Bankers, Watch Your Backs

Mitchell Caplan, CEO of E-Trade Bank, may be one of the busiest bankers in America, and he`s quickly becoming one of the most feared. When the former Telebanc Financial Corp. was acquired by E-Trade Group in January 2000, it had $5 billion in assets, $2.6 billion in deposits, and about 130,000 customers. By April 2001, less than 15 months later, the bank`s assets had ballooned to nearly $12 billion, while deposits soared to $6.8 billion. Total accounts: 405,000.

Favorable rates explain part of the growth. On a recent June day, the bank`s FDIC-insured money market account, with check-writing privileges, offered a return of 3.75% for a minimum deposit of $1,000, compared to a national average of 1.80%. More important has been the aggressive cross-selling of E-Trade`s three million-plus brokerage clients. About 50% of all new banking customers since the merger have come from the brokerage side. “E-Trade`s been as successful as anyone in cross-selling retail financial products,” says Octavio Marenzi, president of Celent Communications in Cambridge, Massachusetts.

Thanks to the bank and some other initiatives, E-Trade Group has diversified its revenues and built deeper relationships with customers, all in time to help blunt the impact of a steep decline in trading revenues. In the first quarter, the company earned $868,000, even as many brokerage competitors experienced losses. Fully 21% of E-Trade`s total revenues came from the bank.

Christine Barry, an analyst with Meridien Research, says E-Trade is exhibit A in the industry`s march toward convergence. Over the past year, the Menlo Park, California-based holding company added a nationwide network of physical touchpoints with its purchase of Card Capture Services, the nation`s third-largest ATM network, and cut a deal to place those ATMs in all Target stores. It also acquired an in-house asset-generating capability with the purchase of online loan originator LoansDirect.com, opened the first in what`s expected to be a series of physical branches in Manhattan, and expanded its reach into the mutual fund and advice businesses. Coming soon: insurance.

“Whether you`re a traditional bank or a pure online brokerage firm, you really need to provide all types of services via different distribution channels,” Barry says. “E-Trade`s well on its way to doing that.”

The bottom line: An increasingly ubiquitous, potentially powerful force in financial services. As Caplan boldly asserted last year, the goal is nothing less than to be “the dominant blue-chip financial services company for the 21st century.”

Is it merely bluster? Perhaps. Diversification hasn`t kept E-Trade`s stock from skidding, and some observers assert that Caplan`s deposit growth is rooted in flighty savings accounts that don`t produce the solid relationships banks need to thrive. “E-Trade Bank is simply another investment vehicle for E-Trade brokerage customers,” says NetBank CEO D.R. Grimes. “It doesn`t have a lot to do with banking.” Caplan says that`s fine with him, as long as customer money stays in the E-Trade family.

A lawyer by training, the 44-year-old took the helm of Telebanc in 1993, before the Internet took off. Today, he`s not only running the largest pure-play Internet bank, earlier this year he was named E-Trade`s managing director of North America and chief wealth management officeru00e2u20ac”a title that puts him in control of the company`s efforts to forge proprietary mutual funds and advice capabilities for customers.

His job responsibilities mean that Caplan is rarely grounded in his Arlington, Virginia office. But that doesn`t make him any less outspoken on what`s going on in the industry, and at E-Trade. Bank Director recently caught up with him in France. Here`s what he had to say.

Bank Director: What`s it like running a diversified online bank in this environment?

Mitchell Caplan:

It`s phenomenally challenging and incredibly exciting to be a part of an industry that you see changing so rapidly. When we started Telebanc 11 years ago, we had this vision that the world was clearly ripe for some sort of change. Our simple philosophy was to buy a small bank with a very few branches, shut them down as quickly as possible to lower the cost structure, and pass back the value. Little did we know that during our period of building around this model, you would have the emergence of the Internet; that it would evolve in ways that allowed you to create much better value.

What was the rationale behind the merger with E-Trade?

At its core, I believed that we would have a much easier time penetrating, responding, and converting a base of customers if we had an integrated financial product between bank and brokerage, as opposed to being a standalone. Inherent in both E-Trade`s strategy and Telebanc`s was a belief that it was all about empowering customers through value. The cultures were very similar in terms of the creativity, the lack of bureaucracy, the desire to be part of a company that was helping to change an industry. It was a situation where one plus one could equal five, not two.

Has the merger lived up to those expectations?

Well, if I said “No” it would be pretty depressing, since I`m the one who`s in charge of making it happen. A couple of years ago, people would have said that we could grow 100% a year or more in any of our metricsu00e2u20ac”assets, deposits, accountsu00e2u20ac”for a while, but as we got bigger, that growth rate would slow. E-Trade, meanwhile, has pumped hundreds of millions of dollars in capital into the business, and it has a very strong brand. So we`ve been able to continue growing off a bigger base.

