When NetBank Inc. acquired Compubank's deposit business last March, the deal highlighted an underlying weakness in Internet-only banking. After nearly three years, Compubank had 57,000 accounts and $75.7 million of deposits but had failed to become profitable before brick-and-mortar banks started rolling out their own Web services.
The market could accommodate some pure-play Internet banks, industry observers and experts said at the time of the deal, but not all of the roughly three dozen that were operating then. Atlanta's NetBank, a large and profitable institution by Web-banking standards, was one they predicted would succeed.
Almost a year later securities analysts are still generally upbeat about NetBank's prospects, though there are few signs in its financial reports that the Compubank deal made a difference. NetBank, with $2.5 billion of assets, has reported a string of consecutive quarterly profits, but they were slim, at least through the third quarter of last year.
D.R. Grimes, NetBank's chief executive officer, said the most promising result of the Compubank deal has been opportunity to boost the balances of individual account holders and to sell additional products to new customers.
There were signs of that in the third and fourth quarters, when average balances per account rose modestly. Compubank accounts, which had far lower balances than NetBank accounts ($1,328 compared with $6,000 when the deal was struck) initially pulled NetBank's averages down to about $5,172. That figure rose, however, to $5,603 at the end of the third quarter and $6,122 at yearend.
Mr. Grimes said he is confident the acquisition will pay off.
"We're going to see higher profits," he said, "because when I can sell an existing customer an account, it's going to cost me a lot less than the $100 it costs me to get a new customer."
As banking mergers and acquisitions go, the thinking behind NetBank's purchase of Compubank's deposit business was fairly straightforward.
"Compubank was going under," said Todd Halky, an analyst with Putnam Lovell Securities Inc. "NetBank bought the accounts at a cheap rate."
NetBank paid $4 million for the mostly checking-account book of business. After spending $1.1 million to convert the accounts to its own systems, NetBank put the total cost of acquisition at $110 per account. That is roughly the same as from standard marketing efforts.
Mr. Grimes said the average balance on former Compubank accounts has increased by 43% since the acquisition, a difference that he attributes to NetBank's paying higher interest rates than Compubank did. In addition, he said, enrollment in electronic bill payment services has grown by 25% among former Compubank customers - which ought to make them more profitable than customers who continue to use paper checks.
But integration of the Compubank accounts into NetBank went poorly for as many as 5,000 customers whose accounts were frozen last May during a review of documents to confirm their identities. NetBank sought to verify basic data, such as addresses and Social Security numbers, to fulfill its "know your customer" obligations, Mr. Grimes said. It froze accounts when it was unable to reconcile problematic information and unable to contact the account holders, he said.
For weeks the bank was assailed on Internet chat boards for its handling of the account review. And three former Compubank customers have since sued NetBank in U.S. District Court in Seattle, alleging that NetBank violated the Expedited Funds Availability Act, which dictates the time banks have to clear deposits and make funds available.
Keith S. Dubanevich, the lawyer representing the former Compubank customers, is seeking class-action status for the case, which would enable it to include other similarly affected customers. Mr. Dubanevich, a partner at Garvey, Schubert & Barer in Portland, Ore., said that he did not know the extent of damages that a class action would seek, but that the Expedited Funds Availability Act allows judges to award total damages in such a case of up to $500,000 beyond those sustained by claimants.
Mr. Dubanevich said NetBank should have finished its account review before completing the purchase. Then the bank could have discarded any problematic accounts, he said.
Neither industry analysts nor Mr. Grimes say they are particularly worried about the suit, and Mr. Grimes argued that given Compubank's rapidly declining financial condition, which resulted in its filing for bankruptcy protection just a week after selling the deposit business, NetBank did not have enough time to handle the review any differently.
And luckily for NetBank, "the lawsuit is not attracting a lot of press," said Paul Miller, an analyst with Arlington, Va.-based Friedman, Billings, Ramsey & Co.
Poorly handled merger integration has spelled big trouble for banks in the past, but Mr. Grimes said NetBank has experienced no additional fallout from the situation. New-account applications have remained steady throughout the past year, he said.
This is actually somewhat difficult to assess. In the first two quarters of 2001 the company reported a 43% increase in its number of accounts: to 232,000, from 162,000 on Dec. 31, 2000. In the third quarter it reported no growth at all, and by the end of the fourth quarter the total was 245,000.
The key to understanding the growth pattern, Mr. Grimes said, is that his bank started imposing some fees in late 2000 to encourage customers to do their banking entirely online. For example, he said, it began charging $3 a month for mailing paper statements. Many customers closed accounts as a result of this and other fees, he said, with the largest number of customers acting last summer.
"Because our accounts were completely free from the beginning," Mr. Grimes said, "we had many people set up three or four accounts." In addition, he said, some people held both NetBank and Compubank accounts, and kept only one after the sale.
In other acquisition deals last year, NetBank bought Market Street Mortgage, a Clearwater, Fla., mortgage banking company, from Republic Bancorp of Ann Arbor, Mich., for $4 million in a cash and stock deal worth $15 million at the time of closing.
With 42 offices in 10 states, Market Street had originated $1.2 billion in mortgages last year before it was purchased in June.
In November, NetBank announced that it would buy Resource Bancshares Mortgage Group Inc., a Columbia, S.C., wholesale mortgage lender, in an exchange of stock. Under the terms of the deal, each Resource share will be swapped for 1.1382 NetBank shares. (That worked out to $165 million when the deal was announced.)
Resource produced $12 billion of loans last year and had a servicing portfolio of $8 billion at yearend. Most significantly, perhaps, Mr. Grimes will cede the CEO spot to Douglas K. Freeman, currently Resource's chief. The deal is expected to close in the spring; afterward, Mr. Grimes will be the combined company's vice chairman.
The logic behind both mortgage-company deals, analysts say, is that NetBank gets higher-yielding assets and the mortgage companies gain access to lower-cost funding. Before acquiring Market Street, NetBank's assets were mostly mortgage-backed securities.
With one mortgage deal done and the next in the hopper, NetBank's asset picture is "starting to look like it was supposed to look all along," said Kevin Reynolds, an analyst with Morgan Keegan & Co. Inc. "I think we're going to look back in a couple of years and say, 'Wow, look at the moves they made.' "
NetBank may need that couple of years. Through the first three quarters of 2001 it had a net interest margin of 2.13%, an efficiency ratio of 93%, return on assets of 0.20% and return on equity of 1.83%.
Figures like those suggest bleak prospects, said Tom McGrath, a managing partner at Bank Earnings International LLP, an Orange, Va., consulting firm. The underlying problem, Mr. McGrath said, is that consumers can get just about everything NetBank offers at traditional banks.
"There's nothing in a stand-alone Internet bank that represents a compelling case," he said. "And if you need to go into a branch and you need to talk to someone, you can't do it."
Mr. Grimes said NetBank differentiates its offerings from those of traditional banks with higher interest rates; integrated banking and brokerage services that debit customers' checking accounts when they purchase investments and credit them when they sell or receive distributions; and account aggregation services that use a single log-on.
That is enough for NetBank to hold its share of a growing Web-banking market, Morgan Keegan's Mr. Reynolds said.
Mr. McGrath said he thought otherwise - and that he is unimpressed with either the Compubank or the mortgage deals.
"This is an online savings and loan of the oldest type," he said.
