Three banks have closed in the US this year. The most
significant casualty has been NetBank, an online-only bank that
diversified quickly into mortgages and became over-exposed to the
subprime segment. Troubles mounting in the US mortgage industry may
claim more banks before the crisis is past, reports Charles

The spectacular failure of US internet banking pioneer NetBank,
followed closely by the collapse of an Ohio bank after regulators
cited asset deterioration, namely subprime mortgages, ensures that
the national conversation over mortgage lending will not abate any
time soon.

The closure of Miami Valley Bank of Lakeview, Ohio, marked just the
third bank this year – but the second in seven days – to fail in
the US. Regulators closed the bank on 4 October citing “unsafe and
unsound conditions”. The Federal Deposit Insurance Corporation
(FDIC) was named receiver for the $86.7 million-asset bank;
Citizens Banking Company of Sandusky assumed its $62 million of
insured deposits at a 2 percent premium.

Both failures were linked at least in part to subprime mortgages.
Miami Valley held on its books roughly $30 million of subprime
loans, much of which had deteriorated in recent months as problems
mounted in the subprime sector, the FDIC said.

Violating lending limits

Federal regulators cited the Ohio bank’s mortgage operation earlier
this year for violating lending limits in the Federal Reserve Act
meant to limit transactions between banks and affiliates. The order
said the bank operated “in such a manner as to produce an
inadequate level of capital protection for the kind and quality of
assets held” and had engaged in “hazardous lending and lax
collection practices, including the failure to provide adequate
limits on the volume and quality of loans acquired through the
bank’s mortgage bankers”.

The $2.5 billion-asset NetBank received even more attention, as it
marked the largest US bank failure since 1993. NetBank was closed
on 28 September by the Office of Thrift Supervision, which found
early payment defaults on loans sold, weak underwriting, poor
documentation, lack of proper controls and failed business

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The NetBank collapse came a little over a week after NetBank’s plan
to sell itself to EverBank Financial fell through. NetBank’s parent
company then filed for protection in the US Bankruptcy Court in
Florida, listing assets of $87.2 million and debts totalling $42.4
million. Federal law, however, prohibited it from filing for
bankruptcy protection from creditors – chartered banks cannot be
reorganised and instead must be liquidated by the deposit insurance

NetBank was one of the high-flying brands of the dotcom glory
years. The online bank was founded in 1996 and went public in 1997.
The bank had 286,000 customers and $4.8 billion in assets at its
peak in 2005, but was caught from behind as national and regional
banks countered with online banking services of their own.

The decline of the Georgia-based institution can be traced to a
2005 expansion of its online mortgage unit. But a bid to increase
its mortgage lending resulted in relaxed underwriting in two newly
purchased subsidiaries, leading to a spike in troubled mortgage

Fire-sale price

As part of the takeover by the government agency, Dutch financial
services giant ING announced it would assume $1.4 billion of the
failed unit’s deposits and 104,000 of its customers, while EverBank
eventually agreed to acquire $700 million of NetBank’s mortgage
assets. That fire-sale price amounts to about one cent per dollar
of deposits for ING’s ING Direct subsidiary – another, albeit much
bigger, internet player in the US.

ING Direct remains one of the largest internet-only banks in the
country, with 6 million customers. EverBank, a mostly online bank
based in Florida, is also doing well financially, so the NetBank
collapse is far from a death knell for the online model. In
mid-September, EverBank announced earnings of over $17 million for
the first half of 2007, an 11 percent growth rate from the first
half of 2006. EverBank’s assets grew to more than $4.7 billion – a
20 percent increase over the same period last year.

“ING Direct has a passionate focus on delivering a first-rate,
technology-enhanced customer experience and we want to ensure the
early adopters remain at the forefront of branch-free online
banking,” said Arkadi Kuhlmann, CEO of ING Direct, in a statement
announcing the acquisition.

“The acquisition of NetBank’s customer relationships is part of ING
Direct’s goal to broaden its reach and inspire Americans to become
a nation of savers. We anticipate a seamless transition for
NetBank’s customers into the ING Direct family.”

FDIC chairman Sheila Bair reported that since 1934, “not a single
depositor has lost a penny of insured deposits. Customers of
NetBank should have confidence and security knowing that they will
have access to their insured funds in a timely and orderly

The ills facing troubled institutions

Bank failures have been rare in recent years, as regulators have
worked to resolve the ills facing troubled institutions, but the
troubles mounting in the mortgage industry may claim more banks
before the crisis is past.

Jaret Seiberg, an analyst with Stanford Washington Research Group,
wrote in a research note that while in recent years bank managers
“had to try real hard to cause a bank to fail”, that era might be
coming to an end. “We do not expect a wave of failures. Yet as the
NetBank failure demonstrates, banks today have much less margin to
recover from mistakes,” Seiberg wrote. “In our view, it means
regulators will keep a short leash on banks that are in financial

Moreover, the subprime crisis in the US continues to claim victim
after victim, keeping the issue very much in the forefront of
industry jitters and congressional finger-pointing.

The online brokerage firm E*Trade Financial has indicated that it
has been badly affected by the mortgage market crisis and sharply
lowered its full-year forecast. E*Trade said its 2007 earnings
would be 31 percent below its previously issued forecast as a
result of increased provisions for loan losses and potential
declines in the value of some securities. It also said it intended
to exit the wholesale mortgage business (see RBI 579).

Swiss investment bank UBS said it would take a $3.4 billion hit in
the third quarter due to problems stemming from the mortgage
crisis. On 15 October, Citi reported 2007 third-quarter net income
of $2.38 billion, down 57 percent from a year earlier.