**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 September  30, 2002**                                       |
|                                                                                         |
| **Commission File No. 0-22361**                                                              |

 

**NETBANK, INC.**

(Exact name of registrant as specified in its charter)

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

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe 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 the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date:

 

| **Class**                    |   | **Shares Outstanding At November 8, 2002** |
|------------------------------|--------|--------------------------------------------|
| Common Stock, par value $.01 |   | 49,340,884                                 |

 

 

----

 

**Part I. Item 1.**

**NETBANK, INC.**

**INDEXTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 
| **Part I. Financial  Statements**                                                                                                              |
|------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                           |
|                                                                                                                                           | Condensed  consolidated balance sheets as of September 30, 2002 and as of  December 31, 2001 | **3** |
|                                                                                                                                           |
|                                                                                                                                           | **Condensed consolidated statements of  operations for the three and nine months ended September 30, 2002 and 2001** | 4 |
|                                                                                                                                           |
|                                                                                                                                           | **Condensed consolidated statements of  shareholders’ equity from December 31, 2000 to September 30, 2001 and  December 31, 2001 to September 30,  2002** | 5 |
|                                                                                                                                           |
|                                                                                                                                           | **Condensed consolidated statements of cash flows for the nine months  ended September 30, 2002and 2001** | 6 |
|                                                                                                                                           |
|                                                                                                                                           | **Notes to condensed consolidated financial  statements** | 7 |
|                                                                                                                                           |
|                                                                                                                                           | Information required by Item 303 of  Regulation S-K |
|                                                                                                                                           |
|                                                                                                                                           | **Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations** | 14 |
|                                                                                                                                           |   |
|                                                                                                                                           | **Item  3. Quantitative and Qualitative Disclosures about Market Risk** | 27 |
|                                                                                                                                           |   |
|                                                                                                                                           | **Item  4. Controls and Procedures** | 28 |
|                                                                                                                                           |   |
| **Part  II. OTHER INFORMATION**                                                                                                                |
|                                                                                                                                           |   |
|                                                                                                                                           | **Item 1. Legal Proceedings** | 28 |
|                                                                                                                                           |   |
|                                                                                                                                           | **Item 2.  Changes in Securities** | 30 |
|                                                                                                                                           |   |
|                                                                                                                                           | **Item 3. Defaults upon senior securities** | 30 |
|                                                                                                                                           |   |
|                                                                                                                                           | **Item 4. Submission of matters to a vote of  security holders** | 30 |
|                                                                                                                                           |   |
|                                                                                                                                           | **Item  5. Other information** | 30 |
|                                                                                                                                           |   |
|                                                                                                                                           | **Item 6. Exhibits and reports on Form 8-K** | 30 |
|                                                                                                                                           |   |
| **Signature page**                                                                                                                             | 30 |
|                                                                                                                                           |   |
| **Chief executive officer certification**                                                                                                      | 31 |
|                                                                                                                                           |   |
| **Chief financial executive certification**                                                                                                    | 32 |
|                                                                                                                                           |   |
| **Exhibit 99.1 – certification  pursuant to 18 U.S.C section 1350 as adopted pursuant to section 905 of the  Sarbanes-Oxley Act of 2002** | 33 |
|                                                                                                                                                |  |  |  |

 

2

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**NETBANK, INC.CONDENSED CONSOLIDATED BALANCE SHEETS(in 000’s except share amounts)**

** **
|                                                                                                             |   | **September 30,  2002** |       | **December 31,  2001** |       |
|------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|-----------------------------|------------|
|                                                                                                             |   | **(unaudited)**         |       |                        |       |
| **ASSETS**                                                                                                       |   |                    | ** ** |                        | ** ** |
| Cash and cash  equivalents:                                                                                      |   |                    |       |                        |       |
| Cash and due  from banks                                                                                         |   | $                       | 124,984    |                        | $          | 17,562 |   |
| Federal funds  sold                                                                                              |   | 133,205                 |       | 4,785                       |       |
| Total cash and  cash equivalents                                                                                 |   | 258,189                 |       | 22,347                      |       |
| Investment  securities available for sale-at fair value (amortized cost of $660,032 and  $855,967, respectively) |   | 673,272                 |       | 850,079                     |       |
| Stock of  Federal Home Loan Bank of Atlanta-at cost                                                              |   | 33,305                  |       | 55,539                      |       |
| Mortgage loans  receivable held for sale                                                                         |   | 1,126,186               |       | 295,529                     |       |
| Commercial  loans receivable held for sale                                                                       |   | 104,034                 |       | —                      |       |
| Loans and  leases receivable-net of allowance for loan and lease losses of $47,664 and  $22,865, respectively    |   | 960,207                 |       | 1,489,521                   |       |
| Mortgage  servicing rights-net                                                                                   |   | 60,001                  |       | 2,271                       |       |
| Accrued  interest receivable                                                                                     |   | 14,722                  |       | 10,804                      |       |
| Furniture,  equipment and capitalized software-net                                                               |   | 41,823                  |       | 12,210                      |       |
| Goodwill and  other intangibles - net                                                                            |   | 41,203                  |       | 26,932                      |       |
| Due from  servicers and investors                                                                                |   | 76,930                  |       | 82,386                      |       |
| Other assets                                                                                                     |   | 88,447                  |       | 31,915                      |       |
| Total assets                                                                                                     |   | $                       | 3,478,319  |                        | $          | 2,879,533 |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                    |   |                    |       |                        |       |
|                                                                                                             |   |                    |       |                        |       |
| Liabilities:                                                                                                     |   |                    |       |                        |       |
| Deposits                                                                                                         |   | $                       | 2,059,373  |                        | $          | 1,493,819 |   |
| Other borrowed  funds                                                                                            |   | 755,076                 |       | 1,011,985                   |       |
| Convertible  subordinated debt                                                                                   |   | 27,049                  |       | 26,923                      |       |
| Accrued  interest payable                                                                                        |   | 15,974                  |       | 16,632                      |       |
| Loans in  process                                                                                                |   | 66,924                  |       | 33,632                      |       |
| Accounts  payable and accrued liabilities                                                                        |   | 157,483                 |       | 41,088                      |       |
| Total  liabilities                                                                                               |   | 3,081,879               |       | 2,624,079                   |       |
| Commitments and  contingencies                                                                                   |   | —                  |       | —                      |       |
| Shareholders’  equity:                                                                                      |   |                    |       |                        |       |
| Preferred  stock, no par (10,000,000 shares authorized, none outstanding)                                        |   | —                  |       | —                      |       |
| Common stock,  $.01 par (100,000,000 shares authorized, 52,671,337 and 31,751,369 shares  issued, respectively)  |   | 540                     |       | 318                         |       |
| Additional  paid-in capital                                                                                      |   | 426,446                 |       | 267,004                     |       |
| Retained  (deficit) earnings                                                                                     |   | (15,119                 | )          | 13,289                      |       |
| Accumulated  other comprehensive income (loss), net of tax                                                       |   | 8,244                   |       | (3,648                      | )          |
| Treasury stock, at cost (2,934,553 and  2,736,870 shares, respectively)                                          |   | (23,671                 | )          | (21,509                     | )          |
| Total  shareholders’ equity                                                                                 |   | 396,440                 |       | 255,454                     |       |
| Total  liabilities and shareholders’ equity                                                                 |   | $                       | 3,478,319  |                        | $          | 2,879,533 |   |

 

3

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**NETBANK, INC.****CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS****(unaudited and in 000's except share amounts)**
|                                                                                 |   | **Three  months ended** |   | **Nine  months ended** |   |
|--------------------------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                                 |   | **September  30,**      |   | **September  30,**     |   |
|                                                                                 |   | **2002**                |   | **2001**               |   | **2002** |   | **2001** |   |
| Interest income:                                                                     |   |                    |   |                   |   |   |   |   |   |
| Loans and leases                                                                     |   | $                       | 39,666 |                   | $      | 28,908 |   | $ | 94,608 |   | $ | 83,188 |   |
| Investment securities                                                                |   | 7,822                   |   | 9,374                  |   | 24,255 |   | 24,156 |   |
| Short–term investments                                                          |   | 479                     |   | 663                    |   | 2,121 |   | 2,120 |   |
| Total interest income                                                                |   | 47,967                  |   | 38,945                 |   | 120,984 |   | 109,464 |   |
|                                                                                 |   |                    |   |                   |   |   |   |   |   |
| Interest expense:                                                                    |   |                    |   |                   |   |   |   |   |   |
| Deposits                                                                             |   | 13,909                  |   | 15,194                 |   | 41,692 |   | 45,796 |   |
| Other borrowed funds                                                                 |   | 11,244                  |   | 10,970                 |   | 38,323 |   | 29,314 |   |
| Total interest expense                                                               |   | 25,153                  |   | 26,164                 |   | 80,015 |   | 75,110 |   |
|                                                                                 |   |                    |   |                   |   |   |   |   |   |
| Net interest income                                                                  |   | 22,814                  |   | 12,781                 |   | 40,969 |   | 34,354 |   |
| Provision for loan and lease losses                                                  |   | (95                     | )      | 83                     |   | 26,432 |   | 253 |   |
| Net interest income after provision for  losses                                      |   | 22,909                  |   | 12,698                 |   | 14,537 |   | 34,101 |   |
|                                                                                 |   |                    |   |                   |   |   |   |   |   |
| Non–interest income:                                                            |   |                    |   |                   |   |   |   |   |   |
| Service charges and fees                                                             |   | 10,601                  |   | 3,697                  |   | 26,559 |   | 7,171 |   |
| Gains on sales of mortgage loans and  servicing rights                               |   | 35,225                  |   | 4,825                  |   | 70,403 |   | 4,825 |   |
| Other income                                                                         |   | 11,369                  |   | -                      |   | 12,367 |   | - |   |
| Gains on sales of securities                                                         |   | 7,638                   |   | 1,034                  |   | 5,781 |   | 3,557 |   |
| Total non-interest income                                                            |   | 64,833                  |   | 9,556                  |   | 115,110 |   | 15,553 |   |
|                                                                                 |   |                    |   |                   |   |   |   |   |   |
| Non–interest expense:                                                           |   |                    |   |                   |   |   |   |   |   |
| Salaries and benefits                                                                |   | 28,024                  |   | 5,667                  |   | 61,707 |   | 9,837 |   |
| Customer service                                                                     |   | 3,447                   |   | 3,259                  |   | 10,220 |   | 10,329 |   |
| Loan servicing                                                                       |   | 1,155                   |   | 1,350                  |   | 5,312 |   | 4,077 |   |
| Marketing                                                                            |   | 1,454                   |   | 1,488                  |   | 4,739 |   | 4,143 |   |
| Data processing                                                                      |   | 3,453                   |   | 2,188                  |   | 9,264 |   | 5,221 |   |
| Depreciation and amortization                                                        |   | 7,424                   |   | 1,755                  |   | 15,640 |   | 4,231 |   |
| Impairment of mortgage servicing rights                                              |   | 7,173                   |   | -                      |   | 14,677 |   | - |   |
| Office expenses                                                                      |   | 2,400                   |   | 899                    |   | 6,076 |   | 1,604 |   |
| Occupancy                                                                            |   | 4,929                   |   | 986                    |   | 11,777 |   | 1,383 |   |
| Travel and entertainment                                                             |   | 872                     |   | 152                    |   | 2,042 |   | 344 |   |
| Other                                                                                |   | 6,262                   |   | 1,046                  |   | 13,293 |   | 2,477 |   |
| Prepayment penalties on the early  extinguishment of Federal Home Loan Bank advances |   | 7,451                   |   | -                      |   | 9,944 |   | - |   |
| Non-recurring acquisition & severance                                            |   | -                       |   | -                      |   | 10,085 |   | - |   |
| Total non–interest expense                                                      |   | 74,044                  |   | 18,790                 |   | 174,776 |   | 43,646 |   |
| Income (loss) before income taxes                                                    |   | 13,698                  |   | 3,464                  |   | (45,129 | ) | 6,008 |   |
| Income tax (expense) benefit                                                         |   | (5,181                  | )      | (1,316                 | )      | 16,721 |   | (2,283 | ) |
| Net income (loss)                                                               |   | $                       | 8,517  |                   | $      | 2,148 |   | $ | (28,408 | ) | $ | 3,725 |   |
| Net income (loss) per common and potential  common share outstanding:                |   |                    |   |                   |   |   |   |   |   |
| Basic                                                                                |   | $                       | 0.17   |                   | $      | 0.07 |   | $ | (0.66 | ) | $ | 0.13 |   |
| Diluted                                                                              |   | $                       | 0.17   |                   | $      | 0.07 |   | $ | (0.66 | ) | $ | 0.13 |   |
|                                                                                 |   |                    |   |                   |   |   |   |   |   |
| Weighted average common and potential  common shares outstanding:                    |   |                    |   |                   |   |   |   |   |   |
| Basic                                                                                |   | 49,778                  |   | 30,182                 |   | 42,830 |   | 29,214 |   |
| Diluted                                                                              |   | 50,141                  |   | 30,711                 |   | 42,830 |   | 29,777 |   |

 

 

4

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**NETBANK, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY(unaudited and in 000’s)**

** **
|                                                                                                        |   | **Common  shares** |   | **Common  stock  ($.01 par)** |   | **Additional  paid-in  capital** |   | **Retained  earnings** |   | **Accumulated  other  comprehensive  income  (loss)** |   | **Treasury  stock at  cost** |   | **Total** |   |
|-------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|-------------------------------|--------|----------------------------------|--------|------------------------|--------|-------------------------------------------------------|--------|------------------------------|--------|-----------|--------|
| Balance-December 31,  2000                                                                             |   | 30,013             |   | $                             | 300    |                             | $      | 251,579                |   | $                                                     | 6,688  |                         | $      | (352      | )      | $ | (7,608 | ) | $ | 250,607 |   |
| Comprehensive  income:                                                                                      |   |               |   |                          |   |                             |   |                   |   |                                                  |   |                         |   |      |   |
| Net income for  the nine months ended September 30, 2001                                                    |   | —             |   | —                        |   | —                           |   | 3,725                  |   | —                                                |   | —                       |   | 3,725     |   |
| Unrealized gain  on securities, net of taxes and reclassification adjustment                                |   | —             |   | —                        |   | —                           |   | —                 |   | 4,662                                                 |   | —                       |   | 4,662     |   |
| Comprehensive  income                                                                                       |   |               |   |                          |   |                             |   |                   |   |                                                  |   |                         |   | 8,387     |   |
| Purchase of  shares of common stock for treasury (2,317,765 shares held in treasury at  September 30, 2001) |   | —             |   | —                        |   | —                           |   | —                 |   | —                                                |   | (10,612                      | )      | (10,612   | )      |
| Issuance of  stock in conjunction with acquisition                                                          |   | 1,689              |   | 17                            |   | 15,115                           |   | —                 |   | —                                                |   | —                       |   | 15,132    |   |
| Exercise of  stock options                                                                                  |   | 49                 |   | 1                             |   | 329                              |   | —                 |   | —                                                |   | —                       |   | 330       |   |
| Balance-September  30, 2001                                                                                 |   | 31,751             |   | $                             | 318    |                             | $      | 267,023                |   | $                                                     | 10,413 |                         | $      | 4,310     |   | $ | (18,220 | ) | $ | 263,844 |   |

 
|                                                                                                            |   | **Common  shares** |   | **Common  stock  ($.01 par)** |   | **Additional  paid-in  capital** |   | **Retained  earnings/  (deficit)** |   | **Accumulated  other  comprehensive  income  (loss)** |    | **Treasury  stock at  cost** |   | **Total** |    |
|-----------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|-------------------------------|--------|----------------------------------|--------|------------------------------------|--------|-------------------------------------------------------|---------|------------------------------|--------|-----------|---------|
| Balance-December 31,  2001                                                                                 |   | 31,751             |   | $                             | 318    |                             | $      | 267,004                            |   | $                                                     | 13,289  |                         | $      | (3,648    | )       | $ | (21,509 | ) | $ | 255,454 |   |
| Comprehensive  loss:                                                                                            |   |               |   |                          |   |                             |   |                               |   |                                                  |    |                         |   |      |    |
| Net loss for  the nine months ended September 30, 2002                                                          |   | —             |   | —                        |   | —                           |   | (28,408                            | )      | —                                                |    | —                       |   | (28,408   | )  |
| Unrealized gain  on securities, net of taxes and reclassification adjustment                                    |   | —             |   | —                        |   | —                           |   | —                             |   | 11,892                                                |    | —                       |   | 11,892    |    |
| Comprehensive  loss                                                                                             |   |               |   |                          |   |                             |   |                               |   |                                                  |    |                         |   | (16,516   | )  |
| Purchase of  shares of common stock held in treasury (2,934,553 shares held in treasury at  September 30, 2002) |   | —             |   | —                        |   | —                           |   | —                             |   | —                                                |    | (2,463                       | )      | (2,463    | )       |
| Issuance of  stock in conjunction with acquisition of Resource Bancshares Mortgage Group,  Inc.                 |   | 19,717             |   | 197                           |   | 155,365                          |   | —                             |   | —                                                |    | —                       |   | 155,562   |    |
| Shares issued  or purchased under Employee Stock Purchase Plan                                                  |   | —             |   | —                        |   | 7                                |   | —                             |   | —                                                |    | 301                          |   | 308       |    |
| Exercise of  stock options                                                                                      |   | 1,203              |   | 25                            |   | 4,070                            |   | —                             |   | —                                                |    | —                       |   | 4,095     |    |
| Balance-September  30, 2002                                                                                     |   | 52,671             |   | $                             | 540    |                             | $      | 426,446                            |   | $                                                     | (15,119 | )                            | $      | 8,244     |    | $ | (23,671 | ) | $ | 396,440 |   |

