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Nothing but Net

As he beams proudly over his VirtualBank, Rory A. Brown seems to scatter the long shadows of failed e-businesses that got it wrong where his dot-com is getting it right. Only a year old, VirtualBank already has $300 million in assets -- growth that dwarfs that of stodgy, traditional bank startups. Even better, Brown expects VirtualBank to be profitable in the first quarter. Money magazine, Brown says to make his case, named VirtualBank the best online bank. "It's working brilliantly,'' Brown enthuses.

Listen to Brown long enough, and you begin to believe that VirtualBank validated the dot-com model. And who better to head a well-conceived online thrift than an internet CEO-type like Brown, a casually confident 38-year-old California native -- sockless, open-collared, with tousled hair and suntanned face, fresh from his Mercedes convertible.

But Brown, like many a dot-com CEO looking to survive the e-shakeout, has taken a giant step out of the virtual world to incorporate a brick-and-mortar component into his business operations. Is Brown's company still the pure internet creation of only a year ago? No. Was the company's evolution planned all along? Brown says so. Will it work? Maybe.

In any event, VirtualBank has had to adapt in the cold, forbidding place that cyberspace proved to be for many of VirtualBank's Florida kin. Sunrise-based Mortgage.com and its 600-plus workers were going to revolutionize how people got mortgages. It failed. So did a competitor with similar ideas, Onloan.com in Fort Lauderdale. Thud.

BancoInternet in Miami was going to capitalize on a Hispanic audience. Its bank never opened. Two other Florida online banks, G&L Bank in Pensacola and Marketplace Bank in Maitland, aren't profitable. Fizzle. A third, Net 1st National Bank in Boca Raton, has an Office of the Comptroller of the Currency consent order filed against it that reads like a regulatory scourging. Ouch.

"Net banking has not delivered on its promises," says Miami banking consultant Ken Thomas.

To say the least.

Promises, promises
Undelivered Promise No. 1: Since they don't need costly real estate and buildings for branches, online banks were supposed to be able to operate cheaper. Unfortunately, programmers demand higher salaries -- big surprise -- than branch tellers. So much for the cost advantage.

Undelivered Promise No. 2: With lower operating costs, internet banks can offer better deposit rates. It turns out that as a group, they don't, says a study of six pure internet banks published by the Federal Reserve Bank of Chicago earlier this year. (The study didn't include VirtualBank.)

Undelivered Promise No. 3: The better rates would fuel fast growth. Indeed, online banks, whose market areas have no geographic limits, do grow faster than Old Economy startup banks. But profits don't track growth. Pure online banks have low or no profits, says study author and senior economist Robert DeYoung. Long-term prospects for pure internet banks? Too soon to tell, says DeYoung.

Others, however, smell dot-bombs in the aroma of fast growth and low/no profits. The internet will complement -- not replace -- face-to-face contact, says Deborah Beylus, a senior analyst with Sterling Financial Investment Group in Boca Raton. "The pure-play internet banks are missing the other piece of the puzzle," she says. Consultant Thomas agrees: "People want the personal touch."

Touch? Brown says he has touch covered. Each customer gets an assigned representative with whom to deal when calling in. The bank tests prospective employees for a service mentality before hiring.

Profits? Brown has that figured too. Forget the internet as a tool for the masses. Let Washington Mutual toil for the hoi polloi and their unprofitable $100 account balances. VirtualBank has been jacking up its account minimums so it deals only with profitable customers.

As a strategy, it has promise -- albeit one not lost on traditional banks. While VirtualBank has standout technology -- "the sharpest I've seen," says Steve Wicker, a senior research analyst at META Group in Stamford, Conn. -- it will have to prove it can win those profitable customers all banks seek. "If they can find a way to get them, they've discovered the pot of gold at the end of the rainbow," Wicker says. "It's going to be difficult. The customers who have a lot of funds are going to be those treated the best and coddled the most by other institutions. They have a huge obstacle."

Still, says Robert Sterling, an analyst with research firm Jupiter Media Metrix, which has VirtualBank as a client, VirtualBank doesn't need to capture the lion's share of the market to be successful. Indeed, most people may not want a pure internet bank, Sterling says, "but the fact of the matter is, they don't need most people. There are 10,000 FDIC-insured banks." VirtualBank just needs to get "some of the pie," Sterling says.

Experience and money
Profit-wringing is something Brown and VirtualBank's other founders mastered at West Palm Beach's Ocwen Financial, a company that made its mark buying delinquent loans and employing a profit-maximizing model to decide when to foreclose ["Yearning for the Bad Old Days," November 1998].

Brown, a San Diego native who played linebacker at Humboldt State University in California, joined Ocwen as its eighth employee in 1988. He left in 1996 as a managing director after Ocwen's IPO boosted the value of his stock to approximately $11 million."

In the next few years, Brown and fellow Ocwen veterans Stephen Wilhoit and Trevor Rozowsky, along with Bill Decker, the former chief executive of Enterprise Bank in Palm Beach Gardens, worked out a plan for an internet bank. They set out to raise $15 million while the internet bubble was bulging. John Studdard, VirtualBank's chief technology officer, remembers a call from Decker, who told him, "We already have $21 million, and there's no end in sight."

The virtual doors opened shortly thereafter in April 2000. Investors, who have put up about $50 million, include DaimlerChrysler, GE Capital, retired Miami Dolphins quarterback Dan Marino and Bernie Ebbers, one of WorldCom's founders.

The thrift they invested in aimed for an unequaled technology platform to service high net worth, tech-savvy customers -- like those at tech firms. To reach them, VirtualBank has a deal with EMC Corp., WorldCom, Textron and Compaq to co-brand websites where employees can bank. All told, VirtualBank, when mature, will deliver an above-industry-average return-on-equity in the low 20s, Brown says.

Wealth management
But the dot-com world the investors bought into has imploded. Brown says there are no plans for a VirtualBank IPO. And this year, VirtualBank began treading a path forged by other dot-coms that found the going tough in cyberspace. For one, VirtualBank plans to sell the use of its platform to a major financial institution -- perhaps a brokerage -- to boost VirtualBank's return on the cost of developing it. And VirtualBank has taken the first step of what promises to be a large-scale shift into the brick-and-mortar world. In January, it acquired CMS Financial Services, a Rockville, Md., wealth-management firm with $4 billion in assets under management.

CMS targets customers with at least $2 million to invest. Fee-based, it receives no commissions on selling products and has no in-house investments to steer clients into. VirtualBank wants to take on the likes of Northern Trust Bank and Bessemer Trust for the loyalties and fees of the rich with "next generation wealth management" and "private banking for the wired world."

Brown says the wealth- management business was planned all along and didn't amount to mere casting about for a future. But with VirtualBank projecting 300 wealth-management offices someday, VirtualBank's corporate future starts to look more and more like that of a brick-and-mortar wealth-management business supported by great technology and, oh by the way, an internet bank.

As Brown speaks, workers a floor below finish out a new headquarters for the 105-employee company. Behind the scenes, the new headquarters is pure dot-com chic -- black-fixture halogen lights and black flooring made from recycled tires. But that's all hidden behind opaque etched glass windows. The only thing any CD-toting seniors who wander in will see is a confidence-building marble-tiled lobby with dark cherry trim on their way to three teller "offices" with traditional decor.

It's a smart design. Brown insists the VirtualBank plan will prove to be smart too. "The reason it's going to work is because people don't want to go to the bank," he says. "They're a dinosaur. People want to get in and out.

Everybody hates their bank. ATM cards took 30 years to be accepted. You talk to your parents, they probably still don't even use an ATM card. In a decade, that would be a good time to look back and see it worked."