Ivan,
I still can't figure out where is the problem....
$ sftp -vvv machnet@bat-bc2
Connecting to bat-bc2...
OpenSSH_5.1p1+sftpfilecontrol-v1.2-hpn13v5, OpenSSL 0.9.7m 23 Feb 2007
HP-UX Secure Shell-A.05.10.006, HP-UX Secure Shell version
debug1: Reading configuration data /opt/ssh/etc/ssh_config
debug3: Seeding PRNG from /opt/ssh/libexec/ssh-rand-helper
debug2: ssh_connect: needpriv 0
debug1: Connecting to bat-bc2 [10.3.4.17] port 22.
debug1: Connection established.
debug3: Not a RSA1 key file /home/machnet/.ssh/id_rsa.
debug2: key_type_from_name: unknown key type '-----BEGIN'
debug3: key_read: missing keytype
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug3: key_read: missing whitespace
debug2: key_type_from_name: unknown key type '-----END'
debug3: key_read: missing keytype
debug1: identity file /home/machnet/.ssh/id_rsa type 1
debug1: identity file /home/machnet/.ssh/id_dsa type -1
debug1: Remote protocol version 1.99, remote software version OpenSSH_5.2p1+sftpfilecontrol-v1.3
debug1: match: OpenSSH_5.2p1+sftpfilecontrol-v1.3 pat OpenSSH*
debug1: Remote is NON-HPN aware
debug1: Enabling compatibility mode for protocol 2.0
debug1: Local version string SSH-2.0-OpenSSH_5.1p1+sftpfilecontrol-v1.2-hpn13v5
debug2: fd 4 setting O_NONBLOCK
debug3: RNG is ready, skipping seeding
debug1: SSH2_MSG_KEXINIT sent
debug1: SSH2_MSG_KEXINIT received
debug1: AUTH STATE IS 0
debug2: kex_parse_kexinit: diffie-hellman-group-exchange-sha256,diffie-hellman-group-exchange-sha1,diffie-hellman-group14-sha1,diffie-hellman-group1-sha1
debug2: kex_parse_kexinit: ssh-rsa,ssh-dss
debug2: kex_parse_kexinit: aes128-cbc,3des-cbc,blowfish-cbc,cast128-cbc,arcfour128,arcfour256,arcfour,aes192-cbc,aes256-cbc,rijndael-cbc@lysator.liu.se,aes128-ctr,aes192-ctr,aes256-ctr
debug2: kex_parse_kexinit: aes128-cbc,3des-cbc,blowfish-cbc,cast128-cbc,arcfour128,arcfour256,arcfour,aes192-cbc,aes256-cbc,rijndael-cbc@lysator.liu.se,aes128-ctr,aes192-ctr,aes256-ctr
debug2: kex_parse_kexinit: hmac-md5,hmac-sha1,umac-64@openssh.com,hmac-ripemd160,hmac-ripemd160@openssh.com,hmac-sha1-96,hmac-md5-96
debug2: kex_parse_kexinit: hmac-md5,hmac-sha1,umac-64@openssh.com,hmac-ripemd160,hmac-ripemd160@openssh.com,hmac-sha1-96,hmac-md5-96
debug2: kex_parse_kexinit: none,zlib@openssh.com,zlib
debug2: kex_parse_kexinit: none,zlib@openssh.com,zlib
debug2: kex_parse_kexinit:
debug2: kex_parse_kexinit:
debug2: kex_parse_kexinit: first_kex_follows 0
debug2: kex_parse_kexinit: reserved 0
debug2: kex_parse_kexinit: diffie-hellman-group-exchange-sha256,diffie-hellman-group-exchange-sha1,diffie-hellman-group14-sha1,diffie-hellman-group1-sha1
debug2: kex_parse_kexinit: ssh-rsa,ssh-dss
debug2: kex_parse_kexinit: aes128-ctr,aes192-ctr,aes256-ctr,arcfour256,arcfour128,aes128-cbc,3des-cbc,blowfish-cbc,cast128-cbc,aes192-cbc,aes256-cbc,arcfour,rijndael-cbc@lysator.liu.se
debug2: kex_parse_kexinit: aes128-ctr,aes192-ctr,aes256-ctr,arcfour256,arcfour128,aes128-cbc,3des-cbc,blowfish-cbc,cast128-cbc,aes192-cbc,aes256-cbc,arcfour,rijndael-cbc@lysator.liu.se