From the broader E-Trade perspective, the same is true. We`ve been able to penetrate a very successful base of brokerage customers and bring them online to banking. From my perspective in running E-Trade North America, I want to keep money in the E-Trade family. We`re getting a greater share of wallet, a deeper relationship. And frankly, it`s a natural hedge. During the last couple quarters, when trading volumes have been down and the market has been slower, that`s OK, because you see huge growth in banking. When the market gets hot again, you will see some funds flow out of banking because people will want to get back into the stock market, and it will move to the brokerage side. That`s OK, too.

What in your experience with E-Trade would surprise the average banker the most?

The sheer growth. People think E-Trade is still an online broker. They don`t realize just how successful we`ve been, and how aggressively we intend to attack the opportunities in front of us.

How would you describe E-Trade`s overall strategy?

We`re driven as a culture to succeed and be number one, and we have a very long-term view of this. Unlike some other Internet companies, our view has always been to grow revenues, be profitable, and build a franchise for the future. This isn`t a quick hit for the short term. We`re extremely focused on building long-term core value for our customers, our shareholders, and our associates.

At the end of the day, our goal is to be the dominant online diversified financial services company.

Those are pretty big aspirations. How do you back them up?

If you look at what we`ve already done, we`re moving rapidly and gaining market share in the online investing segment. We`re by far the largest Internet bank. And then look at the other acquisitions we`ve done. We`ve bought the third-largest ATM network in the country. Then you move to LoansDirect, which through acquisition and branding has become the largest Internet mortgage company. So we really are in a position where, as we continue to do acquisitions, we constantly put ourselves in the number one, two, or three position, striving to be number one.

You recently were named head of wealth management at E-Trade. What does that involve?

Our product groups are bank, brokerage, and wealth management. Wealth management is centered on our growing base of affluent customers. Mutual funds are a great example. We also have a business unit called personal money management, which allows anyone with a $100,000 minimum to have a professional money manager. We have another product based around stock baskets, which allows you to create your own mutual fund. You buy when you want, sell when you want. But it`s dollar denominated, not share denominated, so you`re not hit with the tax implications that you would have if it were a mutual fund.

The most exciting thing is that we`ve developed the ability to give advice, which is crucial to selling these products. It`s all about teaching people to take control and giving them advice: “What are your financial goals? What are you trying to accomplish?” and, in the process of doing that, “What are the products and services that we can make available to help you achieve those goals?”

That kind of thing has some people viewing E-Trade as an early convergence play. What does your strategy say about where you think financial services is heading? Do customers want one-stop shopping?

Customers want a place to aggregate their financial information. That doesn`t necessarily mean they want one-stop shopping. The concept of one-stop shopping has never been successful offline, and it`s questionable as to whether it ever will be successful online.

But you can make things more interesting online by offering a host of products and services, some of which are yours, some of which come from a best-of-breed provider. The key is allowing for an integrated experience, so that all of a customer`s information can be kept and gathered in one place. Then you can use that information to provide a host of resources for that customer, whether it`s analysis and financial advice or tax planning or estate planning.

How does operating in an online environment differentiate E-Trade from other banks?

What we`ve seen is that, in many respects, smaller banks can still offer all these products, emphasizing service over price. As you move to larger banks, there`s also a definite Internet banking strategy that can be successful. The banks in the middle are the ones that are having the toughest time in terms of what they should offer to their customers, what they should or shouldn`t invest in, and how to make it all work.

One of the key differentiators between E-Trade and a traditional bank, no matter the size, is that most banks view the Internet and Internet-related distribution of products as being nothing more than a service, and they don`t price differentiate. I think people are awake to the fact that their banks often aren`t giving them the service they want. With us, they have the ability to say, “Well, in exchange for not being able to walk into a brick-and-mortar branch with marble and tellers, I can be empowered in a way in which I can get a better value.”

You say that E-Trade doesn`t need branches, but some of the steps you`ve taken seem to indicate that you believe a physical presence is needed. Can you explain?

Without a doubt, everyone at E-Trade realizes that you have to have multiple distribution points and channels for your customers. We will deliver products and services any way our customers want them delivered, as long as it doesn`t require the costs associated with a large brick-and-mortar branch infrastructure.

I`ll give you a great example. We`ve got 10,000 ATMs across the U.S. The cost for us to manage and service those 10,000 ATMs is the same as it is to manage five branches. So if you think about what we can do with 10,000 touchpoints, whether it`s around deposit taking, cash withdrawal, messaging, or other product sales and service… all of that can be done for a fraction of the cost of being committed to brick-and-mortar.

