** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

** **

**QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For theQuarterly Period Ended June 30, 2005**

** **

**CommissionFile 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 area code: |

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities 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 90days:  YES ý  NO o

 

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

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date:
| **Class**                     | ** ** | **Shares  Outstanding at July 31, 2005** |
|-------------------------------|------------|------------------------------------------|
| Common  Stock, par value $.01 |       | 46,318,407                               |

 

 

----

 

**NETBANK, INC.****TABLE OF CONTENTS**
| **Part I. Financial  Information**                                                                                 | **3**      |
|--------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                         | ** ** |
| **Item  1. Financial Statements (Unaudited)**                                                                      | **3**      |
| ** **                                                                                                         | ** ** |
| **Consolidated  balance sheets as of June 30, 2005 and December 31, 2004**                                         | **3**      |
| ** **                                                                                                         | ** ** |
| **Consolidated statements of operations for the three  and six months ended June 30, 2005 and 2004**               | **4**      |
| ** **                                                                                                         | ** ** |
| **Consolidated statements of shareholders’ equity for the three and six months ended June 30, 2005 and 2004** | **5**      |
| ** **                                                                                                         | ** ** |
| **Consolidated  statements of cash flows for the six months ended June 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**                                            | **34**     |
| ** **                                                                                                         | ** ** |
| **Item 4. Controls and Procedures**                                                                                | **36**     |
| ** **                                                                                                         | ** ** |
| **Part  II. Other Information**                                                                                    | **37**     |
| ** **                                                                                                         | ** ** |
| **Item  1. Legal Proceedings**                                                                                     | **37**     |
| ** **                                                                                                         | ** ** |
| **Item 2. Changes in Securities and Use of Proceeds**                                                              | **39**     |
| ** **                                                                                                         | ** ** |
| **Item 3. Defaults Upon Senior Securities**                                                                        | **39**     |
| ** **                                                                                                         | ** ** |
| **Item 4. Submission of Matters to a Vote of Security  Holders**                                                   | **40**     |
| ** **                                                                                                         | ** ** |
| **Item 5. Other Information**                                                                                      | **40**     |
| ** **                                                                                                         | ** ** |
| **Item 6. Exhibits and Reports on Form 8-K**                                                                       | **40**     |
| ** **                                                                                                         | ** ** |
| **Signature  Page**                                                                                                | **40**     |

 

2

----

 

**Part I. Financial Information**

**Item 1. FinancialStatements (Unaudited)**

**NetBank, Inc.**

**Consolidated BalanceSheets**

**(in 000’s except share amounts)**

 
| ** **                                                                                                        | ** **   | **June 30,**    | ** **   | **December 31,** | ** **   |
|-------------------------------------------------------------------------------------------------------------------|--------------|-----------------|--------------|------------------|--------------|
| ** **                                                                                                        | ** **   | **2005**        | ** **   | **2004**         | ** **   |
| ** **                                                                                                        | *** *** | **(unaudited)** | ** **   | **(audited)**    | *** *** |
| **Assets**                                                                                                        | *** *** | *** ***    | *** *** | *** ***     | *** *** |
| Cash and cash equivalents:                                                                                        |         |            |         |             |         |
| Cash and due from banks                                                                                           |         | $               | 119,108      |             | $            | 104,070 |   |
| Cash equivalents and federal funds sold                                                                           |         | 67,279          |         | 46,232           |         |
| Total cash and cash equivalents                                                                                   |         | 186,387         |         | 150,302          |         |
| Investment securities  available for sale-at fair value (amortized costs of $659,880 and $702,127,  respectively) |         | 659,093         |         | 700,295          |         |
| Stock of Federal Home Loan Bank of Atlanta - at cost                                                              |         | 66,172          |         | 60,128           |         |
| Loans held for sale                                                                                               |         | 1,388,495       |         | 1,173,779        |         |
| Loan and lease receivables  - net of allowance for credit losses of $25,792 and $24,462, respectively             |         | 2,181,089       |         | 2,095,832        |         |
| Mortgage servicing rights — net                                                                              |         | 176,583         |         | 172,819          |         |
| Accrued interest receivable                                                                                       |         | 13,673          |         | 11,513           |         |
| Furniture, equipment and capitalized software — net                                                          |         | 47,186          |         | 51,438           |         |
| Goodwill and other intangibles — net                                                                         |         | 81,424          |         | 79,195           |         |
| Due from servicers and investors                                                                                  |         | 26,513          |         | 52,441           |         |
| Receivable from unsettled trades                                                                                  |         | 26,171          |         | —           |         |
| Other assets                                                                                                      |         | 101,981         |         | 74,439           |         |
| **Total assets**                                                                                                  |         | $               | 4,954,767    |             | $            | 4,622,181 |   |
|                                                                                                              |         |            |         |             |         |
| **Liabilities, minority interests and  shareholders’ equity**                                                |         |            |         |             |         |
| **Liabilities:**                                                                                                  |         |            |         |             |         |
| Deposits                                                                                                          |         | $               | 2,792,100    |             | $            | 2,639,441 |   |
| Other borrowed funds                                                                                              |         | 1,470,775       |         | 1,311,491        |         |
| Subordinated debt                                                                                                 |         | 32,477          |         | 11,857           |         |
| Accrued interest payable                                                                                          |         | 13,449          |         | 10,309           |         |
| Loans in process                                                                                                  |         | 61,473          |         | 27,820           |         |
| Unsettled trades                                                                                                  |         | —          |         | 50,543           |         |
| Representations and warranties                                                                                    |         | 19,037          |         | 22,676           |         |
| Accounts payable and accrued liabilities                                                                          |         | 155,807         |         | 133,562          |         |
| Total liabilities                                                                                                 |         | 4,545,118       |         | 4,207,699        |         |
|                                                                                                              |         |            |         |             |         |
| Commitments and contingencies — note 11                                                                      |         | —          |         | -                |         |
| Minority interests in  affiliates                                                                                 |         | 560             |         | 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                                                                                        |         | 432,192         |         | 432,132          |         |
| Retained earnings                                                                                                 |         | 41,618          |         | 43,849           |         |
| Accumulated other  comprehensive loss, net of taxes of $(299) and $(696), respectively                            |         | (488            | )            | (1,136           | )            |
| Treasury stock, at cost (6,521,901 and 6,292,082 shares,  respectively)                                           |         | (63,236         | )            | (61,087          | )            |
| Unearned compensation                                                                                             |         | (1,525          | )            | (259             | )            |
| **Total shareholders’ equity**                                                                               |         | 409,089         |         | 414,027          |         |
| **Total liabilities, minority interests and  shareholders’ equity**                                          | ** **   | $               | 4,954,767    |             | $            | 4,622,181 |   |

See notes to consolidated financial statements.

 

3

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**NetBank,Inc.**

**ConsolidatedStatements of Operations**

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

 
| ** **                                                       | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                       | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Interest income:**                                             |       |                            |       |                          |       |   |   |   |   |
| Loans and leases                                                 |       | $                               | 53,106     |                          | $          | 54,582 |   | $ | 100,959 |   | $ | 102,621 |   |
| Investment securities                                            |       | 8,879                           |       | 3,905                         |       | 17,667 |   | 7,871 |   |
| Short-term investments                                           |       | 516                             |       | 190                           |       | 895 |   | 370 |   |
| Total interest income                                            |       | 62,501                          |       | 58,677                        |       | 119,521 |   | 110,862 |   |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| **Interest expense:**                                            |       |                            |       |                          |       |   |   |   |   |
| Deposits                                                         |       | 15,598                          |       | 10,684                        |       | 28,814 |   | 22,502 |   |
| Other borrowed funds                                             |       | 15,961                          |       | 11,494                        |       | 28,988 |   | 20,112 |   |
| Total interest expense                                           |       | 31,559                          |       | 22,178                        |       | 57,802 |   | 42,614 |   |
| Net interest income                                              |       | 30,942                          |       | 36,499                        |       | 61,719 |   | 68,248 |   |
| Provision for credit losses                                      |       | 2,330                           |       | 1,666                         |       | 4,681 |   | 3,513 |   |
| Net interest income after provision for credit losses            |       | 28,612                          |       | 34,833                        |       | 57,038 |   | 64,735 |   |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| **Non-interest income:**                                         |       |                            |       |                          |       |   |   |   |   |
| Mortgage servicing fees                                          |       | 13,192                          |       | 10,624                        |       | 25,454 |   | 23,633 |   |
| Amortization of mortgage  servicing rights                       |       | (11,516                         | )          | (9,847                        | )          | (22,144 | ) | (18,923 | ) |
| Recovery (impairment) of  mortgage servicing rights              |       | (1,700                          | )          | 5,813                         |       | (1,020 | ) | 4,643 |   |
| Gains (losses) on  derivatives                                   |       | 1,845                           |       | (2,743                        | )          | (944 | ) | (1,542 | ) |
| Gains on sales of investment securities                          |       | 1,705                           |       | —                        |       | 4,182 |   | 3,169 |   |
| Service charges and fees                                         |       | 5,092                           |       | 6,014                         |       | 9,843 |   | 10,037 |   |
| Gains on sales of loans  and mortgage servicing rights           |       | 29,932                          |       | 33,899                        |       | 54,752 |   | 66,213 |   |
| Other income                                                     |       | 2,691                           |       | 2,826                         |       | 5,579 |   | 5,801 |   |
| Total non-interest income                                        |       | 41,241                          |       | 46,586                        |       | 75,702 |   | 93,031 |   |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| **Non-interest expense:**                                        |       |                            |       |                          |       |   |   |   |   |
| Salaries and benefits                                            |       | 30,094                          |       | 32,155                        |       | 61,817 |   | 63,082 |   |
| Customer service                                                 |       | 3,396                           |       | 3,111                         |       | 6,520 |   | 6,024 |   |
| Marketing                                                        |       | 2,366                           |       | 2,164                         |       | 5,221 |   | 4,423 |   |
| Data processing                                                  |       | 4,412                           |       | 4,675                         |       | 8,787 |   | 9,166 |   |
| Depreciation and  amortization                                   |       | 6,010                           |       | 4,833                         |       | 11,613 |   | 9,616 |   |
| Office expenses                                                  |       | 3,002                           |       | 2,791                         |       | 5,822 |   | 5,471 |   |
| Occupancy                                                        |       | 5,952                           |       | 5,373                         |       | 11,853 |   | 10,507 |   |
| Travel and entertainment                                         |       | 1,390                           |       | 1,386                         |       | 2,640 |   | 2,562 |   |
| Professional fees                                                |       | 4,815                           |       | 5,003                         |       | 8,805 |   | 7,913 |   |
| Prepaid lost interest from  curtailments                         |       | 1,059                           |       | 1,896                         |       | 2,083 |   | 3,268 |   |
| Other expenses                                                   |       | 3,483                           |       | 4,589                         |       | 6,832 |   | 7,259 |   |
| Total non-interest expense                                       |       | 65,979                          |       | 67,976                        |       | 131,993 |   | 129,291 |   |
| Income before income taxes                                       |       | 3,874                           |       | 13,443                        |       | 747 |   | 28,475 |   |
| Income tax expense                                               |       | (1,549                          | )          | (4,976                        | )          | (451 | ) | (10,614 | ) |
| **Net income**                                                   |       | $                               | 2,325      |                          | $          | 8,467 |   | $ | 296 |   | $ | 17,861 |   |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| Net income per common and  potential common shares outstanding:  |       |                            |       |                          |       |   |   |   |   |
| Basic                                                            |       | $                               | 0.05       |                          | $          | 0.18 |   | $ | 0.01 |   | $ | 0.38 |   |
| Diluted                                                          |       | $                               | 0.05       |                          | $          | 0.18 |   | $ | 0.01 |   | $ | 0.38 |   |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| Weighted average common and potential common shares outstanding: |       |                            |       |                          |       |   |   |   |   |
| Basic                                                            |       | 46,116                          |       | 46,790                        |       | 46,241 |   | 47,020 |   |
| Diluted                                                          |       | 46,492                          |       | 47,169                        |       | 46,538 |   | 47,568 |   |
|                                                             |       |                            |       |                          |       |   |   |   |   |
| Dividends declared on common stock per share                     |       | $                               | 0.02       |                          | $          | 0.02 |   | $ | 0.04 |   | $ | 0.04 |   |

 

See notes to consolidated financial statements.

 

4

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**NetBank, Inc.**

**Consolidated Statements ofShareholders’ Equity**

**(unaudited and in 000s)**

 
| ** **                                                                                                  | ** ** | **For the three months ended  June 30,** | ** ** | **For the six months ended  June 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                                                                                           |       | $                                        | 432,132    |                                   | $          | 431,920 |   | $ | 432,132 |   | $ | 432,035 |   |
| Issuance of treasury stock, net of repurchases                                                              |       | —                                   |       | 109                                    |       | — |   | (6 | ) |
| Unearned compensation from  issuance of restricted stock                                                    |       | 60                                       |       | —                                 |       | 60 |   | — |   |
| Ending balance                                                                                              |       | $                                        | 432,192    |                                   | $          | 432,029 |   | $ | 432,192 |   | $ | 432,029 |   |
| **Retained earnings**                                                                                       |       |                                     |       |                                   |       |   |   |   |   |
| Beginning balance                                                                                           |       | $                                        | 40,553     |                                   | $          | 52,555 |   | $ | 43,849 |   | $ | 44,102 |   |
| Net income                                                                                                  |       | 2,325                                    |       | 8,467                                  |       | 296 |   | 17,861 |   |
| Cash dividends declared                                                                                     |       | (925                                     | )          | (938                                   | )          | (1,851 | ) | (1,879 | ) |
| Loss on re-issuance of shares of common stock                                                               |       | (335                                     | )          | (196                                   | )          | (676 | ) | (196 | ) |
| Ending balance                                                                                              |       | $                                        | 41,618     |                                   | $          | 59,888 |   | $ | 41,618 |   | $ | 59,888 |   |
| **Accumulated other comprehensive loss**                                                                    |       |                                     |       |                                   |       |   |   |   |   |
| Beginning balance                                                                                           |       | $                                        | (6,738     | )                                      | $          | 4,992 |   | $ | (1,136 | ) | $ | 2,742 |   |
| Realized gain on sale of securities, net of taxes                                                           |       | (1,057                                   | )          | —                                 |       | (2,593 | ) | (1,980 | ) |
| Unrealized gain (loss) on securities, net of taxes                                                          |       | 7,307                                    |       | (6,967                                 | )          | 3,241 |   | (2,737 | ) |
| Ending balance                                                                                              |       | $                                        | (488       | )                                      | $          | (1,975 | ) | $ | (488 | ) | $ | (1,975 | ) |
| **Treasury stock, at cost**                                                                                 |       |                                     |       |                                   |       |   |   |   |   |
| Beginning balance                                                                                           |       | $                                        | (64,020    | )                                      | $          | (56,056 | ) | $ | (61,087 | ) | $ | (48,674 | ) |
| Purchase of shares of  common stock for treasury,  net of re-issuances                                      |       | (916                                     | )          | (3,583                                 | )          | (3,814 | ) | (10,965 | ) |
| Unearned compensation from  issuance of restricted stock                                                    |       | 1,700                                    |       | —                                 |       | 1,700 |   | — |   |
| Employee forfeitures of restricted stock                                                                    |       | —                                   |       | —                                 |       | (35 | ) | — |   |
| Ending balance                                                                                              |       | $                                        | (63,236    | )                                      | $          | (59,639 | ) | $ | (63,236 | ) | $ | (59,639 | ) |
| **Unearned compensation**                                                                                   |       |                                     |       |                                   |       |   |   |   |   |
| Beginning balance                                                                                           |       | $                                        | (195       | )                                      | $          | (352 | ) | $ | (259 | ) | $ | (383 | ) |
| Amortization of unearned compensation                                                                       |       | 105                                      |       | 31                                     |       | 134 |   | 62 |   |
| Unearned compensation from  issuance of restricted stock                                                    |       | (1,435                                   | )          | —                                 |       | (1,435 | ) | — |   |
| Employee forfeitures of restricted stock                                                                    |       | —                                   |       | —                                 |       | 35 |   | — |   |
| Ending balance                                                                                              |       | $                                        | (1,525     | )                                      | $          | (321 | ) | $ | (1,525 | ) | $ | (321 | ) |
| **Total shareholders’ equity**                                                                         |       | $                                        | 409,089    |                                   | $          | 430,510 |   | $ | 409,089 |   | $ | 430,510 |   |
|                                                                                                        |       |                                     |       |                                   |       |   |   |   |   |
| **Comprehensive income**                                                                                    |       |                                     |       |                                   |       |   |   |   |   |
| Net income                                                                                                  |       | $                                        | 2,325      |                                   | $          | 8,467 |   | $ | 296 |   | $ | 17,861 |   |
| Realized gain on sale of  securities, net of taxes of $648, $0, $1,589 and $1,214, respectively             |       | (1,057                                   | )          | —                                 |       | (2,593 | ) | (1,980 | ) |
| Unrealized gain (loss) on  securities, net of taxes of $(4,478), $4,270, $(1,986) and $1,678,  respectively |       | 7,307                                    |       | (6,967                                 | )          | 3,241 |   | (2,737 | ) |
| Comprehensive income                                                                                        |       | $                                        | 8,575      |                                   | $          | 1,500 |   | $ | 944 |   | $ | 13,144 |   |

 

See notes to consolidated financial statements.

