** **

**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, 2005**

** **

**Commission File No. 0-22361**

 

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

 

| **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 areacode:

 

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

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Exchange Act Rule12b-2):YES ý  NO o

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act):

YES o  NO ý

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock, as of the latest practicabledate:

 

| **Class**                    | ** ** | **Shares Outstanding at October  31, 2005** |
|------------------------------|------------|---------------------------------------------|
| Common Stock, par value $.01 |       | 46,359,564                                  |

 

 

----

 

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

 
| **Part I.  Financial Information**                                                                                                  | **3**      |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                          | ** ** |
| **Item  1. Financial Statements (Unaudited)**                                                                                       | **3**      |
| ** **                                                                                                                          |       |
| **Consolidated  balance sheets as of September 30, 2005 and December 31, 2004**                                           | **3**      |
| ** **                                                                                                                          |       |
| **Consolidated  statements of operations for the three and nine months ended September 30, 2005 and 2004**                | **4**      |
| ** **                                                                                                                          |       |
| **Consolidated  statements of shareholders’ equity for the three and nine months ended September 30, 2005 and 2004** | 5          |
| ** **                                                                                                                          |       |
| **Consolidated  statements of cash flows for the nine months ended September 30, 2005 and 2004**                          | 6          |
| ** **                                                                                                                          |       |
| **Notes  to consolidated financial statements**                                                                                     | 7          |
|                                                                                                                                |       |
| **Item  2. Management’s Discussion and Analysis of Financial Condition and Results of  Operations**                            | 18         |
|                                                                                                                                |       |
| **Item 3. Quantitative and Qualitative Disclosures about  Market Risk**                                                             | 36         |
|                                                                                                                                |       |
| **Item 4. Controls and Procedures**                                                                                                 | 37         |
| ** **                                                                                                                          |       |
| **Part II. Other Information**                                                                                                      | 38         |
|                                                                                                                                |       |
| **Item  1. Legal Proceedings**                                                                                                      | **38**     |
|                                                                                                                                |       |
| **Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds**                                                            | 41         |
|                                                                                                                                |       |
| **Item 3. Defaults Upon Senior Securities**                                                                                         | **41**     |
| ** **                                                                                                                          |       |
| **Item 4. Submission of Matters to a Vote of Security  Holders**                                                                    | 41         |
| ** **                                                                                                                          |       |
| **Item  5. Other Information**                                                                                                      | 41         |
| ** **                                                                                                                          |       |
| **Item 6.  Exhibits and Reports on Form 8-K**                                                                                       | 41         |
|                                                                                                                                |       |
| **Signature  Page**                                                                                                                 | 42         |
| ** **                                                                                                                          |       |
| **Index  to Exhibits**                                                                                                              | 43         |

 

2

----

 

**Part I.Financial Information**

**Item 1.Financial Statements (Unaudited)**

**NetBank,Inc.**

**ConsolidatedBalance Sheets**

**(in 000sexcept share amounts)**

 
| ** **                                                                                                       | ** **   | **September 30,** | ** **   | **December 31,** | ** **   |
|------------------------------------------------------------------------------------------------------------------|--------------|-------------------|--------------|------------------|--------------|
| ** **                                                                                                       | ** **   | **2005**          | ** **   | **2004**         | ** **   |
| ** **                                                                                                       | *** *** | ***(unaudited)*** | *** *** | ***(audited)***  | *** *** |
| **Assets**                                                                                                       | *** *** | *** ***      | *** *** | *** ***     | *** *** |
| Cash and cash equivalents:                                                                                       |         |              |         |             |         |
| Cash and due from banks                                                                                          |         | $                 | 189,930      |             | $            | 104,070 |   |
| Cash equivalents and federal funds sold                                                                          |         | 112,390           |         | 46,232           |         |
| Total cash and cash equivalents                                                                                  |         | 302,320           |         | 150,302          |         |
| Investment securities available for sale-at fair value (amortized  costs of $691,235 and $702,127, respectively) |         | 681,420           |         | 700,295          |         |
| Stock of Federal Home Loan Bank of Atlanta - at cost                                                             |         | 69,952            |         | 60,128           |         |
| Loans held for sale                                                                                              |         | 1,459,717         |         | 1,173,779        |         |
| Loan and lease receivables - net of allowance for credit losses of  $26,730 and $24,462, respectively            |         | 2,145,023         |         | 2,095,832        |         |
| Mortgage servicing rights—net                                                                               |         | 193,798           |         | 172,819          |         |
| Accrued interest receivable                                                                                      |         | 16,113            |         | 11,513           |         |
| Furniture, equipment and capitalized software—net                                                           |         | 49,004            |         | 51,438           |         |
| Goodwill and other intangibles—net                                                                          |         | 81,131            |         | 79,195           |         |
| Due from servicers and investors                                                                                 |         | 26,837            |         | 52,441           |         |
| Other assets                                                                                                     |         | 89,998            |         | 74,439           |         |
| Total assets                                                                                                     |         | $                 | 5,115,313    |             | $            | 4,622,181 |   |
|                                                                                                             |         |              |         |             |         |
| **Liabilities, minority interests and  shareholders’ equity**                                               |         |              |         |             |         |
| **Liabilities:**                                                                                                 |         |              |         |             |         |
| Deposits                                                                                                         |         | $                 | 3,007,143    |             | $            | 2,639,441 |   |
| Other borrowed funds                                                                                             |         | 1,444,018         |         | 1,311,491        |         |
| Subordinated debt                                                                                                |         | 32,477            |         | 11,857           |         |
| Accrued interest payable                                                                                         |         | 16,684            |         | 10,309           |         |
| Loans in process                                                                                                 |         | 59,122            |         | 27,820           |         |
| Unsettled trades                                                                                                 |         | —            |         | 50,543           |         |
| Representations and warranties                                                                                   |         | 21,275            |         | 22,676           |         |
| Accounts payable and accrued liabilities                                                                         |         | 132,250           |         | 133,562          |         |
| Total liabilities                                                                                                |         | 4,712,969         |         | 4,207,699        |         |
|                                                                                                             |         |              |         |             |         |
| Commitments and contingencies—note 11                                                                       |         | —            |         | —           |         |
| Minority interests in  affiliates                                                                                |         | 561               |         | 455              |         |
|                                                                                                             |         |              |         |             |         |
| **Shareholders’ equity:**                                                                                   |         |              |         |             |         |
| Preferred stock, no par (10,000,000 shares authorized; none issued  and outstanding)                             |         | —            |         | —           |         |
| Common stock, $.01 par (100,000,000 shares authorized, 52,820,308 and  52,820,308 shares issued, respectively)   |         | 528               |         | 528              |         |
| Additional paid-in capital                                                                                       |         | 432,202           |         | 432,132          |         |
| Retained earnings                                                                                                |         | 39,180            |         | 43,849           |         |
| Accumulated other comprehensive loss, net of taxes of $(3,723) and  $(696), respectively                         |         | (6,092            | )            | (1,136           | )            |
| Treasury stock, at cost (6,462,108 and 6,292,082 shares,  respectively)                                          |         | (62,628           | )            | (61,087          | )            |
| Unearned compensation                                                                                            |         | (1,407            | )            | (259             | )            |
| **Total shareholders’ equity**                                                                              |         | 401,783           |         | 414,027          |         |
| **Total liabilities, minority interests and  shareholders’ equity**                                         |         | $                 | 5,115,313    |             | $            | 4,622,181 |   |
|                                                                                                                  |              |                   |              |                  |              |  |  |  |  |  |  |

 

Seenotes to consolidated financial statements.

 

3

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**NetBank, Inc.**

**Consolidated Statements of Operations**

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

 
| ** **                                                            | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Interest income:**                                                  |       |                                       |       |                                      |       |   |   |   |   |
| Loans and leases                                                      |       | $                                          | 58,092     |                                      | $          | 57,481 |   | $ | 159,051 |   | $ | 160,102 |   |
| Investment securities                                                 |       | 8,502                                      |       | 5,697                                     |       | 26,169 |   | 13,568 |   |
| Short-term investments                                                |       | 662                                        |       | 314                                       |       | 1,557 |   | 684 |   |
| Total interest income                                                 |       | 67,256                                     |       | 63,492                                    |       | 186,777 |   | 174,354 |   |
|                                                                  |       |                                       |       |                                      |       |   |   |   |   |
| **Interest expense:**                                                 |       |                                       |       |                                      |       |   |   |   |   |
| Deposits                                                              |       | 20,178                                     |       | 11,862                                    |       | 48,992 |   | 34,364 |   |
| Other borrowed funds                                                  |       | 16,848                                     |       | 13,513                                    |       | 45,836 |   | 33,625 |   |
| Total interest expense                                                |       | 37,026                                     |       | 25,375                                    |       | 94,828 |   | 67,989 |   |
| Net interest income                                                   |       | 30,230                                     |       | 38,117                                    |       | 91,949 |   | 106,365 |   |
| Provision for credit losses                                           |       | 2,708                                      |       | 469                                       |       | 7,389 |   | 3,982 |   |
| Net interest income after provision for credit losses                 |       | 27,522                                     |       | 37,648                                    |       | 84,560 |   | 102,383 |   |
|                                                                  |       |                                       |       |                                      |       |   |   |   |   |
| **Non-interest income:**                                              |       |                                       |       |                                      |       |   |   |   |   |
| Mortgage servicing fees                                               |       | 13,292                                     |       | 12,727                                    |       | 38,746 |   | 38,058 |   |
| Amortization of mortgage servicing rights                             |       | (12,729                                    | )          | (9,499                                    | )          | (34,873 | ) | (28,422 | ) |
| Recovery (impairment) of mortgage servicing rights                    |       | 4,244                                      |       | (15,031                                   | )          | 3,224 |   | (10,388 | ) |
| Gains (losses) on derivatives                                         |       | 795                                        |       | 7,272                                     |       | (149 | ) | 5,730 |   |
| Gains on sales of  investment securities                              |       | —                                     |       | 2,248                                     |       | 4,182 |   | 5,417 |   |
| Service charges and fees                                              |       | 5,296                                      |       | 4,713                                     |       | 15,139 |   | 13,052 |   |
| Gains on sales of loans and mortgage servicing rights                 |       | 28,070                                     |       | 27,755                                    |       | 82,822 |   | 93,968 |   |
| Other income                                                          |       | 2,180                                      |       | 3,204                                     |       | 7,759 |   | 9,005 |   |
| Total non-interest income                                             |       | 41,148                                     |       | 33,389                                    |       | 116,850 |   | 126,420 |   |
|                                                                  |       |                                       |       |                                      |       |   |   |   |   |
| **Non-interest expense:**                                             |       |                                       |       |                                      |       |   |   |   |   |
| Salaries and benefits                                                 |       | 30,832                                     |       | 31,730                                    |       | 92,649 |   | 94,812 |   |
| Customer service                                                      |       | 3,596                                      |       | 3,383                                     |       | 10,116 |   | 9,407 |   |
| Marketing                                                             |       | 4,476                                      |       | 2,551                                     |       | 9,697 |   | 6,974 |   |
| Data processing                                                       |       | 4,318                                      |       | 4,722                                     |       | 13,105 |   | 13,888 |   |
| Depreciation and amortization                                         |       | 6,080                                      |       | 5,098                                     |       | 17,693 |   | 14,714 |   |
| Office expenses                                                       |       | 3,600                                      |       | 2,938                                     |       | 9,422 |   | 8,409 |   |
| Occupancy                                                             |       | 6,558                                      |       | 5,770                                     |       | 18,411 |   | 16,277 |   |
| Travel and entertainment                                              |       | 1,583                                      |       | 1,100                                     |       | 4,223 |   | 3,662 |   |
| Professional fees                                                     |       | 4,471                                      |       | 2,806                                     |       | 13,276 |   | 10,719 |   |
| Prepaid lost interest from curtailments                               |       | 1,262                                      |       | 906                                       |       | 3,345 |   | 4,174 |   |
| Other expenses                                                        |       | 3,924                                      |       | 3,532                                     |       | 10,756 |   | 10,791 |   |
| Total non-interest expense                                            |       | 70,700                                     |       | 64,536                                    |       | 202,693 |   | 193,827 |   |
| (Loss) income before income taxes                                     |       | (2,030                                     | )          | 6,501                                     |       | (1,283 | ) | 34,976 |   |
| Income tax benefit (expense)                                          |       | 659                                        |       | (2,486                                    | )          | 208 |   | (13,100 | ) |
| **Net (loss) income**                                                 |       | $                                          | (1,371     | )                                         | $          | 4,015 |   | $ | (1,075 | ) | $ | 21,876 |   |
|                                                                  |       |                                       |       |                                      |       |   |   |   |   |
| Net (loss) income per common and potential common shares outstanding: |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                 |       | $                                          | (0.03      | )                                         | $          | 0.09 |   | $ | (0.02 | ) | $ | 0.47 |   |
| Diluted                                                               |       | $                                          | (0.03      | )                                         | $          | 0.09 |   | $ | (0.02 | ) | $ | 0.46 |   |
|                                                                  |       |                                       |       |                                      |       |   |   |   |   |
| Weighted average common and potential common shares outstanding:      |       |                                       |       |                                      |       |   |   |   |   |
| Basic                                                                 |       | 46,119                                     |       | 46,846                                    |       | 46,201 |   | 46,962 |   |
| Diluted                                                               |       | 46,119                                     |       | 47,156                                    |       | 46,201 |   | 47,431 |   |
|                                                                  |       |                                       |       |                                      |       |   |   |   |   |
| Dividends declared on common stock per share                          |       | $                                          | 0.02       |                                      | $          | 0.02 |   | $ | 0.06 |   | $ | 0.06 |   |
|                                                                       |            |                                            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |

 

Seenotes to consolidated financial statements. 

 

4

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**NetBank,Inc.**

**ConsolidatedStatements of Shareholders’ Equity**

**(unauditedand in 000s)**

** **
| ** **                                                                                                 | ** ** | **For the three months ended  September 30,** | ** ** | **For the nine months ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2005**                                      | ** ** | **2004**                                     | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Common shares**                                                                                          |       |                                          |       |                                         |       |   |   |   |   |
| Beginning balance                                                                                          |       | 52,820                                        |       | 52,820                                       |       | 52,820 |   | 52,820 |   |
| Issuance of common shares                                                                                  |       | —                                        |       | —                                       |       | — |   | — |   |
| Ending balance                                                                                             |       | 52,820                                        |       | 52,820                                       |       | 52,820 |   | 52,820 |   |
| **Common stock**                                                                                           |       |                                          |       |                                         |       |   |   |   |   |
| Beginning balance                                                                                          |       | $                                             | 528        |                                         | $          | 528 |   | $ | 528 |   | $ | 528 |   |
| Issuance of common stock                                                                                   |       | —                                        |       | —                                       |       | — |   | — |   |
| Ending balance                                                                                             |       | $                                             | 528        |                                         | $          | 528 |   | $ | 528 |   | $ | 528 |   |
| **Paid-in capital**                                                                                        |       |                                          |       |                                         |       |   |   |   |   |
| Beginning balance                                                                                          |       | $                                             | 432,192    |                                         | $          | 432,029 |   | $ | 432,132 |   | $ | 432,035 |   |
| Issuance of treasury stock, net of repurchases                                                             |       | —                                        |       | (317                                         | )          | — |   | (323 | ) |
| Unearned compensation from issuance of restricted stock                                                    |       | 10                                            |       | —                                       |       | 70 |   | — |   |
| Ending balance                                                                                             |       | $                                             | 432,202    |                                         | $          | 431,712 |   | $ | 432,202 |   | $ | 431,712 |   |
| **Retained earnings**                                                                                      |       |                                          |       |                                         |       |   |   |   |   |
| Beginning balance                                                                                          |       | $                                             | 41,618     |                                         | $          | 59,888 |   | $ | 43,849 |   | $ | 44,102 |   |
| Net income                                                                                                 |       | (1,371                                        | )          | 4,015                                        |       | (1,075 | ) | 21,876 |   |
| Cash dividends declared                                                                                    |       | (923                                          | )          | (939                                         | )          | (2,774 | ) | (2,818 | ) |
| Loss on re-issuance of shares of common stock                                                              |       | (144                                          | )          | (46                                          | )          | (820 | ) | (242 | ) |
| Ending balance                                                                                             |       | $                                             | 39,180     |                                         | $          | 62,918 |   | $ | 39,180 |   | $ | 62,918 |   |
| **Accumulated other comprehensive (loss) income**                                                          |       |                                          |       |                                         |       |   |   |   |   |
| Beginning balance                                                                                          |       | $                                             | (488       | )                                            | $          | (1,975 | ) | $ | (1,136 | ) | $ | 2,742 |   |
| Realized gain on sale of securities, net of taxes                                                          |       | —                                        |       | (1,416                                       | )          | (2,593 | ) | (3,396 | ) |
| Unrealized (loss) gain on securities, net of taxes                                                         |       | (5,604                                        | )          | 4,811                                        |       | (2,363 | ) | 2,074 |   |
| Ending balance                                                                                             |       | $                                             | (6,092     | )                                            | $          | 1,420 |   | $ | (6,092 | ) | $ | 1,420 |   |
| **Treasury stock, at cost**                                                                                |       |                                          |       |                                         |       |   |   |   |   |
| Beginning balance                                                                                          |       | $                                             | (63,236    | )                                            | $          | (59,639 | ) | $ | (61,087 | ) | $ | (48,674 | ) |
| Purchase of shares of common stock for treasury, net of re-issuances                                       |       | 608                                           |       | 708                                          |       | (3,200 | ) | (10,257 | ) |
| Unearned compensation from issuance of restricted stock                                                    |       | —                                        |       | —                                       |       | 1,700 |   | — |   |
| Employee forfeitures of restricted stock                                                                   |       | —                                        |       | —                                       |       | (41 | ) | — |   |
| Ending balance                                                                                             |       | $                                             | (62,628    | )                                            | $          | (58,931 | ) | $ | (62,628 | ) | $ | (58,931 | ) |
| **Unearned compensation**                                                                                  |       |                                          |       |                                         |       |   |   |   |   |
| Beginning balance                                                                                          |       | $                                             | (1,525     | )                                            | $          | (321 | ) | $ | (259 | ) | $ | (383 | ) |
| Amortization of unearned compensation                                                                      |       | 118                                           |       | 31                                           |       | 246 |   | 93 |   |
| Unearned compensation from issuance of restricted stock                                                    |       | —                                        |       | —                                       |       | (1,435 | ) | — |   |
| Employee forfeitures of restricted stock                                                                   |       | —                                        |       | —                                       |       | 41 |   | — |   |
| Ending balance                                                                                             |       | $                                             | (1,407     | )                                            | $          | (290 | ) | $ | (1,407 | ) | $ | (290 | ) |
| **Total shareholders’ equity**                                                                        |       | $                                             | 401,783    |                                         | $          | 437,357 |   | $ | 401,783 |   | $ | 437,357 |   |
|                                                                                                       |       |                                          |       |                                         |       |   |   |   |   |
| **Comprehensive income**                                                                                   |       |                                          |       |                                         |       |   |   |   |   |
| Net (loss) income                                                                                          |       | $                                             | (1,371     | )                                            | $          | 4,015 |   | $ | (1,075 | ) | $ | 21,876 |   |
| Realized gain on sale of securities, net of taxes of $0, $762, $1,396  and $1,829, respectively            |       | —                                        |       | (1,416                                       | )          | (2,593 | ) | (3,396 | ) |
| Unrealized (loss) gain on securities, net of taxes of $3,018,  $(2,591), $1,272 and $(1,117), respectively |       | (5,604                                        | )          | 4,811                                        |       | (2,363 | ) | 2,074 |   |
| Comprehensive (loss) income                                                                                |       | $                                             | (6,975     | )                                            | $          | 7,410 |   | $ | (6,031 | ) | $ | 20,554 |   |
|                                                                                                            |            |                                               |            |                                              |            |  |  |  |  |  |  |  |  |  |  |

 

See notes to consolidated financialstatements.   