Our strategy will always be around value and empowering the customer. That value can come in the form of rate or cost or return, or customer service, or convenience. Convenience is about how you deliver that integrated experience. What we`ve always said categorically is that we`re willing to look at a blended delivery approach. What we`re not willing to do is look at a pure brick-and-mortar channel in the form of branches. We believe branches undermine the cost equation, so that you can no longer offer value back to the consumer.

But you believe customers want human touchpoints?

Absolutely. They always have.

Before the Internet, Telebanc was phone-based. When all these Internet companies were beginning, and they would say that the Internet was going to revolutionize the distribution of goods and services, they were right. It has. But it`s not standalone. At some point in your relationship with customers, they want human contact. The difference between a traditional bank and us is that I believe human contact can be remote.

People make the argument that unless you have a branch and a teller, you can`t build a core relationship. I think that`s nonsense. How many people do you know today who have long-distance relationshipsu00e2u20ac”with their parents or siblingsu00e2u20ac”and stay connected by speaking over the phone? The contact doesn`t have to be in person, it can be through a call center. You don`t need to have branches on every corner.

You`ve achieved some pretty stunning cross-sell numbers between the bank and the brokerage. Can you talk more about how the two sides work together?

We spent a tremendous amount of money and time building a customer relationship management system. We built it from scratch and it`s totally proprietary. It allows us to maintain a fairly sophisticated database of information on our existing customers. We`re not getting the information about them from anywhere else. It`s simply from information that we`ve gathered.

We use that information to understand how successful we can be at selling them a product, based on propensity modeling. So we can say, “I have customer X on the brokerage side, and based on his demographics and psychographicsu00e2u20ac”the kinds of other products he owns, where those products are, whether they use aggregationu00e2u20ac”I`m going to offer him a CD with 10 extra basis points, or a checking account with some free services.” And we know the likelihood that the customer will respond and convert. By using this information, we`ve been incredibly successful at cross-selling that brokerage customer base into a series of bank products.

Do you consider the use of that information more important than rates?

It`s extraordinarily important. What you`re really talking about is a package. I think rates are important, but the only time they really matter by themselves is if you`re among the top three in the rate surveys, and you`re specifically targeting customers who are particularly interested in the highest rate and don`t have any affinity to the bank. It`s hot money.

So we`ve learned that being in the top three or four doesn`t make sense. The banks that show up on those surveys are the new Internet banks that can`t afford to spend money on marketing or, of late, the credit card banks that are arbitraging the commercial paper market. Their relationships are all on the credit card side, not the deposit side, and it`s cheaper for them to raise money with a CD or a money market account.

Should bankers feel threatened by the numbers you`ve achieved?

I think the better word is “impressed.” We`ve shown how effective and successful you can be if you have the technology and resources to understand who your customers are and what sort of products meet their needs. We market almost one-to-one to them. We have a brand that people know and like, and our cost structure is so much lower than the competition that we can effectively offer a better value product and still produce a high return on equity.

Some people say that most of E-Trade Bank`s accounts are secondary accountsu00e2u20ac”investment money that`s being parkedu00e2u20ac”which is not as powerful as a primary relationship. How do you respond?

That`s a great question. People made that argument when we were Telebanc, too. They said, “It`s a savings account, and you can`t build a core relationship around a savings account.” My view is, nonsense. There are a lot of people who feel they have strong and powerful relationships with a whole series of mutual fund companies. They`re branded relationships that stand for savings opportunities, and they`re very successful. Either way, it`s not relevant, because we`re able to effectively cross-sell a banking customer from a savings product into a transactional checking product, which most of the world still views as the core relationship.

What does what you`re doing at E-Trade Bank say about the role of technology in driving profits and growth?

What it says is that there`s clearly a very large and growing base of customers who recognize and realize the importance of value. As a bank, if you don`t recognize that, you are ultimately at risk of losing your customers.

If you want to deliver value in the way I believe value needs to be deliveredu00e2u20ac”a combination of rates, convenience, and customer serviceu00e2u20ac”you`ve got to use technology, because you`ve got to keep your costs lower. And technology is also at the core of understanding who your customers are through your database, and what sorts of products and services they need.

So you think technology has revolutionized the way bankers do their business?

Absolutely. But what`s interesting is that a lot of bankers don`t quite see that or understand it yet.

In my mind, the traditional brokerage piece grew faster and quicker because it was a more inherently interesting productu00e2u20ac”it was sexier and more exciting. Let`s face it: Banking is still, at its core, a little bit like a root canal. And no matter how fast or successful or interesting or integrated you make it, it`s still banking. Most people view it as a necessary evil. So you need to use technology to make it easier and simpler and more empowering for the consumer.

A lot of traditional banks still view the Internet as just a service offering. They don`t really recognize the value that can be had in differentiating products and pricing. A big part of that is because consumers have been slow to adopt Internet banking. Our adoption rate has been not only fast, but extraordinary, because it`s been integrated with brokerage and a whole host of other services and products.