 

5

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**NetBank, Inc.**

**Consolidated Statements ofCash Flows**

**(unaudited and in 000’s)**

 
| ** **                                                                                   | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                   | ** ** | **2005**                      | ** ** | **2004** | ** ** |
| Operating activities:                                                                        |       |                          |       |   |   |
| Net income                                                                                   |       | $                             | 296        |   | $ | 17,861 |   |
| Adjustments to reconcile  net income to net cash (used in) provided by operating activities: |       |                          |       |   |   |
| Depreciation and amortization                                                                |       | 11,613                        |       | 9,616 |   |
| Amortization of premiums  on investment securities, loan and lease receivables and debt      |       | 9,344                         |       | 5,101 |   |
| Origination of loans held for sale                                                           |       | (6,229,079                    | )          | (7,162,203 | ) |
| Repurchase of previously sold mortgages                                                      |       | (55,388                       | )          | (27,026 | ) |
| Proceeds from sales of loans held for sale                                                   |       | 6,121,074                     |       | 7,420,302 |   |
| Net gain on sales of loans and servicing rights                                              |       | (54,752                       | )          | (66,213 | ) |
| Capitalization of mortgage servicing rights                                                  |       | (9,900                        | )          | (68,202 | ) |
| Proceeds from sale of mortgage servicing rights                                              |       | 964                           |       | 3,182 |   |
| Mark-to-market adjustment on mortgage servicing rights                                       |       | 18,193                        |       | 15,400 |   |
| Impairment and amortization of mortgage servicing rights                                     |       | 23,164                        |       | 14,280 |   |
| Provision for credit losses                                                                  |       | 4,681                         |       | 3,513 |   |
| Amortization of unearned compensation                                                        |       | 194                           |       | 62 |   |
| Gains on sales of investment securities                                                      |       | (4,182                        | )          | (3,169 | ) |
| Changes in assets and liabilities which provide (use) cash:                                  |       |                          |       |   |   |
| (Increase) decrease in  accrued interest receivable                                          |       | (2,160                        | )          | 788 |   |
| Decrease (increase) in due  from servicers and investors                                     |       | 25,928                        |       | (4,715 | ) |
| (Increase) decrease in  other assets                                                         |       | (27,542                       | )          | 5,126 |   |
| Increase in accrued  interest payable                                                        |       | 3,140                         |       | 786 |   |
| Increase (decrease) in  accounts payable and accrued liabilities                             |       | 21,848                        |       | (1,265 | ) |
| Increase in loans in  process                                                                |       | 33,653                        |       | 21,212 |   |
| Net cash (used in)  provided by operating activities                                         |       | (108,911                      | )          | 184,436 |   |
|                                                                                         |       |                          |       |   |   |
| Investing activities:                                                                        |       |                          |       |   |   |
| Purchases of available for sale investment securities                                        |       | (391,472                      | )          | (165,156 | ) |
| Principal repayments on available for sale investment securities                             |       | 57,179                        |       | 32,102 |   |
| Sales and maturities of available for sale investment securities                             |       | 304,144                       |       | 14,216 |   |
| Purchase of Federal Home Loan Bank Stock                                                     |       | (6,044                        | )          | (35,370 | ) |
| Bulk purchase of mortgage servicing rights                                                   |       | (36,395                       | )          | — |   |
| Origination of loans and leases                                                              |       | (406,554                      | )          | (816,970 | ) |
| Principal repayments on loans and leases                                                     |       | 307,136                       |       | 242,690 |   |
| Purchases of furniture, fixtures, and equipment                                              |       | (5,944                        | )          | (8,611 | ) |
| Acquisitions, net of cash acquired                                                           |       | (3,646                        | )          | (8,033 | ) |
| Other investing activities                                                                   |       | 105                           |       | 389 |   |
| Net cash used in investing  activities                                                       |       | (181,491                      | )          | (744,743 | ) |
|                                                                                         |       |                          |       |   |   |
| Financing activities:                                                                        |       |                          |       |   |   |
| Decrease in money market and checking accounts                                               |       | (135,768                      | )          | (6,589 | ) |
| Increase (decrease) in certificates of deposit                                               |       | 288,427                       |       | (84,353 | ) |
| Proceeds from other borrowed funds                                                           |       | 4,189,983                     |       | 8,689,794 |   |
| Repayments of other borrowed funds                                                           |       | (4,030,699                    | )          | (7,961,841 | ) |
| Net proceeds from issuance of trust preferred securities                                     |       | 20,620                        |       | — |   |
| Net purchase of treasury stock                                                               |       | (4,225                        | )          | (11,167 | ) |
| Dividend payments on common stock                                                            |       | (1,851                        | )          | (1,879 | ) |
| Net cash provided by  financing activities                                                   |       | 326,487                       |       | 623,965 |   |
| Net increase in cash and cash equivalents                                                    |       | 36,085                        |       | 63,658 |   |
| Cash and cash equivalents:                                                                   |       |                          |       |   |   |
| Cash, beginning of period                                                                    |       | 150,302                       |       | 33,627 |   |
| Cash, end of period                                                                          |       | $                             | 186,387    |   | $ | 97,285 |   |
|                                                                                         |       |                          |       |   |   |
| Supplemental disclosures of cash flow information:                                           |       |                          |       |   |   |
| Cash paid during the period for interest                                                     |       | $                             | 54,662     |   | $ | 41,828 |   |
| Cash paid (refunds received) during the period for income taxes                              |       | $                             | 476        |   | $ | (8,362 | ) |

 

See notes to consolidated financial statements.

 

6

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**NETBANK, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTSJune 30, 2005(unaudited)**

 

**1.             ORGANIZATION AND BASIS OFPRESENTATION**

 

NetBank, Inc. is a financial holding company engaged primarily inretail banking, mortgage banking, business finance and providing ATM andmerchant processing services. NetBank, Inc. wholly owns the outstandingstock of NetBank (“NetBank, FSB” or “the Bank”), a federal savings bank; MGReinsurance Company (“MG Reinsurance”), a captive reinsurance company;NetInsurance, Inc. (“NetInsurance”), a licensed insurance agency; and NBPartners, 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 unaudited consolidated financialstatements included herein reflect all adjustments, consisting only of normalrecurring accruals, which are necessary for the fair presentation of thefinancial condition and results of operations for the interim periodspresented. Certain information and footnote disclosures normally included infinancial statements have been condensed or omitted pursuant to applicablerules and regulations of the Securities and Exchange Commission (“SEC”). Thefinancial statements included herein should be read in conjunction with thefinancial statements and notes thereto included in our Annual Report onForm 10-K filed with the SEC for the year ended December 31, 2004 (“2004Form 10-K”). The results of operations for the interim periods reported hereinare not necessarily indicative of results to be expected for the full year.Certain 2004 amounts have been reclassified for comparability with 2005amounts.

 

All dollar figures are presented in thousands (000s), except share andper share data, unless otherwise noted. All of our operations and assets arelocated within the United States.

** **

**Net income per share is presented on a diluted basis, unless otherwisenoted.**

** **

**2.             ACQUISITIONS**

 

During the six months endedJune 30, 2005, NPS acquired certain assets or processing contracts of varioussmaller ATM and merchant processors.  Theacquisitions were accounted for as purchases, and as such, approximately $3,553of amortizable intangibles were recorded. Consideration for these assets and processing contracts totaled $3,661. Theimpact of these purchases has been included in the Company’s results ofoperations from the respective dates of acquisition.

 

**3.             ACCOUNTING POLICIES**

 

Reference is made to our accounting policies described in the notes toconsolidated financial statements contained in our 2004 Form 10-K. TheCompany has followed those policies in preparing this report.

 

*Significant Estimates.*The preparationof the consolidated financial statements in conformity with accountingprinciples generally accepted in the United States (“GAAP”) requires managementto make estimates and assumptions that affect the amounts reported in the consolidatedfinancial statements and accompanying notes.  Certain of these estimates relate to theCompany’s allowance for credit losses; the fair values of loans held for sale,mortgage servicing rights, servicing hedges and the Company’s other hedging instruments;and reserves for estimated losses on representations and warranties

 

7

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provided to purchasers of loans or mortgage servicing rights. Becauseof the inherent uncertainties associated with any estimation process and due topossible future changes in market and economic conditions that will affect fairvalues, it is possible that actual future results and realization of theunderlying assets and liabilities could differ significantly from the amountsreflected as of the balance sheet date.

 

*Stock-Based Compensation.*The Company accounts forstock options issued under the recognition and measurement principles ofAccounting Principles Board Opinion No. 25, *Accounting for StockIssued to Employees,*and related Interpretations. No stockoption-based employee compensation cost is reflected in the results ofoperations, as all options granted under those plans had an exercise priceequal to or greater than the market value of the underlying common stock on thedate of grant.   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 of FinancialAccounting Standard No. 123 (“SFAS 123”), *Accounting for Stock-BasedCompensation — Transition and Disclosure,*to stock-based employeecompensation.

 
| ** **                                                                                                                                          | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                          | ** ** | **2005**                         | ** ** | **2004**                       | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net  income, as reported                                                                                                                            |       | $                                | 2,325      |                           | $          | 8,467 |   | $ | 296 |   | $ | 17,861 |   |
| Deduct  total stock option-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects |       | (1,144                           | )          | (1,091                         | )          | (1,891 | ) | (1,950 | ) |
| Pro  forma net income (loss)                                                                                                                        |       | $                                | 1,181      |                           | $          | 7,376 |   | $ | (1,595 | ) | $ | 15,911 |   |
|                                                                                                                                                |       |                             |       |                           |       |   |   |   |   |
| Earnings  per share:                                                                                                                                |       |                             |       |                           |       |   |   |   |   |
| Basic — as reported                                                                                                                            |       | $                                | 0.05       |                           | $          | 0.18 |   | $ | 0.01 |   | $ | 0.38 |   |
| Basic — pro forma                                                                                                                              |       | $                                | 0.03       |                           | $          | 0.16 |   | $ | (0.03 | ) | $ | 0.34 |   |
|                                                                                                                                                |       |                             |       |                           |       |   |   |   |   |
| Diluted — as reported                                                                                                                          |       | $                                | 0.05       |                           | $          | 0.18 |   | $ | 0.01 |   | $ | 0.38 |   |
| Diluted — pro forma                                                                                                                            |       | $                                | 0.03       |                           | $          | 0.16 |   | $ | (0.03 | ) | $ | 0.33 |   |

** **

**In addition, for the three andsix months ended June 30, 2005, pre-tax compensation expense of $165 and $187,respectively, related to restricted stock awards was recognized and included innet income as reported.  For the threeand six months ended June 30, 2004, comparable pre-tax compensation expenserecognized and included in net income was $31 and $62, respectively.**

* *

*New AccountingPronouncements. *In December 2004,the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards No. 123 (revised 2004) (“SFAS 123r”), *Share-Based Payment*, which is a revision of SFAS 123.SFAS 123r supersedes APB 25 and amends Statement of Financial AccountingStandards 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, including grantsof stock options, to be recognized in the financial statements based on theirfair 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.

 

8

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In May 2005, the FinancialAccounting Standards Board (“FASB”) issued SFAS No. 154 (“SFAS 154”), *Accounting Changes and Error Corrections* — a replacement ofAPB Opinion No. 20 and SFAS No. 3.  APB No. 20, *AccountingChanges*, and SFAS No. 3, *Reporting AccountingChanges in Interim Financial Statement*, required the inclusion ofthe cumulative effect of changes in accounting principle in net income in theperiod of change.  SFAS 154 establishes, unless impracticableretrospective application to prior periods’ financial statements as therequired method for reporting a voluntary change in accounting principle in theabsence of explicit transition requirements specific to the newly adoptedaccounting principle.  This statement is effective for accounting changesand corrections of errors made in fiscal years beginning after December 15,2005.  The Company will assess the impact of a retrospective applicationof a change in accounting principle in accordance with SFAS 154 if the need forsuch a change arises after the effective date.

** **

** **

**4.             LOAN AND LEASE RECEIVABLES**

 

The Company’s portfolio of loan and lease receivables consistsprimarily of internally originated 1-4 family first and second mortgage loans,home equity loans, automobile loans and business equipment financing loans andleases.

 

As of June 30, 2005 and December 31, 2004 the Company had unamortizednet premiums on its loan and lease receivables of $35,958 and $33,765,respectively.

 

The following is a summary of the Company’s loan and lease receivablesportfolio:

 
| ** **                        | ** ** | **As of**         | ** ** | **As of**             | ** ** |
|-----------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
| ** **                        | ** ** | **Amount**        | ** ** | **%**                 | ** ** | **Amount** | ** ** | **%** | ** ** |
| First  mortgages                  |       | $                 | 956,329    |                  | 43.3       | % | $ | 1,081,676 |   | 51.0 | % |
| Second  mortgages                 |       | 143,200           |       | 6.5                   | %          | 170,993 |   | 8.1 | % |
| Leases                            |       | 377,621           |       | 17.1                  | %          | 356,016 |   | 16.8 | % |
| Auto                              |       | 529,455           |       | 24.0                  | %          | 391,934 |   | 18.5 | % |
| Home  equity lines                |       | 189,105           |       | 8.6                   | %          | 115,068 |   | 5.4 | % |
| Consumer                          |       | 11,171            |       | 0.5                   | %          | 4,607 |   | 0.2 | % |
| Total                             |       | 2,206,881         |       | 100.0                 | %          | 2,120,294 |   | 100.0 | % |
| Less  allowance for credit losses |       | (25,792           | )          |                  |       | (24,462 | ) |   |   |
| Total                             |       | $                 | 2,181,089  |                  |       |   | $ | 2,095,832 |   |   |   |

** **

**Our lease receivables consistprimarily of business equipment leases originated and serviced by the NetBankBusiness Finance division. In addition to originated lease receivables,NetBank, FSB owns a portfolio of purchased lease receivables originated byCommercial Money Center, Inc. (“CMC”). NetBank, FSB is involved inlitigation with three insurance companies who are sureties on the purchasedleases. Since the second quarter of 2002, the entire portfolio has been onnon-accrual status pending outcome of the litigation. During June 2005, thebankruptcy proceedings for CMC resulted in a release to NetBank, FSB of $3,995of its funds being held by the bankruptcy trustee. The entire amount wasapplied to principal. NetBank, FSB has filed a claim against CMC and theinsurance company sureties for all principal and interest payments that arecurrently past due, approximately $92,000. The remaining recorded balance of CMC leases receivable as of June 30,2005 was $26,960.**

** **

**5.             NON-PERFORMING ASSETS AND ALLOWANCEFOR CREDIT LOSSES**

 

The Company considers a loanor lease receivable to be impaired when it is probable that it will be unableto collect all amounts due according to the original terms of the loan or leaseagreement.  The Company measuresimpairment of a loan

 

9

----

 

or lease on a loan-by-loanor lease-by-lease basis.  Amounts ofimpaired loans or leases that are not probable of collection are charged offimmediately.

 

The following table details the Company’s non-accrual and troubled debtrestructurings:

 
| ** **                        | ** ** | **As of**         | ** ** | **As of**             | ** ** |
|-----------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **June 30, 2005** | ** ** | **December 31, 2004** | ** ** |
| Loan and lease receivables  (1)   |       | $                 | 32,016     |                  | $          | 37,045 |   |
| Loans held for sale (1)           |       | $                 | 23,248     |                  | $          | 36,633 |   |
| Troubled debt  restructurings (2) |       | $                 | 155        |                  | $          | 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 as of June 30, 2005 andDecember 31, 2004 included $26,960 and $31,527, respectively, of non-performinglease receivables related to the CMC lease portfolio.

 

On average, the Company held approximately $64,087 and $115,148 ofrestructured and non-accrual loans during the three months ended June 30, 2005and 2004, respectively. Foregone interest for the three months ended June 30,2005 and 2004 was approximately $3,467 and $5,873, respectively. Foregoneinterest for the six months ended June 30, 2005 and 2004 was approximately $7,395and $11,209, respectively.  The Companyhad $7,102 and $5,799 in repossessed assets consisting primarily of residentialmortgage loan foreclosures at June 30, 2005 and December 31, 2004,respectively.

 

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

 
| ** **                                                            | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                            | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Beginning balance**                                                 |       | $                               | 25,075     |                          | $          | 44,591 |   | $ | 24,462 |   | $ | 43,689 |   |
| Provision  for credit losses                                          |       | 2,330                           |       | 1,666                         |       | 4,681 |   | 3,513 |   |
| Charge-offs:                                                          |       |                            |       |                          |       |   |   |   |   |
| First mortgages                                                       |       | (8                              | )          | —                        |       | (8 | ) | (18 | ) |
| Second mortgages                                                      |       | (527                            | )          | (99                           | )          | (528 | ) | (234 | ) |
| Leases                                                                |       | (1,124                          | )          | (722                          | )          | (2,674 | ) | (1,695 | ) |
| Auto                                                                  |       | (791                            | )          | (419                          | )          | (1,692 | ) | (743 | ) |
| Home equity lines                                                     |       | (135                            | )          | (132                          | )          | (157 | ) | (319 | ) |
| Consumer                                                              |       | (49                             | )          | (25                           | )          | (76 | ) | (73 | ) |
| Total charge-offs                                                     |       | (2,634                          | )          | (1,397                        | )          | (5,135 | ) | (3,082 | ) |
| Recoveries:                                                           |       |                            |       |                          |       |   |   |   |   |
| First mortgages                                                       |       | —                          |       | —                        |       | 1 |   | — |   |
| Second mortgages                                                      |       | 45                              |       | 104                           |       | 87 |   | 115 |   |
| Leases                                                                |       | 425                             |       | 686                           |       | 873 |   | 1,253 |   |
| Auto                                                                  |       | 289                             |       | 267                           |       | 538 |   | 429 |   |
| Home equity lines                                                     |       | 262                             |       | 116                           |       | 285 |   | 116 |   |
| Consumer                                                              |       | —                          |       | —                        |       | — |   | — |   |
| Total recoveries                                                      |       | 1,021                           |       | 1,173                         |       | 1,784 |   | 1,913 |   |
| Total charge-offs, net                                                |       | (1,613                          | )          | (224                          | )          | (3,351 | ) | (1,169 | ) |
| **Ending balance**                                                    |       | $                               | 25,792     |                          | $          | 46,033 |   | $ | 25,792 |   | $ | 46,033 |   |
|                                                                  |       |                            |       |                          |       |   |   |   |   |
| Allowance  for credit losses as a percent of average loans and leases |       | 1.2                             | %          | 2.1                           | %          | 1.2 | % | 2.3 | % |

** **

**10**

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** **

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

 

The Company accounts for its entire mortgage servicing rights (“MSR”)portfolio at the aggregate of the lower of cost or market (“LOCOM”). Forpurposes of evaluating the MSR portfolio for impairment, the Companydisaggregates its MSR portfolio into two primary groupings: available for saleand held for sale.

 

The segment of the portfoliodesignated as available for sale is composed of MSRs that were retained out ofproduction pursuant to individual portfolio retention decisions or purchased inbulk transactions. The available for sale portfolio is disaggregated forpurposes of measuring potential impairments according to defined risk tranches.The Company has defined these risk tranches based upon interest rate band andproduct type.  With respect to each suchrisk tranche, the fair value thereof, which is based upon an internal analysisthat considers current market conditions, prevailing interest rates, prepaymentspeeds, default rates and other relevant factors, is compared to amortizedcarrying values of the MSRs for purposes of measuring potential impairment.

 

The segment of the portfolio designated as held for sale is composed ofrecently produced MSRs that are scheduled for sale and have been allocated to specificforward servicing sales contracts.  Theheld for sale portfolio is disaggregated for purposes of measuring possibleimpairments according to the specific forward sales contracts to which the MSRis allocated. For each such risk tranche, the fair value is based upon theallocated forward committed delivery price, which is compared to amortizedcarrying value for purposes of measuring potential impairment.

