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Online Finance Hits Its Stride


The scene at E*Trade Financial's (ET) Manhattan office in January seemed like pure 1999. Shiny blond wood, staffers in black, and E*Trade execs introducing each other by titles such as "missionary"--all at a catered, open-bar press conference to unveil new TV spots. But something was different. Monitors around the room played a video loop of the company's products: checking accounts, savings, and mortgages. Only later did you get hints of the fire-your-broker ethos that once made E*Trade the epitome of online stock trading. "Brokerage was the emotional arm," said CEO Christos M. Cotsakos. "Banking is the rational arm."

A funny thing happened while everyone was laughing at the dot-com implosion: E-finance grew up and got real. Since the Nasdaq bust began two years ago, Net finance businesses have exchanged glitz for substance. Instead of trying to persuade people to chuck their day jobs and become stock traders, E*Trade and its rivals are focusing on the mundane transactions Americans do every day. The new growth sectors of online finance involve paying bills, managing bank accounts, figuring taxes, and taking out mortgages.

And it's working. Tens of millions of people now use the Net for financial transactions, and their ranks are swelling. Last year, 15 million Americans paid bills online--up 60% from the year before. Almost 15% of Americans who prepared their own tax return through Mar. 22 filed with the Internal Revenue Service online. And Americans took out at least $160 billion in mortgages online in 2001, 8% of the total market. "I don't know that there's a single more viable use of the Internet than financial services," says Mark Zandi, chief economist at Economy.com Inc.

What's more, this generation of e-finance outfits is making money. For the first time, more than half of the 21 public e-finance companies turned a profit in the first quarter under generally accepted accounting principles, if Wall Street estimates hold up. That's up from nine in the fourth quarter of 2001 and is expected to rise to 14 companies by yearend. Those now profitable include lender E-Loan (EELN), mortgage provider IndyMac Bancorp (NDE), financial software developer Intuit (INTU), and online bank Netbank (NTBK).

To be sure, certain sectors of e-finance are still struggling. The brokerage business adapted to the Internet faster than any other arm of finance, with Net brokers grabbing 45% of the New York Stock Exchange and Nasdaq trades by early 2000. But with the stock market crash and with day traders counting their losses, that share is down to 22%. Few analysts expect it to return to its peak anytime soon, and the result is consolidation. Several small players, including WebStreet, sold out in recent months. And on Apr. 8, Ameritrade Holding Corp. (AMTD) said it would buy Datek Online Holdings Corp. for $1.3 billion, becoming the largest Net broker in the country measured by trades per day.

Even those sectors of e-finance that are growing face challenges ahead. Net mortgages will see slower demand as interest rates stabilize or even rise. The Mortgage Bankers Assn. predicts the volume of mortgages will drop 29% in 2002 from the record $2 trillion last year. And online bill payments and Net banking will need continued backing from the large corporations promoting them to keep growing. The downturn for Net brokers underscores how cyclical some finance sectors can be.

Why are so many e-finance services taking off now? For starters, finance is better suited to the capabilities of the Internet than, say, retail. It deals in information, not goods. Companies don't have the cost of shipping books, dog food, or sofas around the country. And buyers don't have to test to see whether a bank account is comfortable--unlike with a mattress or a pair of shoes. "There's nothing a customer has to see or feel," says analyst Michael Hodes of Goldman, Sachs & Co.

More important, e-finance companies have used smarter tactics during the past year and have been blessed by favorable markets. Consider online mortgages. A flowering of innovation and a refinancing boom prompted by tumbling interest rates helped boost online loan volume to more than $160 billion in 2001--up to 10 times as much as the year before. About $25 billion of that came from dot-com lenders, but far more came from big boys such as Countrywide Credit Industries Inc.