 

5

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**NETBANK, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| **(unaudited and in 000’s)**                                                                    |   | **Nine months ended  September 30,** |      |
|------------------------------------------------------------------------------------------------------|--------|--------------------------------------|-----------|
|                                                                                                 |   | **2002**                             |      | **2001** |   |
| **Operating  activities:**                                                                           |   |                                 |      |   |   |
| Net (loss)  income                                                                                   |   | $                                    | (28,408   | ) | $ | 3,725 |   |
| Adjustments to  reconcile net (loss) income to net cash provided by (used in) operating  activities: |   |                                 |      |   |   |
| Depreciation  and amortization                                                                       |   | 15,640                               |      | 4,231 |   |
| Amortization of  premiums on loans receivable                                                        |   | 29,075                               |      | 11,353 |   |
| Net  amortization (accretion) of premiums (discounts) on investment securities                       |   | 223                                  |      | (3,063 | ) |
| Gain on sales  of fixed assets                                                                       |   | (2,814                               | )         | — |   |
| Origination of  mortgage loans held for sale                                                         |   | (7,024,767                           | )         | (586,049 | ) |
| Proceeds from  sales of mortgage loans held for sale                                                 |   | 7,020,666                            |      | 580,753 |   |
| Net gain on  sales of mortgage loans and servicing rights                                            |   | (70,403                              | )         | (4,825 | ) |
| Capitalization  of mortgage servicing rights                                                         |   | (84,683                              | )         | (10,512 | ) |
| Proceeds from  sales of mortgage servicing rights                                                    |   | 138,853                              |      | 11,734 |   |
| Impairment of  mortgage servicing rights                                                             |   | 14,677                               |      | — |   |
| Provision for  loan losses                                                                           |   | 26,432                               |      | 253 |   |
| Change in  assets and liabilities which provide (use) cash:                                          |   |                                 |      |   |   |
| Increase in  accrued interest receivable                                                             |   | (1,726                               | )         | (2,012 | ) |
| Decrease  (increase) in other assets, due from servicers and intangibles                             |   | 36,741                               |      | (24,263 | ) |
| (Decrease)  increase in accrued interest payable                                                     |   | (1,929                               | )         | 3,269 |   |
| Increase (decrease)  in accounts payable and accrued liabilities                                     |   | 15,704                               |      | (59,092 | ) |
| Increase in  loans in process                                                                        |   | 33,292                               |      | 55,189 |   |
| Net cash  provided by (used in) operating activities                                                 |   | 116,573                              |      | (19,309 | ) |
| **Investing  activities:**                                                                           |   |                                 |      |   |   |
| Purchase of  investment securities available for sale                                                |   | (1,758,746                           | )         | (624,721 | ) |
| Principal  repayments on investment securities available for sale                                    |   | 211,333                              |      | 75,427 |   |
| Sales and  maturities of investment securities available for sale                                    |   | 1,741,670                            |      | 221,656 |   |
| Gain on sales  of investment securities available for sale                                           |   | (5,781                               | )         | (3,557 | ) |
| Sale (purchase)  of Federal Home Loan Bank stock, net                                                |   | 22,234                               |      | (9,691 | ) |
| Origination and purchase of loans                                                                    |   | (304,769                             | )         | (688,603 | ) |
| Principal repayments on loans                                                                        |   | 696,752                              |      | 696,443 |   |
| Capital  expenditures                                                                                |   | (5,803                               | )         | (5,273 | ) |
| Net cash  acquired in business combination                                                           |   | 29,762                               |      | 9,595 |   |
| Net cash  provided by (used in) investing activities                                                 |   | 626,652                              |      | (328,724 | ) |
| **Financing  activities:**                                                                           |   |                                 |      |   |   |
| Increase in  deposits                                                                                |   | 565,554                              |      | 361,788 |   |
| Proceeds from  borrowed funds                                                                        |   | 5,805,577                            |      | 441,460 |   |
| Repayments of  borrowed funds                                                                        |   | (6,880,454                           | )         | (415,300 | ) |
| Exercise of  stock options                                                                           |   | 4,095                                |      | 330 |   |
| Shares issued  under employee stock purchase plan                                                    |   | 308                                  |      | — |   |
| Net purchase of  treasury stock                                                                      |   | (2,463                               | )         | (10,612 | ) |
| Net cash (used  in) provided by financing activities                                                 |   | (507,383                             | )         | 377,666 |   |
| Net increase in  cash                                                                                |   | 235,842                              |      | 29,633 |   |
| Cash at  beginning of period                                                                         |   | 22,347                               |      | 11,958 |   |
| Cash at end of  period                                                                               |   | $                                    | 258,189   |   | $ | 41,591 |   |
|                                                                                                 |   |                                 |      |   |   |
| Supplemental  disclosures of cash flow information:                                                  |   |                                 |      |   |   |
| Cash paid  during the period for interest                                                            |   | $                                    | 80,673    |   | $ | 71,841 |   |
| Cash paid  during the period for income taxes                                                        |   | $                                    | 1,034     |   | $ | 1,460 |   |
|                                                                                                 |   |                                 |      |   |   |
| Non-cash  investing and financing activities:                                                        |   |                                 |      |   |   |
| Fair value of  assets acquired                                                                       |   | $                                    | 1,075,492 |   | $ | 267,124 |   |
| Liabilities  assumed                                                                                 |   | (919,930                             | )         | (247,157 | ) |
| Stock issued in  transaction                                                                         |   | (155,562                             | )         | (15,132 | ) |
| Cash paid for  business                                                                              |   | $                                    | —    |   | $ | 4,835 |   |

 

6

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NETBANK,INC.

NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September30, 2002 (unaudited)

 

**1.****                                      ORGANIZATION AND BASIS OF PRESENTATION**

 

NetBank, Inc. is a bank holdingcompany that wholly owns the outstanding stock of NetBank, (“NetBank, FSB”), afederal savings bank; Meritage Mortgage Corporation (“Meritage”), a wholesale nonconformingmortgage provider; MG Reinsurance Company (“MG Reinsurance”), a captivereinsurance company; RBMG Insurance Services, Inc., (“RBMG Insurance”), alicensed insurance agency; and NB Partners, Inc., a corporation formed to beinvolved in strategic partnering opportunities.  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 equipment originator.  NetBank, Inc. acquired Resource on March 31,2002 and subsequently reorganized the holding company structure as describedabove based on operational, licensing and funding needs. The entireconsolidated company is referred to herein as “NetBank” or  “the Company”.

 

In theopinion of management, the unaudited condensed consolidated financialstatements included herein reflect all adjustments, consisting only of normalrecurring accruals, which are necessary for the fair statement of the resultsfor the interim periods presented. Certain information and footnote disclosuresnormally included in financial statements have been condensed or omittedpursuant to applicable rules and regulations of the Securities and ExchangeCommission (“SEC”). The financial statements included herein should be read inconjunction with the financial statements and notes thereto, included in NetBank’sForm 10-K filed with the SEC for the year ended December 31, 2001.The results of operations for the interim periods reported herein are notnecessarily indicative of results to be expected for the full year. Certain2001 amounts have been reclassified for comparability with 2002 amounts.  All dollar amounts are presented inthousands (1,000s) unless otherwise indicated.

** **

**2.****                                      ACCOUNTING POLICIES**

 

Reference is made to theaccounting policies of NetBank described in the notes to financial statements containedin NetBank’s Form 10-K for the year ended December 31, 2001. TheCompany has followed those policies in preparing this report.  Inaddition, NetBank adopted the following new pronouncements during the ninemonths ended September 30, 2002:

* *

*New accountingpronouncements*

 

EffectiveJanuary 1, 2002, the Company adopted SFAS No. 141,“Business Combinations” (“SFAS 141”) and SFAS No. 142, “Goodwill andOther Intangible Assets” (“SFAS 142”). SFAS 141 requires all businesscombinations initiated after June 30, 2001 to be accounted for using thepurchase method of accounting. SFAS 142 changes the accounting forgoodwill and other intangible assets. Based on the adoption, goodwill is nolonger being amortized and will be subject to an annual impairment test. The effect of the adoption on NetBank’s financial statements for the ninemonths ended September 30, 2002 was a reduction of amortization expense of$197.  The Company will complete an impairment test annually and willrecord an impairment charge if any impairment is indicated.

 

Effective January 1, 2002,NetBank adopted SFAS No. 144, *Accounting for the Impairment of Long-Lived Assets,*which addresses accounting for and reporting of the impairment or disposal oflong-lived assets. The adoption of SFAS No. 144 did not have an impact onthe Company’s results of operations, financial position, or cash flows.

 

In April 2002, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 145, *Recission of FASB Statements No. 4, 44and 64, Amendment of FASB Statement No. 13, and Technical Corrections,*that,among various topics, eliminated the requirement that all forms of gains orlosses on debt extinguishments, such as the prepayment of FHLB advances, bereported as extraordinary items.  Theprepayment of FHLB advances is a normal part of the Company’s asset andliability management strategy.  Asencouraged by this pronouncement, we applied the provisions of SFAS No. 145related to the treatment of debt extinguishments as of January 1, 2002.  Accordingly, the loss from the prepayment ofFHLB advances for the three and nine months ended September 30, 2002 in theamount of $7.5 and $9.9 million is now recorded as a component of non-interestexpense.  There were no similartransactions in the prior period financial statements.

 

In June 2002, the FASB issued SFAS No. 146, *Accountingfor Costs Associated with Exit or Disposal Activities.*  This Statement requires that a liability forcosts associated with exit or disposition activities be recognized when theliability is incurred and be measured at fair value and adjusted for changes inestimated cash flows.  Existinggenerally accepted accounting principles provide for the recognition of suchcosts at the date of management’s commitment to an exit plan.  Under SFAS No. 146, management’s commitmentto an exit plan would not be sufficient, by itself, to recognize aliability.  The Statement is effectivefor exit or disposal activities initiated after December 31, 2002 and is notexpected to have a material impact on the results of operations or financialcondition of the Company.

 

In October 2002, theFASB issued SFAS No. 147, *Acquisitions ofCertain Financial Institutions*. This Statement provides guidance onthe accounting for the acquisition of a financial institution, which hadpreviously been addressed in SFAS No. 72, *Accountingfor Certain Acquisitions of Banking or Thrift Institutions*. Theprovisions of Statement No. 147 are effective for acquisitions for which thedate of acquisition is on or after October 1, 2002. The Statement ****is notexpected to have a material impact on the results of operations or financialcondition of the Company.****

 

In addition, the Companyadopted the following new policies as of March 31, 2002 as a result of itsacquisition of Resource:

 

Interest rate lock commitmentsare measured by the change in value from the date of rate lock to the balancesheet date and are recorded as assets or liabilities on the balance sheet.

 

Lease receivables consist ofdirect finance equipment leases which are carried at the lower of aggregatecost or market value.  Interest income is recognized monthly based on thenet lease outstanding balance.  Residuals are recognized monthly based onthe estimated end-of-lease value and are included as an adjustment to interestincome.

 

7

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*SignificantEstimates*

 

In preparingthe financial statements, management is required to make estimates based onavailable information that can affect the reported amounts of assets,liabilities and disclosures as of the balance sheet dates and revenues andexpenses for the related periods.  Such estimates relate principally tothe Company’s allowance for foreclosure losses and repurchased loans, theallowance for lease losses, the allowance for credit losses, and theunamortized premiums on loans and leases held for investment. Additionally, estimates concerning the fair values of mortgage loansheld-for-sale, lease receivables, interest rate lock commitments, servicingrights, servicing hedges and the Company’s other hedging instruments are allrelevant to ensuring that leases and mortgage loans are carried at the lower ofcost or market, that interest rate locks are carried at market, and thatpotential impairments of servicing rights are recognized if required. Because of the inherent uncertainties associated with any estimation processand due to possible future changes in the market and economic conditions thatwill affect fair values, it is possible that actual future results in realizationof the underlying assets and liabilities could differ significantly from theamounts reflected as of the balance sheet date.

 

**3.             ACQUISITIONS**

 

On March 31, 2002, NetBankconsummated its acquisition of Resource pursuant to an Agreement and Plan ofMerger dated November 18, 2001 among NetBank, Palmetto Acquisition Corp.(“Merger Sub”) and Resource providing for the merger of Merger Sub with andinto Resource, with Resource surviving the merger. In the merger, NetBankissued 1.1382 shares of NetBank common stock in exchange for each outstandingshare of Resource common stock, equivalent to 19,716,358 shares of common stockplus cash in lieu of fractional shares.  The transaction was accounted for as a purchase, and a total of $17.1million of goodwill has been recorded. At March 31, 2002 the Company had recorded $14.8 million of goodwill,which was subsequently increased during the six months ended September 30, 2002by an additional $2.3 million.  Thisincrease is due to the following pre-acquisition contingencies: 1) $1.4 millionfor specific loan loss allowances; 2) $0.3 million for unrecoverable servicingadvances; 3) $0.9 million for other comprehensive income related to Resource’sretirement plan and 4) ($0.3) million of other compensation related to Resource’sincentive stock option plan.

 

On June 29, 2001, NetBank, Inc.acquired all of the outstanding stock of Market Street pursuant to an agreement(the “Agreement”) dated April 15, 2001 and amended as of June 29, 2001among NetBank, Net Interim, Inc., Republic Bank, Republic Bancorp, Inc.(“Republic”) and certain shareholders of Market Street.  The consideration paid consisted of1,689,000 shares of NetBank common stock valued at $8.96 per share and cash of$6.1 million.  The acquisition wasaccounted for as a purchase, and approximately $20.1 million in goodwill,including transaction costs, was recorded.