 

The following amounts relateto the Company’s MSR portfolio:

 
| ** **                                  | ** ** | **Available for sale** | ** ** | **Held for sale** | ** ** |
|---------------------------------------------|------------|------------------------|------------|-------------------|------------|
| ** **                                  | ** ** | **June 30,**           | ** ** | **December 31,**  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| ** **                                  | ** ** | **2005**               | ** ** | **2004**          | ** ** | **2005** | ** ** | **2004** | ** ** |
| Unpaid  Principal Balance (“UPB”) |       | $                      | 14,221,167 |              | $          | 12,699,935 |   | $ | 210,658 |   | $ | 193,877 |   |
| Carrying  value                             |       | $                      | 174,221    |              | $          | 170,651 |   | $ | 2,362 |   | $ | 2,168 |   |
| Carrying  value / UPB                       |       | 1.23                   | %          | 1.34              | %          | 1.12 | % | 1.12 | % |
| Fair  value                                 |       | $                      | 174,567    |              | $          | 171,075 |   | $ | 2,362 |   | $ | 2,168 |   |
| Fair  value / UPB                           |       | 1.23                   | %          | 1.35              | %          | 1.12 | % | 1.12 | % |
| Weighted  average note rate                 |       | 5.89                   | %          | 5.95              | %          | 6.51 | % | 6.32 | % |
| Weighted  average service fee               |       | 0.32                   | %          | 0.33              | %          | 0.36 | % | 0.33 | % |
| Net  basis as multiple                      |       | 3.83                   |       | 4.13              |       | 3.07 |   | 3.36 |   |

 

The following tablesummarizes changes in the impairment reserve for the Company’s MSRs for thethree and six months ended June 30, 2005 and 2004:

 
| ** **                                  | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                  | ** ** | **2005**                        | ** ** | **2004**                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| Beginning  balance                          |       | $                               | 64,877     |                          | $          | 59,423 |   | $ | 65,557 |   | $ | 58,253 |   |
| Servicing  valuation impairment (recapture) |       | 1,700                           |       | (5,813                        | )          | 1,020 |   | (4,643 | ) |
| Ending  balance                             |       | $                               | 66,577     |                          | $          | 53,610 |   | $ | 66,577 |   | $ | 53,610 |   |

** **

**11**

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** **

**7.             DEPOSITS**

 

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

 
| ** **                              | ** ** | **As of June 30, 2005** | ** ** | **As of December 31, 2004** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                              | ** ** | **Amount**              | ** ** | **Percentage**              | ** ** | **Weighted  average  interest rate** | ** ** | **Amount** | ** ** | **Percentage** | ** ** | **Weighted  average  interest  rate** | ** ** |
| Non-interest bearing  checking accounts |       | $                       | 323,101    |                        | 11.6       | % | — |   | $ | 285,218 |   | 10.8 | % | — |   |
| Interest  bearing:                      |       |                    |       |                        |       |   |   |   |   |   |   |   |   |
| Checking accounts                       |       | 226,473                 |       | 8.1                         | %          | 1.0 | % | 261,588 |   | 9.9 | % | 1.0 | % |
| Money market                            |       | 1,019,993               |       | 36.5                        | %          | 2.5 | % | 1,158,529 |   | 43.9 | % | 1.9 | % |
| Certificate of deposit  under $100      |       | 1,139,221               |       | 40.8                        | %          | 3.4 | % | 830,996 |   | 31.5 | % | 2.9 | % |
| Certificate of deposit  over $100       |       | 83,312                  |       | 3.0                         | %          | 3.6 | % | 103,110 |   | 3.9 | % | 3.3 | % |
| Total  deposits                         |       | $                       | 2,792,100  |                        | 100.0      | % |   |   | $ | 2,639,441 |   | 100.0 | % |   |   |

 

Accrued interest as of June 30, 2005 related to checking, money marketand certificates of deposit accounts was $75, $827 and $6,957,respectively.  Accrued interest as ofDecember 31, 2004 related to checking, money market, and certificates ofdeposit accounts was $66, $607 and $5,426, respectively.  At June 30, 2005 and December 31, 2004, $696and $764 of overdrawn deposits were classified as loans, respectively.

** **

** **

**8.             BORROWINGS**

 

A summary of borrowings andavailable borrowings, grouped by year of maturity, as of June 30, 2005 follows:

 

12

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| **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                                      | %*         | 146,956                                |       |
| FHLB warehouse line of credit          |       | 2005                             |       | DRC  + 0.50                                        | %*         | 135,000                                |       |
| FHLB  overnight advances               |       | 2005                             |       | DRC                                                | *          | 151,000                                |       |
| FHLB  advances                         |       | 2005                             |       | 1.77 to 6.25                                       | %          | 130,000                                |       |
| FHLB  advances                         |       | 2006                             |       | 2.04 to 5.63                                       | %          | 260,000                                |       |
| FHLB  advances                         |       | 2007                             |       | 2.57                                               | %          | 40,000                                 |       |
| FHLB  advances                         |       | 2008                             |       | 1.90                                               | %          | 50,000                                 |       |
| FHLB  advances                         |       | 2009                             |       | 1.80 to 4.64                                       | %          | 215,000                                |       |
| FHLB  advances                         |       | 2010                             |       | 3.63 to 3.73                                       | %          | 100,000                                |       |
| 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                             |       | 3.15                                               | %          | 57,819                                 |       |
| Total  debt                            |       |                             |       |                                               |       | $                                      | 1,503,252  |   |

----

*              Indicates a variable rate.

 

The total borrowingsavailable through the Federal Home Loan Bank (“FHLB”) are determined eachquarter as 50% of total assets of NetBank, FSB subject to limitations ofavailable collateral. The Company utilizes this line through fixed andconvertible term advances, as well as short-term advances, including thirty dayand overnight borrowings. Five of the FHLB advances totaling $170,000 are fixedrate. The remaining advances totaling $810,000 are also fixed rate; however,they may be converted at the FHLB’s option to adjustable rate based on thethree month floating LIBOR. The FHLB warehouse line is an adjustable line ofcredit with a floating rate based on the daily rate credit (“DRC”) plus 50basis points. This warehouse line can be used to fund mortgages originated bythe Company. All of the FHLB advances and the FHLB warehouse line are securedby investment securities or mortgage loans. At June 30, 2005, we had pledged$550,860 of investment securities and $1.25 billion of mortgage loans to theFHLB as collateral for the various FHLB advances.

 

The $57,819 repurchaseagreement was collateralized by $62,320 of investment securities. Thisagreement matured in July 2005.

 

The Company’s subordinateddebt is supported by trust preferred securities, which were issued in 2002,2003 and 2005 in private pooled transactions through off-balance sheet trusts:NBI Trust I, II, III and IV. The subordinated debt and the associatedtrust preferred securities carry variable rates and were initially priced atLIBOR plus a spread ranging from 2.85% to 3.35% with a cap of 12.5% for fivesyears after their respective date of issuances. Interest payments and theresetting of the rates both occur on a quarterly basis. The debt is scheduledto mature from December 2032 through December 2034 and cannot beredeemed by the trust for a minimum of five years after issuance.

 

Most of the revolving linesof credit, warehouse lines of credit (other than the FHLB warehouse line) andthe master repurchase facilities are secured by mortgage loans and are subjectto restrictive covenants. The covenants include certain

 

13

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minimum net worthrequirements, minimum tangible net worth requirements, minimum financialratios, capital requirements, maintenance of servicer eligibility for variousgovernment agencies and certain minimum liquidity requirements, which are alldefined in the terms of the related debt agreements. In addition, the covenantsrestrict the types of business activities in which the Company may engage. TheCompany was in compliance with or had obtained a waiver for all debt covenantsin place as of June 30, 2005. Although management anticipates complying withall current debt covenants, there can be no assurance that the Company or itsindividual subsidiaries will be able to comply with all debt covenants in thefuture. Failure to comply could result in the acceleration of the repayment ofthe related financing.

 

Short-term debt outstanding reached the highest month-end level duringthe current quarter on May 31, 2005 with a short-term balance of $853,413. Short-termdebt outstanding during the six months ended June 30, 2005 reached the highestmonth-end level on January 31, 2005 with a short-term balance of $904,254.

 

** **

**9.             NET INCOME PER COMMON AND COMMONEQUIVALENT SHARE**

 

Basic and diluted net incomeper common and potential common share has been calculated based on the weightedaverage number of shares outstanding. The following table reconciles the numerator and denominator of thebasic and diluted net income per common and potential common share for the threeand six months ended June 30, 2005 and 2004. 

 
| ** **                                                        | ** ** | **Net Income (Numerator)** | ** ** | **Shares (Denominator)** | ** ** | **Per Share  Amount** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------|------------|--------------------------|------------|-----------------------|------------|
| Six months ended June 30,  2005                                   |       |                       |       |                     |       |                  |       |
| Basic EPS                                                         |       | $                          | 296        |                     | 46,241     |                  | $          | 0.01 |   |
| Effect of dilutive  securities - option to purchase common shares |       | —                     |       | 297                      |       | —                |       |
| Diluted EPS                                                       |       | $                          | 296        |                     | 46,538     |                  | $          | 0.01 |   |
|                                                              |       |                       |       |                     |       |                  |       |
| Six months ended June 30,  2004                                   |       |                       |       |                     |       |                  |       |
| Basic EPS                                                         |       | $                          | 17,861     |                     | 47,020     |                  | $          | 0.38 |   |
| Effect of dilutive  securities - option to purchase common shares |       | —                     |       | 548                      |       | —                |       |
| Diluted EPS                                                       |       | $                          | 17,861     |                     | 47,568     |                  | $          | 0.38 |   |

 
|                                                              | ** ** | **Net Income (Numerator)** | ** ** | **Shares  (Denominator)** | ** ** | **Per  Share  Amount** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|------------------------|------------|
| Three months ended June  30, 2005                                 |       |                       |       |                      |       |                   |       |
| Basic EPS                                                         |       | $                          | 2,325      |                      | 46,116     |                   | $          | 0.05 |   |
| Effect of dilutive  securities - option to purchase common shares |       | —                     |       | 376                       |       | —                 |       |
| Diluted EPS                                                       |       | $                          | 2,325      |                      | 46,492     |                   | $          | 0.05 |   |
|                                                              |       |                       |       |                      |       |                   |       |
| Three months ended June  30, 2004                                 |       |                       |       |                      |       |                   |       |
| Basic EPS                                                         |       | $                          | 8,467      |                      | 46,790     |                   | $          | 0.18 |   |
| Effect of dilutive  securities - option to purchase common shares |       | —                     |       | 379                       |       | —                 |       |
| Diluted EPS                                                       |       | $                          | 8,467      |                      | 47,169     |                   | $          | 0.18 |   |

 

14

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**10.          BUSINESS SEGMENTS**

 

The Company’s principal activities include retail banking, financialintermediary and transaction processing.  The retail banking segmentprimarily consists of offering consumer banking products such as checking,money market, and certificates of deposit. The retail banking segment’s investments primarily consist of 1-4 familymortgage loans originated by the financial intermediary segment, small businessfinancing loans and leases originated by the NetBank Business Financingdivision, auto loans originated by the dealer financial services division,purchased securities for investment, mortgage servicing assets and variousother purchased or retained loan products.  The financial intermediarysegment originates mortgage loans directly with borrowers and purchasesmortgage 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 transaction processing segment subservicesloans for the retail bank segment, financial intermediary segment and forthird-party customers; provides ATM and merchant processing services; and sellsvarious insurance products using an Internet-based platform.

 

The financial informationfor each business segment reflects specific identifiable transactions orallocated transactions based on an internal allocation method.  The measurement of the performance of thebusiness segments is based on our management structure and is not necessarilycomparable with similar information from any other financial institution. Theinformation presented is also not necessarily indicative of the segment’soperations if they were independent entities.

 
| ** **                                       | ** ** | **For the three months ended June 30, 2005** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                       | ** ** | **Retail  banking**                          | ** ** | **Financial  intermediary** | ** ** | **Transaction  processing** | ** ** | **Other &  Eliminations** | ** ** | **Consolidated** | ** ** |
| Interest income                                  |       | $                                            | 36,843     |   | $ | 25,325 |   | $ | 9 |   | $ | 324 |   | $ | 62,501 |   |
| Intersegment interest  income                    |       | 16,934                                       |       | 150 |   | (1 | ) | (17,083 | ) | — |   |
| Total interest income                            |       | 53,777                                       |       | 25,475 |   | 8 |   | (16,759 | ) | 62,501 |   |
| Interest expense                                 |       | 28,777                                       |       | 2,267 |   | 11 |   | 504 |   | 31,559 |   |
| Intersegment interest  expense                   |       | 2,245                                        |       | 15,153 |   | 6 |   | (17,404 | ) | — |   |
| Total interest expense                           |       | 31,022                                       |       | 17,420 |   | 17 |   | (16,900 | ) | 31,559 |   |
| Net interest income                              |       | 22,755                                       |       | 8,055 |   | (9 | ) | 141 |   | 30,942 |   |
| Provision for credit  losses                     |       | 2,316                                        |       | 14 |   | — |   | — |   | 2,330 |   |
| Intersegment- servicing  and processing fees     |       | —                                       |       | — |   | 3,435 |   | (3,435 | ) | — |   |
| Non-interest income                              |       | 4,843                                        |       | 31,652 |   | 4,733 |   | 13 |   | 41,241 |   |
| Non-interest expense                             |       | 19,375                                       |       | 37,128 |   | 7,260 |   | 2,216 |   | 65,979 |   |
| Intersegment- servicing  and processing expenses |       | 2,480                                        |       | 954 |   | — |   | (3,434 | ) | — |   |
| Pre-tax income (loss)                            |       | $                                            | 3,427      |   | $ | 1,611 |   | $ | 899 |   | $ | (2,063 | ) | $ | 3,874 |   |
| Total assets                                     |       | $                                            | 4,479,379  |   | $ | 1,568,215 |   | $ | 39,331 |   | $ | (1,132,158 | ) | $ | 4,954,767 |   |

** **

**15**

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** **
| ** **                                       | ** ** | **For the three months ended June 30, 2004** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                       | ** ** | **Retail  banking**                          | ** ** | **Financial  intermediary** | ** ** | **Transaction  processing** | ** ** | **Other &  Eliminations** | ** ** | **Consolidated** | ** ** |
| Interest income                                  |       | $                                            | 29,231     |   | $ | 28,781 |   | $ | 10 |   | $ | 655 |   | $ | 58,677 |   |
| Intersegment interest  income                    |       | 9,941                                        |       | 55 |   | — |   | (9,996 | ) | — |   |
| Total interest income                            |       | 39,172                                       |       | 28,836 |   | 10 |   | (9,341 | ) | 58,677 |   |
| Interest expense                                 |       | 19,411                                       |       | 2,601 |   | 21 |   | 145 |   | 22,178 |   |
| Intersegment interest  expense                   |       | 90                                           |       | 9,814 |   | — |   | (9,904 | ) | — |   |
| Total interest expense                           |       | 19,501                                       |       | 12,415 |   | 21 |   | (9,759 | ) | 22,178 |   |
| Net interest income                              |       | 19,671                                       |       | 16,421 |   | (11 | ) | 418 |   | 36,499 |   |
| Provision for credit  losses                     |       | 1,643                                        |       | 23 |   | — |   | — |   | 1,666 |   |
| Intersegment- servicing  and processing fees     |       | —                                       |       | — |   | 3,527 |   | (3,527 | ) | — |   |
| Non-interest income                              |       | 12,041                                       |       | 35,715 |   | 4,405 |   | (1,541 | ) | 50,620 |   |
| Non-interest expense                             |       | 22,790                                       |       | 38,918 |   | 8,690 |   | 1,612 |   | 72,010 |   |
| Intersegment- servicing  and processing expenses |       | 2,495                                        |       | 1,032 |   | — |   | (3,527 | ) | — |   |
| Pre-tax income (loss)                            |       | $                                            | 4,784      |   | $ | 12,163 |   | $ | (769 | ) | $ | (2,735 | ) | $ | 13,443 |   |
| Total assets                                     |       | $                                            | 5,261,513  |   | $ | 1,627,285 |   | $ | 34,352 |   | $ | (1,747,386 | ) | $ | 5,175,764 |   |

** **
| ** **                                       | ** ** | **For the six months ended June 30, 2005** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                       | ** ** | **Retail  banking**                        | ** ** | **Financial  intermediary** | ** ** | **Transaction  processing** | ** ** | **Other &  Eliminations** | ** ** | **Consolidated** | ** ** |
| Interest income                                  |       | $                                          | 72,666     |   | $ | 46,397 |   | $ | 19 |   | $ | 439 |   | $ | 119,521 |   |
| Intersegment interest  income                    |       | 30,000                                     |       | 2,428 |   | 6 |   | (32,434 | ) | — |   |
| Total interest income                            |       | 102,666                                    |       | 48,825 |   | 25 |   | (31,995 | ) | 119,521 |   |
| Interest expense                                 |       | 53,217                                     |       | 3,747 |   | 31 |   | 807 |   | 57,802 |   |
| Intersegment interest  expense                   |       | 4,219                                      |       | 28,773 |   | 6 |   | (32,998 | ) | — |   |
| Total interest expense                           |       | 57,436                                     |       | 32,520 |   | 37 |   | (32,191 | ) | 57,802 |   |
| Net interest income                              |       | 45,230                                     |       | 16,305 |   | (12 | ) | 196 |   | 61,719 |   |
| Provision for credit  losses                     |       | 4,652                                      |       | 29 |   | — |   | — |   | 4,681 |   |
| Intersegment- servicing  and processing fees     |       | —                                     |       | — |   | 6,891 |   | (6,891 | ) | — |   |
| Non-interest income                              |       | 8,685                                      |       | 57,354 |   | 9,553 |   | 110 |   | 75,702 |   |
| Non-interest expense                             |       | 38,173                                     |       | 75,528 |   | 14,519 |   | 3,773 |   | 131,993 |   |
| Intersegment- servicing  and processing expenses |       | 5,046                                      |       | 1,844 |   | — |   | (6,890 | ) | — |   |
| Pre-tax income (loss)                            |       | $                                          | 6,044      |   | $ | (3,742 | ) | $ | 1,913 |   | $ | (3,468 | ) | $ | 747 |   |
| Total assets                                     |       | $                                          | 4,479,379  |   | $ | 1,568,215 |   | $ | 39,331 |   | $ | (1,132,158 | ) | $ | 4,954,767 |   |

** **

**16**

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** **
| ** **                                       | ** ** | **For the six months ended June 30, 2004** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                       | ** ** | **Retail  banking**                        | ** ** | **Financial  intermediary** | ** ** | **Transaction  processing** | ** ** | **Other &  Eliminations** | ** ** | **Consolidated** | ** ** |
| Interest income                                  |       | $                                          | 54,641     |   | $ | 54,583 |   | $ | 18 |   | $ | 1,620 |   | $ | 110,862 |   |
| Intersegment interest  income                    |       | 20,317                                     |       | 113 |   | — |   | (20,430 | ) | — |   |
| Total interest income                            |       | 74,958                                     |       | 54,696 |   | 18 |   | (18,810 | ) | 110,862 |   |
| Interest expense                                 |       | 38,137                                     |       | 4,146 |   | 45 |   | 286 |   | 42,614 |   |
| Intersegment interest  expense                   |       | 243                                        |       | 20,008 |   | — |   | (20,251 | ) | — |   |
| Total interest expense                           |       | 38,380                                     |       | 24,154 |   | 45 |   | (19,965 | ) | 42,614 |   |
| Net interest income                              |       | 36,578                                     |       | 30,542 |   | (27 | ) | 1,155 |   | 68,248 |   |
| Provision for credit  losses                     |       | 3,472                                      |       | 41 |   | — |   | — |   | 3,513 |   |
| Intersegment- servicing  and processing fees     |       | —                                     |       | — |   | 7,054 |   | (7,054 | ) | — |   |
| Non-interest income                              |       | 31,236                                     |       | 70,288 |   | 8,376 |   | (2,589 | ) | 107,311 |   |
| Non-interest expense                             |       | 50,131                                     |       | 74,896 |   | 15,668 |   | 2,876 |   | 143,571 |   |
| Intersegment- servicing  and processing expenses |       | 4,875                                      |       | 2,179 |   | — |   | (7,054 | ) | — |   |
| Pre-tax income (loss)                            |       | $                                          | 9,336      |   | $ | 23,714 |   | $ | (265 | ) | $ | (4,310 | ) | $ | 28,475 |   |
| Total assets                                     |       | $                                          | 5,261,513  |   | $ | 1,627,285 |   | $ | 34,352 |   | $ | (1,747,386 | ) | $ | 5,175,764 |   |
|                                                  |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

# ** **

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

 

The Company was servicing or subservicing for the benefit of others116,320 and 106,781 residential loans with unpaid principal balancesaggregating approximately $15.4 billion and $14.0 billion at June 30, 2005and December 31, 2004, respectively. Mortgagors’ taxes and insuranceescrow funds and investors’ principal and interest escrow funds totaledapproximately $312,821 and $288,347 as of June 30, 2005 and December 31,2004, respectively. Loans serviced for others and the related escrow funds arenot owned by the Company; however, the majority of the escrow funds aredeposited in NetBank, FSB.