 

5

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**NetBank,Inc.**

**ConsolidatedStatements of Cash Flows**

**(unauditedand in 000s)**

 
| ** **                                                                                   | ** ** | **Nine  months ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Operating activities:                                                                        |       |                                       |       |   |   |
| Net (loss) income                                                                            |       | $                                          | (1,075     | ) | $ | 21,876 |   |
| Adjustments to reconcile net income to net cash (used  in) provided by operating activities: |       |                                       |       |   |   |
| Depreciation and amortization                                                                |       | 17,693                                     |       | 14,714 |   |
| Amortization of premiums on investment securities,  loan and lease receivables and debt      |       | 14,648                                     |       | 5,101 |   |
| Origination of loans held for sale                                                           |       | (10,060,223                                | )          | (9,729,806 | ) |
| Repurchase of previously sold mortgages                                                      |       | (98,031                                    | )          | (70,455 | ) |
| Proceeds from sales of loans held for sale                                                   |       | 9,954,185                                  |       | 10,555,455 |   |
| Net gain on sales of loans and servicing rights                                              |       | (82,822                                    | )          | (93,968 | ) |
| Capitalization of mortgage servicing rights                                                  |       | (17,049                                    | )          | (48,690 | ) |
| Proceeds from sale of mortgage servicing rights                                              |       | 833                                        |       | 4,356 |   |
| Mark-to-market adjustment on mortgage servicing  rights                                      |       | (1,679                                     | )          | (1,424 | ) |
| Impairment and amortization of mortgage servicing  rights                                    |       | 31,649                                     |       | 38,810 |   |
| Provision for credit losses                                                                  |       | 7,389                                      |       | 3,982 |   |
| Amortization of unearned compensation                                                        |       | 316                                        |       | 93 |   |
| Gains on sales of investment securities                                                      |       | (4,182                                     | )          | (5,417 | ) |
| Changes in assets and liabilities which provide (use)  cash:                                 |       |                                       |       |   |   |
| (Increase)  decrease in accrued interest receivable                                          |       | (4,600                                     | )          | 3,654 |   |
| Decrease  (increase) in due from servicers and investors                                     |       | 25,604                                     |       | (76,925 | ) |
| Increase in other  assets                                                                    |       | (15,559                                    | )          | (19,596 | ) |
| Increase in  accrued interest payable                                                        |       | 6,375                                      |       | 906 |   |
| Increase in  accounts payable and accrued liabilities                                        |       | 1,625                                      |       | 6,016 |   |
| Increase in loans  in process                                                                |       | 31,302                                     |       | 16,806 |   |
| Net cash (used  in) provided by operating activities                                         |       | (193,601                                   | )          | 625,488 |   |
|                                                                                         |       |                                       |       |   |   |
| Investing activities:                                                                        |       |                                       |       |   |   |
| Purchases of available for sale investment securities                                        |       | (457,128                                   | )          | (315,411 | ) |
| Principal repayments on available for sale investment  securities                            |       | 91,363                                     |       | 37,817 |   |
| Sales and maturities of available for sale investment  securities                            |       | 330,315                                    |       | 290,835 |   |
| Purchase of Federal Home Loan Bank stock                                                     |       | (9,824                                     | )          | (6,955 | ) |
| Bulk purchase of mortgage servicing rights                                                   |       | (35,181                                    | )          | — |   |
| Origination of loans and leases                                                              |       | (584,719                                   | )          | (1,215,724 | ) |
| Principal repayments on loans and leases                                                     |       | 513,562                                    |       | 537,320 |   |
| Proceeds from sales of loans and leases                                                      |       | —                                     |       | 346,039 |   |
| Purchases of furniture, fixtures, and equipment                                              |       | (13,035                                    | )          | (11,975 | ) |
| Acquisitions, net of cash acquired                                                           |       | (4,160                                     | )          | (16,424 | ) |
| Other investing activities                                                                   |       | 106                                        |       | 450 |   |
| Net cash used in  investing activities                                                       |       | (168,701                                   | )          | (354,028 | ) |
|                                                                                         |       |                                       |       |   |   |
| Financing activities:                                                                        |       |                                       |       |   |   |
| Decrease in money market and checking accounts                                               |       | (142,081                                   | )          | (1,664 | ) |
| Increase in certificates of deposit                                                          |       | 509,783                                    |       | 206,946 |   |
| Proceeds from other borrowed funds                                                           |       | 6,843,083                                  |       | 11,826,643 |   |
| Repayments of other borrowed funds                                                           |       | (6,710,556                                 | )          | (12,092,370 | ) |
| Net proceeds from issuance of subordinated notes                                             |       | 20,620                                     |       | — |   |
| Net purchase of treasury stock                                                               |       | (3,755                                     | )          | (12,414 | ) |
| Dividend payments on common stock                                                            |       | (2,774                                     | )          | (2,818 | ) |
| Net cash provided  by (used in) financing activities                                         |       | 514,320                                    |       | (75,677 | ) |
| Net increase in cash and cash equivalents                                                    |       | 152,018                                    |       | 195,783 |   |
| Cash and cash equivalents:                                                                   |       |                                       |       |   |   |
| Cash, beginning of period                                                                    |       | 150,302                                    |       | 33,627 |   |
| Cash, end of period                                                                          |       | $                                          | 302,320    |   | $ | 229,410 |   |
|                                                                                         |       |                                       |       |   |   |
| Supplemental disclosures of cash flow information:                                           |       |                                       |       |   |   |
| Cash paid during the period for interest                                                     |       | $                                          | 88,453     |   | $ | 67,203 |   |
| Cash paid (refunds received) during the period for  income taxes                             |       | $                                          | 162        |   | $ | (8,869 | ) |
|                                                                                              |            |                                            |            |  |  |  |  |  |  |

 

See notes to consolidated financial statements.  

 

 

6

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**NETBANK, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**September 30, 2005(unaudited)**

 

**1.             ORGANIZATIONAND BASIS OF PRESENTATION**

** **

NetBank, Inc. is a financial holdingcompany engaged primarily in retail banking, mortgage banking, business financeand providing ATM and merchant processing services. NetBank, Inc. whollyowns the outstanding stock of NetBank (“NetBank, FSB” or “the Bank”), a federalsavings bank; MG Reinsurance Company (“MG Reinsurance”), a captive reinsurancecompany; NetInsurance, Inc. (“NetInsurance”), a licensed insurance agency;and NB Partners, Inc., a corporation involved in strategic partneringopportunities. NB Partners, Inc. owns all of the outstanding stock ofFinancial Technologies, Inc., a corporation formed in 2004 to markettransaction processing services to other financial services companies. NetBank,FSB owns all of the outstanding stock of Market Street Mortgage Corporation (“MarketStreet”), a retail mortgage company, NetBank Payment Systems, Inc. (“NPS”),a provider of ATM and merchant processing services for retail and othernon-bank businesses, and Meritage Mortgage Corporation (“Meritage”), awholesale non-conforming mortgage provider. Additionally, NetBank, FSB’swholesale mortgage division operates as NetBank Funding Services and itsbusiness financing unit operates as NetBank Business Finance.  The consolidated company is referred toherein as “we,” “our” or “the Company”.

 

In the opinion of management, the unauditedconsolidated financial statements included herein reflect all adjustments,consisting only of normal recurring accruals, which are necessary for the fairpresentation of the financial condition and results of operations for theinterim 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 ourAnnual Report on Form 10-K filed with the SEC for the year endedDecember 31, 2004 (“2004 Form 10-K”). The results of operations for theinterim periods reported herein are not necessarily indicative of results to beexpected for the full year. Certain 2004 amounts have been reclassified forcomparability with 2005 amounts.

 

All dollar figures are presented in thousands(000s), except share and per share data, unless otherwise noted. All of ouroperations and assets are located within the United States.

 

**Net (loss) income per share is presented on a dilutedbasis, unless otherwise noted.**

** **

**2.             ACQUISITIONS**

** **

**Duringthe nine months ended September 30, 2005, NPS acquired certain assets or processingcontracts of various smaller ATM and merchant processors.  The acquisitions were accounted for aspurchases, and as such, approximately $3,569 of amortizable intangibles wererecorded.  Consideration for these assetsand processing contracts totaled $3,707. On July 8, 2005, Market Streetacquired 27 retail branch offices and certain associated assets of MajorMortgage, a mortgage banking business, pursuant to an asset purchase agreement.The consideration paid, including transaction costs, was approximately$1,885.  The acquisition was accountedfor as a purchase, and as such, approximately $167 of goodwill, includingtransaction costs, was recorded. On July 29, 2005, Market Street acquired 3retail branch offices and certain associated assets of Pine State Mortgage, amortgage banking business, pursuant to an asset purchase agreement. Theconsideration paid, including transaction costs, was approximately $150.  The acquisition was accounted for as apurchase, and as such, approximately $2 of goodwill, including transactioncosts, was recorded. The impact of these purchases has been included in theCompany’s results of operations from the respective dates of acquisition.**

** **

**7**

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**3.             ACCOUNTINGPOLICIES**

** **

Reference is made to our accounting policiesdescribed in the notes to consolidated financial statements contained in our2004 Form 10-K. The Company has followed those policies in preparing thisreport.

 

*SignificantEstimates.*The preparation of the consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States (“GAAP”) requires management to make estimates and assumptionsthat affect the amounts reported in the consolidated financial statements andaccompanying notes.  Certain of theseestimates relate to the Company’s allowance for credit losses; the fair valuesof loans held for sale, mortgage servicing rights, servicing hedges and theCompany’s other hedging instruments; and reserves for estimated losses on representationsand warranties provided to purchasers of loans or mortgage servicing rights.Because of the inherent uncertainties associated with any estimation processand due to possible future changes in market and economic conditions that willaffect fair values, it is possible that actual future results and realizationof the underlying assets and liabilities could differ significantly from theamounts reflected as of the balance sheet date.

 

*Stock-Based Compensation.*The Companyaccounts for stock options issued under the recognition and measurementprinciples of Accounting Principles Board Opinion No. 25, *Accountingfor Stock Issued to Employees,*and related Interpretations. No stockoption-based employee compensation cost is reflected in the results of operations,as all options granted under those plans had an exercise price equal to orgreater than the market value of the underlying common stock on the date ofgrant.   The Company also allowsparticipants to purchase stock under the NetBank, Inc. Employee Stock PurchasePlan (“the Stock Plan”).  The Stock Planpurchases shares of the Company’s common stock from the Company on the last dayof each quarter at 85% of the market value on the purchase date.  The following table illustrates the pro formaeffects on the results of operations and net income (loss) per share if theCompany had applied the fair value recognition provisions of Statement ofFinancial Accounting Standard No. 123 (“SFAS 123”), *Accountingfor Stock-Based Compensation—Transition and Disclosure,*tostock-based employee compensation.

 
| ** **                                                                                                                                          | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                                          | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net (loss) income, as reported                                                                                                                      |       | $                                          | (1,371     | )                                         | $          | 4,015 |   | $ | (1,075 | ) | $ | 21,876 |   |
| Deduct total stock option-based employee compensation expense  determined under fair value based method for all awards, net of related tax  effects |       | (837                                       | )          | (1,198                                    | )          | (2,829 | ) | (3,160 | ) |
| Pro forma net (loss) income                                                                                                                         |       | $                                          | (2,208     | )                                         | $          | 2,817 |   | $ | (3,904 | ) | $ | 18,716 |   |
|                                                                                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| (Loss) earnings per share:                                                                                                                          |       |                                       |       |                                      |       |   |   |   |   |
| Basic—as reported                                                                                                                              |       | $                                          | (0.03      | )                                         | $          | 0.09 |   | $ | (0.02 | ) | $ | 0.47 |   |
| Basic—pro forma                                                                                                                                |       | $                                          | (0.05      | )                                         | $          | 0.06 |   | $ | (0.08 | ) | $ | 0.40 |   |
|                                                                                                                                                |       |                                       |       |                                      |       |   |   |   |   |
| Diluted—as reported                                                                                                                            |       | $                                          | (0.03      | )                                         | $          | 0.09 |   | $ | (0.02 | ) | $ | 0.46 |   |
| Diluted—pro forma                                                                                                                              |       | $                                          | (0.05      | )                                         | $          | 0.06 |   | $ | (0.08 | ) | $ | 0.39 |   |
|                                                                                                                                                     |            |                                            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

** **

**Inaddition, for the three and nine months ended September 30, 2005, pre-taxcompensation expense of $128 and $316, respectively, related to restrictedstock awards was recognized and included in net loss as reported.  For the three and nine months ended September30, 2004, comparable pre-tax compensation expense recognized and included innet income was $31 and $93, respectively.**

** **

**8**

----

*NewAccounting Pronouncements. *InDecember 2004, the Financial Accounting Standards Board issued Statementof Financial Accounting Standards No. 123 (revised 2004) (“SFAS 123r”),*Share-Based Payment*, which is a revisionof SFAS 123. SFAS 123r supersedes APB 25 and amends Statement ofFinancial Accounting Standards No. 95, *Statement of Cash flows*.Generally, the approach to accounting for share-based payments inSFAS 123r is similar to the approach described in SFAS 123, exceptthat SFAS 123r requires all share-based payments to employees, includinggrants of stock options, to be recognized in the financial statements based ontheir fair values. SEC release No. 33-8568 delayed the effective dateof SFAS 123r to fiscal years beginning on or after December 15, 2005.  Pursuant to this release, the Company willadopt SFAS 123r on January 1, 2006. We intend to adoptSFAS 123r using the Modified-Prospective Transition provisions ofSFAS 123r, which will require financial statement recognition of the fairvalue of all share-based payments that vest subsequent to adoption. The Companyhas not determined the impact that this statement will have on its results ofoperations or financial condition.  Proforma disclosure will be required for all prior periods presented.

 

InMay 2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154(“SFAS 154”), *Accounting Changes and Error Corrections*— a replacement of APB Opinion No. 20 and SFAS Statement No. 3.  APB No.20, *Accounting Changes*, and SFAS No. 3, *Reporting Accounting Changes in Interim Financial Statements*,required the inclusion of the cumulative effect of changes in accountingprinciple in net income in the period of change.  SFAS 154 establishes,unless impracticable, retrospective application to prior periods’ financialstatements as the required method for reporting a voluntary change inaccounting principle in the absence of explicit transition requirementsspecific to the newly adopted accounting principle.  This statement iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005.  The Company will assess the impact ofa retrospective application of a change in accounting principle in accordancewith SFAS 154 if the need for such a change arises after the effective date.

 

InJune 2005, the FASB ratified the Emerging Issues Task Forces’ Issue No. 05-06,Determining the Amortization Period for Leasehold Improvements (“Issue 05-06”).  Issue 05-06 provides that the amortizationperiod used for leasehold improvements acquired in a business combination orpurchased after the inception of a lease be the shorter of (a) the useful lifeof the assets or (b) a term that includes required lease periods and renewalsthat are reasonably assured upon the acquisition or the purchase.  The provisions of Issue 05-06 are effectiveon a prospective basis for leasehold improvements purchased or acquiredbeginning in 2006.  We do not believe theadoption of Issue 05-06 will have a material impact on our financial position,results of operations or cash flows.

 

**4.             LOANAND LEASE RECEIVABLES**

** **

The Company’s portfolio of loan and leasereceivables consists primarily of internally originated 1-4 family first andsecond mortgage loans, home equity loans, automobile loans, business equipmentfinancing leases, marine and recreational vehicle loans.

 

As of September 30, 2005 andDecember 31, 2004 the Company had unamortized net premiums on its loan andlease receivables of $35,812 and $33,765, respectively. The following is asummary of the Company’s loan and lease receivables portfolio:

 
| ** **                       | ** ** | **As of September 30, 2005** | ** ** | **As of December 31, 2004** | ** ** |
|----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **Amount**                   | ** ** | **%**                       | ** ** | **Amount** | ** ** | **%** | ** ** |
| First mortgages                  |       | $                            | 878,329    |                        | 40.4       | % | $ | 1,081,676 |   | 51.0 | % |
| Second mortgages                 |       | 127,416                      |       | 5.9                         | %          | 170,993 |   | 8.1 | % |
| Leases                           |       | 387,360                      |       | 17.8                        | %          | 356,016 |   | 16.8 | % |
| Auto                             |       | 592,391                      |       | 27.4                        | %          | 391,934 |   | 18.5 | % |
| Home equity lines                |       | 155,134                      |       | 7.1                         | %          | 115,068 |   | 5.4 | % |
| Consumer                         |       | 31,123                       |       | 1.4                         | %          | 4,607 |   | 0.2 | % |
| Total                            |       | 2,171,753                    |       | 100.0                       | %          | 2,120,294 |   | 100.0 | % |
| Less allowance for credit losses |       | (26,730                      | )          |                        |       | (24,462 | ) |   |   |
| Total                            |       | $                            | 2,145,023  |                        |       |   | $ | 2,095,832 |   |   |   |
|                                  |            |                              |            |                             |            |  |  |  |  |  |  |  |

 

9

----

 

Our lease receivables consist primarily of business equipment leasesoriginated and serviced by the NetBank Business Finance division. In additionto originated lease receivables, NetBank, FSB owns a portfolio of purchasedlease receivables originated by Commercial Money Center, Inc. (“CMC”).NetBank, FSB is involved in litigation with three insurance companies who aresureties on the purchased receivables. Since the second quarter of 2002, theentire portfolio has been on non-accrual status pending the outcome of thelitigation. During June 2005, the bankruptcy proceedings for CMC resulted in arelease to NetBank, FSB of $3,995 of its funds being held by the bankruptcytrustee. The entire amount was applied to principal. NetBank, FSB has filed aclaim against CMC and the insurance company sureties for all principal andinterest payments that are currently past due, approximately $91,000. Theremaining recorded balance of CMC leases receivable as of September 30, 2005was $26,435.

 

**5.             NON-PERFORMINGASSETS AND ALLOWANCE FOR CREDIT LOSSES**

** **

The Company considers a loan or lease receivable to be impaired when itis probable that it will be unable to collect all amounts due according to theoriginal terms of the loan or lease agreement. The Company measures impairment of a loan or lease on a loan-by-loan orlease-by-lease basis.  Amounts ofimpaired loans or leases that are not probable of collection are charged offimmediately.

 

The following table details the Company’snon-accrual and troubled debt restructurings:

 
| ** **                       | ** ** | **As of**              | ** ** | **As of**             | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
| Loan and lease  receivables(1)   |       | $                      | 32,916     |                  | $          | 37,045 |   |
| Loans held for sale(1)           |       | $                      | 27,432     |                  | $          | 36,633 |   |
| Troubled debt  restructurings(2) |       | $                      | 2,129      |                  | $          | 210 |   |

----

(1)          All loans andleases over 90 days contractually past due are placed on non-accrual status.

(2)          Includes onlythose troubled debt restructurings which were less than 90 days past due as ofthe periods reported. Troubled debt restructurings over 90 days past due havebeen included in the non-accrual categories.

 

Non-performing loan and lease receivables asof September 30, 2005 and December 31, 2004 included $26,435 and $31,527,respectively, of non-performing lease receivables related to the CMC leaseportfolio.

 

On average, the Company held approximately$57,806 and $123,580 of restructured and non-accrual loans during the threemonths ended September 30, 2005 and 2004, respectively. Foregone interest forthe three months ended September 30, 2005 and 2004 was approximately $834 and$1,661, respectively. Foregone interest for the nine months ended September 30,2005 and 2004 was approximately $2,832 and $4,600, respectively.  The Company had $7,963 and $5,799 inrepossessed assets consisting primarily of residential mortgage loanforeclosures at September 30, 2005 and December 31, 2004, respectively.

 

10

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The following is a summary of the allowancefor credit losses:

 
| ** **                                                           | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Beginning balance**                                                |       | $                                          | 25,792     |                                      | $          | 46,033 |   | $ | 24,462 |   | $ | 43,689 |   |
| Provision for credit  losses                                         |       | 2,708                                      |       | 469                                       |       | 7,389 |   | 3,982 |   |
| Charge-offs:                                                         |       |                                       |       |                                      |       |   |   |   |   |
| First mortgages                                                      |       | (14                                        | )          | —                                    |       | (22 | ) | (18 | ) |
| Second mortgages                                                     |       | (136                                       | )          | (409                                      | )          | (664 | ) | (643 | ) |
| Leases                                                               |       | (1,491                                     | )          | (1,048                                    | )          | (4,165 | ) | (2,743 | ) |
| Auto                                                                 |       | (1,180                                     | )          | (688                                      | )          | (2,872 | ) | (1,431 | ) |
| Home equity lines                                                    |       | (143                                       | )          | (100                                      | )          | (300 | ) | (419 | ) |
| Consumer                                                             |       | (13                                        | )          | (28                                       | )          | (89 | ) | (101 | ) |
| Total charge-offs                                                    |       | (2,977                                     | )          | (2,273                                    | )          | (8,112 | ) | (5,355 | ) |
| Recoveries:                                                          |       |                                       |       |                                      |       |   |   |   |   |
| First mortgages                                                      |       | 6                                          |       | —                                    |       | 7 |   | — |   |
| Second mortgages                                                     |       | 10                                         |       | 191                                       |       | 97 |   | 306 |   |
| Leases                                                               |       | 779                                        |       | 573                                       |       | 1,652 |   | 1,826 |   |
| Auto                                                                 |       | 350                                        |       | 305                                       |       | 888 |   | 734 |   |
| Home equity lines                                                    |       | 62                                         |       | 8                                         |       | 347 |   | 124 |   |
| Consumer                                                             |       | —                                     |       | —                                    |       | — |   | — |   |
| Total recoveries                                                     |       | 1,207                                      |       | 1,077                                     |       | 2,991 |   | 2,990 |   |
| Total charge-offs, net                                               |       | (1,770                                     | )          | (1,196                                    | )          | (5,121 | ) | (2,365 | ) |
| **Ending balance**                                                   |       | $                                          | 26,730     |                                      | $          | 45,306 |   | $ | 26,730 |   | $ | 45,306 |   |
|                                                                 |       |                                       |       |                                      |       |   |   |   |   |
| Allowance for credit losses as a percent of average loans and leases |       | 1.2                                        | %          | 2.0                                       | %          | 1.2 | % | 2.2 | % |
|                                                                      |            |                                            |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |

** **

**6.             FAIRVALUE AND IMPAIRMENT OF MORTGAGE SERVICING RIGHTS**

** **

The Company accounts for itsentire mortgage servicing rights (“MSR”) portfolio at the aggregate of thelower of cost or market (“LOCOM”). For purposes of evaluating the MSR portfoliofor impairment, the Company disaggregates its MSR portfolio into two primarygroupings: available for sale and held for sale.

