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An Online Bank That Could -- and Is

By Geoffrey Smith NetBank is an unlikely survivor. Online-only banks were almost doomed before they got started, and NetBank was among the smallest and least aggressive. I remember meeting CEO D.R. Grimes two years ago, when he confidently predicted he would not only produce steady revenue growth at his company but do it profitably.

Dream on, I thought. His peers in the industry were losing billions of dollars in startup money put up by venture capitalists. Some were getting skewered by online fraud. And every time a traditional bank launched a Web site offering even the most basic banking services online, another online bank failed, it seemed.

Now look at NetBank (NTBK). Profits jumped to $6.6 million last year, from a loss of $1.1 million in 2000. Deposits increased 50%, to $1.4 billion, on a corresponding 50% increase in accounts, to 245,000.

PLAIN VANILLA. With just $2.9 billion in assets, the company poses no threat to industry leaders. But while many large bank stocks languish amid fears of rising credit losses, NetBank's stock has been soaring. Trading around $16 a share as of Mar. 18, it has nearly tripled from its September low and is now near its 52-week high. The stock is valued at a price-earnings multiple of 34 times Wall Street analysts' consensus earnings forecast for 2002. That's far ahead of the average p-e ratio of 14 for large banks.

NetBank offers plain-vanilla financial services. Until last year, it had almost no borrowers. Most of its customers had simple checking accounts and money-market deposits. And simple has been good. NetBank appears to have achieved its growth without taking unusual risks. It does little direct lending, letting it sidestep the credit-quality problems that devastated one of its most prominent online banking peers, NextCard, which was recently shut down by the Federal Deposit Insurance Corp. NetBank offers credit cards, but only as an originator. It passes the credit risk onto First USA.

Most of the company's growth came the way most traditional bankers achieve theirs -- through acquisitions. Last year, it bought 50,000 accounts from former rival CompuBank. It also expanded its core business to include mortgage lending. Few online banking customers borrow money from their online bank. So to build its lending business, NetBank bought two mortgage lenders that sharply boosted the bank's fee income.

MASS APPEAL? Last year, NetBank paid $20 million to buy Florida mortgage lender Market Street Mortgage. Earlier this year, it bought another mortgage lender, Resource Bancshares Mortgage Group. The deals should put NetBank among the nation's top 20 mortgage originators.

One of the problems with Internet-only banks is the high marketing costs required to attract new customers. But last year, NetBank cut that expense by 55% from the previous year, while its application volume increased by 6%. It achieved that by taking advantage of lower costs for online banner ads, signing up marketing partners, including Federated Department Stores and Six Continent Hotels, and cross-selling to its mortgage customers.

No matter how productive its marketing strategy, NetBank will ultimately remain a niche player. It has no branches. Customers get access to their accounts exclusively through the Web or ATM machines. Deposits are made via U.S. mail, or a limited number of ATMs. If you want to make a cash deposit, NetBank suggests that you convert it to a money order first. This isn't the kind of business model that appeals to the mass market.

Still, it's proving to be a good business for NetBank. Wall Street expects its profits to jump 114% this year. Of course, any hint of bad news would send its shares tumbling. But for now, this tiny bank is coming up big. Smith covers online banking and finance from BusinessWeek's Boston bureau

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