 

The Company has issued mortgage-backed securities under programssponsored by Ginnie Mae, Freddie Mac and Fannie Mae. In connection withservicing mortgage-backed securities guaranteed by Ginnie Mae, Freddie Mac orFannie Mae, the Company advances certain principal and interest payments tosecurity holders prior to their collection from specific mortgagors.Additionally, the Company must remit certain payments of property taxes andinsurance premiums in advance of collecting them from specific mortgagors andmake certain payments of attorney’s fees and other costs related to loans inforeclosure. These amounts are included in servicing advances under the caption“due from servicers and investors” in the accompanying consolidated balancesheets. Likewise, during the month that a mortgagor pays off his/her mortgage,the Company must accept an interest payment from the borrower that is pro-ratedto the date of payoff and pass through a full month’s interest to the securityholder. The Company includes its projection of the cost of such advances andlost interest on mortgages that prepay, and the expense of unreimbursedattorney and other costs associated with foreclosure in its valuation of itsMSRs.

 

In the ordinary course of business, the Company is exposed to liabilityunder representations and warranties made to purchasers and insurers ofmortgage loans and the purchasers of MSRs. Under certain circumstances, theCompany may be required to repurchase mortgage loans or indemnify thepurchasers of loans or MSRs for losses if there has been a breach ofrepresentations or warranties. Repurchased loans are carried at the lower of cost or net realizablevalue.  As of June 30, 2005 and December31, 2004, loans held for sale included repurchased loans with a net carryingvalue of $29,054 and $39,240, respectively.

 

We are required under GAAP to disclose our maximum exposure under ourrepresentations and warranties.  Themaximum exposure would be the current unpaid principal balance of any loan wehave ever sold, excluding loans sold which specifically excluded ourrepresentations and warranties, plus any fee or premium we received for thesale.  Additionally, we potentially couldhave to refund any fees or premiums we received for the sale of MSRs that arestill on the purchasers’ books.  However,since we are not the current servicer for the majority of the loans and MSRs asdescribed above, we cannot determine our maximum exposure.

 

The Company repurchased approximately $55,388 and $27,026 of unpaidprincipal balances during the six months ended June 30, 2005 and 2004,respectively. The Company had $19,037 and $22,676 of reserves for estimatedlosses on future repurchases as of June 30, 2005 and December 31, 2004,respectively.

 

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As of June 30, 2005, the Company had commitments to fund mortgage loansof $1.3 billion, open-end consumer lines of credit of $83,699, undisbursedmortgage construction loans of $72,872, undisbursed leasing commitments of $2,774and commercial financing commitments of $2,860.

 

**The Company is involved incertain legal proceedings, excluding the CMC litigation, incidental to itsbusiness.  The Company does not believethat the outcome of these proceedings will have a material adverse effect uponits financial condition, results of operations or cash flows.**

** **

**Item2:                   Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

* *

*The following discussion may include forward-looking statements.Forward-looking statements regarding the intent, belief or current expectationsof NetBank, Inc. or its officers and directors can be identified by the use offorward-looking terms such as “believe”, “anticipate”, “estimate”, “expect”, “may”,“will”, “should”, “plan”, “intend”, “project”, or other comparable terminology.Various internal and external factors could cause the Company’s actual resultsto differ materially from those anticipated by the forward-looking statements.These factors include, but are in no way limited to, 1) the evolving nature ofthe market for Internet banking and financial services generally; 2) the public’sperception of the Internet as a secure, reliable channel for transactions; 3)the success of new products and lines of business considered critical to theCompany’s long-term strategy, such as small business banking and transactionprocessing services; 4) potential difficulties in integrating the Company’soperations across its multiple lines of business; 5) the cyclical nature of themortgage banking industry generally; 6) a possible decline in asset quality; 7)changes in general economic or operating conditions which could adverselyaffect mortgage loan production and sales, mortgage servicing rights, loandelinquency rates and/or loan defaults; 8) the possible adverse effects of unexpected changes in the interestrate environment; 9) adverse legal rulings, particularly in the Company’slitigation over leases originated by Commercial Money Center, Inc.; and/or 10)increased competition and regulatory changes. The Company’s 2004 Form 10-K, contains additional details on these andother risks that are material to operations. All forward-looking statements inthis report are based on information available at the time of filing. Except asrequired by the federal securities laws, the Company has no obligation toupdate any forward-looking statement included herein.  Forward-looking statements are made inreliance on the safe harbor provisions of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934, asamended.*

 

**General**

 

NetBank, Inc. is a financial holding company engaged primarily inretail banking, mortgage banking, business finance and providing ATM andmerchant processing services. NetBank, Inc. wholly owns the outstandingstock of NetBank (“NetBank, FSB” or “the Bank”), a federal savings bank; MGReinsurance Company (“MG Reinsurance”), a captive reinsurance company;NetInsurance, Inc. (“NetInsurance”), a licensed insurance agency; and NBPartners, 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 unaudited consolidated financialstatements included herein reflect all adjustments, consisting only of normalrecurring accruals, which are necessary for the fair presentation of thefinancial condition and results of operations for the interim periodspresented. Certain information and footnote disclosures normally included infinancial statements have been condensed or omitted pursuant to applicablerules and regulations of the Securities and Exchange Commission (“SEC”). Thefinancial statements included herein should be read in conjunction with thefinancial statements and notes thereto included in our 2004 Form 10-K. Theresults of operations for the interim periods reported herein are notnecessarily indicative of results to be expected for the full year. Certain2004 amounts have been reclassified for comparability with 2005 amounts.

 

18

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All figures are presented in thousands (000s), except share and pershare data, unless otherwise noted. All of our operations and assets arelocated within the United States.

 

**Executive Summary and Future Outlook**

 

For the three months ended June 30, 2005 we recorded net income of$2,325 or $0.05 per share compared to net income of $8,467 or $0.18 per sharefor the three months ended June 30, 2004, a $6,142 decline.  However, net income of $2,325 for the quarterended June 30, 2005 is a $4,354 improvement over the quarter ended March 31,2005, as most of our segments reported stable or improving conditions. Thisincludes consistent net interest income after provision at the retail bankingsegment, continued strength in the business financing operation within theretail banking segment, better mortgage production and sales volume in thefinancial intermediary segment and improved revenue margins at the non-conformingmortgage operation within the financial intermediary segment.  Based on current market conditions, we expectthe third and fourth quarters of 2005 to more closely resemble the currentquarter as opposed to the first quarter of 2005.

 

*Retail Banking.* The retail banking segment recorded pre-taxincome of $3,427 for the second quarter of 2005 compared to $4,784 in the 2004period.  The Internet-only banking,leasing and auto operations within the retail banking segment collectivelyincreased their period over period pre-tax income by $1,696 to $5,721. Thisincrease was primarily driven by the $207,356 increase in the average balanceof interest earning assets, slightly offset by a 13-basis point decline in netinterest income after provision.  However,the improvement in these operations was more than offset by the $3,053 declinein the period over period performance of the retail banking segment’s investmentin mortgage servicing rights (“MSRs”).

 

*Financial Intermediary*. The financial intermediarysegment recorded pre-tax income of $1,611 for the second quarter of 2005, a $10,552pre-tax decline period over period.  Thisdecline was primarily driven by a $295,045 decline in mortgage sales coupledwith severely compressed margins, especially in its non-conforming mortgageoperation.

 

The non-conforming operation within the financial intermediary segment recordeda pre-tax loss of $925 during the current quarter compared to pre-tax income of$4,055 during the same quarter in 2004, a $4,980 decline.  While the non-conforming operation’s pre-tax resultsperiod over period declined $4,980, its pre-tax results improved $3,888 fromits low point in the first quarter of 2005. The improvement over the first quarterwas primarily the result of a 33-basis point increase in the revenue margincoupled with a $98,244 increase in sales of mortgage loans.

 

The conforming mortgage operation within the financial intermediarysegment recorded pre-tax income of $1,817 for the current quarter compared topre-tax income of $7,573 during the same quarter in 2004.  This decline was primarily the result of a 14%or $384,374 decline in sales of mortgage loans, coupled with a 21-basis point declinein the revenue margin. The decline in margin was centered in our wholesale andcorrespondent channels as a result of increased industry competition and higherrepurchase provision expense.  The lockedconforming mortgage pipeline increased to $1.2 billion at June 30, 2005compared to $1.1 billion at June 30, 2004 and only $755 million at December 31,2004. The Mortgage Bankers Association of America’s July 2005 forecast formortgage originations has been revised upward to $2.738 trillion compared to$2.542 trillion at December 31, 2004. While management views this as a positiveindication that current competitive pressures could return to historicallevels, we caution that there remains a heightened risk that the current increasedcompetitive pressures could persist resulting in lower than expected returns withinthe mortgage banking operations. Additionally, during recent quarters, we haveseen an increase in the frequency and severity of mortgage loan repurchases. Accordingly,we have increased our provisioning to better reflect this higher frequency andseverity trend.  It is still uncertainwhether this trend will continue or abate. If this trend continues in futureperiods, it would require us to continue to increase our reserves to coverfuture losses on the disposition of repurchased loans.

 

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*Transaction Processing.* The transaction processingsegment recorded pre-tax income of $899 compared to a pre-tax loss of $769 inthe 2004 period. The increase was primarily driven by strict cost controls atthe servicing factory, NetInsurance and expansion of the ATM and merchantprocessing operation. The servicing factory, which services loans on behalf ofthe retail banking and financial intermediary segments, should see continuedimprovement as the number of loans serviced increases, positively impacting itsrevenues and providing additional leveraging of its fixed cost base, thereby drivingdown its cost of servicing per loan.

 

*Other/Eliminations.* The other/eliminationssegment recorded a pre-tax loss of $2,063, which is a $672 improvement over the2004 period.  The improvement isprimarily due to overhead cost controls at the corporate level and a reductionof inter-segment revenue eliminations related to the $296,462 decline in loanssold to the retail banking segment from the financial intermediary segment.

 

*Risk and Contingencies*. Reference is made to thediscussion under the heading “Risks Relating to NetBank’s Business” in Item 1.Business and to the heading “Future Outlook” in Item 7. Management’s Discussionand Analysis of Financial Condition and Results of operations in the 2004 Form10-K for further information regarding the risks and challenges of ourbusiness. Reference is made to note 11 of the notes to consolidated financialstatements included in this report and to Item 1. “Legal Proceedings” in PartII of this report for additional discussion of certain risk and contingenciesthat may affect us.

 

# **Financial Condition**

* *

*General. *Our assets totaled $4.95 billion at June 30, 2005, an increase of $332,586or 7% from December 31, 2004.  This isprimarily the result of increases of $214,716 in loans held for sale and$85,257 in loan and lease receivables. These increases were partially offset by decreases of $41,202 ininvestment securities and $25,928 in due from servicers and investors.  The increase in loans held for sale isprimarily the result of mortgage loan production of $6.2 billion outpacingsales of mortgage loans of $5.8 billion during the six months ended June 30,2005. The increase in loan and lease receivables was primarily due to the retentionof $91,874 of mortgage loans, primarily second mortgages, and home equity linesof credit (“HELOCs”), $219,216 of auto loans and $92,435 of business equipment financingleases.

 

*Investment Securities.*  For the six monthsended June 30, 2005, the investment security portfolio decreased by $41,202. Thisdecrease was substantially due to the sale or maturity of $380,858 ofsecurities, primarily Fannie Mae mortgage pool securities, and the receipt of $57,197of payments on mortgage pool securities. The decrease was offset, in part, bythe purchase of $391,472 of new investment securities, primarily Ginnie Maemortgage pool securities. During the six months ended June 30, 2005, we wereable to take advantage of market conditions and replace certain of our FannieMae securities with similar yielding Ginnie Mae securities. With only a slightreduction in yield, we also strengthened our risk-weighted capital ratios dueto Ginnie Mae securities being zero percent risk-weighted.

 

The following tables setforth certain information relating to our available for sale securities:

 
| **As of June 30, 2005**                                 | ** ** | **Amortized  cost** | ** **  | **Unrealized  gains** | ** ** | **Unrealized  losses** | ** ** | **Estimated  fair value** | ** ** |
|---------------------------------------------------------|------------|---------------------|-------------|-----------------------|------------|------------------------|------------|---------------------------|------------|
| U.S. government agency —  mortgage pool securities | ** ** | **$**               | **550,340** | ** **            | **$**      | **930**                | ** ** | **$**                     | **2,356**  | ** ** | **$** | **548,914** | ** ** |
| Collateralized mortgage  obligations                    | ** ** | **66,585**          | ** **  | **39**                | ** ** | **276**                | ** ** | **66,348**                | ** ** |
| Corporate bonds                                         | ** ** | **39,162**          | ** **  | **868**               | ** ** | **205**                | ** ** | **39,825**                | ** ** |
| Habitat bonds and other                                 | ** ** | **3,793**           | ** **  | **213**               | ** ** | **—**             | ** ** | **4,006**                 | ** ** |
| Total                                                   | ** ** | **$**               | **659,880** | ** **            | **$**      | **2,050**              | ** ** | **$**                     | **2,837**  | ** ** | **$** | **659,093** | ** ** |

 

20

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| **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 held for sale.* As more fully described in note 3 of the notes to the consolidatedfinancial statements included in our 2004 Form 10-K, loans held for sale are carried at theaggregate of the lower of cost or market until sold, typically 30 to 90 daysafter origination or purchase. The majority of the non-performing loans heldfor sale consist of loans which have been repurchased under representations andwarranties provided to purchasers. Once a loan has been repurchased, it isgenerally resold at a price less than the repurchase price. Upon repurchase,reserves are transferred from the reserve for representations and warranties toa valuation reserve for repurchased loans to record such loans at estimated netrealizable value. At June 30, 2005, the aggregate cost basis of loans held forsale, adjusted for unrealized losses on the hedges, exceeded the aggregatemarket value by $1,541.  This amount wasrecorded as a current period reduction of gain on sale of mortgage loans.  At December 31, 2004, the aggregate fairvalue of loans held for sale exceeded the aggregate cost.  The following tables set forthinformation regarding our portfolio of loans held for sale:

 
| **As of June 30, 2005**   | ** ** | **Gross UPB** | ** **    | **Non-  performing** | ** ** | **Reserve** | ** ** |
|---------------------------|------------|---------------|---------------|----------------------|------------|-------------|------------|
| Conforming mortgages      | ** ** | **$**         | **1,026,175** | ** **           | **$**      | **12,855**  | ** ** | **$** | **3,701** | ** ** |
| Non-conforming mortgages  | ** ** | **293,141**   | ** **    | **10,172**           | ** ** | **4,519**   | ** ** |
| Construction              | ** ** | **67,750**    | ** **    | **221**              | ** ** | **139**     | ** ** |
| Commercial / recreational | ** ** | **10,212**    | ** **    | **—**           | ** ** | **424**     | ** ** |
| Total loans held for sale | ** ** | **$**         | **1,397,278** | ** **           | **$**      | **23,248**  | ** ** | **$** | **8,783** | ** ** |

 
| **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 repurchase mortgage loans, bundles suchloans in pools and re-sells them, generally at a loss.  The $13,385 decline in non-performing loansheld for sale is primarily related to such re-sales of mortgage loans duringthe three months ended June 30, 2005. The size of the repurchase inventory, which is primarily comprised ofnon-performing loans, will vary depending on the timing of the repurchases andthe subsequent dispositions.

 

*Loan and Lease Receivables.*  For the six monthsended June 30, 2005, the loan and lease receivables portfolio increased $85,257or 4%.  The increase in loan and lease receivables was primarily due to theretention of $91,874 of mortgage loans, $219,216 of auto loans, and $92,435 of businessequipment finance leases, partially offset by principal reductions and prepaymentsof $307,136.  As of June 30, 2005, ourportfolio of loan and lease receivables, excluding the CMC lease receivables, consistedof 91% internally originated assets versus 9% of purchased assets. We intend tocontinue selectively retaining internally originated loans and leases tocapitalize on cross-selling opportunities, internally service the assets andmore effectively control our credit and interest rate risk.

 

*Asset Quality and Non-performing Assets.* We periodically review theperformance of our loan and lease receivables portfolio by reviewingcharge-offs, delinquency statistics, and various other industrystatistics.  Large non-homogeneouscredits are reviewed on a loan-by-loan or lease-by-lease basis, whereasrelatively small credits with similar risk

 

21

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characteristics are reviewed on a pool-by-pool basis.  If a decline in credit quality for a specificpool or individual loan or lease is noted, we record additional allowancethrough a charge to the provision for credit losses.  The allowance for credit losses is maintainedat a level estimated to be adequate to provide for probable losses in the loanand lease receivables portfolio. We determine the adequacy of the allowancebased upon reviews of individual loans and leases or pools as applicable,recent loss experience, current economic conditions, the risk characteristicsof the various categories of loans and leases and other pertinent factors. Ournon-performing assets as a percentage of gross UPB improved from 1.75% atDecember 31, 2004, to 1.45% at June 30, 2005, as the level of non-performingassets declined by $5,029 and gross UPB increased $86,587 or 4.08%.  During June 2005, the bankruptcy proceedingsfor CMC resulted in the payment to us of $3,995 of our funds being held by thebankruptcy trustee. The entire amount was applied to UPB. The remainingrecorded balance of the CMC lease receivable as of June 30, 2005 was $26,960.  Reference is made to Item 1. “LegalProceedings” in Part II of this report for additional information related tothe Company’s ongoing CMC litigation.

 

The following tables detail our held for investment loan and lease receivablesportfolio, the associated allowance for credit losses, and non-performingassets:

 
| **As of June 30, 2005**          | ** ** | **Gross UPB** | ** **    | **Allocated  Allowance** | ** ** | **(1) Non-  performing** | ** ** |
|----------------------------------|------------|---------------|---------------|--------------------------|------------|--------------------------|------------|
| First mortgages                  | ** ** | **$**         | **956,329**   | ** **               | **$**      | **3,612**                | ** ** | **$** | **2,704** | ** ** |
| Second mortgages                 | ** ** | **143,200**   | ** **    | **3,137**                | ** ** | **362**                  | ** ** |
| Leases                           | ** ** | **350,661**   | ** **    | **13,682**               | ** ** | **1,480**                | ** ** |
| Auto                             | ** ** | **529,455**   | ** **    | **2,335**                | ** ** | **297**                  | ** ** |
| Home equity lines                | ** ** | **189,105**   | ** **    | **2,913**                | ** ** | **213**                  | ** ** |
| Consumer                         | ** ** | **11,171**    | ** **    | **113**                  | ** ** | **—**               | ** ** |
| Loan and lease receivables       | ** ** | **2,179,921** | ** **    | **25,792**               | ** ** | **5,056**                | ** ** |
| CMC leases (2)                   | ** ** | **26,960**    | ** **    | **—**               | ** ** | **26,960**               | ** ** |
| Total loan and lease receivables | ** ** | **$**         | **2,206,881** | ** **               | **$**      | **25,792**               | ** ** | **$** | **32,016** | ** ** |

 
| **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 |   |

----

(1) Non-performing includes all loans that are 90 daysor more contractually past due including loans which have beenrestructured.  The Company also held $155and $210 of restructured loans which were performing in accordance with therestructured terms as of June 30, 2005 and December 31, 2004, respectively.

