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The Green Sheet Online Edition

October 22, 2007 • Issue 07:10:02

NetBank bubble bursts over mortgage loans

NetBank is now but a memory, a mere postscript to the "Internet bubble." However, NetBank's demise was due to mortgage lending practices, not the Internet.

The failure itself shouldn't matter much to the acquiring community. But the implication is that mortgage loans and equity lines, considered by many to be the largest funding source for small businesses in recent years, may be in jeopardy.

NetBank, which had maintained offices in Alpharetta, Ga., and reported assets of $2.5 billion in June 2007, represents the largest bank failure in the last 14 years, when the so-called savings and loan crisis ended.

A branchless bank that only did business over the Web, NetBank was closed by the Office of Thrift Supervision (OTS) on Sept. 28, and the Federal Deposit Insurance Corp. (FDIC) was appointed receiver. The FDIC then transferred the bulk of NetBank's deposits to ING Bank FSB, an Internet bank owned by a U.S. subsidiary of the Dutch banking group ING Groep NV.

Regulators said NetBank had been on their radar for at least a year. "NetBank sustained significant losses in 2006 primarily due to early payment defaults on loans sold, weak underwriting, poor documentation, a lack of proper controls and failed business strategies," according to an OTS statement.

An agency of the U.S. Treasury Department, OTS regulates the nation's thrift industry, which consists of federally insured financial institutions that specialize in mortgage lending.

Although NetBank did business exclusively via the Internet, it was chartered as a thrift institution, and its loan portfolio was chock full of mortgage instruments. The bank had tried to sell off its nonperforming assets, but ran out of time.

"[I]t became clear that high operating expenses combined with continuing losses were jeopardizing the institution's viability," OTS stated.

When a financial institution is shut down by regulators, customers with deposit accounts totaling $100,000 or less are made whole. In the case of NetBank, this was accomplished through the transfer of accounts to ING; everyone with accounts at NetBank on Sept. 28 woke up the next day as ING Bank account holders.

NetBank customers with deposits exceeding $100,000 received 50% of the amounts over $100,000, which was immediately accessible through accounts at ING, the FDIC said. Unfortunately, they'll need to line up behind other creditors in bankruptcy court if they want a shot at the rest of their money.

There were about 1,500 accounts at NetBank with uninsured deposits totaling $109 million when the bank was shuttered, according to the FDIC. For ISOs and merchant level salespeople (MLSs) NetBank's closing has not been disruptive.

"The sky might be falling for NetBank employees and management, but I don't think [that is true] for ISOs or MLSs," Michael Nardy, Chief Executive Officer, Electronic Payments Inc., wrote in a recent exchange about the issue on GS Online's MLS Forum.

Jared Isaacman, CEO, United Bank Card Inc., agreed. "Most processors and ISOs/MSPs are sponsored by strong and very financially stable banks," he noted. "The concern is usually not the bank failing. ... It's usually the ISO/MSP or processor going out of business that can threaten an ISO or MLS's residuals."

However, the failure of NetBank appears to be symptomatic of deteriorating economic conditions and should be heeded as a warning sign by the feet on the street. end of article

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