 

Pro-forma financial informationassuming both the acquisition of Market Street and Resource had occurred as ofJanuary 1, 2002 and January 1, 2001 follows:

 
|                                                                        |   | **Nine  months ended  September 30,  2002** |    | **Nine  months ended  September 30,  2001** |   |
|-----------------------------------------------------------------------------|--------|---------------------------------------------|---------|---------------------------------------------|--------|
| Net interest income                                                         |   | $                                           | 50,276  |                                        | $      | 54,917 |   |
| Net (loss) income                                                           |   | $                                           | (43,058 | )                                           | $      | 21,936 |   |
| Basic and diluted net (loss) income per  common and common equivalent share |   | $                                           | (1.01   | )                                           | $      | 0.44 |   |

 

8

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**4.             LOANS**

 

During the three months endedSeptember 30, 2002, NetBank did not purchase any loan pools.

 

Ananalysis of the allowance for loan losses for the three and nine months endedSeptember 30, 2002 follows ($ in 000’s):

** **
|                                                          |   | **For the  three  months ended  September 30,  2002** |   | **For the  nine  months ended  September 30,  2002** |   |
|---------------------------------------------------------------|--------|-------------------------------------------------------|--------|------------------------------------------------------|--------|
| Balance-beginning of period                                   |   | $                                                     | 53,277 |                                                 | $      | 19,595 | * |
| Allowance recorded in connection with  purchase of loan pools |   | —                                                |   | 7,257                                                |   |
| Provision for loan losses                                     |   | (95                                                   | )      | 26,432                                               |   |
| Loans charged-off, net of recoveries                          |   | (5,518                                                | )      | (7,283                                               | )      |
| Acquired allowance in connection with  Resource               |   | —                                                |   | 1,663                                                |   |
| Balance-end of period                                         |   | $                                                     | 47,664 |                                                 | $      | 47,664 |   |

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* The December 31, 2001 balancehas been adjusted down by $3,270 to reflect the transfer of the Company'scommercial loan portfolio to held for sale.

 

**5.****                                      BORROWINGS**

 

A summary of borrowings and available borrowings, grouped by year ofmaturity, as of September 30, 2002 follows (in 000’s):

 
| **Type of borrowing**                    |   | **Year of  maturity** |   | **Range of  stated  interest rates at  September 30,  2002** |   | **Principal  amount  outstanding at  September 30,  2002** |    |
|------------------------------------------|--------|-----------------------|--------|--------------------------------------------------------------|--------|------------------------------------------------------------|---------|
| FHLB advances                            |   | 2002                  |   | 2.67                                                         | %      | $                                                          | 2,214   |   |
| $75 million warehouse line of credit     |   | 2002                  |   | 3.21                                                         | %*     | 8,163                                                      |    |
| $300 million master repurchase  facility |   | 2002                  |   | 3.09                                                         | %*     | 54,230                                                     |    |
| $10 million unsecured line  of credit    |   | 2002                  |   | —                                                       | *      | —                                                     |    |
| FHLB advances                            |   | 2002                  |   | 2.03                                                         | %      | 20,000                                                     |    |
| FHLB warehouse line                      |   | 2003                  |   | —                                                       | *      | —                                                     |    |
| $200 million master  repurchase facility |   | 2003                  |   | 3.07                                                         | %      | 17,915                                                     |    |
| FHLB advances                            |   | 2003                  |   | 2.50-3.61                                                    | %      | 55,000                                                     |    |
| FHLB advances                            |   | 2004                  |   | 2.31-6.03                                                    | %      | 330,000                                                    |    |
| Convertible subordinated notes           |   | 2004                  |   | 4.75                                                         | %      | 27,316                                                     |    |
| 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                                                     |    |
| $175 million master repurchase facility  |   | N/A                   |   | 1.61                                                         | %*     | 27,553                                                     |    |
| Total                                    |   |                  |   |                                                         |   | 782,391                                                    |    |
| Less unamortized discount                |   |                  |   |                                                         |   | (266                                                       | )       |
| Total Debt                               |   |                  |   |                                                         |   | $                                                          | 782,125 |   |

 

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* Indicates a variable rate

 

9

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All of the Federal Home LoanBank (“FHLB”) advances are fixed rate; however, seven advances totaling$230,000 may be converted at the FHLB’s option to adjustable rate based on thethree month floating LIBOR.  The FHLB warehouse line is a $250,000adjustable line of credit with a floating rate based on the DRC rate plus 50basis points used to fund mortgages originated by Market Street. All of the FHLB advances and the FHLB warehouseline are secured by investment securities or mortgage loans.  Theconvertible subordinated notes are unsecured. As a part of the company’s strategic transactions to reposition thebalance sheet for future profitability, during third quarter proceeds from thesale of select securities were used to pay off certain high-rate term advancesfrom the FHLB.  Although the earlypayment of these advances resulted in pre-tax charges of $7.5 million, whichare recorded in non-interest expense, the net effect of the transactions will reducethe duration of the bank’s higher-cost liabilities.

 

Most ofthe revolving lines of credit, warehouse lines of credit (other than the FHLBwarehouse line), the master repurchase facilities and commercial paper conduitfacility are all secured by mortgage loans and are subject to restrictivecovenants, such as minimum net worth requirements; minimum tangible net worthrequirements; certain minimum financial ratios, all as defined inthe terms of the related debt agreements; maintenance of servicer eligibilityfor various government agencies; a minimum balance in the mortgage servicingrights portfolio, and certain minimum liquidity requirements.  Inaddition, the covenants restrict business activities to those related to themortgage banking and lending business and the servicing of mortgage loans. NetBank was in compliance with all material debt covenants in place as ofSeptember 30, 2002.  Although management anticipates complying with allcurrent debt covenants, there can be no assurance that NetBank or itsindividual subsidiaries will be able to comply with all debt covenants in thefuture.  Failure to comply could result in the loss of the relatedfinancing.

 

**6.****                                      NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE**

 

Basic and diluted net income per common andpotential common share has been calculated based on the weighted average numberof shares outstanding. The following schedule reconciles the numerator anddenominator of the basic and diluted net income per common and potential commonshare (in 000’s except per share amounts) for the three and nine months endedSeptember 30, 2001 and the three months ended September 30, 2002.  For the nine months ended September 30,2002, there is no difference in basic and diluted shares as the effect ofoptions outstanding to purchase common shares would be anti-dilutive to the netloss for that period. The effect of convertible debt securities outstanding hasnot been included in any of the periods presented because the assumedconversion of such securities would be anti–dilutive to earnings pershare for that period.

 
|                                                             |   | **Net  income  (numerator)**              |       | **Shares  (denominator)** |       | **Per share  amount** |       |
|------------------------------------------------------------------|--------|-------------------------------------------|------------|---------------------------|------------|-----------------------|------------|
|                                                             |   | **Three months ended September 30, 2002** |       |
|                                                             |   |                                      | ** ** |                      | ** ** |                  | ** ** |
| Basic EPS                                                        |   | $                                         | 8,517      |                      | 49,778     |                  | $          | 0.17 |   |
| Effect of  dilutive securities-options to purchase common shares |   |                                      | ** ** | 363                       | ** ** |                  | ** ** |
| Diluted EPS                                                      |   | $                                         | 8,517      |                      | 50,141     |                  | $          | 0.17 |   |
|                                                             |   |                                      | ** ** |                      | ** ** |                  | ** ** |
|                                                             |   | **Three months ended September 30, 2001** |       |
|                                                             |   |                                      |       |
| Basic EPS                                                        |   | $                                         | 2,148      |                      | 30,182     |                  | $          | 0.07 |   |
| Effect of  dilutive securities-options to purchase common shares |   |                                      |       | 529                       |       |                  |       |
| Diluted EPS                                                      |   | $                                         | 2,148      |                      | 30,711     |                  | $          | 0.07 |   |
|                                                             |   |                                      |       |                      |       |                  |       |
|                                                             |   | **Nine months ended September 30, 2001**  |       |
|                                                             |   |                                      |       |
| Basic EPS                                                        |   | $                                         | 3,725      |                      | 29,214     |                  | $          | 0.13 |   |
| Effect of  dilutive securities-options to purchase common shares |   |                                      |       | 563                       |       |                  |       |
| Diluted EPS                                                      |   | $                                         | 3,725      |                      | 29,777     |                  | $          | 0.13 |   |

 

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**7.****                                      SHAREHOLDERS’EQUITY**

 

*Common Stock* – AtSeptember 30, 2002 and December 31, 2001 there were 52,671,337 and 31,751,369,respectively, shares of NetBank common stock issued.  The 20,919,968 increase in shares is from 19,716,358 shares issuedin conjunction with the purchase of Resource and 1,203,610 of option exercises.

* *

*Additional Paid-in Capital*– During the nine months ended September 30, 2002, paid-in capital increased by$159,442 primarily due to the acquisition of Resource, which accounted for$155,365 of the increase.  Optionexercises and shares purchased under the Company’s Employee Stock Purchase Planaccounted for $4,070 and $7 of the increase, respectively.

* *

*Retained Earnings* –During the nine months ended September 30, 2002 the Company had a net loss of$28,408, which decreased retained earnings to a deficit of $15,119 as ofSeptember 30, 2002.

* *

*Accumulated Other Comprehensive Loss (“OCI”)*- At September 30, 2002 the Company had $8,244 of OCI, an increase of $11,892for the nine months ended September 30, 2002. This change is due to increases in the fair market value of theinvestment securities available for sale.

* *

*Treasury Stock*– At September 30, 2002 the Companyhad 2,934,553 shares of treasury stock compared to 2,736,870 at December 31,2001.  The 197,683 increase in shares isprimarily due to the purchase of 231,500 treasury shares of the Company’scommon stock during the nine months ended September 30, 2002.  The total number of shares available forrepurchase was 1,421,300.  The remainingchange is due to the reissuance of 33,817 treasury shares relating to theCompany’s employee stock purchase plan.

** **

**8.****                                      DERIVATIVES**

 

During the quarter endedSeptember 30, 2002, NetBank entered into forward delivery commitments through itswholly owned subsidiaries, RBMG and Market Street, to protect against changesin the fair value (secondary market value) of short-term commitments to fundmortgage loan applications in process (“the pipeline”) and mortgage loans heldfor sale (“the warehouse”) due to fluctuations in interest rates.  These forward commitments are designated asfair value hedges under SFAS No. 133, “Accounting for Derivative Instrumentsand Hedging Activities”.  As such, theseforward commitments are recorded at fair value on the balance sheet with anoffset to mortgage loans held for sale for the effective portion of the hedge.The ineffective portion of the hedge is recorded as a gain (loss) in thestatement of operations. NetBank is generally not exposed to significant lossesnor does it expect to realize significant gains related to the pipeline orwarehouse due to changes in interest rates, net of gains or losses on relatedhedge positions.

 

NetBank uses variousderivatives, including Constant Maturity Treasury rate (CMT) floors, ConstantMaturity Swap (CMS) floors, and forward purchase contracts on FNMA mortgagebacked securities (FNMA TBA) to protect itself against interest rate andprepayment risk on its available-for-sale servicing portfolio and the servicingvalues inherent in pipeline and warehouse.

** **

**9.****                                      BUSINESSSEGMENTS**

 

NetBank’s principal activitiesinclude retail banking and mortgage lending.  The retail banking segmentprimarily consists of the offering of consumer banking products such aschecking, money market, and certificates of deposit and the purchase of bulkloan portfolios.  The mortgage banking segment, either originates mortgageloans or purchases mortgage loans from correspondents and/or brokers andpackages pools of such loans either inclusive or exclusive of servicing rightsfor sale into the secondary market.

 

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Since the acquisition ofResource was completed on March 31, 2002, the nine-month mortgage bankingsegment includes Resource’s results of operations for only the six months endedSeptember 30, 2002.  The three and nine-month tables also include theeffects of certain transactions related to the acquisition of Resourceincluding the effects of purchase accounting, restructuring of the investmentportfolio in anticipation of the transaction and certain compensation chargesrelated to changes in management as a result of the transaction.

 

The financial information foreach business segment reflects specific identifiable transactions or allocated transactionsbased on an internal allocation method. The measurement of the performance ofthe business segments is based on the management structure of NetBank, Inc. andis not necessarily comparable with similar information from any other financialinstitution. The information presented is also not necessarily indicative ofthe segment’s operations if they were independent entities.

 
|                                |   | ***For the three months ended  September 30, 2002*** |      |
|-------------------------------------|--------|------------------------------------------------------|-----------|
| **($s in  000s)**                   |   | **Retail  banking**                                  |      | **Mortgage  banking** |   | **Other** |   | **Eliminations** |   | **Consolidated** |   |
| Net interest income                 |   | $                                                    | 9,689     |   | $ | 13,270 |   | $ | (145 | ) | $ | — |   | $ | 22,814 |   |
| Provision for loan and lease losses |   | $                                                    | (95       | ) | $ | — |   | $ | — |   | $ | — |   | $ | (95 | ) |
| Non-interest income                 |   | $                                                    | 15,604    |   | $ | 46,957 |   | $ | 3,167 |   | $ | (895 | ) | $ | 64,833 |   |
| Non-interest expense                |   | $                                                    | 22,529    |   | $ | 49,875 |   | $ | 2,225 |   | $ | (585 | ) | $ | 74,044 |   |
| Income before income taxes          |   | $                                                    | 2,859     |   | $ | 10,352 |   | $ | 797 |   | $ | (310 | ) | $ | 13,698 |   |
| Total assets                        |   | $                                                    | 3,159,399 |   | $ | 1,347,013 |   | $ | 570,392 |   | $ | (1,598,485 | ) | $ | 3,478,319 |   |
|                                |   |                                                 |      |   |   |   |   |   |   |   |   |
|                                |   | ***For the three months ended September 30,  2001*** |      |
| **($s in  000s)**                   |   | **Retail  banking**                                  |      | **Mortgage  banking** |   | **Other** |   | **Eliminations** |   | **Consolidated** |   |
| Net interest income                 |   | $                                                    | 11,362    |   | $ | 1,419 |   | $ | — |   | $ | — |   | $ | 12,781 |   |
| Provision for loan and lease losses |   | $                                                    | 76        |   | $ | 7 |   | $ | — |   | $ | — |   | $ | 83 |   |
| Non-interest income                 |   | $                                                    | 4,179     |   | $ | 5,377 |   | $ | — |   | $ | — |   | $ | 9,556 |   |
| Non-interest expense                |   | $                                                    | 12,579    |   | $ | 6,193 |   | $ | — |   | $ | — |   | $ | 18,790 |   |
| Income before income taxes          |   | $                                                    | 2,868     |   | $ | 596 |   | $ | — |   | $ | — |   | $ | 3,464 |   |
| Total assets                        |   | $                                                    | 2,321,226 |   | $ | 278,125 |   | $ | — |   | $ | (114,907 | ) | $ | 2,484,444 |   |
|                                |   |                                                 |      |   |   |   |   |   |   |   |   |
|                                |   | ***For the nine months ended September 30,  2002***  |      |
| **($s in  000s)**                   |   | **Retail  banking**                                  |      | **Mortgage  banking** |   | **Other** |   | **Eliminations** |   | **Consolidated** |   |
| Net interest income                 |   | $                                                    | 17,006    |   | $ | 24,502 |   | $ | (539 | ) | $ | — |   | $ | 40,969 |   |
| Provision for loan and lease losses |   | $                                                    | 26,432    |   | $ | — |   | $ | — |   | $ | — |   | $ | 26,432 |   |
| Non-interest income                 |   | $                                                    | 19,241    |   | $ | 93,425 |   | $ | 3,775 |   | $ | (1,331 | ) | $ | 115,110 |   |
| Non-interest expense                |   | $                                                    | 63,316    |   | $ | 98,377 |   | $ | 14,104 |   | $ | (1,021 | ) | $ | 174,776 |   |
| Income before income taxes          |   | $                                                    | (53,501   | ) | $ | 19,550 |   | $ | (10,868 | ) | $ | (310 | ) | $ | (45,129 | ) |
| Total assets                        |   | $                                                    | 3,159,399 |   | $ | 1,347,013 |   | $ | 570,392 |   | $ | (1,598,485 | ) | $ | 3,478,319 |   |
|                                |   |                                                 |      |   |   |   |   |   |   |   |   |

