Touted as the world’s first Federal Reserve Board-approved internet bank, Security First Network Bank (SFNB) was one of 1996’s hottest internet IPOs. The $48.8 million deal, sole-managed by Friedman Billings Ramsey, a Virginia-based investment-banking boutique, was priced at $20 a share. Some early investors may have done well, as the share price more than doubled to $45 soon after launch. But the virtual bank, which had garnered only about $55 million in deposits by the end of 1997, was just a little too far ahead of its time. The Atlanta-based company focused on developing its widely acclaimed software, and didn’t have anything left over to build the bank. Losses for 1996 and 1997 totalled $50 million, $3 million more than SFNB had raised during the public offering. The stock sank into the single digits last year.
Royal Bank of Canada came to SFNB’s rescue last month, agreeing to buy the banking assets for $13 million, a small premium above book value, but little comfort to investors in the IPO. Shares only managed to climb back to just over $13, on news that a sale was planned. SFNB’s software-development subsidiary, Security First Technologies (S1), will retain its independence. The bank had been founded by two brothers-in-law: James McMahan, CEO of Cardinal, a Kentucky thrift holding company; and Michael McChesney, CEO of software company Five Paces which had developed computer security for computer maker Hewlett Packard. To start the bank, they spun out assets from a branch of the Kentucky thrift.
SFNB raised $14 million last summer by licensing its technology to a number of US banks, including Citicorp. The technology is being used by 22 US institutions in their proprietary banking websites. As part of last month’s deal, Royal Bank of Canada also paid $7 million in technology licensing and consulting fees to S1.
Internet junkies bemoaned the sale as a blow to the notion of stand-alone internet banking. But for Royal Bank of Canada, buying SFNB solved a dilemma. “We had been trying for a long time to get into the US market, in a non-wholesale banking sense,” says James Rager, executive vice-president for personal financial services. “And we had come to the conclusion that a major acquisition of a US retail banking operation was pretty much out of the question because of the high premium it would command, given the high cost of a branch network.” Branchless consumer banking has always seemed alluring. But for Royal, possibly the most valuable of SFNB’s assets were its banking license from the Federal Reserve Board, and its FDIC insurance, allowing it to take deposits.
The sale no doubt relieved the regulators, who were miffed by the use of SFNB’s banking charter as a showcase for developing the technology that drained its coffers. SFNB president Eric Hartz says that this was not the bank’s original intent. But when a second US internet bank, Atlanta Internet Bank, or Net.B@nk, went public last summer, again seeking Fed approval and FDIC backing, it was specifically prohibited from developing software. “After what happened at SFNB, the regulators wanted to avoid those problems,” says analyst John Moore at Morgan Freeman, the small regional bank that launched Net.B@nk’s IPO.
SFNB’s purchase by a foreign institution highlights one of the internet’s more compelling characteristics: its lack of geographic boundaries. One of the main differences between internet banking and its predecessor, PC or on-line banking, is the ability of internet banking consumers to tap into any computer in the world, type in their password, access their accounts, pay bills, and transfer money. “We have customers in every state in the United States and we believe on every continent in the world. We once had a customer in Antarctica,” says a spokesperson at SFNB.
According to bankers who have bought into S1’s technology, it is consumer friendly and capable of storing years’ worth of banking data. Security, long a worry about the internet, is state-of-the-art, and SFNB offers a “no-risk guarantee” against fraud, something that Citibank doesn’t offer on its on-line banking website.
Market research has targeted several underserved market segments, notably small to medium-size businesses. Moreover, Rager says that these customers tend to prefer “remote channels” because “they are busy and are in fast-paced industries. They don’t have the time to go to the bank and talk about these things.”
But the fact remains that internet banking has been a hard sell, while at the same time companies such as e*Trade, which offer on-line trading for individual investors, have taken off. Hartz, a former McKinsey consultant, admits that the economics of on-line banking aren’t as great as with on-line trading. “It’s easier to say you will save $70 a trade,” he says, referring to e*Trade’s discount stock trading. By contrast internet banking has to be sold more on convenience. “When I say you’ll save all this time in banking, it’s a harder story to sell,” says Hartz.
Hartz, who will remain as president, promises a marketing effort to build up SFNB. But so far, above-market rates on money-market accounts and CDs haven’t done the trick. And while most of the company’s losses were related to technology development, the banking operations themselves also reported a $689,000 loss for 1997 and a $4.2 million loss the year before. Only the sale of SFNB’s former Kentucky thrift assets earlier last year narrowed 1997’s banking losses. CFO Robert Stockwell says it would take $300 million in deposits to make the internet bank profitable.
SFNB and Royal Bank of Canada clearly need to offer more to reach critical mass. “We’re kind of a bank today but the real vision is to handle all your financial needs,” says Hartz. It is already lending out of Atlanta, where the bank has an office, and plans to offer mortgage loans, insurance and even brokerage through its website later this year. That would be one up on e*Trade. “It will allow people to buy and sell securities and pay for them through internet banking,” says Rager. “That would be one-stop shopping.” Michelle Celarier
