The new crop of "Net banks" operating exclusively on the Internet face what may prove insurmountable challenges, according to a new study.

The businesses have limited offerings and therefore limited profit opportunities, said analysts at First Security Van Kasper.

In one of the first reports to weigh in on these business, the analysts urge investors to sell their shares of Net.Bank and Telebanc.

The analysts find more opportunities for traditional banks to prosper.

"Through Internet delivery, Net banks hope to achieve cost savings that can be returned to the customer in the form of better rates and fees," said Van Kasper analyst Jeff Runnfeldt.

"In our view the appeal of these new banks will remain severely limited to a relatively small niche group of highly rate-sensitive customers who are willing to accept certain inconveniences and do not have sophisticated loan or service requirements," Mr. Runnfeldt said.

By dispensing with brick-and-mortar facilities, the Net banks lose the relationship approach to lending, in which loan officers review business plans and borrowers can sign loan documents, Mr. Runnfeldt said.

The Net banks have higher funding costs and lower-yielding investment strategies that cause their unimpressive margins to run at only a third to a half the industry average, Mr. Runnfeldt said.

And fee income has so far been modest.

Unless the branchless banks can improve their revenues, they will have to make unrealistic cuts in their expense-to-assets ratio just to approach industry average returns of 1.2% on assets and 15.7% on equity. That makes industry-leading profitability appear unobtainable, said analyst Joseph K. Morford, who co-authored the report.

The Net banks account for less than 2% of the U.S. on-line banking customer base, and regional banks are rapidly widening the gap.

The Net banks steadfastly maintain they will succeed.

"The banking market is huge," said D.R. Grimes, vice chairman and chief executive of Net.Bank. "What we are looking for is a segment of the market that is interested in higher interest (accounts), lower fees, and the flexibility and convenience of banking on the Internet."

The company recently began a $3.6 million marketing campaign, which is helping fuel a sharp rise in deposits. The Atlanta company reported that deposits increased to $333 million at the end of the first quarter from $129 million a year earlier.

Nonetheless the blunt Van Kasper report may have made an impression on investors. The report was issued issued May 17. Net.Bank shares, which traded then at $59.67, are now around $43. Telebanc shares, $92.25 when the report came out, are now around $66.

Meanwhile banks large and small say they are getting more involved with Internet banking.

John S. Reed, chairman of Citigroup Inc., speaking at the 51st annual New Jersey Business Conference, said, "The market is telling us the Internet is an immensely powerful vehicle in its reach to customers and its low marginal cost."

"If you run a business on the Internet," he said, the market "will value you at two or three times what it is valuing your earnings right now. If you can't take your business into that medium, it is not going to value your earnings that highly."

Among regional banks, First Tennessee National Corp., is signing up customers for its Internet banking site at the rate of 1,000 a month, said Ralph Horn, president and chief executive officer.

The bank has 18,000 Internet users, representing more than $450 million of deposits. The bank, using the Internet as one of several banking methods, boasts a customer retention rate of about 97%.

"We see all the different delivery channels as playing a big piece in building and keeping that relationship," Mr. Horn said.

"That has allowed us to have one of the highest retention rates of our target customers.

According to the Van Kasper analysts, traditional banks have many opportunities in cyberspace.

The most auspicious is electronic bill payment, in which bills are issued and paid over the Internet.

"This promising new product has the ability to gain relatively near-term mass adoption and could become the first major attraction to further broaden the on-line banking customer base while also generating more frequent usage," Mr. Runnfeldt said.

Traditional banks can also use the Internet as a convenience to customers, the analysts said.

An Internet site can be a "virtual bank" that provides nearly anything offered in the bank, such as checks, loans, and new accounts.

Another opportunity is what the analysts call a "financial portal," where customers can electronically tap into services related to personal finance, such as stock brokerage, asset management, insurance, and tax planning.

The analysts said banks probably have little if any choice but to expand onto the Internet as fast as possible.

Sean Ryan, a banking analyst with Bear, Stearns & Co. who hosted a panel discussion on Internet banking this month, said staying on the sidelines could be costly for banks.

Banks' unwillingness to venture into new areas "led them to lose their historic stranglehold on the asset management business," Mr. Ryan said.

"It will be interesting to see if banks make the same mistake again."

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