(2) Reference is made to note 4 of the notes to theconsolidated financial statements included in this report for additionaldetails regarding the CMC lease portfolio.

 

 

*Mortgage Servicing Rights.*  We intend to retain substantially all of ouroriginated conventional MSRs in order to achieve the necessary critical mass ourservicing division requires to become operationally profitable.  During 2005, however, based on marketconditions, we chose to sell approximately 70% of our conventional mortgageloan 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 sixmonths ended June 30, 2005, the value of our MSR portfolio increased $3,764 or 2%.  The increase in value was primarily driven bythe purchase of a bulk

 

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$2.5 billion portfolio, which had a capitalizedvalue of $36,395, and the capitalization of $9,900 from the retention ofMSRs.  These increases were partially offsetby $1,020 of valuation impairment, $22,144 of amortization, and a fair valuemark-to-market adjustment of $18,193.  Theimpairment and mark-to-market adjustments of the MSRs were offset by anincrease of $22,495 in the market value of the derivatives portfolio hedgingthe MSRs.  The change in fair value ofthe derivative portfolio hedging the MSRs is recorded in other assets.

 
| ** **                                  | ** ** | **As of  June 30, 2005** | ** **  | **As of  December 31, 2004** | ** ** |
|---------------------------------------------|------------|--------------------------|-------------|------------------------------|------------|
| Fair value                                  | ** ** | **$**                    | **174,567** |                         | $          | 171,075 |   |
| Weighted average life in  years             | ** ** | **4.1**                  |        | 4.7                          |       |
|                                        |       |                     |        |                         |       |
| Prepayment speed  assumption (annual rate)  | ** ** | **18.40**                | **%**       | 16.00                        | %          |
| Impact on fair value of  10% adverse change | ** ** | **$**                    | **(9,054**  | **)**                        | $          | (9,314 | ) |
| Impact on fair value of  20% adverse change | ** ** | **$**                    | **(17,040** | **)**                        | $          | (17,758 | ) |
|                                        |       |                     | ** **  |                         |       |
| Discount rate                               | ** ** | **10.22**                | **%**       | 10.52                        | %          |
| Impact on fair value of  10% adverse change | ** ** | **$**                    | **(9,262**  | **)**                        | $          | (4,276 | ) |
| Impact on fair value of  20% adverse change | ** ** | **$**                    | **(14,435** | **)**                        | $          | (8,186 | ) |

 

The sensitivities above are hypothetical andshould be used with caution.  As thefigures indicate, changes in fair value based on a 10% variation in assumptionsgenerally cannot be extrapolated because the relationship of the change inassumption to the change in fair value may not be linear.  Also, in the table above, the effect of avariation in a particular assumption on the fair value of the available forsale servicing rights is calculated without changing any other assumption; inreality, changes in one factor may result in changes in another, which mightmagnify or counteract the sensitivities. The analysis above excludes the impact of our hedging activities relatedto the available for sale servicing rights.

 

*Derivatives.*The value of derivativeshedging the MSR portfolio was $32,576 at June 30, 2005 compared to $10,081 atDecember 31, 2004, an increase of $22,495. The derivatives consist primarily ofcommitments to purchase mortgage pool securities, options, floors, swaps,swaptions, caps, and floors.  The valueof the derivatives hedging the pipeline of MSRs was a loss of $147 compared toa loss of $68 at December 31, 2004.  Thevalue of our loan commitments for which the interest rate is locked (“ratelocks”) increased in value to $2,357 compared to $1,687 at December 31, 2004,an increase of $670. Our portfolio of mandatory delivery commitments hedging ourrate locks was a loss of $629 compared to loss of $707 at December 31, 2004.Both of these amounts are marked-to-market and reflected in our consolidatedstatement of operations. The value of the mandatory delivery commitmentshedging our inventory of closed loans was a loss of $4,555 compared to a lossof $1,034 at December 31, 2004, a decline of $3,521. Since the mandatorydelivery commitments qualify for hedge accounting, this amount was recorded asa basis adjustment to our inventory of mortgage loans held for sale.

 

*Liabilities.* Totalliabilities increased $337,419 during the six months ended June 30, 2005.  The increase was primarily related to increasesof $152,659 in deposits, $159,284 in other borrowed funds, $20,620 insubordinated debt, $33,653 in loans in process and $22,245 in accounts payableand accrued liabilities.  These increaseswere used to support the higher levels of loans held for sale and loan andlease receivables.  The increases werepartially offset by a $50,543 decline in unsettled trades and a $3,639 declinein the reserve for representations and warranties.

 

*Deposits.*  Depositswere $2.79 billion at June 30, 2005, a 6% increase compared to $2.64 billion atDecember 31, 2004.  As of June 30, 2005,deposits represented 65% of total interest-bearing liabilities (includingdeposits, other borrowed funds, and subordinated debt) outstanding. FederalHome Loan Bank (“FHLB”) advances, warehouse lines of credit, and repurchaseagreements represented approximately 34% in the aggregate, and subordinateddebt was only 1%.  We will continueworking to deepen our relationships with new and existing customers to expandour deposit base. The following table summarizes our deposits:

 

23

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| ** **                              | ** ** | **As of June 30, 2005** | ** **    | **As of December 31, 2004** | ** ** |
|-----------------------------------------|------------|-------------------------|---------------|-----------------------------|------------|
| ** **                              | ** ** | **Amount**              | ** **    | **Percentage**              | ** ** | **Weighted  average  interest rate** | ** ** | **Amount** | ** ** | **Percentage** | ** ** | **Weighted  average  interest rate** | ** ** |
| Non-interest bearing  checking accounts | ** ** | **$**                   | **323,101**   | ** **                  | **11.6**   | **%** | **—** | ** ** | $ | 285,218 |   | 10.8 | % | — |   |
| Interest bearing:                       |       |                    |          |                        |       |   | ** ** |   |   |   |   |   |   |
| Checking accounts                       | ** ** | **226,473**             | ** **    | **8.1**                     | **%**      | **1.0** | **%** | 261,588 |   | 9.9 | % | 1.0 | % |
| Money market                            | ** ** | **1,019,993**           | ** **    | **36.5**                    | **%**      | **2.5** | **%** | 1,158,529 |   | 43.9 | % | 1.9 | % |
| Certificate of deposit under $100       | ** ** | **1,139,221**           | ** **    | **40.8**                    | **%**      | **3.4** | **%** | 830,996 |   | 31.5 | % | 2.9 | % |
| Certificate of deposit over $100        | ** ** | **83,312**              | ** **    | **3.0**                     | **%**      | **3.6** | **%** | 103,110 |   | 3.9 | % | 3.3 | % |
| Total deposits                          | ** ** | **$**                   | **2,792,100** | ** **                  | **100.0**  | **%** | ** ** | ** ** | $ | 2,639,441 |   | 100.0 | % |   |   |

* *

*Reserve for Representations and Warranties.*The reserve forrepresentations and warranties is maintained at a level estimated to beadequate to cover future losses on loans which we may be required to repurchaseunder representations and warranties provided to purchasers. We establish thereserve for future losses by reducing current period gain on sale of loans.  The reserve declined by $3,639 during the sixmonths ended June 30, 2005.  This declineis primarily attributable to the decline in the volume of loans sold during2005 and late 2004 compared to the first six months of 2004 and late 2003.  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 to providefor losses at higher levels to cover future losses on the disposition ofrepurchased loans.

 

*Shareholders’ Equity.*  Total shareholders’ equity decreased $4,938for the six months ended June 30, 2005. The decline is primarily due to a decline of $2,231 in retained earningscoupled with increases of $2,149 in treasury stock and $1,266 of unearnedcompensation.  The decline in retainedearnings is primarily the result of the $296 of net income for the first halfof 2005 being more than offset by $1,851 of dividends and $676 of losses on thereissuance of treasury stock.  Theincrease in treasury stock is the result of the repurchase of 571,391 shares ofcommon stock at a weighted average cost of $9.08 per share offset, in part, bythe reissuance of 141,103 shares under the employee stock purchase plan andexercise of employee stock options.  Additionally,we issued 174,910 shares of restricted stock to employees which primarily drovethe $1,266 increase in unearned compensation. We will continue to repurchaseshares periodically in the public market or through private transactions.  As of June 30, 2005, 1,092,573 sharesremained available for repurchase under current Board authorization.

 

**Results of Operations — Three months ended June 30, 2005 compared tothe three months ended June 30, 2004**

* *

*General.*  Net income for the three months ended June 30,2005 was $2,325 or $0.05 per share, compared to net income of $8,467 or $0.18per share for the same period in 2004.  Thecurrent quarter was negatively impacted by an increase in the cost ofshort-term borrowings, a decline in gains on sales of mortgage loans, and a declinein the change in value of the MSR portfolio net of hedge results. Thesenegative variances were partially offset by an increase in interest income of$3,824 and a decline in non-interest expenses of $1,997.

 

*Interest Income*.  Our interest income for the threemonths ended June 30, 2005 was $62,501 compared to $58,677 for the same periodin 2004.  This increase was the result ofthe average yield increasing by 33 basis points to 5.48% of interest-earningassets coupled with a $10,287 increase in the average balance ofinterest-earning assets.  Reference ismade to the following rate volume variance table for additional detailregarding the changes in interest income.

 

*Interest Expense*. Total interest expense for the three monthsended June 30, 2005 was $31,559 compared to $22,178 for the same period of 2004.  The $9,381 increase is due to an increase of$49,763 in the average balance of interest-bearing liabilities coupled with an88-basis point increase in the average cost of funds.  For the three months ended June 30, 2005compared to same period of 2004, interest expense on deposits increased $4,914as a result of a 78-basis point increase in

 

24

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the average interest rate paid coupled with a $78,976 increase in theaverage outstanding balance of deposits. For the three months ended June 30, 2005, interest expense on otherborrowed funds (including short-term debt, FHLB advances, and convertiblesubordinated debt) was $15,961 compared to $11,494 for the same period of 2004.  The $4,467 increase in interest expenserelated to other borrowed funds is primarily the result of a 101-basis point increasein the average cost of funds.  Thisincrease was slightly offset by a decline of $29,213 in the average outstandingbalance.

 

*Net Interest Income. *Net interestincome is determined by interest rate spread, which is the difference betweenthe yields earned on interest-earning assets and the rates paid oninterest-bearing liabilities, and the relative amounts of interest-earningassets and interest-bearing liabilities. Net interest income was $30,942 or 2.71% of average interest-earningassets for the three months ended June 30, 2005, compared to $36,499 or 3.20%of average interest-earning assets for the three months ended June 30, 2004.  The 49-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 detailsthe relative interest rates and average balances of our interest-earning assetsand interest-bearing liabilities for the three months ended June 30, 2005 and2004:

 
| **Average  Balance** | ** ** | **Average  Yield /  Rate** | ** ** | ** ** | ** ** | **Interest** | ** ** | ** **                         | ** ** | **Variance  attributable to**                  | ** ** |
|----------------------|------------|----------------------------|------------|------------|------------|--------------|------------|------------------------------------|------------|------------------------------------------------|------------|
| ** **           | ** ** | ** **                 | ** ** | ** ** | ** ** | ** **   | ** ** | ** **                         | ** ** | ** **                                     | ** ** |
| **2005**             | ** ** | **2004**                   | ** ** | **2005**   | ** ** | **2004**     | ** ** | ** **                         | ** ** | **2005**                                       | ** ** | **2004** | ** ** | **Variance** | ** ** | **Rate** | ** ** | **Volume  (3)** | ** ** |
| ** **           |       |                       |       |       |       |         |       | **Interest-earning assets:**       |       |                                           |       |   |   |   |   |   |   |   |   |
| $                    | 60,719     |                       | $          | 76,187     |       | 3.40         | %          | 1.00                               | %          | Short-term investments                         |       | $ | 516 |   | $ | 190 |   | $ | 326 |   | $ | 457 |   | $ | (131 | ) |
| 774,570              |       | 445,432                    |       | 4.59       | %          | 3.51         | %          | Investment securities (1)          |       | 8,879                                          |       | 3,905 |   | 4,974 |   | 1,201 |   | 3,773 |   |
| 1,587,778            |       | 1,869,731                  |       | 6.25       | %          | 6.00         | %          | Loans held for sale (2)            |       | 24,795                                         |       | 28,051 |   | (3,256 | ) | 1,147 |   | (4,403 | ) |
| 2,143,076            |       | 2,164,506                  |       | 5.28       | %          | 4.90         | %          | Loans and leases receivable (2)    |       | 28,311                                         |       | 26,531 |   | 1,780 |   | 2,063 |   | (283 | ) |
| 4,566,143            |       | 4,555,856                  |       | 5.48       | %          | 5.15         | %          | Total interest-earning assets      |       | 62,501                                         |       | 58,677 |   | 3,824 |   | 4,868 |   | (1,044 | ) |
|                 |       |                       |       |       |       |         |       |                               |       |                                           |       |   |   |   |   |   |   |   |   |
| ** **           |       |                       |       |       |       |         |       | **Interest-bearing liabilities:**  |       |                                           |       |   |   |   |   |   |   |   |   |
| 233,159              |       | 238,923                    |       | 1.34       | %          | 1.12         | %          | Checking accounts                  |       | 783                                            |       | 669 |   | 114 |   | 133 |   | (19 | ) |
| 1,067,740            |       | 1,315,623                  |       | 2.35       | %          | 1.65         | %          | Money market                       |       | 6,285                                          |       | 5,428 |   | 857 |   | 2,316 |   | (1,459 | ) |
| 1,007,674            |       | 675,051                    |       | 3.39       | %          | 2.72         | %          | Certificates of deposit            |       | 8,530                                          |       | 4,587 |   | 3,943 |   | 1,127 |   | 2,816 |   |
| 1,036,872            |       | 1,023,186                  |       | 3.48       | %          | 1.89         | %          | Short-term debt                    |       | 9,031                                          |       | 4,837 |   | 4,194 |   | 4,075 |   | 119 |   |
| 776,677              |       | 840,196                    |       | 3.32       | %          | 3.10         | %          | FHLB advances                      |       | 6,437                                          |       | 6,512 |   | (75 | ) | 451 |   | (526 | ) |
| 32,477               |       | 11,857                     |       | 6.07       | %          | 4.89         | %          | Subordinated debt                  |       | 493                                            |       | 145 |   | 348 |   | 35 |   | 313 |   |
| 4,154,599            |       | 4,104,836                  |       | 3.04       | %          | 2.16         | %          | Total interest-bearing liabilities |       | 31,559                                         |       | 22,178 |   | 9,381 |   | 8,137 |   | 1,244 |   |
|                 |       |                       |       |       |       |         |       |                               |       |                                           |       |   |   |   |   |   |   |   |   |
| —               |       | —                     |       | 2.44       | %          | 2.99         | %          | Net interest margin                |       | 30,942                                         |       | 36,499 |   | (5,557 | ) | (3,269 | ) | (2,288 | ) |
| 411,544              |       | 451,020                    |       | 0.27       | %          | 0.21         | %          | Interest free sources              |       | —                                         |       | — |   | — |   | — |   | — |   |
| $                    | 4,566,143  |                       | $          | 4,555,856  |       | 2.71         | %          | 3.20                               | %          | Net interest income to interest-earning assets |       | $ | 30,942 |   | $ | 36,499 |   | $ | (5,557 | ) | $ | (3,269 | ) | $ | (2,288 | ) |
|                      |            |                            |            |            |            |              |            |                                    |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(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.

 

*Provision for Credit Losses.*  The provision forcredit losses was $2,330 for the three months ended June 30, 2005 compared to $1,666for the same period of 2004.  Theincrease in provision relates primarily to the retention of more auto loans,HELOCs, and business financing leases compared to the 2004 period. Reference ismade to the heading Financial Condition - “Asset Quality and Non-performingAssets” above for additional detail concerning the determination of provisionexpense related to maintaining the proper level of allowance for credit losses.

 

*Non-interest Income.* Non-interest income declined$5,345 to $41,241 for the three months ended June 30, 2005 compared to the sameperiod of 2004.  This decline isprimarily related to the $3,967 decline in gain on sales of mortgage loans due

 

25

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to a decline in the margin on sales of mortgage loans which reflectsincreased competitive pressures, especially in the non-conforming, wholesaleand correspondent channels.  Currentperiod gain on sales of mortgage loans was also impacted by the need forincreased provision for reserves under representations and warranties inresponse to a recent increase in the frequency and severity of losses onrepurchased mortgage loans.  The currentperiod performance of our investment in MSRs resulted in income of $1,850compared to a gain of $3,070 for the same period of 2004, a $1,220 declineperiod over period.  The $1,850 of incomeconsists of a $1,700 current period impairment of MSRs offset by derivativegains of $1,845 and gains on the sales of investment securities of $1,705.  Non-interest income increased as the result ofan increase in mortgage servicing fees of $2,568 due to the $1.5 billion or 11%increase in the average principal balance underlying the MSR portfolio. Thisincrease was partially offset by a $1,669 increase in amortization of MSRs dueto the increase in underlying principal balance.

 

*Non-interest Expense.*  Non-interest expenseincludes all operating expenses such as salaries and benefits, marketing, andgeneral and administrative expenses. Non-interest expense decreased $1,997 or 3% for the three months endedJune 30, 2005 compared to the same period of 2004.  This decline was primarily driven by the $2,061decline in salaries and wages and a $1,106 decline in other expenses. Thedecline in salary and wages and other expenses was primarily the result of the$930,095 decline in mortgage loan production period over period. These declineswere partially offset by increases of $1,177 in depreciation and amortizationand $579 in occupancy.  These increaseswere primarily related to accelerating the amortization of leaseholdimprovements related to the planned relocation of our Alpharetta and LakeOswego offices to new facilities and to the general expansion of our operationsthrough the acquisition of GRL mortgage, Beacon Credit Services, and theexpansion of the ATM and merchant processing business.