 

The segment of the portfolio designated as available for sale iscomposed of MSRs that were retained out of production pursuant to individualportfolio retention decisions or purchased in bulk transactions. The availablefor sale portfolio is disaggregated for purposes of measuring potentialimpairments according to defined risk tranches. The Company has defined theserisk tranches based upon interest rate band and product type.  With respect to each such risk tranche, thefair value thereof, which is based upon an internal analysis that considerscurrent market conditions, prevailing interest rates, prepayment speeds,default rates and other relevant factors, is compared to amortized carryingvalues of the MSRs for purposes of measuring potential impairment.

 

The segment of the portfolio designated asheld for sale is composed of recently produced MSRs that are scheduled for saleand have been allocated to specific forward servicing sales contracts.  The held for sale portfolio is disaggregatedfor purposes of measuring possible impairments according to the specificforward sales contracts to which the MSR is allocated. For each such risktranche, the fair value is based upon the allocated forward committed deliveryprice, which is compared to amortized carrying value for purposes of measuringpotential impairment.

 

11

----

 

The following amounts relate to the Company’s MSR portfolio:

 
| ** **                                 | ** ** | **Available for sale** | ** ** | **Held for sale** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                 | ** ** | **September 30,**      | ** ** | **December 31,**  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                                 | ** ** | **2005**               | ** ** | **2004**          | ** ** | **2005** | ** ** | **2004** | ** ** |
| Unpaid Principal Balance (“UPB”) |       | $                      | 13,600,374 |              | $          | 12,699,935 |   | $ | 249,597 |   | $ | 193,877 |   |
| Carrying value                             |       | $                      | 191,167    |              | $          | 170,651 |   | $ | 2,631 |   | $ | 2,168 |   |
| Carrying value / UPB                       |       | 1.41                   | %          | 1.34              | %          | 1.05 | % | 1.12 | % |
| Fair value                                 |       | $                      | 191,648    |              | $          | 171,075 |   | $ | 2,631 |   | $ | 2,168 |   |
| Fair value / UPB                           |       | 1.41                   | %          | 1.35              | %          | 1.05 | % | 1.12 | % |
| Weighted average note rate                 |       | 5.89                   | %          | 5.95              | %          | 6.47 | % | 6.32 | % |
| Weighted average service fee               |       | 0.32                   | %          | 0.33              | %          | 0.36 | % | 0.33 | % |
| Net basis as multiple                      |       | 4.39                   |       | 4.13              |       | 2.96 |   | 3.36 |   |
|                                            |            |                        |            |                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

The following table summarizes changes in the impairment reserve forthe Company’s MSRs for the three and nine months ended September 30, 2005 and2004:

 
| ** **                                | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                | ** ** | **2005**                                   | ** ** | **2004**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| Beginning balance                         |       | $                                          | 66,577     |                                      | $          | 53,609 |   | $ | 65,557 |   | $ | 58,252 |   |
| Servicing valuation (recovery) impairment |       | (4,244                                     | )          | 15,031                                    |       | (3,224 | ) | 10,388 |   |
| Ending balance                            |       | $                                          | 62,333     |                                      | $          | 68,640 |   | $ | 62,333 |   | $ | 68,640 |   |
|                                           |            |                                            |            |                                           |            |  |  |  |  |  |  |  |  |  |

** **

**7.             DEPOSITS**

** **

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

 
| ** **                             | ** ** | **As of September 30, 2005** | ** ** | **As of December 31, 2004** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **Amount**                        | ** ** | **Percentage**                   | ** ** | **Weighted  average  interest  rate** | ** ** | **Amount** | ** ** | **Percentage** | ** ** | **Weighted  average  interest  rate** | ** ** |
| Non-interest bearing checking accounts |       | $                                 | 345,938    |                             | 11.5       | % | — |   | $ | 285,218 |   | 10.8 | % | — |   |
| Interest bearing:                      |       |                              |       |                             |       |   |   |   |   |   |   |   |   |
| Checking accounts                      |       | 230,081                           |       | 7.7                              | %          | 1.0 | % | 261,588 |   | 9.9 | % | 1.0 | % |
| Money market                           |       | 987,235                           |       | 32.8                             | %          | 2.9 | % | 1,158,529 |   | 43.9 | % | 1.9 | % |
| Certificate of deposit under $100      |       | 1,359,131                         |       | 45.2                             | %          | 3.7 | % | 830,996 |   | 31.5 | % | 2.9 | % |
| Certificate of deposit over $100       |       | 84,758                            |       | 2.8                              | %          | 3.8 | % | 103,110 |   | 3.9 | % | 3.3 | % |
| Total deposits                         |       | $                                 | 3,007,143  |                             | 100.0      | % |   |   | $ | 2,639,441 |   | 100.0 | % |   |   |
|                                        |            |                                   |            |                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Accrued interest as of September 30, 2005related to checking, money market and certificates of deposit accounts was $74,$863 and $10,189, respectively.  Accruedinterest as of December 31, 2004 related to checking, money market, andcertificates of deposit accounts was $66, $607 and $5,426, respectively.  At September 30, 2005 and December 31, 2004,$683 and $764 of overdrawn deposits were classified as loans, respectively.

 

**12**

----

**8.             BORROWINGS**

** **

A summary of borrowings and available borrowings, grouped by year ofmaturity, as of September 30, 2005 follows:

 
| **Type of borrowing**        | ** ** | **Year of   maturity** | ** ** | **Range of stated  interest rates** | ** ** | **Principal amount  outstanding** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|----------------------------------------------------|------------|----------------------------------------|------------|
| $25 million line of credit             |       | 2005                             |       | Fed  Funds + 0.25 %                                | *          | $                                      | —     |   |
| $75 million master repurchase facility |       | 2005                             |       | LIBOR  + 1.25 %                                    | *          | —                                 |       |
| $200 million warehouse line of credit  |       | 2005                             |       | LIBOR  + 0.85 %                                    | *          | 36,400                                 |       |
| FHLB warehouse line                    |       | 2005                             |       | DRC  + 0.50 %                                      | *          | 167,500                                |       |
| FHLB overnight facility                |       | 2005                             |       | DRC                                                | *          | 232,500                                |       |
| FHLB advances                          |       | 2005                             |       | 6.02  to 6.25 %                                    |       | 90,000                                 |       |
| FHLB advances                          |       | 2006                             |       | 2.04  to 5.63 %                                    |       | 310,000                                |       |
| FHLB advances                          |       | 2007                             |       | 2.57  %                                            |       | 40,000                                 |       |
| FHLB advances                          |       | 2009                             |       | 1.94  to 4.64 %                                    |       | 175,000                                |       |
| FHLB advances                          |       | 2010                             |       | 3.63  to 3.97 %                                    |       | 150,000                                |       |
| FHLB advances                          |       | 2014                             |       | 1.79  to 2.93 %                                    |       | 185,000                                |       |
| Subordinated debt                      |       | 2032                             |       | LIBOR  + 3.35 %                                    | *          | 4,382                                  |       |
| Subordinated debt                      |       | 2033                             |       | LIBOR  + 3.25 %                                    | *          | 4,382                                  |       |
| Subordinated debt                      |       | 2034                             |       | LIBOR  + 2.85 %                                    | *          | 3,093                                  |       |
| Subordinated debt                      |       | 2034                             |       | LIBOR  + 3.00 %                                    | *          | 20,620                                 |       |
| Repurchase agreement                   |       | 2005                             |       | 3.60  %                                            |       | 57,618                                 |       |
| Total debt                             |       |                             |       |                                               |       | $                                      | 1,476,495  |   |
|                                        |            |                                  |            |                                                    |            |                                        |            |  |  |

----

*              Indicates a variable rate.

 

The total borrowings available through the Federal Home Loan Bank (“FHLB”)are determined each quarter as 50% of total assets of NetBank, FSB subject tolimitations of available collateral. The Company utilizes this line throughfixed and convertible term advances, as well as short-term advances, includingthirty day and overnight borrowings. Four of the FHLB advances totaling$130,000 are fixed rate. The remaining advances totaling $820,000 are alsofixed rate; however, they may be converted at the FHLB’s option to adjustablerate based on the three month floating LIBOR. The FHLB warehouse line is anadjustable line of credit with a floating rate based on the daily rate credit (“DRC”)plus 50 basis points. This warehouse line can be used to fund mortgagesoriginated by the Company. All of the FHLB advances and the FHLB warehouse lineare secured by investment securities or mortgage loans. At September 30, 2005,$573,820 of investment securities and $1,580,958 of mortgage loans were pledgedto the FHLB as collateral for the various FHLB advances.

 

The $57,618 repurchase agreement was collateralized by $71,511 ofinvestment securities. This agreement matured on October 11, 2005.

 

The Company’s subordinated debt is supported by trust preferredsecurities, which were issued in 2002, 2003 and 2005 in private pooledtransactions through off-balance sheet trusts: NBI Trust I, II, III andIV. The subordinated debt and the associated trust preferred securities carryvariable rates and were initially priced at LIBOR plus a spread ranging from2.85% to 3.35% with a cap of 12.5% for five years after their respective dateof issuances. Interest payments and the resetting of the rates both occur on aquarterly basis. The debt is scheduled to mature from December 2032through December 2034 and cannot be redeemed by the trust for a minimum offive years after issuance.

 

Most of the revolving lines of credit, warehouse lines of credit (otherthan the FHLB warehouse line) and the master repurchase facilities are securedby mortgage loans and are subject to restrictive covenants. The covenantsinclude certain minimum net worth requirements, minimum tangible net worthrequirements, minimum financial ratios, capital requirements, maintenance ofservicer eligibility for various government agencies and certain minimumliquidity requirements, which are all defined in the terms of the related debtagreements. In addition, the covenants restrict the types of businessactivities in which the Company may engage. The Company was in compliance withor had obtained a waiver for all debt covenants in place as of September 30,2005. Although management anticipates complying with all current debtcovenants, there can be no assurance that the Company or its individualsubsidiaries will be able to comply with all debt covenants in the future.Failure to comply could result in the acceleration of the repayment of therelated financing.

 

13

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Short-term debt outstanding reached thehighest month-end level during the three and nine months ended September 30,2005 on August 31, 2005 with a short-term balance of $987,667.

 

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

** **

Basic and diluted net (loss) income per common and potential commonshare has been calculated based on the weighted average number of sharesoutstanding.  The following tablereconciles the numerator and denominator of the basic and diluted net (loss)income per common and potential common share for the three and nine monthsended September 30, 2005 and 2004.

 
|                                  | ** ** | **Net (Loss)   Income  (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|---------------------------|------------|-----------------------|------------|
| Nine months ended September 30, 2005  |       |                                 |       |                      |       |                  |       |
| Basic EPS                             |       | $                                    | (1,075     | )                         | 46,201     |                  | $          | (0.02 | ) |
| Effect of dilutive securities:        |       |                                 |       |                      |       |                  |       |
| Option to purchase common shares      |       | —                               |       | —                    |       | —                |       |
| Diluted EPS                           |       | $                                    | (1,075     | )                         | 46,201     |                  | $          | (0.02 | ) |
|                                  |       |                                 |       |                      |       |                  |       |
| Nine months ended September 30, 2004  |       |                                 |       |                      |       |                  |       |
| Basic EPS                             |       | $                                    | 21,876     |                      | 46,962     |                  | $          | 0.47 |   |
| Effect of dilutive securities:        |       |                                 |       |                      |       |                  |       |
| Option to purchase common shares      |       | —                               |       | 469                       |       | (0.01                 | )          |
| Diluted EPS                           |       | $                                    | 21,876     |                      | 47,431     |                  | $          | 0.46 |   |
|                                  |       |                                 |       |                      |       |                  |       |
| ** **                            | ** ** | **Net (Loss)  Income  (Numerator)**  | ** ** | **Shares  (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
| Three months ended September 30, 2005 |       |                                 |       |                      |       |                  |       |
| Basic EPS                             |       | $                                    | (1,371     | )                         | 46,119     |                  | $          | (0.03 | ) |
| Effect of dilutive securities:        |       |                                 |       |                      |       |                  |       |
| Option to purchase common shares      |       | —                               |       | —                    |       | —                |       |
| Diluted EPS                           |       | $                                    | (1,371     | )                         | 46,119     |                  | $          | (0.03 | ) |
|                                  |       |                                 |       |                      |       |                  |       |
| Three months ended September 30, 2004 |       |                                 |       |                      |       |                  |       |
| Basic EPS                             |       | $                                    | 4,015      |                      | 46,846     |                  | $          | 0.09 |   |
| Effect of dilutive securities:        |       |                                 |       |                      |       |                  |       |
| Option to purchase common shares      |       | —                               |       | 310                       |       | —                |       |
| Diluted EPS                           |       | $                                    | 4,015      |                      | 47,156     |                  | $          | 0.09 |   |
|                                       |            |                                      |            |                           |            |                       |            |  |  |  |  |  |

** **

**14**

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**10.          BUSINESSSEGMENTS**

** **

The Company’s principal activities includeretail banking, financial intermediary and transaction processing.  Theretail banking segment primarily consists of offering consumer bankingproducts such as checking, money market, and certificates of deposit.  The retail banking segment’s investmentsprimarily consist of 1-4 family mortgage loans originated by the financialintermediary segment, small business financing loans and leases originated bythe NetBank Business Finance division, auto loans originated by the dealerfinancial services division, purchased securities for investment, mortgageservicing assets and various other purchased or retained loan products. The financial intermediary segment originates mortgage loans directly withborrowers and purchases mortgage loans from correspondents and/or brokers.  The financial intermediary segment packagesor pools such loans either inclusive or exclusive of servicing rights forretention by the retail banking segment or sale into the secondary market.  The financial intermediary segmentdiversified its operations to include the origination of loans for recreationalvehicles (RVs), boats and aircraft.  Thetransaction processing segment subservices loans for the retail bank segment,financial intermediary segment and for third-party customers; provides ATM andmerchant processing services; and sells various insurance products using anInternet-based platform.

 

The financial information for each business segment reflects specificidentifiable transactions or allocated transactions based on an internalallocation method.  The measurement ofthe performance of the business segments is based on our management structureand is not necessarily comparable with similar information from any otherfinancial institution. The information presented is also not necessarilyindicative of the segment’s operations if they were independent entities.

 
| ** **                                      | ** ** | **For the three months ended September 30, 2005** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                      | ** ** | **Retail  banking**                               | ** ** | **Financial intermediary** | ** ** | **Transaction processing** | ** ** | **Other & Eliminations** | ** ** | **Consolidated** | ** ** |
| Interest income                                 |       | $                                                 | 37,561     |   | $ | 29,347 |   | $ | 8 |   | $ | 340 |   | $ | 67,256 |   |
| Intersegment interest income                    |       | 22,426                                            |       | 123 |   | (26 | ) | (22,523 | ) | — |   |
| Total interest income                           |       | 59,987                                            |       | 29,470 |   | (18 | ) | (22,183 | ) | 67,256 |   |
| Interest expense                                |       | 34,586                                            |       | 1,890 |   | 1 |   | 549 |   | 37,026 |   |
| Intersegment interest expense                   |       | 2,372                                             |       | 20,484 |   | — |   | (22,856 | ) | — |   |
| Total interest expense                          |       | 36,958                                            |       | 22,374 |   | 1 |   | (22,307 | ) | 37,026 |   |
| Net interest income                             |       | 23,029                                            |       | 7,096 |   | (19 | ) | 124 |   | 30,230 |   |
| Provision for credit losses                     |       | 2,646                                             |       | 62 |   | — |   | — |   | 2,708 |   |
| Intersegment- servicing and processing fees     |       | —                                            |       | — |   | 3,591 |   | (3,591 | ) | — |   |
| Non-interest income                             |       | 7,684                                             |       | 28,656 |   | 4,601 |   | 207 |   | 41,148 |   |
| Non-interest expense                            |       | 22,374                                            |       | 39,212 |   | 7,674 |   | 1,440 |   | 70,700 |   |
| Intersegment- servicing and processing expenses |       | 2,620                                             |       | 971 |   | — |   | (3,591 | ) | — |   |
| Pre-tax income (loss)                           |       | $                                                 | 3,073      |   | $ | (4,493 | ) | $ | 499 |   | $ | (1,109 | ) | $ | (2,030 | ) |
| Total assets                                    |       | $                                                 | 4,801,220  |   | $ | 1,638,749 |   | $ | 39,050 |   | $ | (1,330,860 | ) | $ | 5,148,159 |   |

 

15

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| ** **                                      | ** ** | **For the three months ended September 30, 2004** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                      | ** ** | **Retail  banking**                               | ** ** | **Financial intermediary** | ** ** | **Transaction processing** | ** ** | **Other & Eliminations** | ** ** | **Consolidated** | ** ** |
| Interest income                                 |       | $                                                 | 33,639     |   | $ | 29,420 |   | $ | 12 |   | $ | 421 |   | $ | 63,492 |   |
| Intersegment interest income                    |       | 11,597                                            |       | 549 |   | — |   | (12,146 | ) | — |   |
| Total interest income                           |       | 45,236                                            |       | 29,969 |   | 12 |   | (11,725 | ) | 63,492 |   |
| Interest expense                                |       | 22,685                                            |       | 2,476 |   | 20 |   | 194 |   | 25,375 |   |
| Intersegment interest expense                   |       | 138                                               |       | 11,814 |   | — |   | (11,952 | ) | — |   |
| Total interest expense                          |       | 22,823                                            |       | 14,290 |   | 20 |   | (11,758 | ) | 25,375 |   |
| Net interest income                             |       | 22,413                                            |       | 15,679 |   | (8 | ) | 33 |   | 38,117 |   |
| Provision for credit losses                     |       | 466                                               |       | 3 |   | — |   | — |   | 469 |   |
| Intersegment- servicing and processing fees     |       | —                                            |       | — |   | 3,721 |   | (3,721 | ) | — |   |
| Non-interest income                             |       | 771                                               |       | 28,514 |   | 4,616 |   | (512 | ) | 33,389 |   |
| Non-interest expense                            |       | 17,958                                            |       | 38,035 |   | 7,300 |   | 1,243 |   | 64,536 |   |
| Intersegment- servicing and processing expenses |       | 2,560                                             |       | 1,161 |   | — |   | (3,721 | ) | — |   |
| Pre-tax income (loss)                           |       | $                                                 | 2,200      |   | $ | 4,994 |   | $ | 1,029 |   | $ | (1,722 | ) | $ | 6,501 |   |
| Total assets                                    |       | $                                                 | 4,148,062  |   | $ | 1,494,300 |   | $ | 36,436 |   | $ | (1,190,527 | ) | $ | 4,488,271 |   |

** **
| ** **                                      | ** ** | **For the nine months ended September 30, 2005** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                      | ** ** | **Retail  banking**                              | ** ** | **Financial intermediary** | ** ** | **Transaction processing** | ** ** | **Other & Eliminations** | ** ** | **Consolidated** | ** ** |
| Interest income                                 |       | $                                                | 110,227    |   | $ | 75,744 |   | $ | 27 |   | $ | 779 |   | $ | 186,777 |   |
| Intersegment interest income                    |       | 52,426                                           |       | 2,551 |   | (20 | ) | (54,957 | ) | — |   |
| Total interest income                           |       | 162,653                                          |       | 78,295 |   | 7 |   | (54,178 | ) | 186,777 |   |
| Interest expense                                |       | 87,803                                           |       | 5,637 |   | 32 |   | 1,356 |   | 94,828 |   |
| Intersegment interest expense                   |       | 6,591                                            |       | 49,257 |   | 6 |   | (55,854 | ) | — |   |
| Total interest expense                          |       | 94,394                                           |       | 54,894 |   | 38 |   | (54,498 | ) | 94,828 |   |
| Net interest income                             |       | 68,259                                           |       | 23,401 |   | (31 | ) | 320 |   | 91,949 |   |
| Provision for credit losses                     |       | 7,298                                            |       | 91 |   | — |   | — |   | 7,389 |   |
| Intersegment- servicing and processing fees     |       | —                                           |       | — |   | 10,482 |   | (10,482 | ) | — |   |
| Non-interest income                             |       | 16,369                                           |       | 86,010 |   | 14,154 |   | 317 |   | 116,850 |   |
| Non-interest expense                            |       | 60,547                                           |       | 114,739 |   | 22,193 |   | 5,214 |   | 202,693 |   |
| Intersegment- servicing and processing expenses |       | 7,666                                            |       | 2,816 |   | — |   | (10,482 | ) | — |   |
| Pre-tax income (loss)                           |       | $                                                | 9,117      |   | $ | (8,235 | ) | $ | 2,412 |   | $ | (4,577 | ) | $ | (1,283 | ) |
| Total assets                                    |       | $                                                | 4,769,903  |   | $ | 1,638,749 |   | $ | 39,050 |   | $ | (1,332,389 | ) | $ | 5,115,313 |   |

** **

**16**

----

 
| ** **                                      | ** ** | **For the nine months ended September 30, 2004** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                      | ** ** | **Retail  banking**                              | ** ** | **Financial intermediary** | ** ** | **Transaction processing** | ** ** | **Other & Eliminations** | ** ** | **Consolidated** | ** ** |
| Interest income                                 |       | $                                                | 88,280     |   | $ | 84,003 |   | $ | 30 |   | $ | 2,041 |   | $ | 174,354 |   |
| Intersegment interest income                    |       | 31,914                                           |       | 662 |   | — |   | (32,576 | ) | — |   |
| Total interest income                           |       | 120,194                                          |       | 84,665 |   | 30 |   | (30,535 | ) | 174,354 |   |
| Interest expense                                |       | 60,822                                           |       | 6,622 |   | 65 |   | 480 |   | 67,989 |   |
| Intersegment interest expense                   |       | 381                                              |       | 31,822 |   | — |   | (32,203 | ) | — |   |
| Total interest expense                          |       | 61,203                                           |       | 38,444 |   | 65 |   | (31,723 | ) | 67,989 |   |
| Net interest income                             |       | 58,991                                           |       | 46,221 |   | (35 | ) | 1,188 |   | 106,365 |   |
| Provision for credit losses                     |       | 3,938                                            |       | 44 |   | — |   | — |   | 3,982 |   |
| Intersegment- servicing and processing fees     |       | —                                           |       | — |   | 10,775 |   | (10,775 | ) | — |   |
| Non-interest income                             |       | 17,841                                           |       | 98,688 |   | 12,992 |   | (3,101 | ) | 126,420 |   |
| Non-interest expense                            |       | 53,923                                           |       | 112,817 |   | 22,968 |   | 4,119 |   | 193,827 |   |
| Intersegment- servicing and processing expenses |       | 7,435                                            |       | 3,340 |   | — |   | (10,775 | ) | — |   |
| Pre-tax income (loss)                           |       | $                                                | 11,536     |   | $ | 28,708 |   | $ | 764 |   | $ | (6,032 | ) | $ | 34,976 |   |
| Total assets                                    |       | $                                                | 4,148,062  |   | $ | 1,494,300 |   | $ | 36,436 |   | $ | (1,190,527 | ) | $ | 4,488,271 |   |

# ** **

# **11.          COMMITMENTS,CONTINGENCIES AND GUARANTEES**

 

The Company was servicing or subservicing forthe benefit of others 115,952 and 106,781 residential loans with unpaidprincipal balances aggregating approximately $15.2 and $14.0 billion atSeptember 30, 2005 and December 31, 2004, respectively. Mortgagors’ taxesand insurance escrow funds and investors’ principal and interest escrow fundstotaled approximately $334,106 and $288,347 as of September 30, 2005 andDecember 31, 2004, respectively. Loans serviced for others and the relatedescrow funds are not owned by the Company; however, the majority of the escrowfunds are deposited in NetBank, FSB.

