

TheCompany has also sent numerous letters to other entities that appear to beinfringing the Company’s rights in the NETBANK® service mark andvariations of that mark.  The letters demand that the entities immediatelycease and desist from any such infringing activities.  If the entities refuse to cease the infringement,the Company intends to file additional lawsuits similar to those that havealready been filed.  Given the fact thatthe NETBANK® registration has reached incontestable status, itscancellation is unlikely.  For thisreason, future litigation to enforce trademark rights will not be reported.

** **

**Part II.****          Item2:  Changes in Securities and Use ofProceeds**

 

**None**

** **

**Part II.****          Item3:  Defaults Upon Senior Securities**

 

**None**

** **

**Part II.**          Item 4:  Submission of Matters to a Vote ofSecurity Holders

 

**None**

** **

**Part II.****          Item5:  OtherInformation**

 

**None**

** **

**Part II.****          Item6:  Exhibitsand Reports on Form 8-K**

 

(a)          Exhibits

 

99.1 –Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

(b)         Reports on Form 8-K

 
|   | i.     |   | NetBank  filed a Current Report on Form 8-K on February 20, 2003, disclosing the  proposed bankruptcy settlement agreement associated with the Commercial Money  Center, Inc. (“CMC”) lease portfolio.          |
|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                      |
|   | ii.    |   | On March 10,  2003, pursuant to Regulation FD, NetBank filed a Current Report on Form 8-K  publicly disclosing an investor slide show which was subsequently presented  to outside analysts by NetBank’s management. |

 

28

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#### **SIGNATURE**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
|                | NETBANK, INC. |
|---------------------|---------------|
|                |          |
|                | By:           | /s/ Steven F. Herbert |   |
|                |          |   |
|                |          |   |
|                |          | Steven F. Herbert |
|                |          |   |
| Dated: May 13, 2003 |          | *Chief  Financial Executive* |

 

29

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**Certification**

 

I, Douglas K. Freeman, ChiefExecutive Officer of NetBank, Inc., certify that:

 

1.                           I havereviewed this quarterly report on Form 10-Q of NetBank, Inc.;

 

2.                           Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                           Based on my knowledge, thefinancial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.                           Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b)                               evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.                           Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                               allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                              anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                           Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  | May 13, 2003 |   |                                 | /s/ Douglas  K. Freeman |   |
|-------------|--------------|--------|--------------------------------------|-------------------------|--------|
|        |         |   |                                 |
|        |         |   | Douglas K.  Freeman                  |
|        |         |   |                                 |
|        |         |   | Chairman and Chief Executive Officer |

** **

**30**

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**Certification**

 

I, Steven F. Herbert, ChiefFinancial Executive of NetBank, Inc., certify that:

 

1.                           I havereviewed this quarterly report on Form 10-Q of NetBank, Inc.;

 

2.                           Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                           Based on my knowledge, thefinancial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.                           Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b)                               evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.                           Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                               allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                              anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                           Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  | May 13, 2003 |   |                      | /s/ Steven  F. Herbert |   |
|-------------|--------------|--------|---------------------------|------------------------|--------|
|        |         |   |                      |
|        |         |   | Steven F.  Herbert        |
|        |         |   |                      |
|        |         |   | Chief Financial Executive |

 

31

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