 

# ***Retail Banking Segment***

 

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

 
| ** **                                    | ** ** | **For the three months ended June 30,** | ** **     |
|-----------------------------------------------|------------|-----------------------------------------|----------------|
| ** **                                    | ** ** | **2005**                                | ** **     | **2004** | ** ** | **change** | ** ** |
| Net interest income                           | ** ** | **$**                                   | **22,820**     | ** ** | $ | 19,750 |   | $ | 3,070 |   |
| Provision for credit  losses                  | ** ** | **2,316**                               | ** **     | 1,643 |   | 673 |   |
| Net interest income after provision           | ** ** | **20,504**                              | ** **     | 18,107 |   | 2,397 |   |
| Gains (losses) on sales of  loans             | ** ** | **—**                              | ** **     | (2 | ) | 2 |   |
| Fees, charges and other  income               | ** ** | **3,597**                               | ** **     | 3,264 |   | 333 |   |
| Total revenues                                | ** ** | **24,101**                              | ** **     | 21,369 |   | 2,732 |   |
| Total expenses                                | ** ** | **18,380**                              | ** **     | 17,344 |   | 1,036 |   |
| Pre-tax income before net servicing results   | ** ** | **5,721**                               | ** **     | 4,025 |   | 1,696 |   |
| Net servicing results                         | ** ** | **(2,294**                              | **)**          | 759 |   | (3,053 | ) |
| Pre-tax income                                | ** ** | **$**                                   | **3,427**      | ** ** | $ | 4,784 |   | $ | (1,357 | ) |
|                                          |       |                                    | ** **     |   |   |   |   |
| Average earning assets                        | ** ** | **$**                                   | **4,496,414**  | ** ** | $ | 4,289,058 |   | $ | 207,356 |   |
| UPB underlying MSRs                           | ** ** | **$**                                   | **14,593,781** | ** ** | $ | 12,889,546 |   | $ | 1,704,235 |   |
|                                          |       |                                    | ** **     |   |   |   |   |
| **Operations to earning assets**              |       |                                    | ** **     |   |   |   |   |
| Net interest income after  provision          | ** ** | **1.82**                                | **%**          | 1.69 | % | 0.13 | % |
| Gain on sale, fees,  charges and other income | ** ** | **0.32**                                | **%**          | 0.30 | % | 0.02 | % |
| Banking revenues                              | ** ** | **2.14**                                | **%**          | 1.99 | % | 0.15 | % |
| Total expenses                                | ** ** | **1.64**                                | **%**          | 1.62 | % | 0.02 | % |
| Pre-tax income before net servicing results   | ** ** | **0.50**                                | **%**          | 0.37 | % | 0.13 | % |
|                                          |       |                                    | ** **     |   |   |   |   |
| Net servicing results to  UPB underlying MSRs | ** ** | **(0.06**                               | **)%**         | 0.02 | % | (0.08 | )% |

 

26

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The retail banking segmentrecorded pre-tax income of $3,427 this period, a $1,357 decline over thecomparable period in 2004. Collectively, the Internet-only banking, leasing andauto operations within the retail banking segment increased their period overperiod pre-tax income by $1,696 to $5,721. This increase was primarily drivenby the $207,356 increase in the average balance of interest earning assetscoupled with a 13-basis point increase in net interest income after provision.  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.  Theimprovement in these operations was more than offset by the $3,053 decline inthe retail banking segment’s net servicing results.

 

*FinancialIntermediary Segment*

 

The following tablehighlights the financial intermediary segment’s pre-tax results:

 
| ** **                            | ** ** | **For the three months ended June 30,** | ** **    |
|---------------------------------------|------------|-----------------------------------------|---------------|
| ** **                            | ** ** | **2005**                                | ** **    | **2004** | ** ** | **change** | ** ** |
| Net interest income                   | ** ** | **$**                                   | **7,959**     | ** ** | $ | 16,403 |   | $ | (8,444 | ) |
| Gain on sales of loans                | ** ** | **28,810**                              | ** **    | 35,442 |   | (6,632 | ) |
| Other income                          | ** ** | **1,253**                               | ** **    | (590 | ) | 1,843 |   |
| Net Beacon Credit Services  results   | ** ** | **(122**                                | **)**         | — |   | (122 | ) |
| Net MG Reinsurance results            | ** ** | **841**                                 | ** **    | 535 |   | 306 |   |
| Total revenues                        | ** ** | **38,741**                              | ** **    | 51,790 |   | (13,049 | ) |
| Salary and employee  benefits         | ** ** | **20,883**                              | ** **    | 24,320 |   | (3,437 | ) |
| Occupancy &  Depreciation expense | ** ** | **7,494**                               | ** **    | 7,063 |   | 431 |   |
| Other expenses                        | ** ** | **8,753**                               | ** **    | 8,244 |   | 509 |   |
| Total expenses                        | ** ** | **37,130**                              | ** **    | 39,627 |   | (2,497 | ) |
| Pre-tax income                        | ** ** | **$**                                   | **1,611**     | ** ** | $ | 12,163 |   | $ | (10,552 | ) |
|                                  |       |                                    | ** **    |   |   |   |   |
| Production                            | ** ** | **$**                                   | **3,455,499** | ** ** | $ | 3,903,437 |   | $ | (447,938 | ) |
| Sales (includes  intersegment sales)  | ** ** | **$**                                   | **3,138,302** | ** ** | $ | 3,433,347 |   | $ | (295,045 | ) |
|                                  |       |                                    | ** **    |   |   |   |   |
| Total revenues to sales               | ** ** | **1.23**                                | **%**         | 1.51 | % | (0.28 | )% |
| Total expenses to  production         | ** ** | **1.07**                                | **%**         | 1.02 | % | 0.05 | % |
| Pre-tax margin                        | ** ** | **0.16**                                | **%**         | 0.49 | % | (0.33 | )% |

----

Note: The ratio of revenuesto sales is based on mortgage banking sales, which includes inter-segment salesto the retail bank segment.

 

Competitive pressures within the mortgage industry drove the totalrevenue to sales margin down 28 basis points period over period.  This pressure was most severe in thenon-conforming channel which saw its revenue to sales margins decline 50 basispoints period over period.  During thecurrent period, the non-conforming channel’s revenue to sales margin improved33 basis points from a first quarter low of 136 basis points.  Compounding the decline in sales margins,during recent quarters we have seen an increase in the frequency and severityof losses on mortgage loan repurchases in the wholesale and correspondentchannels. This trend resulted in increased provision expense during the currentquarter. It is still uncertain whether this trend will continue or abate. Ifthis trend continues in future periods, it would require us to continue toincrease our provision expense to cover future losses on the disposition ofrepurchased loans.

 

Expenses declined by $2,497 to $37,130 for the three months ended June30, 2005 compared to the same period in 2004. Expenses in basis points of production increased from 102 basis points to107 basis points as a result of a $447,938 decline in mortgage loan productionproviding less leverage over the fixed expense base.

 

27

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*Transaction Processing Segment*

 

The transaction processing segment subservices loans for the retailbanking segment, financial intermediary segment and for third party customers;provides ATM and merchant processing services; and sells various insuranceproducts using an Internet-based platform.

 

The following table highlights the results of operations for thetransaction processing segment: 

 
| ** **     | ** ** | **For the three months ended June 30,** | ** ** |
|----------------|------------|-----------------------------------------|------------|
| ** **     | ** ** | **2005**                                | ** ** | **2004** | ** ** | **Change** | ** ** |
| Total revenue  | ** ** | **$**                                   | **6,680**  |   | $ | 6,518 |   | $ | 162 |   |
| Total expenses | ** ** | **5,781**                               |       | 7,287 |   | (1,506 | ) |
| ** **     |       | **$**                                   | **899**    |   | $ | (769 | ) | $ | 1,668 |   |

 

The transaction processing segment recorded pre-tax income of $899, a $1,668improvement period over period. The significant improvement in pre-tax resultswas primarily due to the servicing factory reducing its cost by $1,512 or 25%period over period. The servicing factory should continue to see improvement asits number of loans serviced increases during the third quarter with theaddition of approximately 14,000 new loans as part of the $2.5 billion bulkacquisition.  Additionally, NetInsurancecut its pre-tax loss to $235, a $447 improvement period over period, bycontinuing to increase its policies-in-force and cutting expenses.  NPS’s pre-tax income declined by $176; however,its operations continue to expand as its number of ATMs and merchant serviceterminals increased by 2,113.

 

*Other /Elimination*

 

The other/elimination segment contains the holding company expensesalong with the elimination of inter-segment gains and losses on loans sold tothe retail banking segment from the financial intermediary segment. The other /elimination segment lost $2,063 for the three months ended June 30, 2005compared to a loss of $2,735 for the comparable period of 2004.  The $672 improvement was primarily related tostrict expense control at the holding company coupled with a reduction ofdeferred gains related to a decline in inter-segment loan sales.

 

 

**Results of Operations — Six months ended June 30, 2005 compared to thesix months ended June 30, 2004**

* *

*General.*  Net income for the six months ended June 30,2005 was $296 or $0.01 per share compared to net income of $17,861 or $0.38 pershare for the same period in 2004. We capitalized on the favorable interestrate environment during the first six months of 2004 and posted exceptionally strongrevenues in our financial intermediary segment. In contrast, a rising and volatile interest rate environment during thefirst six months of 2005 adversely impacted the results reported in thefinancial intermediary segment.  Mortgageproduction dropped from $7.2 billion to $6.2 billion, while sales of mortgagesdropped from $6.6 billion to $5.8 billion comparing the first six months of 2004to 2005, respectively.  During the firstsix months of 2005, we experienced considerable margin pressure on sales ofmortgage loans in the financial intermediary segment due to increasedcompetition, especially in the non-conforming, wholesale and correspondentchannels.   The decline in sales ofmortgage loans and compression of the margin on sales of mortgage loansresulted in a decline of $11,461 in gains on sales of mortgage loans periodover period.

 

*Interest Income*.  Interest income for the six monthsended June 30, 2005 was $119,521 compared to $110,862 for the same period in2004.  This increase was primarily theresult of a 31-basis point increase in the average yield on interest-earningassets coupled with a $64,555 increase in the average outstanding balance ofinterest-earning assets.

 

*Interest Expense*. Interest expense for the six months endedJune 30, 2005 was $57,802 compared to $42,614 during the same period in2004.  The $15,188 increase in interestexpense is primarily the result of a 72-basis point increase in the

 

28

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average cost of funds coupled with a $67,722 increase in the averageoutstanding balance of interest-bearing liabilities.  These increases were compounded due to theincrease in average interest-bearing liabilities being primarily centered inshort-term borrowings which saw a 127-basis point increase in the average costof funds.  Our deposit base experienced a39-basis point increase in the average cost while other borrowed funds(including short-term debt, FHLB advances and subordinated debt) experienced a60-basis point increase.  We willcontinue to focus on its relationships with new and existing customers as westrive to become our customers’ first choice for all their financial needs, whichin-turn should increase our deposit base and lower our cost of funds.

 

*Net Interest Income. *Net interestincome is determined by interest rate spread, which is the difference betweenthe yields earned on interest-earning assets and the rates paid oninterest-bearing liabilities, and the relative amounts of interest-earningassets and interest-bearing liabilities. Net interest income was $61,719, or 2.8% of average interest-earningassets for the six months ended June 30, 2005, compared to $68,248, or 3.14% ofaverage interest-earning assets for the six months ended June 30, 2004.  The 34-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 detailsthe relative interest rates and average balances of our interest-earning assetsand interest-bearing liabilities for the six months ended June 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:**       |       |                                           |       |   |   |   |   |   |   |   |   |
| 81,144               |       | 73,852                    |       | 2.21       | %          | 1.00         | %          | Short-term investments             |       | $                                              | 895        |   | $ | 370 |   | $ | 525 |   | $ | 447 |   | $ | 78 |   |
| 775,102              |       | 449,405                   |       | 4.56       | %          | 3.50         | %          | Investment securities (1)          |       | 17,667                                         |       | 7,871 |   | 9,796 |   | 2,382 |   | 7,414 |   |
| 1,437,000            |       | 1,813,295                 |       | 6.32       | %          | 5.80         | %          | Loans held for sale (2)            |       | 45,378                                         |       | 52,569 |   | (7,191 | ) | 4,715 |   | (11,906 | ) |
| 2,121,759            |       | 2,013,898                 |       | 5.24       | %          | 4.97         | %          | Loans and leases receivable (2)    |       | 55,581                                         |       | 50,052 |   | 5,529 |   | 2,719 |   | 2,810 |   |
| 4,415,005            |       | 4,350,450                 |       | 5.41       | %          | 5.10         | %          | Total interest-earning assets      |       | 119,521                                        |       | 110,862 |   | 8,659 |   | 10,263 |   | (1,604 | ) |
|                 |       |                      |       |       |       |         |       |                               |       |                                           |       |   |   |   |   |   |   |   |   |
| ** **           |       |                      |       |       |       |         |       | **Interest-bearing liabilities:**  |       |                                           |       |   |   |   |   |   |   |   |   |
| 232,235              |       | 233,020                   |       | 1.32       | %          | 1.18         | %          | Checking accounts                  |       | 1,527                                          |       | 1,373 |   | 154 |   | 163 |   | (9 | ) |
| 1,101,006            |       | 1,336,270                 |       | 2.18       | %          | 1.70         | %          | Money market                       |       | 11,998                                         |       | 11,326 |   | 672 |   | 3,207 |   | (2,535 | ) |
| 933,029              |       | 713,578                   |       | 3.28       | %          | 2.75         | %          | Certificates of deposit            |       | 15,289                                         |       | 9,803 |   | 5,486 |   | 1,891 |   | 3,595 |   |
| 967,244              |       | 821,343                   |       | 3.22       | %          | 1.95         | %          | Short-term debt                    |       | 15,556                                         |       | 7,994 |   | 7,562 |   | 5,216 |   | 2,346 |   |
| 771,814              |       | 849,547                   |       | 3.26       | %          | 2.79         | %          | FHLB advances                      |       | 12,599                                         |       | 11,832 |   | 767 |   | 1,996 |   | (1,229 | ) |
| 28,009               |       | 11,857                    |       | 5.95       | %          | 4.82         | %          | Subordinated debt                  |       | 833                                            |       | 286 |   | 547 |   | 67 |   | 480 |   |
| 4,033,337            |       | 3,965,615                 |       | 2.87       | %          | 2.15         | %          | Total interest-bearing liabilities |       | 57,802                                         |       | 42,614 |   | 15,188 |   | 12,540 |   | 2,648 |   |
|                 |       |                      |       |       |       |         |       |                               |       |                                           |       |   |   |   |   |   |   |   |   |
| —               |       | —                    |       | 2.54       | %          | 2.95         | %          | Net interest margin                |       | 61,719                                         |       | 68,248 |   | (6,529 | ) | (2,277 | ) | (4,252 | ) |
| 381,668              |       | 384,835                   |       | 0.26       | %          | 0.19         | %          | Interest free sources              |       | —                                         |       | — |   | — |   | — |   | — |   |
| $                    | 4,415,005  |                      | $          | 4,350,450  |       | 2.80         | %          | 3.14                               | %          | Net interest income to interest-earning assets |       | $ | 61,719 |   | $ | 68,248 |   | $ | (6,529 | ) | $ | (2,277 | ) | $ | (4,252 | ) |
|                      |            |                           |            |            |            |              |            |                                    |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(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.

 

*Provision for Credit Losses.*  The provision forcredit losses was $4,681 for the six months ended June 30, 2005, compared to $3,513for the same period of 2004.  Theincrease in the provision relates primarily to the mix of loans and leasesbeing retained during the six months ended June 30, 2005 compared to the sameperiod in 2004.  During the currentperiod, we retained a higher percentage of auto loans, second-mortgages, HELOCsand business equipment financing leases, which generally provide a higher riskadjusted yield, as compared to the retention of primarily first-mortgageadjustable-rate loans during the 2004 period. Reference is made to the headingFinancial Condition - “Asset Quality and

 

29

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Non-performing Assets” above for additional detail concerning thedetermination of provision expense related to maintaining the proper level ofallowance for credit losses.

 

*Non-interest Income.* Non-interest income declined$17,329 for the six months ended June 30, 2005 compared to the same period of2004.  This decline was primarily drivenby the $11,461 decline in gain on sales of loans due to the $754,654, or 12%,decline in sales of mortgage loans.  Thedecline in sales was compounded by the decline in margins on sales due toincreased competitive pressures, especially in the non-conforming, wholesaleand correspondent channels. Current period gain on sales of mortgage 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.  The current performance of our investment inMSRs resulted in income of $2,218 compared to income of $6,270 for the sameperiod of 2004, a $4,052 decline period over period.  The $2,218 of income consists of the $1,020current period impairment of MSRs plus derivative losses of $944, offset bygains on the sales of investment securities of $4,182.  During the first six months of 2004, interestrates began to rise which resulted in a $4,643 recovery of previous impairmentof the MSRs coupled with $3,169 of gains on sales of investment securities,offset by $1,542 of derivative losses. Non-interest income increased as the result of an increase in mortgageservicing fees of $1,821 due to the $1.1 billion, or 8%, increase in theaverage principal balance underlying the MSR portfolio. This increase wasoffset by a $3,221 increase in amortization of MSRs due to the same increase inunderlying principal balance coupled with higher prepayment speeds.

 

*Non-interest Expense.*  Non-interest expenseincludes all operating expenses such as salaries and benefits, marketing, andgeneral and administrative expenses. Non-interest expense increased $2,702, or 2%, for the six months endedJune 30, 2005 compared to the same period of 2004.  The increase was primarily driven by increasesof $1,997 in depreciation and amortization, $1,346 in occupancy expense, $892in professional fees, $798 in marketing expenses and $496 in customer serviceexpenses.  The increase in depreciationand amortization is primarily related to the expansion of our operationsthrough the acquisitions of GRL Mortgage and Beacon Credit Services, coupledwith higher amortization expense related to the acquisition of ATM and merchantprocessing contracts by NPS as it continues to expand.  Depreciation and occupancy were also impactedduring the six months ended June 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.  These increases were partially offset bydecreases of $1,265 in salaries and wages and $1,185 in prepaid lost intereston curtailments.  The decrease insalaries and wages primarily related to the decline in production at the mortgageoperations.

