Bankers are justifiably concerned about the financial health of their borrowers, and they should be equally concerned about the earnings performance of their technology providers.

With a few exceptions, Internet banking software developers and application service providers have reported second-quarter results. Though you would never know it from reading the headlines on their press releases, it was another financial bloodbath.

Self-described (and oft-quoted) Internet banking leaders such as S1 Corp., 724 Solutions Inc., Intelidata Technologies Corp., Corillian Corp., and Digital Insight Corp. managed to spend money far faster than they were able to earn it.

Collectively, these five "generation-d," "born on the Web" enterprises managed in three short months to lose $187.2 million on revenues of $83.1 million. To be fair, 81.7% of the loss belonged to S1. The other four together lost only slightly more than $34 million on revenues of just $24 million.

A million bucks isn't what it used to be, but one million multiplied by 34 or 187 is still a lot of dough to everyone except the Internet entrepreneurs who are fearlessly and feverishly spending other people's money.

These losses pose a substantial problem for bankers wrestling with Internet investment decisions.

Are these and other similarly situated New Economy enterprises (and, more importantly, their employees) going to be around to deliver on their sales promises and contractual obligations?

If the vendor's employees responsible for development, installation, and user training and support flee in the wake of a Chapter 11 filing, sale, or merger forced by profligate spending, the bank customers are going to suffer every bit as much as the investors.

The banking industry has been stiffed before - by companies with better track records. We recently witnessed Chase Manhattan suing Policy Management Systems (now Mynd) over a failed mortgage system project. If you have been involved with bank technology for more than five minutes, you know the EDS/Bank One/Norwest Strategic Banking System story - tens of millions down the chute on a never-quite-completed solution.

No one having the misfortune to experience it has forgotten the years of neglect at the hands of a perpetually strapped and habitually understaffed Unisys during the 1970s and 1980s. If the hardware and software they delivered did not work to specification, they would take the cheapest way out - delivering more equipment rather than fixing the old machines or paying the performance penalty.

The lessons are simple. Even companies with successful track records can have trouble. However, when vendors start feeling a financial pinch, their customers pay the ultimate price in the form of deteriorating performance.

No endorsement can guarantee a vendor's long-term viability. No contractual provision can prevent failure. Only thoughtful evaluation and thorough due diligence can reduce the risk associated with acquiring Internet products and services.

In addition to the information technology department's usual 20 pages of technical questions and user-requirement criteria for functions and features, here are some questions bankers should ask about a supplier's viability:

  • What do your lenders think of the vendor's income statement, balance sheet, and cash-flow statements? Would the bank lend it money?
  • Who are the senior executives of these enterprises, and what was their track record before hopping on the dot-com bandwagon?
  • Has the company consistently achieved its financial projections and met its product-introduction target dates?
  • What is the employee turnover rate in the past year?
  • How do they train new employees, especially in a rapidly expanding company?
  • What do all their clients - as opposed to their showcase installations or bank partners - have to say about after-sales service?

Though assessments by third-party researchers are useful and other banks' conclusions are helpful, there is no substitute for each bank's doing its own evaluation.Think of this as participating in a syndicated loan. No banker blindly accepts the evaluation of the agent bank; it has its own team look at the credit. Similarly, no banker should simply accept another bank's evaluation of Internet vendors.
Regional and community banks should be particularly skeptical of the largest institutions on the client list. Major institutions have a habit of behaving like Noah - accumulating two of everything. They can afford what amount to R&D expenditures. They have demonstrated a willingness to test systems on real customers and to subject them to continual disruption - an untenable approach for most of the industry.

Though it is difficult to resist the constant barrage of Internet hype, a painstaking assessment of the vendors who appear on your doorstep is both necessary and wise.

If you don't want to be left holding the bag when vendors wallow and then sink in the quagmire of unsustainable losses, take your time to do a thorough due diligence before spending another dollar on Internet banking solutions.

It's a buyer's market. Don't be rushed into making a decision.


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

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