 

12

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|                                |   | ***For the nine months ended September 30,  2001*** |      |
|-------------------------------------|--------|-----------------------------------------------------|-----------|
| **($s in  000s)**                   |   | **Retail  banking**                                 |      | **Mortgage  banking** |   | **Other** |   | **Eliminations** |   | **Consolidated** |   |
| Net interest income                 |   | $                                                   | 32,935    |   | $ | 1,419 |   | $ | — |   | $ | — |   | $ | 34,354 |   |
| Provision for loan and lease losses |   | $                                                   | 246       |   | $ | 7 |   | $ | — |   | $ | — |   | $ | 253 |   |
| Non-interest income                 |   | $                                                   | 10,176    |   | $ | 5,377 |   | $ | — |   | $ | — |   | $ | 15,553 |   |
| Non-interest expense                |   | $                                                   | 37,455    |   | $ | 6,193 |   | $ | — |   | $ | (2 | ) | $ | 43,464 |   |
| Income before income taxes          |   | $                                                   | 5,410     |   | $ | 596 |   | $ | — |   | $ | 2 |   | $ | 6,008 |   |
| Total assets                        |   | $                                                   | 2,321,226 |   | $ | 278,125 |   | $ | — |   | $ | (114,907 | ) | $ | 2,484,444 |   |

 

**10.****                               LOSSCONTINGENCY**

 

NetBank, FSB is involved inlitigation with three insurance companies who are sureties on some of NetBank,FSB’s commercial lease portfolios. NetBank, FSB has filed a claim for $24.3 million in principal andinterest payments that are currently past due. The unpaid principal and unpaid interest balances total $83.8 millionand $1.4 million, respectively.  Theentire portfolio has been placed on non-accrual status pending outcome of thelitigation.  Approximately $1.9 millionand $5.1 million of interest was not received or accrued during the three andnine months ended September 30, 2002, respectively.  Management believes after consultation with legal counsel, thatNetBank, FSB has substantive basis for its claims.

** **

**11.****                               MORTGAGESERVICING RIGHTS**

 

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

 

The segment of the portfolio designated as available-for-sale iscomposed of servicing rights that were purchased in bulk transactions or thatwere retained out of production pursuant to individual portfolio retentiondecisions.  As of September 30, 2002,the Company is retaining the majority of its conventional mortgage loanservicing rights.  Theavailable-for-sale portfolio is disaggregated for purposes of measuringpotential impairments according to defined risk tranches.  The Company has defined its risk tranchesbased upon interest rate band and product type.  With respect to each such risk tranche, the fair value thereof,which is based upon an internal analysis that considers current marketconditions, prevailing interest, prepayment speed and default rates and otherrelevant factors, is compared to amortized carrying values of the mortgageservicing rights for purposes of measuring potential impairment.  The Company uses Constant Maturity Swap rate(CMS) floors, Constant Maturity Treasury rate (CMT) floors and corridors,interest rate swap contracts, interest rate caps and forward purchase contractson FNMA mortgage backed securities (FNMA TBA) to protect itself againstinterest rate and prepayment risk on its available-for-sale portfolio.

 

The segment of the portfoliodesignated as held-for-sale is composed of recently produced servicing rightsthat are scheduled for sale and have been allocated to specific forwardservicing sales contracts.  The held-for-sale portfolio is disaggregatedfor purposes of measuring possible impairments according to the specificforward sales contracts to which allocated, which the Company has determined tobe the appropriate approach to disaggregation by predominant riskcharacteristic for this portfolio segment.  For each such risk tranche,the fair value is based upon the allocated forward committed delivery price,which is compared to amortized carrying value for purposes of measuringpotential impairment. 

 
| **As of  September 30, 2002** |   |
|-------------------------------|--------|
| **($s in  000s)**             |   | **UPB** |   | **Fair value** |   | **Fair value  /  UPB** |   | **Net  carrying  value** |   | **Net  carrying  value / UPB** |   | **Weighted  average  note rate** |   | **Weighted  average  service fee** |   | **Net Basis  as multiple** |   |
| Held-for-Sale                 |   | $ | 376,291 |   | $ | 4,880 |   | 1.30 | % | $ | 4,880 |   | 1.30 | % | 6.57 | % | 0.39 | % | 3.37 |   |
| Available-for-Sale*           |   | $ | 5,191,247 |   | $ | 55,252 |   | 1.06 | % | $ | 55,121 |   | 1.06 | % | 7.09 | % | 0.42 | % | 2.50 |   |
|                          |   | b |   | a |   | a / b = c |   | d |   | d / b = e |   |   |   | f |   | e / f |   |

 

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* $64 million of the availablefor sale portfolio is committed for sale under a forward bulk commitment.

 

13

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**12.****                               NEWEXECUTIVE AND DIRECTOR BENEFIT PLANS**

 

The Company has adopted an“Executive Supplemental Retirement Plan” and a “Director SupplementalRetirement Plan” for key members of senior management and the board ofdirectors.  Each Plan provides for anannual benefit payable at normal retirement (age 65) targeted at 40% of finalcompensation projected at an assumed 4% salary progression rate.  Actual total benefits payable under the Planare dependant on an indexed retirement benefit formula, which accrues benefitsequal to the aggregate after-tax income of associated life insurance contractsless the Company’s tax-effected cost of funds for that plan year.  While benefits are guaranteed until therespective participant’s projected mortality, the total lifetime benefit isindexed to the performance of the insurance contract.  Therefore, benefits under the Plan are ultimately dependent onthe performance of the insurance contracts and are not guaranteed by theCompany.

 

The Company has financed thecontracts through the purchase of bank-owned life insurance, (BOLI), which isanticipated to fully finance the projected benefit payout afterretirement.  The total amount investedin BOLI for the Plan to date and the corresponding cash surrender value atSeptember 30, 2002 was $12.2 million and $12.6 million, respectively. The associatedobligation expense incurred in connection with the Plan was $1.1 million forthe first nine months of 2002. The first nine months of expense was higher thannormal due to the accelerated vesting under the plan for four participants whoterminated early as a result of the recent merger.  The income derived from policy appreciation was $0.4 million asof September 30, 2002.

 

In connection with the Plan,the Company has also entered into Life Insurance Endorsement Method SplitDollar Agreements (the “Agreements”) with the individuals covered under thePlan.  Under the Agreements, the Companyshares 80% of death benefits over and above the cash surrender value (the netat risk death benefit) with the designated beneficiaries of the planparticipants under life insurance contracts referenced in the Plan. TheCompany, as owner of the policies, retains a 20% interest in the net at risklife proceeds and a 100% interest in the cash surrender value of thepolicies.  The Plan also containsprovisions for change of control, as defined, which allow the participants toretain benefits, subject to certain conditions, under the Plan in the event ofa change in control. Because the Plan was designed to retain the futureservices of key executives, no benefits are payable under the Plan until age 65and the amount of those benefits will be determined based upon the individualparticipants vesting schedule.

** **

**Part 1. Item2:   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS**

* *

*Some of thestatements in this report are forward-looking statements. Forward-lookingstatements include statements regarding the intent, belief or currentexpectations of NetBank or its officers and directors and can be identified bythe use of forward-looking terms such as “may,” “will,” “should,” “believe,”“expect,” “anticipate,” “estimate,” “continue,” or comparable terminology. TheCompany’s actual results could differ materially from those anticipated fromthe forward-looking statements, depending on various important factors. Thesefactors include a possible decline in asset quality, potential difficulties inintegrating the Company’s operations with those of companies acquired, thecyclical nature of the mortgage banking industry generally, the evolving natureof the market for internet banking and financial services generally, thepossible adverse effects of unexpected changes in the interest rateenvironment, and increasing competition and regulatory changes. The sectionheaded “Risk Factors” in the Company’s prospectus dated January 14, 2002contains additional details on these and other risks that are material tooperations. All forward-looking statements in this report are based oninformation available as of the date this report was filed with the SEC. TheCompany does not undertake to update any forward-looking statements that may bemade.*

** **

**General**

 

NetBank,Inc. is a bank holding company that wholly owns the outstanding stock ofNetBank (“NetBank, FSB”), a federal savings bank; Meritage Mortgage Corporation(“Meritage”), a wholesale nonconforming mortgage provider; MG ReinsuranceCompany (“MG Reinsurance”), a captive reinsurance company; RBMG InsuranceServices, Inc., (“RBMG Insurance”); and NB Partners, Inc., a corporationestablished for strategic partnering opportunities.  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 equipment leasingcompany.  NetBank, Inc. acquiredResource on March 31, 2002 and subsequently reorganized the holding companystructure as described above based on operational, licensing and funding needs.The entire consolidated company is referred to herein

 

14

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as“NetBank” or  “the Company”.  As of September 30, 2002, NetBank hadapproximately 231,363 accounts and $2.1 billion in deposits.

 
|                                       |   | **At or for  the three  months ended  September 30,  2002** |      | **At or for  the three  months ended  September 30,  2001** |   | **At or for  the nine  months ended  September 30,  2002** |   | **At or for  the nine  months ended  September 30,  2001** |      |
|--------------------------------------------|--------|-------------------------------------------------------------|-----------|-------------------------------------------------------------|--------|------------------------------------------------------------|--------|------------------------------------------------------------|-----------|
| **($in 000s,  except per share)**          |   |                                                        |      |                                                        |   |                                                       |   |                                                       |      |
| **Summary Financial Data:**                |   |                                                        |      |                                                        |   |                                                       |   |                                                       |      |
| Net interest income                        |   | $                                                           | 22,814    |                                                        | $      | 12,781                                                     |   | $                                                          | 40,969    |   | $ | 34,354 |   |
| Provision for loan and lease losses        |   | $                                                           | (95       | )                                                           | $      | 83                                                         |   | $                                                          | 26,432    |   | $ | 253 |   |
| Non-interest income                        |   | $                                                           | 64,833    |                                                        | $      | 9,556                                                      |   | $                                                          | 115,110   |   | $ | 15,553 |   |
| Non-interest expense                       |   | $                                                           | 74,044    |                                                        | $      | 18,790                                                     |   | $                                                          | 174,776   |   | $ | 43,646 |   |
| Net income (loss)                          |   | $                                                           | 8,517     |                                                        | $      | 2,148                                                      |   | $                                                          | (28,408   | ) | $ | 3,725 |   |
| Net income (loss) per common share         |   | $                                                           | 0.17      |                                                        | $      | 0.07                                                       |   | $                                                          | (0.66     | ) | $ | 0.13 |   |
| Net income (loss) per common diluted share |   | $                                                           | 0.17      |                                                        | $      | 0.07                                                       |   | $                                                          | (0.66     | ) | $ | 0.13 |   |
| Average assets                             |   | $                                                           | 3,534,371 |                                                        | $      | 2,498,121                                                  |   | $                                                          | 3,682,725 |   | $ | 2,178,353 |   |
| Average liabilities                        |   | $                                                           | 3,143,707 |                                                        | $      | 2,234,368                                                  |   | $                                                          | 3,287,149 |   | $ | 1,924,777 |   |
| Average shareholders’ equity          |   | $                                                           | 390,664   |                                                        | $      | 263,753                                                    |   | $                                                          | 395,576   |   | $ | 253,576 |   |
| Return on average assets                   |   | 1.0                                                         | %         | 0.3                                                         | %      | (1.0                                                       | )%     | 0.2                                                        | %         |
| Return on average equity                   |   | 8.7                                                         | %         | 3.3                                                         | %      | (9.6                                                       | )%     | 2.0                                                        | %         |
| Net interest margin                        |   | 2.6                                                         | %         | 2.1                                                         | %      | 1.6                                                        | %      | 2.3                                                        | %         |
| Efficiency ratio                           |   | 82.9                                                        | %         | 84.4                                                        | %      | 137.7                                                      | %      | 87.9                                                       | %         |

 

**Financial Condition**

* *

*Assets.*The Company’s assets were $3.5 billion atSeptember 30, 2002 compared to $2.9 billion at December 31, 2001. Theincrease of $0.6 billion from December 31, 2001 to September 30, 2002 wasprimarily due to the acquisition of Resource on March 31, 2002 which added $1.1billion in total assets, including $756 million in mortgage loans receivableheld for sale, $20 million in lease receivables, $129 million in mortgageservicing rights, $30 million in cash, and $149 million in furniture andequipment, miscellaneous receivables, and other assets.  During the ninemonths ended September 30, 2002, NetBank began a process of repositioning itsbalance sheet to reflect the change in strategy as a result of the acquisitionof Resource.  The repositioning primarily consisted of liquidating aportion of the investment securities portfolio available for sale, a netdecrease of $176.8 million for the first nine months of 2002.  The Company used the resulting proceeds topay down pre-existing Resource lines of credit.  During the first nine months of 2002 the Company’s cash and cashequivalents increased $235.8 million. The increase in cash and cash equivalentsis primarily due to the proceeds from the sales of loans arriving on the lastday of the month.  The $830.7 millionincrease in mortgage loans receivable for the nine months ended September 30,2002 is due primarily to the acquisition of Resource and its higher level ofmortgage production activities. The Company’s loan and lease receivablesdeclined by $529.3 million primarily as a result of the sale of $172.4 millionof commercial and second mortgage loans considered non-core assets and thereclassification of  $104 million ofcommercial loans to held for sale. The remaining decline is due to $212 millionin principal repayments net of purchases and $41 million of additionalprovision, premium impairment and net of amortization. The Company’s investmentin stock of the Federal Home Loan Bank of Atlanta also decreased $22 million asthe Company redeemed stock related to FHLB advances paid down during the ninemonths ended September 30, 2002.  All ofthe following items increased for the nine months ending September 30, 2002primarily as a result of the acquisition of Resource: mortgage servicing rightsby $58 million; accrued interest receivable by $4 million; furniture, equipmentand capitalized software by $30 million and other assets by $57 million.