 

The Company has issued mortgage-backedsecurities under programs sponsored by Ginnie Mae, Freddie Mac and Fannie Mae.In connection with servicing mortgage-backed securities guaranteed by GinnieMae, Freddie Mac or Fannie Mae, the Company advances certain principal andinterest payments to security holders prior to their collection from specificmortgagors. Additionally, the Company must remit certain payments of propertytaxes and insurance premiums in advance of collecting them from specificmortgagors and make certain payments of attorney’s fees and other costs relatedto loans in foreclosure. These amounts are included in servicing advances underthe caption “due from servicers and investors” in the accompanying consolidatedbalance sheets. Likewise, during the month that a mortgagor pays off his/hermortgage, the Company must accept an interest payment from the borrower that ispro-rated to the date of payoff and pass through a full month’s interest to thesecurity holder. The Company includes its projection of the cost of suchadvances and lost interest on mortgages that prepay, and the expense ofunreimbursed attorney and other costs associated with foreclosure in its valuationof its MSRs.

 

In the ordinary course of business, theCompany is exposed to liability under representations and warranties made topurchasers and insurers of mortgage loans and the purchasers of MSRs. Undercertain circumstances, the Company may be required to repurchase mortgage loansor indemnify the purchasers of loans or MSRs for losses if there has been abreach of representations or warranties. Repurchased loans are carried at the lower of cost or net realizablevalue.  As of September 30, 2005 andDecember 31, 2004, loans held for sale included repurchased loans with a netcarrying value of $38,353 and $48,852, respectively.

 

We are required under GAAP to disclose ourmaximum exposure under our representations and warranties.  The maximum exposure would be the currentunpaid principal balance of any loan we have ever sold, excluding loans soldwhich specifically excluded our representations and warranties, plus any fee orpremium we received for the sale.

 

17

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Additionally, we potentially could have torefund any fees or premiums we received for the sale of MSRs that are still onthe purchasers’ books.  However, since weare not the current servicer for the majority of the loans and MSRs asdescribed above, we cannot determine our maximum exposure.

 

The Company repurchased approximately $98,031and $70,455 of unpaid principal balances during the nine months ended September30, 2005 and 2004, respectively. The Company had $17,776 and $22,676 of reservesfor estimated losses on future repurchases as of September 30, 2005 andDecember 31, 2004, respectively.

 

During the quarter endedSeptember 30, 2005, the Company became aware of certain conforming mortgageloans originated and sold previously in which misrepresentations may have beenmade by on or more of the parties involved during the loan application process.These loans have an outstanding principal balance of approximately $13,000. Assuch, management considered it prudent to record a $3,500 special provision inits representations and warranties liability and a reduction of gains on salesof loans and mortgage servicing rights. The special provision is based on areview of the underlying property values in a foreclosure or liquidationscenario. In the event of any losses on these loans, the Company may beentitled to pursue recovery from title insurers and other parties to theorigination. However, these sources of recovery involve varying degrees ofuncertainty and, as a result, have not been considered in management’sassessment.

 

As of September 30, 2005, the Company hadcommitments to fund mortgage loans of $1.1 billion, open-end consumer lines ofcredit of $90,809, undisbursed mortgage construction loans of $93,134,undisbursed leasing commitments of $3,479 and commercial financing commitmentsof $3,352.

 

**TheCompany is involved in certain legal proceedings, excluding the CMC litigation,incidental to its business.  The Companydoes not believe that the outcome of these proceedings will have a materialadverse effect upon its financial condition, results of operations or cashflows.**

** **

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

** **

*The following discussion mayinclude forward-looking statements. Forward-looking statements regarding theintent, belief or current expectations of NetBank, Inc. or its officers anddirectors can be identified by the use of forward-looking terms such as “believe”,“anticipate”, “estimate”, “expect”, “may”, “will”, “should”, “plan”, “intend”, “project”,or other comparable terminology. Various internal and external factors couldcause the Company’s actual results to differ materially from those anticipatedby the forward-looking statements. These factors include, but are in no waylimited to, 1) the evolving nature of the market for Internet banking andfinancial services generally; 2) the public’s perception of the Internet as asecure, reliable channel for transactions; 3) the success of new products andlines of business considered critical to the Company’s long-term strategy, suchas small business banking and transaction processing services; 4) potentialdifficulties in integrating the Company’s operations across its multiple linesof business; 5) the cyclical nature of the mortgage banking industry generally;6) a possible decline in asset quality; 7) changes in general economic oroperating conditions which could adversely affect mortgage loan production andsales, mortgage servicing rights, loan delinquency rates and/or loandefaults;  8) the possible adverseeffects of unexpected changes in the interest rate environment; 9) adverselegal rulings, particularly in the Company’s litigation over leases originatedby Commercial Money Center, Inc.; and/or 10) increased competition andregulatory changes.  The Company’s 2004Form 10-K contains additional details on these and other risks that arematerial to our operations. All forward-looking statements in this report arebased on information available at the time of filing. Except as required by thefederal securities laws, the Company has no obligation to update anyforward-looking statement included herein. Forward-looking statements are made in reliance on the safe harborprovisions of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended.*

 

18

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**General**

 

NetBank, Inc. is a financial holdingcompany engaged primarily in retail banking, mortgage banking, business financeand providing ATM and merchant processing services. NetBank, Inc. whollyowns the outstanding stock of NetBank (“NetBank, FSB” or “the Bank”), a federalsavings bank; MG Reinsurance Company (“MG Reinsurance”), a captive reinsurancecompany; NetInsurance, Inc. (“NetInsurance”), a licensed insurance agency;and NB Partners, Inc., a corporation involved in strategic partneringopportunities. NB Partners, Inc. owns all of the outstanding stock ofFinancial Technologies, Inc., a corporation formed in 2004 to markettransaction processing services to other financial services companies. NetBank,FSB owns all of the outstanding stock of Market Street Mortgage Corporation (“MarketStreet”), a retail mortgage company, NetBank Payment Systems, Inc. (“NPS”),a provider of ATM and merchant processing services for retail and othernon-bank businesses and Meritage Mortgage Corporation (“Meritage”), a wholesalenon-conforming mortgage provider. Additionally, NetBank, FSB’s wholesalemortgage division operates as NetBank Funding Services and its businessfinancing unit operates as NetBank Business Finance.  The consolidated company is referred toherein as “we,” “our” or “the Company”.

 

In the opinion of management, the unauditedconsolidated financial statements included herein reflect all adjustments,consisting only of normal recurring accruals, which are necessary for the fairpresentation of the financial condition and results of operations for theinterim 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 our2004 Form 10-K. The results of operations for the interim periods reportedherein are not necessarily indicative of results to be expected for the fullyear. Certain 2004 amounts have been reclassified for comparability with 2005amounts.

 

All figures are presented in thousands(000s), except share and per share data, unless otherwise noted. All of ouroperations and assets are located within the United States.

** **

**ExecutiveSummary and Future Outlook**

 

For the three months ended September 30, 2005we recorded net loss of $1,371 or $0.03 per share compared to net income of$4,015 or $0.09 per share for the three months ended September 30, 2004, a$5,386 decline.  NetBank’s resultscontinue to be adversely impacted by 1) flattening of the yield curve whichreduces net interest earned on interest-earning assets held-for-sale andheld-for-investment, 2) depressed gain on sale margins within the financialintermediary segment resulting from competitive conditions, 3) continued highvolume of repurchase losses related to representations and warranties on loanssold, and 4) a $3,500 special provision discussed above related to certainconforming loans previously sold to investors. Based on current market conditions, we expect the fourth quarter of 2005to closely resemble the third quarter of 2005, exclusive of the $3,500 specialprovision.

* *

*Retail Banking.*The retail banking segmentrecorded pre-tax income of $3,073 during the third quarter of 2005, an $873increase over the comparable period in 2004. Net servicing results improved by$8,049 relating primarily to the recovery of a portion of the impairmentreserves on MSRs relating to slower forecasted prepayments, offset, in part, bylosses on related hedges.  However, collectively,the Internet-only banking, leasing and auto operations within the retailbanking segment saw a decrease in their period over period pre-tax income by$7,176 to $2,943. This decrease was primarily driven by an increase inoperating expenses in the retail bank of $3,936, a reduction in gain on sale ofloans of $2,011, and an increase in provision expense for credit losses of$2,180.  The increase in the provisionfor credit losses period-over-period relates to the retail banking segmentretaining a higher percentage of auto loans, second-mortgage loans, HELOCs, andbusiness financing leases compared to the first-mortgage loans which dominatedthe retention activity during 2004. These loans and leases generally have a higher risk adjusted yield thanthe adjustable-rate first-mortgage loans that were previously being retained.

* *

*Financial Intermediary*. The financialintermediary segment recorded pre-tax loss of $4,493 for the third quarter of2005, a $9,487 pre-tax decline period over period.  This decline was primarily driven by an$88,903 decline in mortgage sales coupled with severely compressed margins andthe $3,500 special provision which resulted in

 

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a reduction of gain on salesof loans and mortgage servicing rights. Reference is made to note 11 of the notes to the consolidated financialstatements included in this report for further discussion on this specialprovision.

 

The non-conforming operationwithin the financial intermediary segment recorded pre-tax income of $301during the third quarter of 2005 compared to pre-tax income of $2,240 duringthe same quarter in 2004, a $1,939 decline. While the non-conforming operation’s pre-tax results period over perioddeclined, its pre-tax results improved $5,114 from its low point in the firstquarter of 2005. The improvement over the first quarter was the result of a32-basis point increase in the revenue margin coupled with a $145,874 increasein sales of mortgage loans.  Likewise,production volumes increased by $253,027 to $883,210 comparing the firstquarter 2005 to the third quarter 2005, resulting in an improvement in theratio of expenses to production from 228-basis points in the first quarter to158-bps in the third quarter of 2005, as fixed expenses were leveraged acrosshigher production volume.  Competitiveconditions in the non-conforming market remain adverse, and management believesthat the results of the non-conforming operations may remain volatile overcoming quarters.

 

The conforming mortgageoperation within the financial intermediary segment recorded a pre-tax loss of$5,303 for the third quarter of 2005 compared to pre-tax income of $2,386during the same quarter in 2004.  Thisdecline was primarily the result of a 34-basis point decline in the revenuemargin. Although margins continue to be depressed related to competitiveconditions within the mortgage banking industry, much of the change in marginis the result of a higher level of loan repurchases in the conforming channel andthe aforementioned special $3,500 provision discussed above relating tocertain conforming loans.  Net interestincome declined by $6,278 related to the flattening of the yield curve yearover year.  Generally, NetBank earns along-term interest rate on loans held for sale and finances those loans withshort-term borrowings.  As the yieldcurve flattens, the net interest margin compresses.  It is uncertain whether the trends inrepurchases and the flattening of the yield curve will continue.  If the repurchase trends and flattening ofthe yield curve continue, NetBank will continue to provide higher levels ofprovisions for repurchases and realize reduced levels of net interest margin onloans held-for-sale in future quarters.

* *

*Transaction Processing.* Thetransaction processing segment recorded pre-tax income of $499 for the threemonth period ended September 30, 2005 compared to  pre-tax income of $1,029  for the same period in  2004. The decrease relates primarily toadditional reserves related to corporate advances and a reduction in pre-taxearnings of NPS of $512, offset in part by a reduction in the loss ofNetInsurance of $480 period over period. NetInsurance increased itspolicies-in-force and cut its operating expenses.

* *

*Other/Eliminations.* The other/eliminationssegment contains the holding company expenses along with the elimination ofinter-segment gains and losses on loans sold to the retail banking segment fromthe financial intermediary segment. The other/eliminations segment recorded apre-tax loss of $1,109 for the three months ended September 30, 2005 comparedto a pre-tax loss of $1,722 for the comparable period of 2004.  The $613 improvement was primarily related tostrict expense control at the holding company.

* *

*Risk and Contingencies*. Reference ismade to the discussion under the heading “Risks Relating to NetBank’s Business”in Item 1. Business and to the heading “Future Outlook” in Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of operations in the2004 Form 10-K for further information regarding the risks and challenges ofour business. Reference is made to note 11 of the notes to consolidatedfinancial statements included in this report and to Item 1. Legal Proceedingsin Part II of this report for additional discussion of certain risks andcontingencies that may affect us.

* *

*Recent Hurricanes.*  The company originates loans throughout theUnited States, including those areas recently affected by hurricanes.  As of September 30, 2005, within thosehurricane-affected areas, the Company had loans held for sale totaling $27,114(less than 2% of the Company’s outstanding held for sale mortgage loanportfolio) and loans held for investment totaling $14,426 (approximately 1% ofthe Company’s outstanding held for investment mortgage loan portfolio).  In addition, the Company services mortgageloans in the hurricane-affected areas totaling $190,756 (less than 2% of the Company’sservicing portfolio) for third party investors. The Company

 

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believes that the propertyunderlying the aforementioned mortgage loans is covered by hazard and, whereapplicable, flood insurance.  The Companyis proactively working with borrowers to minimize losses.  Although we expect a small rise indelinquency rates as a result of the hurricanes, we do not expect a materialimpact to the Company’s ongoing operations.

 

# **Financial Condition**

 

*General. *Ourassets totaled $5.12 billion at September 30, 2005, an increase of $493,132 or11% from December 31, 2004.  This isprimarily the result of increases of $285,938 in loans held for sale and $152,018in cash and cash equivalents.    Theincrease in loans held for sale is primarily the result of mortgage loanproduction outpacing sales of mortgage loans during the nine months endedSeptember 30, 2005 by $409,922.  Theincrease in cash and cash equivalents was the result of a sale of loans thatsettled on September 30, 2005.  Theincrease in assets since December 31, 2004 was funded by increases in depositsand other borrowed funds of $367,702 and $132,527, respectively.

 

*Investment Securities.*  For thenine months ended September 30, 2005, the investment security portfoliodecreased by $18,875. This decrease was substantially due to the sale or maturityof $380,858 of securities, primarily Fannie Mae mortgage pool securities, andthe receipt of $87,181 of payments on mortgage pool securities. The decreasewas offset, in part, by the purchase of $457,128 of new investment securities,primarily Ginnie Mae mortgage pool securities. During the nine months endedSeptember 30, 2005, we were able to take advantage of market conditions andreplace certain of our Fannie Mae securities with similar yielding Ginnie Maesecurities. With only a slight reduction in yield, we strengthened ourrisk-weighted capital ratios due to Ginnie Mae securities being zero percentrisk-weighted.

 

The following tables set forth certain information relating to ouravailable for sale securities:

 
| **As of  September 30, 2005**                           | ** ** | **Amortized  cost** | ** ** | **Unrealized  gains** | ** ** | **Unrealized  losses** | ** ** | **Estimated  fair value** | ** ** |
|---------------------------------------------------------|------------|---------------------|------------|-----------------------|------------|------------------------|------------|---------------------------|------------|
| U.S. government  agency — mortgage pool securities |       | $                   | 545,157    |                  | $          | —                 |       | $                         | 9,242      |   | $ | 535,915 |   |
| Collateralized  mortgage obligations                    |       | 62,518              |       | 37                    |       | 477                    |       | 62,078                    |       |
| U.S. government  agencies                               |       | 27,641              |       | —                |       | 278                    |       | 27,363                    |       |
| Corporate bonds                                         |       | 39,168              |       | 552                   |       | 198                    |       | 39,522                    |       |
| U.S. treasury  securities                               |       | 12,926              |       | —                |       | 348                    |       | 12,578                    |       |
| Habitat bonds  and other                                |       | 3,825               |       | 139                   |       | —                 |       | 3,964                     |       |
| Total                                                   |       | $                   | 691,235    |                  | $          | 728                    |       | $                         | 10,543     |   | $ | 681,420 |   |
|                                                    |       |                |       |                  |       |                   |       |                      |       |
| **As of  December 31, 2004**                            | ** ** | **Amortized  cost** | ** ** | **Unrealized  gains** | ** ** | **Unrealized  losses** | ** ** | **Estimated  fair value** | ** ** |
| U.S. government  agency — mortgage pool securities |       | $                   | 574,495    |                  | $          | —                 |       | $                         | 3,205      |   | $ | 571,290 |   |
| Collateralized mortgage obligations                     |       | 31,572              |       | 108                   |       | 87                     |       | 31,593                    |       |
| U.S. treasury securities                                |       | 53,177              |       | 865                   |       | 87                     |       | 53,955                    |       |
| Corporate bonds                                         |       | 39,150              |       | 609                   |       | 218                    |       | 39,541                    |       |
| Habitat bonds and other                                 |       | 3,733               |       | 183                   |       | —                 |       | 3,916                     |       |
| Total                                                   |       | $                   | 702,127    |                  | $          | 1,765                  |       | $                         | 3,597      |   | $ | 700,295 |   |
|                                                         |            |                     |            |                       |            |                        |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Loans Heldfor Sale.* As more fully describedin note 4 of the notes to the consolidated financial statements included in our2004 Form 10-K, loans held for sale arecarried at the aggregate of the lower of cost or market until sold, typically30 to 90 days after origination or purchase. The majority of the non-performingloans held for sale consist of loans which have been repurchased underrepresentations and warranties provided to purchasers. Once a loan has beenrepurchased, it is generally resold at a price less than the repurchase price.Upon repurchase, reserves are transferred from the reserve for

 

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representations andwarranties to a valuation reserve for repurchased loans to record such loans atestimated net realizable value.  AtSeptember 30, 2005 and December 31, 2004, the aggregate fair value of loansheld for sale exceeded the aggregate cost.

 

The following tables set forth informationregarding our portfolio of loans held for sale:

 
| **As of  September 30, 2005** | ** ** | **Gross UPB** | ** ** | **Non-  performing** | ** ** | **Reserve** | ** ** |
|-------------------------------|------------|---------------|------------|----------------------|------------|-------------|------------|
| Conforming mortgages          |       | $             | 1,043,099  |                 | $          | 16,791      |       | $ | 2,732 |   |
| Non-conforming mortgages      |       | 339,649       |       | 10,492               |       | 5,682       |       |
| Construction                  |       | 76,499        |       | 149                  |       | 112         |       |
| Commercial / recreational     |       | 9,462         |       | —               |       | 466         |       |
| Total loans held for sale     |       | $             | 1,468,709  |                 | $          | 27,432      |       | $ | 8,992 |   |
|                          |       |          |       |                 |       |        |       |
| **As of  December 31, 2004**  | ** ** | **Gross UPB** | ** ** | **Non-  performing** | ** ** | **Reserve** | ** ** |
| Conforming mortgages          |       | $             | 821,422    |                 | $          | 23,488      |       | $ | 4,179 |   |
| Non-conforming mortgages      |       | 300,406       |       | 12,810               |       | 5,293       |       |
| Construction                  |       | 54,564        |       | 335                  |       | 140         |       |
| Commercial / recreational     |       | 7,893         |       | —               |       | 894         |       |
| Total loans held for sale     |       | $             | 1,184,285  |                 | $          | 36,633      |       | $ | 10,506 |   |
|                               |            |               |            |                      |            |             |            |  |  |  |  |  |  |  |  |

 

The Company, when required to repurchasemortgage loans, bundles such loans in pools and re-sells them, generally at aloss.  The $9,201 decline innon-performing loans held for sale is primarily related to such re-sales ofmortgage loans during the nine months ended September 30, 2005.  The size of the repurchase inventory, whichis primarily comprised of non-performing loans, will vary depending on thetiming of the repurchases and the subsequent dispositions.

