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It's time to keep an eye on




This Georgia-based Internet bank has quietly amassed $2.9 billion in assets and 245,000 accounts in all 50 states and 20 foreign countries. After searching for its niche, NetBank is showing signs of maturity and looks poised to become a full-service financial services firm.

A Solid Base

The company recently reported fourth-quarter profits of 10 cents a share, beating estimates by 3 cents. Net interest income increased 29% from the third quarter, and new accounts were 6% higher than the third quarter and 51% higher than a year ago.

As NetBank has become more widely known and accepted, its need to pay high rates to attract deposits has declined. Net interest margin improved to 2.38% in the fourth quarter from 2.09% in the prior quarter.

Another bright spot for NetBank was the continued integration of Market Street Mortgage, a residential mortgage lender, acquired last June. In the fourth quarter, Market Street originated nearly $750 million in loans, up from $568 million in the third quarter. In the fourth quarter, 65% of originations were for new homes as opposed to refinancings. In all, Market Street originated $2.5 billion in mortgages in 2001.

With its focus on home lending, NetBank's credit quality is bolstered by its large portfolio of mortgages. Non-accrual loans are only 0.72% of total loans, and net chargeoffs were only 0.18% in the fourth quarter, all healthier than the average traditional thrift.

Getting Stronger

Besides solid fourth-quarter performance, NetBank shareholders have even more reason to be optimistic: A number of initiatives slated for 2002 should help push the stock higher.

First, NetBank's integration of

Resource Bancshares Mortgage Group


should be a catalyst for higher earnings this year and beyond. The two companies simply complement each other very well.

"NetBank is a liquidity generator for low-cost deposits of customers serviced via the Internet and non-branch outlets such as ATMs," says Christopher Marinac, director of financial services research at SunTrust Robinson Humphrey. "Resource Bancshares is an asset creator primarily of residential mortgages and consumer finance loans."

As a standalone company, NetBank has deposits, but a lack of lending mass to earn competitive margins. Conversely, Resource Bancshares has significant loan volume, but has to use high-cost funding and produces lower-than-average margins.

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Bring NetBank's deposits together with Resource Bancshares' loans, and you get instant earnings leverage. "The marriage of NetBank and Resource Bancshares solves each other's problems immediately," says Marinac. He rates the stock an outperform, and his firm has not provided banking services for NetBank.

Marinac thinks the merger, scheduled to close in March, will add 30 cents to NetBank's 2002 per-share earnings and even more in 2003. He expects Resource Bancshares to originate about $8 billion in new mortgage loans in 2002, even after accounting for reduced activity as interest rates stabilize and refinancings slow.

He also notes that Resource Bancshares brings to NetBank a consumer finance division, EquiCredit, which originates nonconforming loans that traditional banks avoid. Resource also serves as a preferred mortgage lender for the Independent Community Bankers Association, an organization of small banks that do not have full-time mortgage lenders. NetBank has indicated it expects this business to grow significantly once the merger closes.

Banking on the Future

Although NetBank's 2001 results were a step in the right direction, further growth and stock price performance depend on execution and a little help from the economy.

The best economic situation for NetBank is a slow, steady recovery. A protracted downturn could challenge credit quality, especially if unemployment continues to rise and the housing market softens significantly. Conversely, a sharp uptick in economic activity could lead to higher interest rates and an unexpected decline in home mortgage origination, a key contributor to NetBank's future earnings growth.

The company has made strides over the past two years in establishing a reputation as something more than a dot-com fad, but it still has to fight the stigma of being a "bank without branches." Its continued success depends on its ability to attract customers.

Nevertheless, Marinac thinks the potential of the Resource acquisition will captivate investors as the year progresses, and that provides an opportunity for multiple expansion.

"The stock sells at 23 times 2002 estimates, but only 13 times 2003 estimates," he says. "As integration between NetBank and Resource occurs, we expect confidence to grow and greater weight to be placed on 2003 projections. Assuming our $1 estimate is within reason, we think the stock receives a minimum high-teens multiple on 2003 earnings."

I'm also enthusiastic about the Resource merger, and I like the prospects of NetBank's internal growth as Internet banking is viewed more as a convenience than as a fad. The stock looks fairly valued in the short term, and I'd like to buy it below $12. Investors looking for a longer-term pure-growth vehicle in the financial services sector should consider NetBank. I give it three barrels.

For an explanation of our barrel rating system, see our recent description.

Over a Barrel

If you had any doubt that the recent market selloff has impacted small-caps, just take a look at the changes in the Bottom of the Barrel portfolio. I'll examine many of these stocks in-depth in the coming weeks, but a few comments are in order.

I've mentioned in previous columns that I was likely early on

Quanta Systems

(PWR) - Get Quanta Services Inc. Report

, and that is now confirmed. Combine the slide of power companies, the ongoing challenges in the telecom sector and the general small-cap doldrums, and Quanta is now down 23% in less than a month. Despite this frustration, the stock looks to have support around $12, although I'm trying to get comfortable with expectations for earnings, which are due Feb. 14. More on this one next week.

I see little except the general market to explain the decline in



. And take a look at the earnings from

Witness Systems


, announced Monday. With a solid quarter, it remains a solid stock.

Do you have candidates for Bottom of the Barrel? If so, shoot me an email with the company's name, why you think it qualifies and your full name and hometown. If I profile your suggestion, I'll send you a


gift to commemorate your pick.

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to

Chris Edmonds.