 

15

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*InvestmentSecurities.* The following tables set forth certain information relating to the Company’savailable-for-sale securities at September 30, 2002 and December 31,2001: ($s in 000s)**

 
|                                |   | **Amortized  cost**           |    | **Unrealized  gains** |   | **Unrealized  losses** |   | **Estimated  fair value** |   |
|-------------------------------------|--------|-------------------------------|---------|-----------------------|--------|------------------------|--------|---------------------------|--------|
|                                |   | **As of  September 30, 2002** |    |
|                                |   |                          |    |                  |   |                   |   |                      |   |
| Mortgage pool securities            |   | $                             | 139,596 |                  | $      | 3,848                  |   | $                         | — |   | $ | 143,444 |   |
| Collateralized mortgage obligations |   | 12,676                        |    | 320                   |   | 13                     |   | 12,983                    |   |
| U.S. government agencies            |   | 494,604                       |    | 9,728                 |   | —                 |   | 504,332                   |   |
| Corporate bonds                     |   | 9,676                         |    | —                |   | 904                    |   | 8,772                     |   |
| Habitat bonds and other             |   | 3,480                         |    | 261                   |   | —                 |   | 3,741                     |   |
|                                |   |                          |    |                  |   |                   |   |                      |   |
| Total                               |   | $                             | 660,032 |                  | $      | 14,157                 |   | $                         | 917    |   | $ | 673,272 |   |
|                                |   |                          |    |                  |   |                   |   |                      |   |
|                                |   | **Amortized  cost**           |    | **Unrealized  gains** |   | **Unrealized  losses** |   | **Estimated  fair value** |   |
|                                |   | **As of  December 31, 2001**  |    |
|                                |   |                          |    |                  |   |                   |   |                      |   |
| Mortgage pool securities            |   | $                             | 596,675 |                  | $      | 345                    |   | $                         | 5,374  |   | $ | 591,646 |   |
| Collateralized mortgage obligations |   | 185,768                       |    | 513                   |   | 1,261                  |   | 185,020                   |   |
| U.S. government agencies            |   | 60,000                        |    | 834                   |   | —                 |   | 60,834                    |   |
| Corporate bonds                     |   | 9,666                         |    | —                |   | 1,006                  |   | 8,660                     |   |
| Habitat bonds and other             |   | 3,858                         |    | 61                    |   | —                 |   | 3,919                     |   |
|                                |   |                          |    |                  |   |                   |   |                      |   |
| Total                               |   | $                             | 855,967 |                  | $      | 1,753                  |   | $                         | 7,641  |   | $ | 850,079 |   |

* *

*Loan PortfolioComposition.* The following table sets forth the composition of our loan and lease portfolio,including loans receivable held for sale, by type of loan as of September 30,2002 and December 31, 2001: ($s in 000s)

 
|                                      |   | **As of September 30,****2002** |      | **As of December 31,****2001** |   |
|-------------------------------------------|--------|---------------------------------|-----------|--------------------------------|--------|
|                                      |   | **Amount**                      |      | **% of  total**                |   | **Amount** |   | **% of  total** |   |
| Residential mortgages                     |   | $                               | 580,189   |                           | 25.9   | % | $ | 977,768 |   | 54.1 | % |
| Residential mortgages held for  sale      |   | 1,126,186                       |      | 50.4                           |   | 295,529 |   | 16.3 |   |
| Commercial loans held for sale            |   | 104,034                         |      | 4.4                            |   | — |   | — |   |
| Commercial loans                          |   | —                          |      | —                         |   | 231,739 |   | 12.8 |   |
| Leases                                    |   | 325,923                         |      | 14.6                           |   | 150,918 |   | 8.3 |   |
| Home equity lines of credit               |   | 97,546                          |      | 4.4                            |   | 140,806 |   | 7.8 |   |
| Consumer                                  |   | 3,997                           |      | 0.3                            |   | 10,747 |   | 0.7 |   |
| Construction                              |   | 191                             |      | —                         |   | 197 |   | — |   |
| Auto                                      |   | 25                              |      | —                         |   | 211 |   | — |   |
| Total                                     |   | 2,238,091                       |      | 100.0                          | %      | 1,807,915 |   | 100.0 | % |
|                                      |   |                            |      |                           |   |   |   |   |   |
| Less allowance for loan and  lease losses |   | 47,664                          |      |                           |   | 22,865 |   |   |   |
| Total                                     |   | $                               | 2,190,427 |                           |   |   | $ | 1,785,050 |   |   |   |

 

16

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*Asset Quality andNon-performing Assets-*As of September 30, 2002 and December 31, 2001 NetBank had $120.7million and $3.2 million of loans on non-accrual status, which includes allloans past due 90 days or more.  Of the $120.7 million at September30, 2002, $83.8 million related to one portfolio of commercial leases which areguaranteed by three insurance companies acting as sureties under the terms ofthe related sales and servicing agreements.  NetBank is currently involvedin litigation with each of those three insurance companies and is optimisticabout the ultimate recovery of amounts due under the terms of the sales andservicing agreements; however, until the matter is resolved, management hasplaced the entire balance of the portfolio on a non-accrual status.  SeePart II, Item 1: Legal Proceedings for additional details. During the threemonths ended September 30, 2002 there were $1.7 million of loansrestructured.  As of September 30, 2002 and December 31, 2001, NetBank had$3.1 million and $0.1 million in other real estate owned.

 

Allocationof the allowance for loan and lease losses as of September 30, 2002 andDecember 31, 2001:

 
|                        |   | **As of  September 30, 2002** |   | **As of  December 31, 2001** |   |
|-----------------------------|--------|-------------------------------|--------|------------------------------|--------|
| **($in 000s)**              |   | **Amount**                    |   | **% of total**               |   | **Amount** |   | **% of total** |   |
| Residential mortgages       |   | $                             | 14,446 |                         | 30.3   | % | $ | 14,463 |   | 63.3 | % |
| Home equity lines of credit |   | 2,105                         |   | 4.4                          | %      | 1,714 |   | 7.5 | % |
| Commercial loans            |   | —                        |   | 0.0                          | %      | 3,291 |   | 14.4 | % |
| Leases                      |   | 30,864                        |   | 64.7                         | %      | 3,331 |   | 14.5 | % |
| Consumer                    |   | 224                           |   | 0.5                          | %      | 50 |   | 0.2 | % |
| Auto                        |   | 25                            |   | 0.1                          | %      | 16 |   | 0.1 | % |
| Total                       |   | $                             | 47,664 |                         | 100.0  | % | $ | 22,865 |   | 100.0 | % |

 

*Liabilities.* Total liabilities for the nine months endedSeptember 30, 2002 increased $457.8 million. This increase was primarily due to an increase in deposits of $565.6million (38%), which was partially offset by a decrease of $256.9 million inother borrowed funds.  The decrease inother borrowed funds was primarily due to the Company’s re-engineering of itsasset liability mix to shorten the duration of assets and liabilities.  Loans in process increased by $33.3 milliondue to the higher mortgage production activities during the nine months.  Accounts payable and accrued liabilitiesincreased $116.4 million during the nine months ended September 30, 2002 primarilyrelated to liabilities assumed as a result of the acquisition of Resource.

* *

*Deposits-*  The following table sets forth the dollaramount of deposits and weighted average interest rates in the various types ofdeposit programs offered by the Company at September 30, 2002 andDecember 31, 2001:

 
| **($s in  000s)**                      |   | **Amount**              |      | **Percentage**         |   | **Weighted  average  interest  rate** |   | **Amount** |   | **Percentage** |   | **Weighted  average  interest  rate** |   |
|----------------------------------------|--------|-------------------------|-----------|------------------------|--------|---------------------------------------|--------|------------|--------|----------------|--------|---------------------------------------|--------|
|                                   |   | **September  30, 2002** |      | **December  31, 2001** |   |
| Non-interest bearing checking accounts |   | $                       | 215,734   |                   | 10.5   | %                                     | N/A    |       | $      | 26,858         |   | 1.8                                   | %      | N/A |   |
| Interest bearing:                      |   |                    |      |                   |   |                                  |   |       |   |           |   |                                  |   |
| Checking accounts                      |   | 155,612                 |      | 7.6                    | %      | 1.7                                   | %      | 131,887    |   | 8.8            | %      | 1.8                                   | %      |
| Money market                           |   | 715,579                 |      | 34.8                   | %      | 2.7                                   | %      | 492,424    |   | 33.0           | %      | 3.7                                   | %      |
| Certificate of deposit under $100,000  |   | 878,979                 |      | 42.6                   | %      | 3.5                                   | %      | 724,328    |   | 48.5           | %      | 5.8                                   | %      |
| Certificate of deposit over $100,000   |   | 93,469                  |      | 4.5                    | %      | 3.5                                   | %      | 118,322    |   | 7.9            | %      | 5.8                                   | %      |
| Total deposits                         |   | $                       | 2,059,373 |                   | 100.0  | %                                     |   |       | $      | 1,493,819      |   | 100.0                                 | %      |   |   |

 

17

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*Shareholders’equity.* Totalshareholders’ equity increased $141.0 million for the nine months endedSeptember 30, 2002.  This increase isprimarily a result of the issuance of $155.4 million in new equity to effectthe purchase of Resource, offset by a $28.4 million decrease in retainedearnings as a result of a loss for the nine months ended September 30,2002.  Shareholders’ equity alsoreflected an $11.9 million increase in other comprehensive income due to theincrease in fair market value of investment securities available for sale.   Implementation of the Company’s plan topurchase up to 1 million shares of its common stock resulted in 231,500 sharesbeing repurchased for $2.5 million during the first nine months of 2002.  Also, option exercises and shares purchasedunder the Company’s Employee Stock Purchase Plan increased equity balances by$4.1 million and $0.3 million, respectively. As of October 23, 2002, theCompany had authorization to repurchase up to 2 million shares of the Company’soutstanding shares, of which 578,700 have been purchased at an average price of$9.85 per share.

 

**Results of Operations– Three months ended September 30, 2002 compared to the three months endedSeptember 30, 2001**

* *

*General.*  Net income for the three months endedSeptember 30, 2002 was $8.5 million, or $0.17 per share, compared with netincome of $2.1 million, or $0.07 per share, for the three months endedSeptember 30, 2001.  The increase in netincome was driven primarily by the acquisition of Resource and a more favorableinterest rate environment.  These twofactors resulted in a 539% increase ($3.1 billion) in mortgage production and a530% increase ($2.9 billion) in the sales of mortgage loans for the quarterended September 30, 2002 compared to the same quarter in 2001.

* *

*Interest Income*. Interest income related to the Company’sloans, leases, and investment portfolio for the three months ended September30, 2002 was $48.0 million compared to $38.9 million for the three monthsended September 30, 2001. The increase in interest income was a result of theinclusion of $968.1 million of average mortgage loan receivables from theacquisition of Resource, offset by a decrease in the average yield on earningassets due to a declining rate environment.  The yield on the investmentsecurities portfolio declined from 6.0% for the three months ended September30, 2001 to 4.2% for the three months ended September 30, 2002 as managementshortened the duration to reduce the convexity risk and improve the interestrate characteristics of the portfolio with the reinvestment of the funds indiscount agency notes or Fed Funds. The yield was further negatively impactedby the overall decline in interest rates from period to period.  Loanyields on loan and lease receivables declined from 7.7% for the three monthsended September 30, 2001 to 6.0% for the three months ended September 30,2002 as a result of the non-accrual status of delinquent surety-wrappedbusiness equipment leases resulting in $1.9 million of lost interest, and theadjustable portfolio re-pricing downward and prepayments accelerating in adeclining rate environment. Loan yields on mortgages held for sale for thethree months ended September 30, 2002 were 7.1% as compared to 7.6% for thethree months ended September 30, 2001. Average yields on mortgages held forsale declined in relation to the decline in overall interest rates from periodto period.

* *

*Interest Expense*. Total interest expense for the three monthsended September 30, 2002 decreased by $1.0 million from $26.2 million to $25.2million primarily due to the replacement of higher rate other borrowed fundswith the use of NetBank, FSB lower cost funding sources to support the mortgageoperations.  For the three months endedSeptember 30, 2002 there was $13.9 million in interest expense on deposits(checking, money market and certificates of deposits) as compared to$15.1 million for the three months ended September 30, 2001.  The netdecrease in interest expense on deposits was the result of the average interestrate paid on deposits falling from 4.7% for the three months ended September30, 2001 to 2.9% for the three months ended September 30, 2002, offset in-partby an increase in customer deposit balances from $1.8 billion at September30, 2001 to $2.1 billion at September 30, 2002. Interest expense associatedwith other borrowed funds increased $0.3 million from $11.0 million for thethree months ended September 30, 2001 to $11.3 million for the three monthsended September 30, 2002 due to the addition of $349.1 million of several new revolvinglines of credit, warehouse lines of credit, master repurchase facilities and acommercial paper conduit facility all secured by mortgage loans from theacquisition of Resource.  Average rateson other borrowed funds decreased from 4.9% for the three months endedSeptember 30, 2001 to 4.1% for the three months ended September 30, 2002. Thedecrease was associated with the use of NetBank, FSB’s lower borrowing costthrough the Federal Home Loan Bank and deposits versus the use of mortgagewarehouse lines of credit.

* *

*Net Interest Income.*Net interest incomeis determined by interest rate spread, which is the difference between theyields earned on interest–earning assets and the rates paid on interest–bearingliabilities, and the relative amounts of interest–earning assets andinterest–bearing liabilities. Net interest income was $22.8 million, or a netinterest margin of 2.6% for the three months ended September 30, 2002 comparedto $12.8 million, or a net interest margin of 2.1% for the three months endedSeptember 30, 2001. The increase in net

 

18

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####  

interestincome resulted from a steepening of the yield curve and from the higheraverage balances of mortgage loan receivables related to the acquisition ofResource.

 

 
| **As of and  for the three months ended Septermber 30, 2002** |
|---------------------------------------------------------------|
| **Average  balance**                                          | ** ** | **Average  yield / rate** | ** ** |   | ** ** | **Interest** | ** ** |   | ** ** | **Variance attributable to** | ** ** |
| **2002**                                                      |   | **2001** | ** ** | **2002** |   | **2001** |   | **($s in  000s)** |   | **2002** | ** ** | **2001** | ** ** | **Variance** | ** ** | **Rate** | ** ** | **Volume(3)** |   |
|                                                          |   |   |   |   |   |   |   | **Interest-earning assets:** |   |   |   |   |   |   |   |   |   |   |   |
| $                                                             | 73,026 |   | $ | 121,561 |   | 2.62 | % | 2.18 | % | Short-term investments |   | $ | 479 |   | $ | 663 |   | $ | (184 | ) | $ | 134 |   | $ | (318 | ) |
| 742,547                                                       |   | 626,297 |   | 4.21 | % | 5.99 | % | Investment securities(1) |   | 7,822 |   | 9,374 |   | (1,552 | ) | (2,777 | ) | 1,225 |   |
| 1,200,054                                                     |   | 236,861 |   | 7.13 | % | 7.65 | % | Mortgage loans held for  sale(2) |   | 21,394 |   | 4,531 |   | 16,863 |   | (308 | ) | 17,171 |   |
| 1,209,488                                                     |   | 1,269,860 |   | 6.04 | % | 7.68 | % | Loan and leases  receivable(2) |   | 18,272 |   | 24,377 |   | (6,105 | ) | (5,193 | ) | (912 | ) |
| 3,225,115                                                     |   | 2,254,579 |   | 5.95 | % | 6.91 | % | Total interest-earning  assets |   | 47,967 |   | 38,945 |   | 9,022 |   | (8,144 | ) | 17,166 |   |
| 309,256                                                       |   | 243,542 |   |   |   |   |   | Non-interest-earning  assets |   |   |   |   |   |   |   |   |   |   |   |
| 3,534,371                                                     |   | 2,498,121 |   |   |   |   |   | Total assets |   |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   |   |   |   |   | **Interest-bearing liabilities:** |   |   |   |   |   |   |   |   |   |   |   |
| 147,282                                                       |   | 110,554 |   | 1.64 | % | 2.10 | % | Checking accounts |   | 603 |   | 580 |   | 23 |   | (127 | ) | 150 |   |
| 678,766                                                       |   | 386,409 |   | 2.67 | % | 4.14 | % | Money market |   | 4,536 |   | 4,002 |   | 534 |   | (1,420 | ) | 1,954 |   |
| 1,091,656                                                     |   | 761,639 |   | 3.21 | % | 5.57 | % | Certificates of deposit |   | 8,770 |   | 10,612 |   | (1,842 | ) | (4,493 | ) | 2,651 |   |
| 1,059,822                                                     |   | 876,287 |   | 4.12 | % | 4.86 | % | Other borrowed funds |   | 10,916 |   | 10,642 |   | 274 |   | (1,616 | ) | 1,890 |   |
| 27,316                                                        |   | 27,316 |   | 4.80 | % | 4.80 | % | Convertible subordinate  debt |   | 328 |   | 328 |   | — |   | — |   | — |   |
| 3,004,842                                                     |   | 2,162,205 |   | 3.35 | % | 4.84 | % | Total interest-bearing  liabilities |   | 25,153 |   | 26,164 |   | (1,011 | ) | (7,656 | ) | 6,645 |   |
| 138,865                                                       |   | 72,163 |   |   |   |   |   | Non-interest-bearing liabilities |   |   |   |   |   |   |   |   |   |   |   |
| 3,143,707                                                     |   | 2,234,368 |   |   |   |   |   | Total liabilities |   |   |   |   |   |   |   |   |   |   |   |
| 390,664                                                       |   | 263,753 |   |   |   |   |   | Shareholders’ equity |   |   |   |   |   |   |   |   |   |   |   |
| $                                                             | 3,534,371 |   | $ | 2,498,121 |   |   |   |   |   | Total liabilities and shareholders’ equity |   |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                          |   |   |   |   |   |   |   | Net interest earnings |   | $ | 22,814 |   | $ | 12,781 |   | $ | 10,033 |   | $ | (488 | ) | $ | 10,521 |   |
|                                                          |   |   |   | 2.60 | % | 2.07 | % | Net yield |   |   |   |   |   |   |   |   |   |   |   |

 

----

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

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

(3) Variance attributable to mix is includedin the volume variance

* *

*Provision for Loan and Lease Losses.* The Company periodically reviews the performance of its loan portfolio byreviewing chargeoffs, delinquency statistics, and industry statistics on apool-by-pool basis for its purchased portfolio and a loan-by-loan basis for itsoriginated loans. If a decline in credit quality for a specific pool or a loanis noted, the Company records an additional allowance through a charge to theprovision for loan losses. The allowance for loan losses is maintained at alevel estimated to be adequate to provide for inherent losses in the loanportfolio. The Company determines the adequacy of the allowance based uponreviews of individual loans, recent loss experience, current economicconditions, the risk characteristics of the various categories of loans andother pertinent factors.  The Companydecreased its allowance for loan and lease losses by $5.6 million for thequarter ended September 30, 2002 as a result of $5.5 million of net chargeoffsand recoveries and the recapture of $0.1 million of allowance through generalreview of loan pools.