* *

*Loan and Lease Receivables.*  For thenine months ended September 30, 2005, the loan and lease receivables portfolioincreased $49,191 or 2%.  The increase in loan and lease receivableswas primarily due to the retention of $4,770 of mortgage loans, $337,721 ofauto loans, $137,895 of business equipment finance leases, $146,841 in homeequity lines of credit (“HELOCs”), and $25,724 of marine and recreationalvehicle loans.   Aggregate principalreductions and prepayments were $513,562. In addition, $68,182 of HELOCs weretransferred to held for sale loans during the nine month period ended September30, 2005.

* *

*Asset Quality and Non-performingAssets.* We periodically review the performance of our loan and leasereceivables portfolio by reviewing charge-offs, delinquency statistics, andvarious other industry statistics.  Largenon-homogeneous credits are reviewed on a loan-by-loan or lease-by-lease basis,whereas relatively small credits with similar risk characteristics are reviewedon a pool-by-pool basis.  If a decline incredit quality for a specific pool or individual loan or lease is noted, werecord additional allowance through a charge to the provision for creditlosses.  The allowance for credit lossesis maintained at a level estimated to be adequate to provide for probablelosses in the loan and lease receivables portfolio. We determine the adequacyof the allowance based upon reviews of individual loans and leases or pools asapplicable, recent loss experience, current economic conditions, the riskcharacteristics of the various categories of loans and leases and otherpertinent factors. Our non-performing assets as a percentage of gross UPBimproved from 1.75% at December 31, 2004, to 1.51% at September 30, 2005, as thelevel of non-performing assets declined by $4,139 and gross UPB increased$51,459 or 2.4%.  In the CMClitigation, during the third quarter of 2005 the judge in the multi-districtlitigation ruled in favor of the banks and against one of the sureties, IllinoisUnion.  With respect to the other twosureties, the court did not grant the banks’ motion, but instead stated thatthe banks must prove that they were the intended “obligee” in the leases andthat there was no fraud on the part of the banks.  The Company believes that the facts andcircumstances and evidence gathered in discovery will support its claim asobligee under the bonds and will support the conclusion that there was no fraudcommitted by NetBank, FSB.  It isimportant to note that NetBank, FSB is not technically a party to these rulingssince it previously withdrew its motion for judgment on the pleadings.  The judge has provided NetBank, FSB anopportunity to renew its interest in the motion as relates to Illinois Union sothe Illinois Union ruling could eventually apply to NetBank, FSB.  Reference is made to Item 1. LegalProceedings in Part II of this report for additional information related to theCompany’s ongoing CMC litigation.

 

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The following tables detail our held forinvestment loan and lease receivables portfolio, the associated allowance forcredit losses, and non-performing assets:

 
| **As of  September 30, 2005**    | ** ** | **Gross UPB** | ** ** | **Allocated  Allowance** | ** ** | **(1) Non-  performing** | ** ** |
|----------------------------------|------------|---------------|------------|--------------------------|------------|--------------------------|------------|
| First mortgages                  |       | $             | 878,329    |                     | $          | 3,588                    |       | $ | 2,768 |   |
| Second mortgages                 |       | 127,416       |       | 3,203                    |       | 408                      |       |
| Leases                           |       | 360,925       |       | 14,496                   |       | 2,864                    |       |
| Auto                             |       | 592,391       |       | 2,611                    |       | 231                      |       |
| Home equity lines                |       | 155,134       |       | 2,650                    |       | 210                      |       |
| Consumer                         |       | 31,123        |       | 182                      |       | —                   |       |
| Loan and lease receivables       |       | 2,145,318     |       | 26,730                   |       | 6,481                    |       |
| CMC leases(2)                    |       | 26,435        |       | —                   |       | 26,435                   |       |
| Total loan and lease receivables |       | $             | 2,171,753  |                     | $          | 26,730                   |       | $ | 32,916 |   |
|                             |       |          |       |                     |       |                     |       |
| **As of  December 31, 2004**     | ** ** | **Gross UPB** | ** ** | **Allocated  Allowance** | ** ** | **(1) Non-  performing** | ** ** |
| First mortgages                  |       | $             | 1,081,676  |                     | $          | 3,842                    |       | $ | 3,232 |   |
| Second mortgages                 |       | 170,993       |       | 4,451                    |       | 183                      |       |
| Leases                           |       | 324,489       |       | 13,146                   |       | 1,532                    |       |
| Auto                             |       | 391,934       |       | 1,593                    |       | 278                      |       |
| Home equity lines                |       | 115,068       |       | 1,334                    |       | 291                      |       |
| Consumer                         |       | 4,607         |       | 96                       |       | 2                        |       |
| Loan and lease receivables       |       | 2,088,767     |       | 24,462                   |       | 5,518                    |       |
| CMC leases(2)                    |       | 31,527        |       | —                   |       | 31,527                   |       |
| Total loan and lease receivables |       | $             | 2,120,294  |                     | $          | 24,462                   |       | $ | 37,045 |   |
|                                  |            |               |            |                          |            |                          |            |  |  |  |  |  |  |  |  |

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(1) Non-performingincludes all loans that are 90 days or more contractually past due includingloans which have been restructured.  TheCompany also held $2,129 and $210 of restructured loans which were performingin accordance with the restructured terms as of September 30, 2005 and December31, 2004, respectively.

(2) Reference ismade to note 4 of the notes to the consolidated financial statements includedin this report for additional details regarding the CMC lease portfolio.

 

*Mortgage Servicing Rights.*  We intend to retainsubstantially all of our originated conventional MSRs in order to achieve thenecessary critical mass our servicing division requires to become operationallyprofitable.  During 2005, however, basedon market conditions, we chose to sell the majority of our conventionalmortgage loan production on a whole loan, servicing-released basis.  We will continue to monitor market conditionsand return to retaining a larger percentage of our conventional MSRs if andwhen the market changes.  For the ninemonths ended September 30, 2005, the MSR portfolio increased $20,979 or 12%.  The increase was primarily driven by thepurchase of a bulk $2.5 billion portfolio, which had a capitalized value of$35,181, the capitalization of $23,496 from the retention of MSRs, amark-to-market adjustment of $1,679 and a $3,224 valuation recovery.  These increases were partially offset by$34,873 of amortization, and $1,281 net impact of sales of MSRs.  During the nine month period ended September30, 2004, NetBank recorded an increase of $7,153 in the market value of thederivatives portfolio hedging the MSRs. The fair value of the derivative portfolio hedging the MSRs is recordedin other assets.

 

 

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The following table provides a sensitivityanalysis of MSRs:

 
| ** **                                  | ** ** | **As of  September 30, 2005** | ** **  | **As of  December 31, 2004** | ** ** |
|---------------------------------------------|------------|------------------------------------|-------------|-----------------------------------|------------|
| Fair value                                  | ** ** | **$**                              | **191,648** |                              | $          | 171,075 |   |
| Weighted average life in  years             | ** ** | **4.8**                            |        | 4.7                               |       |
|                                        |       |                               |        |                              |       |
| Prepayment speed  assumption (annual rate)  | ** ** | **15.40**                          | %           | 16.00                             | %          |
| Impact on fair value of  10% adverse change | ** ** | **$**                              | **(9,146**  | )                                 | $          | (9,314 | ) |
| Impact on fair value of  20% adverse change | ** ** | **$**                              | **(19,880** | )                                 | $          | (17,758 | ) |
|                                        |       |                               |        |                              |       |
| Discount rate                               | ** ** | **11.00**                          | %           | 10.52                             | %          |
| Impact on fair value of  10% adverse change | ** ** | **$**                              | **(11,639** | )                                 | $          | (4,276 | ) |
| Impact on fair value of  20% adverse change | ** ** | **$**                              | **(17,859** | )                                 | $          | (8,186 | ) |
|                                             |            |                                    |             |                                   |            |  |  |  |

 

The sensitivitiesabove are hypothetical and should be used with caution.  As the figures indicate, changes in fairvalue based on a 10% variation in assumptions generally cannot be extrapolatedbecause the relationship of the change in assumption to the change in fairvalue may not be linear.  Also, in thetable above, the effect of a variation in a particular assumption on the fairvalue of the available for sale servicing rights is calculated without changingany other assumption; in reality, changes in one factor may result in changesin another, which might magnify or counteract the sensitivities.  The analysis above excludes the impact of ourhedging activities related to the available for sale servicing rights.

 

*Derivatives.*The value of derivatives hedging the MSR portfolio was $17,234 atSeptember 30, 2005 compared to $10,081 at December 31, 2004, an increase of$7,153. The derivatives consist primarily of commitments to purchase mortgagepool securities, options, floors, swaps, swaptions, caps, and floors.  The value of the derivatives hedging thepipeline of MSRs was a loss of $672 compared to a loss of $147 at December 31,2004.  The value of our loan commitmentsfor which the interest rate is locked (“rate locks”) decreased in value to aloss of $2,549 compared to a gain of $1,687 at December 31, 2004, a decrease of $4,236. Our portfolio ofmandatory delivery commitments hedging our rate locks was a gain of $3,392compared to a loss of $707 at December 31, 2004. Both of these amounts aremarked-to-market and reflected in our consolidated statement of operations. Thevalue of the mandatory delivery commitments hedging our inventory of closedloans was a gain of $3,765 compared to a loss of $1,034 at December 31, 2004,an improvement of $4,799. Since the mandatory delivery commitments qualify forhedge accounting, this amount was recorded as a basis adjustment to ourinventory of mortgage loans held for sale.

 

*Liabilities.* Total liabilities increased $565,270 duringthe nine months ended September 30, 2005. The increase was primarily related to increases of $367,702 in deposits,$132,527 in other borrowed funds, $20,620 in subordinated debt, and $31,302 inloans in process offset, in part, by a decrease of $50,543 in unsettled tradesand a decrease in representations and warranties of $1,401.  These net increases in liabilities were usedto support the higher levels of loans held for sale and loan and leasereceivables.

 

*Deposits.*  Deposits were $3.01 billion at September 30,2005, a 13.9% increase compared to $2.64 billion at December 31, 2004.  As of September 30, 2005, depositsrepresented 67% of total interest-bearing liabilities (including deposits,other borrowed funds, and subordinated debt) outstanding; Federal Home LoanBank (“FHLB”) advances, warehouse lines of credit, and repurchase agreementsrepresented approximately 32% in the aggregate; and subordinated debt was only1%.  We will continue working to deepenour relationships with new and existing customers to expand our deposit base.

 

24

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The following table summarizes our deposits:

 
| ** **                             | ** ** | **As of September 30, 2005** | ** ** | **As of December 31, 2004** | ** ** |
|----------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | **Amount**                   | ** ** | **Percentage**              | ** ** | **Weighted  average  interest  rate** | ** ** | **Amount** | ** ** | **Percentage** | ** ** | **Weighted  average  interest  rate** | ** ** |
| Non-interest bearing checking accounts |       | $                            | 345,938    |                        | 11.5       | % | — |   | $ | 285,218 |   | 10.8 | % | — |   |
| Interest bearing:                      |       |                         |       |                        |       |   |   |   |   |   |   |   |   |
| Checking accounts                      |       | 230,081                      |       | 7.7                         | %          | 1.0 | % | 261,588 |   | 9.9 | % | 1.0 | % |
| Money market                           |       | 987,235                      |       | 32.8                        | %          | 2.9 | % | 1,158,529 |   | 43.9 | % | 1.9 | % |
| Certificate of deposit under $100      |       | 1,359,131                    |       | 45.2                        | %          | 3.7 | % | 830,996 |   | 31.5 | % | 2.9 | % |
| Certificate of deposit over $100       |       | 84,758                       |       | 2.8                         | %          | 3.8 | % | 103,110 |   | 3.9 | % | 3.3 | % |
| Total deposits                         |       | $                            | 3,007,143  |                        | 100.0      | % |   |   | $ | 2,639,441 |   | 100.0 | % |   |   |

* *

*Reserve for Representations andWarranties.*The reserve for representations and warranties ismaintained at a level estimated to be adequate to cover future losses on loanswhich we may be required to repurchase under representations and warrantiesprovided to purchasers. We establish the reserve for future losses by reducingcurrent period gain on sale of loans. The reserve declined by $1,401 during the nine months ended September30, 2005.  This decline is primarilyattributable to the decline in the volume of loans sold during 2005 and late2004 compared to the first six months of 2004 and in 2003, offset by the $3,500special provision discussed above established in the third quarter related tocertain conforming loans previously sold to investors.  The majority of repurchases occur during thefirst 24 months following the date of sale. Recently we have experienced an increase in the frequency and severityrelated to repurchases; however, it is still uncertain whether this trend willcontinue or abate.  If the trendcontinues to increase in future periods, it would require us to continue toprovide for losses at higher levels to cover future losses on the dispositionof repurchased loans.

 

*Shareholders’ Equity.*  Total shareholders’ equity decreased $12,244for the nine months ended September 30, 2005. The decline is primarily due to a decline of $4,956 in accumulated othercomprehensive income,  $4,669 in retainedearnings, $1,541 in treasury stock and $1,148 of unearned compensation.  These decreases were offset, in part, by a$70 increase in additional paid in capital. The decline in retained earnings is primarily the result of the net lossof $1,075 for the nine months ended September 30, 2005, $2,774 of dividends,$555 of losses on the reissuance of treasury stock, and a loss on the issuanceof restricted stock of $265.  The declinein treasury stock is the result of the repurchase of 571,391 shares of commonstock at a weighted average cost of $9.08 per share offset, in part, by thereissuance of 203,790 shares under the employee stock purchase plan andexercise of employee stock options and by forfeitures of restricted stock of2,894 shares.  Additionally, we issued174,910 shares of restricted stock to employees which primarily drove theincrease in unearned compensation. We will continue to repurchase sharesperiodically in the public market or through private transactions.  As of September 30, 2005, 1,092,573 sharesremained available for repurchase under current Board authorization.

 

**Results of Operations — Threemonths ended September 30, 2005 compared to the three months ended September30, 2004**

 

*General.*  Net lossfor the three months ended September 30, 2005 was $1,371 or $0.03 per share,compared to net income of $4,015 or $0.09 per share for the same period in2004.  The current quarter was negativelyimpacted by an increase in the cost of short-term borrowings, a decline ingains on sales of mortgage loans, and the $3,500 special provision discussedabove relating to certain conforming loans. These negative variances werepartially offset by an improvement in net servicing results of $8,049.

 

*Interest Income*.  Ourinterest income for the three months ended September 30, 2005 was $67,256compared to $63,492 for the same period in 2004.  This increase was the result of the averageyield increasing by 27 basis points to 5.53% of interest-earning assets coupledwith a $37,460 increase in the average balance of interest-earning assets.  Reference is made to the rate volume variancetable set forth below for additional detail regarding the changes in interestincome.

 

25

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*Interest Expense*. Totalinterest expense for the three months ended September 30, 2005 was $37,026compared to $25,375 for the same period of 2004.  The $11,651 net increase is due to a decreaseof $48,115 in the average balance of interest-bearing liabilities offset by a 110-basispoint increase in the average cost of funds. For the three months ended September 30, 2005 compared to same period of2004, interest expense on deposits increased $8,316 as a result of a 107-basispoint increase in the average interest rate paid coupled with a $268,006increase in the average outstanding balance of deposits.  For the three months ended September 30,2005, interest expense on other borrowed funds (including short-term debt, FHLBadvances, and convertible subordinated debt) was $16,848 compared to $13,513for the same period of 2004.  The $3,335increase in interest expense related to other borrowed funds is primarily theresult of a 126-basis point increase in the average cost of funds.  This increase was offset in part by a declineof $316,121 in the average outstanding balance.

 

*Net Interest Income. *Net interest income isdetermined by interest rate spread, which is the difference between the yieldsearned on interest-earning assets and the rates paid on interest-bearingliabilities, and the relative amounts of interest-earning assets andinterest-bearing liabilities.  Netinterest income was $30,230 or 2.48% of average interest-earning assets for thethree months ended September 30, 2005, compared to $38,117 or 3.16% of averageinterest-earning assets for the three months ended September 30, 2004.  The 68-basis point decline is primarily dueto a flattening of the yield curve as recent increases in short-term rates havenot carried through to the long end of the yield curve. The rates we pay on ourdeposits and short-term borrowings is generally related to the short end of theyield curve; whereas the yield we earn on our mortgage loans held for sale isbased primarily on the long end of the curve.

 

The following table details the relative interest rates and averagebalances of our interest-earning assets and interest-bearing liabilities forthe three months ended September 30, 2005 and 2004:

 
| **Average  Balance** | ** ** | **Average Yield /  Rate** | ** ** | ** ** | ** ** | **Interest** | ** ** | ** **                          | ** ** | **Variance  attributable to**              | ** ** |
|----------------------|------------|-------------------------------------|------------|------------|------------|--------------|------------|-------------------------------------|------------|-------------------------------------------------|------------|
| **2005**             | ** ** | **2004**                            | ** ** | **2005**   | ** ** | **2004**     | ** ** | ** **                          | ** ** | **2005**                                        | ** ** | **2004** | ** ** | **Variance** | ** ** | **Rate** | ** ** | **Volume(3)** | ** ** |
|                 |       |                                |       |       |       |         | ** ** | **Interest-earning  assets:**       |       |                                            |       |   |   |   |   |   |   |   |   |
| $                    | 73,577     |                           | $          | 75,108     |       | 3.60         | %          | 1.67                                | %          | Short-term  investments                         |       | $ | 662 |   | $ | 314 |   | $ | 348 |   | $ | 362 |   | $ | (14 | ) |
| 773,550              |       | 583,017                             |       | 4.40       | %          | 3.91         | %          | Investment  securities (1)          |       | 8,502                                           |       | 5,697 |   | 2,805 |   | 711 |   | 2,094 |   |
| 1,829,233            |       | 1,920,128                           |       | 6.20       | %          | 5.98         | %          | Loans held for  sale (2)            |       | 28,368                                          |       | 28,721 |   | (353 | ) | 1,057 |   | (1,410 | ) |
| 2,190,372            |       | 2,251,019                           |       | 5.43       | %          | 5.11         | %          | Loans and leases  receivable (2)    |       | 29,724                                          |       | 28,760 |   | 964 |   | 1,787 |   | (823 | ) |
| 4,866,732            |       | 4,829,272                           |       | 5.53       | %          | 5.26         | %          | Total  interest-earning assets      |       | 67,256                                          |       | 63,492 |   | 3,764 |   | 3,917 |   | (153 | ) |
|                 |       |                                |       |       |       |         |       |                                |       |                                            |       |   |   |   |   |   |   |   |   |
|                 |       |                                |       |       |       |         | ** ** | **Interest-bearing  liabilities:**  |       |                                            |       |   |   |   |   |   |   |   |   |
| 222,697              |       | 236,228                             |       | 1.44       | %          | 1.20         | %          | Checking accounts                   |       | 804                                             |       | 710 |   | 94 |   | 143 |   | (49 | ) |
| 1,000,906            |       | 1,254,827                           |       | 2.65       | %          | 1.65         | %          | Money market                        |       | 6,636                                           |       | 5,183 |   | 1,453 |   | 3,136 |   | (1,683 | ) |
| 1,400,893            |       | 865,435                             |       | 3.64       | %          | 2.76         | %          | Certificates of  deposit            |       | 12,738                                          |       | 5,969 |   | 6,769 |   | 1,900 |   | 4,869 |   |
| 652,829              |       | 1,270,014                           |       | 3.78       | %          | 2.07         | %          | Short-term debt                     |       | 6,167                                           |       | 6,582 |   | (415 | ) | 5,415 |   | (5,830 | ) |
| 1,031,846            |       | 751,402                             |       | 3.94       | %          | 3.62         | %          | FHLB advances                       |       | 10,154                                          |       | 6,799 |   | 3,355 |   | 595 |   | 2,760 |   |
| 32,477               |       | 11,857                              |       | 6.49       | %          | 4.45         | %          | Subordinated debt                   |       | 527                                             |       | 132 |   | 395 |   | 60 |   | 335 |   |
| 4,341,648            |       | 4,389,763                           |       | 3.41       | %          | 2.31         | %          | Total  interest-bearing liabilities |       | 37,026                                          |       | 25,375 |   | 11,651 |   | 11,249 |   | 402 |   |
|                 |       |                                |       |       |       |         |       |                                |       |                                            |       |   |   |   |   |   |   |   |   |
| —               |       |                                |       | 2.12       | %          | 2.95         | %          | Net interest  margin                |       | 30,230                                          |       | 38,117 |   | (7,887 | ) | (7,332 | ) | (555 | ) |
| 525,084              |       | 439,509                             |       | 0.36       | %          | 0.21         | %          | Interest free  sources              |       | —                                          |       | — |   | — |   | — |   | — |   |
| $                    | 4,866,732  |                                | $          | 4,829,272  |       | 2.48         | %          | 3.16                                | %          | Net interest  income to interest-earning assets |       | $ | 30,230 |   | $ | 38,117 |   | $ | (7,887 | ) | $ | (7,332 | ) | $ | (555 | ) |
|                 |       |                                |       |       |       |         |       |                                |       |                                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

----

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

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

(3) Variances attributable to the rate andvolume mix are included in the volume variances.