 

# ***Retail Banking Segment***

 

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

 
| ** **                                            | ** ** | **For the six months ended June 30,** | ** **     |
|-------------------------------------------------------|------------|---------------------------------------|----------------|
| ** **                                            | ** ** | **2005**                              | ** **     | **2004** | ** ** | **change** | ** ** |
| Net interest income                                   | ** ** | **$**                                 | **45,362**     | ** ** | $ | 36,739 |   | $ | 8,623 |   |
| Provision for credit  losses                          | ** ** | **4,652**                             | ** **     | 3,472 |   | 1,180 |   |
| Net interest income after provision                   | ** ** | **40,710**                            | ** **     | 33,267 |   | 7,443 |   |
| Gains on sales of loans                               | ** ** | **501**                               | ** **     | 1,061 |   | (560 | ) |
| Fees, charges and other  income                       | ** ** | **6,924**                             | ** **     | 6,186 |   | 738 |   |
| Total revenues                                        | ** ** | **48,135**                            | ** **     | 40,514 |   | 7,621 |   |
| Total expenses                                        | ** ** | **36,225**                            | ** **     | 32,999 |   | 3,226 |   |
| Pre-tax income before net servicing results           | ** ** | **11,910**                            | ** **     | 7,515 |   | 4,395 |   |
| Net servicing results                                 | ** ** | **(5,866**                            | **)**          | 1,821 |   | (7,687 | ) |
| Pre-tax income                                        | ** ** | **$**                                 | **6,044**      | ** ** | $ | 9,336 |   | $ | (3,292 | ) |
|                                                  |       |                                  | ** **     |   |   |   |   |
| Average earning assets                                | ** ** | **$**                                 | **4,400,824**  | ** ** | $ | 4,222,710 |   | $ | 178,114 |   |
| Average UPB underlying  MSRs                          | ** ** | **$**                                 | **13,884,514** | ** ** | $ | 12,988,546 |   | $ | 895,968 |   |
|                                                  |       |                                  | ** **     |   |   |   |   |
| **Operations to earning assets**                      |       |                                  | ** **     |   |   |   |   |
| Net interest income after  provision                  | ** ** | **1.85**                              | **%**          | 1.58 | % | 0.27 | % |
| Gain on sale, fees,  charges and other income         | ** ** | **0.34**                              | **%**          | 0.34 | % | 0.00 | % |
| Banking revenues                                      | ** ** | **2.19**                              | **%**          | 1.92 | % | 0.27 | % |
| Total expenses                                        | ** ** | **1.65**                              | **%**          | 1.56 | % | 0.09 | % |
| Pre-tax income before net servicing results           | ** ** | **0.54**                              | **%**          | 0.36 | % | 0.18 | % |
|                                                  |       |                                  | ** **     |   |   |   |   |
| Net servicing results to  average UPB underlying MSRs | ** ** | **(0.08**                             | **)%**         | 0.03 | % | (0.11 | )% |

 

30

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The retail banking segmentrecorded pre-tax income of $6,044 in the 2005 period, a $3,292 decline over thecomparable period in 2004. Collectively, the Internet-only banking, leasing andauto operations within the retail banking segment increased their period overperiod pre-tax income by $4,395 to $11,910. This increase was primarily drivenby the $178,114 increase in the average balance of interest earning assetscoupled with a 27-basis point increase in net interest income afterprovision.  During the past twelve months,the retail banking segment retained a higher percentage of auto loans,second-mortgage loans, HELOCs, and business financing leases compared to thefirst-mortgage loans which dominated the retention activity during late 2003and early 2004.  These loans and leasesgenerally have a higher risk adjusted yield than the adjustable-ratefirst-mortgage loans that were previously being retained.  The improvement in these operations was morethan offset by the $7,687 decline in the retail banking segment’s net servicingresults.  During the 2004 period, the netservicing results benefited from increasing long-term rates which allowed for impairmentrecovery of $4,643 compared to $1,020 of impairment expense during the sameperiod of 2005, a $5,663 decline.

 

*FinancialIntermediary*

 

The following tablehighlights the financial intermediary segment production and sales activities:

 
| ** **                            | ** ** | **For the six months ended June 30,** | ** **    |
|---------------------------------------|------------|---------------------------------------|---------------|
|                                  | ** ** | **2005**                              | ** **    | **2004** | ** ** | **change** | ** ** |
| Pre-tax results                       | ** ** | ** **                            | ** **    | ** ** | ** ** | ** ** | ** ** |
| Net interest income                   | ** ** | **$**                                 | **16,130**    | ** ** | $ | 30,508 |   | $ | (14,378 | ) |
| Gain on sales of loans                | ** ** | **52,111**                            | ** **    | 67,741 |   | (15,630 | ) |
| Other income                          | ** ** | **2,066**                             | ** **    | 1,121 |   | 945 |   |
| Net Beacon Credit Services  results   | ** ** | **(786**                              | **)**         | — |   | (786 | ) |
| Net MG Reinsurance results            | ** ** | **1,705**                             | ** **    | 1,042 |   | 663 |   |
| Total revenues                        | ** ** | **71,226**                            | ** **    | 100,412 |   | (29,186 | ) |
| Salary and employee  benefits         | ** ** | **43,557**                            | ** **    | 47,111 |   | (3,554 | ) |
| Occupancy &  Depreciation expense | ** ** | **14,570**                            | ** **    | 13,867 |   | 703 |   |
| Other expenses                        | ** ** | **16,841**                            | ** **    | 15,720 |   | 1,121 |   |
| Total expenses                        | ** ** | **74,968**                            | ** **    | 76,698 |   | (1,730 | ) |
| Pre-tax income (loss)                 | ** ** | **$**                                 | **(3,742**    | **)** | $ | 23,714 |   | $ | (27,456 | ) |
|                                  |       |                                  | ** **    |   |   |   |   |
| Production                            | ** ** | **$**                                 | **6,232,108** | ** ** | $ | 7,162,203 |   | $ | (930,095 | ) |
| Sales (includes  inter-segment sales) | ** ** | **$**                                 | **5,898,765** | ** ** | $ | 7,204,850 |   | $ | (1,306,085 | ) |
|                                  |       |                                  | ** **    |   |   |   |   |
| Total revenues to sales               | ** ** | **1.21**                              | **%**         | 1.39 | % | (0.18 | )% |
| Total expenses to  production         | ** ** | **1.20**                              | **%**         | 1.07 | % | 0.13 | % |
| Pre-tax margin                        | ** ** | **0.01**                              | **%**         | 0.32 | % | (0.31 | )% |

----

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

 

The interest rate environment during the six months ended June 30, 2004was much more favorable to mortgage production than the environment during thecomparable 2005 quarter.  The loanpipelines of originators throughout the

 

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mortgage banking industry were filled, resulting in less pressure onmargins, especially in the non-conforming, wholesale and correspondent channels.  This resulted in an 18-basis point decline inthe margin on sale of mortgage loans, which coupled with a $1.3 billion, or18%, decline in sales resulted in a $15,630 decline in gain on sales of loans. Totalexpenses were down primarily as a result of the $930,095 decline in mortgageloan production.

 

*Transaction Processing Segment*

 

The transaction processing segment subservices loans for the retailbanking segment, financial intermediary segment and for third party customers;provides ATM and merchant processing services; and sells various insuranceproducts using an Internet-based platform.

 

The following table highlights the results of operations for thetransaction processing segment for the six months ended June 30, 2005 and 2004:

 
| ** **     | ** ** | **2005**   | ** ** | **2004** | ** ** | **Change** | ** ** |
|----------------|------------|------------|------------|----------|------------|------------|------------|
| Total revenues | ** ** | **$**      | **13,422** |     | $          | 12,924     |       | $ | 498 |   |
| Total expenses | ** ** | **11,509** |       | 13,189   |       | (1,680     | )          |
| Margin         | ** ** | **$**      | **1,913**  |     | $          | (265       | )          | $ | 2,178 |   |

 

The transaction processing segment recorded pre-tax income of $1,913, a$2,178 improvement period over period.  Theimproved pre-tax results are primarily due to the servicing factory reducing itscost by $1,808 or 17% period over period. The servicing factory should continueto see improvement as its number of loans serviced increases during the thirdquarter with the addition of approximately 14,000 new loans as part of the $2.5billion bulk acquisition.   Additionally, NetInsurance reduced its pre-taxloss to $523, a $744 improvement period over period, by continuing to increaseits policies-in-force and cutting expenses. NPS’s pre-tax income declined by $96; however, its operations continueto expand as its number of ATMs and merchant service terminals increased by2,113.

 

*Other /Elimination*

 

The other/elimination segment contains the holding company expensesalong with the elimination of inter-segment gains and losses on loans sold tothe retail banking segment from the financial intermediary segment. The other /elimination segment lost $3,468 for the six months ended June 30, 2005 comparedto a loss of $4,310 for the comparable period of 2004.  The $842 improvement was primarily related tostrict expense control at the holding company coupled with a reduction ofdeferred gains related to a decline in inter-segment loan sales.

###### ** **

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

 

Senior management, in conjunction with the Audit Committee of the Boardof Directors, has identified valuation of the MSR portfolio, determination ofthe allowance for credit losses, liabilities for representations and warrantieson loans and MSRs sold and accounting for derivative financial instruments as ourmost critical accounting policies. These policies were identified as being themost critical based on the SEC’s guidance in identifying them based on whether1) the accounting estimate required management to make assumptions aboutmatters that were highly uncertain at the time the accounting estimate was madeand 2) different estimates reasonably could have been used in the currentperiod, or changes in the accounting estimate that are reasonably likely tooccur from period to period, would have a material impact on the presentationof the financial condition or results of operations. Management believes thatgiven current information, its judgments, estimates and assumptions used inthese policies are appropriate.  Forfurther information regarding our critical accounting policies, refer to theheading “Critical Accounting Policies” on page 55 of our 2004 Form 10-K.

 

32

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

 

The Company, in the normal course of business, had contractual obligationsto make scheduled payments for its operating leases; its liability torepurchase loans under representations and warranties provided to purchasers ofits mortgage loans and MSRs; and its obligation to make scheduled principal andinterest 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 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.

 

# **Liquidity and Capital Resources**

* *

*Liquidity. *The Company’sliquidity, represented by cash and cash equivalents, is a product of ouroperating, investing, and financing activities. Our primary sources of funds are deposits, borrowings, prepayments andmaturities of outstanding loans, sales of loans, sales or maturities ofinvestment securities and other short-term investments, and funds provided fromoperations.  While scheduled loanpayments and maturing investment securities and short-term investments arerelatively predictable sources of funds, deposit flows and loan prepayments aregreatly influenced by general interest rates, economic conditions, andcompetition. We can use cash generated through the retail deposit market, ourtraditional funding source, to offset the cash utilized in investing activities.  Our available for sale securities andshort-term interest-earning assets can also be used to provide liquidity forlending and other operational requirements. For the six months ended June 30, 2005, we had a net increase in cashand cash equivalents of $36,085 compared to a net increase of $63,658 for thesame period of 2004.  The increase in the2005 period primarily related to increases of $152,659 in deposits and $159,284in other borrowed funds.  These cashinflows were offset, in part, by increases of $214,716 in loans held for saleand $85,257 in loan and lease receivables. The large increase in loans held for sale was primarily a function ofmortgage loan production of $6.2 billion outpacing sales of mortgage loans of$5.8 billion. As an additional source of funds, we had available under existingline of credit agreements $1.4 billion at June 30, 2005 (see note 8 of thenotes to consolidated financial statements included in this report foradditional details regarding the available lines of credit).

 

We use deposits as ourprincipal source of funds.  For the sixmonths ended June 30, 2005, deposits increased by $152,659 to $2.8 billion from$2.6 billion as of December 31, 2004.  Ourdeposit products include checking, money market and certificates of depositaccounts.  Deposit account terms vary,with the principal differences being the minimum balance required, the timeperiods the funds must remain on deposit, and the interest rate.  We arecompetitive in the types of accounts, services and ranges of interest ratesoffered on deposit products.  Althoughmarket demand generally dictates which deposit maturities and rates will beaccepted by the public, we intend to continue to promote checking, money marketand certificates of deposit to the extent possible consistent with asset andliability management goals.

 

*Capital Resources.**  *The Company and NetBank, FSBare subject to various regulatory capital requirements administered by thefederal banking agencies. Failure of either company to meet minimum capitalrequirements can initiate certain mandatory and possibly additionaldiscretionary actions by regulators that, if undertaken, could have a directmaterial effect on the consolidated financial statements. Under capitaladequacy guidelines and the regulatory framework for prompt corrective action,NetBank, FSB must meet specific capital guidelines that involve quantitativemeasures of NetBank, FSB’s assets, liabilities, and certain off-balance sheetitems as calculated under regulatory accounting practices. NetBank, FSB’scapital amounts and classifications are also subject to qualitative judgmentsby the regulators about components, risk weightings and other factors. Undercurrent regulatory guidelines, NetBank, FSB may not make a capital distributionto the Company without prior approval of the Office of Thrift Supervision (“OTS”),the governmental agency that regulates NetBank, FSB. Current guidelinesrequire, among other things, that NetBank, FSB not make an unapproved capitaldistribution in excess of its current period year-to-date undistributedearnings plus the preceding two years undistributed earnings and in no eventmake a distribution which would cause NetBank, FSB to be less than adequatelycapitalized as defined below.

 

Quantitative measures established by regulation to ensure capitaladequacy require NetBank, FSB to maintain minimum amounts and ratios as setforth in the following table. NetBank, FSB’s regulatory agency, the OTS,requires NetBank, FSB to maintain minimum ratios of tangible capital totangible assets of 1.5%, core capital to tangible assets of 4.0% and

 

33

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total capital to risk-weighted assets of 8.0%.  The following table presents informationrelated to NetBank, FSB along with capital requirements mandated by the OTS:

 
| ** **                                   | ** ** | **Actual** | ** ** | **For capital adequacy purposes** | ** ** | **To be categorized as Well Capitalized under prompt corrective action  plan** | ** ** |
|----------------------------------------------|------------|------------|------------|-----------------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Amount** | ** ** | **Ratio**                         | ** ** | **Amount**                                                                     | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **June 30, 2005**                            | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                                                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total capital (to  risk-weighted assets)     |       | $          | 324,056    |                              | 10.36      | %                                                                              | $          | 250,236 |   | 8.00 | % | $ | 312,795 |   | 10.00 | % |
| Core capital (to adjusted  total assets)     |       | $          | 298,264    |                              | 6.17       | %                                                                              | $          | 193,364 |   | 4.00 | % | $ | 241,705 |   | 5.00 | % |
| Tangible capital (to  adjusted total assets) |       | $          | 298,264    |                              | 6.17       | %                                                                              | $          | 72,512 |   | 1.50 | % | N/A |   | N/A |   |
| Tier I capital (to  risk-weighted assets)    |       | $          | 298,264    |                              | 9.53       | %                                                                              | N/A        |   | N/A |   | $ | 187,784 |   | 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 mortgage banking must adhere tovarious HUD regulatory guidelines including required minimum net worth tomaintain their FHA approved lending status. Failure to comply with the HUD guidelines could result in withdrawal ofthis certification.  As of June 30, 2005,Market Street and Meritage were in compliance with HUD guidelines.

 

The Company and its subsidiaries are subject to various other capitalrequirements 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 June 30, 2005, all of the capital requirements placed upon theCompany and its subsidiaries were met.

 

# **Item 3. Quantitativeand Qualitative Market Risk**

 

Our principal businesses are retail banking and the origination andpurchase of loans and business equipment financing. These businesses are fundedby customer deposits and, to the extent necessary, other borrowed funds.Consequently, a significant portion of our assets and liabilities are monetaryin nature and fluctuations in interest rates will affect future net interestincome and cash flows. This interest rate risk is our primary market riskexposure. For the six months ended June 30, 2005, the only derivative financialinstruments that we entered into were associated with our mortgage bankingactivities, which include (1) the portfolio of mortgage loans held forsale, (2) the pipeline of rate locks, (3) hedging the securitizationand sale of loans, (4) the current MSR portfolio and (5) the MSRsthat will be created as a byproduct of securitization activities associatedwith loans held for sale and the pipeline of rate locks.  Exposure to market risk is reviewed on aregular basis by management.  

 
| ** **                                                                                                                                                                      | ** ** | ** **   | ** ** | ** **     | ** ** | **If interest rates were to** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------|------------|----------------|------------|-------------------------------|------------|
| ** **                                                                                                                                                                      | ** ** | **2005**     | ** ** | **Increase**   | ** ** | **Decrease**                  | ** ** | **Increase** | ** ** | **Decrease** | ** ** |
| ** **                                                                                                                                                                      | ** ** | **Carrying** | ** ** | **Estimated**  | ** ** | **25 basis points**           | ** ** | **50 basis points** | ** ** |
| ** **                                                                                                                                                                      | ** ** | **Amount**   | ** ** | **Fair Value** | ** ** | **Estimated Fair Value**      | ** ** | **Estimated Fair Value** | ** ** |
| **Assets:**                                                                                                                                                                     | ** ** | ** **   | ** ** | ** **     | ** ** | ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash equivalents                                                                                                                                                       |       | $            | 186,387    |           | $          | 186,387                       |       | $ | 186,387 |   | $ | 186,387 |   | $ | 186,387 |   | $ | 186,387 |   |
| Investment securities available for sale                                                                                                                                        |       | 659,093      |       | 659,093        |       | 653,615                       |       | 663,948 |   | 647,708 |   | 668,078 |   |
| Mortgage loans held for sale                                                                                                                                                    |       | 1,388,495    |       | 1,389,387      |       | 1,384,546                     |       | 1,393,438 |   | 1,379,128 |   | 1,397,065 |   |
| Mandatory  delivery commitments                                                                                                                                                 |       | (5,183       | )          | (5,985         | )          | 4,353                         |       | (14,706 | ) | 15,788 |   | (22,342 | ) |
| Mortgage loan  purchase commitments                                                                                                                                             |       | 2,357        |       | 2,891          |       | (1,621                        | )          | 6,315 |   | (6,917 | ) | 9,297 |   |
| Loan and lease receivables-net of allowance for  credit losses                                                                                                                  |       | 2,181,089    |       | 2,185,102      |       | 2,175,916                     |       | 2,194,050 |   | 2,166,564 |   | 2,202,725 |   |
| Mortgage servicing rights                                                                                                                                                       |       | 176,583      |       | 179,274        |       | 192,054                       |       | 165,362 |   | 203,598 |   | 150,686 |   |
| Swaps, swaptions, caps, floors, corridors and forward  purchase commitments hedging mortgage servicing rights available for sale and  the pipeline of mortgage servicing rights |       | 32,508       |       | 32,508         |       | 20,031                        |       | 47,358 |   | 9,980 |   | 64,389 |   |
| Total interest rate sensitive assets                                                                                                                                            |       | 4,621,329    |       | 4,628,657      |       | 4,615,281                     |       | 4,642,152 |   | 4,602,236 |   | 4,656,285 |   |
| Non-interest rate sensitive assets                                                                                                                                              |       | 333,438      |       | 333,438        |       | 333,438                       |       | 333,438 |   | 333,438 |   | 333,438 |   |
| Total assets                                                                                                                                                                    |       | $            | 4,954,767  |           | $          | 4,962,095                     |       | $ | 4,948,719 |   | $ | 4,975,590 |   | $ | 4,935,674 |   | $ | 4,989,723 |   |
|                                                                                                                                                                            |       |         |       |           |       |                          |       |   |   |   |   |   |   |
| **Liabilities:**                                                                                                                                                                |       |         |       |           |       |                          |       |   |   |   |   |   |   |
| Non-interest bearing deposits                                                                                                                                                   |       | $            | 323,101    |           | $          | 318,008                       |       | $ | 317,717 |   | $ | 318,319 |   | $ | 317,435 |   | $ | 318,635 |   |
| Interest bearing deposits                                                                                                                                                       |       | 1,246,466    |       | 1,148,542      |       | 1,143,753                     |       | 1,153,519 |   | 1,139,032 |   | 1,158,577 |   |
| Interest bearing certificates of deposit                                                                                                                                        |       | 1,222,533    |       | 1,221,841      |       | 1,218,659                     |       | 1,225,030 |   | 1,215,514 |   | 1,228,245 |   |
| Short-term borrowings                                                                                                                                                           |       | 640,775      |       | 640,593        |       | 640,507                       |       | 640,679 |   | 640,420 |   | 640,766 |   |
| Long-term borrowings                                                                                                                                                            |       | 830,000      |       | 825,649        |       | 823,046                       |       | 828,396 |   | 820,529 |   | 831,279 |   |
| Subordinated debt                                                                                                                                                               |       | 32,477       |       | 32,477         |       | 32,477                        |       | 32,477 |   | 32,477 |   | 32,477 |   |
| Total interest rate sensitive liabilities                                                                                                                                       |       | 4,295,352    |       | 4,187,110      |       | 4,176,159                     |       | 4,198,420 |   | 4,165,407 |   | 4,209,979 |   |
| Non-interest rate sensitive liabilities                                                                                                                                         |       | 249,766      |       | 249,206        |       | 249,206                       |       | 249,206 |   | 249,206 |   | 249,206 |   |
| Total liabilities                                                                                                                                                               |       | 4,545,118    |       | 4,436,316      |       | 4,425,365                     |       | 4,447,626 |   | 4,414,613 |   | 4,459,185 |   |
|                                                                                                                                                                            |       |         |       |           |       |                          |       |   |   |   |   |   |   |
| Minority interest                                                                                                                                                               |       | 560          |       | 560            |       | 560                           |       | 560 |   | 560 |   | 560 |   |
| **Shareholders’ equity**                                                                                                                                                   |       | 409,089      |       | 525,219        |       | 522,794                       |       | 527,404 |   | 520,501 |   | 529,978 |   |
| **Total liabilities and shareholders’ equity**                                                                                                                             |       | $            | 4,954,767  |           | $          | 4,962,095                     |       | $ | 4,948,719 |   | $ | 4,975,590 |   | $ | 4,935,674 |   | $ | 4,989,723 |   |