*Non-interest Income.*  Non-interest income increased $55.3 millionto $64.8 million for the three months ended September 30, 2002 compared to $9.6million for the three months ended September 30, 2001.  Of thisincrease, gain on sales of mortgage loans accounted for $30.4 million or 55%,of which $21.1 million is attributable to the mortgage subsidiaries from theacquisition of Resource on March 31, 2002, which were not included in the 2001results.  All of the mortgagesubsidiaries’ improved results were attributable to a lower interest rateenvironment resulting in more favorable pricing conditions.  Service charges and fees increased by $6.9million to $10.6 million for the three months ended September 30, 2002 from$3.7 million in the same period of 2001. The majority of this increase, $7.7 million, is attributable to theaddition of Resource’s mortgage servicing division during the quarter, whichwas not included in the three months ending September 30, 2001.  Other income was $11.4 million for the threemonths ended September 30, 2002.  Thisprimarily consisted of $7.3 million of gains associated with SFAS No. 133, a$2.8 million gain on the sale of an unoccupied office building formerly ownedby Resource and $0.6 million of revenues from MG Reinsurance, a captivereinsurance company acquired as part of the acquisition of Resource on March31, 2002, and $0.7 million from the bank’s leasing operations.  During the three months ended September 30,2002, securities were sold for a gain of $7.6 million, resulting in an increaseof $6.6 million over the gain on sales of securities of  $1.0 million for the three months endedSeptember 30, 2001.

*Non-interestExpense.* Non-interest expense includes all operating expenses such as salaries andbenefits, marketing and general and administrative expenses.  Non-interest expense increased by $55.2million to $74.0 million for the three months ended September 30, 2002 from$18.8 million for the three months ended September 30, 2001.  Of this increase, $42.4 million was due tothe addition of Resource’s non-interest expense. Additionally, during thequarter ended September 30, 2002 the Company incurred $7.5 million of prepaymentpenalty fees on the early extinguishment of $200 million of FHLB advances. Netof the addition of Resource and the prepayment penalty fees, the Company’snon-interest expenses increased $5.3 million related primarily to the overallgrowth of the banking operations and the pre-existing mortgage operations.  The majority of the $5.3 million increase isdue to a $4.1 million increase in salaries and benefits and $1.2 million ofother office, occupancy and general and administrative expenses.

 

 

19

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**Results of Operations– Nine months ended September 30, 2002 compared to the nine months endedSeptember 30, 2001**

* *

*General.*  Net loss for the nine monthsended September 30, 2002 was $28.4 million, or $(0.66) per share, compared withnet income of $3.7 million, or $0.13 per share, for the nine months endedSeptember 30, 2001.  The net loss contained numerous one-time chargesrelated to the acquisition of Resource on March 31, 2002 and the subsequentrepositioning of the Company’s balance sheet and operational units to reflectNetBank’s financial intermediary strategy. The charges, on a pre-tax basis, include: 1) $27.6 million of additionalprovision for loan and lease losses, of which $20.1 million relates to oneportfolio of delinquent surety-wrapped business equipment leases, see Note 10of the Condensed Consolidated Financial Statements for additional details; 2)write-down of premiums associated with higher prepayment experience due to thedecline in interest rates ($12.5 million); 3) non-recurring acquisition andseverance costs ($10.1 million); 4) $9.9 million of prepayment fees associatedwith the early extinguishment of FHLB advances; 5) restructuring of theCompany’s investment portfolio into shorter-term investments, mainly Fed Fundssold and agency discount notes, to facilitate the payoff of pre-existingResource’s lines of credit following the acquisition and the ongoing funding ofthe newly acquired mortgage operations ($6.7 million); 6) $2.5 million from thewrite down of core deposit intangibles related to purchased deposits fromCompubank; 7) $2.1 million associated with the reorganization of non-conformingbranches, the consolidation of the retail bank’s headquarters and the sale ofResource former corporate headquarters. The nine-month period ended September 30, 2002 was also impacted due tothe lost interest of $5.1 million on the delinquent surety-wrapped businessequipment leases, as discussed above.

* *

*Interest Income.*  Interest income related to theCompany’s loans, leases, and investment portfolio for the nine months endedSeptember 30, 2002 was $121.0 million compared to $109.5 million for thenine months ended September 30, 2001. The increase in interest income was aresult of the inclusion of $322.7 of average mortgage loan receivables from theacquisition of Resource, offset by a decrease in the average yield oninvestments and loans and $19.2 million of re-engineering charges taken duringthe first nine months of 2002.  Investment yields declined from 6.4% forthe nine months ended September 30, 2001 to 4.2% for the nine months endedSeptember 30, 2002 as management shortened the duration to reduce the convexityrisk and improve the interest rate characteristics of the portfolio with thereinvestment of the funds in discount agency notes or Fed Funds. The yield wasfurther negatively impacted by the overall decline in interest rates fromperiod to period.  The yield on loan and lease receivables declined from8.0% for the nine months ended September 30, 2001 to 4.9% for the ninemonths ended September 30, 2002 as a result of the write down of loan premiumsof $12.5 million due to accelerated prepayments from a declining rateenvironment, non-accrual status of delinquent surety-wrapped business equipmentleases resulting in lost interest of $5.1 million and the adjustable portfoliore-pricing downward.  Loan yields onmortgages held for sale for the nine months ended September 30, 2002 were 7.5%as compared to 7.7% for the nine months ended September 30, 2001. Averageyields on mortgages held for sale declined in relation to the decline ininterest rates from period to period.

* *

*Interest Expense.*  Interest expense increased by $4.9 millionto $80.0 million for the nine months ended September 30, 2002 compared to $75.1million for the nine months ended September 30, 2001.  The net increase is primarily due to the increased average volumeof other borrowed funds as a result of the acquisition of Resource, offset inpart by the use of the retail bank’s lower cost of funds.  Interest expense on deposits (checking,money market and certificates of deposit) was $41.7

 

20

----

 

millionfor the nine months ending September 30, 2002 compared to $45.8 millionfor the nine months ended September 30, 2001.  The net decrease ininterest expense on deposits was the result of a decrease in the averageinterest rate paid on deposits from 5.3% for the nine months ended September30, 2001 to 3.2% for the nine months ended September 30, 2002, offset in-partby an increase in customer deposit balances from $1.8 billion at September30, 2001 to $2.1 billion at September 30, 2002. Interest expense associatedwith other borrowed funds and convertible subordinated debt increased $9.0million from $29.3 million for the nine months ended September 30, 2001 to$38.3 million for the nine months ended September 30, 2002 due to the additionof $475.6 million of several new revolving lines of credit, warehouse lines ofcredit, master repurchase facilities and a commercial paper conduit facilityall secured by mortgage loans from the acquisition of Resource. In addition,advances from the FHLB increased by $36.0 million for the nine months endedSeptember 30, 2002 as compared to September 30, 2001. Average rates on otherborrowed funds and convertible subordinated debt decreased from 5.1% for thenine months ended September 30, 2001 to 4.5% for the nine months endedSeptember 30, 2002. The decrease in the cost of funds was associated with theuse of the retail bank’s lower borrowing cost through FHLB advances anddeposits versus the use of mortgage warehouse lines of credit.

* *

*Net interest income.* Net interest income is determined by interestrate spread, which is the difference between the yields earned oninterest-earning assets and the rates paid on interest-bearing liabilities, andthe relative amounts of interest-earning assets and interest-bearingliabilities. Net interest income was $41.0 million, or a net interest margin of1.6% for the nine months ended September 30, 2002 compared to$34.4 million, or a net interest margin of 2.3% for the nine months endedSeptember 30, 2001.  The increase in netinterest income resulted primarily from the increase in averageinterest-earning assets from the acquisition of Resource coupled with the lowercost of funds. Net interest income was negatively impacted by repositioningcharges of $19.2 million that were previously discussed in the interest incomesection above.

 

21

----

 
| **As of and  for the nine months ended September 30, 2002** |       |
|-------------------------------------------------------------|------------|
| **Average  balance**                                        | ** ** | **Average  yield / rate** | ** ** |   | ** ** | **Interest** | ** ** |   | ** ** | **Variance  attributable to** | ** ** |
| **2002**                                                    |       | **2001** |   | **2002** |   | **2001** |   | **($s in  000s)** |   | **2002** |   | **2001** |   | **Variance** |   | **Rate** |   | **Volume(3)** |   |
|                                                        |       |   |   |   |   |   |   | **Interest-earning  assets:** |   |   |   |   |   |   |   |   |   |   |   |
| $                                                           | 126,959    |   | $ | 51,553 |   | 2.23 | % | 5.48 | % | Short-term investments |   | $ | 2,121 |   | $ | 2,120 |   | $ | 1 |   | $ | (1,259 | ) | $ | 1,260 |   |
| 772,730                                                     |       | 502,809 |   | 4.19 | % | 6.41 | % | Investment securities (1) |   | 24,255 |   | 24,156 |   | 99 |   | (8,373 | ) | 8,472 |   |
| 786,089                                                     |       | 78,954 |   | 7.45 | % | 7.65 | % | Mortgage loans held for sale(2) |   | 43,913 |   | 4,531 |   | 39,382 |   | (120 | ) | 39,502 |   |
| 1,383,378                                                   |       | 1,315,668 |   | 4.89 | % | 7.97 | % | Loan and lease receivable (2) |   | 50,695 |   | 78,657 |   | (27,962 | ) | (30,443 | ) | 2,481 |   |
| 3,069,156                                                   |       | 1,948,984 |   | 5.26 | % | 7.49 | % | Total interest-earning assets |   | 120,984 |   | 109,464 |   | 11,520 |   | (40,195 | ) | 51,715 |   |
| 613,569                                                     |       | 229,369 |   |   |   |   |   | Non-interest-earning assets |   |   |   |   |   |   |   |   |   |   |   |
| 3,682,725                                                   |       | 2,178,353 |   |   |   |   |   | Total assets |   |   |   |   |   |   |   |   |   |   |   |
|                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                        |       |   |   |   |   |   |   | **Interest-bearing  liabilities:** |   |   |   |   |   |   |   |   |   |   |   |
| 141,495                                                     |       | 94,925 |   | 1.65 | % | 2.33 | % | Checking accounts |   | 1,752 |   | 1,661 |   | 91 |   | (486 | ) | 577 |   |
| 622,281                                                     |       | 336,562 |   | 2.73 | % | 4.62 | % | Money market |   | 12,754 |   | 11,671 |   | 1,083 |   | (4,773 | ) | 5,856 |   |
| 987,840                                                     |       | 720,837 |   | 3.67 | % | 6.00 | % | Certificates of deposit |   | 27,185 |   | 32,464 |   | (5,279 | ) | (12,627 | ) | 7,348 |   |
| 1,099,520                                                   |       | 737,025 |   | 4.53 | % | 5.13 | % | Other borrowed funds |   | 37,347 |   | 28,337 |   | 9,010 |   | (3,303 | ) | 12,313 |   |
| 27,316                                                      |       | 27,316 |   | 4.77 | % | 4.77 | % | Convertible subordinate debt |   | 977 |   | 977 |   | — |   | — |   | — |   |
| 2,878,452                                                   |       | 1,916,665 |   | 3.71 | % | 5.23 | % | Total interest-bearing liabilities |   | 80,015 |   | 75,110 |   | 4,905 |   | (21,189 | ) | 26,094 |   |
| 408,697                                                     |       | 8,112 |   |   |   |   |   | Non-interest-bearing liabilities |   |   |   |   |   |   |   |   |   |   |   |
| 3,287,149                                                   |       | 1,924,777 |   |   |   |   |   | Total liabilities |   |   |   |   |   |   |   |   |   |   |   |
| 395,576                                                     |       | 253,576 |   |   |   |   |   | Shareholders’ equity |   |   |   |   |   |   |   |   |   |   |   |
| $                                                           | 3,682,725  |   | $ | 2,178,353 |   |   |   |   |   | Total liabilities and shareholders’ equity |   |   |   |   |   |   |   |   |   |   |   |
|                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                        |       |   |   |   |   |   |   | Net interest earnings |   | $ | 40,969 |   | $ | 34,354 |   | $ | 6,615 |   | $ | (19,006 | ) | $ | 25,621 |   |
|                                                        |       |   |   | 1.55 | % | 2.26 | % | Net yield |   |   |   |   |   |   |   |   |   |   |   |

 

----

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

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

(3) Variance attributable tomix is included in the volume variance

 

*Provision for Loanand Lease Losses.* The Company periodically reviews the performance of its loan portfolio byreviewing chargeoffs, delinquency statistics, and industry statistics on apool-by-pool basis for its purchased portfolio and a loan-by-loan basis for itsoriginated loans. If a decline in credit quality for a specific pool or a loanis noted, the Company records an additional allowance through a charge to theprovision for loan losses. The allowance for loan losses is maintained at alevel estimated to be adequate to provide for inherent losses in the loanportfolio. The Company determines the adequacy of the allowance based uponreviews of individual loans, recent loss experience, current economicconditions, the risk characteristics of the various categories of loans andother pertinent factors.  During thenine months ended September 30, 2002 the Company increased its allowance forloan losses from $22.9 million to $47.7 million, an increase of $24.8 million.  This increase is primarily due to theestablishment of an additional allowance for commercial leases of $20.1million, as discussed in Note 10 of the Company’s Condensed ConsolidatedFinancial Statements. 