The LoansDirect acquisition gave you some asset-generating capabilities. What`s the bank`s asset strategy?

For years we`ve wanted to generate our own assets. We`ve been growing our assets at 100% a year, and we didn`t want to take any credit risk. So we focused our assets entirely on generic asset classes, like residential mortgages, first-lien positions, and even more conservatively on those bought in the secondary market.

Our asset size is big enough now. We can continue our aggressive deposit growth and replace some of our other borrowings with deposits. On the asset side, we can look at building platforms to originate a host of asset classes that will significantly widen our spreads.

So would you anticipate, for instance, moving into areas like subprime lending?

No. You`ll see us look at other asset classes, not move down the credit spectrum. I don`t believe in moving down the credit spectrum. What I do believe in is this: If we have a relationship with a customer and we understand that customer and he or she has great credit, then we should be making that customer a mortgage loan, a home equity loan, a credit card loan, etc.

Despite the bank`s success, E-Trade Group`s stock has suffered in the recent market turbulence. Do you think you`re creating something that will better weather that kind of turmoil in the future?

If you look at the last few quarters, we`ve broken even in a marketplace where trading volumes and revenues are down, and it`s all because of our diversified revenue streams. Banking and brokerage are complementary. The bank is now generating 60% of the company`s interest income. Two years ago, 90% of E-Trade`s revenues were entirely trading-related. Today it`s down to below 40%. So I not only think it will work, I know it will work, because it`s already working.

The stock price hasn`t performed the way that some people have wanted it to perform. But neither has anyone else`s in this space. So when you`re in both financial services and the Internet, it`s a wait-and-see game. The vision is really about building a franchise for the long term, rather than looking for a short-term response.

What role does your board play?

We have both the E-Trade Group board and our own six-member

E-Trade Bank board, which holds monthly meetings and is integrally involved. [The bank board includes Caplan and three other E-Trade officers.] Those same directors are also on the board of the intermediary holding company, which owns LoansDirect, E-Trade Access, and E-Trade Global Asset Management.

What sort of issues are they grappling with?

Most bank boards grapple with how to continue to grow. We`re in the exact opposite position. The question for us is, how do you deal with hypergrowth?

Our directors also have to stay abreast of the brokerage business, the mutual fund business, and other wealth management and institutional businesses. And they have to ensure from a regulatory perspective that we`re withholding [capital reserves] and adhering to all the regulatory guidelines, while trying to maximize the value of being part of a larger holding company.

Those sound like problems that a lot of bank boards wouldn`t mind having.

You`re probably right. But it doesn`t mean that you don`t have a lot of concerns about ensuring that the infrastructure is in place, that people are doing what they`re supposed to be doing in terms of running the business and executing the strategy, while also respecting the fact that it`s in a regulated environment.

How would you assess the performance of bank boards today?

Since the savings-and-loan crisis, there`s definitely a greater respect for the regulatory process, which is intended to protect depositors. A lot of bankers realize that even though we`ve gone through an incredible economic boom, at some point we`ll go through a credit cycle. I think most boards have thought through those issues. Those that haven`t will probably face a lot of challenges.

Some people might think that a fast-growing Internet bank doesn`t need to worry about credit cycles.

We are a fast-growing Internet bank. But we also have deposits and borrowings that need to be invested in assets that are safe and secure. At all times, we`re receiving a rational, risk-adjusted yield for the asset class we`ve invested in. That`s no different from any other bank.

How should banks and their boards be positioning themselves for the future?

It`s about understanding. One of the things I love about our board is that the directors are as involved and excited as management is. They recognize that the world of banking has changed, that it`s not the same business it was 20 years ago. The typical workday at E-Trade Bank is about 12 or 13 hours. Having our board understand what`s involved in building on an entrepreneurial vision, yet executing within regulatory guidelines, is crucial to our success.

What keeps you awake at night?

What doesn`t keep me awake at night? I worry more about two guys in a garage with the next brilliant idea than the large institutions that are outfitted with huge bureaucracies, because it`s always about innovation, and then executing on that innovation.

I think about who competes with us, and in what ways they compete with us. For me, it`s a game of time. I`m determined to win, and we have what it takes to win. So it`s not time in the sense of direct competitors. It`s time in terms of adoption and acceptance, and being there with all the right products, services, and experience.

What does the future hold for E-Trade and the bank?

I think it`s pretty limitless. There`s tremendous opportunity, because it`s all in the execution, and we can get better by penetrating a wider group of customers, growing outside the United States, and continuing to expand products and services. The real key is harnessing our enthusiasm and executing against a prioritized group of initiatives to make sure we`re generating the highest return for our shareholders. |BD|