 

34

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The table above shows the carrying values and fair values of our portfolioof assets and liabilities.  Fair values of financial assets andliabilities are estimated using several methods.  The first method is byuse of directly observable market prices.  This method applies to most ofthe loans held for sale and investment securities available for sale whichtrade in highly liquid markets.  A second method employs the use of marketbenchmarks.  In this method, a benchmark financial asset or liability isselected which matches many of the characteristics of the financial instrumentbeing evaluated.  The instrument being evaluated is then priced at aspread relative to the benchmark instrument.  This method applies to manyloan and lease receivables.  A third method used to estimate the fairvalue of an instrument employs approximating a spread over a readily availablemarket index or yield curve.  This method is used where no directlyobservable market exists and no suitable benchmark instrument can befound.  Many deposit accounts are evaluated in this manner.  Based onthese fair value estimates, the data indicates that the net fair value ofassets and liabilities exceeds that of their associated carrying value. Most of this excess value is derived from the origination of interest bearingdeposits.  Additionally, the table shows the exposure of the portfolio totheoretical instantaneous and parallel changes in market interest rates of 25and 50 basis points.  These simulated values are created using complexfinancial models which incorporate many assumptions.  Prudent balancesheet management dictates that changes in value for one instrument should beoffset to some extent by another balance sheet instrument.  For example,loans and lease receivables decline in theoretical value by $9.2 million for a25 basis point increase in rates.  This exposure is mitigated by theduration of interest-bearing deposits having offsetting exposure of $4.8million, and interest-bearing certificates of deposit with offsetting exposureof $3.2 million.  While most of the risk is balanced out in this manner,the data suggests that the Company benefits in a declining interest rateenvironment, versus a rising interest rate environment.  This is commonlyreferred to as a liability sensitive position.  Management carefullymanages the exposure to these scenario simulations and many others, which areintended to be broadly representative of the likely future path of interest rates. In considering the table presented above, it should be noted that, as asimplifying assumption, this analysis assumes that risk exposure is passivelyrather than actively managed; in other words, the analysis assumes thatmanagement does not attempt to alter the balance sheet position to changing interestrate environments.  In practice, however, management closely monitorsmarket exposure levels and actively manages the position.

 

Reference is made to Item 7A. Quantitative and Qualitative DisclosuresAbout Market Risk on page 71 of our 2004 Form 10-K for additional detailsregarding the Company’s exposure to and management of market risks.

 

One of the ways NetBank, FSB, like other savings banks, measuresinterest rate risk is based on a Net Portfolio Value (“NPV”) analysis. NPVequals the present value of expected net cash flows from existing assets minusthe present value of expected net cash flows from existing liabilities. An NPVratio is determined by dividing NPV by the present value of

 

35

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assets. The following table sets forth the estimated NetBank, FSB NPVratios as of June 30, 2005 and December 31 and June 30, 2004 assuming rateshocks of +300 to -100 basis points:

 

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

 

| **Rate shock  (in basis points)** | ** ** | **As of  June 30,  2005** | ** ** | **As of  December 31,  2004** | ** ** | **As of  June 30,  2004** | ** ** | **Minimum as  of June 30,  2005** | ** ** |
|-----------------------------------|------------|---------------------------|------------|-------------------------------|------------|---------------------------|------------|-----------------------------------|------------|
| **+300**                          |       | 8.13%                     |       | 7.75%                         |       | 7.66%                     |       | 4.00%                             |       |
| **+200**                          |       | 8.30%                     |       | 8.03%                         |       | 8.19%                     |       | 6.00%                             |       |
| **+100**                          |       | 8.47%                     |       | 8.63%                         |       | 8.80%                     |       | 6.00%                             |       |
| **Flat**                          |       | 8.66%                     |       | 8.96%                         |       | 9.14%                     |       | 6.00%                             |       |
| **-100**                          |       | 8.89%                     |       | 9.19%                         |       | 9.31%                     |       | 6.00%                             |       |

 

Minimum ratios for NPV risk are established by the Board of Directorsas prudent levels for the respective interest rate scenarios. Lower NPV ratiosdenote more market rate sensitivity for a given rate scenario.  As of June 30, 2005 the analysis indicatessensitivity to rising market interest rates. The sensitivities presented in the table above are within the Boardapproved limits for these scenarios. Computation of prospective effects of hypothetical rate changes is basedon many assumptions, including relative levels of market interest rates, loanprepayments and deposit decay. They should not be relied upon as indicative ofactual results. Further, the computations do not contemplate certain actionsmanagement could undertake in response to changes in interest rates.

 

 

**Item 4.  Controls andProcedures**

** **

**Management’s Conclusion on the Effectiveness of Disclosure Controls andProcedures**

 

*Evaluation of Disclosure Controls and Procedures*. We evaluatedthe effectiveness of the design and operation of our “disclosure controls andprocedures,” as defined in Rule 13a-15(e) under the Securities Exchange Act of1934, as amended (the “Exchange Act”) as of the end of the period covered bythis report. This evaluation (the “controls evaluation”) was done under thesupervision and with the participation of management, including our chiefexecutive officer (“CEO”) and chief financial executive (“CFO”). 

  

*Objectives of Controls*. Disclosure controls andprocedures are designed so that information required to be disclosed in ourreports filed under the Exchange Act, such as this quarterly report on Form10-Q, is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms. Disclosure controls and procedures arealso intended to ensure that such information is accumulated and communicatedto our management, including the CEO and CFO, as appropriate to allow timelydecisions regarding required disclosure. In designing and evaluating disclosurecontrols and procedures, management recognizes that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, andmanagement is required to apply its judgment in evaluating the cost-benefitrelationship of possible controls and procedures.

 

*Conclusions*. Based upon the controls evaluation, our CEO andCFO have concluded that as of June 30, 2005, our disclosure controls andprocedures are effective to provide reasonable assurance that the foregoingobjectives are achieved.

 

 *Changes inInternal 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.

 

36

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# **PART II — OTHER INFORMATION**

# ** **

# **Item 1.  Legal Proceedings**

 

IllinoisUnion 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 proceedings of Commercial Money Center, Inc. and In re CommercialMoney Center, Inc., Debtor (Kipperman v. NetBank, FSB), Bankruptcy No.02-09721; In the United States Bankruptcy Court for the Southern District ofCalifornia

 

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

 

As reported in previous filings, NetBank, FSB had joined with the otherclaimants in a motion for judgment on the pleadings, which motion was filed onJanuary 31, 2003, and is still pending before the MDL Court.  Meanwhile, discovery in the case has beenproceeding and fact discovery is now complete. Amendments to the pleadings are currently due 14 days after the MDLCourt rules on the motions for judgment on the pleadings.  NetBank, FSB has prepared an amendment andsupplement to its complaint to include additional claims against the Suretiesbased on discovery adduced and events that have occurred to date and plans tofile the amendment prior to the final date fixed by the MDL Court for filingamendments.  Furthermore, NetBank, FSBhas withdrawn its motion for judgment 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. If the Remand Motion is granted, the Nevada court would then decide theSummary Judgment Motion and, if necessary, proceed to trial on any remainingissues of fact. The Sureties have filed oppositions to the Remand Motion, andthey have argued that they don’t need to respond to the Summary Judgment Motionuntil an unspecified date in the future after the MDL Court rules on thepending Consolidated Motion for Judgment on the Pleadings.  NetBank, FSB has filed a motion, currentlypending with the MDL Court, to enforce or clarify the briefing schedule sothat, if the Remand Motion is denied, the Sureties will be required to respondpromptly to the Summary Judgment Motion.   The Company believes that based on the overall facts and circumstances,the defenses asserted by the Sureties will fail and that NetBank, FSB willultimately prevail on its claims.

 

Also, as reported in previous filings, on May 30, 2002, CMC filed forbankruptcy protection.  The bankruptcyproceeding is not a part of the consolidation of cases in Ohio.  On June 11, 2003, the Bankruptcy Court inCalifornia approved an amended settlement agreement (the “NetBank Agreement”)among NetBank, FSB, Lakeland Bank and the Trustee.   The NetBank Agreement resolves all claims ofthe Trustee with respect to the lease payments that were guaranteed by suretybonds and insurance policies issued by Safeco and Illinois Union, as well asall claims related to the surety bonds and insurance policies.  Inaddition to approving the NetBank Agreement, the Bankruptcy Court approved asettlement

 

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agreement between the Trustee and Royal (the “RoyalAgreement’).  Under the Royal Agreement,Royal has agreed, among other things, to fund litigation by the Trustee againstNetBank, FSB to avoid its interests in the leases that were guaranteed bysurety bonds issued by Royal, as well as NetBank, FSB’s interests in the suretybonds themselves.  On September 4, 2003,the Trustee filed a Complaint against NetBank, FSB as contemplated by the RoyalAgreement, seeking to avoid NetBank, FSB’s interest in the leases and suretybonds relating to the Royal guaranteed lease pools.  On May 6, 2004, NetBank, FSB filed a motionfor partial summary judgment against the Trustee.  The Trustee filed a motion for partialsummary judgment against NetBank, FSB on June 18, 2004.

 

At a status conference on July 15, 2004, theBankruptcy Court ordered a stay in the bankruptcy proceedings pending a hearingon July 30, 2004.  At that hearing theBankruptcy Court continued the stay as to all adversary proceedings andrequested the parties to attempt to mediate their disputes.  At a status conference on October 1,2004, the Bankruptcy Court lifted the stay of the adversary proceeding againstNetBank, FSB.  A hearing on NetBank, FSB’s and the Trustee’smotions for partial summary judgment was held on December 14, 2004.  On January 27, 2005, the Bankruptcy Courtentered its Memorandum Decision granting the Trustee’s motion for partialsummary judgment and denying NetBank, FSB’s motion for partial summaryjudgment.  The Bankruptcy Court enteredan order to that effect on February 28, 2005.   On April 27, 2005, the Bankruptcy Court entered a judgment conforming tothe Memorandum Decision.   On May 20,2005, the Bankruptcy Court entered an amended judgment conforming to theMemorandum Decision.  The BankruptcyCourt held in the Memorandum Decision that NetBank, FSB was required, butfailed, to perfect its security interest in the payment streams that were transferredto it from CMC in the subject transactions and that the subject transactionswere loans rather than sales.  Also onMay 20, 2005, NetBank, FSB appealed the amended judgment to the BankruptcyAppellate Panel for the Ninth Circuit Court of Appeals.  On May 25, 2005, NetBank, FSB sought a stay pendingappeal of the turnover provisions of the amended judgment from the BankruptcyCourt.  The Bankruptcy Court denied therequest for stay on August 1, 2005.  Weare considering our response to such denial. In the meantime, the parties to the bankruptcy action have resolvedtheir disputes and entered into a Global Settlement Agreement, which wasapproved by the Bankruptcy Court on May 31, 2005.  Pursuant to the Global Settlement Agreement,NetBank, FSB received a settlement payment of approximately $4 million.  In addition, the Global Settlement Agreementprovided that NetBank, FSB receive, retroactive to October 1, 2004, 100% of alllease payments made by lessees with respect to the underlying leasesthat were guaranteed by surety bonds and insurance policies issued by Royal,Safeco and Illinois Union.  Also,NetBank, FSB was relieved of any obligation to share with the Trustee anyfuture proceeds payable to NetBank, FSB byany of the Sureties.  However, the GlobalSettlement Agreement does not affect the amended judgment that is the subjectof the appeal to the Bankruptcy Appellate Panel.

 

NetBank, FSB intends to vigorously pursue its claims against all theSureties, including claims for any loss associated with the claims brought bythe Trustee against NetBank, FSB.  Atthis time, the Company is unable to express an opinion as to the likelihood ofloss, or the amount or range of potential loss, with regard to this matter.

 

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

 

On June 27, 2001, several lessees of equipment leased from CMC filedsuit in Los Angeles Superior Court against CMC and several John Doe defendantsalleging that the leases violated California usury laws, the CaliforniaFinancial Code, and the California Unfair Business Practices Act.  The plaintiff lessees were seeking to rescindor reform their obligations under the leases and were seeking to recoverstatutory damages and attorney’s fees. The plaintiffs subsequently amended their complaint to name NetBank,FSB, several other investor banks, and several surety companies asco-defendants in the action.  After CMCfiled for bankruptcy, the action was removed to the bankruptcy court in theCentral District of California, but the plaintiffs subsequently agreed towithdraw their claims against CMC and were successful in their motion to remandthe case back to state court.

 

On March 15, 2004, the Superior Court sustained demurrers and motionsto quash filed by NetBank, FSB and various other defendants on certain of theplaintiffs’ claims.  The Superior Courtsustained the demurrers under the California Financial Code, without leave toamend.  The Superior Court also sustaineddemurrers on the Unfair Business Practices Act, with leave to amend the claimsto add greater specificity to the claims, but without leave to amend as tounnamed representatives 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

 

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for restitution (the named plaintiffs may amend to establish individualentitlement to restitution); (3) plaintiffs’ request for disgorgement; (4)plaintiffs’ request for punitive damages; (5) plaintiffs’ request forcompensatory damages under the California Unfair Business Practices Act; and(6) plaintiffs’ request for attorneys’ fees.

 

On April 29, 2004, the plaintiffs served an amended complaint againstNetBank, FSB alleging claims for, among other things, violations of anothersection of the California Financial Code, unfair competition under Section17200 of the California Business and Professions Code and usury.  On October 26, 2004, the court overruled thedefendants’ 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 and weexpect 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 to pursuerecovery 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.

 

 

**Item 2.  UnregisteredSales of Equity Securities and Use of Proceeds**

 

In August 2002, the Board of Directors approved a plan torepurchase up to 1 million shares of the Company’s common stock. The plan wassubsequently increased by 1 million shares in October 2002, 2 millionshares in January 2003, 1 million shares in April 2004 and 1 millionshares in April 2005. As summarized below, repurchase activity for the threemonths ended June 30, 2005 included 174,665 shares repurchased at a weightedaverage cost of $8.45 per share.

 

The table below sets forth information regarding the repurchase ofshares of our common stock during the three months ended June 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 (1)** | ** ** | **Maximum Number (or Appropriate Dollar Value) of Shares (or Units)  that May Yet Be Purchased Under the Plans or Programs** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|-----------------------------------|------------|------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|
| Balance as of March 31,  2005   |       | 423,726                              |       | —                            |       | 423,726                                                                                              |       | 240,238                                                                                                                      |       |
| April 1 through April 30,  2005 |       | 59,500                               |       | $                                 | 8.29       |                                                                                                 | 59,500     |                                                                                                                         | 180,738    |   |
| May 1 through May 31, 2005      |       | 88,165                               |       | $                                 | 8.56       |                                                                                                 | 88,165     |                                                                                                                         | 1,092,573  |   |
| June 1 through June 30,  2005   |       | —                               |       | —                            |       | —                                                                                               |       | 1,092,573                                                                                                                    |       |
|                            |       |                                 |       |                              |       |                                                                                                 |       |                                                                                                                         |       |
| Total                           |       | 571,391                              |       | $                                 | 8.45       |                                                                                                 | 571,391    |                                                                                                                         |       |   |

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(1) As of August 1, 2005, 1,092,573 shares remained available forrepurchase under current Board authority.

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** **

**Item3.  DefaultsUpon Senior Securities**

** **

**                None.**

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**Item4.  Submissionof Matters to a Vote of Security Holders**

 

Our Board of Directors is divided into three classes that servestaggered three-year terms.  At the 2005Annual Meeting of Shareholders of NetBank, Inc. held on April 28, 2005, theshareholders elected the following persons to the Company’s Board ofDirectors.  Ms. Ghiglieri and Messrs. Freemanand Heard were elected to serve until the 2008 Annual Meeting of Shareholders,or until his or her successor is elected and qualified, by the votes indicatedbelow:

 

| **Name**               | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|------------------------|------------|------------|------------|--------------|------------|
|                   |       |       |       |         |       |
| J. Stephen Heard       |       | 40,617,533 |       | 846,406      |       |
| Douglas K. Freeman     |       | 40,524,986 |       | 938,953      |       |
| Catherine A. Ghiglieri |       | 40,614,650 |       | 849,289      |       |

 

Directors continuing in office until the 2006 Annual Meeting ofShareholders are Robin C. Kelton, Thomas H. Muller, Jr., David W. Johnson, Jr.,and Tamara L. Adler.  Directorscontinuing in office until the 2007 Annual Meeting of Shareholders are StuartM. Cable, Joel A. Smith, III and Eula L. Adams. The vacancy resulting from the resignation effective April 29, 2005 ofT. Stephen Johnson, whose term as director would have continued until the 2007Annual Meeting of Shareholders, has not been filled.

 

Also at the 2005 Annual Meeting of Shareholders, the shareholdersratified the appointment of Ernst & Young LLP as the Company’s independentauditors for fiscal year 2005 by the votes indicated below:

 

| **For**    | ** ** | **Against** | ** ** | **Abstained** | ** ** |
|------------|------------|-------------|------------|---------------|------------|
|       |       |        |       |          |       |
| 40,832,101 |       | 622,361     |       | 9,477         |       |

 

** **

**Item 5.  OtherInformation**

** **

**                None.**

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**Item 6.  Exhibits**

 

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.

#### ** **

#### **SIGNATURE**

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

 
|                  | NETBANK, INC. |
|-----------------------|---------------|
|                  |          |
|                  | By:           | /s/ Steven F. Herbert |
|                  |          | Steven F. Herbert |
| Dated: August 9, 2005 |          | *Chief Finance Executive  (Chief Accounting Officer)* |

 

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**INDEX TOEXHIBITS**

** **
| ** **          | ** ** | ** **                                                                                                                                       | ** ** | **Incorporated by Reference** | ** ** | ** **      |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------|
|                |       |                                                                                                                                             |       |                          |       |            |   |   |   |   |   |   |
| **Exhibit  Number** | ** ** | **Exhibit Description**                                                                                                                          | ** ** | **Form**                      | ** ** | **File Number** | ** ** | **Exhibit** | ** ** | **Filing****Date** | ** ** | **Filed Herewith** |
| ** **          | ** ** | ** **                                                                                                                                       | ** ** | ** **                    | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| 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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**† Thecertification attached as Exhibit 32.1 that accompanies this report is notdeemed 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 amemded, 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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