 

*Non-interest Income.*  Non-interest income increased by $99.6million to $115.1 million for the nine months ended September 30, 2002 comparedto $15.6 million for the same period of 2001. This increase is primarily due to gain on sales of mortgage loans andmortgage servicing rights of $70.4 million generated by the Company’s mortgagesubsidiaries, RBMG, Meritage and Market Street as compared to $4.8 milliongenerated for the same period of 2001. RBMG and Meritage had not been acquired and, therefore, were notincluded in the Company’s 2001 results, which only included Market Street forthe three months ended September 30, 2001. Service charges and fees increased by $19.4 million to $26.6 millionfrom $7.2 million for the periods ending September 30, 2002 and 2001,respectively, also due to the acquisitions of the mortgage subsidiaries. TheCompany recorded an increase in gain on sale of securities of $2.2 million to$5.8 million for the nine months ended September 30, 2002 compared to $3.6million for the nine months ended September 30, 2001.  Other income was $12.4 million for the period ended September 30,2002. Other income consisted primarily of 1) $6.9 million of gains associatedwith SFAS No. 133, 2) a $2.8 million gain on the sale of an unoccupied officebuilding formerly owned by Resource, 3) $1.2 million of revenues from MGReinsurance, a captive reinsurance company acquired as part of the acquisitionof Resource on March 31, 2002, 4) $0.5 million from the bank’s leasingoperations, 5) $1.0 of other ancillary income. 

 

 

22

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*Non-interest Expense.*  Non-interest expense includes all operatingexpenses such as salaries and benefits, marketing and general andadministrative expenses. Non-interest expense increased by $131.1 million to$174.8 million for the nine months ended September 30, 2002 compared to $43.6million for the nine months ended September 30, 2001.  Of this increase, $93.1 million relates to the addition ofResource and Market Street’s non-interest expense, as Resource and MarketStreet were not acquired until March 31, 2002 and June 29, 2001, respectively.Also during the nine months ended September 30, 2002 the Company incurred $9.9million of prepayment penalty fees associated with the early extinguishment ofFHLB advances.  Additionally for thenine months ended September 30, 2002, non-interest expense included $10.1million of non-recurring acquisition and severance costs.  There were also$7.3 million of repositioning charges incurred during the nine months endedSeptember 30, 2002 including $1.9 million of severance, $2.5 million related tothe write down of deposit intangibles associated with the acquisition ofdeposits from Compubank, a $2.0 million charge for the consolidation of leasedoffice space and $0.9 million of other repositioning charges. Net of theaddition of the new subsidiaries, prepayment penalties, transaction costsrelated to the acquisition of Resource and the strategic repositioning charges,the Company’s non-interest expenses increased $10.8 million.  This is primarily attributable to theoverall growth of the banking operations including a $6.1 million increase insalaries and benefits, a $1.2 million increase in loan servicing expenses, a$1.1 million increase in data processing expense, a $1.0 million increase indepreciation and amortization, and $1.3 million of other increases.

 

***Retail Bank Operations***

 

**The table below provides anoverview of the results of operations for the retail bank for the quartersended September 30, 2002 and 2001:**

** **
|                                                        |   | **For the  quarters ended September 30,** |       |
|-------------------------------------------------------------|--------|-------------------------------------------|------------|
| **($s in 000s)**                                            |   | **2002**                                  | ** ** | **2001** | ** ** | **Change** | ** ** |
| Net interest income                                         |   | $                                         | 9,689      |   | $ | 11,362 |   | $ | (1,673 | ) |
| Provision for loan losses                                   |   | 95                                        |       | (76 | ) | 171 |   |
| Gain on sales of loans                                      |   | 3,701                                     |       | — |   | 3,701 |   |
| Service charges and fees                                    |   | 4,265                                     |       | 3,144 |   | 1,121 |   |
| Total revenues                                              |   | 17,750                                    |       | 14,430 |   | 3,320 |   |
|                                                        |   |                                      |       |   |   |   |   |
| Total expenses                                              |   | 15,078                                    |       | 12,597 |   | 2,481 |   |
| Pre-tax income before gains on securities                   |   | 2,672                                     |       | 1,833 |   | 839 |   |
| Gain (loss) on securities sales and  extinguishment of debt |   | 187                                       |       | 1,035 |   | (848 | ) |
| Pre-tax income                                              |   | $                                         | 2,859      |   | $ | 2,868 |   | $ | (9 | ) |

** **

**Netinterest income declined $1.7 million from $11.4 million to $9.7 million forthe three months ended September 30, 2002 compared to the three months endedSeptember 30, 2001.  This was dueprimarily to the non-accrual status of CMC leases, which adversely impacted netinterest income by $1.9 million for the three months ended September 30, 2002.Gain on sale of loans increased as the result of the sale of loans deemed to benon-core under NetBank’s financial intermediary strategy, whereby assets areheld temporarily and mined for cross-sell opportunities.  Assets where cross-sell efforts areunsuccesful are subsequently sold on an opportunistic basis.   Service charges increased by $1.1 millionfor the quarter ended September 30, 2002 compared to the comparable quarter of2001 primarily due to increased revenue in the retail bank’s leasingoperation.  Expenses increased as aresult of the addition of the bank’s leasing operations stemming from theacquisition of Resource and variable expenses related to the increase in depositgrowth. Deposits at September 30, 2002 totaled $2.1 billion, with totalcustomers of 150,234 compared with $1.3 billion and 157,446 total customers atSeptember 30, 2001.**

** **

**23**

----

** **

**Thetable below provides an overview of the results of operations for the retailbank for the nine-month periods ended September 30, 2002 and 2001:**

 
|                                                              |   | **For the  nine months ended  September 30,** |       |
|-------------------------------------------------------------------|--------|-----------------------------------------------|------------|
| **($s in 000s)**                                                  |   | **2002**                                      | ** ** | **2001** | ** ** | **Change** | ** ** |
| Net  interest income                                              |   | $                                             | 17,006     |   | $ | 32,935 |   | $ | (15,929 | ) |
| Provision for loan losses                                         |   | (27,896                                       | )          | (246 | ) | (27,650 | ) |
| Gain on sales of loans                                            |   | 3,701                                         |       | — |   | 3,701 |   |
| Service charges and fees                                          |   | 11,138                                        |       | 7,652 |   | 3,486 |   |
| Total revenues                                                    |   | 3,949                                         |       | 40,341 |   | (36,392 | ) |
|                                                              |   |                                          |       |   |   |   |   |
| Total expenses                                                    |   | 53,372                                        |       | 37,454 |   | 15,918 |   |
| Pre-tax (loss) income before gains on  securities                 |   | (49,423                                       | )          | 2,887 |   | (52,310 | ) |
| (Loss) gain on securities sales and  extinguishment  of debt |   | (4,078                                        | )          | 2,524 |   | (6,602 | ) |
| Pre-tax (loss) income                                             |   | $                                             | (53,501    | ) | $ | 5,411 |   | $ | (58,912 | ) |

 

The reduced net interestincome for the nine months ended September 30, 2002 compared with thecomparable period in 2001 is the result of: 1) a writedown of loan premiums of$12.5 million during the second quarter of 2002 due to the acceleration ofprepayments in a declining rate environment, 2) the non-accrual status of theCMC leases, which reduced 2002 interest income by $5.1 million, see Note 10 ofthe Company’s Condensed Consolidated Financial Statements, and 3) shorteningthe duration of assets in the first and second quarters of 2002 in anticipationof the Resource merger and resulting warehouse funding for its conformingmortgage banking operations.  Theprovision for loan losses increased by $27.7 million related to theestablishment of additional allowance for CMC leases of $20.1 million,discussed in Note 10 of the Company’s Condensed Consolidated FinancialStatements, an additional $6.6 million allowance recorded for the retail bank’ssecond mortgage portfolio, both during the second quarter of 2002 and 3) $1.0of provision net of chargeoffs and recoveries. Gain on sales of loans increased as the result of the sale of loansdeemed to be non-core under NetBank’s financial intermediary strategy, wherebyassets are held temporarily and mined for cross-sell opportunities.  Assets where cross-sell efforts areunsuccessful are subsequently sold on an opportunistic basis.  Service charges increased by $3.5 millionfor the nine months ended September 30, 2002 compared to the comparable periodin 2001 related to increased revenue in the retail bank’s leasingoperation.  Operating expenses increasedby $15.9 million related to 1) $7.5 million of non-operating expenses andcharges associated with the retail bank’s strategic repositioning as a financialintermediary, 2) expenses relating to leasing operations acquired in theResource merger of $2.3 million, and 3) the increase in variable expensesrelated to deposit growth.  Deposits atSeptember 30, 2002 totaled $2.1 billion, with total customers of 150,234compared with $1.3 billion and 157,446 total customers at September 30, 2001.

 

24

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**MortgageBanking**

** **

The following highlights themortgage production and sales activities for the three and nine-month periodsended September 30, 2002 and 2001:

 
|                     |   | **For the  quarter ended  September 30,** |       | **For the  nine months ended  September 30,** |       |
|--------------------------|--------|-------------------------------------------|------------|-----------------------------------------------|------------|
| **($s in  000s)**        |   | **2002**                                  | ** ** | **2001**                                      | ** ** | **2002** | ** ** | **2001** | ** ** |
| **Production Activity:** |   |                                      |       |                                          |       |   |   |   |   |
| Retail                   |   | $                                         | 628,669    |                                          | $          | 567,461 |   | $ | 1,636,097 |   | $ | 567,461 |   |
| Correspondent            |   | 1,686,094                                 |       | —                                        |       | 2,978,448 |   | — |   |
| Wholesale                |   | 877,712                                   |       | —                                        |       | 1,502,227 |   | — |   |
| Total agency-eligible    |   | 3,192,475                                 |       | 567,461                                       |       | 6,116,772 |   | 567,461 |   |
| Non-conforming           |   | 433,559                                   |       | —                                        |       | 908,113 |   | — |   |
| Total                    |   | $                                         | 3,626,034  |                                          | $          | 567,461 |   | $ | 7,024,885 |   | $ | 567,461 |   |
|                     |   |                                      |       |                                          |       |   |   |   |   |
| **Sales Activity:**      |   | $                                         | 3,440,597  |                                          | $          | 545,763 |   | $ | 6,949,565 |   | $ | 545,763 |   |

 

The increase in retailproduction was primarily due to the improved mortgage market as a result ofgenerally lower interest rates.  Theincreases in the correspondent, wholesale and non-conforming production andsales activities in 2002 compared with 2001 relates to the acquisition ofResource Bancshares Mortgage Group, Inc. on March 31, 2002, which would not beincluded in the 2001 results.  SinceMarket Street was not acquired until June 29, 2001 its results were onlyincluded in the three months ended September 30, 2001 of the nine monthspresented for 2001.

 

Thefollowing highlights the mortgage loan production and sales-related revenue andexpenses for the three and nine-month periods ended September 30, 2002 and2001:

 
|                                              |   | **For the  quarter ended  September 30,** |       | **For the  nine months ended  September 30,** |       |
|---------------------------------------------------|--------|-------------------------------------------|------------|-----------------------------------------------|------------|
| **($s in  000s)**                                 |   | **2002**                                  | ** ** | **2001**                                      | ** ** | **2002** | ** ** | **2001** | ** ** |
| Production revenues                               |   | $                                         | 60,227     |                                          | $          | 6,796 |   | $ | 117,927 |   | $ | 6,796 |   |
|                                              |   |                                      |       |                                          |       |   |   |   |   |
| Production expenses                               |   | 49,875                                    |       | 6,200                                         |       | 98,377 |   | 6,200 |   |
| Pre-tax profit                                    |   | $                                         | 10,352     |                                          | $          | 596 |   | $ | 19,550 |   | $ | 596 |   |
|                                              |   |                                      |       |                                          |       |   |   |   |   |
| Production revenues in bps of sales               |   | 175.05                                    |       | 124.52                                        |       | 169.69 |   | 124.52 |   |
|                                              |   |                                      |       |                                          |       |   |   |   |   |
| Production expenses in bps of principal  produced |   | 137.55                                    |       | 109.26                                        |       | 140.04 |   | 109.26 |   |
|                                              |   |                                      |       |                                          |       |   |   |   |   |
| Net production margin in bps                      |   | 37.50                                     |       | 15.26                                         |       | 29.65 |   | 15.26 |   |

 

The increase in the productionrevenues and expenses in 2002 compared with 2001 primarily relates to theacquisition of Resource on March 31, 2002.

 

25

----

 

The following summarizes theresults of servicing operations for the quarter and nine months ended September30, 2002 and 2001:

 
|                                                      |   | **For the  quarter ended  September 30,** |       | **For the  nine months ended  September 30,** |       |
|-----------------------------------------------------------|--------|-------------------------------------------|------------|-----------------------------------------------|------------|
| **($s in  000s)**                                         |   | **2002**                                  | ** ** | **2001**                                      | ** ** | **2002** | ** ** | **2001** | ** ** |
| Servicing revenue:                                        |   |                                      |       |                                          |       |   |   |   |   |
| Net interest income                                       |   | 264                                       |       | —                                        |       | (492 | ) | — |   |
| Service charges and fees                                  |   | 7,095                                     |       | —                                        |       | 14,194 |   | — |   |
| (Loss) gain on sale of mortgage servicing  rights         |   | (946                                      | )          | —                                        |       | 37 |   |   |   |
| Other income                                              |   | 3,785                                     |       | —                                        |       | 3,617 |   | — |   |
| Total servicing revenue                                   |   | $                                         | 10,198     |                                          | $          | — |   | $ | 17,356 |   | $ | — |   |
|                                                      |   |                                      |       |                                          |       |   |   |   |   |
| Servicing expenses:                                       |   |                                      |       |                                          |       |   |   |   |   |
| Operating expenses                                        |   | 4,425                                     |       | —                                        |       | 8,769 |   | — |   |
| Amortization and impairment of mortgage  servicing rights |   | 10,828                                    |       | —                                        |       | 18,332 |   | — |   |
| Total servicing expenses                                  |   | 15,253                                    |       | —                                        |       | 27,101 |   | — |   |
| Pre-tax loss                                              |   | $                                         | (5,055     | )                                             | $          | — |   | $ | (9,745 | ) | $ | — |   |

 

The increase in servicingrevenues and expenses in 2002 when compared to 2001 relates to the acquisitionof Resource on March 31, 2002.   Theloss in the servicing operations resulted primarily from impairmentadjustments, net of hedge results, related to the Company’s investment inmortgage servicing rights.  Mortgageservicing values continued the downward trend associated with current highlevels of prepayments related to the low interest rate economic environment.