 

26

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*Provision for Credit Losses.*  Theprovision for credit losses was $2,708 for the three months ended September 30,2005 compared to $469 for the same period of 2004.  The increase in provision relates primarilyto the retention of more auto loans, HELOCs, and business financing leasescompared to the 2004 period. Reference is made to the heading “FinancialCondition - Asset Quality and Non-performing Assets” above for additionaldetail concerning the determination of provision expense related to maintainingthe proper level of allowance for credit losses.

 

*Non-interest Income.* Non-interestincome improved by $7,759 to $41,148 for the three months ended September 30,2005 compared to the same period of 2004. Mortgage servicing income improved by $7,885 during the three monthsended September 30, 2005 compared to the same period of 2004  due to a reduction in actual and forecastprepayment speeds.  This improvement wasoffset, in part, by related hedge losses.

 

*Non-interest Expense.* Non-interest expense includes all operating expenses such as salaries andbenefits, marketing, and general and administrative expenses.  Non-interest expense increased $6,164 or 10%for the three months ended September 30, 2005 compared to the same period of2004.  This increase was primarily drivenby the $1,925 increase in marketing costs related to specific promotions andon-line advertising campaigns that occurred during the third quarter of 2005and a $1,665 increase in professional fees related primarily to a credit to legalexpense in 2004 resulting from the settlement of a legal matter.  Likewise, depreciation and amortizationexpenses are up $982 and occupancy expense is up $788 related primarily toaccelerating the amortization of leasehold improvements related to the plannedrelocation of our Alpharetta and Lake Oswego offices to new facilities.  Office expense is up $662 and other expensesare up generally relating to the growth of the business including Market Street’sacquisitions of additional branches and the expansion of our ATM and merchantprocessing businesses.  These increasesare offset, in part, by reductions in salaries and benefits of $898 relatingprimarily to incentive compensation tied to corporate and line of businessperformance.

 

# ***Retail Banking Segment***

 

The table below provides an overview of thepre-tax results of operations for the retail banking segment:

 
| ** **                                   | ** ** | **For the three months ended September 30,** | ** **     |
|----------------------------------------------|------------|---------------------------------------------------|----------------|
| ** **                                   | ** ** | **2005**                                          | ** **     | **2004** | ** ** | **Change** | ** ** |   |
| Net interest income                          | ** ** | **$**                                             | **23,094**     |   | $ | 22,499 |   | $ | 595 |   |   |
| Provision for credit losses                  | ** ** | **2,646**                                         |           | 466 |   | 2,180 |   |   |
| Net interest income after provision          | ** ** | **20,448**                                        |           | 22,033 |   | (1,585 | ) |   |
| Gains on sales of loans                      | ** ** | **—**                                        |           | 2,011 |   | (2,011 | ) |   |
| Fees, charges and other income               | ** ** | **3,663**                                         |           | 3,307 |   | 356 |   |   |
| Total revenues                               | ** ** | **24,111**                                        |           | 27,351 |   | (3,240 | ) |   |
| Total expenses                               | ** ** | **21,168**                                        |           | 17,232 |   | 3,936 |   |   |
| Pre-tax income before net servicing results  | ** ** | **2,943**                                         |           | 10,119 |   | (7,176 | ) |   |
| Net servicing results                        | ** ** | **130**                                           |           | (7,919 | ) | 8,049 |   |   |
| Pre-tax income                               | ** ** | **$**                                             | **3,073**      |   | $ | 2,200 |   | $ | 873 |   |   |
|                                         |       |                                              |           |   |   |   |   |   |
| Average earning assets                       | ** ** | **$**                                             | **4,832,728**  |   | $ | 4,609,700 |   | $ | 223,028 |   |   |
| Average UPB underlying MSRs                  | ** ** | **$**                                             | **13,976,998** |   | $ | 13,154,634 |   | $ | 822,364 |   |   |
|                                         |       |                                              |           |   |   |   |   |   |
| **Operations to average earning assets**     |       |                                              |           |   |   |   |   |   |
| Net interest income after provision          | ** ** | **1.69**                                          | %              | 1.91 | % | (0.22 | %) |   |
| Gain on sale, fees, charges and other income | ** ** | **0.30**                                          | %              | 0.46 | % | (0.16 | %) |   |
| Banking revenues                             | ** ** | **1.99**                                          | %              | 2.37 | % | (0.38 | %) |   |
| Total expenses                               | ** ** | **1.75**                                          | %              | 1.50 | % | 0.25 | % |   |
| Pre-tax income before net servicing results  | ** ** | **0.24**                                          | %              | 0.87 | % | (0.63 | %) |   |
|                                         |       |                                              |           |   |   |   |   |   |
| Net servicing results to UPB underlying MSRs | ** ** | **0.00**                                          | %              | (0.24 | %) | 0.24 | % |   |
|                                              |            |                                                   |                |  |  |  |  |  |  |  |  |  |  |  |

 

27

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Theretail banking segment recorded pre-tax income of $3,073 in the third quarterof 2005, an $873 increase over the comparable period in 2004. Collectively, theInternet-only banking, leasing and auto operations period over period pre-taxincome decreased by $7,176 to $2,943. This decrease was primarily driven by anincrease in operating expenses in the retail bank of $3,936, a reduction ingain on sale of loans of $2,011, and an increase in provision expense of $2,180.  These were offset, in part, by an increase ininterest income of $595 and an increase in fees, charges and other income of$356.  The increase in net interestincome is the result of the $223,028 increase in the average balance ofinterest earning assets offset in part by a 22-basis point decrease in netinterest income after provision relating to the flattening of the yieldcurve.  The increase in the provision forcredit losses period-over-period relates to the retail banking segmentretaining a higher percentage of auto loans, second-mortgage loans, HELOCs, andbusiness financing leases compared to the first-mortgage loans which dominatedthe retention activity during 2004. These loans and leases generally have a higher risk adjusted yield thanthe adjustable-rate first-mortgage loans that were previously beingretained.  Net servicing results improvedby $8,049 relating primarily to the recovery of a portion of the impairmentreserves on MSRs relating to slower forecasted prepayments, offset, in part, bylosses on related hedges. Expenses increased primarily as the result ofincrease in marketing costs related to specific promotions and on-lineadvertising campaigns that occurred during the third quarter of 2005, expansionof Dealer Financial Services’ operations, and the roll-out in 2005 of QuickPost,which provides a more convenient way for customers to make deposits to theirNetBank accounts.

 

*Financial Intermediary Segment*

 

The following table highlights the financial intermediary segment’s pre-taxresults and production and sales activities:

 
| ** **                          | ** ** | **For the three months ended September 30,** | ** **    |
|-------------------------------------|------------|---------------------------------------------------|---------------|
| ** **                          | ** ** | **2005**                                          | ** **    | **2004** | ** ** | **Change** | ** ** |
| Net interest income                 | ** ** | **$**                                             | **6,901**     |   | $ | 15,651 |   | $ | (8,750 | ) |
| Gain on sales of loans              | ** ** | **27,034**                                        |          | 25,489 |   | 1,545 |   |
| Other income                        | ** ** | **107**                                           |          | 3,129 |   | (3,022 | ) |
| Net Beacon credit services results  | ** ** | **(303**                                          | )             | (189 | ) | (114 | ) |
| Net MG Reinsurance results          | ** ** | **812**                                           |          | 557 |   | 255 |   |
| Total revenues                      | ** ** | **34,551**                                        |          | 44,637 |   | (10,086 | ) |
| Salary and employee benefits        | ** ** | **21,776**                                        |          | 23,531 |   | (1,755 | ) |
| Occupancy and Depreciation expense  | ** ** | **7,987**                                         |          | 7,155 |   | 832 |   |
| Other expenses                      | ** ** | **9,281**                                         |          | 8,957 |   | 324 |   |
| Total expenses                      | ** ** | **39,044**                                        |          | 39,643 |   | (599 | ) |
| Pre-tax (loss) income               | ** ** | **$**                                             | **(4,493**    | ) | $ | 4,994 |   | $ | (9,487 | ) |
|                                |       |                                              |          |   |   |   |   |
| Production                          | ** ** | **$**                                             | **3,764,981** |   | $ | 3,348,876 |   | $ | 416,105 |   |
| Sales (includes intersegment sales) | ** ** | **$**                                             | **3,688,402** |   | $ | 3,777,305 |   | $ | (88,903 | ) |
|                                |       |                                              |          |   |   |   |   |
| Total revenues to sales             | ** ** | **0.94**                                          | %             | 1.18 | % | (0.24% | ) |
| Total expenses to production        | ** ** | **1.04**                                          | %             | 1.18 | % | (0.14% | ) |
| Pre-tax margin                      | ** ** | **(0.10%**                                        | )             | 0.00 | % | (0.10% | ) |

----

Note: The ratio of revenues to sales is based on mortgage bankingsales, which includes inter-segment sales to the retail bank segment.

 

Production volumes were stronger during thethree months ended September 30, 2005 compared to the same period in 2004.  However, sales lagged production during thethree months ended September 30, 2005. The margins on sales remained depressed by the continued strongcompetitive conditions.  The margin forthe three months ended September 30, 2005 was also impacted by a higher levelof loan repurchases in the conforming channel and the $3,500 special provision discussedabove relating to certain conforming loans. Net interest income declined by $8,750 related to the flattening of theyield curve year over year.  Generally,NetBank earns a long-term interest rate on loans held for sale and financesthose loans with short-term borrowings. As the yield curve flattens, the net interest margin compresses.

 

28

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Expenses increased by $599 to $39,044 for thethree months ended September 30, 2005 compared to the same period in 2004.  Expenses in basis points of productiondecreased from 118 basis points to 104 basis points as a result of a $416,105increase in mortgage loan production providing greater leverage over the fixedexpense base.

 

*Transaction Processing Segment*

 

The transaction processing segmentsubservices loans for the retail banking segment, financial intermediarysegment and  third party customers;provides ATM and merchant processing services; and sells various insurance productsusing an Internet-based platform.

 

The following table highlights the results ofoperations for the transaction processing segment: 

 
| ** **     | ** ** | **For the three months ended September 30,** | ** ** |
|----------------|------------|----------------------------------------------|------------|
| ** **     | ** ** | **2005**                                     | ** ** | **2004** | ** ** | **Change** | ** ** |
| Total revenue  | ** ** | **$**                                        | **6,634**  |   | $ | 7,066 |   | $ | (432 | ) |
| Total expenses | ** ** | **6,135**                                    |       | 6,037 |   | 98 |   |
| Pre-tax income | ** ** | **$**                                        | **499**    |   | $ | 1,029 |   | $ | (530 | ) |

 

The transaction processing segment recordedpre-tax income of $499, a $530 decrease period over period. The reduction  in pre-tax results was primarily due to theservicing factory recording a $500 additional reserve related to corporateadvances and a reduction in pre-tax earnings of NPS of $512, offset in part bya reduction in the loss of NetInsurance of $480 period over period. NetInsuranceincreased its policies-in-force and reduced its operating expenses.

 

*Other/Eliminations*

 

The other/eliminations segment contains theholding company expenses along with the elimination of inter-segment gains andlosses on loans sold to the retail banking segment from the financial intermediarysegment. The other/eliminations segment lost $1,109 for the three months endedSeptember 30, 2005 compared to a loss of $1,722 for the comparable period of2004.  The $613 improvement was primarilyrelated to strict expense control at the holding company.

 

**Results of Operations—Nine monthsended September 30, 2005 compared to the nine months ended September 30, 2004**

 

*General.*  Net lossfor the nine months ended September 30, 2005 was $1,075 or $0.02 per sharecompared to net income of $21,876 or $0.46 per share for the same period in2004. We capitalized on the favorable interest rate environment during thefirst nine months of 2004 and posted exceptionally strong revenues in ourfinancial intermediary segment.  Incontrast, a rising and volatile interest rate environment during the first ninemonths of 2005 adversely impacted the results reported in the financialintermediary segment.  Mortgageproduction dropped from $10.5 billion to $10.0 billion, while sales of mortgagesdropped from $11.0 billion to $9.6 billion comparing the first nine months of2004 to 2005, respectively.  The declinein sales of mortgage loans resulted in a decline of $14,085 in gains on salesof mortgage loans period over period. Likewise, the flattening yield curve unfavorably impacted net interestmargin.  Net interest margin declined by$14,416 period over period.  Also, duringthe nine months ended September 30, 2005, we established the $3,500 specialprovision discussed above related to certain conforming loans previously soldto investors.

 

*Interest Income*. Interest income for the nine months ended September 30, 2005 was $186,777compared to $174,354 for the same period in 2004.  This increase was primarily the result of a32-basis point increase in the average yield on interest-earning assets coupledwith a $41,291 increase in the average outstanding balance of interest-earningassets.

 

29

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*Interest Expense*. Interestexpense for the nine months ended September 30, 2005 was $94,828 compared to$67,989 during the same period in 2004. The $26,839 increase in interest expense is primarily the result of an85-basis point increase in the average cost of funds coupled with a $29,108increase in the average outstanding balance of interest-bearing liabilities.The increase in rates relates to the Federal Reserve’s increases in targetedshort-term interest rates.  Our depositbase experienced a 75-basis point increase in the average cost while otherborrowed funds (including short-term debt, FHLB advances and subordinated debt)experienced a 100-basis point increase.

 

*Net Interest Income. *Net interest income isdetermined by interest rate spread, which is the difference between the yieldsearned on interest-earning assets and the rates paid on interest-bearingliabilities, and the relative amounts of interest-earning assets andinterest-bearing liabilities.  Netinterest income was $91,949, or 2.69% of average interest-earning assets forthe nine months ended September 30, 2005, compared to $106,365, or 3.14% ofaverage interest-earning assets for the nine months ended September 30,2004.  The 45-basis point decline isprimarily due to a flattening of the yield curve as recent increases inshort-term rates have not carried through to the long end of the yield curve.The rates we pay on our deposits and short-term borrowings are generallyrelated to the short end of the yield curve; whereas the yield we earn on ourmortgage loans held for sale is based primarily on the long end of the curve.

 

The following table details the relative interest rates and averagebalances of our interest-earning assets and interest-bearing liabilities forthe nine months ended September 30, 2005 and 2004:

 
| **Average  Balance** | ** ** | **Average  Yield /  Rate** | ** ** | ** ** | ** ** | **Interest** | ** ** | ** **                          | ** ** | **Variance  attributable to**               | ** ** |
|----------------------|------------|---------------------------------|------------|------------|------------|--------------|------------|-------------------------------------|------------|--------------------------------------------------|------------|
| **2005**             | ** ** | **2004**                        | ** ** | **2005**   | ** ** | **2004**     | ** ** | ** **                          | ** ** | **2005**                                         | ** ** | **2004** | ** ** | **Variance** | ** ** | **Rate** | ** ** | **Volume (3)** | ** ** |
|                 |       |                            |       |       |       |         | ** ** | **Interest-earning  assets:**       |       |                                             |       |   |   |   |   |   |   |   |   |
| $                    | 64,388     |                            | $          | 74,270     |       | 3.22         | %          | 1.23                                | %          | Short-term  investments                          |       | $ | 1,557 |   | $ | 684 |   | $ | 873 |   | $ | 1,108 |   | $ | (235 | ) |
| 774,585              |       | 493,942                         |       | 4.50       | %          | 3.66         | %          | Investment  securities (1)          |       | 26,169                                           |       | 13,568 |   | 12,601 |   | 3,112 |   | 9,489 |   |
| 1,567,744            |       | 1,848,906                       |       | 6.27       | %          | 5.86         | %          | Loans held for  sale (2)            |       | 73,746                                           |       | 81,290 |   | (7,544 | ) | 5,685 |   | (13,229 | ) |
| 2,144,630            |       | 2,092,938                       |       | 5.30       | %          | 5.02         | %          | Loans and leases  receivable (2)    |       | 85,305                                           |       | 78,812 |   | 6,493 |   | 4,395 |   | 2,098 |   |
| 4,551,347            |       | 4,510,056                       |       | 5.47       | %          | 5.15         | %          | Total  interest-earning assets      |       | 186,777                                          |       | 174,354 |   | 12,423 |   | 14,300 |   | (1,877 | ) |
|                 |       |                            |       |       |       |         |       |                                |       |                                             |       |   |   |   |   |   |   |   |   |
|                 |       |                            |       |       |       |         | ** ** | **Interest-bearing  liabilities:**  |       |                                             |       |   |   |   |   |   |   |   |   |
| 229,055              |       | 234,089                         |       | 1.36       | %          | 1.19         | %          | Checking accounts                   |       | 2,331                                            |       | 2,083 |   | 248 |   | 298 |   | (50 | ) |
| 1,067,639            |       | 1,309,122                       |       | 2.33       | %          | 1.68         | %          | Money market                        |       | 18,634                                           |       | 16,509 |   | 2,125 |   | 6,382 |   | (4,257 | ) |
| 1,088,983            |       | 764,197                         |       | 3.43       | %          | 2.75         | %          | Certificates of  deposit            |       | 28,027                                           |       | 15,772 |   | 12,255 |   | 3,897 |   | 8,358 |   |
| 862,439              |       | 970,900                         |       | 3.36       | %          | 2.00         | %          | Short-term debt                     |       | 21,723                                           |       | 14,576 |   | 7,147 |   | 9,903 |   | (2,756 | ) |
| 858,491              |       | 816,832                         |       | 3.53       | %          | 3.04         | %          | FHLB advances                       |       | 22,753                                           |       | 18,631 |   | 4,122 |   | 3,002 |   | 1,120 |   |
| 29,498               |       | 11,857                          |       | 6.15       | %          | 4.70         | %          | Subordinated debt                   |       | 1,360                                            |       | 418 |   | 942 |   | 129 |   | 813 |   |
| 4,136,105            |       | 4,106,997                       |       | 3.06       | %          | 2.21         | %          | Total  interest-bearing liabilities |       | 94,828                                           |       | 67,989 |   | 26,839 |   | 23,611 |   | 3,228 |   |
|                 |       |                            |       |       |       |         |       |                                |       |                                             |       |   |   |   |   |   |   |   |   |
| —               |       | —                          |       | 2.41       | %          | 2.94         | %          | Net interest  margin                |       | 91,949                                           |       | 106,365 |   | (14,416 | ) | (9,311 | ) | (5,105 | ) |
| 415,242              |       | 403,059                         |       | 0.28       | %          | 0.20         | %          | Interest free  sources              |       | —                                           |       | — |   | — |   | — |   | — |   |
| $                    | 4,551,347  |                            | $          | 4,510,056  |       | 2.69         | %          | 3.14                                | %          | Net interest  income to interest- earning assets |       | $ | 91,949 |   | $ | 106,365 |   | $ | (14,416 | ) | $ | (9,311 | ) | $ | (5,105 | ) |

----

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

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

(3) Variances attributable to the rate andvolume mix are included in the volume variances.

 

30

----

 

*Provision for Credit Losses.*  Theprovision for credit losses was $7,389 for the nine months ended September 30,2005, compared to $3,982 for the same period of 2004.  The increase in the provision relatesprimarily to the mix of loans and leases being retained during the nine monthsended September 30, 2005 compared to the same period in 2004.  During the current period, we retained ahigher percentage of auto loans, second-mortgages, HELOCs and businessequipment financing leases, which generally provide a higher risk adjustedyield, as compared to the retention of primarily first-mortgage adjustable-rateloans during the 2004 period. Reference is made to the heading FinancialCondition - “Asset Quality and Non-performing Assets” above for additionaldetail concerning the determination of provision expense related to maintainingthe proper level of allowance for credit losses.

 

*Non-interest Income.* Non-interestincome declined $9,570 for the nine months ended September 30, 2005 compared tothe same period of 2004.  This declinewas primarily driven by the $14,085 decline in gain on sales of loans due tothe $1.4 billion, or 13%, decline in sales of mortgage loans.  Current period gain on sales of loans wasalso impacted by the need for increased provision for reserves underrepresentations and warranties in response to recent increases in the frequencyand severity of losses on repurchased mortgage loans and the $3,500 specialprovision discussed above relating to certain conforming loans previously soldto investors.  The current performance ofour investment in MSRs resulted in income of $11,130 compared to income of $10,395for the same period of 2004, a $735 increase period over period.  The $735 increase relates to increased amortizationexpense offset in part by improved hedge performance for the nine months endedSeptember 30, 2005 compared to the same period in 2004.  The declines in gain on sales were offset inpart by an increase of $2,087 in service charges and fees for the nine monthsended September 30, 2005 compared with the same period in 2004.  This increase relates to having more ATMs andmerchant processing terminals in place during 2005.

