ING Direct: Bare Bones, Plump Profits

ING Direct is now the largest online bank, and competitors are starting to pile in

ING Direct floods mailboxes with $25 checks for signing up. It operates a chain of trendy cafés. And its favorite color is orange. Is this any way for a savings bank to behave?

For an online bank that opened in the U.S. less than five years ago, so far it is. In that time, ING has collected 2.2 million U.S. customers and $29 billion in deposits. No mystery there: the bank aims to pay the highest rates on savings accounts, 2.6% now, vs. 0.56% for the average money-market account at a bank. And lots of money goes into making sure everyone knows it. Last year, ING Direct, a division of Dutch financial-services giant ING Group, became the largest online bank -- passing E*Trade Bank (ET ) -- and the fourth-largest thrift in the U.S., according to Charlottesville (Va.)-based research firm SNL Financial.

Paying high rates? Spending tons on marketing? Seems like a recipe for red ink. Instead, profits are rising. ING Direct's U.S. division (it also operates in eight other countries) says it earned a pretax profit of $250 million last year, up from $110 million in 2003. The high-volume, low-margin business depends on using online efficiencies to offer a bare-bones service to low-maintenance customers. The bank doesn't offer checking accounts -- that costs too much -- and has almost no bricks and mortar, just four of the cafés that promote the bank, in New York, Philadelphia, Los Angeles, and Wilmington, Del. What's more, a converted Wilmington warehouse serves as its U.S. headquarters, in contrast with its parent's digs in a gleaming sneaker-shaped Amsterdam structure known as "the shoe." Says Arkadi Kuhlmann, who runs ING Direct's U.S. division: "We can't be avant-garde and glitzy, so we might as well be retro and unique."

But ING Direct isn't so singular anymore. Attracted by the Dutch invader's easy success, competitors are crowding into the market. MetLife launched an Internet bank in late 2002 and has been heavily promoting its high rates -- now 2.5% on savings. New York's Emigrant Savings Bank opened one in January and is pushing a 3% rate.


Rising short-term interest rates present another hurdle, even though they're likely to attract more customers. Because long-term rates aren't climbing at the same pace, income from ING's loans and investments, mostly in mortgage securities, won't rise as fast, squeezing the bank's already tight profit margins. Many large banks delay hiking the rates they pay on deposits to get more mileage out of rate spreads, but online banks don't have that luxury, says Eric Reinford, an analyst at SNL. Indeed, Kuhlmann says its customer-attrition rates are half that of other banks, but rising rates will "put that to the test."

One more challenge: ING Direct is trying to expand into new products to keep growing. It is ramping up its mortgage business and next month will air a 30-minute TV infomercial promoting adjustable-rate loans. But for other Internet banks, such as Britain's Egg, diversification brought trouble. "Now that they've captured a lot of customers, the key is to cross-sell and increase customer loyalty," says Keith MacDonald, a partner at consulting firm Capco.

Not to worry, says Kuhlmann, a smooth and seasoned banker who has run the U.S. division since it began. He points out that all banks must deal with the shrinking spread between short- and long-term rates. And ING Group Chief Executive Michel Tilmant expects the new U.S. rivals to attract more customers to online banking and ING Direct. "We feel we have a head start," he says. His biggest concern is making sure the bank keeps paying attention to basic details as it continues to grow quickly. It's a concern other banks would love to have.

By Amey Stone in New York

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