 

**Liquidity and CapitalResources**

 

NetBank’sliquidity, represented by cash and cash equivalents, is a product of itsoperating, investing and financial activities. NetBank’s primary sources offunds are deposits, borrowings, prepayments and maturities of outstandingloans, sales of loans, maturities of investment securities and other short-terminvestments and funds provided from operations. While scheduled loan paymentsand maturing investment securities and short-term investments are relativelypredictable sources of funds, deposit flows and loan prepayments are greatlyinfluenced by general interest rates, economic conditions and competition.NetBank invests excess funds in overnight deposits and other short-terminterest–earning assets. NetBank can use cash generated through the retaildeposit market, its traditional funding source, to offset the cash utilized ininvesting activities. NetBank’s available for sale securities and short-terminterest–earning assets can also be used to provide liquidity for lending andother operational requirements.  Thetable below reflects the capital position and capital requirement of NetBank,FSB as filed in its Thrift Financial Report (TFR) for the quarterly periodending September 30, 2002.

 
|                                     |   | **Actual** |    | **For  capital adequacy  purposes** |   | **To be  categorized as  Well Capitalized  under prompt  corrective action plan** |   |
|------------------------------------------|--------|------------|---------|-------------------------------------|--------|-----------------------------------------------------------------------------------|--------|
| **($s in  000s)**                        |   | **Amount** |    | **Ratio**                           |   | **Amount**                                                                        |   | **Ratio** |   | **Amount** |   | **Ratio** |   |
| **September 30, 2002**                   |   |       |    |                                |   |                                                                              |   |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)  |   | $          | 259,358 |                                | 14.86  | %                                                                                 | $      | 139,592 |   | 8.00 | % | $ | 174,534 |   | 10.00 | % |
| Core capital (to tangible assets)        |   | $          | 232,465 |                                | 7.28   | %                                                                                 | $      | 127,682 |   | 4.00 | % | $ | 159,660 |   | 5.00 | % |
| Tangible capital (to tangible assets)    |   | $          | 232,465 |                                | 7.28   | %                                                                                 | $      | 47,898 |   | 1.50 | % | N/A |   | N/A |   |
| Tier I capital (to risk-weighted assets) |   | $          | 232,465 |                                | 13.32  | %                                                                                 | N/A    |   | N/A |   | $ | 104,714 |   | 6.00 | % |
| **December 31, 2001**                    |   |       |    |                                |   |                                                                              |   |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)  |   | $          | 220,982 |                                | 14.64  | %                                                                                 | $      | 120,775 |   | 8.00 | % | $ | 150,969 |   | 10.00 | % |
| Core capital (to tangible assets)        |   | $          | 202,061 |                                | 7.10   | %                                                                                 | $      | 113,847 |   | 4.00 | % | $ | 142,309 |   | 5.00 | % |
| Tangible capital (to tangible assets)    |   | $          | 202,061 |                                | 7.10   | %                                                                                 | $      | 42,693 |   | 1.50 | % | N/A |   | N/A |   |
| Tier I capital (to risk-weighted assets) |   | $          | 202,061 |                                | 13.38  | %                                                                                 | N/A    |   | N/A |   | $ | 90,581 |   | 6.00 | % |

 

26

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#### **Part I. Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK**

 

*Interest RateSensitivity*******-**The Company measure 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-rate sensitiveliabilities exceeds the amount of interest-rate sensitive assets. In a risingrate environment, an institution with a positive gap would see an increase innet interest income, where an institution with a negative gap would see adecrease. During a period of falling interest rates the reverse is true.

 

Thefollowing table sets forth the interest rate sensitivity of the Company'sassets and liabilities as of September 30, 2002:

 
|                                                                       |   | **Less than  three months**                   |      | **Over three  months  through one  year** |   | **Over one   year through  five years** |   | **Over five  years and  insensitive** |      | **Total** |   |
|----------------------------------------------------------------------------|--------|-----------------------------------------------|-----------|-------------------------------------------|--------|-----------------------------------------|--------|---------------------------------------|-----------|-----------|--------|
| **($s in the  000s)**                                                      |   | **Term to  repricing, repayment or maturity** |      |
| Interest-earning Assets:                                                   |   |                                          |      |                                      |   |                                    |   |                                  |      |      |   |
| Cash and cash equivalents                                                  |   | $                                             | 124,984   |                                      | $      | —                                  |   | $                                     | —    |      | $      | — |   | $ | 124,984 |   |
| Federal funds sold                                                         |   | 133,205                                       |      | —                                    |   | —                                  |   | —                                |      | 133,205   |   |
| Investment securities                                                      |   | 27,107                                        |      | 53,308                                    |   | 348,139                                 |   | 244,718                               |      | 673,272   |   |
|                                                                       |   |                                          |      |                                      |   |                                    |   |                                  |      |      |   |
| Stock of Federal Home Loan Bank of Atlanta                                 |   | 33,305                                        |      | —                                    |   | —                                  |   | —                                |      | 33,305    |   |
| Loans held for sale                                                        |   | 1,230,220                                     |      | —                                    |   | —                                  |   | —                                |      | 1,230,220 |   |
| Loans receivable                                                           |   | 275,843                                       |      | 259,989                                   |   | 410,934                                 |   | 13,441                                |      | 960,207   |   |
| Total interest-earning assets:                                             |   | 1,824,664                                     |      | 313,297                                   |   | 759,073                                 |   | 258,159                               |      | 3,155,193 |   |
| Non interest-earning assets                                                |   | —                                        |      | —                                    |   | —                                  |   | 323,126                               |      | 323,126   |   |
| Total assets                                                               |   | 1,824,664                                     |      | 313,297                                   |   | 759,073                                 |   | 581,285                               |      | 3,478,319 |   |
|                                                                       |   |                                          |      |                                      |   |                                    |   |                                  |      |      |   |
| Interest-bearing liabilities:                                              |   |                                          |      |                                      |   |                                    |   |                                  |      |      |   |
| Interest-bearing deposits                                                  |   | 301,457                                       |      | 863,424                                   |   | 519,678                                 |   | 159,080                               |      | 1,843,639 |   |
| Convertible subordinated debt                                              |   | —                                        |      | —                                    |   | 27,049                                  |   | —                                |      | 27,049    |   |
| Other borrowed funds                                                       |   | 130,076                                       |      | 30,000                                    |   | 570,000                                 |   | 25,000                                |      | 755,076   |   |
| Total interest-bearing liabilities:                                        |   | 431,533                                       |      | 893,424                                   |   | 1,116,727                               |   | 184,080                               |      | 2,625,764 |   |
| Interest-free deposits                                                     |   | —                                        |      | —                                    |   | —                                  |   | 215,734                               |      | 215,734   |   |
| Other interest-free liabilities and equity                                 |   | —                                        |      | —                                    |   | —                                  |   | 636,821                               |      | 636,821   |   |
| Total liabilities and equity                                               |   | $                                             | 431,533   |                                      | $      | 893,424                                 |   | $                                     | 1,116,727 |      | $      | 1,036,635 |   | $ | 3,478,319 |   |
|                                                                       |   |                                          |      |                                      |   |                                    |   |                                  |      |      |   |
| Net interest rate sensitivity gap                                          |   | $                                             | 1,393,131 |                                      | $      | (580,127                                | )      | $                                     | (357,654  | )         | $      | 74,079 |   | $ | 529,429 |   |
| Cumulative gap                                                             |   | $                                             | 1,393,131 |                                      | $      | 813,004                                 |   | $                                     | 455,350   |      | $      | 529,429 |   | N/A |   |
| Net interest rate sensitivity gap as a  percent of interest-earning assets |   | 76.35                                         | %         | (185.17                                   | )%     | (47.12                                  | )%     | 28.70                                 | %         | 16.78     | %      |
| Cumulative gap as a percent of cumulative  interest-earning assets         |   | 76.35                                         | %         | 38.03                                     | %      | 15.72                                   | %      | 16.78                                 | %         | N/A       |   |

 

*Market Risk -*The Company’s principal business is originatingand purchasing of mortgage loans funded by customer deposits and, to the extentnecessary, other borrowed funds. Consequently, a significant portion of theCompany's assets and liabilities are monetary in nature and fluctuations ininterest rates will affect the Company's future net interest income and cashflows. This interest rate risk is the Company's primary market risk exposure.During the three months ended September 30, 2002, the only derivative financialinstruments that the Company entered into were related to hedging activitiesrelated to 1) the portfolio mortgage loans held for sale, 2) the pipeline ofmortgage loans for which the interest rate has been locked, 3) the ownedservicing rights asset and 4) the servicing rights which the Company intends toretain associated with the pipeline of mortgage loans for which the interestrate has already been locked. The Company has no market risk-sensitiveinstruments held for trading purposes. The Company's exposure to market risk isreviewed on a regular basis by management.

 

27

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TheCompany measures interest rate risk based on Net Portfolio Value (“NPV”)analysis.  NPV equals the present valueof expected net cash flows from existing assets minus the present value ofexpected net cash flows from existing liabilities. A NPV ratio is determined bydividing NPV by the present value of assets. The following table sets forth theestimated percentage change in NetBank NPV ratio as of September 30, 2002assuming rate shocks of +300 to -200 basis points:

 

**Limitsand current NPV ratios for NetBank, FSB**

 

| **Rate shock  (in basis points)** |   | **9/30/02  NPV ratios for  NetBank, FSB** |   | **9/30/01NPV ratios for  NetBank, FSB** |   |
|-----------------------------------|--------|-------------------------------------------|--------|-----------------------------------------|--------|
| +300                              |   | 9.55                                      | %      | 7.34                                    | %      |
| +200                              |   | 9.80                                      | %      | 8.34                                    | %      |
| +100                              |   | 9.97                                      | %      | 9.21                                    | %      |
| Flat                              |   | 9.95                                      | %      | 9.98                                    | %      |
| -100                              |   | 10.12                                     | %      | 9.65                                    | %      |
| -200                              |   | 10.96                                     | %      | 9.11                                    | %      |

 

Computationof prospective effects of hypothetical rate changes is based on manyassumptions, including relative levels of market interest rates, loanprepayments and deposit decay. They should not be relied upon as indicative ofactual results. Further, the computations do not contemplate certain actionsmanagement could undertake in response to changes in interest rates.

** **

**Part I. Item 4:****  Controls andProcedures**

 

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,including the Company’s Chief Executive Officer and Chief Financial Officer, ofthe effectiveness 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 could significantlyaffect those internal controls subsequent to the date the Company carried outits evaluation, and there have been no corrective actions with respect tosignificant deficiencies and material weaknesses.

#### ** **

#### **Part II. Item 1: LEGAL PROCEEDINGS**

 

Illinois UnionInsurance Co. v. Commercial Money Center, Inc., et al., Case No. CV-01-0685-KJD-RJJ (District Court of Nevada)

 

On December 3, 2001, NetBank,FSB was served with a complaint filed by Illinois Union Insurance Company inthe United States District Court for the District of Nevada.  The complaintseeks rescission of certain insurance policies relating to leases purchased byNetBank, FSB and restitution and recovery of any benefits paid to NetBank,FSB.  NetBank, FSB has filed a motion to dismiss the complaint, which iscurrently pending with the Nevada court. NetBank, FSB, in turn, filed a separate action in the United StatesDistrict Court for the Northern District of Georgia against Commercial MoneyCenter, Inc. (“CMC”), the originator, seller, and subservicer of the leases,and Illinois Union, Safeco Insurance Company of America, and Royal IndemnityCompany, the insurance companies that issued surety bonds and insurancepolicies guaranteeing payment of the income stream from the leases and thatalso served as master servicers of the leases. The NetBank, FSB action alleges claims for breach of contract, fraud,and bad faith, and seeks, among other things, payment under and enforcement ofperformance bonds and insurance policies issued by the insurance and suretycompanies.  The Georgia case has been transferred to the District ofNevada. Meanwhile, on October 25, 2002, the Judicial Panel on Multi-DistrictLitigation consolidated the action brought by NetBank, FSB with 22 other casespending around the country involving other investors who are seeking to enforcesurety bonds and 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.  On May 30,2002, CMC filed for bankruptcy protection in the United States Bankruptcy 

 

28

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Court for the Southern Districtof Florida. However, on September 18, 2002, that bankruptcy proceeding wastransferred to the United States Bankruptcy Court for the Southern District ofCalifornia and is not part of the consolidation of cases in Ohio.  NetBank, FSB intends to vigorously pursueits claims against the insurance companies.

 

In reCommercial Money Center, Inc./Clayton v. Commercial Money Center, Inc.,Case No 02-24068 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 recently amended theircomplaint to name NetBank, FSB, several other investor banks, and severalsurety companies as co-defendants in the action.  After CMC filed for bankruptcy, Royal Indemnity Company removed theaction to the bankruptcy court in the Central District of California, and theplaintiffs have filed a motion to remand the case back to state court.  The court tentatively ruled that the caseshould be remanded to state court, but later transferred the case to thebankruptcy court in the Southern District of California, where the CMCbankruptcy is now pending.  As a result,the motion to remand now is pending before the transferee bankruptcycourt.  NetBank, FSB intends tovigorously defend the case and to pursue recovery against Safeco InsuranceCompany, Royal Indemnity Company, and Illinois Union Insurance Company for anydamages and costs incurred in this case.

* *

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

 

On June 27, 2001, the Company wasserved with a complaint for a declaratory judgment filed by interState NetBankin the District of New Jersey challenging the “NETBANK®” service mark. The Company answered and counterclaimed for trademark infringement on July 13,2001.  Discovery was stayed pending a ruling on interState NetBank’sNovember 19, 2001 motion for summary judgment, which claimed that“NETBANK” is generic for all banking services delivered over the Internet. OnSeptember 22, 2002, the District Court ruled that “NETBANK” is generic but didnot cancel the Company’s existing service mark registration.   The Company filed a motion forreconsideration of the District Court’s decision.

 

The Company intends tovigorously defend against interState NetBank’s challenge of the “NETBANK®”service mark and will pursue its counterclaims for trademark infringement,cyberpiracy and unfair competition. While there is a possibility of an adverseoutcome for the Company, at this stage of the matter, we cannot fairlydetermine the likelihood of an adverse outcome.  However, in the event ofan adverse outcome, it is unlikely that there would be a monetary loss asidefrom the loss in value of the intellectual property rights in the NETBANK®registration.

 

The Company has also sentnumerous letters to other entities that appear to be infringing the Company’srights in the NETBANK® service mark and variations of that mark.  Theletters demand that the entities immediately cease and desist from any suchinfringing 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, its cancellation isunlikely.  For this reason, future litigationto enforce trademark rights will not be reported.

 

29

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** **
| **Part II.** | **Item 2 - Changes in securities and use of proceeds**                                          |
|--------------|-------------------------------------------------------------------------------------------------|
|         |
|         | **None**                                                                                        |
|         |                                                                                            |
| **Part II.** | **Item 3 - Defaults upon senior securities**                                                    |
|         |
|         | **None**                                                                                        |
|         |                                                                                            |
| **Part II.** | **Item 4 - Submission  of matters to a vote of security holders**                               |
|         |
|         | **None**                                                                                        |
|         |                                                                                            |
| **Part II.** | **Item 5 – Other information**                                                             |
|         |
|         | **None**                                                                                        |
|         |                                                                                            |
| **Part II.** | **Item 6. - Exhibits and reports on Form 8-k**                                                  |
|         |
|         | Exhibit 99.1  – Certifications pursuant to Section 906 of the Sarbanes-Oxley Act of 2002   |
|         |                                                                                            |
|         | The Company  did not file any reports on Form 8-k during the quarter ended September 30,  2002. |

 

#### **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: November 14, 2002 |          | *Chief Financial Executive* |

 

30

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**Certification**

 

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

 

1.         I have reviewed this quarterly reporton 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(s) 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(s) and I have disclosed, based on ourmost recent 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.             The registrant’s other certifying officer(s) and I haveindicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date:  | November 14,  2002 |                     | /s/ Douglas  K. Freeman |   |
|--------|--------------------|--------------------------|-------------------------|--------|
|   |               |                     |                    |   |
|   |               | Douglas K.  Freeman      |
|   |               | Chief Executive  Officer |

 

31

----

 

**Certification**

** **

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

 

1.         I have reviewed this quarterly reporton 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(s) 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(s) and I have disclosed, based on ourmost recent 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.             The registrant’s other certifying officer(s) and I haveindicated in this quarterly report whether or not there were significantchanges in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of our most recent evaluation,including any corrective actions with regard to significant deficiencies andmaterial weaknesses.

 
| Date:  | November 14,  2002 |                       | /s/ Steven  F. Herbert |   |
|--------|--------------------|----------------------------|------------------------|--------|
|   |               |                       |                   |   |
|   |               | Steven F.  Herbert         |
|   |               | Chief  Financial Executive |

# * *

32

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