The dot-com leader is LendingTree Inc. (TREE) in Charlotte, N.C. Users of its online marketplace effectively apply to as many as four of the 150 lenders in LendingTree's network, which compete with one another for the business. LendingTree gets referral fees for each lead and commissions averaging $450 on loans that close. Last year, LendingTree helped lenders land $8 billion in mortgages and $4 billion in other loans. "It was real convenient, [and] they saved me a couple of hundred a month," says George Mendros, who refinanced his Taunton (Mass.) house through LendingTree.

Numbers like LendingTree's pale beside the market power of huge banks. Take Countrywide (CCR) and Washington Mutual Inc. (WM), two of the nation's top five mortgage lenders. At midyear, Washington Mutual made its brokers and sales staff begin using the Web to process applications. Result: $60 billion in online volume by December. Countrywide says it did $13 billion in e-commerce loans in the first two months of 2002--about 90% of its broker-originated business and 47% of its total. "We'll be north of $100 billion this year," says Craig S. Davis, president of Washington Mutual's mortgage unit.

Bigger lenders have managed to tailor Net mortgages even to customers who don't like the Net. Instead of applying online, most IndyMac customers go to a broker--who applies online for them. Then Web software tracks documents, pulls credit reports, and figures out the interest rate needed to match a borrower's credit record, spitting out price decisions in minutes. Technology also lets IndyMac beat average mortgage rates by 0.25% or 0.375%--up to $50 a month on a $200,000 mortgage. Why? By automating many things that had been done manually in the past, it has pushed its processing costs to 55% to 60% below the industry average. "People can copy the look and feel of our Web site," says IndyMac CEO Michael W. Perry. "But what's difficult to copy is what's underneath the Web site."

While innovation helped boost Net mortgages, it may have saved online bill payment from extinction. In the past, startup bill-consolidation firms, banks, and portals tried to persuade consumers to pay $5 to $13 a month to pay their bills online--and got few takers. But credit-card companies and other billers wanted online billing to grow because it saves them processing costs. So billers started offering it to customers free of charge. From 15 million last year, the number of Americans who pay bills online is expected to hit 26 million this year and 46 million by 2005, according to researcher Gartner Group Inc. "We knew we had to build it," says Colleen Zambole, vice-president for e-commerce at Discover Financial Services Inc. "They [the startups] had a business model that didn't make sense."

The model for billers certainly does. Gartner analyst Avivah Litan says the 100-plus major billers she surveyed spent an average of $1.1 million on their Web payment-processing systems. A company can recoup that money in a year by getting 200,000 customers to pay their monthly bills online--and the cost savings continue year after year.

Paying taxes online is getting a similar push from the IRS. The agency saves about $1 for each return filed online, and it's under congressional mandate to see that 80% of returns are filed electronically by 2007. The agency has proposed giving e-filers two extra weeks to get their returns in. Consumers don't fare too badly, either: The $33 tab for most online tax returns from Intuit's TurboTax for the Web is a third of the average bill from pros who use similar software. The result: The IRS thinks 8.5 million people will e-file this year, up from 6.7 million last year.

Online banking is more of a middling success. While the number of people looking at their checking or savings account information rose 33% last year, to 16 million, according to the newsletter Online Banking Report, it's just beginning to make money for banks. The payoff for customers is more convenience than cash--since they usually don't get any discounts on service charges.

The big impact on the industry: The Web makes customers much more loyal to their banks. A study by Boston Consulting Group (BCG) says online patrons switch banks 40% less often than other customers---because they invest time in understanding the service and configure their accounts to do things like automatically send out monthly car loan payments. Says Chicago video-game reviewer Michael McGehee: "It makes the decision to switch banks more complicated. The online service at Bank One is pretty good."

E-finance has turned the corner. It has tens of millions of customers now, not three years from now--which was the sort of vague promise Web companies once used. Certain sectors, such as mortgages, will suffer cyclical declines as the volume of business slides. But taxes and bills know no bear markets. By Timothy J. Mullaney in New York, with Darnell Little in Chicago


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