 

*Non-interest Expense.* Non-interest expense includes all operating expenses such as salaries andbenefits, marketing, and general and administrative expenses.  Non-interest expense increased $8,866, or 5%,for the nine months ended September 30, 2005 compared to the same period of2004.  The increase was primarily drivenby increases of $2,979 in depreciation and amortization, $2,723 in marketingexpense, $2,557 in professional fees, $2,134 in occupancy expense, and $1,013in office expenses.  The increase indepreciation and amortization is primarily related to the expansion of our operationsthrough the acquisitions of certain assets of GRL Mortgage and Beacon CreditServices, coupled with higher amortization expense related to the acquisitionof ATM and merchant processing contracts by NPS as it continues to expand.  Depreciation and occupancy were also impactedduring the nine months ended September 30, 2005 as a result of accelerating theamortization of leasehold improvements related to the planned relocation of ourAlpharetta and Lake Oswego offices to new facilities.  The increase in marketing expense relates tospecific promotions and on-line advertising campaigns that occurred during thenine months ended September 30, 2005. The increase in professional fees relate in part to the timing ofexpenses related to Sarbanes Oxley section 404 compliance and in part to acredit received in 2004 resulting from the settlement of a legal matter. Theseincreases were partially offset by decreases of $2,163 in salaries and wagesand $829 in prepaid lost interest on curtailments.  The decrease in salaries and wages primarilyrelated to the decline in production at the mortgage operations.

 

31

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# ***Retail Banking Segment***

 

The table below provides an overview of theresults of operations for the retail banking segment:

 
| ** **                                   | ** ** | **For the nine months ended September 30,** | ** **     |
|----------------------------------------------|------------|---------------------------------------------|----------------|
| ** **                                   | ** ** | **2005**                                    | ** **     | **2004** | ** ** | **Change** | ** ** |
| Net interest income                          | ** ** | **$**                                       | **68,456**     |   | $ | 59,238 |   | $ | 9,218 |   |
| Provision for credit losses                  | ** ** | **7,298**                                   |           | 3,938 |   | 3,360 |   |
| Net interest income after provision          | ** ** | **61,158**                                  |           | 55,300 |   | 5,858 |   |
| Gains on sales of loans                      | ** ** | **501**                                     |           | 3,072 |   | (2,571 | ) |
| Fees, charges and other income               | ** ** | **10,587**                                  |           | 9,493 |   | 1,094 |   |
| Total revenues                               | ** ** | **72,246**                                  |           | 67,865 |   | 4,381 |   |
| Total expenses                               | ** ** | **57,393**                                  |           | 50,231 |   | 7,162 |   |
| Pre-tax income before net servicing results  | ** ** | **14,853**                                  |           | 17,634 |   | (2,781 | ) |
| Net servicing results                        | ** ** | **(5,736**                                  | )              | (6,098 | ) | 362 |   |
| Pre-tax income                               | ** ** | **$**                                       | **9,117**      |   | $ | 11,536 |   | $ | (2,419 | ) |
|                                         |       |                                        |           |   |   |   |   |
| Average earning assets                       | ** ** | **$**                                       | **4,529,348**  |   | $ | 4,351,706 |   | $ | 177,642 |   |
| Average UPB underlying MSRs                  | ** ** | **$**                                       | **13,915,342** |   | $ | 13,043,709 |   | $ | 871,633 |   |
|                                         |       |                                        |           |   |   |   |   |
| **Operations to average earning assets**     |       |                                        |           |   |   |   |   |
| Net interest income after provision          | ** ** | **1.80**                                    | %              | 1.69 | % | 0.11 | % |
| Gain on sale, fees, charges and other income | ** ** | **0.33**                                    | %              | 0.38 | % | (0.05 | %) |
| Banking revenues                             | ** ** | **2.13**                                    | %              | 2.07 | % | 0.06 | % |
| Total expenses                               | ** ** | **1.69**                                    | %              | 1.54 | % | 0.15 | % |
| Pre-tax income before net servicing results  | ** ** | **0.44**                                    | %              | 0.53 | % | (0.09 | %) |
|                                         |       |                                        |           |   |   |   |   |
| Net servicing results to UPB underlying MSRs | ** ** | **(0.05**                                   | **%**)         | (0.06 | %) | 0.01 | % |
|                                              |            |                                             |                |  |  |  |  |  |  |  |  |  |

 

Theretail banking segment recorded pre-tax income of $9,117 in the third quarterof 2005, a $2,419 decline over the comparable period in 2004. Collectively, theInternet-only banking, leasing and auto operations within the retail bankingsegment saw a reduction in period over period pre-tax income of $2,781 to$14,853. This decrease was primarily driven by the reduction in gain on salesof loans during the nine months ended September 30, 2005 of $2,571 comparedwith the same period in 2004.  Theprovision for credit losses increased by $3,360 for the nine months endedSeptember 30, 2005 compared with the same period in 2004.  During the past twelve months, the retailbanking segment retained a higher percentage of auto loans, second-mortgageloans, HELOCs, and business financing leases compared to the first-mortgageloans which dominated the retention activity during late 2003 and early2004.  These loans and leases generallyhave a higher risk adjusted yield than the adjustable-rate first-mortgage loansthat were previously being retained.  Operating expenses are up due to the expansion of operations of DealerFinancial Services, the introduction of QuickPost, and specific marketingpromotions and on-line advertising campaigns that occurred during the ninemonths ended September 30, 2005.

 

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*Financial Intermediary Segment*

 

The following table highlights the financial intermediary segment’spre-tax results and production and sales activities:

 
| ** **                          | ** ** | **For the nine months ended September 30,** | ** **    |
|-------------------------------------|------------|---------------------------------------------|---------------|
| ** **                          | ** ** | **2005**                                    | ** **    | **2004** | ** ** | **Change** | ** ** |
| Net interest income                 | ** ** | **$**                                       | **23,031**    |   | $ | 46,159 |   | $ | (23,128 | ) |
| Gain on sales of loans              | ** ** | **79,145**                                  |          | 93,230 |   | (14,085 | ) |
| Other income                        | ** ** | **1,902**                                   |          | 4,136 |   | (2,234 | ) |
| Net Beacon Credit Services results  | ** ** | **(1,089**                                  | )             | (189 | ) | (900 | ) |
| Net MG Reinsurance results          | ** ** | **2,517**                                   |          | 1,599 |   | 918 |   |
| Total revenues                      | ** ** | **105,506**                                 |          | 144,935 |   | (39,429 | ) |
| Salary and employee benefits        | ** ** | **65,333**                                  |          | 70,642 |   | (5,309 | ) |
| Occupancy and Depreciation expense  | ** ** | **22,557**                                  |          | 21,022 |   | 1,535 |   |
| Other expenses                      | ** ** | **25,851**                                  |          | 24,563 |   | 1,288 |   |
| Total expenses                      | ** ** | **113,741**                                 |          | 116,227 |   | (2,486 | ) |
| Pre-tax (loss) income               | ** ** | **$**                                       | **(8,235**    | ) | $ | 28,708 |   | $ | (36,943 | ) |
|                                |       |                                        |          |   |   |   |   |
| Production                          | ** ** | **$**                                       | **9,997,089** |   | $ | 10,511,079 |   | $ | (513,990 | ) |
| Sales (includes intersegment sales) | ** ** | **$**                                       | **9,587,167** |   | $ | 10,982,155 |   | $ | (1,394,988 | ) |
|                                |       |                                        |          |   |   |   |   |
| Total revenues to sales             | ** ** | **1.10**                                    | %             | 1.32 | % | (0.22 | %) |
| Total expenses to production        | ** ** | **1.14**                                    | %             | 1.11 | % | 0.03 | % |
| Pre-tax margin                      | ** ** | **(0.04**                                   | **%**)        | 0.21 | % | (0.25 | %) |
|                                     |            |                                             |               |  |  |  |  |  |  |  |  |  |  |  |

----

Note: The ratio of revenues to sales is based on mortgage bankingsales, which includes inter-segment sales to the retail banking segment.

 

The interest rate environment during the ninemonths ended September 30, 2004 was much more favorable to mortgage productionthan the environment during the comparable 2005 quarter.  Reduced sales volumes of $1.4 billion, or13%, coupled with the $3,500 special provision discussed above related tocertain conforming loans previously sold to investors, resulted in a $14,085decline in gain on sales of loans. The gain on sales of loans was alsoadversely impacted by the need for increased provision for reserves underrepresentations and warranties in response to recent increases in the frequencyand severity of losses on repurchased mortgage loans.  Net interest income declined by $23,128related to the flattening of the yield curve year over year.  Generally, NetBank earns a long-term interestrate on loans held for sale and finances those loans with short-termborrowings.  As the yield curve flattens,the net interest margin compresses.

 

*Transaction Processing Segment*

 

The transaction processing segmentsubservices loans for the retail banking segment, financial intermediarysegment and third party customers; provides ATM and merchant processingservices; and sells various insurance products using an Internet-basedplatform.

 

The following table highlights the results ofoperations for the transaction processing segment: 

 
| ** **     | ** ** | **For the nine months ended September 30,** | ** ** |
|----------------|------------|---------------------------------------------|------------|
| ** **     | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **Change** | ** ** |
| Total revenues | ** ** | **$**                                       | **20,056** |   | $ | 19,990 |   | 66 |   |
| Total expenses | ** ** | **17,644**                                  |       | 19,226 |   | (1,582 | ) |
| Pre-tax income | ** ** | **$**                                       | **2,412**  |   | $ | 764 |   | $ | 1,648 |   |
|                |            |                                             |            |  |  |  |  |  |  |  |  |

 

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The transaction processing segment recordedpre-tax income of $2,412, a $1,648 improvement period over period.  NetInsurance’s pre-tax loss decreased by$1,224, and Servicing Factory’s pre-tax income increased by $327 for the ninemonth period ended September 30, 2005 compared with the same period for2004.  These improvements were offset inpart by a reduction in the pre-tax earnings of NPS of $608 for the nine monthperiod ended September 30, 2005 compared with the same period for 2004.    Additionally, NetInsurance reduced itspre-tax loss  by continuing to increaseits policies-in-force and cutting expenses. NPS’s pre-tax income declined related to the increase in amortization of intangibles resulting fromits acquisition of an additional 846 ATM and merchant processing servicecontracts.

 

*Other /Eliminations*

 

The other/eliminations segment contains theholding company expenses along with the elimination of inter-segment gains andlosses on loans sold to the retail banking segment from the financialintermediary segment. The other/eliminations segment lost $4,577 for the ninemonths ended September 30, 2005 compared to a loss of $6,032 for the comparableperiod of 2004.  The $1,455 improvementwas primarily related to strict expense control at the holding company coupledwith a reduction of deferred gains related to a decline in inter-segment loansales.

 

###### **Critical Accounting Policies**

 

Senior management, in conjunction with theAudit Committee of the Board of Directors, has identified valuation of the MSRportfolio, determination of the allowance for credit losses, liabilities forrepresentations and warranties on loans and MSRs sold and accounting forderivative financial instruments as our most critical accounting policies.These policies were identified as being the most critical based on the SEC’sguidance in identifying them based on whether 1) the accounting estimaterequired management to make assumptions about matters that were highlyuncertain at the time the accounting estimate was made and 2) differentestimates reasonably could have been used in the current period, or changes inthe accounting estimate that are reasonably likely to occur from period toperiod, would have a material impact on the presentation of the financial conditionor results of operations. Management believes that given current information,its judgments, estimates and assumptions used in these policies areappropriate.  For further informationregarding our critical accounting policies, refer to the heading “CriticalAccounting Policies” on page 55 of our 2004 Form 10-K.

 

# **Contractual Obligations and Off-Balance SheetArrangements**

 

The Company, in the normal course ofbusiness, had contractual obligations to make scheduled payments for itsoperating leases; its liability to repurchase loans under representations andwarranties provided to purchasers of its mortgage loans and MSRs; and principaland interest payments on borrowed funds. The Company is not a party to anyoff-balance sheet financing arrangements nor does it hold unconsolidatedinterests in any variable interest entities that could give rise to futurecontractual obligations. For information as of December 31, 2004 regarding theschedule of amounts contractually due, please refer to the discussion under theheading “Contractual Obligations and Off-Balance Sheet Arrangements” on page 57of our 2004 Form 10-K.

 

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# **Liquidity and Capital Resources**

 

*Liquidity. *TheCompany’s liquidity, represented by cash and cash equivalents, is a product ofour operating, investing, and financing activities.  Our primary sources of funds are deposits,borrowings, prepayments and maturities of outstanding loans, sales of loans,sales or maturities of investment securities and other short-term investments,and funds provided from operations. While scheduled loan payments and maturing investment securities andshort-term investments are relatively predictable sources of funds, deposit flowsand loan prepayments are greatly influenced by general interest rates, economicconditions, and competition. We can use cash generated through the retaildeposit market, our traditional funding source, to offset the cash utilized ininvesting activities.  Our available forsale securities and short-term interest-earning assets can also be used toprovide liquidity for lending and other operational requirements.  For the nine months ended September 30, 2005,we had a net increase in cash and cash equivalents of $152,018 compared to anet increase of $195,783 for the same period of 2004.  The increase in the 2005 period primarilyrelated to increases of $367,702 in deposits and $132,527 in other borrowedfunds.  These cash inflows were offset,in part, by increases of $285,938 in loans held for sale and $49,191 in loanand lease receivables.  The largeincrease in loans held for sale was primarily a function of mortgage loanproduction of $3.8 billion outpacing sales of mortgage loans of $3.6 billion.As an additional source of funds, we had available under existing line ofcredit agreements $1.5 billion at September 30, 2005.  Reference is made to note 8 of the notes toconsolidated financial statements included in this report for additionaldetails regarding the available lines of credit.

 

Weuse deposits as our principal source of funds. For the nine months ended September 30, 2005, deposits increased by $367,702to $3 billion from $2.6 billion as of December 31, 2004.  Our deposit products include checking, moneymarket and certificates of deposit accounts. Deposit account terms vary, with the principal differences being theminimum balance required, the time periods the funds must remain on deposit,and the interest rate.  We are competitive in the types of accounts, services and ranges of interestrates offered on deposit products. Although market demand generally dictates which deposit maturities andrates will be accepted by the public, we intend to continue to promotechecking, money market and certificates of deposit to the extent possibleconsistent with asset and liability management goals.

 

*Capital Resources.**  *The Company and NetBank, FSB are subject to variousregulatory capital requirements administered by the federal banking agencies.Failure of either company to meet minimum capital requirements can initiatecertain mandatory and possibly additional discretionary actions by regulatorsthat, if undertaken, could have a direct material effect on the consolidatedfinancial statements. Under capital adequacy guidelines and the regulatoryframework for prompt corrective action, NetBank, FSB must meet specific capitalguidelines that involve quantitative measures of NetBank, FSB’s assets,liabilities, and certain off-balance sheet items as calculated under regulatoryaccounting practices. NetBank, FSB’s capital amounts and classifications arealso subject to qualitative judgments by the regulators about components, riskweightings and other factors. Under current regulatory guidelines, NetBank, FSBmay not make a capital distribution to the Company without prior approval ofthe Office of Thrift Supervision (“OTS”), the governmental agency thatregulates NetBank, FSB. Current guidelines require, among other things, thatNetBank, FSB not make an unapproved capital distribution in excess of itscurrent period year-to-date undistributed earnings plus the preceding two yearsundistributed earnings and in no event make a distribution which would causeNetBank, FSB to be less than adequately capitalized as defined below.

 

Quantitative measures established byregulation to ensure capital adequacy require NetBank, FSB to maintain minimumamounts and ratios as set forth in the following table. NetBank, FSB’sregulatory agency, the OTS, requires NetBank, FSB to maintain minimum ratios oftangible capital to tangible assets of 1.5%, core capital to tangible assets of4.0% and total capital to risk-weighted assets of 8.0%.

 

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The following table presents informationrelated to NetBank, FSB along with capital requirements mandated by the OTS:

 
| ** **                                  | ** ** | **Actual** | ** ** | **For capital adequacy  purposes** | ** ** | **To be categorized as  Well Capitalized   under prompt  corrective action plan** | ** ** |
|---------------------------------------------|------------|------------|------------|------------------------------------|------------|-----------------------------------------------------------------------------------|------------|
| **September  30, 2005**                     | ** ** | **Amount** | ** ** | **Ratio**                          | ** ** | **Amount**                                                                        | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total capital (to risk-weighted assets)     |       | $          | 331,012    |                               | 10.21      | %                                                                                 | $          | 259,422 |   | 8.00 | % | $ | 324,278 |   | 10.00 | % |
| Core capital (to adjusted total assets)     |       | $          | 304,282    |                               | 6.09       | %                                                                                 | $          | 199,855 |   | 4.00 | % | $ | 249,819 |   | 5.00 | % |
| Tangible capital (to adjusted total assets) |       | $          | 304,282    |                               | 6.09       | %                                                                                 | $          | 74,946 |   | 1.50 | % | N/A |   | N/A |   |
| Tier I capital (to risk-weighted assets)    |       | $          | 304,282    |                               | 9.38       | %                                                                                 | N/A        |   | N/A |   | $ | 194,567 |   | 6.00 | % |
| **December 31, 2004**                       |       |       |       |                               |       |                                                                              |       |   |   |   |   |   |   |
| Total capital (to risk-weighted assets)     |       | $          | 327,829    |                               | 11.30      | %                                                                                 | $          | 232,091 |   | 8.00 | % | $ | 290,114 |   | 10.00 | % |
| Core capital (to adjusted total assets)     |       | $          | 303,368    |                               | 6.73       | %                                                                                 | $          | 180,308 |   | 4.00 | % | $ | 225,385 |   | 5.00 | % |
| Tangible capital (to adjusted total assets) |       | $          | 303,368    |                               | 6.73       | %                                                                                 | $          | 67,615 |   | 1.50 | % | N/A |   | N/A |   |
| Tier I capital (to risk-weighted assets)    |       | $          | 303,368    |                               | 10.46      | %                                                                                 | N/A        |   | N/A |   | $ | 174,016 |   | 6.00 | % |
|                                             |            |            |            |                                    |            |                                                                                   |            |  |  |  |  |  |  |  |  |  |  |  |

 

In addition, subsidiaries engaged in mortgagebanking must adhere to various HUD regulatory guidelines including requiredminimum net worth to maintain their FHA approved lending status.  Failure to comply with the HUD guidelinescould result in withdrawal of this certification.  As of September 30, 2005, Market Street andMeritage were in compliance with HUD guidelines.

 

The Company and its subsidiaries are subjectto various other capital requirements by secondary market investors and states.  None of these capital requirements are morestringent than the OTS capital requirements. Failure to comply with these restrictions could have a material adverseimpact on the Company’s results of operations. At September 30, 2005, all of the capital requirements placed upon theCompany and its subsidiaries were met.

 

# **Item3. Quantitative and Qualitative Disclosures about Market Risk**

 

Our principal businesses are retail bankingand the origination and purchase of loans and business equipment financing. Thesebusinesses are funded by customer deposits and, to the extent necessary, otherborrowed funds. Consequently, a significant portion of our assets andliabilities are monetary in nature and fluctuations in interest rates willaffect future net interest income and cash flows. This interest rate risk isour primary market risk exposure. For the nine months ended September 30, 2005,the only derivative financial instruments that we entered into were associatedwith our mortgage banking activities, which include (1) the portfolio ofmortgage loans held for sale, (2) the pipeline of rate locks,(3) hedging the securitization and sale of loans, (4) the current MSRportfolio and (5) the MSRs that will be created as a byproduct of securitizationactivities associated with loans held for sale and the pipeline of ratelocks.  Exposure to market risk isreviewed on a regular basis by management.

 

Reference is made to Item 7A. Quantative andQualitative Disclosures About Market Risk on page 71 of our 2004 Form 10-K foradditional details regarding the Company’s exposure to management of marketrisk.

 

One of the ways NetBank, FSB, like othersavings banks, measures interest rate risk is based on a Net Portfolio Value (“NPV”)analysis. NPV equals the present value of expected net cash flows from existingassets minus the present value of expected net cash flows from existingliabilities. An NPV ratio is determined by dividing NPV by the present value ofassets.

 

36

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The following table sets forth the estimatedNetBank, FSB NPV ratios as of September 30, 2005 and December 31 andSeptember 30, 2004 assuming rate shocks of +300 to -100 basis points:

 

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

 
| **Rate shock  (in basis points)** | ** ** | **As of  September 30,  2005** | ** ** | **As of  December 31, 2004** | ** ** | **As of  September 30,  2004** | ** ** | **Minimum as of September 30, 2005** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|------------------------------|------------|--------------------------------|------------|--------------------------------------|------------|
| **+300**                          |       | 7.02                           | %          | 7.75                         | %          | 9.40                           | %          | 4.00                                 | %          |
| **+200**                          |       | 7.55                           | %          | 8.03                         | %          | 9.53                           | %          | 6.00                                 | %          |
| **+100**                          |       | 8.03                           | %          | 8.63                         | %          | 9.71                           | %          | 6.00                                 | %          |
| **Flat**                          |       | 8.39                           | %          | 8.96                         | %          | 9.67                           | %          | 6.00                                 | %          |
| **-100**                          |       | 8.77                           | %          | 9.19                         | %          | 9.87                           | %          | 6.00                                 | %          |

 

Minimum ratios for NPV risk are establishedby the Board of Directors as prudent levels for the respective interest ratescenarios. Lower NPV ratios denote more market rate sensitivity for a givenrate scenario.  As of September 30, 2005the analysis indicates sensitivity to rising market interest rates.  The sensitivities presented in the tableabove are within the Board approved limits for these scenarios.  Computation of prospective effects ofhypothetical rate changes is based on many assumptions, including relativelevels of market interest rates, loan prepayments and deposit decay. Theyshould not be relied upon as indicative of actual results. Further, thecomputations do not contemplate certain actions management could undertake inresponse to changes in interest rates.