debug2: kex_parse_kexinit: hmac-md5,hmac-sha1,umac-64@openssh.com,hmac-ripemd160,hmac-ripemd160@openssh.com,hmac-sha1-96,hmac-md5-96
debug2: kex_parse_kexinit: hmac-md5,hmac-sha1,umac-64@openssh.com,hmac-ripemd160,hmac-ripemd160@openssh.com,hmac-sha1-96,hmac-md5-96
debug2: kex_parse_kexinit: none,zlib@openssh.com
debug2: kex_parse_kexinit: none,zlib@openssh.com
debug2: kex_parse_kexinit:
debug2: kex_parse_kexinit:
debug2: kex_parse_kexinit: first_kex_follows 0
debug2: kex_parse_kexinit: reserved 0
debug2: mac_setup: found hmac-md5
debug1: REQUESTED ENC.NAME is 'aes128-cbc'
debug1: kex: server->client aes128-cbc hmac-md5 none
debug2: mac_setup: found hmac-md5
debug1: REQUESTED ENC.NAME is 'aes128-cbc'
debug1: kex: client->server aes128-cbc hmac-md5 none
debug1: SSH2_MSG_KEX_DH_GEX_REQUEST(1024<1024<8192) sent
debug1: expecting SSH2_MSG_KEX_DH_GEX_GROUP
debug2: dh_gen_key: priv key bits set: 138/256
debug2: bits set: 521/1024
debug1: SSH2_MSG_KEX_DH_GEX_INIT sent
debug1: expecting SSH2_MSG_KEX_DH_GEX_REPLY
debug3: check_host_in_hostfile: filename /home/machnet/.ssh/known_hosts
debug3: check_host_in_hostfile: match line 1
debug3: check_host_in_hostfile: filename /home/machnet/.ssh/known_hosts
debug3: check_host_in_hostfile: match line 2
debug1: Host 'bat-bc2' is known and matches the RSA host key.
debug1: Found key in /home/machnet/.ssh/known_hosts:1
debug2: bits set: 490/1024
debug1: ssh_rsa_verify: signature correct
debug2: kex_derive_keys
debug2: set_newkeys: mode 1
debug1: SSH2_MSG_NEWKEYS sent
debug1: expecting SSH2_MSG_NEWKEYS
debug2: set_newkeys: mode 0
debug1: SSH2_MSG_NEWKEYS received
debug1: SSH2_MSG_SERVICE_REQUEST sent
debug2: service_accept: ssh-userauth
debug1: SSH2_MSG_SERVICE_ACCEPT received
debug2: key: /home/machnet/.ssh/id_rsa (40031c98)
debug2: key: /home/machnet/.ssh/id_dsa (0)
debug1: Authentications that can continue: publickey,password,keyboard-interactive
debug3: start over, passed a different list publickey,password,keyboard-interactive
debug3: preferred publickey,keyboard-interactive,password
debug3: authmethod_lookup publickey
debug3: remaining preferred: keyboard-interactive,password
debug3: authmethod_is_enabled publickey
debug1: Next authentication method: publickey
debug1: Offering public key: /home/machnet/.ssh/id_rsa
debug3: send_pubkey_test
debug2: we sent a publickey packet, wait for reply
debug1: Authentications that can continue: publickey,password,keyboard-interactive
debug1: Trying private key: /home/machnet/.ssh/id_dsa
debug3: no such identity: /home/machnet/.ssh/id_dsa
debug2: we did not send a packet, disable method
debug3: authmethod_lookup keyboard-interactive
debug3: remaining preferred: password
debug3: authmethod_is_enabled keyboard-interactive
debug1: Next authentication method: keyboard-interactive
debug2: userauth_kbdint
debug2: we sent a keyboard-interactive packet, wait for reply
debug2: input_userauth_info_req
debug2: input_userauth_info_req: num_prompts 1
Password: