No one expects a company to release an earnings statement that stresses its failures and weaknesses. But in NetBank’s case, the ever-widening gap between wildly spun misdirection and anything resembling a rational discussion should concern anyone trying to distinguish actual profit potential from dubious business practices.

To read its latest earnings announcement, you’d think NetBank is a tremendous success. Ironically, the accompanying financials tell the real story of a company with substandard financial performance. In truth, NetBank’s claim of another profitable year relies on booking a series of non-recurring gains, not on producing more income from operations than it spent to earn the money.

The simple, irreducible fact is that while NetBank’s assets increased by nearly 47%, its interest and non-interest expenses to generate this book of business grew by more than 110% during the same period.

It is worth noting that its 70% increase in revenue was accompanied by an 82% increase in salary costs, a 117% increase in information technology expenses, a 118% increase in occupancy expense, and a 78% increase in marketing expenditures.

NetBank’s efficiency ratio for 2000 ballooned to 105% for the year and was still moving in the wrong direction — to nearly 110% — in the fourth quarter. It cost NetBank nearly twice what it costs the average thrift peer institution to generate the same dollar of income.

NetBank may have added 96,000 net new accounts — an impressive 146% increase. But a category of expenditures, poorly defined as “customer service,” shot up 173% (an increase of more than $8 million), presumably to service the new work load.

As a result of such expenditures increasing faster than income was being produced, operating profits declined 155%, from a profit in 1999 to a loss of $2.4 million before a tax credit and special items in 2000.

This is unacceptable for a bank — at least if the goal is to make money by running a financial enterprise as opposed to generating gains by swapping equity for convertible debt.

Face it: There is no mathematical formula that will yield a positive earnings number if NetBank continues to generate results in these same proportions. It is not insignificant that all these results are worse than the small profit generated in 1999.

In the face of this obvious financial carnage, chief executive officer D.R. Grimes steadfastly maintained his position that “NetBank continues to demonstrate that the Internet banking model is a profitable business model.”

Not in real banking. If a traditional bank produced such results and attempted to paper over inadequate operating earnings with an accounting gimmick, the pressure from analysts would be swift, intense, and unrelenting. Just ask any CEO who has been criticized for adjusting a loss provision or booking a large security gain or otherwise generating a net earnings number for the sake of meeting analysts’ expectations.

An announcement from a real bank that produced such results would be greeted with extreme skepticism if not downright hostility. The bank’s executives sure wouldn’t be joshing with analysts — as Mr. Grimes did during his analyst call — about the legality or illegality of providing earnings guidance. They would be justifiably pilloried for not knowing what the bank’s net interest margin was or is, and would have been crucified for an unintelligible response to an analyst’s question about exploding costs for customer service.

It is high time someone called NetBank’s bluff. It is bloated and is increasingly inefficient. Were it not for the good timing of its original initial public offering, this Internet bank would not have had the capital to retire debt to create accounting gains and a profit mirage. Such good fortune has nothing to do with good planning, banking savvy, or a sustainable business model.

The real story about NetBank’s performance is not in its marketing hyperbole. It’s in the Internet bank’s balance sheet and income statement. All the extraneous blather about its new products, affinity relationships, and extending services through various networks amounts to nothing more than disinformation intended to distract us from the truth.

Mr. McGrath is managing partner of Bank Earnings International LLP, a financial services consulting firm in Orange, Va.

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