 

**Item 4.  Controls and Procedures**

 

**Management’s Conclusion on theEffectiveness of Disclosure Controls and Procedures**

 

*Evaluation of Disclosure Controls and Procedures*. We evaluated the effectiveness of thedesign and operation of our “disclosure controls and procedures,” as defined inRule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”), as of the end of the period covered by this report. This evaluation (the“controls evaluation”) was done under the supervision and with theparticipation of management, including our chief executive officer (“CEO”) andchief financial executive (“CFO”). 

 

*Objectives of Controls*. Disclosure controls and procedures aredesigned so that information required to be disclosed in our reports filedunder the Exchange Act, such as this quarterly report on Form 10-Q, isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms. Disclosure controls and procedures are alsointended to ensure that such information is accumulated and communicated to ourmanagement, including the CEO and CFO, as appropriate to allow timely decisionsregarding required disclosure. In designing and evaluating disclosure controlsand procedures, management recognizes that any controls and procedures, nomatter how well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, and management is required to applyits judgment in evaluating the cost-benefit relationship of possible controlsand procedures.

 

*Conclusions*. Based uponthe controls evaluation, our CEO and CFO have concluded that as of September30, 2005, our disclosure controls and procedures are effective to provide reasonableassurance that the foregoing objectives are achieved.

 

 *Changes in Internal Control over Financial Reporting*.  There were no changes in our internal controlover financial reporting, as defined in Rule 13a-15(f) under the Exchange Act,during the period covered by this report that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

37

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# **Part II. Other Information**

# ** **

# **Item 1.  LegalProceedings**

 

Illinois Union Insurance Co.v. Commercial Money Center, Inc., et al., Case No. CV-01-0685-KJD-RJJ(District Court of Nevada) and related cases nowpending in *In re Commercial Money Center, Inc. Equipment LeaseLitigation in the United States District Court for the Northern District ofOhio, Eastern Division, MDL Case No. 1:02-CV-16000*; the pendingbankruptcy cases of Commercial Money Center, Inc. and Commercial ServicingCorporation titledIn re: Commercial MoneyCenter, Inc. and Commercial Servicing Corporation, BankruptcyNo. 02-09721-H7 (Jointly Administered), United States Bankruptcy Court For TheSouthern District of California; and In re Commercial Money Center, Inc.,Debtor (Kipperman v. NetBank, FSB), Adversary Proceeding No. 03-90331-JH,In the United States Bankruptcy Court for the Southern District of California, appealpendingNetBank, F.S.B. v. Richard M. Kipperman, Chapter 7 Trusteefor the Bankruptcy Estates of Commercial Money Centers, Inc. and CommercialServicing Corporation v. NetBank, F.S.B, United States Bankruptcy AppellatePanel of the Ninth Circuit; BAP No. SC-05-1238

 

As reported in previous filings, NetBank,FSB, filed a complaint in January 2002 against Commercial Money Center, Inc. (“CMC”),Illinois Union Insurance Company (“Illinois Union”), Safeco Insurance Companyof America (“Safeco”), and Royal Indemnity Company (“Royal,” with IllinoisUnion, Safeco and Royal, collectively, referred to as the “Sureties”).  CMC was the originator and subservicer ofvarious equipment leases (the “Leases”). NetBank, FSB purchased most of the payment streams generated by thesubject Leases from CMC (the “Payment Streams”).  The Sureties are insurance companies thatissued surety bonds and insurance policies guaranteeing payment of the PaymentStreams (the “Bonds”) and that also served as master servicers of theleases.  The NetBank, FSB action allegesseveral claims, including claims for breach of contract, fraud, and bad faith,and seeks, among other things, payment under and enforcement of the Bonds.  The Judicial Panel on Multi-DistrictLitigation (the “MDL Judicial Panel”) has consolidated the actions involvingNetBank, FSB with more than 35 other cases pending around the country involvingother banks and financial institutions that were seeking to enforce suretybonds and insurance policies relating to payment streams sold by CMC.  All pre-trial activity is currently beingheld in the United States District Court for the Northern District of Ohio (the“MDL Court”).

 

As reported in previous filings, NetBank, FSBhad joined with the other claimants (the “Claimants”) in a motion for judgmenton the pleadings, which motion was filed on January 31, 2003.  NetBank, FSB later withdrew its motion forjudgment on the pleadings and on March 25, 2005 filed a Motion for PartialSummary Judgment (the “Summary Judgment Motion”) or, in the alternative, aMotion for Suggestion of Remand (the “Remand Motion”).  The Summary Judgment Motion seeks judgment asa matter of law on NetBank, FSB’s breach of contract claims.  The Remand Motion requests that, in lieu ofdeciding the Summary Judgment Motion, the MDL Court instead suggest to the MDLJudicial Panel that the claims of NetBank, FSB be remanded to the United StatesDistrict Court for the District of Nevada. The Sureties filed oppositions to the Remand Motion, and they haveargued that they don’t need to respond to the Summary Judgment Motion until anunspecified date in the future after the MDL Court rules on the pendingConsolidated Motion for Judgment on the Pleadings.  NetBank, FSB filed a motion to enforce orclarify the briefing schedule so that the Sureties will be required to respondpromptly to the Summary Judgment Motion. The MDL Court denied the Remand Motion but has not yet ruled on themotion to enforce or clarify the briefing schedule.

 

On August 19, 2005, the MDLCourt entered two orders on the Claimants’ Consolidated Motion for Judgment onthe Pleadings.  The Court granted theClaimants’ motion with respect to Illinois Union Insurance Company (the “IllinoisUnion Order”), finding that Illinois Union was liable as a matter of law underthe bonds that it issued and could not assert fraud of CMC as a defense.  Because NetBank, FSB had previously withdrawnfrom the Consolidated Motion in order to file a separate motion for partialsummary judgment, the MDL Court held that NetBank could file a motion to renewits interest in the Consolidated Motion so that the Illinois Union Order couldapply to NetBank, FSB.  NetBank filed itsmotion to renew interest, and Illinois Union has filed an opposition.  The MDL Court has not yet ruled on whetherthe Illinois Union Order will apply to NetBank, FSB.

 

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In the second order on theClaimants’ Consolidated Motion, the MDL Court denied the Motion with respect toall the remaining sureties, including Royal and Safeco.  The MDL Court held that it could notdetermine, based on the pleadings alone, whether the Claimants were the intendedobligees under the bonds and, therefore, whether fraud of CMC would constitutea defense to the Sureties’ obligation to pay under the terms of the suretybonds.  The MDL Court went on to hold,however, that if the Claimants are ultimately determined to be the obligeesunder the surety bonds, the Sureties will be precluded from raising a defenseof fraudulent inducement by CMC.

 

**On September 22, 2005, the MDLCourt conducted a status conference and discussed whether the parties should berequired to mediate the case and a proposed schedule for remaining issues inthe case, including amendments to pleadings, expert discovery, and dispositivemotions.  NetBank, FSB urged the Court toadopt a schedule that would allow it to proceed, without further delay, withmotions for partial summary judgment against Safeco and Royal, and, ifnecessary, Illinois Union.  The MDL Courthas not yet entered a scheduling order for the remainder of the case.  Until the scheduling order is entered, allfurther filings in the case have been stayed, except for matters relating toNetBank, FSB’s motion to renew interest and motions seeking final or partialfinal judgment against Illinois Union.**

** **

The Company believes that based on theoverall facts and circumstances, the defenses asserted by the Sureties willfail and that NetBank, FSB will ultimately prevail on its claims.

 

Also, as reported in previous filings, on May30, 2002, CMC filed for bankruptcy protection. Shortly thereafter, Commercial Servicing Corporation (“CSC”), anaffiliate of CMC, also filed bankruptcy. The bankruptcy cases and related proceedings are not a part of theconsolidation of cases in Ohio.  On September 4, 2003, the Trustee initiated anadversary proceeding in the bankruptcy cases by filing a Complaint againstNetBank, FSB seeking to avoid NetBank, FSB’s interest in the Payment Streamsand their supporting Bonds relating to the Royal guaranteed pools of Leases(the “Adversary Proceeding”).  On May 6,2004, NetBank, FSB filed a motion for partial summary judgment against theTrustee.  The Trustee filed across-motion for partial summary judgment against NetBank, FSB on June 18,2004.  On January 27, 2005, theBankruptcy Court entered its Memorandum Decision granting the Trustee’s motionfor partial summary judgment and denying NetBank, FSB’s motion for partialsummary judgment.  On February 28, 2005,the Bankruptcy Court entered an order denying NetBank, FSB’s Motion for PartialSummary Judgment and granting the Trustee’s Cross-Motion for SummaryJudgment.  On April 27, 2005, theBankruptcy Court entered a judgment conforming to the Memorandum Decision.   On May 20, 2005, the Bankruptcy Courtentered an amended judgment conforming to the Memorandum Decision.  The Bankruptcy Court held in the MemorandumDecision that NetBank, FSB was required, but failed, to perfect its interest inthe Payment Streams that were transferred to it from CMC in the subjecttransactions and that the subject transactions were loans rather thansales.  Also on May 20, 2005, NetBank,FSB appealed the amended judgment to the Bankruptcy Appellate Panel for theNinth Circuit Court of Appeals.  On May25, 2005, NetBank, FSB sought a stay pending appeal of the turnover provisionsof the amended judgment from the Bankruptcy Court.  The Bankruptcy Court denied the request forstay on August 1, 2005.  Instead ofseeking appellate review of the denial of the motion to stay, NetBank, FSBentered into an agreement with the Trustee whereby the Trustee agreed to safelyhold the disputed Bonds pending conclusion of the appellate process.  Currently, NetBank, FSB’s initial brief in theappeal is due on November 18, 2005, but the Company anticipates that theBankruptcy Appellate Panel will extend that date to December 5, 2005.

 

In the meantime, manyof the parties to the CMC and CSC bankruptcy cases resolved their disputes andentered into a Global Settlement Agreement, which was approved by theBankruptcy Court on May 31, 2005.  TheGlobal Settlement Agreement resolved all issues regarding ownership of thePayment Streams that were at issue in the Adversary Proceeding, howeverownership of the Royal issued Bonds remains an issue in the AdversaryProceeding, as discussed above.  Pursuantto the Global Settlement Agreement, NetBank, FSB received a settlement paymentof approximately $4 million.  Inaddition, the Global Settlement Agreement provided that NetBank, FSB receive,retroactive to October 1, 2004, 100% of all lease payments made bylessees of Payment Streams.  Also,NetBank, FSB was relieved of any obligation to share with the Trustee anyfuture payments made to NetBank, FSB by anyof the Sureties.

 

NetBank, FSB intends to vigorously pursue itsclaims against all the Sureties, including claims for any loss associated withthe claims brought by the Trustee against NetBank, FSB.  At this time, the Company is unable toexpress an opinion as to the likelihood of loss, or the amount or range ofpotential loss, with regard to this matter.

 

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

 

On June 27, 2001, several lessees ofequipment leased from CMC filed suit in Los Angeles Superior Court against CMCand several John Doe defendants alleging that the leases violated Californiausury laws, the California Financial Code, and the California Unfair BusinessPractices Act.  The plaintiff lesseeswere seeking to rescind or reform their obligations under the leases and wereseeking to recover statutory damages and attorney’s fees.  The plaintiffs subsequently amended theircomplaint to name NetBank, FSB, several other investor banks, and severalsurety companies as co-defendants in the action.  After CMC filed for bankruptcy, the actionwas removed to the bankruptcy court in the Central District of California, butthe plaintiffs subsequently agreed to withdraw their claims against CMC andwere successful in their motion to remand the case back to state court.

 

On March 15, 2004, the Superior Courtsustained demurrers and motions to quash filed by NetBank, FSB and variousother defendants on certain of the plaintiffs’ claims.  The Superior Court sustained the demurrersunder the California Financial Code, without leave to amend.  The Superior Court also sustained demurrerson the Unfair Business Practices Act, with leave to amend the claims to addgreater specificity to the claims, but without leave to amend as to unnamedrepresentatives of the alleged class of plaintiffs harmed.  The Superior Court also granted motions tostrike: (1) plaintiffs’ claims under the California Unfair Business PracticesAct as to unnamed representative plaintiffs; (2) plaintiffs’ request forrestitution (the named plaintiffs may amend to establish individual entitlementto restitution); (3) plaintiffs’ request for disgorgement; (4) plaintiffs’request for punitive damages; (5) plaintiffs’ request for compensatory damagesunder the California Unfair Business Practices Act; and (6) plaintiffs’ requestfor attorneys’ fees.

 

On April 29, 2004, the plaintiffs served anamended complaint against NetBank, FSB alleging claims for, among other things,violations of another section of the California Financial Code, unfaircompetition under Section 17200 of the California Business and Professions Codeand usury.  On October 26, 2004, thecourt overruled the defendants’ demurrers to the third amended complaint.  However, on December 13, 2004, the courtissued a stay in the action pending a decision by the appeals court on theplaintiffs’ claims that were dismissed without leave to amend.  No discovery has been taken in this case andwe expect no resolution of these surviving claims prior to the outcome ofplaintiffs’ appeal.    The Companyintends to vigorously defend the amended claims in the Clayton action and topursue recovery against Safeco Insurance Company, Royal Indemnity Company, andIllinois Union Insurance Company in the Company’s existing action against themfor any damages and costs incurred in this case.

 

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**Item2.  Unregistered Sales of EquitySecurities and Use of Proceeds**

 

In August 2002, the Board of Directorsapproved a plan to repurchase up to 1 million shares of the Company’s commonstock. The plan was subsequently increased by 1 million shares inOctober 2002, 2 million shares in January 2003, 1 million shares inApril 2004 and 1 million shares in April 2005. As summarized below, therewas no repurchase activity for the three months ended September 30, 2005.

 

The table below sets forth informationregarding the repurchase of shares of our common stock during the three monthsended September 30, 2005:

 
| **Period**                                   | ** ** | **Total Number of Shares Purchased** | ** ** | **Average Price Paid Per Share** | ** ** | **Total Number of Shares (or Units) Purchased as Part of Publicly  Announced Plans or Programs** | ** ** | **Maximum Number (or Appropriate Dollar Value) of Shares (or Units)  that May Yet Be Purchased Under the Plans or Programs** | ** ** |
|----------------------------------------------|------------|--------------------------------------|------------|----------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|
| Balance as of June 30,  2005            |       | 571,391                              |       | —                           |       | 571,391                                                                                          |       | 1,092,573                                                                                                                    |       |
| July 1 through July 31,  2005           |       | —                               |       | —                           |       | —                                                                                           |       | 1,092,573                                                                                                                    |       |
| August 1 through August 31,  2005       |       | —                               |       | —                           |       | —                                                                                           |       | 1,092,573                                                                                                                    |       |
| September 1 through  September 30, 2005 |       | —                               |       | —                           |       | —                                                                                           |       | 1,092,573                                                                                                                    |       |
| Total                                        |       | 571,391                              |       | —                           |       | 571,391                                                                                          |       |                                                                                                                         |       |

 

As of November 1, 2005, 1,092,573 sharesremained available for repurchase under current Board authority.

 

Reference is made to the discussion under theheading “Dividends” under Item 5. Market for Registrant’s Common Equity,Related Shareholder Matters and Issuer Purchases of Equity Securities of theCompany’s 2004 Form 10-K for a description of current OTS regulationsapplicable to the ability of NetBank, FSB to pay dividends and make othercapital distributions to the Company.

** **

**Item 3.  Defaults Upon SeniorSecurities**

** **

**               **None.

 

**Item 4.  Submission of Matters to a Vote of SecurityHolders**

** **

**               **None.

 

**Item5.  Other Information**

** **

**                None.**

** **

**Item 6.  Exhibits and Reports onForm 8-K**

 

Theexhibits listed in the accompanying index to exhibits are filed or incorporatedby reference as part of this report, unless otherwise provided in the index toexhibits.

 

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#### **SIGNATURE**

 

Pursuant to the requirements of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.

 
|                     | NETBANK, INC. |
|--------------------------|---------------|
|                     |          |
|                     | By:           | /s/ Steven F. Herbert |
|                     |          | Steven F. Herbert |
| Dated: November 14, 2005 | * *      | *Chief Finance Executive  (principal accounting officer and* *duly authorized officer)* |

 

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**INDEX TOEXHIBITS**

** **
| ** **         | ** ** | ** **                                                                                                                                                                                              | ** ** | **Incorporated by Reference** | ** ** |
|--------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| **Exhibit Number** | ** ** | **Exhibit Description**                                                                                                                                                                                 | ** ** | **Form**                      | ** ** | **File Number** | ** ** | **Exhibit** | ** ** | **Filing****Date** | ** ** | **Filed Herewith** | ** ** |
| 3.1(a)             |       | Amended and Restated Articles of  Incorporation dated November 25, 1996                                                                                                                            |       | S-1                           |       | 333-23717 |   | 3.1 |   | 3/21/97 |   |   |   |
|               |       |                                                                                                                                                                                                    |       |                          |       |   |   |   |   |   |   |   |   |
| (b)                |       | Articles of Amendment of Articles of  Incorporation dated January 20, 2000                                                                                                                         |       | 8-A                           |       | 000-22361 |   | 99.2 |   | 1/28/00 |   |   |   |
|               |       |                                                                                                                                                                                                    |       |                          |       |   |   |   |   |   |   |   |   |
| (c)                |       | Articles of amendment of Articles of  Incorporation dated April 27, 2000                                                                                                                           |       | 10-Q                          |       | 000-22361 |   | 3.1 |   | 5/15/00 |   |   |   |
|               |       |                                                                                                                                                                                                    |       |                          |       |   |   |   |   |   |   |   |   |
| 3.2(a)             |       | Bylaws                                                                                                                                                                                                  |       | S-1                           |       | 333-23717 |   | 3.2 |   | 3/21/97 |   |   |   |
|               |       |                                                                                                                                                                                                    |       |                          |       |   |   |   |   |   |   |   |   |
| (b)                |       | Amendments to the Bylaws adopted by April  22, 1997                                                                                                                                                |       | S-1/A                         |       | 333-23717 |   | 3.3 |   | 4/25/97 |   |   |   |
|               |       |                                                                                                                                                                                                    |       |                          |       |   |   |   |   |   |   |   |   |
| (c)                |       | Amendment to the Bylaws adopted as  of March 31, 2002                                                                                                                                                   |       | S-4                           |       | 333-75298 |   | App. D |   | 12/17/01 |   |   |   |
|               |       |                                                                                                                                                                                                    |       |                          |       |   |   |   |   |   |   |   |   |
| 4.1(a)             |       | Form of Common Stock Certificate                                                                                                                                                                        |       | S-1/A                         |       | 333-23717 |   | 4.1 |   | 4/25/97 |   |   |   |
|               |       |                                                                                                                                                                                                    |       |                          |       |   |   |   |   |   |   |   |   |
| (b)                |       | Rights Agreement dated January 20,  2000 between NetB@nk, Inc. and SunTrust Bank                                                                                                                        |       | 8-A                           |       | 000-22361 |   | 99.1 |   | 1/28/00 |   |   |   |
|               |       |                                                                                                                                                                                                    |       |                          |       |   |   |   |   |   |   |   |   |
| (c)                |       | Pursuant to Regulation S-K Item 601(b)(4)(iii),  registrant by this filing agrees, upon request, to furnish to the SEC a copy  of all instruments defining the rights of long-term debt of the Company. |       |                          |       |   |   |   |   |   |   |   |   |
|               |       |                                                                                                                                                                                                    |       |                          |       |   |   |   |   |   |   |   |   |
| 31.1               |       | Certification Pursuant to Rules  13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as  amended—Chief Executive Officer                                                            |       |                          |       |   |   |   |   |   |   | X |   |
|               |       |                                                                                                                                                                                                    |       |                          |       |   |   |   |   |   |   |   |   |
| 31.2               |       | Certification Pursuant to Rules  13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as  amended—Chief Financial Executive                                                          |       |                          |       |   |   |   |   |   |   | X |   |
|               |       |                                                                                                                                                                                                    |       |                          |       |   |   |   |   |   |   |   |   |
| 32.1               | †     | Certification Pursuant to 18 U.S.C. Section 1350—Chief Executive Officer and Chief Financial  Executive                                                                                            |       |                          |       |   |   |   |   |   |   | X |   |

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†                                          The certification attached as Exhibit 32.1 that accompanies this report isnot deemed filed with the Securities and Exchange Commission and is not to beincorporated by reference into any filing of NetBank, Inc. under the SecuritiesAct of 1934, as amended, or the Securities Exchange Act of 1934, as amended,whether made before or after the date of this report, irrespective of anygeneral incorporation language contained in such filing.

 

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