November 30, 2004

It's not hard to notice that banks continue to add branch locations across the country. But that doesn't make the phenomenon easier to understand. "We frankly don't get it," said Douglas K. Freeman, chairman and CEO of NetBank (Alpharetta, Ga.; $4.7 billion in assets), speaking at a financial services conference sponsored by Sandler O'Neill & Partners. "If all of the demographic trends are for more Internet usage and less branch usage, we don't understand why people are opening more branches."

Already, according to Freeman, 31 percent of U.S. households use the Internet, and that includes many of the industry's most profitable customers. "As people get better educated and make more money, they're better financial customers," noted Freeman. "And, it appears statistically that they're more active Internet users."

Maybe the expanding banks aren't signing long-term leases, or maybe they're counting on coffee revenues. But once a customer switches to online banking, it gets harder for a bank to justify a physical presence. "When a customer starts paying bills online and has direct deposit, you truly reform their banking habits," Freeman said.

NetBank claims 272,000 customers, making it the largest branchless bank in the U.S. Its typical customer: a 43-year-old, time-starved professional in a two-income household, having an impressive account balance exceeding $11,000 at the bank, according to Freeman. "We believe it's a function of our customer base being more wealthy, more income-producing and better educated," he said. "The customers will consolidate more of their banking and financial products with us because of our value proposition, which is to pay them market rates of interest on their accounts."

Many of these customers have come from traditional banks, Freeman claims. "The best source of our customers is when Traditional Large Bank A tries to acquire Traditional Large Bank B and tries to force people to change branch locations," he told attendees. "The market is coming to us, and it's going away from bricks and mortar."

Even those who remain skeptical of the Internet business model in banking can't ignore the cost savings from eliminating real estate. "We run at about 50 percent of the cost structure of a typical bank," Freeman said.

As for those who are skeptical of dot-com leadership, Freeman concurs. "We are not Internet executives," he said. "We're banking executives that use the Internet to deliver our products and services."

Balancing the Business

Nevertheless, the banking business alone isn't enough to sustain market momentum. That's why Freeman envisions that the company will generate an equal amount of net income from three sources: banking, financial intermediary activities and transaction processing.

New initiatives include NetServe, which provides community banks with the ability to offer small-business banking services to their own customers, and a Check 21-enabled service to allow business customers to image their own checks. "It's going to revolutionize the industry in the same way as when we went away from paper acceptance in the credit card business," Freeman said.

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